Advanced Accounting, 5th Edition International Student Version Jeter, Chaney Test Bank by Ace Test Banks

Advanced Accounting, 5th Edition International By Jeter, Chaney

Email: richard@qwconsultancy.com

Chapter 1 Introduction to Business Combinations and the Conceptual Framework Multiple Choice 1. Stock given as consideration for a business combination is valued at a. fair market value b. par value c. historical cost d. None of the above 2. Which of the following situations best describes a business combination to be accounted for as a statutory merger? a. Both companies in a combination continue to operate as separate, but related, legal entities. b. Only one of the combining companies survives and the other loses its separate identity. c. Two companies combine to form a new third company, and the original two companies are dissolved. d. One company transfers assets to another company it has created. 3. A firm can use which method of financing for an acquisition structured as either an asset or stock acquisition? a. Cash b. Issuing Debt c. Issuing Stock d. All of the above 4. The objectives of FASB 141R (Business Combinations) and FASB 160 (Noncontrolling Interests in Consolidated Financial Statements) are as follows: a. to improve the relevance, comparability, and transparency of financial information related to business combinations. b. to eliminate the amortization of Goodwill. c. to facilitate the convergence project of the FASB and the International Accounting Standards Board. d. a and b only 5. A business combination in which the boards of directors of the potential combining companies negotiate mutually agreeable terms is a(n) a. agreeable combination. b. friendly combination. c. hostile combination. d. unfriendly combination. 6. A merger between a supplier and a customer is a(n) a. friendly combination. b. horizontal combination. c. unfriendly combination. d. vertical combination. 7. The impairment standard as it relates to goodwill is an example of a a. consumption of benefit approach. b. loss or lack of benefit approach. c. component of other comprehensive income.

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Test Bank to accompany Jeter and Chaney Advanced Accounting d. direct matching of expenses to revenues.

8. The defense tactic that involves purchasing shares held by the would-be acquiring company at a price substantially in excess of their fair value is called a. poison pill. b. pac-man defense. c. greenmail. d. white knight. 9. The third period of business combinations started after World War II and is called a. horizontal integration. b. merger mania. c. operating integration. d. vertical integration. 10. Which of the following is not a component of other comprehensive income under GAAP? a. earnings. b. gains and losses that bypass earnings. c. impairment losses. d. accumulated other comprehensive income. 11. When a new corporation is formed to acquire two or more other corporations and the acquired corporations cease to exist as separate legal entities, the result is a statutory a. acquisition. b. combination. c. consolidation. d. merger. 12. The excess of the amount offered in an acquisition over the prior stock price of the acquired firm is the a. bonus. b. goodwill. c. implied offering price. d. takeover premium. 13. The difference between normal earnings and expected future earnings is a. average earnings. b. excess earnings. c. ordinary earnings. d. target earnings. 14. The first step in estimating goodwill in the excess earnings approach is to a. determine normal earnings. b. identify a normal rate of return for similar firms. c. compute excess earnings. d. estimate expected future earnings. 15. Many of FASB’s recent pronouncements indicate a shift away from historical cost accounting toward a. an elevated status for the Statements of Financial Accounting Concepts. b. convergence of standards. c. fair value accounting. d. representationally faithful reporting.

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16. Estimated goodwill is determined by computing the present value of the a. average earnings. b. excess earnings. c. expected future earnings. d. normal earnings. 17. Which of the following statements would not be a valid or logical reason for entering into a business combination? a. to increase market share. b. to avoid becoming a takeover target. c. to reduce risk by acquiring established product lines. d. the operating costs of the combined entity would be more than the sum of the separate entities. 18. The parent company concept of consolidation represents the view that the primary purpose of consolidated financial statements is: a. to provide information relevant to the controlling stockholders. b. to represent the view that the affiliated companies are a separate, identifiable economic entity. c. to emphasis control of the whole by a single management. d. to include only a portion of the subsidiary’s assets, liabilities, revenues, expenses, gains, and losses. 19. Which of the following statements is correct? a. Total elimination is consistent with the parent company concept. b. Partial elimination is consistent with the economic unit concept. c. Past accounting standards required the total elimination of unrealized intercompany profit in assets acquired from affiliated companies. d. none of these. 20. Under the parent company concept, consolidated net income __________ the consolidated net income under the economic unit concept. a. is the same as b. is higher than c. is lower than d. can be higher or lower than 21. Under the economic unit concept, noncontrolling interest in net assets is treated as a. a liability. b. an asset. c. stockholders' equity. d. an expense. 22. The parent company concept adjusts subsidiary net asset values for the a. differences between cost and fair value. b. differences between cost and book value. c. total fair value implied by the price paid by the parent. d. total cost implied by the price paid by the parent. 23. According to the economic unit concept, the primary purpose of consolidated financial statements is to provide information that is relevant to a. majority stockholders. b. minority stockholders.

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Test Bank to accompany Jeter and Chaney Advanced Accounting c. creditors. d. both majority and minority stockholders.

24. Which of the following statements is correct? a. The economic unit concept suggests partial elimination of unrealized intercompany profits. b. The parent company concept suggests partial elimination of unrealized intercompany profits. c. The economic unit concept suggests no elimination of unrealized intercompany profits. d. The parent company concept suggests total elimination of unrealized intercompany profits. 25. When following the parent company concept in the preparation of consolidated financial statements, noncontrolling interest in combined income is considered a(n) a. prorated share of the combined income. b. addition to combined income to arrive at consolidated net income. c. expense deducted from combined income to arrive at consolidated net income. d. deduction from current assets in the balance sheet. 26. When following the economic unit concept in the preparation of consolidated financial statements, the basis for valuing the noncontrolling interest in net assets is the a. book values of subsidiary assets and liabilities. b. fair values of subsidiary assets and liabilities. c. general price level adjusted values of subsidiary assets and liabilities. d. fair values of parent company assets and liabilities. 27. The view that consolidated financial statements represent those of a single economic entity with several classes of stockholder interest is consistent with the a. parent company concept. b. current practice concept. c. historical cost company concept. d. economic unit concept. 28. The view that the noncontrolling interest in income reflects the noncontrolling stockholders' allocated share of consolidated income is consistent with the a. economic unit concept. b. parent company concept. c. current practice concept. d. historical cost company concept. 29. The view that only the parent company's share of the unrealized intercompany profit recognized by the selling affiliate that remains in assets should be eliminated in the preparation of consolidated financial statements is consistent with the a. economic unit concept. b. current practice concept. c. parent company concept. d. historical cost company concept. Problems 1-1

Hopkins Company is considering the acquisition of Richfield, Inc. To assess the amount it might be willing to pay, Hopkins makes the following computations and assumptions. A. Richfield, Inc. has identifiable assets with a total fair value of $6,000,000 and liabilities of $3,700,000. The assets include office equipment with a fair value approximating book value,

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buildings with a fair value 25% higher than book value, and land with a fair value 50% higher than book value. The remaining lives of the assets are deemed to be approximately equal to those used by Richfield, Inc. B. Richfield, Inc.'s pretax incomes for the years 2011 through 2013 were $470,000, $570,000, and $370,000, respectively. Hopkins believes that an average of these earnings represents a fair estimate of annual earnings for the indefinite future. However, it may need to consider adjustments for the following items included in pretax earnings: Depreciation on Buildings (each year) Depreciation on Equipment (each year) Extraordinary Loss (year 2013) Salary Expense (each year)

380,000 30,000 130,000 170,000

C. The normal rate of return on net assets for the industry is 15%. Required: A. Assume that Hopkins feels that it must earn a 20% return on its investment, and that goodwill is determined by capitalizing excess earnings. Based on these assumptions, calculate a reasonable offering price for Richfield, Inc. Indicate how much of the price consists of goodwill. B. Assume that Hopkins feels that it must earn a 15% return on its investment, but that average excess earnings are to be capitalized for five years only. Based on these assumptions, calculate a reasonable offering price for Richfield, Inc. Indicate how much of the price consists of goodwill.

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Eden Company is trying to decide whether to acquire Bloomington Inc. The following balance sheet for Bloomington Inc. provides information about book values. Estimated market values are also listed, based upon Eden Company's appraisals. Bloomington Inc. Book Values

Bloomington Inc. Market Values

Current Assets Property, Plant & Equipment (net) Total Assets

$ 450,000 1,140,000 $1,590,000

$ 450,000 1,300,000 $1,750,000

Total Liabilities Common Stock, $10 par value Retained Earnings Total Liabilities and Equities

$700,000 280,000 610,000 $1,590,000

$700,000

Eden Company expects that Bloomington will earn approximately $290,000 per year in net income over the next five years. This income is higher than the 14% annual return on tangible assets considered to be the industry "norm." Required: A. Compute an estimation of goodwill based on the information above that Eden might be willing to pay (include in its purchase price), under each of the following additional assumptions: (1) Eden is willing to pay for excess earnings for an expected life of 4 years (undiscounted). (2) Eden is willing to pay for excess earnings for an expected life of 4 years, which should be capitalized at the industry normal rate of return.

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Test Bank to accompany Jeter and Chaney Advanced Accounting (3) Excess earnings are expected to last indefinitely, but Eden demands a higher rate of return of 20% because of the risk involved. Determine the amount of goodwill to be recorded on the books if Eden pays $1,300,000 cash and assumes Bloomington's liabilities.

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Park Company acquired an 80% interest in the common stock of Southdale Company for $1,540,000 on July 1, 2013. Southdale Company's stockholders' equity on that date consisted of: Common stock Other contributed capital Retained earnings

$800,000 400,000 330,000

Required: Compute the total noncontrolling interest to be reported in the consolidated balance sheet assuming the: (1) parent company concept. (2) economic unit concept.

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The following balances were taken from the records of S Company: Common stock (1/1/13 and 12/31/13) Retained earnings 1/1/13 Net income for 2013 Dividends declared in 2013 Retained earnings, 12/31/13 Total stockholders' equity on 12/31/13

$720,000 $160,000 180,000 (40,000) 300,000 $1,020,000

P Company purchased 75% of S Company's common stock on January 1, 2011 for $900,000. The difference between implied value and book value is attributable to assets with a remaining useful life on January 1, 2013 of ten years. Required: A. Compute the difference between cost/(implied) and book value applying: 1. Parent company theory. 2. Economic unit theory. B. Assuming the economic unit theory: 1. Compute noncontrolling interest in consolidated income for 2013. 2. Compute noncontrolling interest in net assets on December 31, 2013. Short Answer 1.

Estimating the value of goodwill to be included in an offering price can be done under several alternative methods. The excess earnings approach is frequently used. Identify the steps used in this approach to estimate goodwill.

The two alternative views of consolidated financial statements are the parent company concept and the economic entity concept. Briefly explain the differences between the concepts.

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Short Answer Questions in Textbook the 'mistakes' with spacing appeared on my printed files, but not here, so I will NOT attempt to make changes 1. Distinguish between internal and external expansion of a firm. 2. List four advantages of a business combination as compared to internal expansion. 3. What is the primary legal constraint on business combinations? Why does such a constraint exist? 4. Business combinations may be classified into three types based upon the relationships among the combining entities (e.g., combinations with suppliers, customers, competitors, etc.). Identify and define these types. 5. Distinguish among a statutory merger, a statutory consolidation, and a stock acquisition. 6. Define a tender offer and describe its use. 7. When stock is exchanged for stock in a business combination, how is the stock exchange ratio generally expressed? 8. Define some defensive measures used by target firms to avoid a takeover. Are these measures beneficial for shareholders? 9. Explain the potential advantages of a stock acquisition over an asset acquisition. 10. Explain the difference between an accretive and a dilutive acquisition. 11. Describe the difference between the economic entity concept and the parent company concept approaches to the reporting of subsidiary assets and liabilities in the consolidated financial statements on the date of the acquisition. 12. Contrast the consolidated effects of the parent company concept and the economic entity con-cept concept in terms of: (a)The treatment of noncontrolling interests. (b)The elimination of intercompany profits. (c)The valuation of subsidiary net assets in the consolidated financial statements. (d)The definition of consolidated net income. 13. Under the economic entity concept, the net as-sets assets of the subsidiary are included in the consolidated financial statements at the total fair value that is implied by the price paid by the parent company for its controlling interest. What practical or conceptual problems do you see in this approach to valuation? 14. Is the economic entity or the parent concept more consistent with the principles addressed in the FASB’s conceptual framework? Explain your answer. 15. How does the FASB’s conceptual framework influence the development of new standards? 16. What is the difference between net income, or earnings, and comprehensive income?

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Test Bank to accompany Jeter and Chaney Advanced Accounting

Business Ethics Questions from the Textbook From 1999 to 2001, Tyco’s revenue grew approximately24% and it acquired over 700 companies. It was widely rumored that Tyco executives aggressively managed the performance of the companies that they acquired by suggesting that before the acquisition, they should accelerate the payment of liabilities, delay recording the collections of revenue, and increase the estimated amounts in reserve accounts. 1. What effect does each of the three items might list the 3 items as A-B-Chave on the reported net income of the acquired company before the acquisition and on the reported net income of the combined company in the first year of the acquisition and future years? 2. What effect does each of the three items have on the cash from operations of the acquired company before the acquisition and on the cash from operations of the combined company in the first year of the acquisition and future years? 3. If you are the manager of the acquired company, how do you respond to these suggestions? 4. Assume that all three items can be managed within the rules provided by GAAP but would be regarded by many as pushing the limits of GAAP.Is there an ethical issue? Describe your position as: (A) an accountant for the target company and (B) as an accountant for Tyco.

Chapter 1 Introduction to Business Combinations and the Conceptual Framework

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ANSWER KEY Multiple Choice 1. 2. 3. 4. 5. 6. 7. 8.

a b d d b d b c

9. 10. 11. 12. 13. 14. 15. 16.

b d c d b b c b

17. d 18. a 19. c 20. a 21. c 22. b 23. d 24. b

25. c 26. b 27. d 28. a 29. c

Problems 1-1 A.

Normal earnings for similar firms = ($6,000,000 - $3,700,000) × 15% = $345,000 Expected earnings of target: Pretax income of Richfield, Inc., 2011 Subtract: Additional depreciation on buildings ($380,000 × .25) Target's adjusted earnings, 2011

$470,000 (95,000) 375,000

Pretax income of Richfield, Inc., 2012 Subtract: Additional depreciation on buildings Target's adjusted earnings, 2012

$570,000 (95,000)

Pretax income of Richfield, Inc., 2013 Add: Extraordinary loss Subtract: Additional depreciation on buildings Target's adjusted earnings, 2013

$370,000 130,000 (95,000)

475,000

405,000

Target's three year total adjusted earnings Target's three year average adjusted earnings

1,255,000 418,333

Excess earnings of target = $418,333 – $345,000 = $73,333 per year $73,333 Present value of excess earnings (perpetuity) at 20%: 20% = $366,665 (Estimated Goodwill) Implied offering price = $6,000,000 - $3,700,000 + $366,665 = 2,666,665. B.

Excess earnings of target (same as in A): $73,333 Present value of excess earnings (ordinary annuity) for five years at 15%; $73,333 × 3.35216 = $245,824 Implied offering price = $6,000,000 - $3,700,000 + $245,824 = $2,545,824.

1-10 Test Bank to accompany Jeter and Chaney Advanced Accounting Note: The salary expense and depreciation on equipment are expected to continue at the same rate, and thus do not necessitate adjustments. 1-2 A.

Normal earnings for similar firms (based on tangible assets only) = $1,750,000 × 14% = $245,000 Excess earnings = $290,000 - 245,000 = $45,000

(1)

Goodwill based on four years excess earnings undiscounted. Goodwill = ($45,000)(4 years) = $180,000

(2)

Goodwill based on four years discounted excess earnings Goodwill = ($45,000)(2.91371) = $131,117 (present value of an annuity factor for n=4, I=14% is 2.91371)

(3)

Goodwill based on a perpetuity Goodwill = ($45,000)/.20 = $225,000

Goodwill = Cost less fair value of net assets Goodwill = ($1,300,000 - ($1,750,000 - $700,000)) = $250,000

1-3 1. Total book value of Southdale's net assets ($800,000 + $400,000 + $330,000) Noncontrolling interest % Noncontrolling interest in net assets

$1,530,000 × .2 $306,000

2. Total fair value of Southdale's net assets ($1,540,000/.8) $1,925,000 Noncontrolling interest % × .2 Noncontrolling interest in net assets $385,000

1-4 A1. Cost of investment Equity acquired .75($720,000 + $160,000) Difference (parent company theory) 2. Implied value of S Company ($900,000/.75) Book value of S Company ($720,000 + $160,000) Difference (economic unit theory)

$900,000 660,000 $240,000 $1,200,000 880,000 $320,000

B1. Noncontrolling interest in consolidated income: .25[$180,000 - ($320,000/10)]

$37,000

2. Noncontrolling interest in net assets: .25[$1,020,000 + (9/10 × $320,000)]

$327,000

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Short Answer 1.

The excess earnings approach to estimating goodwill includes the following steps: a. Identify a normal rate of return for firms similar to the company being targeted, b. Apply the identified rate of return of the level of identifiable assets (or net assets) of the target to approximate what would be normal earnings in this industry, c. Estimate the expected future earnings of the target, d. Subtract the normal earnings from the expected target earnings to compute “excess earnings”, e. Assume an appropriate time period and a discount rate to compute the discounted value of the excess earnings − the estimated goodwill.

Under the parent company concept, the consolidated financial statements reflect the stockholders’ interests in the parent, plus their undivided interests in the net assets of the parent's subsidiaries. The focus is on the interests of the parent's shareholders. Under the economic entity concept, control of the whole by a single management is emphasized. With this concept, consolidated financial statements are intended to provide information about a group of legal entities − a parent company and its subsidiaries − operating as a single unit.

Short Answer Questions from the Textbook Solutions

1. Internal expansion involves a normal increase in business resulting from increased demand for products and services, achieved without acquisition of preexisting firms. Some companies expand internally by undertaking new product research to expand their total market, or by attempting to obtain a greater share of a given market through advertising and other promotional activities. Marketing can also be expanded into new geographical areas. External expansion is the bringing together of two or more firms under common control by acquisition. Referred to as business combinations, these combined operations may be integrated, or each firm may be left to operate intact. 2. Four advantages of business combinations as compared to internal expansion are: (1) Management is provided with an established operating unit with its own experienced personnel, regular suppliers, productive facilities and distribution channels. (2) Expanding by combination does not create new competition. (3) Permits rapid diversification into new markets. (4) Income tax benefits.

3. The primary legal constraint on business combinations is that of possible antitrust suits. The United States government is opposed to the concentration of economic power that may result from business combinations and has enacted two federal statutes, the Sherman Act and the Clayton Act to deal with antitrust problems. 4. (1) A horizontal combination involves companies within the same industry that have previously been competitors. (2) Vertical combinations involve a company and its suppliers and/or customers. (3) Conglomerate combinations involve companies in unrelated industries having little production or market similarities.

1-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 5. A statutory merger results when one company acquires all of the net assets of one or more other companies through an exchange of stock, payment of cash or property, or the issue of debt instruments. The acquiring company remains as the only legal entity, and the acquired company ceases to exist or remains as a separate division of the acquiring company. A statutory consolidation results when a new corporation is formed to acquire two or more corporations, through an exchange of voting stock, with the acquired corporations ceasing to exist as separate legal entities. A stock acquisition occurs when one corporation issues stock or debt or pays cash for all or part of the voting stock of another company. The stock may be acquired through market purchases or through direct purchase from or exchange with individual stockholders of the investee or subsidiary company. 6. A tender offer is an open offer to purchase up to a stated number of shares of a given corporation at a stipulated price per share. The offering price is generally set above the current market price of the shares to offer an additional incentive to the prospective sellers. 7. A stock exchange ratio is generally expressed as the number of shares of the acquiring company that are to be exchanged for each share of the acquired company. 8. Defensive tactics include: (1) Poison pill – when stock rights are issued to existing stockholders that enable them to purchase additional shares at a price below market value, but exercisable only in the event of a potential takeover. This tactic is effective in some cases. (2) Greenmail – when the shares held by a would-be acquiring firm are purchased at an amount substantially in excess of their fair value. The shares are then usually held in treasury. This tactic is generally ineffective. (3) White knight or white squire – when a third firm more acceptable to the target company management is encouraged to acquire or merge with the target firm. (4) Pac-man defense – when the target firm attempts an unfriendly takeover of the would-be acquiring company. (5) Selling the crown jewels – when the target firms sells valuable assets to others to make the firm less attractive to an acquirer. 9. In an asset acquisition, the firm must acquire 100% of the assets of the other firm, while in a stock acquisition, a firm may gain control by purchasing 50% or more of the voting stock. Also, in a stock acquisition, formal negotiations with the target’s management can sometimes be avoided. Further, in a stock acquisition, there might be advantages in keeping the firms as separate legal entities such as for tax purposes. 10. Does the merger increase or decrease expected earnings performance of the acquiring institution? From a financial and shareholder perspective, the price paid for a firm is hard to justify if earnings per share declines. When this happens, the acquisition is considered dilutive. Conversely, if the earnings per share increases as a result of the acquisition, it is referred to as an accretive acquisition. 11. Under the parent company concept, the writeup or writedown of the net assets of the subsidiary in the consolidated financial statements is restricted to the amount by which the cost of the investment is more or less than the book value of the net assets acquired. Noncontrolling interest in net assets is unaffected by such writeups or writedowns. The economic unit concept supports the writeup or writedown of the net assets of the subsidiary by an amount equal to the entire difference between the fair value and the book value of the net assets on the date of acquisition. In this case, noncontrolling interest in consolidated net assets is adjusted for its share of the

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writeup or writedown of the net assets of the subsidiary. 12.

a) Under the parent company concept, noncontrolling interest is considered a liability of the consolidated entity whereas under the economic unit concept, noncontrolling interest is considered a separate equity interest in consolidated net assets. b) The parent company concept supports partial elimination of intercompany profit whereas the economic unit concept supports 100 percent elimination of intercompany profit. c) The parent company concept supports valuation of subsidiary net assets in the consolidated financial statements at book value plus an amount equal to the parent company’s percentage interest in the difference between fair value and book value. The economic unit concept supports valuation of subsidiary net assets in the consolidated financial statements at their fair value on the date of acquisition without regard to the parent company’s percentage ownership interest. d) Under the parent company concept, consolidated net income measures the interest of the shareholders of the parent company in the operating results of the consolidated entity. Under the economic unit concept, consolidated net income measures the operating results of the consolidated entity which is then allocated between the controlling and noncontrolling interests.

13. The implied fair value based on the price may not be relevant or reliable since the price paid is a negotiated price which may be impacted by considerations other than or in addition to the fair value of the net assets of the acquired company. There may be practical difficulties in determining the fair value of the consideration given and in allocating the total implied fair value to specific assets and liabilities.

In the case of a less than wholly owned company, valuation of net assets at implied fair value violates the cost principle of conventional accounting and results in the reporting of subsidiary assets and liabilities using a different valuation procedure than that used to report the assets and liabilities of the parent company. 14. The economic entity is more consistent with the principles addressed in the FASB’s conceptual framework. It is an integral part of the FASB’s conceptual framework and is named specifically in SFAC No. 5 as one of the basic assumptions in accounting. The economic entity assumption views economic activity as being related to a particular unit of accountability, and the standard indicates that a parent and its subsidiaries represent one economic entity even though they may include several legal entities. 15. The FASB’s conceptual framework provides the guidance for new standards. The quality of comparability was very much at stake in FASB’s decision in 2001 to eliminate the pooling of interests method for business combinations. This method was also argued to violate the historical cost principle as it essentially ignored the value of the consideration (stock) issued for the acquisition of another company. The issue of consistency plays a role in the recent proposal to shift from the parent concept to the economic entity concept, as the former method valued a portion (the noncontrolling interest) of a given asset at prior book values and another portion (the controlling interest) of that same asset at exchange-date market value. 16. Comprehensive income is a broader concept, and it includes some gains and losses explicitly stated by FASB to bypass earnings. The examples of such gains that bypass earnings are some changes in market values of investments, some foreign currency translation adjustments and certain gains and losses, related to minimum pension liability. In the absence of gains or losses designated to bypass earnings, earnings and comprehensive income are the same.

1-14 Test Bank to accompany Jeter and Chaney Advanced Accounting

ANSWERS TO BUSINESS ETHICS CASE

1. The third item will lead to the reduction of net income of the acquired company before acquisition, and will increase the reported net income of the combined company subsequent to acquisition. The accelerated payment of liabilities should not have an effect on net income in current or future years, nor should the delaying of the collection of revenues (assuming those revenues have already been recorded). 2. The first two items will decrease cash from operations prior to acquisition and will increase cash from operations subsequent to acquisition. The third item will not affect cash from operations. 3. As the manager of the acquired company I would want to make it clear that my future performance (if I stay on with the consolidated company) should not be evaluated based upon a future decline that is perceived rather than real. Further, I would express a concern that shareholders and other users might view such accounting maneuvers as sketchy. 4. a) Earnings manipulation is unethical behavior no matter which side of the acquirer/acquiree equation you’re on. The rewards that you stand to reap may differ, and thus your risks may vary. But the ethics are essentially the same. Ultimately the company may be one unified whole and the users that are adversely affected by reliance on distorted information may view your participation in an unfavorable light. b) See answer to (a).

Chapter 2 Accounting for Business Combinations Multiple Choice 1.

SFAS 141R requires that all business combinations be accounted for using a. the pooling of interests method. b. the acquisition method. c. either the acquisition or the pooling of interests methods. d. neither the acquisition nor the pooling of interests methods.

Under the acquisition method, if the fair values of identifiable net assets exceed the value implied by the purchase price of the acquired company, the excess should be a. accounted for as goodwill. b. allocated to reduce current and long-lived assets. c. allocated to reduce current assets and classify any remainder as an extraordinary gain. d. allocated to reduce any previously recorded goodwill on the seller’s books and classify any remainder as an ordinary gain.

In a period in which an impairment loss occurs, SFAS No. 142 requires each of the following note disclosures except a. a description of the facts and circumstances leading to the impairment. b. the amount of goodwill by reporting segment. c. the method of determining the fair value of the reporting unit. d. the amounts of any adjustments made to impairment estimates from earlier periods, if significant.

Once a reporting unit is determined to have a fair value below its carrying value, the goodwill impairment loss is computed by comparing the a. fair value of the reporting unit and the fair value of the identifiable net assets. b. carrying value of the goodwill to its implied fair value. c. fair value of the reporting unit to its carrying amount (goodwill included). d. carrying value of the reporting unit to the fair value of the identifiable net assets.

SFAS 141R requires that the acquirer disclose each of the following for each material business combination except the a. name and a description of the acquiree acquired. b. percentage of voting equity instruments acquired. c. fair value of the consideration transferred. d. each of the above is a required disclosure

In a leveraged buyout, the portion of the net assets of the new corporation provided by the management group is recorded at a. appraisal value. b. book value. c. fair value. d. lower of cost or market.

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Test Bank to Accompany Jeter and Chaney Advanced Accounting

When the acquisition price of an acquired firm is less than the fair value of the identifiable net assets, all of the following are recorded at fair value except a. Assumed liabilities. b. Current assets. c. Long-lived assets. d. Each of the above is recorded at fair value.

Under SFAS 141R, a. both direct and indirect costs are to be capitalized. b. both direct and indirect costs are to be expensed. c. direct costs are to be capitalized and indirect costs are to be expensed. d. indirect costs are to be capitalized and direct costs are to be expensed.

A business combination is accounted for properly as an acquisition. Which of the following expenses related to effecting the business combination should enter into the determination of net income of the combined corporation for the period in which the expenses are incurred?

a. b. c. d. 10.

Security issue costs Yes Yes No No

Overhead allocated to the merger Yes No Yes No

In a business combination, which of the following costs are assigned to the valuation of the security?

a. b. c. d.

Professional or consulting fees Yes Yes No No

Security issue costs Yes No Yes No

11.

Parental Company and Sub Company were combined in an acquisition transaction. Parental was able to acquire Sub at a bargain price. The sum of the fair values of identifiable assets acquired less the fair value of liabilities assumed exceeded the cost to Parental. After eliminating previously recorded goodwill, there was still some "negative goodwill." Proper accounting treatment by Parental is to report the amount as a. paid-in capital. b. a deferred credit, which is amortized. c. an ordinary gain. d. an extraordinary gain.

12.

With an acquisition, direct and indirect expenses are a. expensed in the period incurred. b. capitalized and amortized over a discretionary period. c. considered a part of the total cost of the acquired company. d. charged to retained earnings when incurred.

Chapter 2 Accounting for Business Combinations

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13.

In a business combination accounted for as an acquisition, how should the excess of fair value of net assets acquired over the consideration paid be treated? a. Amortized as a credit to income over a period not to exceed forty years. b. Amortized as a charge to expense over a period not to exceed forty years. c. Amortized directly to retained earnings over a period not to exceed forty years. d. Recorded as an ordinary gain.

14.

P Corporation issued 10,000 shares of common stock with a fair value of $25 per share for all the outstanding common stock of S Company in a business combination properly accounted for as an acquisition. The fair value of S Company's net assets on that date was $220,000. P Company also agreed to issue an additional 2,000 shares of common stock with a fair value of $50,000 to the former stockholders of S Company as an earnings contingency. Assuming that the contingency is expected to be met, the $50,000 fair value of the additional shares to be issued should be treated as a(n) a. decrease in noncurrent liabilities of S Company that were assumed by P Company. b. decrease in consolidated retained earnings. c. increase in consolidated goodwill. d. decrease in consolidated other contributed capital.

15.

On February 5, Pryor Corporation paid $1,600,000 for all the issued and outstanding common stock of Shaw, Inc., in a transaction properly accounted for as an acquisition. The book values and fair values of Shaw's assets and liabilities on February 5 were as follows

Cash Receivables (net) Inventory Plant and equipment (net) Liabilities Net assets

Book Value $ 160,000 180,000 315,000 820,000 (350,000) $1,125,000

Fair Value $ 160,000 180,000 300,000 920,000 (350,000) $1,210,000

What is the amount of goodwill resulting from the business combination? a. $-0-. b. $475,000. c. $85,000. d. $390,000. 16.

P Company purchased the net assets of S Company for $225,000. On the date of P's purchase, S Company had no investments in marketable securities and $30,000 (book and fair value) of liabilities. The fair values of S Company's assets, when acquired, were Current assets Noncurrent assets Total

$ 120,000 180,000 $300,000

How should the $45,000 difference between the fair value of the net assets acquired ($270,000) and the consideration paid ($225,000) be accounted for by P Company? a. The noncurrent assets should be recorded at $ 135,000. b. The $45,000 difference should be credited to retained earnings. c. The current assets should be recorded at $102,000, and the noncurrent assets should be recorded at $153,000. d. An ordinary gain of $45,000 should be recorded.

2-4

Test Bank to Accompany Jeter and Chaney Advanced Accounting

17.

If the value implied by the purchase price of an acquired company exceeds the fair values of identifiable net assets, the excess should be a. allocated to reduce any previously recorded goodwill and classify any remainder as an ordinary gain. b. allocated to reduce current and long-lived assets. c. allocated to reduce long-lived assets. d. accounted for as goodwill.

18.

P Co. issued 5,000 shares of its common stock, valued at $200,000, to the former shareholders of S Company two years after S Company was acquired in an all-stock transaction. The additional shares were issued because P Company agreed to issue additional shares of common stock if the average post combination earnings over the next two years exceeded $500,000. P Company will treat the issuance of the additional shares as a (decrease in) a. consolidated retained earnings. b. consolidated goodwill. c. consolidated paid-in capital. d. non-current liabilities of S Company assumed by P Company. The fair value of assets and liabilities of the acquired entity is to be reflected in the financial statements of the combined entity. When the acquisition takes place over a period of time rather than all at once, at what time is the fair value of the assets and liabilities of the acquired entity determined under SFAS 141R? a. the date the interest in the acquiree was acquired. b. the date the acquirer obtains control of the acquiree c. the date of acquisition of the largest portion of the interest in the acquiree. d. the date of the financial statements.

19.

20.

The first step in determining goodwill impairment involves comparing the a. implied value of a reporting unit to its carrying amount (goodwill excluded). b. fair value of a reporting unit to its carrying amount (goodwill excluded). c. implied value of a reporting unit to its carrying amount (goodwill included). d. fair value of a reporting unit to its carrying amount (goodwill included).

21.

If an impairment loss is recorded on previously recognized goodwill due to the transitional goodwill impairment test, the loss should be treated as a(n): a. loss from a change in accounting principles. b. extraordinary loss c. loss from continuing operations. d. loss from discontinuing operations.

22.

P Company acquires all of the voting stock of S Company for $930,000 cash. The book values of S Company’s assets are $800,000, but the fair values are $840,000 because land has a fair value above its book value. Goodwill from the combination is computed as: a. $130,000. b. $90,000. c. $40,000. d. $0.

Chapter 2 Accounting for Business Combinations

23.

2-5

Under SFAS 141R, what value of the assets and liabilities is reflected in the financial statements on the acquisition date of a business combination? a. Carrying value b. Fair value c. Book value d. Average value

Use the following information to answer questions 24 & 25. North Company issued 24,000 shares of its $20 par value common stock for the net assets of Prairie Company in business combination under which Prairie Company will be merged into North Company. On the date of the combination, North Company common stock had a fair value of $30 per share. Balance sheets for North Company and Prairie Company immediately prior to the combination were as follows: North

Prairie

Current Assets Plant and Equipment (net) Total

$1,314,000 1,725,000 $3,039,000

$192,000 408,000 $600,000

Liabilities Common Stock, $20 par value Other Contributed Capital Retained Earnings Total

$ 900,000 1,650,000 218,000 271,000 $3,039,000

$150,000 240,000 60,000 150,000 $600,000

24.

If the business combination is treated as an acquisition and Prairie Company’s net assets have a fair value of $686,400, North Company’s balance sheet immediately after the combination will include goodwill of a. $30,600. b. $38,400. c. $33,600. d. $56,400.

25.

If the business combination is treated as an acquisition and the fair value of Prairie Company’s current assets is $270,000, its plant and equipment is $726,000, and its liabilities are $168,000, North Company’s financial statements immediately after the combination will include a. Negative goodwill of $108,000. b. Plant and equipment of $2,133,000. c. Plant and equipment of $2,343,000. d. An ordinary gain of $108,000.

2-6 26.

Test Bank to Accompany Jeter and Chaney Advanced Accounting On May 1, 2013, the Phil Company paid $1,200,000 for 80% of the outstanding common stock of Sage Corporation in a transaction properly accounted for as an acquisition. The recorded assets and liabilities of Sage Corporation on May 1, 2013, follow: Cash Inventory Property & equipment (Net of accumulated depreciation) Liabilities

$100,000 200,000 800,000 (160,000)

On May 1, 2013, it was determined that the inventory of Sage had a fair value of $220,000 and the property and equipment (net) has a fair value of $1,200,000. What is the amount of goodwill resulting from the business combination? a. $0. b. $112,000. c. $140,000. d. $28,000. Use the following information to answer questions 27 & 28. Posch Company issued 12,000 shares of its $20 par value common stock for the net assets of Sato Company in a business combination under which Sato Company will be merged into Posch Company. On the date of the combination, Posch Company common stock had a fair value of $30 per share. Balance sheets for Posch Company and Sato Company immediately prior to the combination were as follows: Posch

Sato

Current Assets Plant and Equipment (net) Total

$ 657,000 863,000 $1,520,000

$ 96,000 204,000 $300,000

Liabilities Common Stock, $20 par value Other Contributed Capital Retained Earnings Total

$ 450,000 825,000 109,000 136,000 $1,520,000

$ 75,000 120,000 30,000 75,000 $300,000

27.

If the business combination is treated as an acquisition and Sato Company’s net assets have a fair value of $343,200, Posch Company’s balance sheet immediately after the combination will include goodwill of a. $15,300. b. $19,200. c. $16,800. d. $28,200.

28.

If the business combination is treated as an acquisition and the fair value of Sato Company’s current assets is $135,000, its plant and equipment is $363,000, and its liabilities are $84,000, Posch Company’s financial statements immediately after the combination will include a. Negative goodwill of $54,000. b. Plant and equipment of $1,226,000. c. Plant and equipment of $1,172,000. d. An extraordinary gain of $54,000.

Chapter 2 Accounting for Business Combinations

2-7

29. Following its acquisition of the net assets of Burnt Company, PrimroseCompany assigned goodwill of $60,000 to one of the reporting divisions. Information for this division follows:

Cash Inventory Equipment Goodwill Accounts Payable

Carrying Amount $ 20,000 35,000 125,000 60,000 30,000

Fair Value $20,000 40,000 160,000 30,000

Based on the preceding information, what amount of goodwill will be reported for this division if its fair value is determined to be $200,000? a. $0 b. $60,000 c. $30,000 d. $10,000 30.

The fair value of net identifiable assets exclusive of goodwill of a reporting unit of X Company is $300,000. On X Company's books, the carrying value of this reporting unit's net assets is $350,000, including $60,000 goodwill. If the fair value of the reporting unit is $335,000, what amount of goodwill impairment will be recognized for this unit? a. $0 b. $10,000 c. $25,000 d. $35,000

31.

The fair value of net identifiable assets of a reporting unit exclusive of goodwill of Y Company is $270,000. The carrying value of the reporting unit's net assets on Y Company's books is $320,000, including $50,000 goodwill. If the reported goodwill impairment for the unit is $10,000, what would be the fair value of the reporting unit? a. $320,000 b. $310,000 c. $270,000 d. $290,000

32. Porpoise Corporation acquired Sims Company through an exchange of common shares. All of Sims’ assets and liabilities were immediately transferred to Porpoise. Porpoise Company’s common stock was trading at $20 per share at the time of exchange. The following selected information is also available: Porpoise Company Before Acquisition After Acquisition Par value of shares outstanding $200,000 $250,000 Additional Paid in Capital 350,000 550,000 What number of shares was issued at the time of the exchange? a. 5,000 b. 17,500 c. 12,500 d. 10,000

2-8

Test Bank to Accompany Jeter and Chaney Advanced Accounting

Problems 2-1

Balance sheet information for Hope Corporation at January 1, 2013, is summarized as follows: Current assets $ 920,000 Liabilities $ 1,200,000 Plant assets 1,800,000 Capital stock $10 par 800,000 Retained earnings 720,000 $2,720,000 $ 2,720,000 Hope’s assets and liabilities are fairly valued except for plant assets that are undervalued by $200,000. On January 2, 2013, Robin Corporation issues 80,000 shares of its $10 par value common stock for all of Hope’s net assets and Hope is dissolved. Market quotations for the two stocks on this date are: Robin common: $28 Hope common: $19 Robin pays the following fees and costs in connection with the combination: Finder’s fee Costs of registering and issuing stock Legal and accounting fees

$10,000 5,000 6,000

Required: A. Calculate Robin’s investment cost of Hope Corporation. B. Calculate any goodwill from the business combination.

2-2

Maplewood Corporation purchased the net assets of West Corporation on January 2, 2013 for $560,000 and also paid $20,000 in direct acquisition costs. West’s balance sheet on January 1, 2013 was as follows: Accounts receivable-net Inventory Land Building-net Equipment-net Total assets

$ 180,000 360,000 40,000 60,000 80,000 $ 720,000

Current liabilities $ 70,000 Long term debt 160,000 Common stock ($1 par) 20,000 Paid-in capital 430,000 Retained earnings 40,000 Total liab. & equity $ 720,000

Fair values agree with book values except for inventory, land, and equipment, which have fair values of $400,000, $50,000 and $70,000, respectively. West has patent rights valued at $20,000. Required: A. Prepare Maplewood’s general journal entry for the cash purchase of West’s net assets. B. Assume Maplewood Corporation purchased the net assets of West Corporation for $500,000 rather than $560,000, prepare the general journal entry.

Chapter 2 Accounting for Business Combinations 2-3

2-9

Edina Company acquired the assets (except cash) and assumed the liabilities of Burns Company on January 1, 2013, paying $2,600,000 cash. Immediately prior to the acquisition, Burns Company's balance sheet was as follows:

Accounts receivable (net) Inventory Land Buildings (net) Total

BOOK VALUE $ 240,000 290,000 960,000 1,020,000 $2,510,000

FAIR VALUE $ 220,000 320,000 1,508,000 1,392,000 $3,440,000

Accounts payable Note payable Common stock, $5 par Other contributed capital Retained earnings Total

$ 270,000 600,000 420,000 640,000 580,000 $2,510,000

$ 270,000 600,000

Edina Company agreed to pay Burns Company's former stockholders $200,000 cash in 2014 if postcombination earnings of the combined company reached $1,000,000 during 2013. Required: A. Prepare the journal entry necessary for Edina Company to record the acquisition on January 1, 2013. It is expected that the earnings target is likely to be met. B. Prepare the journal entry necessary for Edina Company in 2014 assuming the earnings contingency was not met.

2-4

Condensed balance sheets for Rich Company and Jordan Company on January 1, 2013 are as follows:

Current Assets Plant and Equipment (net) Total Assets

Rich $ 440,000 1,080,000 $1,520,000

Jordan $200,000 340,000 $540,000

Total Liabilities Common Stock, $10 par value Other Contributed Capital Retained Earnings Total Equities

$ 230,000 840,000 300,000 150,000 $1,520,000

$ 80,000 240,000 130,000 90,000 $540,000

On January 1, 2013 the stockholders of Rich and Jordan agreed to a consolidation whereby a new corporation, Cannon Company, would be formed to consolidate Rich and Jordan. Cannon Company issued 70,000 shares of its $20 par value common stock for the net assets of Rich and Jordan. On the date of consolidation, the fair values of Rich's and Jordan's current assets and liabilities were equal to their book values. The fair value of plant and equipment for each company was: Rich, $1,270,000; Jordan, $360,000.

2-10 Test Bank to Accompany Jeter and Chaney Advanced Accounting An investment banking house estimated that the fair value of Cannon Company's common stock was $35 per share. Rich will incur $45,000 of direct acquisition costs and $15,000 in stock issue costs. Required: Prepare the journal entries to record the consolidation on the books of Cannon Company assuming that the consolidation is accounted for as an acquisition.

2-5

The stockholders’ equities of Penn Corporation and Simon Corporation were as follows on January 1, 2013:

Common Stock, $1 par Other Contributed Capital Retained Earnings Total Stockholders’ Equity

Penn Corp. $1,000,000 2,800,000 600,000 $4,400,000

Simon Corp. $ 600,000 1,100,000 340,000 $2,040,000

On January 2, 2013 Penn Corp. issued 100,000 of its shares with a market value of $14 per share in exchange for all of Simon’s shares, and Simon Corp. was dissolved. Penn Corp. paid $10,000 to register and issue the new common shares. Required: Prepare the stockholders’ equity section of Penn Corp. balance sheet after the business combination on January 2, 2013.

2-6

The managers of Savage Company own 10,000 of its 100,000 outstanding common shares. Swann Company is formed by the managers of Savage Company to take over Savage Company in a leveraged buyout. The managers contribute their shares in Savage Company and Swann Company then borrows $675,000 to purchase the remaining 90,000 shares of Savage Company for $600,000; the remaining $75,000 is used for working capital. Savage Company is then merged into Swann Company effective January 1, 2013. Data relevant to Savage Company immediately prior to the leveraged buyout follow:

Current Assets Plant Assets Liabilities Stockholders' Equity

Book Value $ 90,000 255,000 (45,000) $300,000

Fair Value $ 90,000 525,000 (45,000) $570,000

Required: A. Prepare journal entries on Swann Company's books to reflect the effects of the leveraged buyout. B. Determine the balance of each of the following immediately after the merger: 1. Current Assets 2. Plant Assets 3. Note Payable 4. Common Stock

Chapter 2 Accounting for Business Combinations 2-7

2-11

On January 1, 2010, Brighton Company acquired the net assets of Dakota Company for $1,580,000 cash. The fair value of Dakota’s identifiable net assets was $1,310,000 on his date. Brighton Company decided to measure goodwill impairment using the present value of future cash flows to estimate the fair value of the reporting unit (Dakota). The information for these subsequent years is as follows:

Present value

Carrying value of Dakota’s Identifiable

Year

of Future Cash Flows

Net Assets*

Fair Value Dakota’s Identifiable Net Assets

2013 2014

$1,400,000 $1,400,000

$1,160,000 $1,120,000

$1,190,000 $1,210,000

* Identifiable net assets do not include goodwill. Required: A: For each year determine the amount of goodwill impairment, if any. B: Prepare the journal entries needed each year to record the goodwill impairment (if any) on Brighton’s books. 2-8

The following balance sheets were reported on January 1, 2013, for Wood Company and Rose Company:

Cash Inventory Equipment (net) Total

Wood $ 150,000 450,000 1,320,000 $1,920,000

Rose $ 30,000 150,000 570,000 $750,000

Total liabilities Common stock, $20 par value Other contributed capital Retained earnings Total

$ 450,000 600,000 375,000 495,000 $1,920,000

$150,000 300,000 105,000 195,000 $750,000

Required: Appraisals reveal that the inventory has a fair value $180,000, and the equipment has a current value of $615,000. The book value and fair value of liabilities are the same. Assuming that Wood Company wishes to acquire Rose for cash in an asset acquisition, determine the following cutoff amounts: A. The purchase price above which Wood would record goodwill. B. The purchase price at which Wood would record a $50,000 gain. C. The purchase price below which Wood would obtain a “bargain.” D. The purchase price at which Wood would record $75,000 of goodwill. Short Answer 1.

SFAS No. 142 requires that goodwill impairment be tested annually for each reporting unit. Discuss the necessary steps of the goodwill impairment test.

2-12 Test Bank to Accompany Jeter and Chaney Advanced Accounting

2. Briefly describe the different treatment under SFAS 141 vs. SFAS 141R for the following issues: • Business definition • Acquisition costs • In-process R&D • Contingent consideration

Short Answer Questions from the Textbook 1. When contingent consideration in an acquisition is based on security prices, how should this contingency be reflected on the acquisition date? If the estimate changes during the measurement period, how is this handled? If the estimate changes after the end of the measurement period, how is this adjustment handled? Why? 2. What are pro forma financial statements? What is their purpose? 3. How would a company determine whether goodwill has been impaired? 4. AOL announced that because of an accounting change (FASB Statements Nos. 141R [ASC 805] and142 [ASC 350]), earnings would be increasing over the next 25 years by $5.9 billion a year. What change(s) required by FASB (in SFAS Nos. 141Rand 142) resulted in an increase in AOL’s in-comeincome? Would you expect this increase in earnings to have a positive impact on AOL’s stock price? Why or why not?

Business Ethics Question from Textbook There have been several recent cases of a CEO or CFO resigning or being ousted for misrepresenting academic credentials. For instance, during February 2006,the CEO of RadioShack resigned by ‘mutual agreement’ for inflating his educational background. During 2002, Veritas Software Corporation’s CFO resigned after claiming to have an MBA from Stanford University. On the other hand, Bausch & Lomb Inc.’s board refused the CEO’s offer to resign following a questionable claim to have an MBA. Suppose you have been retained by the board of a company where the CEO has ‘overstated’ credentials. This company has a code of ethics and conduct which states that the employee should always do “the right thing.”(a) What is the board of directors’ responsibility in such matters?(b) What arguments would you make to ask the CEO to resign? What damage might be caused if the decision is made to retain the current CEO?

Chapter 2 Accounting for Business Combinations

ANSWER KEY Multiple Choice 1. 2. 3. 4. 5. 6. 7. 8. 9.

b d b b d b d b c

10. 11. 12. 13. 14. 15. 16. 17. 18.

c c a d c d dsee note on p3 d c

19. 20. 21. 22. 23. 24. 25. 26. 27.

b d a b b c d c c

28. b 29. d 30. c 31. b 32. c

Problems 2-1

A. FMV of shares issued by Robin (80,000 sh × $28) =

$2,240,000

B. Investment cost from Part A $2,240,000 Less: Fair value of Hope’s net assets ($2,720,000+$200,000–$1,200,000) 1,720,000 Goodwill from investment $ 520,000 2-2

A. Accounts Receivable Inventory Land Building Equipment Patent Goodwill Acquisition Expense Current Liabilities Long-term Debt Cash

180,000 400,000 50,000 60,000 70,000 20,000 10,000 20,000

B. Acquisition Expense Accounts Receivable Inventory Land Building Equipment Patent Current Liabilities Long-term Debt Cash Gain on Acquisition

20,000 180,000 400,000 50,000 60,000 70,000 20,000

70,000 160,000 580,000

70,000 160,000 520,000 50,000

2-13

2-14 Test Bank to Accompany Jeter and Chaney Advanced Accounting 2-3

2-4

2-5

A. Accounts Receivable Inventory Land Buildings Goodwill Allowance for Uncollectible Accounts Accounts Payable Note Payable Cash

240,000 320,000 1,508,000 1,392,000 30,000

Goodwill Liability for Contingent Consideration

200,000

20,000 270,000 600,000 2,600,000 200,000

Cost of acquisition Fair value of net assets acquired ($3,440,000 – $870,000) Goodwill

$2,600,000

B. Liability for Contingent Consideration Income from Change in Estimate

200,000

2,570,000 $ 30,000

200,000

Current Assets ($440,000 + $200,000) 640,000 Plant and Equipment ($1,270,000 + $360,000) 1,630,000 Goodwill 490,000 Liabilities ($230,000 + $80,000) Common Stock (70,000 shares @ $20/share) Other Contributed Capital (70,000 × ($35 – $20)) Acquisition Expense Cash

45,000

Other Contributed Capital Cash

15,000

Stockholders’ Equity: Common Stock, $1 par Other Contributed Capital Retained Earnings Total stockholders’ Equity

310,000 1,400,000 1,050,000

45,000

15,000

$1,100,000 4,090,000 [$2,800,000 + (100,000 × $13) – $10,000] 600,000 $ 5,790,000

Chapter 2 Accounting for Business Combinations 2-6

A Investment in Savage Company ($300,000 × .10) 30,000 Common Stock

30,000

Cash Note Payable

675,000 675,000

Investment in Savage Company Cash

600,000

Current Assets Plant Assets (1) Goodwill (2) Liabilities Investment in Savage

90,000 498,000 87,000

2-15

600,000

45,000 630,000

(1) $255,000 + [.90 × ($525,000 – $255,000)] = $498,000 (2) Cost of shares Book value of net assets (.90 × $300,000) = Difference between cost and book value Allocated to: Plant assets (.90 × ($525,000 – $255,000)) = Goodwill B 1. 2. 3. 4. 2-7

Current Assets ($90,000 + $75,000) Plant Assets ($255,000 + $243,000) Note Payable Common Stock

$600,000 270,000 $330,000 243,000 87,000

165,000 498,000 675,000 30,000

A. 2013: Step 1: Fair value of the reporting unit Carrying value of unit: Carrying value of identifiable net assets $1,160,000 Carrying value of goodwill ($1,580,000 – $1,310,000) 270,000 Excess of carrying value over fair value The excess of carrying value over fair value means that step 2 is required. Step 2: Fair value of the reporting unit Fair value of identifiable net assets Implied value of goodwill Recorded value of goodwill ($1,580,000 – $1,310,000) Impairment loss 2014: Step 1: Fair value of the reporting unit Carrying value of unit: Carrying value of identifiable net assets Carrying value of goodwill ($270,000 – $40,000)

$1,400,000

1,430,000 $30,000

$1,400,000 1,190,000 210,000 270,000 $60,000 $1,400,000

$1,120,000 230,000 1,350,000

2-16 Test Bank to Accompany Jeter and Chaney Advanced Accounting Excess of Fair value over Carrying value

$ 50,000

The excess of fair value over carrying value means that step 2 is not required. B. 2013:

2014: 2-8

Impairment Loss—Goodwill Goodwill

60,000 60,000

No entry

a. Fair Value of Identifiable Net Assets Book values $750,000 – $150,000 = Write up of Inventory and Equipment: ($30,000 + $45,000) = Purchase price above which goodwill would result

$600,000 75,000 $675,000

b. Any existing goodwill would be eliminated before recording a gain: $675,000 Fair Value of Identifiable Net Assets – $50,000 Gain = $625,000. c. Anything below $675,000 is technicially considered a bargain. d. Goodwill would be $75,000 at a purchase price of $750,000 or ($675,000 + $75,000). Short Answer 1.

In the first step of the goodwill impairment test, the fair value of the reporting unit is compared to its carrying amount. If the fair value is less than the carrying amount, then the carrying value of the goodwill is compared to its implied fair value. A loss is recognized when the carrying value of goodwill is higher than its fair value.

2. Issue Business definition

SFAS No. 141 A business is defined as a self-sustaining integrated set of activities and assets conducted and managed for the purpose of providing a return to investors. The definition would exclude early-stage development entities.

Acquisition costs

Capitalize the costs.

SFAS No. 141R A business or a group of assets no longer must be self-sustaining. The business or group of assets must be capable of generating a revenue stream. This definition would include early-stage development entities. Expense as incurred.

In-process R&D

Included as part of purchase price, but then immediately expensed.

Included as part of purchase price, treated as an asset.

Contingent Record when determinable and reflect consideration subsequent changes in the purchase price.

Record at fair value on the acquisition date with subsequent changes recorded on the income statement.

Chapter 2 Accounting for Business Combinations

2-17

Short Answer Questions from the Textbook Solutions 1.

At the acquisition date, the information available (and through the end of the measurement period) is used to estimate the expected total consideration at fair value. If the subsequent stock issue valuation differs from this assessment, the Exposure Draft (SFAS 1204-001) expected to replace FASB Statement No. 141R specifies that equity should not be adjusted. The reason is that the valuation was determined at the date of the exchange, and thus the impact on the firm’s equity was measured at that point based on the best information available then.

Pro forma financial statements (sometimes referred to as “as if” statements) are financial statements that are prepared to show the effect of planned or contemplated transactions.

For purposes of the goodwill impairment test, all goodwill must be assigned to a reporting unit. Goodwill impairment for each reporting unit should be tested in a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying amount (goodwill included) at the date of the periodic review. The fair value of the unit may be based on quoted market prices, prices of comparable businesses, or a present value or other valuation technique. If the fair value at the review date is less than the carrying amount, then the second step is necessary. In the second step, the carrying value of the goodwill is compared to its implied fair value. (The calculation of the implied fair value of goodwill used in the impairment test is similar to the method illustrated throughout this chapter for valuing the goodwill at the date of the combination.)

The expected increase was due to the elimination of goodwill amortization expense. However, the impairment loss under the new rules was potentially larger than a periodic amortization charge, and this is in fact what materialized within the first year after adoption (a large impairment loss). If there was any initial stock price impact from elimination of goodwill amortization, it was only a short-term or momentum effect. Another issue is how the stock market responds to the goodwill impairment charge. Some users claim that this charge is a non-cash charge and should be disregarded by the market. However, others argue that the charge is an admission that the price paid was too high, and might result in a stock price decline (unless the market had already adjusted for this overpayment prior to the actual write down).

ANSWERS TO BUSINESS ETHICS CASE a and b. The board has responsibility to investigate anything that might suggest malfeasance or inappropriate conduct. Such incidents suggest broader problems with integrity, honesty, and judgment. In other words, can you trust any reports from the CEO that lied on his resume? If the CEO is not fired, what kind of message does this send to other employees? Employees will feel that top executives are not subject to the same standards of ethical conduct as they are.

Chapter 3 Consolidated Financial Statements—Date of Acquisition Multiple Choice 1.

A majority-owned subsidiary that is in legal reorganization should normally be accounted for using a. consolidated financial statements. b. the equity method. c. the market value method. d. the cost method.

Under the acquisition method, indirect costs relating to acquisitions should be a. included in the investment cost. b. expensed as incurred. c. deducted from other contributed capital. d. none of these.

Eliminating entries are made to cancel the effects of intercompany transactions and are made on the a. books of the parent company. b. books of the subsidiary company. c. workpaper only. d. books of both the parent company and the subsidiary.

One reason a parent company may pay an amount less than the book value of the subsidiary's stock acquired is a. an undervaluation of the subsidiary's assets. b. the existence of unrecorded goodwill. c. an overvaluation of the subsidiary's liabilities. d the existence of unrecorded contingent liabilities.

In a business combination accounted for as an acquisition, registration costs related to common stock issued by the parent company are a. expensed as incurred. b. deducted from other contributed capital. c. included in the investment cost. d. deducted from the investment cost.

On the consolidated balance sheet, consolidated stockholders' equity is a. equal to the sum of the parent and subsidiary stockholders' equity. b. greater than the parent's stockholders' equity. c. less than the parent's stockholders' equity. d. equal to the parent's stockholders' equity.

Majority-owned subsidiaries should be excluded from the consolidated statements when a. control does not rest with the majority owner. b. the subsidiary operates under governmentally imposed uncertainty. c. a foreign subsidiary is domiciled in a country with foreign exchange restrictions or controls. d. any of these circumstances exist.

3-2

Test Bank to accompany Jeter and Chaney Advanced Accounting

Under the economic entity concept, consolidated financial statements are intended primarily for the benefit of the a. stockholders of the parent company. b. creditors of the parent company. c. minority stockholders. d. all of the above.

Reasons a parent company may pay more than book value for the subsidiary company's stock include all of the following except a. the fair value of one of the subsidiary's assets may exceed its recorded value because of appreciation. b. the existence of unrecorded goodwill. c. liabilities may be overvalued. d. stockholders' equity may be undervalued.

10.

What is the method of presentation required by SFAS 160 of “non-controlling interest” on a consolidated balance sheet? a. As a deduction from goodwill from consolidation. b. As a separate item within the long-term liabilities section. c. As a part of stockholders' equity. d. As a separate item between liabilities and stockholders' equity.

11.

Which of the following is a limitation of consolidated financial statements? a. Consolidated statements provide no benefit for the stockholders and creditors of the parent company. b. Consolidated statements of highly diversified companies cannot be compared with industry standards. c. Consolidated statements are beneficial only when the consolidated companies operate within the same industry. d. Consolidated statements are beneficial only when the consolidated companies operate in different industries.

12.

Pina Corp. owns 60% of Simon Corp.'s outstanding common stock. On May 1, 2013, Pina advanced Simon $90,000 in cash, which was still outstanding at December 31, 2013. What portion of this advance should be eliminated in the preparation of the December 31, 2013 consolidated balance sheet? a. $90,000. b. $54,000. c. $36,000. d. $-0-.

Chapter 3 Consolidated Financial Statements—Date of Acquisition

3-3

Use the following information for questions 13-15. On January 1, 2013, Pell Company and Sand Company had condensed balance sheets as follows: Pell Sand Current assets $ 280,000 $ 80,000 Noncurrent assets _360,000 __160,000 Total assets $ 640,000 $240,000 Current liabilities $ 120,000 $ 40,000 Long-term debt 200,000 -0Stockholders' equity __320,000 200,000 Total liabilities & stockholders' equity $ 640,000 $240,000 On January 2, 2013 Pell borrowed $240,000 and used the proceeds to purchase 90% of the outstanding common stock of Sand. This debt is payable in 10 equal annual principal payments, plus interest, starting December 30, 2013. Any difference between book value and the value implied by the purchase price relates to land. On Pell's January 2, 2013 consolidated balance sheet, 13.

Noncurrent assets should be a. $520,000. b. $536,000. c. $544,000. d. $586,667.

14.

Current liabilities should be a. $200,000. b. $184,000. c. $160,000. d. $120,000.

15.

Noncurrent liabilities should be a. $440,000. b. $416,000. c. $240,000. d. $216,000.

16.

A newly acquired subsidiary has pre-existing goodwill on its books. The parent company’s consolidated balance sheet will: a. treat the goodwill the same as other intangible assets of the acquired company. b. will always show the pre-existing goodwill of the subsidiary at its book value. c. not show any value for the subsidiary’s pre-existing goodwill. d. do an impairment test to see if any of it has been impaired.

17. The Difference between Implied and Book Value account titles s/b in Caps, but not italics - you have not done this consistentlyaccount is: a. an asset or liability account reflected on the consolidated balance sheet. b. used in allocating the amounts paid for recorded balance sheet accounts that are different than their fair values. c. the excess implied value assigned to goodwill. d. the unamortized excess that cannot be assigned to any related balance sheet accounts

3-4

Test Bank to accompany Jeter and Chaney Advanced Accounting

18.

The main evidence of control for purposes of consolidated financial statements involves a. possessing majority ownership b. having decision-making ability that is not shared with others. c. being the sole shareholder d. having the parent company and the subsidiary participating in the same industry.

19.

In which of the following cases would consolidation be inappropriate? a. The subsidiary is in bankruptcy. b. Subsidiary's operations are dissimilar from those of the parent. c. The parent owns 90 percent of the subsidiary's common stock, but all of the subsidiary's nonvoting preferred stock is held by a single investor. d. Subsidiary is foreign.

20.

Price Company acquired 75 percent of the common stock of Shandie Corporation on December 31, 2013. On the date of acquisition, Price held land with a book value of $150,000 and a fair value of $300,000; Shandie held land with a book value of $100,000 and fair value of $500,000. What amount would land be reported in the consolidated balance sheet prepared immediately after the combination? a. $650,000 b. $500,000 c. $550,000 d. $375,000

Use the following information to answer questions 21 - 23. On January 1, 2013, Pent Company and Shelter Company had condensed balanced sheets as follows: Pent

Shelter

Current assets Noncurrent assets Total assets

$ 210,000 270,000 $480,000

$ 60,000 120,000 $180,000

Current liabilities Long-term debt Stock holders' equity Total liabilities & stockholders' equity

$ 30,000 -0150,000 $ 180,000

90,000 150,000 240,000 $ 480,000

On January 2, 2013 Pent borrowed $180,000 and used the proceeds to purchase 90% of the outstanding common stock of Shelter. This debt is payable in 10 equal annual principal payments, plus interest, starting December 30, 2013. Any difference between book value and the value implied by the purchase price relates to land. On Pent's January 2, 2013 consolidated balance sheet, 21.

Noncurrent assets should be a. $390,000. b. $402,000. c. $408,000.

Chapter 3 Consolidated Financial Statements—Date of Acquisition

3-5

d. $440,000. 22.

Current liabilities should be a. $150,000. b. $138,000. c. $120,000. d. $90,000.

23.

Noncurrent liabilities should be a. $330,000. b. $312,000. c. $180,000. d. $162,000.

24.

On January 1, 2013, Prima Corporation acquired 80 percent of Sunder Corporation's voting common stock. Sunders's buildings and equipment had a book value of $300,000 and a fair value of $350,000 at the time of acquisition. At what amount will Sunder’s buildings and equipment will be reported in the consolidated statements ? a. $350,000 b. $340,000 c. $280,000 d. $300,000

25.

The primary beneficiary of a variable interest entity (VIE) must consolidate the VIE into its financial statements whenever a. substantially all of the entity’s activities are conducted on behalf of an investor who has disproportionally few voting rights. b. the voting rights are not proportional to the obligations to absorb the expected losses or receive expected residual returns. c. the total equity at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties. d. the holders of the equity investment at risk have the right to receive the residual returns of the legal entity

26.

If an entity is not considered a VIE, the determination of consolidation is based on whether a. the voting rights are proportional to the obligations to absorb expected losses or receive expected residual returns. b. the total equity at risk is sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties. c. the equity investments or investments in subordinated debt are at risk. d. one of the entities in the consolidated group directly or indirectly has a controlling financial interest (usually ownership of a majority voting interest) in the other entities.

27.

IFRS defines control as a. the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise. b. the power to govern the entity’s financial and operating policies as to obtain benefits from its activities. c. the power to direct the activities that impact economic performance, the obligation to absorb expected losses, and the right to receive expected residual returns. d. having a majority of the ownership interests entitled to elect management.

3-6

Test Bank to accompany Jeter and Chaney Advanced Accounting

Problems 3-1

On December 31, 2013, Pinta Company purchased 80% of the outstanding common stock of Snead Company for cash. At the time of acquisition, Snead Company's balance sheet was as follows: Current assets Plant and equipment Land Total assets

$ 1,680,000 1,580,000 280,000 $3,540,000

Liabilities Common stock, $10 par value Other contributed capital Retained earnings Total Treasury stock at cost, 5,000 shares Total equities

$ 1,320,000 1,440,000 700,000 240,000 $3,700,000 <160,000> $3,540,000

Required: Prepare the elimination entry(s) required for the preparation of a consolidated balance sheet workpaper on December 31, 2013, assuming the purchase price of the stock was $1,670,000. Any difference between the value implied by the purchase price of the investment and the book value of net assets acquired relates to subsidiary land. 3-2

P Company purchased 80% of the outstanding common stock of S Company on January 2, 2013, for $380,000. Balance sheets for P Company and S Company immediately after the stock acquisition were as follows:

Current assets Investment in S Company Plant and equipment (net) Land

Current liabilities Long-term notes payable Common stock Other contributed capital Retained earnings

P Company $ 166,000 380,000 560,000 40,000 $1,146,000

S Company $ 96,000 -0224,000 120,000 $440,000

$ 120,000 -0480,000 244,000 302,000 $1,146,000

$ 44,000 36,000 160,000 64,000 136,000 $440,000

S Company owed P Company $16,000 on open account on the date of acquisition. Required:

Chapter 3 Consolidated Financial Statements—Date of Acquisition

3-7

Prepare a consolidated balance sheet for P and S Companies on the date of acquisition. Any difference between the value implied by the purchase price of the investment and the book value of net assets acquired relates to subsidiary land. The book values of S Company's other assets and liabilities are equal to their fair values.

3-3

P Company acquired 54,000 shares of the common stock of S Company on January 1, 2013, for $950,000 cash. The stockholders' equity section of S Company's balance sheet on that date was as follows: Common stock, $10 par value Other contributed capital Retained earnings Total

$600,000 80,000 320,000 $1,000,000

On the date of acquisition, S Company owed P Company $10,000 on open account. Required: Present, in general journal form, the elimination entries for the preparation of a consolidated balance sheet workpaper on January 1, 2013. The difference between the value implied by the purchase price of the investment and the book value of the net assets acquired relates to subsidiary land.

3-4

On January 2, 2013, Pope Company acquired 90% of the outstanding common stock of Smithwick Company for $480,000 cash. Just before the acquisition, the balance sheets of the two companies were as follows:

Cash Accounts Receivable (net) Inventory Plant and Equipment (net) Land Total Assets

Pope $ 650,000 360,000 290,000 970,000 150,000 $2,420,000

Smithwick $ 160,000 60,000 140,000 240,000 80,000 $680,000

Accounts Payable Mortgage Payable Common Stock, $2 par value Other Contributed Capital Retained Earnings Total Equities

$ 260,000 180,000 1,000,000 520,000 460,000 $2,420,000

$ 120,000 100,000 170,000 50,000 240,000 $680,000

The fair values of Smithwick's assets and liabilities are equal to their book values with the exception of land.

Required:

3-8

Test Bank to accompany Jeter and Chaney Advanced Accounting A. Prepare the journal entry necessary to record the purchase of Smithwick's common stock. B. Prepare a consolidated balance sheet at the date of acquisition.

3-5

P Corporation paid $420,000 for 70% of S Corporation’s $10 par common stock on December 31, 2013, when S Corporation’s stockholders’ equity was made up of $300,000 of Common Stock, $90,000 of Other Contributed Capital and $60,000 of Retained Earnings. S’s identifiable assets and liabilities reflected their fair values on December 31, 2013, except for S’s inventory which was undervalued by $60,000 and their land which was undervalued by $25,000. Balance sheets for P and S immediately after the business combination are presented in the partially completed workpaper below.

P ASSETS Cash Accounts receivable-net Inventories Land Plant assetsnet Investment in S Corp. Difference between implied and book value Goodwill Total Assets EQUITIES Current liabilities Capital stock Additional paidin capital Retained earnings Noncontrolling interest Total Equities

$40,000

$30,000

30,000 185,000 45,000

45,000 165,000 120,000

480,000

240,000

Eliminations Debit Credit

Noncontrolling Interest

Consolidated Balances

420,000

$1,200,000

$600,000

$170,000 600,000

$150,000 300,000

150,000

90,000

280,000

60,000

$1,200,000

$600,000

Required: Complete the consolidated balance sheet workpaper for P Corporation and Subsidiary.

Chapter 3 Consolidated Financial Statements—Date of Acquisition

3-6

3-9

Prepare in general journal form the workpaper entries to eliminate Porter Company's investment in Sewell Company in the preparation of a consolidated balance sheet at the date of acquisition for each of the following independent cases: Sewell Company Equity Balances Percent of Stock Owned

Investment Cost

Common Stock

Other Contributed Capital

Retained Earnings

$675,000

$450,000

$180,000

$75,000

318,000

620,000

140,000

20,000

Cash

Any difference between book value of net assets acquired and the value implied by the purchase price relates to subsidiary property, plant, and equipment except for case (b). In case (b) assume that all book values and fair values are the same.

3-7

On December 31, 2013, Priestly Company purchased a controlling interest in Shelter Company for $1,060,000. The consolidated balance sheet on December 31, 2013 reported noncontrolling interest in Shelter Company of $265,000. On the date of acquisition, the stockholders' equity section of Shelter Company's balance sheet was as follows: Common stock Other contributed capital Retained earnings Total

$520,000 380,000 280,000 1,180,000

Required: A. Compute the noncontrolling interest percentage on December 31, 2013. B. Prepare the investment elimination entry made to prepare a consolidated balance sheet workpaper. Any difference between book value and the value implied by the purchase price relates to subsidiary land.

3-8

On January 1, 2013, Prima Company issued 1,500 of its $20 par value common shares with a fair value of $50 per share in exchange for 2,000 outstanding common shares of Swatch Company in a purchase transaction. Registration costs amounted to $1,700 paid in cash. Just prior to the acquisition, the balance sheets of the two companies were as follows:

Cash Accounts Receivable (net) Inventory Plant and Equipment (net)

Prima

Swatch

$ 73,000 95,000 58,000 95,000

$13,000 19,000 25,000 43,000

3-10 Test Bank to accompany Jeter and Chaney Advanced Accounting Land Total Assets

26,000 $ 347,000

20,000 $ 120,000

Accounts Payable Notes Payable Common Stock, $20 par value Other Contributed Capital Retained Earnings Total Liabilities and Equities

$ 66,000 82,000 100,000 60,000 39,000 $ 347,000

16,000 21,000 40,000 24,000 19,000 $ 120,000

Any differences between the book value of equity and the value implied by the purchase price relates to Land. Required: A. Prepare the journal entry on Prima’s books to record the exchange of stock. B. Prepare a Computation and Allocation Schedule for the Difference between book value and value implied by the purchase price. C. Calculate the consolidated balance for each of the following accounts as of December 31, 2013: 1. Cash 2. Land 3. Common Stock 4. Other Contributed Capital

Short Answer 1. There are several reasons why a company would acquire a subsidiary’s voting common stock rather than its net assets. Identify at least two advantages to acquiring a controlling interest in the voting stock of another company rather than its assets. 2. A useful first step in the consolidating process is to prepare a Computation and Allocation of Difference (CAD) Schedule. Identify the steps involved in preparing the CAD schedule.

Short Answer Questions from the Textbook 1. What are the advantages of acquiring the majority of the voting stock of another company rather than acquiring all its voting stock? 2. What is the justification for preparing consolidated financial statements when, in fact, it is apparent that the consolidated group is not a legal entity? 3. Why is it often necessary to prepare separate financial statements for each legal entity in a consolidated

group even though consolidated statements provide a better economic picture of the combined activities? 4. What aspects of control must exist before a subsidiary is consolidated? 5. Why are consolidated work papers used in pre-paring preparing consolidated financial statements?

Chapter 3 Consolidated Financial Statements—Date of Acquisition

3-11

6. Define noncontrolling (minority) interest. List three methods that might be used for reporting the noncontrolling interest in a consolidated balance sheet, and state which is preferred under the SFAS No. 160[topic 810]. 7. Give several reasons why a parent company would be willing to pay more than book value for

subsidiary stock acquired. 8. What effect do subsidiary treasury stock holdings have at the time the subsidiary is acquired? How should the treasury stock be treated on consolidated work papers? 9. What effect does a noncontrolling interest have on the amount of intercompany receivables and payables eliminated on a consolidated balance sheet? 10A SFAS No. 109and SFAS No. 141R [ASC 740 and 805] require that a deferred tax asset or liability be recognized for likely differences between the reported values and tax bases of assets and liabilities recognized in business combinations (for example, in exchanges that are nontaxable to the selling shareholders). Does this decision change the amount of consolidated net income reported in years subsequent to the business combination? Explain.

Business Ethics Question from the Textbook Part I. You are working on the valuation of accounts receivable, and bad debt reserves for the current year’s annual report. The CFO stops by and asks you to reduce the reserve by enough to increase the current year’s EPS by 2 cents a share. The company’s policy has always been to use the previous year’s actual bad debt percentage adjusted for a specific economic index. The CFO’s suggested change would still be within acceptable GAAP. However, later, you learn that with the increased EPS, the CFO would qualify for a significant bonus. What do you do and why? Part II. Consider the following: Accounting firm KPMG created tax shelters called BLIPS, FLIP, OPIS, and SOS that were based largely in the Cayman Islands and allowed wealthy clients (there were 186) to create $5 billion in losses, which were then deducted from their income for IRS tax purposes. BLIPS (Bond Linked Issue Premium Structures) had clients borrow from an offshore bank for purposes of purchasing currency. The client would then sell the currency back to the lender for a loss. However, the IRS contends the losses were phony and that there was never any risk to the client in the deals. The IRS has indicted eight former KPMG partners and an outside lawyer alleging that the transactions were shams, illegal methods for avoiding taxes. KPMG has agreed to pay a$456 million fine, no longer to do tax shelters, and to cooperate with the government in its prosecution of the nine individuals involved in the tax shelter scheme. Many argue that the courts have not always held that such tax avoidance schemes show criminal intent because the tax laws permit individuals to minimize taxes. However, the IRS argues that these shelters evidence intent because of the lack of risk. Question In this case, the IRS contends that the losses generated by the tax shelters were phony and that the clients never incurred any risk. Do tax avoidance schemes indicate criminal intent if the tax laws permit individuals to minimize taxes? Justify your answer.

3-12 Test Bank to accompany Jeter and Chaney Advanced Accounting

ANSWER KEY Multiple Choice 1. d 2. b 3. c 4. d 5. b 6. d 7. d Problems 3-1

8. d 9. d 10. c 11. b 12. a 13. d 14. b

15. b 16. c 17. b 18. b 19. a 20. a 21. d

22. b 23. b 24. a 25. c 26. d 27. b

Common Stock – Snead Other Contributed Capital – Snead Retained Earnings – Snead Investment in Snead Company Treasury Stock - Snead Difference Between Implied and Book Value Noncontrolling Interest

1,440,000 700,000 240,000 1,670,000 160,000 106,000 444,000

Difference Between Implied and Book Value Land 3-2

3-3

106,000 106,000

P COMPANY AND SUBSIDIARY Consolidated Balance Sheet January 2, 2013 Current assets Plant and equipment (net) Land ($160,000 + $115,000 excess cost) Total

$246,000 784,000 275,000 $1,305,000

Current liabilities Long-term notes payable Common stock Noncontrolling interest Other contributed capital Retained earnings Total

$ 148,000 36,000 480,000 95,000 244,000 302,000 $1,305,000

Accounts Payable (to P) Accounts Receivable (from S)

10,000

Common Stock - S Other Contributed Capital - S Retained Earnings - S Difference Between Implied and Book Value

600,000 80,000 320,000 50,000

10,000

Chapter 3 Consolidated Financial Statements—Date of Acquisition Investment in S Company Noncontrolling Interest

3-4 A.

950,000 100,000

Land 50,000 Difference Between Implied and Book Value

50,000

Investment in Smithwick Company Cash

480,000

POPE COMPANY AND SUBSIDIARY Consolidated Balance Sheet January 2, 2013 Assets Cash (650,000 + 160,000 - $480,000) Accounts Receivable Inventory Plant and Equipment (net) Land ($150,000 + $80,000 + $73,333*) Total Assets

$330,000 420,000 430,000 1,210,000 303,333 $2,693,333

Liabilities and Stockholders’ Equity Accounts Payable Mortgage Payable Total liabilities

$380,000 280,000 $660,000

Noncontrolling Interest ($170,000 + $50,000 + $240,000 + 73,333) × .10

$ 53,333

Common Stock $1,000,000 Other Contributed Capital 520,000 Retained Earnings 460,000 Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity * $480,000/.9 - ($170,000 + $50,000 + $240,000)

1,980,000 $2,693,333

3-13

3-14 Test Bank to accompany Jeter and Chaney Advanced Accounting

3-5

ASSETS Cash Accounts receivable-net Inventories Land Plant assetsnet Investment in S Corp. Difference between implied and book value Goodwill Total Assets EQUITIES Current liabilities Capital stock Additional paid-in capital Retained earnings Noncontrolling interest Total Equities

3-6

$40,000

$30,000

30,000 185,000 45,000

45,000 165,000 120,000

480,000

240,000

Eliminations Debit Credit

Noncontrolling Interest

Consolidated Balances

$70,000 75,000 410,000 190,000

(b) 60,000 (b) 25,000

720,000

420,000

(a) 420,000

(a) 150,000 (b) 65,000

(b) 150,000

$1,200,000

$600,000

65,000 $1,530,000

$170,000 600,000

$150,000 300,000

(a) 300,000

$320,000 600,000

150,000

90,000

(a) 90,000

150,000

280,000

60,000

(a) 60,000

280,000

$1,200,000

$600,000

$750,000

(a) 180,000 $750,000

Common Stock – Sewell Other Contributed Capital – Sewell Difference between Implied and Book Values Retained Earnings – Sewell Investment in Sewell Noncontrolling Interest in Equity

450,000 180,000 45,000 75,000

Common Stock – Sewell Other Contributed Capital – Sewell Retained Earnings – Sewell Investment in Sewell Gain on Purchase of Business - Porter Noncontrolling Interest in Equity

620,000 140,000 20,000

180,000

675,000 75,000

318,000 306,000 156,000

180,000 $1,530,000

Chapter 3 Consolidated Financial Statements—Date of Acquisition 3-7

265,000/(1,060,000 +265,000) = 20% Noncontrolling interest

Common Stock – Shelter Other Contributed Capital – Shelter Retained Earnings – Shelter Difference between Implied and Book Values Investment in Shelter Company Noncontrolling Interest in Equity

520,000 380,000 280,000 145,000

Investment in Swatch Company ($50  1,500) Common Stock ($20  1,500) Other Contributed Capital ($30  1,500)

75,000

Other Contributed Capital Cash

1,700

3-8 A.

3-15

1,060,000 265,000

30,000 45,000

1,700

B. Computation and Allocation of Difference

Purchase price and implied value Less: Book value of equity acquired Difference between implied and book value Land Balance * $40,000 + $24,000 + $19,000 = $83,000

Parent Share $75,000 83,000* 7,000 (7,000) -0-

NonControlling Share 0 0 0 (0) -0-

Entire Value 75,000 83,000 7,000 (7,000) -0-

C. Cash balance: 73,000 + 13,000 –1,700 = $84,300 Land balance: 26,000 + 20,000 + 7,000= $ 53,000 Common Stock balance: 100,000 + 30,000 = $130,000 Other Contributed Capital: 60,000 + 45,000 – 1,700 = $ 103,300

Short Answer 1. Reasons why a company would acquire a subsidiary rather than its net assets include the following: a. Stock acquisition is relatively simple and avoids the often lengthy and difficult negotiations that are required in a complete takeover. b. Control of the subsidiary's operations can be accomplished with a much smaller investment. c. The separate legal existence of the individual affiliates provides an element of protection of the parent's assets from attachment by subsidiary creditors.

3-16 Test Bank to accompany Jeter and Chaney Advanced Accounting 2. Preparation of the Computation and Allocation of Difference Schedule involves the following process: a. Determine the percentage of stock acquired in the subsidiary. b. Compute the implied value of the subsidiary by dividing the purchase price by the percentage acquired. c. Allocate any difference between the implied value and the book value of the subsidiary's equity to adjust the underlying assets and/or liabilities of the acquired company.

Short Answer Questions from the Textbook Solutions

1. (1) Stock acquisition is greatly simplified by avoiding the lengthy negotiations required in an exchange of stock for stock in a complete takeover. (2) Effective control can be accomplished with more than 50% but less than all of the voting stock of a subsidiary; thus the necessary investment is smaller. (3) An individual affiliate’s legal existence provides a measure of protection of the parent’s assets delete space from attachment by creditors of the subsidiary. 2. The purpose of consolidated financial statements is to present, primarily for the benefit of the shareholders and creditors of the parent company, the results of operations and the financial position of a parent company and its subsidiaries essentially as if the group were a single company with one or more branches or divisions. The presumption is that these consolidated statements are more meaningful than separate statements and necessary for fair presentation. Emphasis then is on substance rather than legal form, and the legal aspects of the separate entities are therefore ignored in light of economic aspects. 3. Each legal entity must prepare financial statements for use by those who look to the legal entity for analysis. Creditors of the subsidiary will use the separate statements in assessing the degree of protection related to their claims. Noncontrolling shareholders, too, use these individual statements in determining risk and the amounts available for dividends. Regulatory agencies are concerned with the net resources and results of operations of the individual legal entities. 4. (1) Control should exist in fact, through ownership of more than 50% of the voting stock of the subsidiary. (2) The intent of control should be permanent. If there are current plans to dispose of a subsidiary, then the entity should not be consolidated. (3) Majority owners must have control. Such would not be the case if the subsidiary were in bankruptcy or legal reorganization, or if the subsidiary were in a foreign country where political forces were such that control by majority owners was significantly curtailed. 5. Consolidated workpapers are used as a tool to facilitate the preparation of consolidated financial statements. Adjusting and eliminating entries are entered on the workpaper so that the resulting consolidated data reflect the operations and financial position of two or more companies under common control.

Chapter 3 Consolidated Financial Statements—Date of Acquisition

3-17

6. Noncontrolling interest represents the equity in a partially owned subsidiary by those shareholders who are not members in the affiliation and should be accounted and presented in equity, separately from the parents’ shareholders equity. Alternative views have included: presenting the noncontrolling interest as a liability from the perspective of the controlling shareholders; presenting the noncontrolling interest between liabilities and shareholders’ equity to acknowledge its hybrid status; presenting it as a contra-asset so that total assets reflect only the parent’s share; and presenting it as a component of owners’ equity (the choice approved by FASB in its most recent exposure drafts). 7. The fair, or current, value of one or more specific subsidiary assets may exceed its recorded value, or specific liabilities may be overvalued. In either case, an acquiring company might be willing to pay more than book value. Also, goodwill might exist in the form of above normal earnings. Finally, the parent may be willing to pay a premium for the right to acquire control and the related economic advantages gained. 8. The determination of the percentage interest acquired, as well as the total equity acquired, is based on shares outstanding; thus, treasury shares must be excluded. The treasury stock account should be eliminated by offsetting it against subsidiary stockholder equity accounts. The accounts affected as well as the amounts involved will depend upon whether the cost or par method is used to account for the treasury stock. 9. None. The full amount of all intercompany receivables and payables is eliminated without regard to the percentage of control held by the parent. 10 A. The decision in SFAS No. 109 and SFAS No. 141R [topics 740 and 805] is primarily a display issue and would only affect the calculation of consolidated net income if there were changes in expected future tax rates that resulted in an adjustment to the balance of deferred tax assets or deferred tax liabilities. Prior to SFAS No. 109 and SFAS No. 141R, purchased assets and liabilities were displayed at their net of tax amounts and related figures for amortization and depreciation were based on the net of tax amounts. With the adoption of SFAS No. 109 and SFAS No. 141R, assets and liabilities are displayed at fair values and the tax consequences for differences between their assigned values and their tax bases are displayed separately as deferred tax assets or deferred tax liabilities. Although the amounts shown for depreciation, amortization and income tax expense are different under SFAS No. 109 and SFAS No. 141R, absent a change in expected future tax rates, the amount of consolidated net income will be the same.

ANSWERS TO BUSINESS ETHICS CASE Part 1 Even though the suggested changes by the CFO lie within GAAP, the proposed changes will unfairly increase the EPS of the company, misleading the common investors and other users. It is evident that the CFO is doing it for his or her personal gain rather than for the transparency of financial reporting. Thus, manipulating the reserve in this case comes under the heading of

3-18 Test Bank to accompany Jeter and Chaney Advanced Accounting

unethical behavior. Taking a stand in such a situation is a difficult and challenging test for an employee who reports to the CFO. Part 2 The tax laws permit individuals to minimize taxes by means that are within the law like using tax deductions, changing one's tax status through incorporation, or setting up a charitable trust or foundation. In the given case the losses reported were phony and the whole scheme was fabricated to illegally benefit certain individuals; hence there appears to be a criminal intent in the scheme. Although there is no reason to pay more tax than necessary, the lack of risk in these types of shelters makes participation in such schemes of questionable ethics, at the best.

Chapter 4 Consolidated Financial Statements after Acquisition 1.

An investor adjusts the investment account for the amortization of any difference between cost and book value under the a. cost method. b. complete equity method. c. partial equity method. d. complete and partial equity methods.

Under the partial equity method, the entry to eliminate subsidiary income and dividends includes a debit to a. Dividend Income. b. Dividends Declared - S Company. c. Equity in Subsidiary Income. d. Retained Earnings - S Company.

On the consolidated statement of cash flows, the parent’s acquisition of additional shares of the subsidiary’s stock directly from the subsidiary is reported as a. an investing activity. b. a financing activity. c. an operating activity. d. none of these.

Under the cost method, the workpaper entry to establish reciprocity a. debits Retained Earnings - S Company. b. credits Retained Earnings - S Company. c. debits Retained Earnings - P Company. d. credits Retained Earnings - P Company.

Under the cost method, the investment account is reduced when a. there is a liquidating dividend. b. the subsidiary declares a cash dividend. c. the subsidiary incurs a net loss. d. none of these.

The parent company records its share of a subsidiary’s income by a. crediting Investment in S Company under the partial equity method. b. crediting Equity in Subsidiary Income under both the cost and partial equity methods. c. debiting Equity in Subsidiary Income under the cost method. d. none of these.

In years subsequent to the year of acquisition, an entry to establish reciprocity is made under the a. complete equity method. b. cost method. c. partial equity method. d. complete and partial equity methods.

4-2 8.

Test Bank to accompany Jeter and Chaney Advanced Accounting A parent company received dividends in excess of the parent company’s share of the subsidiary’s earnings subsequent to the date of the investment. How will the parent company’s investment account be affected by those dividends under each of the following accounting methods?

a. b. c. d.

Cost Method No effect Decrease No effect Decrease

Partial Equity Method No effect No effect Decrease Decrease

P Company purchased 80% of the outstanding common stock of S Company on May 1, 2014, for a cash payment of $1,272,000. S Company’s December 31, 2013 balance sheet reported common stock of $800,000 and retained earnings of $540,000. During the calendar year 2014, S Company earned $840,000 evenly throughout the year and declared a dividend of $300,000 on November 1. What is the amount needed to establish reciprocity under the cost method in the preparation of a consolidated workpaper on December 31, 2015? a. $208,000 b. $260,000 c. $248,000 d. $432,000

10.

P Company purchased 90% of the outstanding common stock of S Company on January 1, 2010 . S Company’s stockholders’ equity at various dates was: 1/1/10 1/1/14 12/31/14 Common stock $400,000 $400,000 $400,000 Retained earnings 120,000 380,000 460,000 Total $520,000 $780,000 $860,000 The workpaper entry to establish reciprocity under the cost method in the preparation of a consolidated statements workpaper on December 31, 2014 should include a credit to P Company’s retained earnings of a. $80,000. b. $234,000. c. $260,000. d. $306,000.

11.

Consolidated net income for a parent company and its partially owned subsidiary is best defined as the parent company’s a. recorded net income. b. recorded net income plus the subsidiary’s recorded net income. c. recorded net income plus the its share of the subsidiary’s recorded net income. d. income from independent operations plus subsidiary’s income resulting from transactions with outside parties.

12.

In the preparation of a consolidated statements workpaper, dividend income recognized by a parent company for dividends distributed by its subsidiary is a. included with parent company income from other sources to constitute consolidated net income. b. assigned as a component of the noncontrolling interest. c. allocated proportionately to consolidated net income and the noncontrolling interest. d. eliminated.

Chapter 4 Consolidated Financial Statements after Acquisition

4-3

13.

In the preparation of a consolidated statement of cash flows using the indirect method of presenting cash flows from operating activities, the amount of the noncontrolling interest in consolidated income is a. combined with the controlling interest in consolidated net income. b. deducted from the controlling interest in consolidated net income. c. reported as a significant noncash investing and financing activity in the notes. d. reported as a component of cash flows from financing activities.

14.

On October 1, 2014, Perma Company acquired for cash all of the voting common stock of Street Company. The purchase price of Street’s stock equaled the book value and fair value of Street’s net assets. The separate net income for each company, excluding Perma’s share of income from Street was as follows: Perma Street Twelve months ended 12/31/14 $4,500,000 $2,700,000 Three months ended 12/31/14 495,000 450,000 During September, Street paid $150,000 in dividends to its stockholders. For the year ended December 31, 2014, Perma issued parent company only financial statements. These statements are not considered those of the primary reporting entity. Under the partial equity method, what is the amount of net income reported in Perma’s income statement? a. $7,200,000. b. $4,650,000. c. $4,950,000. d. $1,800,000.

15.

A parent company uses the partial equity method to account for an investment in common stock of its subsidiary. A portion of the dividends received this year were in excess of the parent company’s share of the subsidiary’s earnings subsequent to the date of the investment. The amount of dividend income that should be reported in the parent company’s separate income statement should be a. zero. b. the total amount of dividends received this year. c. the portion of the dividends received this year that were in excess of the parent’s share of subsidiary’s earnings subsequent to the date of investment. d. the portion of the dividends received this year that were NOT in excess of the parent’s share of subsidiary’s earnings subsequent to the date of investment.

16.

Pine, Inc. owns 40% of Supra Corporation. During the year, Supra had net earnings of $200,000 and paid dividends of $50,000. Masters used the cost method of accounting. What effect would this have on the investment account, net earnings, and retained earnings, respectively? a. understate, overstate, overstate. b. overstate, understate, understate c. overstate, overstate, overstate d. understate, understate, understate

4-4

Test Bank to accompany Jeter and Chaney Advanced Accounting

Use the following information in answering questions 17 and 18. 17.

Prime Industries acquired a 70 percent interest in Suburbia Company by purchasing 14,000 of its 20,000 outstanding shares of common stock at book value of $210,000 on January 1, 2013. Suburbia reported net income in 2013 of $90,000 and in 2014 of $120,000 earned evenly throughout the respective years. Prime received no bold - inconsistent$24,000 dividends from Suburbia in 2013 and $36,000 in 2014. Prime uses the equity method to record its investment. Prime should record investment income from Suburbia during 2014 of: a. $36,000 b. $120,000 c. $84,000 d. $48,000

18.

The balance of Prime’s Investment in Suburbia account at December 31, 2014 is: a. $210,000 b. $285,000 c. $297,000 d. $315,000

19.

Park Company acquired a 90% interest in Southwestern Company on December 31, 2013, for $320,000. During 2014 Southwestern had a net income of $22,000 and paid a cash dividend of $7,000. Applying the cost method would give a debit balance in the Investment in Stock of Southwestern Company account at the end of 2014 of: a. $335,000 b. $333,500 c. $313,700 d. $320,000

20.

Pall, Inc., owns 40% of the outstanding stock of Sibil Company. During 2014, Pall received a $4,000 cash dividend from Sibil. What effect did this dividend have on Pall’s 2014 financial statements? a. Increased total assets. b. Decreased total assets. c. Increased income. d. Decreased investment account.

21.

P Company purchased 80% of the outstanding common stock of S Company on May 1, 2014, for a cash payment of $318,000. S Company’s December 31, 2013 balance sheet reported common stock of $200,000 and retained earnings of $180,000. During the calendar year 2014, S Company earned $210,000 evenly throughout the year and declared a dividend of $75,000 on November 1. What is the amount needed to establish reciprocity under the cost method in the preparation of a consolidated workpaper on December 31, 2014? a. $52,000 b. $65,000 c. $62,000 d. $108,000

Chapter 4 Consolidated Financial Statements after Acquisition 22.

4-5

P Company purchased 90% of the outstanding common stock of S Company on January 1, 2012. S Company’s stockholders’ equity at various dates was: 1/1/12 1/1/14 12/31/14 Common stock $200,000 $200,000 $200,000 Retained earnings 60,000 190,000 230,000 Total $260,000 $390,000 $430,000 The workpaper entry to establish reciprocity under the cost method in the preparation of a consolidated statements workpaper on December 31, 2014 should include a credit to P Company’s retained earnings of a. $40,000. b. $117,000. c. $130,000. d. $153,000.

Use the following information in answering questions 23 and 24. 23.

Prime Industries acquired an 80 percent interest in Sands Company by purchasing 24,000 of its 30,000 outstanding shares of common stock at book value of $105,000 on January 1, 2013. Sands reported net income in 2013 of $45,000 and in 2014 of $60,000 earned evenly throughout the respective years. Prime received no bold $12,000 dividends from Sands in 2013 and $18,000 in 2014. Prime uses the equity method to record its investment. Prime should record investment income from Sands during 2014 of: a. $18,000. b. $60,000. c. $48,000. d. $33,600.

24.

The balance of Prime’s Investment in Sands account at December 31, 2014 is: a. $105,000. b. $138,600. c. $159,000. d. $165,000.

25.

Pendleton Company acquired a 70% interest in Sunflower Company on December 31, 2013, for $380,000. During 2014 Sunflower had a net income of $30,000 and paid a cash dividend of $10,000. Applying the cost method would give a debit balance in the Investment in Stock of Sunflower Company account at the end of 2014 of: a. $400,000. b. $394,000. c. $373,000. d. $380,000.

4-6

Test Bank to accompany Jeter and Chaney Advanced Accounting

Use the following information to answer questions 26 and 27 On January 1, 2014, Puma Corporation acquired 30 percent of Slume Company's stock for $150,000. On the acquisition date, Slume reported net assets of $450,000 valued at historical cost and $500,000 stated at fair value. The difference was due to the increased value of buildings with a remaining life of 10 years. During 2014 Slume reported net income of $25,000 and paid dividends of $10,000. Puma uses the equity method. 26.

What will be the balance in the Investment account as of Dec 31, 2014? a. $150,000 b. $157,500 c. $154,500 d. $153,000

27.

What amount of investment income will be reported by Puma for the year 2014? a. $7,500 b. $6,000 c. $4,500 d. $25,000

28.

On January 1, 2014, Panda Company purchased 25 % of Skill Company’s common stock; no goodwill resulted from the acquisition. Panda Company appropriately carries the investment using the equity method of accounting and the balance in Panda’s investment account was $190,000 on December 31, 2014. Skill reported net income of $120,000 for the year ended December 31, 2014 and paid dividends on its common stock totaling $48,000 during 2014. How much did Panda pay for its 25% interest in Skill? a. $172,000 b. $202,000 c. $208,000 d. $232,000

Use the following information to answer questions 29 and 30. 29.

On January 1, 2014, Pantera Company purchased 40% of Stratton Company’s 30,000 shares of voting common stock for a cash payment of $1,800,000 when 40% of the net book value of Stratton Company was $1,740,000. The payment in excess of the net book value was attributed to depreciable assets with a remaining useful life of six years. As a result of this transaction Pantera has the ability to exercise significant influence over Stratton Company’s operating and financial policies. Stratton’s net income for the ended December 31, 2014 was $600,000. During 2014, Stratton paid $325,000 in dividends to its shareholders. The income reported by Pantera for its investment in Stratton should be: a. $120,000 b. $130,000 c. $230,000 d. $240,000

30.

What is the ending balance in Pantera’s investment account as of December 31, 2014? a. $1,800,000 b. $1,900,000 c. $1,910,000 d. $2,030,000

Chapter 4 Consolidated Financial Statements after Acquisition 31.

4-7

Which one of the following describes a difference in how the equity method is applied under GAAP than under IFRS? a. the equity method is generally applied to limited partnerships under IFRS for investments of more than 3 to 5%, whereas GAAP adopts a “significant influence” principle. b. IFRS requires uniform accounting policies, whereas GAAP does not. c. significant influence is presumed if the investor has 20% or more of the voting rights in a corporate investee under GAAP, whereas IFRS adopts a “facts and circumstances” approach that looks beyond the voting rights percentage. d. GAAP requires consideration of potential voting rights on currently exercisable of convertible instruments, whereas IFRS does not.

Problems 4-1

On January 1, 2014, Prince Company purchased an 80% interest in the common stock of Sivet Company for $1,040,000, which was $60,000 greater than the book value of equity acquired. The difference between implied and book value relates to the subsidiary’s land. The following information is from the consolidated retained earnings section of the consolidated statements workpaper for the year ended December 31, 2014:

1/01/14 retained earnings Net income Dividends declared 12/31/14 retained earnings

SIVET COMPANY $300,000 220,000 (80,000) $440,000

CONSOLIDATED BALANCES $1,400,000 680,000 (140,000) $1,940,000

Sivet’s stockholders’ equity includes only common stock and retained earnings. Required: A. Prepare the workpaper eliminating entries for a consolidated statements workpaper on December 31, 2014. Prince uses the cost method. B. Compute the total noncontrolling interest to be reported on the consolidated balance sheet on December 31, 2014.

4-2

On October 1, 2014, Pamela Company purchased 90% of the common stock of Shingle Company for $290,000. Additional information for both companies for 2014 follows:

Common stock Other contributed capital Retained Earnings, 1/1 Net Income Dividends declared (10/31)

PAMELA $300,000 120,000 240,000 260,000 40,000

SHINGLE $90,000 40,000 50,000 160,000 8,000

4-8

Test Bank to accompany Jeter and Chaney Advanced Accounting Any difference between implied and book value relates to Shingle’s land. Pamela uses the cost method to record its investment in Shingle. Shingle Company’s income was earned evenly throughout the year. Required: A. Prepare the workpaper entries that would be made on a consolidated statements workpaper on December 31, 2014. Use the full year reporting alternative. B. Calculate the controlling interest in consolidated net income for 2014.

4-3

On January 1, 2014, Pioneer Company purchased 80% of the common stock of Shipley Company for $600,000. At that time, Shipley’s stockholders’ equity consisted of the following: Common stock Other contributed capital Retained earnings

$220,000 90,000 320,000

During 2014, Shipley distributed a dividend in the amount of $120,000 and at year-end reported a $320,000 net income. Any difference between implied and book value relates to subsidiary goodwill. Pioneer Company uses the equity method to record its investment. No impairment of goodwill is observed in the first year. Required: A. Prepare on Pioneer Company’s books journal entries to record the investment related activities for 2014. B. Prepare the workpaper eliminating entries for a workpaper on December 31, 2014.

4-4

Prune Company purchased 80% of the outstanding common stock of Selma Company on January 2, 2004, for $680,000. The composition of Selma Company’s stockholders’ equity on January 2, 2004, and December 31, 2014, was: 1/2/04 12/31/1112/31/14 Common stock $540,000 $540,000 Other contributed capital 325,000 325,000 Retained earnings (deficit) (60,000) 295,000 Total stockholders’ equity $805,000 $1,160,000 During 2014, Selma Company earned $210,000 net income and declared a $60,000 dividend. Any difference between implied and book value relates to land. Prune Company uses the cost method to record its investment in Selma Company. Required: A. Prepare any journal entries that Prune Company would make on its books during 2014 to record the effects of its investment in Selma Company.

Chapter 4 Consolidated Financial Statements after Acquisition

4-9

B. Prepare, in general journal form, all workpaper entries needed for the preparation of a consolidated statements workpaper on December 31, 2014.

4-5

P Company purchased 90% of the common stock of S Company on January 2, 2014 for $900,000. On that date, S Company’s stockholders’ equity was as follows: Common stock, $20 par value Other contributed capital Retained earnings

$400,000 100,000 450,000

During 2014, S Company earned $200,000 and declared a $100,000 dividend. P Company uses the partial equity method to record its investment in S Company. The difference between implied and book value relates to land. Required: Prepared, in general journal form, all eliminating entries for the preparation of a consolidated statements workpaper on December 31, 2014.

4-6

Pure Company acquired 80% of the outstanding common stock of Saxxon Company on January 2, 2013 for $675,000. At that time, Saxxon’s total stockholders’ equity amounted to $1,000,000. Saxxon Company reported net income and dividends for the last two years as follows:

Reported net income Dividends distributed

2013 $45,000 35,000

2014 $60,000 75,000

Required: Prepare journal entries for Pure Company for 2013 and 2014 assuming Pure uses: A. The cost method to record its investment B. The complete equity method to record its investment. The difference between implied value and the book value of equity acquired was attributed solely to a building, with a 20-year expected life.

4-7

Pell Company purchased 90% of the stock of Salton Company on January 1, 2007, for $1,860,000, an amount equal to $60,000 in excess of the book value of equity acquired. All book values were equal to fair values at the time of purchase (i.e., any excess payment relates to subsidiary goodwill). On the date of purchase, Salton Company’s retained earnings balance was $200,000. The remainder of the stockholders’ equity consists of no-par common stock. During 2014, Salton Company declared dividends in the amount of $40,000, and reported net income of $160,000. The retained earnings balance of Salton Company on December 31, 2013 was $640,000. Pell Company uses the cost method to record its investment. No impairment of goodwill was recognized between the date of acquisition and December 31, 2014. Required:

4-10 Test Bank to accompany Jeter and Chaney Advanced Accounting Prepare in general journal form the workpaper entries that would be made in the preparation of a consolidated statements workpaper on December 31, 2014.

4-8

On January 1, 2014, Pruit Company purchased 85% of the outstanding common stock of Salty Company for $525,000. On that date, Salty Company’s stockholders’ equity consisted of common stock, $150,000; other contributed capital, $60,000; and retained earnings, $210,000. Pruit Company paid more than the book value of net assets acquired because the recorded cost of Salty Company’s land was significantly less than its fair value. During 2014 Salty Company earned $222,000 and declared and paid a $75,000 dividend. Pruit Company used the partial equity method to record its investment in Salty Company. Required: A. Prepare the investment related entries on Pruit Company’s books for 2014. B. Prepare the workpaper eliminating entries for a workpaper on December 31, 2014. 4-9 Pinta Company purchased 40% of Snuggie Corporation on January 1, 2014 for $150,000. Snuggie Corporation’s balance sheet at the time of acquisition was as follows:

Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Acc. Depreciation

$30,000 120,000 80,000 150,000 300,000 (120,000)

Current Liabilities Bonds Payable Common Stock Additional Paid in Capital Retained Earnings

$40,000 200,000 200,000 40,000 80,000

Total Assets

$560,000

Total Liabilities and Equities

$560,000

During 2014, Snuggie Corporation reported net income of $30,000 and paid dividends of $9,000. The fair values of Snuggie’s assets and liabilities were equal to their book values at the date of acquisition, with the exception of Building and Equipment, which had a fair value of $35,000 above book value. All buildings and equipment had a remaining useful life of five years at the time of the acquisition. The amount attributed to goodwill as a result of the acquisition in not impaired. Required: A. What amount of investment income will Pinta record during 2014 under the equity method of accounting? B. What amount of income will Pinta record during 2014 under the cost method of accounting? C. What will be the balance in the investment account on December 31, 2014 under the cost and equity method of accounting?

Chapter 4 Consolidated Financial Statements after Acquisition

4-11

Short Answer 1.

There are three levels of influence or control by an investor over an investee, delete ,which determine the appropriate accounting treatment. Identify and briefly describe the three levels and their accounting treatment.

Two methods are available to account for interim acquisitions of a subsidiary’s stock at the end of the first year. Describe the two methods of accounting for interim acquisitions.

Short Answer Questions from the Textbook 1. How should nonconsolidated subsidiaries be re-ported reported in consolidated financial statements? 2. How are liquidating dividends treated on the books of an investor, assuming the investor uses the cost method? Assuming the investor uses the equity method? 3. How are dividends declared and paid by a subsidiary during the year eliminated in the consolidated work papers under each method of ac-counting accountingfor investments? 4. How is the income reported by the subsidiary reflected on the books of the investor under each of the methods of accounting for investments? 5. Define: Consolidated net income; consolidated retained earnings. 6. At the date of an 80% acquisition, a subsidiary had common stock of $100,000 and retained earnings of $16,250. Seven years later, at December 31, 2013, the subsidiary’s retained earnings had increased to $461,430. What adjustment will be made on the consolidated work paper at December 31, 2014, to recognize the parent’s share of the cumulative undistributed profits (losses)of its subsidiary? Under which method(s) is this adjustment needed? Why? 7. On a consolidated work paper for a parent and its partially owned subsidiary, the noncontrolling interest column accumulates the non controlling interests’ share of several account balances. What are these accounts? 8. If a parent company elects to use the partial equity method rather than the cost method to record its investments in subsidiaries, what effect will this choice have on the consolidated financial statements? If the parent company elects the complete equity method? 9. Describe two methods for treating the preacquisition revenue and expense items of a subsidiary purchased during a fiscal period. 10. A principal limitation of consolidated financial statements is their lack of separate financial information about the assets, liabilities, revenues, and expenses of the individual companies included in the consolidation. Identify some problems that the reader of consolidated financial statements would encounter as a result of this limitation. 11. In the preparation of a consolidated statement of cash flows, what adjustments are necessary because of the existence of a noncontrolling interest? (AICPA adapted)

4-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 12. What do potential voting rights refer to, and how do they affect the application of the equity method for investments under IFRS? Under U.S.GAAP? What is the term generally used for equity method investments under IFRS? 13B.why the Bs? Is the recognition of a deferred tax asset or deferred tax liability when allocating the difference between book value and the value implied by the purchase price affected by whether or not the affiliates file a consolidated income tax re-turnreturn? 14B.

What assumptions must be made about the realization of undistributed subsidiary income when the affiliates file separate income tax returns? Why? (Appendix)

15B.

The FASB elected to require that deferred tax effects relating to unrealized intercompany profits be calculated based on the income tax paid by the selling affiliate rather than on the future tax benefit to the purchasing affiliate. Describe circumstances where the amounts calculated under these approaches would be different. (Appendix)

16B.

Identify two types of temporary differences that may arise in the consolidated financial statements when the affiliates file separate income tax returns.

Business Ethics Question from the Textbook On April 5, 2006, the New York State Attorney sued a New York online advertising firm for surreptitiously installing spyware advertising programs on consumers’ computers. The Attorney General claimed that consumers believed they were downloading free games or ‘browser’ enhancements. The company claimed that the spyware was identified as ‘advertising-supported’ and that the software is easy to remove and doesn’t collect personal data. Is there an ethical issue for the company? Comment on and justify your position.

Chapter 4 Consolidated Financial Statements after Acquisition ANSWER KEY Multiple Choice 1. 2. 3. 4. 5. 6. 7.

b c d d a d b

8. 9. 10. 11. 12. 13. 14.

d a b d d a c

15. 16. 17. 18. 19. 20. 21.

a d c c d d a

22. 23. 24. 25. 26. 27. 28.

b c C d d b a

29. 30. 31.

Problems 4-1

A. Dividend Income (80,000 × .80) Dividends Declared – Sivet Common Stock – Sivet Retained Earnings, 1/1 – Sivet Difference Between Implied and Book Value Investment in Sivet Company Noncontrolling Interest in Equity

64,000 64,000 925,000* 300,000 75,000** 1,040,000 260,000

*[(1,040,000 – 60,000)/.8] – 300,000 **60,000/.8 = 75,000 Land Difference Between Implied and Book Value

75,000 75,000

B. Noncontrolling Interest: In 1/1/111/1/14 retained earnings 300,000 × .20 In 2014 net income 220,000 × .20 In dividends declared 80,000 × .20 In common stock of Sivet 925,000 × .20 In difference between implied and book value 75,000 x .20 Total noncontrolling interest 4-2

A. Dividend Income (8,000 × .90) Dividends Declared – Shingle

$60,000 44,000 (16,000) 185,000 15,000 $288,000

7,200

Common Stock - Shingle 90,000 Other Contributed Capital – Shingle 40,000 Retained Earnings 1/1 – Shingle 50,000 Difference between Implied# and Book Value (290,000/.9 – 300,000*) 22,222 Subsidiary Income Purchased (160,000 × 9/12) 120,000 Investment in Shingle Company Noncontrolling Interest in Equity (.10 x $322,222)

7,200

290,000 32,222

c b b

4-13

4-14 Test Bank to accompany Jeter and Chaney Advanced Accounting *BV=[90,000 + 40,000 + 50,000 + (160,000 × 9/12)] = $300,000 #Implied Value = Purchase Price/90% = $322,222 Land Difference Between Implied and Book Value

22,222 22,222

B. Controlling interest in Consolidated Net Income Pamela’s reported net income $260,000 – dividend income from Shingle 7,200 Pamela’s income from independent operations 252,800 + Pamela’s share of Shingle’s net income in 2014 since acquisition (.90 × 40,000) 36,000 Controlling Interest in Consolidated Net Income $288,800 4-3

A. Investment in Shipley Company Cash Investment in Shipley Company (.80 × 320,000) Equity in Subsidiary Income

600,000 600,000

256,000 256,000

Cash (.80 × 120,000) Investment in Shipley Company

96,000

B. Equity in Subsidiary Income Dividends Declared – Shipley Investment in Shipley Company

216,000

Common Stock – Shipley Other Contributed Capital – Shipley Retained Earnings 1/1 – Shipley Difference Between Implied and Book Value Investment in Shipley Company Noncontrolling Interest in Equity

96,000

96,000 120,000 220,000 90,000 320,000 120,000 600,000 150,000

Goodwill 120,000 Difference Between Implied and Book Value

4-4

A. Cash Dividend Income (.8 × $60,000) B. To Establish Reciprocity Investment in Selma Company 1/1 Retained Earnings - Prune Company

120,000

48,000 48,000

164,000 164,000

$295,000 – $210,000 + $60,000 = $145,000 Retained Earnings on 1/1/111/1/14 $145,000 + $60,000 (deficit on date of acquisition) = $205,000 increase in retained earnings from date of acquisition to 1/1/111/1/14 Prune Company’s share of increase = (.8 × $205,000) = $164,000

Chapter 4 Consolidated Financial Statements after Acquisition Eliminating Entries Dividend Income Dividends Declared – Selma Company

48,000 48,000

Common Stock – Selma 540,000 Other Contributed Capital – Selma 325,000 1/1 Retained Earnings – Selma 145,000 Difference Between Implied and Book Value45,000* Investment in Selma Company Noncontrolling Interest in Equity

844,000 211,000

Implied Value = $680,000/.80 = $850,000. Diff = $850,000 – $805,000BV. Land 45,000 Difference Between Implied and Book Value

4-5

Equity in Subsidiary Income Dividends Declared - S Company Investment in S Company

270,000

Common Stock – S Other Contributed Capital – S 1/1 Retained Earnings – S Difference Between Implied and Book Value Investment in S Company Noncontrolling Interest in Equity

400,000 100,000 450,000 50,000

45,000

90,000 180,000

900,000 100,000

Land 50,000 Difference Between Implied and Book Value

50,000

A. 2013 Investment in Saxxon Company Cash

675,000

4-6

Cash Dividend Income (.8 × $35,000)

675,000

28,000 28,000

2014 Cash (.8 × $75,000) 60,000 Investment in Saxxon Company (.8 × $5,000) Dividend Income B. 2013 Investment in Saxxon Company Cash

4,000 56,000

675,000 675,000

4-15

4-16 Test Bank to accompany Jeter and Chaney Advanced Accounting Cash

28,000 Investment in Saxxon Company

28,000

Investment in Saxxon Company Equity in Subsidiary Income (.8 × $45,000) Equity in Subsidiary Income ($75,000*/20) Investment in Saxxon Company

36,000 36,000

3,750 3,750

* $675,000/.8 – $750,000 = $93,750 write-up of PPE; Parent’s share = 80%, or $75,000 2014 Cash Investment in Saxxon Company

60,000 60,000

Investment in Saxxon Company Equity in Subsidiary Income (.8 × $60,000) Equity in Subsidiary Income Investment in Saxxon Company

4-7

48,000 48,000

3,750

Workpaper entries 12/31/111/1/14 Investment in Salton Company Retained Earnings 1/1 - Pell company To establish reciprocity (.90 × ($640,000 – $200,000)) Dividend Income Dividends Declared - Salton Company

3,750

396,000 396,000

36,000 36,000

Common Stock - Salton Company# 1,800,000 Retained Earnings 1/1/111/1/14 - Salton Company 640,000 Difference between Implied and Book Values 66,667 Investment in Salton Company ($1,860,000 + $396,000) Noncontrolling Interest in Equity ($206,667 + $44,000##) #$2,000,000– $200,000 ##NCI share of change in R/E = .10($640,000 - $200,000) Goodwill* Difference between Implied and Book Values

2,256,000 250,667

66,667 66,667

*See computation of difference between implied and book values on following page.

Chapter 4 Consolidated Financial Statements after Acquisition

4-17

Computation and Allocation of Difference between Implied and Book Value Parent Share Purchase price and implied value Equity at book value Difference between Implied value and bv Allocated to undervalued land Balance * $1,860,000 – $60,000 ** $1,800,000/.9

4-8

A. Investment in Salty Cash

$1,860,000 1,800,000* 60,000 (60,000) -0-

525,000 525,000

Investment in Salty ($222,000)(.85) Equity in Subsidiary Income

188,700

Cash ($75,000)(.85) Investment in Salty

63,750

B. Equity in Subsidiary Income Dividends Declared - Salty Investment in Salty

NonEntire Controlling Value Share 206,667 2,066,667 200,000 2,000,000** 6,667 66,667 (6,667) (66,667) -0-0-

188,700

63,750 188,700 63,750 124,950

Common Stock - Salty Other Contributed Capital - Salty Retained Earnings 1/1 - Salty Difference between Implied and Book Value Investment in Salty Noncontrolling Interest in Equity

150,000 60,000 210,000 197,647

Land Difference between Implied and Book Value

197,647

525,000 92,647

197,647

Computation and Allocation of Difference between Implied and Book Value Parent NonShare controlling share Purchase price and implied value $ 525,000 92,647 Book Value of Equity Acquired 357,000 63,000 Difference between Implied and Book Value 168,000 29,647 Adjust Land Upward (168,000) (29,647) Balance -0-0-

Entire value 617,647 420,000 197,647 (197,647) -0-

4-18 Test Bank to accompany Jeter and Chaney Advanced Accounting

4-9 Solution:delete A. Pinta Company 2014 equity-method income: Proportionate share of reported income ($30,000 x .40) Amortization of differential assigned to: Buildings and equipment [($35,000 x .40) / 5 years] Goodwill ($8,000: not impaired) Investment Income

$ 12,000 (2,800) -0$ 9,200

Assignment of differential Purchase price Proportionate share of book value of net assets ($320,000 x .40) Proportionate share of fair value increase in buildings and equipment ($35,000 x .40) Goodwill

$150,000 (128,000) (14,000) $ 8,000

Dividend income, 2014 ($9,000 x .40)

$ 3,600

Cost-method account balance (unchanged):

$150,000

Equity-method account balance: Balance, January 1, 2014 Investment income Dividends received Balance, December 31, 2014

$150,000 9,200 (3,600) $155,600

Short Answers 1. The three levels of influence (control) over an investee are (1) no significant influence, (2) significant influence, and (3) effective control. When an investor has no significant influence over an investee, the investment is accounted for at fair value with year-end adjustment for market changes (the cost method). If the investor has significant influence over the investee, the investment is accounted for under the equity method. In the equity method, the investor adjusts the investment account for changes in the investee's net assets. When an investor has effective control over the investee, consolidated financial statements are prepared. The investor's investment account is eliminated in the consolidated process.

Chapter 4 Consolidated Financial Statements after Acquisition

4-19

2. The two methods of accounting for interim acquisitions are the full-year reporting alternative and the partial-year reporting alternative. The full-year method includes the subsidiary's revenues and expenses in the consolidated income statement for the entire year and then makes a deduction at the bottom of the income statement for the preacquisition earnings. The partial-year method includes in the consolidated income statement only the subsidiary's revenue and expense amounts for the period after acquisition. The full-year method is preferred.

Short Answer Questions in Textbook Solutions

Nonconsolidated subsidiaries are expected to be relatively rare. In those situations where a subsidiary is not consolidated, the investment in the subsidiary should be reported in the consolidated statement of financial position at cost, along with other long-term investments.

A liquidating dividend is a return of investment rather than a return on investment. Consequently, the amount of a liquidating dividend should be credited to the investment account rather than to dividend income when the cost method is used, whereas regular dividends are recorded as dividend income under the cost method. If the equity method is used, all dividends are credited to the investment account.

When the parent company uses the cost method, the work paper elimination of intercompany dividends is made by a debit to Dividend Income and a credit to Dividends Declared. This elimination prevents the double counting of income since the subsidiary's individual revenue and expense items are combined with the parent company's in the determination of consolidated net income. When the parent company uses the equity method, the work paper elimination for intercompany dividends is made by a debit to the investment account and a credit to Dividends Declared.

When the parent company uses the cost method, dividends received are recorded as dividend income. When the parent company uses the partial equity method, the parent company recognizes equity income on its books equal to its ownership percentage times the investee company’s reported net income. When the parent company uses the complete equity method, the parent recognizes income similar to the partial equity method, but adjusts the equity income for additional charges or credits when the purchase price differs from the fair value of the investee company’s net assets, and for intercompany profits (addressed in chapters 6 and 7).

Consolidated net income consists of the parent company's net income from independent operations plus (minus) any income (loss) earned (incurred) by its subsidiaries during the period, adjusted for any intercompany transactions during the period and for any excess depreciation or amortization implied by a purchase price in excess of book values. Consolidated retained earnings consist of the parent company's retained earnings from its independent operations plus (minus) the parent company's share of the increase (decrease) in its subsidiaries' retained earnings from the date of acquisition.

4-20 Test Bank to accompany Jeter and Chaney Advanced Accounting

Investment in S Company 1/1 Retained Earnings, P Company 80%  ($461,430 - $16,250)]

356,144 356,144

This adjustment recognizes that P Company's share of S Company's undistributed profits from the date of acquisition to the beginning of the current year is properly a part of beginning-of-year consolidated retained earnings. It also enhances the elimination of the investment account. This entry is only needed if the parent company uses the cost method. If the equity method is used, the parent’s retained earnings already reflect the undistributed earnings of the subsidiary. 7.

The noncontrolling interest column accumulates the noncontrolling stockholders' share of subsidiary income, less their share of excess depreciation or amortization implied by fair value adjustments (addressed in detail in chapter 5), dividends (as a reduction), and the beginning noncontrolling interest in equity carried forward from the previous period.

The method used to record the investment on the books of the parent company (cost method, partial equity method, or complete equity method) has no effect on the consolidated financial statements. Only the workpaper elimination procedures are affected.

The two methods for treating the preacquisition revenue and expense items of a subsidiary purchased during a fiscal year are (1) including the revenue and expense items of the subsidiary for the entire period with a deduction at the bottom of the consolidated income statement for the net income earned prior to acquisition (this is the preferred method), and (2) including in the consolidated income statement only the subsidiary's revenue earned and expenses incurred subsequent to the date of purchase.

10. (a) Readers of consolidated financial statements will be unable to evaluate the financial position and results of operations (neither of which is shown separately from the parent's) of the subsidiaries. (b) Because consolidated assets are not generally available to meet the claims of the creditors of a subsidiary, creditors will have to look to the financial statements of the debtor (subsidiary) corporation. Similarly, the creditors of the parent company are most interested in only the assets of the parent company, although large creditors are likely to gain control over or have indirect access to the assets of subsidiaries in the case of parent company default. (c) Because consolidated financial statements are a composite, it is impossible to distinguish a financially weak subsidiary from financially strong ones. (d) Ratio analyses based on consolidated data are not reliable guides, especially when the related group produces a conglomerate of unrelated product lines and services.

(e) Consolidated financial statements often do not disclose data about subsidiaries that are not consolidated. (f) A reader of consolidated financial statements cannot assume that a certain amount of unrestricted consolidated retained earnings will be available for dividends. Data on the ability of the individual subsidiaries to pay dividends are frequently unavailable.

Chapter 4 Consolidated Financial Statements after Acquisition

4-21

11. A consolidated statement of cash flows contains two adjustments that result from the existence of a noncontrolling interest: (1) an adjustment for the noncontrolling interest in net income or loss of the subsidiary in the determination of net cash flow from operating activities, and (2) subsidiary dividend payments to the noncontrolling stockholders must be included with parent company dividends paid in determining cash paid as dividends because the entire amount of the noncontrolling interest in net income (loss) is added back (deducted) in determining net cash flows from operating activities. 12. Potential voting rights refer to the rights associated with potentially dilutive securities such as convertible bonds or stocks, or stock options, rights, or warrants that are currently exercisable. These are considered under international standards in determining the applicability of the equity method for investments where the investor may be considered to have significant influence. They are generally not considered under U.S. GAAP. International standards (IFRS) refer to investments that are accounted for under the equity method as “investments in associates.” 13B.again, why the Bs? No. The recognition and display of a deferred tax asset or deferred tax liability relating to the assignment of the difference between implied value and book value is necessary without regard to whether the affiliates file consolidated income tax returns or separate income tax returns. 14B

An assumption must be made as to whether the undistributed income will be realized in a future dividend distribution or as a result of the sale of the subsidiary. This is necessary because the calculation of the tax consequences differs depending on the assumption made. Dividend distributions are subject to a dividends received exclusion, whereas gains or losses on disposal are not. In addition, gains or losses on disposal may be taxed at different tax rates than dividend distributions. Although capital gains are currently taxed at the same rates as ordinary income, the rates have been different in the past and may be again in the future.

15B

The amounts calculated under these two approaches would be different (1) if the affiliates had different marginal tax rates, (2) if the affiliates were in different tax jurisdictions, or (3) when expected future tax rates differ from the tax rate used in determining the tax paid or accrued by the selling affiliate.

16B

When the affiliates file separate returns, two types of temporary differences may arise: 1. Deferred income tax consequences that arise in the consolidated financial statements because of undistributed subsidiary income, and 2. Deferred income tax consequences that arise in the consolidated financial statements because of the elimination of unrealized intercompany profit.

ANSWERS TO BUSINESS ETHICS CASE Surreptitiously installing spyware on computers can be an unethical practice (the word surreptitious implies that the customer is unaware of the activity). The programs run in the background and can significantly slow down the computer’s operating performance. Sometimes these programs are used to pass on the consumer browsing history and may leak personal information to the advertising firm. Installing spyware without permission is unethical (and often illegal) especially if it collects personal data or interferes with the operations of the computer.

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value Multiple Choice 1.

When the implied value exceeds the aggregate fair values of identifiable net assets, the residual difference is accounted for as a. excess of implied over fair value. b. a deferred credit. c. difference between implied and fair value. d. goodwill.

Under which set of circumstances would it not be appropriate to assume the value the noncontrolling shares is the same as the controlling shares? a. The acquisition is for less than 100% of the subsidiary. b. The fair value of the of the noncontrolling shares can be inferred from the value implied by the acquisition price. c. Active market prices for shares not obtained by the acquirer imply a different value. d. The amount of the “control premium” cannot be determined .

On January 1, 2013, Lester Company purchased 70% of Stork Corporation's $5 par common stock for $600,000. The book value of Stork net assets was $640,000 at that time. The fair value of Stork's identifiable net assets were the same as their book value except for equipment that was $40,000 in excess of the book value. In the January 1, 2013, consolidated balance sheet, goodwill would be reported at a. $152,000. b. $177,143. c. $80,000. d. $0.

When the value implied by the purchase price of a subsidiary is in excess of the fair value of identifiable net assets, the workpaper entry to allocate the difference between implied and book value includes a 1. debit to Difference Between Implied and Book Value. 2. credit to Excess of Implied over Fair Value. 3. credit to Difference Between Implied and Book Value. a. 1 b. 2 c. 3 d. Both 1 and 2

If the fair value of the subsidiary's identifiable net assets exceeds both the book value and the value implied by the purchase price, the workpaper entry to eliminate the investment account a. debits Excess of Fair Value over Implied Value. b. debits Difference Between Implied and Fair Value. c. debits Difference Between Implied and Book Value. d. credits Difference Between Implied and Book Value.

5-2

Test Bank to accompany Jeter and Chaney Advanced Accounting

The entry to amortize the amount of difference between implied and book value allocated to an unspecified intangible is recorded 1. on the subsidiary's books. 2. on the parent's books. 3. on the consolidated statements workpaper. a. 1 b. 2 c. 3 d. Both 2 and 3

The excess of fair value over implied value must be allocated to reduce proportionally the fair values initially assigned to a. current assets. b. noncurrent assets. c. both current and noncurrent assets. d. none of the above.

The SEC requires the use of push down accounting when the ownership change is greater than a. 50% b. 80% c. 90% d. 95%

Under push down accounting, the workpaper entry to eliminate the investment account includes a a. debit to Goodwill. b. debit to Revaluation Capital. c. credit to Revaluation Capital. d. debit to Revaluation Assets.

10.

In a business combination accounted for as an acquisition, how should the excess of fair value of identifiable net assets acquired over implied value be treated? a. Amortized as a credit to income over a period not to exceed forty years. b. Amortized as a charge to expense over a period not to exceed forty years. c. Amortized directly to retained earnings over a period not to exceed forty years. d. Recognized as an ordinary gain in the year of acquisition.

11.

On November 30, 2013, Piani Incorporated purchased for cash of $25 per share all 400,000 shares of the outstanding common stock of Surge Company. Surge 's balance sheet at November 30, 2013, showed a book value of $8,000,000. Additionally, the fair value of Surge's property, plant, and equipment on November 30, 2013, was $1,200,000 in excess of its book value. What amount, if any, will be shown in the balance sheet caption "Goodwill" in the November 30, 2013, consolidated balance sheet of Piani Incorporated, and its wholly owned subsidiary, Surge Company? a. $0. b. $800,000. c. $1,200,000. d. $2,000,000.

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value

5-3

12.

Goodwill represents the excess of the implied value of an acquired company over the a. aggregate fair values of identifiable assets less liabilities assumed. b. aggregate fair values of tangible assets less liabilities assumed. c. aggregate fair values of intangible assets less liabilities assumed. d. book value of an acquired company.

13.

Simple Company, a 70%-owned subsidiary of Punter Corporation, reported net income of $240,000 and paid dividends totaling $90,000 during Year 3. Year 3 amortization of differences between current fair values and carrying amounts of Simple's identifiable net assets at the date of the business combination was $45,000. The noncontrolling interest in net income of Simple for Year 3 was a. $58,500. b. $13,500. c. $27,000. d. $72,000.

14.

Pinta Company acquired an 80% interest in Strummer Company on January 1, 2013, for $270,000 cash when Strummer Company had common stock of $150,000 and retained earnings of $150,000. All excess was attributable to plant assets with a 10-year life. Strummer Company made $30,000 in 2013 and paid no dividends. Pinta Company’s separate income in 2013 was $375,000. Controlling interest in consolidated net income for 2013 is: a. $405,000. b. $399,000. c. $396,000. d. $375,000.

15.

In preparing consolidated working papers, beginning retained earnings of the parent company will be adjusted in years subsequent to acquisition with an elimination entry whenever: a. a noncontrolling interest exists. b. it does not reflect the equity method. c. the cost method has been used only. d. the complete equity method is in use.

16.

Dividends declared by a subsidiary are eliminated against dividend income recorded by the parent under the a. partial equity method. b. equity method. c. cost method. d. equity and partial equity methods.

5-4

Test Bank to accompany Jeter and Chaney Advanced Accounting

Use the following information to answer questions 17 through 20. On January 1, 2013, Pamela Company purchased 75% of the common stock of Snicker Company. Separate balance sheet data for the companies at the combination date are given below:

Pamela Co.

Snicker Co. Book Values

Snicker Co. Fair Values

Cash Accounts receivable Inventory Land Plant assets Acc. depreciation Investment in Snicker Co. Total assets

$ 18,000 108,000 99,000 60,000 525,000 (180,000) 330,000 $960,000

$155,000 20,000 26,000 24,000 225,000 (45,000)

$155,000 20,000 45,000 45,000 300,000

$405,000

$565,000

Accounts payable Capital stock Retained earnings Total liabilities & equities

$156,000 600,000 204,000 $960,000

$105,000 225,000 75,000 $405,000

$105,000

Determine below what the consolidated balance would be for each of the requested accounts on January 2, 2013. 17.

What amount of inventory will be reported? a. $125,000 b. $132,750 c. $139,250 d. $144,000

18.

What amount of goodwill will be reported? a. ($20,000) b. ($25,000) c. $25,000 d. $0

19.

What is the amount of consolidated retained earnings? a. $204,000 b. $209,250 c. $260,250 d. $279,000

20.

What is the amount of total assets? a. $921,000 b. $1,185,000 c. $1,525,000 d. $1,195,000

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value

5-5

21.

Sleepy Company, a 70%-owned subsidiary of Pickle Corporation, reported net income of $600,000 and paid dividends totaling $225,000 during Year 3. Year 3 amortization of differences between current fair values and carrying amounts of Sleepy's identifiable net assets at the date of the business combination was $112,500. The noncontrolling interest in consolidated net income of Sleepy for Year 3 was a. $146,250. b. $33,750. c. $67,500. d. $180,000.

22.

Primer Company acquired an 80% interest in SealCoat Company on January 1, 2013, for $450,000 cash when SealCoat Company had common stock of $250,000 and retained earnings of $250,000. All excess was attributable to plant assets with a 10-year life. SealCoat Company made $50,000 in 2013 and paid no dividends. Primer Company’s separate income in 2013 was $625,000. The controlling interest in consolidated net income for 2013 is: a. $675,000. b. $665,000. c. $660,000. d. $625,000.

Use the following information to answer questions 23 through 25. On January 1, 2013, Poole Company purchased 75% of the common stock of Swimmer Company. Separate balance sheet data for the companies at the combination date are given below:

Cash Accounts receivable Inventory Land Plant assets Acc. depreciation Investment in Swimmer Co. Total assets

Poole Co. $ 24,000 144,000 132,000 78,000 700,000 (240,000) 440,000 $1,278,000

Accounts payable Capital stock Retained earnings Total liabilities & equities

$206,000 800,000 272,000 $1,278,000

Swimmer Co. Book Values $206,000 26,000 38,000 32,000 300,000 (60,000)

Swimmer Co. Fair Values $206,000 26,000 60,000 60,000 350,000

$542,000

$702,000

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

$142,000

Determine below what the consolidated balance would be for each of the requested accounts on January 2, 2013. 23.

What amount of inventory will be reported? a. $170,000. b. $177,000. c. $186,500. d. $192,000.

5-6

Test Bank to accompany Jeter and Chaney Advanced Accounting

24.

What amount of goodwill will be reported? a. $26,667. b. $20,000. c. $42,000. d. $86,667.

25.

What is the amount of total assets? a. $1,626,667. b. $1,566,667 c. $1,980,000. d. $2,006,667.

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value

5-7

Problems 5-1

Phillips Company purchased a 90% interest in Standards Corporation for $2,340,000 on January 1, 2013. Standards Corporation had $1,650,000 of common stock and $1,050,000 of retained earnings on that date. The following values were determined for Standards Corporation on the date of purchase:

Inventory Land Equipment

Book Value $240,000 2,400,000 1,620,000

Fair Value $300,000 2,700,000 1,800,000

Required: A. Prepare a computation and allocation schedule for the difference between the implied and book value in the consolidated statements workpaper. B. Prepare the January 1, 2013, workpaper entries to eliminate the investment account and allocate the difference between implied and book value.

5-2

Pullman Corporation acquired a 90% interest in Sleeter Company for $6,500,000 on January 1 2013. At that time Sleeter Company had common stock of $4,500,000 and retained earnings of $1,800,000. The balance sheet information available for Sleeter Company on January 1, 2013, showed the following:

Inventory (FIFO) Equipment (net) Land

Book Value $1,300,000 1,500,000 3,000,000

Fair Value $1,500,000 1,900,000 3,000,000

The equipment had a remaining useful life of ten years. Sleeter Company reported $240,000 of net income in 2013 and declared $60,000 of dividends during the year. Required: Prepare the workpaper entries assuming the cost method is used, to eliminate dividends, eliminate the investment account, and to allocate and depreciate the difference between implied and book value for 2013.

5-3

On January 1, 2013, Preston Corporation acquired an 80% interest in Spiegel Company for $2,400,000. At that time Spiegel Company had common stock of $1,800,000 and retained earnings of $800,000. The book values of Spiegel Company's assets and liabilities were equal to their fair values except for land and bonds payable. The land's fair value was $120,000 and its book value was $100,000. The outstanding bonds were issued on January 1, 2005, at 9% and mature on January 1, 2015. The bond principal is $600,000 and the current yield rate on similar bonds is 8%. Required: Prepare the workpaper entries necessary on December 31, 2013, to allocate, amortize, and depreciate the difference between implied and book value.

5-8

Test Bank to accompany Jeter and Chaney Advanced Accounting

9%, 5 periods 8%, 5 periods 5-4

Present value of 1 .64993 .68058

Present Value of Annuity of 1 3.88965 3.99271

Pennington Corporation purchased 80% of the voting common stock of Stafford Corporation for $3,200,000 cash on January 1, 2013. On this date the book values and fair values of Stafford Corporation's assets and liabilities were as follows: Book Value Fair Value Cash $ 70,000 $ 70,000 Receivables 240,000 240,000 Inventories 600,000 700,000 Other Current Assets 340,000 405,000 Land 600,000 720,000 Buildings – net 1,050,000 1,920,000 Equipment – net 850,000 750,000 $3,750,000 $4,805,000 Accounts Payable Other Liabilities Capital Stock Retained Earnings

$ 250,000 740,000 2,400,000 360,000 $3,750,000

$250,000 670,000

Required: Prepare a schedule showing how the difference between Stafford Corporation's implied value and the book value of the net assets acquired should be allocated. 5-5

Plain Corporation acquired a 75% interest in Swampy Company on January 1, 2013, for $2,000,000. The book value and fair value of the assets and liabilities of Swampy Company on that date were as follows: Book Value Fair Value Current Assets $ 600,000 $ 600,000 Property & Equipment (net) 1,400,000 1,800,000 Land 700,000 900,000 Deferred Charge 300,000 300,000 Total Assets $3,000,000 $3,600,000 Less Liabilities 600,000 600,000 Net Assets $2,400,000 $3,000,000 The property and equipment had a remaining life of 6 years on January 1, 2013, and the deferred charge was being amortized over a period of 5 years from that date. Common stock was $1,500,000 and retained earnings was $900,000 on January 1, 2013. Plain Company records its investment in Swampy Company using the cost method. Required: Prepare, in general journal form, the December 31, 2013, workpaper entries necessary to: A. Eliminate the investment account. B. Allocate and amortize the difference between implied and book value.

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value 5-6

5-9

On January 1, 2013, Pilsner Company acquired an 80% interest in Smalley Company for $3,600,000. On that date, Smalley Company had retained earnings of $800,000 and common stock of $2,800,000. The book values of assets and liabilities were equal to fair values except for the following:

Inventory Equipment (net) Land

Book Value $ 50,000 540,000 300,000

Fair Value $ 85,000 720,000 660,000

The equipment had an estimated remaining useful life of 8 years. One-half of the inventory was sold in 2013 and the remaining half was sold in 2014. Smalley Company reported net income of $240,000 in 2013 and $300,000 in 2014. No dividends were declared or paid in either year. Pilsner Company uses the cost method to record its investment in Smalley Company. Required: Prepare, in general journal form, the workpaper eliminating entries necessary in the consolidated statements workpaper for the year ending December 31, 2014.

5-7

Pulman Company acquired 90% of the stock of Spectrum Company for $6,300,000 on January 1, 2013. On this date, the fair value of the assets and liabilities of Spectrum Company was equal to their book value except for the inventory and equipment accounts. The inventory had a fair value of $2,300,000 and a book value of $1,900,000. The equipment had a fair value of $3,300,000 and a book value of $2,800,000. The balances in Spectrum Company's capital stock and retained earnings accounts on the date of acquisition were $3,700,000 and $1,900,000, respectively. Required: In general journal form, prepare the entries on Spectrum Company's books to record the effect of the pushed down values implied by the acquisition of its stock by Pulman Company assuming that: A values are allocated on the basis of the fair value of Spectrum Company as a whole imputed from the transaction. B values are allocated on the basis of the proportional interest acquired by Pulman Company.

5-8

Pruin Corporation acquired all of the voting stock of Satto Corporation on January 1, 2013, for $210,000 when Satto had common stock of $150,000 and retained earnings of $24,000. The excess of implied over book value was allocated $9,000 to inventories that were sold in 2013, $12,000 to equipment with a 4-year remaining useful life under the straight-line method, and the remainder to goodwill. Financial statements for Pruitt and Satto Corporations at the end of the fiscal year ended December 31, 2014 (two years after acquisition), appear in the first two columns of the partially completed consolidated statements workpaper. Pruin Corp. has accounted for its investment in Satto using the partial equity method of accounting.

5-10 Test Bank to accompany Jeter and Chaney Advanced Accounting Required: Complete the consolidated statements workpaper for Pruin Corporation and Satto Corporation for December 31, 2014. Pruin Corporation and Satto Corporation Consolidated Statements Workpaper at December 31, 2014 Eliminations

INCOME STATEMENT Sales Equity from Subsidiary Income Cost of Sales Other Expenses Net Income to Ret. Earn.

Pruin Corp.

Satto Corp.

618,000

180,000

36,000 (450,000)

(90,000)

(114,000)

(54,000)

90,000

36,000

Pruin Retained Earnings 1/1

72,000

Soto Retained Earnings 1/1 Add: Net Income Less: Dividends Retained Earnings 12/31

3,000 90,000

36,000

(60,000)

(12,000)

102,000

54,000

42,000

21,000

63,000

45,000

33,000

18,000

192,000 240,000

165,000

570,000

249,000

168,000

45,000

300,000

150,000

102,000

54,000

570,000

249,000

BALANCE SHEET Cash Inventories Land Equipment and Buildings-net Investment in Satto Corp. Total Assets LIA & EQUITIES Liabilities Common Stock Retained Earnings Total Equities

Debit

Credit

Consolidated Balances

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value 5-9

5-11

On January 1, 2013, Phoenix Company acquired 80% of the outstanding capital stock of Skyler Company for $570,000. On that date, the capital stock of Skyler Company was $150,000 and its retained earnings were $450,000. On the date of acquisition, the assets of Skyler Company had the following values:

Book Value Inventories........................................................................ $ 90,000 Plant and equipment ............................................................. 150,000

Fair Market Value $165,000 180,000

All other assets and liabilities had book values approximately equal to their respective fair market values. The plant and equipment had a remaining useful life of 10 years from January 1, 2013, and Skyler Company uses the FIFO inventory cost flow assumption. Skyler Company earned $180,000 in 2013 and paid dividends in that year of $90,000. Phoenix Company uses the complete equity method to account for its investment in S Company. Required: A. Prepare a computation and allocation schedule. B. Prepare the balance sheet elimination entries as of December 31, 2013. C. Compute the amount of equity in subsidiary income recorded on the books of Phoenix Company on December 31, 2013. D. Compute the balance in the investment account on December 31, 2013.

Short Answer 1.

When the value implied by the acquisition price is below the fair value of the identifiable net assets the residual amount will be negative (bargain acquisition). Explain the difference in accounting for bargain acquisition between past accounting and proposed accounting requirements.

Push down accounting is an accounting method required for the subsidiary in some instances such as the banking industry. Briefly explain the concept of push down accounting.

5-12 Test Bank to accompany Jeter and Chaney Advanced Accounting Questions from the Textbook 1. Distinguish among the following concepts: (a) Difference between book value and the value implied by the purchase price. (b) Excess of implied value over fair value. (c) Excess of fair value over implied value. (d) Excess of book value over fair value. 2. In what account is the difference between book value and the value implied by the purchase price recorded on the books of the investor? In what account is the “excess of implied over fair value” recorded? 3. How do you determine the amount of “the difference between book value and the value implied by the purchase price” to be allocated to a specific asset of a less than wholly owned subsidiary? 4. The parent company’s share of the fair value of the net assets of a subsidiary may exceed acquisition cost. How must this excess be treated in the preparation of consolidated financial statements? 5. What are the arguments for and against the alternatives for the handling of bargain acquisitions? Why are such acquisitions unlikely to occur with great frequency? 6. P Company acquired a 100% interest in S Company. On the date of acquisition the fair value of the assets and liabilities of S Company was equal to their book value except for land that had a fair value of $1,500,000 and a book value of $300,000. At what amount should the land of S Company be included in the consolidated balance sheet? At what amount should the land of S Company be included in the consolidated balance sheet if P Company acquired an80% interest in S Company rather than a 100%interest? Business Ethics Question from the Textbook Consider the following: Many years ago, a student in a consolidated financial statements class came to me and said that Grand Central (a multi-store grocery and variety chain in Salt Lake City and surrounding towns and cities) was going to be acquired and that I should try to buy the stock and make lots of money. I asked him how he knew and he told me that he worked part-time for Grand Central and heard that Fred Meyer was going to acquire it. I did not know whether the student worked in the accounting department at Grand Central or was a custodian at one of the stores. I thanked him for the information but did not buy the stock. Within a few weeks, the announcement was made that Fred Meyer was acquiring Grand Central and the stock price shot up, almost doubling. It was clear that I had missed an opportunity to make a lot of money ... I don’t know to this day whether or not that would have been insider trading. How-everHowever, I have never gone home at night and asked my wife if the SEC called. From “Don’t go to jail and other good advice for accountants,” by Ron Mano, Accounting Today, October 25, 1999. Question: Do you think this individual would have been guilty of insider trading if he had purchased the stock in Grand Central based on this advice? Why or why not? Are there ever instances where you think it would be wise to miss out on an opportunity to reap benefits simply because the behavior necessitated would have been in a gray ethical area, though not strictly illegal? Defend your position.

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value ANSWER KEY Multiple Choice 1. 2. 3. 4. 5.

d c b c c

6. 7. 8. 9. 10.

c d d b d

11. 12. 13. 14. 15.

b a a c b

16. 17. 18. 19. 20.

c d d a d

21. 22. 23. 24. 25.

a c d a b

Problems 5-1

A. Allocation of Difference Between Implied and Book Value

Purchase price and implied value Less: Book value of equity acquired Difference between implied and book value Inventory Land Equipment Balance (excess of FV over implied value) Gain Increase Noncontrolling interest to fair value of assets Total allocated bargain

Parent Share $2,340,000 2,430,000 (90,000) (54,000) (270,000) (162,000) (576,000) 576,000

Balance

NonControlling Entire Share Value 260,000 2,600,000 270,000 2,700,000 (10,000) (100,000) (6,000) (60,000) (30,000) (300,000) (18,000) (180,000) (64,000) (640,000) 64,000 640,000

-0-

B. Common Stock – Standards 1,650,000 Beginning R/E – Standards 1,050,000 Investment in Standards Corp. Difference Between Implied and Book Value Noncontrolling Interest in Equity Difference Between Implied and Book Value Inventory Land Equipment Gain on Acquisition Noncontrolling Interest

-0-

2,340,000 100,000 260,000

100,000 60,000 300,000 180,000 576,000 64,000

5-13

5-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 5-2

Dividend Income (.90 × 60,000) Dividends Declared

54,000 54,000

Beginning R/E – Sleeter 1,800,000 Common Stock – Sleeter 4,500,000 Difference Between Implied and Book Value 922,222* Investment in Sleeter Company Noncontrolling Interest *$6,500,000/.9 - $1,800,000 - $4,500,000 = $922,222 Allocated to: $922,222 Inventory (200,000) Equipment (400,000) Goodwill $ 322,222 Cost of Goods Sold Depreciation Expense 400,000/10 Equipment 400,000– 40,000 Goodwill Difference Between Implied and Book Value

6,500,000 722,222

200,000 40,000 360,000 322,222 922,222

5-3

Parent Share

NonControlling Share

Entire Value

Purchase price and implied value $2,400,000 Less: Book value of equity acquired 2,080,000 Difference between implied and book value 320,000 Land ($120,000 – $100,000) (16,000) Premium on Bonds Payable (623,954*– 600,000) 19,163 Balance 323,163 Goodwill (323,163) Balance -0-

600,000 520,000 80,000 (4,000) 4,791 80,791 (80,791) -0-

3,000,000 2,600,000 400,000 (20,000) 23,954 403,954 (403,954) -0-

Present Value of 9% Bonds Payable discounted at 8% for 5 periods: $600,000 × .68058 = $408,348 54,000 × 3.99271 = 215,606 $623,954* Land Goodwill Difference Between Implied and Book Value Interest Expense Unamortized Premium on Bonds Payable (23,954 – 4,084) **[54,000 – (623,954 × .08)]

20,000 403,954 400,000 4,084** 19,870

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value Alternative Entries Land 20,000 Goodwill 403,954 Premium on Bonds Payable Difference Between Implied and Book Value Premium on Bonds Payable Interest Expense

4,084 4,084

Parent Share

NonControlling Share

Entire Value

$3,200,000 2,208,000 992,000 (80,000) (52,000) (96,000) (696,000) (56,000) 80,000 92,000 (92,000) -0-

800,000 552,000 248,000 (20,000) (13,000) (24,000) (174,000) (14,000) 20,000 23,000 (23,000) -0-

4,000,000 2,760,000 1,240,000 (100,000) (65,000) (120,000) (870,000) (70,000) * 100,000 115,000 (115,000) -0-

5-4

Purchase price and implied value Less: Book value of equity acquired Difference between implied and book value Inventories Other Current assets Land Buildings (net) Other liabilities Equipment (net) Balance Goodwill Balance

23,954 400,000

*A debit to Other Liabilities is a reduction of their carrying value.

5-5

A. Beginning Retained Earnings (Swampy) Capital Stock (Swampy) Difference Between Implied and Book Value Investment in Swampy Noncontrolling Interest in Equity

900,000 1,500,000 266,667 2,000,000 666,667

B. Depreciation Expense ($400,000/6) 66,667 Equipment (net) ($400,000 – $66,667) 333,333 Land ($900,000 - $700,000) 200,000 Gain on Acquisition ($200,000+$400,000-$266,667) × 0.75 Difference Between Implied and Book Value Noncontrolling Interest ($200,000+$400,000-$266,667) × 0.25

250,000 266,667 83,333

5-15

5-16 Test Bank to accompany Jeter and Chaney Advanced Accounting 5-6

Calculations Cost of Investment and Implied Value ($3,600,000/0.8) Book Value of Equity Acquired Difference between Implied and Book Value

$4,500,000 3,600,000 $ 900,000 Annual Adjustment in Determining Consolidated Net Income

Land Equipment (net) Inventory Goodwill

Difference Between Implied and Book Value 2013 $360,000 --180,000 $22,500 35,000 17,500 325,000 --$900,000 $40,000

(1) Investment in Smalley Beginning Retained Earnings (Pilsner)

192,000

(2) Beginning Retained Earnings (Smalley) Difference between Implied and Book Value Common Stock (Smalley) Investment in Smalley ($3,600,000 + $192,000) Noncontrolling Interest in Equity

1,040,000 900,000 2,800,000

192,000

3,792,000 948,000

(3) Beginning Retained Earnings – PageSmalley 32,000 Noncontrolling Interest 8,000 Depreciation Expense 22,500 Cost of Goods Sold (Beginning Inventory) 17,500 Goodwill 325,000 Land 360,000 Equipment (net) ($180,000 – $22,500 – $22,500) 135,000 Difference between Implied and Book Value

5-7

A Imputed Value ($6,300,000/.9) Recorded Value ($1,900,000 + $3,700,000) Unrecorded Values Allocate to identifiable assets Inventory ($2,300,000 – $1,900,000) Equipment ($3,300,000 – $2,800,000) Goodwill Inventory Equipment Goodwill Revaluation Capital

2014 --$22,500 17,500 --$40,000

900,000

Net Assets $7,000,000 5,600,000 $1,400,000 $400,000 500,000

900,000 $ 500,000

400,000 500,000 500,000 1,400,000

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value

B Unrecorded Value Imputed by Pulman Company's Proportionate Interest (.9 × $1,400,000) Allocate to Inventory ($2,300,000 – $1,900,000) × .9 $360,000 Equipment ($3,300,000 – $2,800,000) × .9 450,000 Goodwill

Inventory Equipment Goodwill Revaluation Capital

$1,260,000

810,000 $ 450,000

360,000 450,000 450,000 1,260,000

5-17

5-18 Test Bank to accompany Jeter and Chaney Advanced Accounting 5-8 Pruin Corporation and Satto Corporation Consolidated Statements Workpaper at December 31, 2014 Eliminations Pruin Corp.

Satto Corp.

618,000

180,000

INCOME STATEMENT Sales Equity from Subsidiary Income Cost of Sales

(450,000)

(90,000)

Other Expenses

(114,000)

(54,000)

90,000

36,000

Net Income to Ret. Earn. Pruin Retained Earnings 1/1 Satto Retained Earnings

36,000

Credit

Consolidated Balances 798,000

(a) 36,000 (540,000) (c)

3,000

(171,000)

39,000 (b) (c)

72,000

1/1

Debit

87,000

9,000 3,000

30,000

(b) 30,000 39,000

60,000

Add: Net Income

90,000

36,000

Less: Dividends

(60,000)

(12,000)

Retained Earnings 12/31

102,000

54,000

Cash

42,000

21,000

63,000

Inventories

63,000

45,000

108,000

Land

33,000

18,000

51,000

Equipment and Buildings-net

192,000

165,000

81,000

87,000 (a) 12,000

(60,000)

12,000

87,000

BALANCE SHEET

(b) 12,000

363,000

Investment in Satto Corp. Goodwill

240,000

Total Assets

570,000

249,000

600,000

Liabilities

168,000

45,000

213,000

Common Stock

300,000

150,000

(b) 150,000

Retained Earnings

102,000

54,000

81,000

12,000

87,000

Total Equities

570,000

249,000

258,000

600,000

(b) 15,000

15,000

LIA & EQUITIES

300,000

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value

5-19

5-9 A.

Purchase price and implied value Less: Book value of equity acquired Difference between implied and book value Inventories Equipment (net) Balance Goodwill Balance

Phoenix Share

NonControlling Share

Entire Value

$570,000 480,000 90,000 (60,000) (24,000) 6,000 (6,000) -0-

142,500 120,000 22,500 (15,000) (6,000) 1,500 (1,500) -0-

712,500 600,000 112,500 (75,000) (30,000) 7,500 (7,500) -0-

B. Common Stock – Skyler Retained Earnings – Skyler Difference Between Implied and Book Value Investment in Skyler Company Noncontrolling Interest in Equity

150,000 450,000 112,500 570,000 142,500

Cost of Goods Sold 75,000 Depreciation Expense ($30,000/10 years) 3,000 Plant and Equipment ($30,000 – $3,000) 27,000 Goodwill 7,500 Difference Between Implied and Book Value C. Skyler Company net income $180,000 × 80% = Less: Inventory sold Plant & equipment depreciation Equity in subsidiary income

D. Investment balance 1/1/10 + Equity in subsidiary income – Dividends ($90,000 × 80%) Investment balance 12/31/10

112,500

$144,000 (60,000) ( 2,400) $81,600

$570,000 81,600 (72,000) $579,600

Short Answer 1.

In the past, when a bargain acquisition occurred some of the acquired assets were reduced below their fair values. Long-lived assets were recorded at fair market value less an adjustment for the bargain. In addition, an extraordinary gain was recorded in certain instances. Under proposed accounting requirements, no assets are reduced below fair value. Instead the credit (negative) balance will be shown as an ordinary gain in the year of acquisition.

Push down accounting is the establishment of a new accounting and reporting basis for a subsidiary company in its separate financial statements based on the purchase price paid by the Parent

5-20 Test Bank to accompany Jeter and Chaney Advanced Accounting Company to acquire a controlling interest in the outstanding voting stock of the subsidiary company. The valuation implied by the price of the stock to the Parent Company is “pushed down” to the subsidiary and used to restate its assets and liabilities in its separate financial statements. Under push down accounting, the Parent Company’s cost of acquiring a subsidiary is used to establish a new accounting basis for the assets and liabilities of the subsidiary in the subsidiary’s separate financial statements. Solutions to Questions from the Textbook 1.

a. The “difference between implied and book value” is the total difference between the value of the subsidiary in total, as implied by the acquisition cost of an investment in that subsidiary, and the book value of the subsidiary’s equity on the date of the acquisition (note that equity is the same as net assets). b. The excess of implied value over fair value, or “Goodwill,” is the excess of the value of the subsidiary, as implied by the amount paid by the parent, over the fair value of the identifiable net assets of that subsidiary on the date of acquisition. c. The “excess of fair value over implied value” is the excess of the fair value of the identifiable net assets of a subsidiary (all assets other than goodwill minus liabilities) on the acquisition date over the value of the subsidiary as implied by the amount paid by the parent. This may be referred to as a bargain acquisition. d. An excess of book value over fair value describes a situation where some (or all) of the subsidiary’s assets need to be written down rather than up (or liabilities need to be increased, or both). It does not, however, tell us whether the acquisition results in the recording of goodwill or an ordinary gain (in a bargain acquisition). That determination depends on the comparison of fair value of identifiable net assets and the implied value (purchase price divided by percentage acquired), referred to in parts (b) and (c) above. 2. The “difference between implied and book value” and the “Goodwill” are a part of the cost of an investment and are included in the amount recorded in the investment account. Although not recorded separately in the records of the parent company, these amounts must be known in order to prepare the consolidated financial statements. 3. In allocating the difference between implied and book value to specific assets of a less than wholly owned subsidiary, the difference between the fair value and book value of each asset on the date of acquisition is reflected by adjusting each asset upward or downward to fair value (marked to market) in its entirety, regardless of the percentage acquired by the parent company. 4. If the parent’s share of the fair value exceeds the cost, then the entire fair value similarly exceeds the implied value of the subsidiary. This constitutes a bargain acquisition, and under proposed GAAP (ED No. 1204-001), the excess is recorded as an ordinary gain in the period of the acquisition. Past GAAP (APB Opinion No. 16) differed in that it provided that the excess of fair value over cost should be allocated to reduce proportionally the values assigned to noncurrent assets with certain exceptions. If such noncurrent assets were reduced to zero (or to the noncontrolling percentage, if there was one) by this allocation, any remaining excess was recorded as an extraordinary gain. 5. The recording of an ordinary (or extraordinary gain) on an acquisition flies in the face of the rules of revenue recognition because no earnings process has been completed. On the other hand, a decision to record certain assets below their fair values is arbitrary, and also rather confusing (how far should they

Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value

5-21

be reduced?). The reason that bargain acquisitions are unlikely to occur very often is because they suggest that the usual assumptions of an arm’s length transaction have been violated. In most accounting scenarios, we assume that both parties are negotiating for a reasonable exchange price and that price, once established, represents fair value both for the item given up and the item received. In the case of a business combination, there is not a single item being exchanged but rather a number of assets and liabilities. Nonetheless, the assumption is still that both parties are negotiating for a fair valuation. If one party is able to obtain a bargain, it most likely indicates that the other party was being influenced by non-quantitative considerations, such as a wish to retire quickly, health concerns, etc. 6. If P Company acquires a 100 percent interest in S Company the land will be included in the consolidated financial statements at its fair value on the date of acquisition of $1,500,000. If P Company acquires an 80 percent interest in S Company, the land will still be included in the consolidated financial statements at $1,500,000, and the noncontrolling interest would be charged with its share of the fair value adjustment. Business Ethics Solution This case brings an interesting question to the table for discussion. As the article by Mano points out, each individual must decide for himself or herself how to respond to the gray issues that are bound to arise in life. Ultimately life is more about being at peace with ourselves and leaving a legacy of a life well-lived and values taught through our example to the generations that we leave behind us than it is about accumulating wealth (that we cannot take to the grave). The individual, had he acted on the advice, may have been guilty of insider trading as the information available to him was, apparently, not available publicly. Although there is no clear-cut definition of what constitutes insider trading, the gray area implies uncertainty; and this uncertainty can in many cases result in decisions that have severe implications both professionally and personally.

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory Multiple Choice 1.

Sales from one subsidiary to another are called a. downstream sales. b. upstream sales. c. intersubsidiary sales. d. horizontal sales.

Noncontrolling interest in consolidated income is never affected by a. upstream sales. b. downstream sales. c. horizontal sales. d. Noncontrolling interest is affected by all sales.

Failure to eliminate intercompany sales would result in an overstatement of consolidated a. net income. b. gross profit. c. cost of sales. d. all of these.

Pruitt Company owns 80% of Stoney Company’s common stock. During 2014, Stoney sold $400,000 of merchandise to Pruitt. At December 31, 2014, one-fourth of the merchandise remained in Pruitt’s inventory. In 2014, gross profit percentages were 25% for Pruitt and 30% for Stoney. The amount of unrealized intercompany profit that should be eliminated in the consolidated statements is a. $80,000. b. $24,000. c. $30,000. d. $25,000.

The noncontrolling interest’s share of the selling affiliate’s profit on intercompany sales is considered to be realized under a. partial elimination. b. total elimination. c. 100% elimination. d. both total and 100% elimination.

The workpaper entry in the year of sale to eliminate unrealized intercompany profit in ending inventory includes a a. credit to Ending Inventory (Cost of Sales). b. credit to Sales. c. debit to Ending Inventory (Cost of Sales). d. debit to Inventory - Balance Sheet.

6-2

Test Bank to accompany Jeter and Chaney Advanced Accounting

Petunia Company acquired an 80% interest in Shaman Company in 201320132013 just once. In 2014 and 2015, Sutton reported net income of $400,000 and $480,000, respectively. During 2014, Shaman sold $80,000 of merchandise to Petunia for a $20,000 profit. Petunia sold the merchandise to outsiders during 2015 for $140,000. For consolidation purposes, what is the noncontrolling interest’s share of Shaman's 2014 and 2015 net income? a. $90,000 and $96,000. b. $100,000 and $76,000. c. $84,000 and $92,000. d. $76,000 and $100,000.

A 90% owned subsidiary sold merchandise at a profit to its parent company near the end of 2013. Under the partial equity method, the workpaper entry in 2014 to recognize the intercompany profit in beginning inventory realized during 2014 includes a debit to a. Retained Earnings - P. b. Noncontrolling interest. c. Cost of Sales. d. both Retained Earnings - P and Noncontrolling Interest.

The noncontrolling interest in consolidated income when the selling affiliate is an 80% owned subsidiary is calculated by multiplying the noncontrolling minoritydelete minority ownership percentage by the subsidiary’s reported net income a. plus unrealized profit in ending inventory less unrealized profit in beginning inventory. b. plus realized profit in ending inventory less realized profit in beginning inventory. c. less unrealized profit in ending inventory plus realized profit in beginning inventory. d. less realized profit in ending inventory plus realized profit in beginning inventory.

10.

In determining controlling interest in consolidated income in the consolidated financial statements, unrealized intercompany profit on inventory acquired by a parent from its subsidiary should: a. not be eliminated. b. be eliminated in full. c. be eliminated to the extent of the parent company’s controlling interest in the subsidiary. d. be eliminated to the extent of the noncontrolling interest in the subsidiary.

11.

P Company sold merchandise costing $240,000 to S Company (90% owned) for $300,000. At the end of the current year, one-third of the merchandise remains in S Company’s inventory. Applying the lower-of- cost-or-market rule, S Company wrote this inventory down to $92,000. What amount of intercompany profit should be eliminated on the consolidated statements workpaper? a. $20,000. b. $18,000. c. $12,000. d. $10,800.

12.

The material sale of inventory items by a parent company to an affiliated company: a. enters the consolidated revenue computation only if the transfer was the result of arm’s length bargaining. b. affects consolidated net income under a periodic inventory system but not under a perpetual inventory system. c. does not result in consolidated income until the merchandise is sold to outside parties. d. does not require a working paper adjustment if the merchandise was transferred at cost.

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-3

13.

A parent company regularly sells merchandise to its 80%-owned subsidiary. Which of the following statements describes the computation of noncontrolling interest income? a. the subsidiary’s net income times 20%. b. (the subsidiary’s net income x 20%) + unrealized profits in the beginning inventory – unrealized profits in the ending inventory. c. (the subsidiary’s net income + unrealized profits in the beginning inventory – unrealized profits in the ending inventory) × 20%. d. (the subsidiary’s net income + unrealized profits in the ending inventory – unrealized profits in the beginning inventory) × 20%.

14.

P Corporation acquired a 60% interest in S Corporation on January 1, 2014, at book value equal to fair value. During 2014, P sold merchandise that cost $135,000 to S for $189,000. One-third of this merchandise remained in S’s inventory at December 31, 2014. S reported net income of $120,000 for 2014. P’s income from S for 2014 is: a. $36,000. b. $50,400. c. $54,000. d. $61,200.

Use the following information for Questions 15 & 16: P Company regularly sells merchandise to its 80%-owned subsidiary, S Corporation. In 2013, P sold merchandise that cost $240,000 to S for $300,000. Half of this merchandise remained in S’s December 31, 2013 inventory. During 2014, P sold merchandise that cost $375,000 to S for $468,000. Forty percent of this merchandise inventory remained in S’s December 31, 2014 inventory. Selected income statement information for the two affiliates for the year 2014 is as follows:

Sales Revenue Cost of Goods Sold Gross profit

P _ $2,250,000 1,800,000 $450,000

S _ $1,125,000 937,500 $187,500

15.

Consolidated sales revenue for P and Subsidiary for 2014 are: a. $2,907,000. b. $3,000,000. c. $3,205,500. d. $3,375,000.

16.

Consolidated cost of goods sold for P Company and Subsidiary for 2014 are: a. $2,260,500. b. $2,268,000. c. $2,276,700. d. $2,737,500.

6-4

Test Bank to accompany Jeter and Chaney Advanced Accounting

Use the following information for Questions 17 & 18: P Company owns an 80% interest in S Company. During 2014, S sells merchandise to P for $200,000 at a profit of $40,000. On December 31, 2014, 50% of this merchandise is included in P’s inventory. Income statements for P and S are summarized below:

Sales Cost of Sales Operating Expenses Net Income (2014)

P __ $1,200,000 (600,000) (300,000) $300,000

S __ $600,000 (400,000) ( 80,000) $120,000

17.

Controlling interest in consolidated net income for 2014 is: a. $300,000. b. $380,000. c. $396,000. d. $420,000.

18.

Noncontrolling interest in income for 2014 is: a. $4,000. b. $19,200. c. $20,000. d. $24,000.

19.

The amount of intercompany profit eliminated is the same under total elimination and partial elimination in the case of 1. upstream sales where the selling affiliate is a less than wholly owned subsidiary. 2. all downstream sales. 3. horizontal sales where the selling affiliate is a wholly owned subsidiary. a. 1. b. 2. c. 3. d. both 2 and 3.

20.

Polly, Inc. owns 80% of Saffron, Inc. During 2014, Polly sold goods with a 40% gross profit to Saffron. Saffron sold all of these goods in 2014. For 2014 consolidated financial statements, how should the summation of Polly and Saffron income statement items be adjusted? a. Sales and cost of goods sold should be reduced by the intercompany sales. b. Sales and cost of goods sold should be reduced by 80% of the intercompany sales. c. Net income should be reduced by 80% of the gross profit on intercompany sales. d. No adjustment is necessary.

21.

P Corporation acquired a 60% interest in S Corporation on January 1, 2014, at book value equal to fair value. During 2014, P sold merchandise that cost $225,000 to S for $315,000. One-third of this merchandise remained in S’s inventory at December 31, 2014. S reported net income of $200,000 for 2014. P’s income from S for 2014 is: a. $60,000. b. $90,000. c. $120,000. d. $102,000.

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-5

Use the following information for Questions 22 & 23: P Company regularly sells merchandise to its 80%-owned subsidiary, S Corporation. In 2013, P sold merchandise that cost $192,000 to S for $240,000. Half of this merchandise remained in S’s December 31, 2013 inventory. During 2014, P sold merchandise that cost $300,000 to S for $375,000. Forty percent of this merchandise inventory remained in S’s December 31, 2014 inventory. Selected income statement information for the two affiliates for the year 2014 is as follows:

Sales Revenue Cost of Goods Sold Gross profit

P _ $1,800,000 1,440,000 $ 360,000

S _ $900,000 750,000 $150,000

22.

Consolidated sales revenue for P and Subsidiary for 2014 are: a. $2,325,000. b. $2,400,000. c. $2,565,000. d. $2,700,000.

23.

Consolidated cost of goods sold for P Company and Subsidiary for 2014 are: a. $1,809,000. b. $1,815,000. c. $1,821,000. d. $2,190,000.

Use the following information for Questions 24 & 25: P Company owns an 80% interest in S Company. During 2014, S sells merchandise to P for $150,000 at a profit of $30,000. On December 31, 2014, 50% of this merchandise is included in P’s inventory. Income statements for P and S are summarized below:

Sales Cost of Sales Operating Expenses Net Income (2014)

P __ $900,000 (450,000) (225,000) $225,000

24.

Controlling interest in consolidated net income for 2014 is: a. $225,000. b. $285,000. c. $297,000. d. $315,000.

25.

Noncontrolling interest in income for 2014 is: a. $3,000. b. $14,400. c. $15,000. d. $18,000.

S __ $450,000 (300,000) ( 60,000) $ 90,000

6-6

Test Bank to accompany Jeter and Chaney Advanced Accounting

Problems 6-1

On January 1, 2014, Pharma Company purchased a 90% interest in Sandy Company for $2,800,000. At that time, Sandy had $1,840,000 of common stock and $360,000 of retained earnings. The difference between implied and book value was allocated to the following assets of Sandy Company: Inventory Plant and equipment (net) Goodwill

$ 80,000 240,000 591,111

The plant and equipment had a 10-year remaining useful life on January 1, 2014. During 2014, Pharma sold merchandise to Sandy at a 20% markup above cost. At December 31, 2014, Sandy still had $180,000 of merchandise in its inventory that it had purchased from Pharma. In 2014, Pharma reported net income from independent operations of $1,600,000, while Sandy reported net income of $600,000. Required: A. Prepare the workpaper entry to allocate, amortize, and depreciate the difference between implied and book value for 2014. B. Calculate controlling interest in consolidated net income for 2014.

6-2

Puma Company owns 80% of the common stock of Smarte Company. Puma sells merchandise to Smarte at 20% above cost. During 2014 and 2015, intercompany sales amounted to $1,080,000 and $1,200,000 respectively. At the end of 2014, Smarte had one-fifth of the goods purchased that year from Puma in its ending inventory. Smarte’s 2015 ending inventory contained one-fourth of that year’s purchases from Puma. There were no intercompany sales prior to 2014. Puma reported net income from its own operations of $720,000 in 2014 and $760,000 in 2015. Smarte reported net income of $400,000 in 2014 and $460,000 in 2015. Neither company declared dividends in either year. Required: A. Prepare in general journal form all entries necessary on the consolidated statements workpapers to eliminate the effects of the intercompany sales for both 2014 and 2015. B. Calculate controlling interest in consolidated net income for 2015.

6-3

Pinta Company owns 90% of the common stock of Simplex Company. Simplex Company sells merchandise to Pinta Company at 25% above cost. During 2013 and 2014 such sales amounted to $800,000 and $1,020,000, respectively. At the end of each year, Pinta Company had in its inventory one-fourth of the amount of goods purchased from Simplex Company during that year. Pinta Company reported income of $1,500,000 from its independent operations in 2013 and $1,720,000 in 2014. Simplex Company reported net income of $600,000 in each year and did not declare any dividends in either year. There were no intercompany sales prior to 2013.

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-7

Required: A. Prepare, in general journal form, all entries necessary on the 2014 consolidated statements workpaper to eliminate the effects of intercompany sales. B. Calculate the amount of noncontrolling interest to be deducted from consolidated income in the consolidated income statement in 2014. C. Calculate controlling interest in consolidated net income for 2014.

6-4

Pine Company owns an 80% interest in Salad Company and a 90% interest in Tuna Company. During 2013 and 2014, intercompany sales of merchandise were made by all three companies. Total sales amounted to $2,400,000 in 2013, and $2,700,000 in 2014. The companies sold their merchandise at the following percentages above cost. Pine 15% Salad 20% Tuna 25% The amount of merchandise remaining in the 2014 beginning and ending inventories of the companies from these intercompany sales is shown below. Merchandise Remaining in Beginning Inventory Pine Salad Tuna Total Sold by Pine Salad Tuna

$225,000 $180,000 180,000

Pine Sold by Pine Salad Tuna

$189,000 216,000

135,000

$414,000 396,000 315,000

Merchandise Remaining in Ending Inventory Salad Tuna Total $207,000

$144,000 195,000

150,000

$138,000 198,000

$345,000 342,000 345,000

Reported net incomes (from independent operations including sales to affiliates) of Pine, Salad, and Tuna for 2014 were $3,600,000, $1,500,000, and $2,400,000, respectively. Required: A. Calculate the amount noncontrolling interest to be deducted from consolidated income in the consolidated income statement for 2014. B. Calculate the controlling interest in consolidated net income for 2014.

6-8

Test Bank to accompany Jeter and Chaney Advanced Accounting

6-5

The following balances were taken from the records of S Company: Common stock Retained earnings, 1/1/11 $1,450,000 Net income for 2014 3,000,000 Dividends declared in 2014 (1,550,000) Retained earnings, 12/31/11 Total stockholders’ equity, 12/31/11

$2,500,000

2,900,000 $5,400,000

P Company owns 80% of the common stock of S Company. During 2014, P Company purchased merchandise from S Company for $4,000,000. S Company sells merchandise to P Company at cost plus 25% of cost. On December 31, 2014, merchandise purchased from S Company for $1,250,000 remains in the inventory of P Company. On January 1, 2014, P Company’s inventory contained merchandise purchased from S Company for $525,000. The affiliated companies file a consolidated income tax return. There was no difference between the implied value and the book value of net assets acquired. Required: A. Prepare all workpaper entries necessitated by the intercompany sales of merchandise. B. Compute noncontrolling interest in consolidated income for 2014. C. Compute noncontrolling interest in consolidated net assets on December 31, 2014.

6-6 P Corporation acquired 80% of S Corporation on January 1, 2014 for $240,000 cash when S’s stockholders’ equity consisted of $100,000 of Common Stock and $30,000 of Retained Earnings. The difference between the price paid by P and the underlying equity acquired in S was allocated solely to a patent amortized over 10 years. P sold merchandise to S during the year in the amount of $30,000. $10,000 worth of inventory is still on hand at the end of the year with an unrealized profit of $4,000. The separate company statements for P and S appear in the first two columns of the partially completed consolidated workpaper. Required: Complete the consolidated workpaper for P and S for the year 2014.

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-9

P Corporation and Subsidiary Consolidated Statements Workpaper at December 31, 2014

Income Statement Sales Dividend Income Cost of Sales Other Expenses Noncontrolling Interest in Income Net Income Retained Earnings Statement Retained Earnings 1/1 Add: Net Income Less: Dividends Retained Earnings 12/31 Balance Sheet Cash Accounts Receivable-net Inventories Patent Land Equipment and Buildings-net Investment in S Corporation Total Assets Equities Accounts Payable Common Stock Retained Earnings 1/1 Noncontrolling Interest in Net Assets 12/31 Noncontrolling Interest in Net Assets Total Equities

P Corp.

S Corp.

200,000 16,000 (92,000) (23,000)

150,000 (47,000) (40,000)

101,000

63,000

110,000 101,000 ( 30,000) 181,000

30,000 63,000 (20,000) 73,000

20,000 120,000 140,000

19,000 55,000 80,000

270,000 600,000 240,000 695,000

420,000 430,000 1,004,000

909,000 300,000 181,000

831,000 100,000 73,000

1,390,000

1,004,000

Eliminations Dr. Cr.

Noncontrolling Interest

Consolidated Balances

6-10 Test Bank to accompany Jeter and Chaney Advanced Accounting 6-7

On January 1, 2014, Perch Company purchased an 80% interest in the capital stock of Salmon Company for $3,400,000. At that time, Salmon Company had common stock of $2,200,000 and retained earnings of $620,000. Perch Company uses the cost method to record its investment in Salmon Company. Differences between the fair value and the book value of the identifiable assets of Salmon Company were as follows: Fair Value in Excess of Book Value Equipment Land Inventory

$400,000 200,000 80,000

The book values of all other assets and liabilities of Salmon Company were equal to their fair values on January 1, 2014. The equipment had a remaining life of five years on January 1, 2014; the inventory was sold in 2014. Salmon Company’s net income and dividends declared in 2014 were as follows:

Year 2014 Net Income of $400,000; Dividends Declared of $100,000 Required: Prepare a consolidated statements workpaper for the year ended December 31, 2015 using the partially completed worksheet.

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-11

PERCH COMPANY AND SUBSIDIARY Consolidated Statements Workpaper For the Year Ended December 31, 2015

Perch Salmon Eliminations Noncontrolling Consolidated Company Company Dr. Cr. Interest Balances Income Statement Sales Dividend Income Total Revenue Cost of Goods Sold Depreciation Expense Other Expenses Total Cost & Expenses Net/Consolidated Income Noncontrolling Interest in Income Net Income to Retained Earnings Retained Earnings Statement 1/1 Retained Earnings Perch Company Salmon Company Net Income from above Dividends Declared Perch Company Salmon Company 12/31 Retained Earnings to Balance Sheet

4,400,000 1,800,000 192,000 4,592,000 1,800,000 3,600,000 800,000 160,000 120,000 240,000 200,000 4,000,000 1,120,000 592,000 680,000 592,000

680,000

2,000,000 592,000

920,000 680,000

(360,000) (240,000) 2,232,000 1,360,000 Perch Salmon Eliminations Noncontrolling Consolidated Company Company Dr. Cr. Interest Balances

Balance Sheet Cash Accounts Receivable Inventory Investment in Salmon Company Difference between Implied and Book Value Land Plant and Equipment Total Assets Accounts Payable Notes Payable Common Stock: Perch Company Salmon Company Retained Earnings from above 1/1 Noncontrolling Interest in Net Assets 12/31 Noncontrolling Interest in Net Assets Total Liabilities & Equity

280,000 1,040,000 960,000 3,400,000

1,440,000 7,120,000 528,000 360,000

260,000 760,000 700,000

1,280,000 1,120,000 4,120,000 440,000 120,000

4,000,000 2,200,000 2,232,000 1,360,000

7,120,000 4,120,000

6-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 6-8

Poole Company owns a 90% interest in Solumbra Company. The consolidated income statement drafted by the controller of Poole Company appeared as follows: Poole Company and Subsidiary Consolidated Income Statement for Year Ended December 31, 2014 Sales Cost of Sales Operating Expenses Consolidated Income Less Noncontrolling Interest in Consolidated Income Controlling Interest in Consolidated Net Income

$13,800,000 $9,000,000 1,800,000

10,800,000 3,000,000 190,000 $2,810,000

During your audit you discover that intercompany sales transactions were not reflected in the controller’s draft of the consolidated income statement. Information relating to intercompany sales and unrealized intercompany profit is as follows:

2013 Sales—Solumbra to Poole 2014 Sales—Poole to Solumbra

Cost

Selling Price

Unsold at Year-End

$1,500,000 900,000

$1,800,000 1,350,000

1/4 2/5

Required: Prepare a corrected consolidated income statement for Poole Company and Slocum Company for the year ended December 31, 2014.

Short Answer 1.

Past and proposed GAAP agree that unrealized intercompany profit should not be included in consolidated net income or assets. Briefly explain the preferred approach of eliminating intercompany profit.

Determination of the noncontrolling interest in consolidated net income differs depending on whether intercompany sales are downstream or upstream. Explain the difference in calculating noncontrolling interest for downstream and upstream sales.

Short Answer Questions from the Textbook 1.

Does the elimination of the effects of intercompany sales of merchandise always affect the amount of reported consolidated net income? Explain.

Why is the gross profit on intercompany sales, rather than profit after deducting selling and administrative expenses, ordinarily eliminated from consolidated inventory balances?

P Company sells inventory costing $100,000 to its subsidiary, S Company, for $150,000. At the end of the current year, one-half of the goods re-mainsremains in S Company’s inventory. Applying the lower of cost or market rule, S Company writes down this inventory to $60,000. What amount of intercompany profit should be eliminated on the consolidated statements workpaper?

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-13

Are the adjustments to the noncontrolling interest for the effects of intercompany profit eliminations illustrated in this text necessary for fair presentation in accordance with generally accepted accounting principles? Explain.

Why are adjustments made to the calculation of the noncontrolling interest for the effects of intercompany profit in upstream but not in down-stream sales?

What procedure is used in the consolidated statements workpaper to adjust the noncontrolling interest in consolidated net assets at the be-ginningbeginning of the year for the effects of intercompany profits?

What is the essential procedural difference between workpaper eliminating entries for unrealized intercompany profit made when the selling affiliate is a less than wholly owned subsidiary and those made when the selling affiliate is the parent company or a wholly owned subsidiary?

Define the controlling interest in consolidated net income using the t-account or analytical approach.

Why is it important to distinguish between up-stream and downstream sales in the analysis of intercompany profit eliminations? missing short answer question 10 and ethics 1>>3

6-14 Test Bank to accompany Jeter and Chaney Advanced Accounting ANSWER KEY Multiple Choice

1. 2. 3. 4.

d b c c

5. 6. 7. 8.

a c d d

9. 10. 11. 12.

c b c c

13. 14. 15. 16.

a c a c

17. 18. 19. 20.

b c d a

21. 22. 23. 24.

c a c b

25. c

Problems 6-1

A. Depreciation Expense (240,000/10) Plant and Equipment (net) (240,000 – 24,000) 1/1 Inventory Goodwill Difference Between Implied and Book Value

24,000 216,000 80,000 591,111 911,111

B. Pharma’s net income from independent operations Less: unrealized profit on sales to Sandy [180,000 – (180,000/1.20)] Pharma’s income from independent operations that has been realized in transactions with third parties Pharma’s share of Sandy’s income (600,000 × .90) Less: amortization of difference between implied and book value Controlling Interest in Consolidated Net Income for 2014

$1,600,000 (30,000) 1,570,000 540,000 (104,000)* $2,006,000

* 80,000 + (240,000/10)

6-2

A. 2014 Sales

1,080,000 Purchases (Cost of Goods Sold)

12/31 Inventory (Income Statement) [216,000 – (216,000/1.20)] 12/31 Inventory(Balance Sheet) 2015 Sales

1,080,000

36,000 36,000

1,200,000 Purchases (Cost of Goods Sold)

1,200,000

12/31 Inventory (Income Statement) [300,000 – (300,000/1.20)] 12/31 Inventory (Balance Sheet)

50,000

Beginning R/E – Puma 1/1 Inventory (Income Statement)

36,000

50,000

36,000

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory B. Puma’s Income from independent operations Less: Unrealized profit in ending inventory Add: Unrealized profit in beginning inventory Puma’s Income Realized in Transactions with third parties Puma’s Share of Subsidiary Income Controlling Interest in Consolidated Net Income

6-3

A. Sales

$760,000 (50,000) 36,000 746,000 $368,000 $1,114,000

1,020,000

Purchases (Cost of Sales) To eliminate intercompany sales.

1,020,000

12/31 Inventory (Income Statement) 51,000 Inventory (Balance Sheet) To eliminate unrealized intercompany profit in ending inventory.

51,000

Beginning Retained Earnings – Pinta (.90 × $40,000) 36,000 Noncontrolling interest 4,000 1/1 Inventory (Balance Sheet) 40,000 To recognize unrealized profit in beginning inventory realized during the year. B. Noncontrolling Interest Calculation: Simplex Company reported net income Less: Unrealized profit in ending inventory Add: Realized profit in beginning inventory Subsidiary income included in consolidated income Noncontrolling interest ownership percentage Noncontrolling interest in consolidated income

$600,000 (51,000) 40,000 589,000 × .1 $ 58,900

C. Controlling Interest in Consolidated Net Income: Pinta Company’s net income from independent operations Reported net income of Simplex Company $600,000 Less: Unrealized profit on sales of 2014 (51,000) Add: Profit on intercompany sales to Pinta realized in transactions with third parties 40,000 Subsidiary income realized in transactions with third parties $589,000 Pinta Company’s share of subsidiary income (589,000 × .9) Controlling interest in consolidated net income

$1,720,000

530,100 $2,250,100

6-15

6-16 Test Bank to accompany Jeter and Chaney Advanced Accounting 6-4 A. Reported subsidiary income Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory Subsidiary income included in consolidated income Noncontrolling interest ownership percentage Noncontrolling interest in consolidated income

Salad $1,500,000 66,000 (57,000) 1,509,000 × .2 $301,800

Tuna $2,400,000 63,000 (69,000) 2,394,000 × .1 $239,400

Total noncontrolling interest:$301,800 + $239,400 = $541,200 B. Power’sPine's Company’s income independent operations Add: Unrealized profit considered realized in 2014 ($414,000 – $414,000/1.15) Less: Unrealized profit in 2014 income ($345,000 – $345,000/1.15) Power’sPine's income realized in transactions with third parties Salad Company’s Reported Net Income Add: Unrealized profit considered realized in 2014 ($396,000 – $396,000/1.2) Less: Unrealized profit in 2014 income ($342,000 – $342,000/1.20) Subsidiary income realized in transactions with third parties

$3,600,000 54,000 (45,000) $3,609,000

$1,500,000 66,000 (57,000) 1,509,000

Power’s Pine'sshare of subsidiary income (.8 × 1,509,000) Tuna Company’s reported net income $2,400,000 Add: Unrealized profit considered realized in 2014 ($315,000 – $315,000/1.25) 63,000 Less: Unrealized profit in 2014 income ($345,000 – $345,000/1.25) (69,000) Subsidiary income realized in transactions with third parties $2,394,000 Power’sPine's share of subsidiary income (.9 × 2,394,000) Controlling Interest in Consolidated Net Income

1,207,200

2,154,600 $6,970,800

6-5 A. Sales

4,000,000 Cost of Goods Sold

4,000,000

Cost of Goods Sold Ending Inventory (Balance Sheet) [$1,250,000 - ($1,250,000/1.25)]

250,000

1/1 Retained Earnings – P Company (1) Noncontrolling interest (2) Cost of Goods Sold (Beginning Inventory) [$525,000 – ($525,000/1.25)] = $105,000

84,000 21,000

250,000

105,000

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-17

(1) .8($105,000) (2) .2($105,000) B. $3,000,000 × .20 = $600,000 noncontrolling interest in consolidated income. C. [(.20 × $5,400,000) -.20($1,250,000 – $1,250,000/1.25)] = $1,030,000 noncontrolling interest in consolidated net assets on December 31, 2014.

6-6

Income Statement Sales Dividend Income Cost of Sales Other Expenses Noncontrolling Interest in Income Net income Retained Earnings Statement Retained Earnings 1/1 Add: Net Income Less: Dividends Retained Earnings 12/31 Balance Sheet Cash Accounts Receivable-net Inventories Patent Land Equipment and Buildings-net Investment in S Corporation Total Assets Equities Accounts Payable Common Stock Retained Earnings from above 1/1 Noncontrolling Interest in Net Assets 12/31 Noncontrolling Interest in Net Assets Total Equities

P Corporation and Subsidiary Consolidated Statements Workpaper at December 31, 2014

Corp.

Eliminations Dr Cr

$200,000 $ 150,000 (a) 30,000 16,000 (c) 16,000 (92,000) (47,000) (b) 4,000 (23,000) (40,000) (e) 17,000 101,000

63,000

67,000

110,000 101,000 ( 30,000) 181,000

30,000 63,000 (20,000) 73,000

(d) 30,000 67,000

20,000 120,000 140,000

19,000 55,000 80,000

97,000

(d)170,000 270,000 420,000 600,000 430,000 240,000 1,390,000 1,004,000 909,000 300,000 181,000

831,000 100,000 73,000

Noncontrolli ng Interest

Balances 320,000

(a) 30,000

30,000

30,000 (c) 16,000 46,000

9,200 9,200

(113,000) (80,000) (9,200) 117,800

9,200 (4,000) 5,200

110,000 117,800 (30,000) 197,800 39,000 175,000 216,000 153,000 690,000 1,030,000

(b) 4,000 (e) 17,000

(d)240,000 2,303,000

(d)100,000 97,000

46,000

5,200

(d)60,000

60,000 65,200

1,390,000 1,004,000

Consolidated

367,000

1,740,000 300,000 197,800

65,200 2,303,000

6-18 Test Bank to accompany Jeter and Chaney Advanced Accounting

6-7

PERCH COMPANY AND SUBSIDIARY Consolidated Statements Workpaper For the Year Ended December 31, 2015

Perch Salmon Company Company Income Statement Sales Dividend Income Total Revenue Cost of Goods Sold Depreciation Expense Other expense Total Cost & Expenses Net/Consolidated Income Noncontrolling Interest in Income Net Income to Retained Earnings Statement of Retained Earnings 1/1 Retained Earnings

Eliminations Dr. Cr.

Noncontrolling Interest

Consolidated Balances

120,000 120,000

6,200,000 ---6,200,000 4,400,000 360,000 440,000 5,200,000 1,000,000 120,000 880,000

4,400,000 1,800,000 192,000 (a) 192,000 4,592,000 1,800,000 3,600,000 800,000 160,000 120,000 (d) 80,000 240,000 20,0000 4,000,000 1,120,000 592,000 680,000 592,000

Perch Company Salmon Company Net Income from above Dividends Declared

2,000,000

Perch Company Salmon Company 12/31 Retained Earnings to Balance Sheet Balance Sheet Cash Accounts Receivable Inventory Investment in Salmon Company Difference between Implied and Book Value Land Plant and Equipment Goodwill Total Assets Accounts Payable Notes Payable Common Stock: Perch Company Salmon Company Retained Earnings from above

(360,000)

592,000

680,000

120,000

(240,000)

(a) 192,000

(48,000)

432,000

72,000

1,440,000 7,120,000 528,000 360,000

2,112,000 880,000

(360,000)

2,232,000 1,360,000 280,000 1,040,000 960,000 3,400,000

272,000

1,320,000

260,000 760,000 700,000

2,632,000

(e) 240,000 (b)3,640,000

540,000 1,800,000 1,660,000 ---

(b) 1,430,000 (c)1,430,000 1,280,000 (c) 200,000 1,120,000 (c) 400,000 (d) 160,000 (c) 750,000 4,120,000 440,000 120,000

1,480,000 2,800,000 750,000 9,030,000 968,000 480,000

4,000,000 2,200,000 (b) 2,200,000 2,232,000 1,360,000 1,320,000

4,000,000 432,000

72,000

2,632,000

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory 1/1 Noncontrolling Interest in Net Assets

12/31 Noncontrolling Interest in Net Assets Total Liabilities & Equity 7,120,000 4,120,000

6-8

6,572,000

6-19

878,000

950,000 712,000

950,000 9,030,000

POOLE COMPANY AND SUBSIDIARY Consolidated Income Statement For the Year Ended December 31, 2014 Sales ($13,800,000 – $1,350,000) Cost of Goods Sold (a) Operating Expenses Consolidated Income Less Noncontrolling Interest in Consolidated Income (b) Controlling Interest in Consolidated Net Income

$12,450,000 $7,755,000 1,800,000

(a) Reported Cost of Goods Sold Less intercompany sales in 2014 Plus unrealized profit in ending inventory (2/5 x ($1,350,000 - $900,000)) Less realized profit in beginning inventory (1/4 x ($1,800,000 - $1,500,000)) Corrected cost of goods sold

9,555,000 2,895,000 197,500 $2,697,500 $9,000,000 (1,350,000) 180,000 (75,000) $7,755,000

$190,000 $1,900,000 0.1 Plus unrealized profit on subsidiary sales in 2013 that is considered realized in 2014 (1/4 x ($1,800,000 - $1,500,000)) 75,000 Less unrealized profit on subsidiary sales in 2014 (there were no upstream sales in 2014) 0 Income realized in transactions with third parties 1,975,000 × 0.10 Noncontrolling interest in consolidated income $197,500

(b) Reported net income of subsidiary

Short Answer 1.

Both current and proposed GAAP require 100% elimination of intercompany profit in the preparation of consolidated financial statements. Under 100% elimination, the entire amount of unconfirmed intercompany profit is eliminated from consolidated net income and the related asset balance. This approach is logical under the proposed view of consolidated financial statements, based on the entity concept.

For downstream sales, no modification to the noncontrolling interest in consolidated income is needed. For upstream sales, the noncontrolling interest must be adjusted. The reported income of the subsidiary is reduced by the amount of gross profit remaining in ending inventory of the purchasing affiliate before multiplying by the noncontrolling percentage interest; it is increased for gross profit realized from beginning inventory.

6-20 Test Bank to accompany Jeter and Chaney Advanced Accounting Short Answer Questions in Textbook Solutions 1. No. If all of the merchandise sold by one affiliate to another has subsequently been sold to outsiders, the only effect that the elimination of intercompany sales of merchandise will have on the consolidated financial statements is to reduce consolidated sales and consolidated cost of sales by an equal amount. Consolidated net income will be unaffected. 2. The effect of eliminating profit on intercompany sales after deducting selling and administrative expenses rather than gross profit is to include selling and administrative expenses associated with the intercompany sale in consolidated inventories. Support for the gross profit approach is based on the proposition that consolidated inventory balances should include manufacturing costs only and that generally accepted accounting standards normally preclude the capitalization of selling and administrative costs. 3. $10,000 in intercompany profit should be eliminated on the consolidated statements workpaper ($60,000

$100,000 = $10,000). After this elimination the merchandise will be included in the consolidated 2 $100,000 statements at its cost to the affiliated group of $50,000 ( ). 2 –

4. Yes. Although 100 percent elimination of intercompany profit has long been required in the preparation of consolidated financial statements, the adjustments to the noncontrolling interest described in this text were discretionary prior to the current standard. The FASB requires that these adjustments be allocated between the noncontrolling and controlling interests. 5. When the subsidiary is the intercompany seller, the unrealized profit is shown in the accounts of the sub (S Company). These accounts provide the starting point for the calculation of the noncontrolling share of current year earnings. Failure to eliminate unrealized profit would result in the overstatement of the noncontrolling share in profits. However, when the parent is the intercompany seller, the unrealized profit is shown in the accounts of the parent (P Company). Since the noncontrolling interest does not share in the earnings of P Company, the noncontrolling interest is not affected by the unrealized profit therein. 6. Noncontrolling interest in consolidated net assets at the beginning of the year is adjusted by debiting or crediting the subsidiary’s beginning retained earnings in the consolidated statements workpaper. 7. The only procedural difference in the workpaper entries relating to the elimination of intercompany profits when the selling affiliate is a less than wholly owned subsidiary is that the noncontrolling interest in the amount of intercompany profit in beginning inventory must be recognized by debiting or crediting the noncontrolling shareholders’ percentage interest in such adjustments to the beginning retained earnings of the subsidiary. 8. Controlling interest in consolidated net income is equal to the parent company’s income from its independent operations that has been realized in transactions with third parties plus its share of reported subsidiary income that has been realized in transactions with third parties and adjusted for its share of the amortization of the difference between implied and book value for the period. 9. It is important to distinguish between upstream and downstream sales because the calculation of noncontrolling interest in the consolidated financial statements differs depending on whether the intercompany sale giving rise to unrealized intercompany profit is upstream or downstream. did not really explain 10. Profit relating to the intercompany sale of merchandise is recognized in the consolidated financial statements in the period in which the merchandise is sold to outsiders. It is recognized in the

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-21

consolidated financial statements by reducing cost of goods sold (thus increasing gross profit and net income). Answers to Business Ethics Case 1. Independence of the auditor is essential in maintaining effective audits. When auditors are involved in non-audit services, their independence may be impaired (in essence they may be viewed as auditing their own work). Many times auditors have to rely on management representation when no supporting evidence is available. Auditors’ involvement in non-audit services can help them gain sufficient familiarity with their client’s business and operational activities to reduce such dependencies and perhaps to lower audit risk. 2. The growing economic importance of non-audit service fees to the audit firms over time may have increased the potential for the auditors to lose independence, even to the extent of financial fraud involvement. The increasing effort to reduce costs (in a competitive marketplace for audit services) imposes limitations on the scope of the audit work involvedand avoids operating at a loss. Subsidizing any shortfall between audit revenues and audit costs with non-audit fees can help in overcoming such limitations. 3. Audit fees would have to increase if auditors are held liable to a greater degree. The increased fees would cover both increased auditor effort to detect errors and to cover the increased litigation settlements/insurance premiums. The additional benefits would be weighed against the costs. Timeliness and accuracy present constant tradeoffs in any audit. Time and budget constraints may potentially result in an audit staff not performing sufficient work to meet deadlines. Further, excessive cost-cutting may cause audit work to be inappropriately reduced, which leads to increased reliance by auditors on client presentations to document areas where the data are not easily available. Such reliance can cause audit judgments to be inappropriately influenced. When factors outside their control cause auditors to rely on the representations of others, they should not be solely responsible for resulting errors. Legislation aimed at protecting auditors to some extent also serves to keep audits from becoming prohibitively expensive.

Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment Multiple Choice 1.

In the year a subsidiary sells land to its parent company at a gain, a workpaper entry is made debiting 1. Retained Earnings - P Company. 2. Retained Earnings - S Company. 3. Gain on Sale of Land. a. 1 b. 2 c. 3 d. both 1 and 2.

In years subsequent to the year a 90% owned subsidiary sells equipment to its parent company at a gain, the noncontrolling interest in consolidated income is computed by multiplying the noncontrolling interest percentage by the subsidiary’s reported net income a. minus the net amount of unrealized gain on the intercompany sale. b. plus the net amount of unrealized gain on the intercompany sale. c. minus intercompany gain considered realized in the current period. d. plus intercompany gain considered realized in the current period.

Company S sells equipment to its parent company (P) at a gain. In years subsequent to the year of the intercompany sale, a workpaper entry is made under the cost method debiting a. Retained Earnings - P. b. Noncontrolling interest. c. Equipment. d. all of these.

P Corp. owns 90% of the outstanding common stock of S Company. On December 31, 2014, S sold equipment to P for an amount greater than the equipment’s book value but less than its original cost. The equipment should be reported on the December 31, 2014 consolidated balance sheet at a. P’s original cost less 90% of S’s recorded gain. b. P’s original cost less S’s recorded gain. c. S’s original cost. d. P’s original cost.

Petunia Company owns 100% of Sage Corporation. On January 1, 2014 Petunia sold equipment to Sage at a gain. Petunia had owned the equipment for four years and used a ten-year straight-line rate with no residual value. Sage is using an eight-year straight-line rate with no residual value. In the consolidated income statement, Sage’s recorded depreciation expense on the equipment for 2014 will be reduced by a. 10% of the gain on sale. b. 12 1/2% of the gain on sale. c. 80% of the gain on sale. d. 100% of the gain on sale.

7-2

Test Bank to accompany Jeter and Chaney Advanced Accounting

Petunia Corporation owns 100% of Stone Company’s common stock. On January 1, 2014, Petunia sold equipment with a book value of $210,000 to Stone for $300,000. Stone is depreciating the equipment over a tenyear life by the straight-line method. The net adjustments to compute 2014 and 2015 consolidated income would be an increase (decrease) of 2014 2015 a. ($90,000) $0 b. ($90,000) $9,000 c. ($81,000) $0 d. ($81,000) $9,000

In the year an 80% owned subsidiary sells equipment to its parent company at a gain, the noncontrolling interest in consolidated income is calculated by multiplying the noncontrolling interest percentage by the subsidiary’s reported net income a. plus the intercompany gain considered realized in the current period. b. plus the net amount of unrealized gain on the intercompany sale. c. minus the net amount of unrealized gain on the intercompany sale. d. minus the intercompany gain considered realized in the current period.

The amount of the adjustment to the noncontrolling interest in consolidated net assets is equal to the noncontrolling interest’s percentage of the a. unrealized intercompany gain at the beginning of the period. b. unrealized intercompany gain at the end of the period. c. realized intercompany gain at the beginning of the period. d. realized intercompany gain at the end of the period.

In January 2008 2011?, S Company, an 80% owned subsidiary of P Company, sold equipment to P Company for $1,980,000. S Company’s original cost for this equipment was $2,000,000 and had accumulated depreciation of $200,000. P Company continued to depreciate the equipment over its 9 year remaining life using the straight-line method. This equipment was sold to a third party on January 1, 2014 for $1,440,000. What amount of gain should P Company record on its books in 2014? a. $60,000. b. $120,000. c. $240,000. d. $360,000.

10.

In years subsequent to the upstream intercompany sale of nondepreciable assets, the necessary consolidated workpaper entry under the cost method is to debit the a. Noncontrolling interest and Retained Earnings (Parent) accounts, and credit the nondepreciable asset. b. Retained Earnings (Parent) account and credit the nondepreciable asset. c. Nondepreciable asset, and credit the Noncontrolling interest and Investment in Subsidiary accounts. d. No entries are necessary.

11.

When preparing consolidated financial statement workpapers, unrealized intercompany gains, as a result of equipment or inventory sales by affiliates, are allocated proportionately by percent of ownership between parent and subsidiary only when the selling affiliate is a. the parent and the subsidiary is less than wholly owned. b. a wholly owned subsidiary. c. the subsidiary and the subsidiary is less than wholly owned. d. the parent of a wholly owned subsidiary.

Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

7-3

12.

Gain or loss resulting from an intercompany sale of equipment between a parent and a subsidiary is a. recognized in the consolidated statements in the year of the sale. b. considered to be realized over the remaining useful life of the equipment as an adjustment to depreciation in the consolidated statements. c. considered to be unrealized in the consolidated statements until the equipment is sold to a third party. d. amortized over a period not less than 2 years and not greater than 40 years.

13.

In 2014, P Company sells land to its 80% owned subsidiary, S Company, at a gain of $50,000. What is the effect of this sale of land on consolidated net income assuming S Company still owns the land at the end of the year? a. consolidated net income will be the same as if the sale had not occurred. b. consolidated net income will be $50,000 less than it would had the sale not occurred. c. consolidated net income will be $40,000 less than it would had the sale not occurred. d. consolidated net income will be $50,000 greater than it would had the sale not occurred.

14.

Several years ago, P Company bought land from S Company, its 80% owned subsidiary, at a gain of $50,000 to S Company. The land is still owned by P Company. The consolidated working papers for this year will require: a. no entry because the gain happened prior to this year. b. a credit to land for $50,000. c. a debit to P’s retained earnings for $50,000. d. a debit to Noncontrolling interest for $50,000.

15.

On January 1, 2013 S Corporation sold equipment that cost $120,000 and had a book value of $48,000 to P Corporation for $60,000. P Corporation owns 100% of S Corporation and the equipment has a 4-year remaining life. What is the effect of the sale on P Corporation’s Equity from Subsidiary Income account for 2014? a. no effect b. increase of $12,000. c. decrease of $12,000. d. increase of $3,000.

16.

P Corporation acquired an 80% interest in S Corporation two years ago at an implied value equal to the book value of S. On January 2, 2014, S sold equipment with a five-year remaining life to P for a gain of $120,000. S reports net income of $600,000 for 2014 and pays dividends of $200,000. P’s Equity from Subsidiary Income for 2014 is: a. $480,000. b. $384,000. c. $403,200. d. $576,000

17.

P Company purchased land from its 80% owned subsidiary at a cost of $100,000 greater than it subsidiary’s book value. Two years later P sold the land to an outside entity for $50,000 more than it’s cost. In its current year consolidated income statement P and its subsidiary should report a gain on the sale of land of: a. $50,000. b. $120,000. c. $130,000. d. $150,000.

7-4

Test Bank to accompany Jeter and Chaney Advanced Accounting

18.

On January 1, 2013, P Corporation sold equipment with a 3-year remaining life and a book value of $40,000 to its 70% owned subsidiary for a price of $46,000. In the consolidated workpapers for the year ended December 31, 2014, an elimination entry for this transaction will include a: a. debit to Equipment for $6,000. b. debit to Gain on Sale of Equipment for $6,000. c. credit to Depreciation Expense for $6,000. d. debit to Accumulated Depreciation for $4,000.

19.

Patriot Corporation owns 100% of Simon Company’s common stock. On January 1, 2014, Patriot sold equipment with a book value of $350,000 to Simon for $500,000. Simon is depreciating the equipment over a ten-year life by the straight-line method. The net adjustments to compute 2014 and 2015 consolidated income would be an increase (decrease) of 2014 2015 a. ($150,000) $0 b. ($150,000) $15,000 c. ($135,000) $0 d. ($135,000) $15,000

20.

In January 20082011?, S Company, an 80% owned subsidiary of P Company, sold equipment to P Company for $990,000. S Company’s original cost for this equipment was $1,000,000 and had accumulated depreciation of $100,000. P Company continued to depreciate the equipment over its 9 year remaining life using the straight-line method. This equipment was sold to a third party on January 1, 2014 for $720,000. What amount of gain should P Company record on its books in 2014? a. $30,000. b. $60,000. c. $120,000. d. $180,000.

21.

P Corporation acquired an 80% interest in S Corporation two years ago at an implied value equal to the book value of S. On January 2, 2014, S sold equipment with a five-year remaining life to P for a gain of $180,000. S reports net income of $900,000 for 2014 and pays dividends of $300,000. P’s Equity from Subsidiary Income for 2014 is: a. $720,000. b. $576,000. c. $604,800. d. $864,000

22.

P Company purchased land from its 80% owned subsidiary at a cost of $30,000 greater than it subsidiary’s book value. Two years later P sold the land to an outside entity for $15,000 more than it’s cost. In its current year consolidated income statement P and its subsidiary should report a gain on the sale of land of: a. $15,000. b. $36,000. c. $39,000. d. $45,000.

23.

On January 1, 2013, P Corporation sold equipment with a 3-year remaining life and a book value of $100,000 to its 70% owned subsidiary for a price of $115,000. In the consolidated workpapers for the year ended December 31, 2014, an elimination entry for this transaction will include a: a. debit to Equipment for $15,000. b. debit to Gain on Sale of Equipment for $15,000. c. credit to Depreciation Expense for $15,000.

Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

7-5

d. debit to Accumulated Depreciation for $10,000. Problems 7-1

Pine Company, a computer manufacturer, owns 90% of the outstanding stock of Slider Company. On January 1, 2014, Pine sold computers to Slider for $500,000. The computers, which are inventory to Pine, had a cost to Pine of $350,000. Slider Company estimated that the computers had a useful life of six years from the date of purchase. Slider Company reported net income of $310,000, and Pine Company reported net income of $870,000 from its independent operations (including sales to affiliates) for the year ended December 31, 2014. Required: A. Prepare in general journal form the workpaper entries necessary because of the intercompany sales in the consolidated statements workpaper for both 2014 and 2015. B. Calculate controlling interest in consolidated net income for 2014.

7-2

On January 1, 2008, Perry Company purchased a 90% interest in Sludge Company for $800,000, the same as the book value on that date. On January 1, 2014, Sludge sold new equipment to Perry for $16,000. The equipment cost $11,000 and had a five year estimated life as of January 1, 2014. need data to include CGS = 42,000 - used in solution, but not here During 2015, Perry sold merchandise to Sludge at 20% above cost in the amount (selling price) of $126,000. At the end of the year, Sludge had one-third of this merchandise in its ending inventory. At the beginning of 2015, Sludge had $48,000 of inventory purchased in 2014 from Perry Required: A. Prepare all workpaper entries necessary to eliminate the effects of the intercompany sales on the consolidated financial statements for 2015. B. Calculate the amount of noncontrolling interest to be deducted from consolidated net income in the consolidated income statement for 2015. Sludge Company reported $40,000 of net income in 2015.

7-3

Prince Company owns 104,000 of the 130,000 shares outstanding of Serf Corporation. Serf Corporation sold equipment to Prince Company on January 1, 2014 for $740,000. The equipment was originally purchased by Serf Corporation on January 1, 2013 for $1,280,000 and at that time its estimated depreciable life was 8 years. The equipment is estimated to have a remaining useful life of four years on January 1, 2014. Both companies use the straight-line method to depreciate equipment. In 2015 Prince Company reported net income from its independent operations of $3,270,000, and Serf Corporation reported net income of $820,000 and declared dividends of $60,000. Prince Company uses the cost method to record the investment in Serf Company. Required: A. Prepare, in general journal form, the workpaper entries relating to the intercompany sale of equipment that are necessary in the December 31, 2015 consolidated financial statements workpapers. B. Calculate the amount of noncontrolling interest to be deducted from consolidated net income in the consolidated income statement for 2015. C. Calculate controlling interest in consolidated net income for 2015.

7-6 7-4

Test Bank to accompany Jeter and Chaney Advanced Accounting P Company bought 60% of the common stock of S Company on January 1, 2014. On January 1, 2014 there was an intercompany sale of equipment at a gain of $63,000. The equipment had an estimated remaining life of six years. Net incomes of the two companies from their own operations (including sales to affiliates) were as follows: 2014 2015 P Company $280,000 $210,000 S Company 70,000 105,000 A. If S Company sold the equipment to P Company, fill in the following matrix: 2014 2015 Noncontrolling interest in consolidated net income Controlling Interest in Consolidated net income B. If P Company sold the equipment to S Company, fill in the following matrix: 2014 2015 Noncontrolling interest in consolidated net income Controlling interest in consolidated net income

7-5

On January 1, 2014, Pharma Company purchased equipment from its 80%-owned subsidiary for $2,400,000. On the date of the sale, the carrying value of the equipment on the books of the subsidiary company was $1,800,000. The equipment had a remaining useful life of six years on January 2014. On January 1, 2015, Pharma Company sold the equipment to an outside party for $2,200,000. Required: A. Prepare, in general journal form, the entries necessary in 2014 and 2015 on the books of Pharma Company to account for the purchase and sale of the equipment. B. Determine the consolidated gain or loss on the sale of the equipment and prepare, in general journal form, the entry necessary on the December 31, 2015 consolidated statements workpaper to properly reflect this gain or loss.

Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment 7-6

7-7

P Corporation acquired 80% of the outstanding voting stock of S Corporation when the fair values equaled the book values. On July 1, 2013, P sold land to S for $300,000. The land originally cost P $200,000. S recently resold the land on October 30, 2014 for $350,000. On October 1, 2014, S Corporation sold equipment to P Corporation for $80,000. S originally paid $100,000 for this equipment and had accumulated depreciation of $40,000 thus far. The equipment has a five-year remaining life. Required: A. Complete the consolidated income statement for P Corporation and subsidiary for the year ended December 31, 2014.

Sales Dividend Income from S

1,200,000

600,000

Noncontrolling Interest

Consolidated Balances

80,000

Gain on Sale of Equipment Gain on Sale of Land

7-7

Elimination Entries Dr. Cr.

20,000 50,000

Cost of Sales

(800,000)

(300,000)

Depreciation Expense

(160,000)

(80,000)

Other Expenses

(200,000)

(160,000)

Noncontrolling Interest in Income Net Income

120,000

130,000

Pale Company owns 90% of the outstanding common stock of Shale Company. On January 1, 2014, Shale Company sold equipment to Pale Company for $300,000. Shale Company had purchased the equipment for $450,000 on January 1, 2006 and has been depreciating it over a 10 year life by the straight-line method. The management of Pale Company estimated that the equipment had a remaining life of 5 years on January 1, 2014. In 2014, Pale Company reported $225,000 and Shale Company reported $150,000 in net income from their independent operations. Required: A. Prepare in general journal form the workpaper entries relating to the intercompany sale of equipment that are necessary in the December 31, 2014 and 2015 consolidated statements workpapers. Pale Company uses the cost method to record its investment in Shale Company. B. Calculate equity in subsidiary income for 2014 and noncontrolling interest in net income for 2014.

7-8 7-8

Test Bank to accompany Jeter and Chaney Advanced Accounting On January 1, 2013, Pound Company acquired an 80% interest in the common stock of Sound Company on the open market for $3,000,000, the book value at that date. On January 1, 2014, Pound Company purchased new equipment for $58,000 from Sound Company. The equipment cost $36,000 and had an estimated life of five years as of January 1, 2014. During 2015, Pound Company had merchandise sales to Sound Company of $400,000; the merchandise was priced at 25% above Pound Company’s cost. Sound Company still owes Pound Company $70,000 on open account and has 20% of this merchandise in inventory at December 31, 2015. At the beginning of 2015, Sound Company had in inventory $100,000 of merchandise purchased in the previous period from Pound Company. Required: A. Prepare all workpaper entries necessary to eliminate the effects of the intercompany sales on the consolidated financial statements for the year ended December 31, 2015. B. Assume that Sound Company reports net income of $160,000 for the year ended December 31, 2015. Calculate the amount of noncontrolling interest to be deducted from consolidated income in the consolidated income statement for the year ended December 31, 2015.

Short Answer 1.

When there have been intercompany sales of depreciable property, workpaper entries are necessary to accomplish several financial reporting objectives. Identify three of these financial reporting objectives for depreciable property.

An eliminating entry is needed to adjust the consolidated financial statements when the purchasing affiliate sells a depreciable asset that was acquired from another affiliate. Describe the necessary eliminating entry.

Short Answer Questions from the Textbook 1.

From a consolidated point of view, when should profit be recognized on intercompany sales of depreciable assets? Nondepreciable assets?

In what circumstances might a consolidated gain be recognized on the sale of assets to a nonaffiliate when the selling affiliate recognizes a loss?

What is the essential procedural difference between workpaper eliminating entries for un-realized unrealized intercompany profit when the selling affiliate is a less than wholly owned subsidiary and such entries when the selling affiliate is the parent company or a wholly owned subsidiary?

Define the controlling interest in consolidated net income using the t-account approach.

Why is it important to distinguish between up-stream upstream and downstream sales in the analysis of intercompany profit eliminations?

In what period and in what manner should profits relating to the intercompany sale of depreciable property and equipment be recognized in the consolidated financial statements?

Define consolidated retained earnings using the analytical approach.

Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment Business Ethics Question from the Textbook Some people believe that the use of executive stock options is directly related to the increased number of earnings restatements. For each of the following items, discuss the potential ethical issues that might be related to earnings management within the firm. 1. Should stock options be expensed on the Income Statement? 2. Should the CEO or CFO be a past employee of the firm’s audit firm? 3. Should the firm’s audit committee be composed entirely of outside members and be solely responsible for hiring the firm’s auditors?

7-9

7-10 Test Bank to accompany Jeter and Chaney Advanced Accounting ANSWER KEY Multiple Choice

1. 2. 3. 4. 5. 6.

c d d b b d

7. 8. 9. 10. 11. 12.

c a b a c b

13. 14. 15. 16. 17. 18.

a b d c d d

19. 20. 21. 22. 23.

d b c d d

Problems 7-1

A. 2014 Sales

500,000 Cost of Sales Equipment

Accumulated Depreciation Depreciation Expense (150,000/6) 2015 Beginning R/E – Pine Equipment Accumulated Depreciation Depreciation Expense Beginning R/E – Pine B. Pine’s net income from independent operations - Unrealized profit on 2014 sales to Slider + Profit on sales to Slider realized through 2014 depreciation

350,000 150,000 25,000 25,000

150,000 150,000 50,000 25,000 25,000 $870,000 (150,000) 25,000

Pine’s income from independent operations that has been realized from third party transactions 745,000 Income of Slider that has been realized in transactions with third parties $310,000 Pine’s share thereof (.9 × $310,000) 279,000 Controlling Interest in Consolidated Net Income – 2014 $1,024,000

Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment 7-2

A. Sales

126,000 Cost of Sales

126,000

Cost of Sales Inventory [42,000 – (42,000/1.20)

7,000 7,000

42,000 not shown in data - page 5

Beginning R/E – Perry Cost of Sales [48,000 – (48,000/1.20)]

8,000

Beginning R/E – Perry ($5,000 × .9) Noncontrolling interest ($5,000 × .1) Equipment (16,000 – 11,000)

4,500 500

Accumulated Depreciation Depreciation Expense (5,000/5) Beginning R/E – Perry ($1,000 × .9) Noncontrolling interest ($1,000 × .1)

2,000

8,000

5,000 1,000 900 100

B. Noncontrolling Interest in Consolidated net Income: .1 × (40,000 + 1,000) = $4,100 7-3

A. Equipment Beginning R/E – Prince ($100,000 × .80) Noncontrolling Interest ($100,000 × .20) Accumulated Depreciation Accumulated Depreciation ($100,000/4) × 2 Depreciation Expense Beginning R/E – Prince ($25,000 × .80) Noncontrolling Interest ($25,000 × .20) B. Noncontrolling Interest Calculation: Reported income of Serf Company Plus: Intercompany profit considered realized in the current period Noncontrolling interest in Serf Company (.20 × 845,000) C. Controlling Interest in Consolidated Net Income: Prince Company’s income from its independent operations Reported net income of Serf Company Plus profit on intercompany sale of equipment considered to be realized through depreciation in 2014 Reported subsidiary income that has been realized in transactions with third parties Prince Company’s share thereof Controlling Interest in Consolidated net income

540,000 80,000 20,000 640,000 50,000 25,000 20,000 5,000 $820,000 25,000 $845,000 $169,000

$3,270,000 $820,000

25,000

845,000 × .8 676,000 $3,946,000

7-11

7-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 7-4

2014

2015

Noncontrolling interest in Consolidated net income

$ 7,000 (1)

$ 46,200 (2)

Controlling interest in Consolidated net income

290,500 (3)

279,300 (4)

(1) .4($70,000 – $63,000 + $10,500) = $7,000 (2) .4($105,000 + $10,500) = $46,200 (3) $280,000 + .6($70,000 – $63,000 + $10,500) = $290,500 (4) $210,000 + .6($105,000 + $10,500) = $279,300 2014

2015

B. Noncontrolling interest in $ 28,000 (5) $ 42,000 (6) Consolidated income Controlling interest in 269,500 (7) 283,500 (8) Consolidated net income (5) .4($70,000) = $28,000 (6) .4($105,000) = $42,000 (7) ($280,000 – $63,000 + $10,500) + .6($70,000) = $269,500 (8) ($210,000 + $10,500) + .6($105,000) = $283,500

7-5

A. 2014 (1) Equipment Cash

2,400,000 2,400,000

(2) Depreciation Expense (1/6 × $2,400,000) Accumulated Depreciation 2015 (3) Cash Accumulated Depreciation Equipment Gain on Sale of Equipment B. Cost Accumulated Depreciation 1/1/12 Book Value Proceeds from Sale Gain on Sale

400,000 400,000

2,200,000 400,000 2,400,000 200,000 Pharma Company Consolidated $2,400,000 (400,000) 2,000,000 $1,500,000* 2,200,000 2,200,000 $ 200,000 $700,000

*$1,800,000 – 1/6($1,800,000) = $1,500,000 1/1 Retained Earnings - Pharma [.8 × ($600,000 – $100,000)] 1/1 Noncontrolling interest [.2 × ($600,000 – $100,000)] Gain on Sale of Equipment

400,000 100,000 500,000

Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

7-13

$2,400,000 – $1,800,000 = $600,000 $600,000/6 = $100,000 Unrealized intercompany gain on date of sale to outsiders = $600,000 – $100,000 = $500,000

7-6

Sales Dividend Income from S

$1,200,000

$600,000

80,000

Elimination Entries Dr. Cr.

Noncontrolling Interest

Consolidating Balances $1,800,000

(a)80,000

Gain on Sale of Equipment

20,000

Gain on Sale of Land

50,000

Cost of Sales

(800,000) (300,000)

Depreciation Expense

(160,000)

Other Expenses

(200,000) (160,000)

(b)20,000

(80,000)

(d)100,000

150,000 (1,100,000)

(239,000) (360,000)

Noncontrolling Interest in Income ($130,000 – $20,000 + 1,000) × .20 Net Income a.

$120,000 Dividend Income from S Dividends Declared

80,000

Gain on Sale of Equipment Equipment Accumulated Depreciation

20,000 20,000

Accumulated Depreciation Depreciation Expense

1,000*

Retained Earnings – P Gain on Sale of Land

100,000

* ($20,000/5) × 3/12

22,200 22,200

$130,000

80,000

40,000

1,000

100,000

(22,200) $228,800

7-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 7-7 A.

2014 Gain on Sale of Equipment Equipment Accumulated Depreciation Accumulated Depreciation Depreciation Expense 2015 Retained Earnings – Pale Noncontrolling Interest Equipment Accumulated Depreciation

75,000 150,000 225,000 15,000 15,000

67,500 7,500 150,000 225,000

Accumulated Depreciation 30,000 Depreciation Expense Beginning Retained Earnings – Pale Noncontrolling Interest B. Shale Company net income Unrealized gain-equipment ($75,000) upstream Confirmed gain

7-8

15,000 13,500 1,500

Equity in Sub. Income $135,000

Noncontrolling Interest $15,000

(67,500) 13,500 $81,000

(7,500) 1,500 $ 9,000

A. (1) Sales

400,000 Cost of Sales

400,000

(2) Accounts Payable Accounts Receivable

70,000

(3) Cost of Sales (beginning inventory – income statement) Inventory ($80,000 – ($80,000/1.25))

16,000

(4) Beginning Retained Earnings – Pound ($100,000 – ($100,000/1.25)) Cost of Sales (beginning inventory – income statement)

20,000

(5) Beginning Retained Earnings – Pound ($22,000 × .8) Noncontrolling Interest ($22,000 × .2) Property, Plant and Equipment

17,600 4,400

(6) Accumulated Depreciation Depreciation Expense ($22,000/5) Beginning Retained Earnings – Pound ($4,400 × .8) Noncontrolling Interest ($4,400 × .2)

8,800

70,000

16,000

20,000

22,000

B. Noncontrolling Interest in Consolidated Income .2 × ($160,000 + $4,400) = $32,880

4,400 3,520 880

Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

7-15

Short Answer 1.

Workpaper entries are necessary to accomplish the following financial reporting objectives: a. To report as gains or losses in the consolidated income statement only those that result from the sale of depreciable property to parties outside the affiliated group. b. To present property in the consolidated balance sheet at its cost to the affiliated group. c. To present accumulated depreciation in the consolidated balance sheet and depreciation expense in the consolidated income statement based on the cost to the affiliated group of the related assets.

The eliminating entry adjusts the gain or loss reported by the purchasing affiliate from the amount it recorded to the correct amount from the perspective of the consolidated entity, and adjusts the controlling and noncontrolling interests for the unrealized intercompany profit associated with the equipment on the date of its premature disposal.

Solutions to Short Answer Questions from the Textbook

1. Intercompany profit in depreciable asset transfers is realized as a result of the utilization of the asset in the generation of revenue. Such utilization is measured by depreciation and, accordingly, the recognition of the realization of intercompany profit is accomplished through depreciation adjustments in the periods following the intercompany transfers.

When intercompany sales involve nondepreciable assets, any profit recognized by the selling affiliate will remain unrealized from the consolidated entity’s point of view for all subsequent periods or until the asset is disposed of. 2. Intercompany profit may be included in the selling affiliate’s carrying value of an asset that is sold to third parties. If the sales price in the sale to the third party is less that the inflated carrying value, the selling affiliate will recognize a loss on the sale. From the point of view of the consolidated entity, however, the carrying value of the asset is its cost to the affiliated group (selling affiliate’s cost less unrealized intercompany profit) and if this value is less than the selling price to the third party, the consolidated group will recognize a gain. In effect, previously unrecognized intercompany profit is realized upon the sale of the asset to a third party. 3. The only procedural difference in the workpaper entries relating to the elimination of unrealized intercompany profit in depreciable or nondepreciable assets when the selling affiliate is a less than wholly owned subsidiary is that the noncontrolling interest in the unrealized intercompany profit at the beginning of the year must be recognized by debiting or crediting the noncontrolling shareholders’ percentage interest in such adjustments to the beginning retained earnings of the subsidiary.

7-16 Test Bank to accompany Jeter and Chaney Advanced Accounting

4. Consolidated income is equal to the parent company’s income from its independent operations that has been realized in transactions with third parties plus subsidiary income that has been realized in transactions with third parties and adjusted for the amortization, depreciation, or impairment of the differences between implied and book values (this total is then allocated to the controlling and noncontrolling interests). The controlling interest in consolidated income is equal to the parent company’s income from its independent operations that has been realized in transactions with third parties plus its share of subsidiary income that has been realized in transactions with third parties and adjusted for the amortization, depreciation, or impairment of the differences between implied and book values. Controlling Interest in Consolidated Income Unrealized gain on intercompany sale (downstream sales)

Net income internally generated by P Company Gain realized through usage (depreciation adjustment)

Unrealized profit on downstream sales to S Company (ending Inventory)

Realized profit (downstream sales) from beginning inventory P Company's percentage of S Company's adjusted income realized from third parties

Controlling interest in Consolidated Income

5. It is important to distinguish between upstream and downstream sales of property and equipment because calculation of the noncontrolling interest in the consolidated financial statements differs depending on whether the sale giving rise to the intercompany profit is upstream or downstream. 6. Profit relating to the intercompany sale of property and equipment is recognized in the consolidated financial statements over the useful life of the equipment. It is recognized in the consolidated financial statements by reducing depreciation expense (thus increasing consolidated income). 7. Consolidated retained earnings may be defined as the parent company’s cost basis retained earnings that has been realized in transactions with third parties plus (minus) the parent company’s share of the increase (decrease) in subsidiary retained earnings that has been realized in transactions with third parties from the date of acquisition to the current date and adjusted for the cumulative effect of amortization of the difference between implied and book values.

Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

7-17

ANSWERS TO BUSINESS ETHICS CASE 1. The arguments against expensing options include the following: • Valuation is subjective, involves assumptions that may be unrealistic, and may yield numbers that time will prove to be of limited usefulness. • Disclosure is a reasonable substitute. • Companies may alter their reward systems with the result that lower level employees are most affected. • Options are not a “real” expense and may never be exercised. • Option valuation opens the door for manipulation as managers can alter their assumptions. • Diluted earnings per share are already disclosed, and expensing options amounts to double counting. • Expensing may destroy any advantage held by the U.S. as a world leader in technology, and distract corporate America from more important issues related to executive compensation and governance in general. The arguments in favor of expensing options include the following: • Difficulty or subjectivity in valuation is not a reason for avoidance of recording other relevant financial statement items, such as deferred taxes, pension liabilities, etc. • Transparency is a major objective of financial reporting, and without proper expensing of executive compensation, transparency is lacking. • Not expensing options generates costs of misinformation. • If employees are over-compensated, the users need to be aware of that fact. • When options qualify as a “real” expense, as defined in the conceptual framework, based on the best available information at the balance sheet date, they should be reflected as such in the financial statements. • Generally accepted accounting principles currently require that options be expensed. 2.

Ideally the CEO or CFO should not be a past employee of the company’s audit firm, as such a relationship could jeopardize his or her independence. However, it is not unusual for a company to hire a former auditor, who might later be promoted to CEO or CFO, or might even be hired to such a position. If this happens, the company might want to consider switching auditors or taking other measures to make sure that the audit firm is viewed as sufficiently independent. Under the Sarbanes-Oxley Act of 2002 mandates that the audit firm’s independence is impaired if a former member of the audit engagement team accepts a supervisory accounting position, unless the individual observes a one-year ‘cooling off’ period.

The Sarbanes-Oxley Act of 2002 mandates that each member of the audit committee be an outside member of the board of directors of the issuer and to be independent. Independent means not receiving any consulting, advisory, or other compensatory fee from the issuer. At least one member must be a financial expert. The audit committee is responsible for appointment, compensation, retention, and oversight of the independent auditors.

Chapter 8 Changes in Ownership Interest Multiple Choice 1.

When the parent company sells a portion of its investment in a subsidiary, the workpaper entry to adjust for the current year’s income sold to noncontrolling stockholders includes a a. debit to Subsidiary Income Sold. b. debit to Equity in Subsidiary Income. c. credit to Equity in Subsidiary Income. d. credit to Subsidiary Income Sold.

Which one of the following statements regarding IFRS and accounting for step acquisitions is most correct? a. Under IFRS goodwill is identified and net assets remeasured to fair value for all subsequent transactions, both increasing and decreasing the ownership percentage, after control is achieved. b. IFRS requires the recording of additional goodwill on subsequent increases in the parent’s ownership percentage. c. Under IFRS acquisition accounting is applied only at the date that control is achieved. d. IFRS requires the non-controlling interest to be measured at fair value.

If a portion of an investment is sold, the value of the shares sold is determined by using the: 1. first-in, first-out method. 2. average cost method. 3. specific identification method. a. 1 b. 2 c. 3 d. 1 and 3

If a parent company acquires additional shares of its subsidiary’s stock directly from the subsidiary for a price less than their book value: 1. total noncontrolling book value interest increases. 2. the controlling book value interest increases. 3. the controlling book value interest decreases. a. 1 b. 2 c. 3 d. 1 and 3

If a subsidiary issues new shares of its stock to noncontrolling stockholders, the book value of the parent’s interest in the subsidiary may a. increase. b. decrease. c. remain the same. d. increase, decrease, or remain the same.

8-2

Test Bank to accompany Jeter and Chaney Advanced Accounting

The purchase by a subsidiary of some of its shares from noncontrolling stockholders results in the parent company’s share of the subsidiary’s net assets a. increasing. b. decreasing. c. remaining unchanged. d. increasing, decreasing, or remaining unchanged.

The computation of noncontrolling interest in net assets is made by multiplying the noncontrolling interest percentage at the a. beginning of the year times subsidiary stockholders’ equity amounts. b. beginning of the year times consolidated stockholders’ equity amounts. c. end of the year times subsidiary stockholders’ equity amounts. d. end of the year times consolidated stockholders’ equity amounts.

Under the partial equity method, the workpaper entry that reverses the effect of subsidiary income for the year includes a: 1. credit to Equity in Subsidiary Income. 2. debit to Subsidiary Income Sold. 3. debit to Equity in Subsidiary Income. a. 1 b. 2 c. 3 d. both 1 and 2

Parr Company owned 24,000 of the 30,000 outstanding common shares of Solomon Company on January 1, 2013. Parr’s shares were purchased at book value when the fair values of Solomon’s assets and liabilities were equal to their book values. The stockholders’ equity of Solomon Company on January 1, 2013, consisted of the following: Common stock, $15 par value $ 450,000 Other contributed capital 337,500 Retained earnings 712,500 Total $1,500,000 Solomon Company sold 7,500 additional shares of common stock for $90 per share on January 2, 2013. If Parr Company purchased all 7,500 shares, the book entry to record the purchase should increase the Investment in Solomon Company account by a. $562,500. b. $590,625. c. $675,000. d. $150,000. e. Some other account.why now have 5 choices? most professors would prefer the consistency of 4 only - be consistent

Chapter 8 Changes in Ownership Interest

8-3

10.

Parr Company owned 24,000 of the 30,000 outstanding common shares of Solomon Company on January 1, 2013. Parr’s shares were purchased at book value when the fair values of Solomon’s assets and liabilities were equal to their book values. The stockholders’ equity of Solomon Company on January 1, 2013, consisted of the following: Common stock, $15 par value $ 450,000 Other contributed capital 337,500 Retained earnings 712,500 Total $1,500,000 Solomon Company sold 7,500 additional shares of common stock for $90 per share on January 2, 2013. If all 7,500 shares were sold to noncontrolling stockholders, the workpaper adjustment needed each time a workpaper is prepared should increase (decrease) the Investment in Solomon Company by a. ($140,625). b. $140,625. c. ($112,500). d. $192,000. e. None of these.

11.

On January 1, 2009, Parent Company purchased 32,000 of the 40,000 outstanding common shares of Sub Company for $1,520,000. On January 1, 2013, Parent Company sold 4,000 of its shares of Sub Company on the open market for $90 per share. Sub Company’s stockholders’ equity on January 1, 2009, and January 1, 2013, was as follows: 1/1/061/1/09 1/1/101/1/13 Common stock, $10 par value $400,000 $ 400,000 Other contributed capital 400,000 400,000 Retained earnings 800,000 1,400,000 $1,600,000 $2,200,000

12.

The difference between implied and book value is assigned to Sub Company’s land. The amount of the gain on sale of the 4,000 shares that should be recorded on the books of Parent Company is a. $68,000. b. $170,000. c. $96,000. d. $200,000. e. None of these. On January 1, 2009, Pine Corporation purchased 24,000 of the 30,000 outstanding common shares of Summit Company for $1,140,000. On January 1, 2013, Pine Corporation sold 3,000 of its shares of Summit Company on the open market for $90 per share. Summit Company’s stockholders’ equity on January 1, 2009, and January 1, 2013, was as follows: 1/1/061/1/09 1/1/101/1/13 Common stock, $10 par value $ 300,000 $ 300,000 Other contributed capital 300,000 300,000 Retained earnings 600,000 1,050,000 $1,200,000 $1,650,000 The difference between implied and book value is assigned to Summit Company’s land. As a result of the sale, Pine Corporation’s Investment in Summit account should be credited for a. $165,000. b. $206,250. c. $120,000. d. $142,500.

8-4

Test Bank to accompany Jeter and Chaney Advanced Accounting e. None of these.

13.

On January 1, 2009, Panda Company purchased 16,000 of the 20,000 outstanding common shares of Simian Company for $760,000. On January 1, 2013, Panda Company sold 2,000 of its shares of Simian Company on the open market for $90 per share. Simian Company’s stockholders’ equity on January 1, 2009, and January 1, 2013, was as follows: 1/1/09 1/1/13 Common stock, $10 par value $200,000 $ 200,000 Other contributed capital 200,000 200,000 Retained earnings 400,000 700,000 $800,000 $1,100,000 The difference between implied and book value is assigned to Simian Company’s land. Assuming no other equity transactions, the amount of the difference between implied and book value that would be added to land on a workpaper for the preparation of consolidated statements on December 31, 2013, would be a. $120,000. b. $115,000. c. $105,000. d. $84,000. e. None of these.

14.

15.

On January 1 2013, Paulus Company purchased 75% of Sweet Corporation for $500,000. Sweet’ stockholders’ equity on that date was equal to $600,000 and Sweet had 60,000 shares issued and outstanding on that date. Sweet Corporation sold an additional 15,000 shares of previously unissued stock on December 31, 2013. AssumeAssuming that Paulus Company purchased the additional shares, what would be their current percentage ownership on December 31, 2013? a. 92% b. 87% c. 80% d. 100% On January 1 2013, Pounder Company purchased 75% of SludgeSmile Company for $500,000. SludgeSmile Company’s stockholders’ equity on that date was equal to $600,000 and SludgeSmile Company had 60,000 shares issued and outstanding on that date. SludgeSmile Company Corporation sold an additional 15,000 shares of previously unissued stock on December 31, 2013. Assume SludgeSmile Company sold the 15,000 shares to outside interests, Pounder Company’s percent ownership would be: a. 33 1/3% b. 60% c. 75% d. 80%

Chapter 8 Changes in Ownership Interest

8-5

16.

P Corporation purchased an 80% interest in S Corporation on January 1, 2013, at book value for $300,000. S’s net income for 2013 was $90,000 and no dividends were declared. On May 1, 2013, P reduced its interest in S by selling a 20% interest, or one-fourth of its investment for $90,000. What will be the Consolidated Gain on Sale and Subsidiary Income Sold for 2013? Consolidated Gain on Sale Subsidiary Income Sold a. $9,000 $6,000 b. $9,000 $15,000 c. $15,000 $6,000 d. $15,000 $15,000

17.

P Corporation purchased an 80% interest in S Corporation on January 1, 2013, at book value for $300,000. S’s net income for 2013 was $90,000 and no dividends were declared. On May 1, 2013, P reduced its interest in S by selling a 20% interest, or one-fourth of its investment for $90,000. What would be the balance in the Investment of S Corporation account on December 31, 2013? a. $300,000. b. $225,000. c. $279,000. d. $261,000.

18.

The purchase by a subsidiary of some of its shares from the noncontrolling stockholders results in an increase in the parent’s percentage interest in the subsidiary. The parent company’s share of the subsidiary’s net assets will increase if the shares are purchased: a. at a price equal to book value. b. at a price below book value. c. at a price above book value. d. will not show an increase.

Use the following information for Questions 19-21. On January 1, 2009, Pharma Company purchased 16,000 of the 20,000 outstanding common shares of Sludge Company for $760,000. On January 1, 2013, Pharma Company sold 2,000 of its shares of Sludge Company on the open market for $90 per share. Sludge Company’s stockholders’ equity on January 1, 2009, and January 1, 2013, was as follows: 1/1/09 1/1/13 Common stock, $10 par value $ 200,000 $ 200,000 Other contributed capital 200,000 200,000 Retained earnings 400,000 700,000 $800,000 $1,100,000 The difference between implied and book value is assigned to Sludge Company’s land. 19. The amount of the gain on sale of the 2,000 shares that should be recorded on the books of Pharma Company is a. $34,000. b. $85,000. c. $48,000. d. $100,000. e. None of these.

8-6

Test Bank to accompany Jeter and Chaney Advanced Accounting

20.

As a result of the sale, Pharma Company’s Investment in Sludge account should be credited for a. $110,000. b. $137,500. c. $80,000. d. $95,000. e. None of these.

21.

Assuming no other equity transactions, the amount of the difference between implied and book value that would be added to land on a work paper for the preparation of consolidated statements on December 31, 2013 would be a. $120,000. b. $115,000. c. $105,000. d. $84,000.

22.

On January 1, 2013, P Corporation purchased 75% of S Corporation for $500,000. S’s stockholders’ equity on that date was equal to $600,000 and S had 40,000 shares issued and outstanding on that date. S Corporation sold an additional 8,000 shares of previously unissued stock on December 31, 2013. Assume that P Corporation purchased the additional shares what would be their current percentage ownership on December 31, 2013? a. 62 1/2%. b. 75% c. 79 1/6% d. 100%

23.

Assume S sold the 8,000 shares to outside interests, P’s percent ownership would be: a. 56 1/4% b. 62 1/2% c. 75% d. 79 1/6%

Chapter 8 Changes in Ownership Interest

8-7

Problems 8-1

Pizza Company purchased Salt Company common stock through open-market purchases as follows: Acquired Date Shares Cost 1/1/12 1,500 $ 50,000 1/1/13 3,300 $ 90,000 1/1/14 6,600 $250,000 Salt Company had 12,000 shares of $20 par value common stock outstanding during the entire period. Salt had the following retained earnings balances on the relevant dates: January 1, 2012 January 1, 2013 January 1, 2014 December 31, 2014

$ 90,000 30,000 150,000 300,000

Salt Company declared no dividends in 2012 or 2013 but did declare $60,000 of dividends in 2014. Any difference between cost and book value is assigned to subsidiary land. Pizza uses the equity method to account for its investment in Salt. Required: A. Prepare the journal entries Pizza Company will make during 2013 and 2014 to account for its investment in Salt Company. B. Prepare workpaper eliminating entries necessary to prepare a consolidated statements workpaper on December 31, 2014.

8-2

On January 1, 2011, Panel Company acquired 90% of the common stock of Singapore Company for $650,000. At that time, Singapore had common stock ($5 par) of $500,000 and retained earnings of $200,000. On January 1, 2013, Singapore issued 20,000 shares of its unissued common stock, with a market value of $7 per share, to noncontrolling stockholders. Singapore’s retained earnings balance on this date was $300,000. Any difference between cost and book value relates to Singapore’s land. No dividends were declared in 2013. Required: A. Prepare the entry on Panel’s books to record the effect of the issuance assuming the cost method. B. Prepare the elimination entries for the preparation of a consolidated statements workpaper on December 31, 2013 assuming the cost method.

8-8

Test Bank to accompany Jeter and Chaney Advanced Accounting

8-3

Pratt Company purchased 40,000 shares of Silas Company’s common stock for $860,000 on January 1, 2013. At that time Silas Company had $500,000 of $10 par value common stock and $300,000 of retained earnings. Silas Company’s income earned and increase in retained earnings during 2013 and 2014 were: 2013 Income earned $260,000 Increase in Retained Earnings 200,000

2014 $360,000 300,000

Silas Company income is earned evenly throughout the year. On September 1, 2014, Pratt Company sold on the open market, 12,000 shares of its Silas Company stock for $460,000. Any difference between cost and book value relates to Silas Company land. Pratt Company uses the cost method to account for its investment in Silas Company. Required: A. Compute Pratt Company’s reported gain (loss) on the sale. B. Prepare all consolidated statements workpaper eliminating entries for a workpaper on December 31, 2014.

8-4

Poole made the following purchases of Smarte Company common stock: Date 1/1/13 1/1/14

Shares 70,000 (70%) 10,000 (10%)

Cost $1,000,000 160,000

Stockholders’ equity information for Smarte Company for 2013 and 2014 follows:

Common stock, $10 par value

2013 $1,000,000

2014 $1,000,000

1/1 Retained earnings Net income Dividends declared, 12/15 Retained earnings, 12/31 Total stockholders’ equity, 12/31

300,000 110,000 (30,000) 380,000 $1,380,000

380,000 140,000 (40,000) 480,000 $1,480,000

On July 1, 2014, Poole sold 14,000 shares of Smarte Company common stock on the open market for $22 per share. The shares sold were purchased on January 1, 2013. Smarte notified Poole that its net income for the first six months was $70,000. Any difference between cost and book value relates to subsidiary land. Poole uses the cost method to account for its investment in Smarte Company. Required: A. Prepare the journal entry made by Poole to record the sale of the 14,000 shares on July 1, 2014. B. Prepare the workpaper eliminating entries needed for a consolidated statements workpaper on December 31, 2014. C. Compute the amount of noncontrolling interest that would be reported on the consolidated balance sheet on December 31, 2014.

Chapter 8 Changes in Ownership Interest

8-5

8-9

P Company purchased 96,000 shares of the common stock of S Company for $1,200,000 on January 1, 2010, when S’s stockholders’ equity consisted of $5 par value, Common Stock at $600,000 and Retained Earnings of $800,000. The difference between cost and book value relates to goodwill. On January 2, 2013, S Company purchased 20,000 of its own shares from noncontrolling interests for cash of $300,000 to be held as treasury stock. S Company’s retained earnings had increased to $1,000,000 by January 2, 2013. S Company uses the cost method in regards to its treasury stock and P Company uses the equity method to account for its investment in S Company. Required: Prepare all determinable workpaper entries for the preparation of consolidated statements on December 31, 2013.

8-6

Pamela Company acquired 80% of the outstanding common stock of Silt Company on January 1, 2011, for $396,000. At the date of purchase, Silt Company had a balance in its $2 par value common stock account of $360,000 and retained earnings of $90,000. On January 1, 2013, Silt Company issued 45,000 shares of its previously unissued stock to noncontrolling stockholders for $3 per share. On this date, Silt Company had a retained earnings balance of $152,000. The difference between cost and book value relates to subsidiary land. No dividends were paid in 2013. Silt Company reported income of $30,000 in 2013. Required: A. Prepare the journal entry on Pamela’s books to record the effect of the issuance assuming the equity method. B. Prepare the eliminating entries needed for the preparation of a consolidated statements workpaper on December 31, 2013, assuming the equity method.

8-7

Partner Company acquired 85% of the common stock of Simplex Company in two separate cash transactions. The first purchase of 108,000 shares (60%) on January 1, 2012, cost $735,000. The second purchase, one year later, of 45,000 shares (25%) cost $330,000. Simplex Company’s stockholders’ equity was as follows:

Common Stock, $5 par Retained Earnings, 1/1 Net Income Dividends Declared, 9/30 Retained Earnings, 12/31 Total Stockholders’ Equity, 12/31

December 31 2012

December 31 2013

$ 900,000 262,000 69,000 (30,000) 301,000 $1,201,000

$ 900,000 302,000 90,000 (38,000) 354,000 $1,254,000

On April 1, 2013, after a significant rise in the market price of Simplex Company’s stock, Partner Company sold 32,400 of its Simplex Company shares for $390,000. Simplex Company notified Partner Company that its net income for the first three months was $22,000. The shares sold were identified as those obtained in the first purchase. Any difference between cost and book value relates to goodwill. Partner uses the partial equity method to account for its investment in Simplex Company.

8-10

Test Bank to accompany Jeter and Chaney Advanced Accounting Required: A. Prepare the journal entries Partner Company will make on its books during 2012 and 2013 to account for its investment in Simplex Company. B. Prepare the workpaper eliminating entries needed for a consolidated statements workpaper on December 31, 2013. Short Answer 1. A parent’s ownership percentage in a subsidiary may change for several reasons. Identify three reasons the ownership percentage may change. 2.

A parent company’s equity interest in a subsidiary may change as the result of the issuance of additional shares of stock by the subsidiary. Describe the affect on the parent’s investment account when the new shares are (a) purchased ratably by the parent and noncontrolling shareholders or (b) entirely by the noncontrolling shareholders.

Short Answer Question from the Textbook 1. Identify three types of transactions that result in a change in a parent company’s ownership interest in its subsidiary. 2. Why is the date of acquisition of subsidiary stock important under the purchase method? 3. When a parent company has obtained control of a subsidiary through several purchases and subsequently sells a portion of its shares in the subsidiary, how is the carrying value of the shares sold determined? 4. When a parent company that records its investment using the cost method during a fiscal year sells a portion of its investment, explain the correct accounting for any differences between selling price and recorded values. 5. ABC Corporation purchased 10,000 shares(80%) of EZ Company at $35 per share and sold them several years later for $35 per share. The consolidated income statement reports a loss on the sale of this investment. Explain.same share price - need to adjust 6. Explain how a parent company that owns less than100% of a subsidiary can purchase an entire new issue of common stock directly from the subsidiary. 7. When a subsidiary issues additional shares of stock to noncontrolling stockholders and such issuance results in an increase in the book value of the parent’s share of the subsidiary’s equity, how should the increase be reflected in the financial statements? What if it results in a decrease? 8. P Company holds an 80% interest in S Company. Determine the effect (that is, increase, decrease, no change, not determinable) on both the total book value of the noncontrolling interest and the noncontrolling interest’s percentage of ownership in the net assets of S Company for each of the following situations: a. P Company acquires additional shares directly from S Company at a price equal to the book value per share of the S Company stock immediately prior to the issuance. b. S Company acquires its own shares on the open market. The cost of these shares is less than their book value. c. Assume the same situation as in (b) except that the cost of the shares is greater than their book value.

Chapter 8 Changes in Ownership Interest 8-11 d. P Company and a noncontrolling stockholder each acquire 100 shares directly from S Company at a price below the book value per share. Business Ethics Question from Textbook During a recent review of the quarterly financial statements and supporting ledgers, you noticed several unusual journal entries. While the dollar amounts of the journal entries were not large, there did not appear to be supporting documentation. You decide to bring the matter to the attention of your immediate supervisor. After you mentioned the issue, the supervisor calmly stated that the matter would be looked into and that you should not worry about it.1.delete 1. or add a 2.You feel a bit uncomfortable about the situation. What is your responsibility and what action, if any, should you take?

8-12

Test Bank to accompany Jeter and Chaney Advanced Accounting

ANSWER KEY Multiple Choice 1. 2. 3. 4. 5.

d c d b d

6. d 7. c 8. c 9. c 10. d

11. b 12. d 13. c 14. c 15. b

16. a 17. c 18. b 19. b 20. d

21. c 22. c 23. b

Problems 8-1

A. 2013 Retained Earnings [0.125 × (90,000 – 30,000)] Investment in Salt Company

7,500 7,500

Investment in Salt Company [0.40 × (150,000 – 30,000)] indentCash

48,000

2014 Cash (60,000 × 0.95) Investment in Salt Company

57,000

Investment in Salt Company [0.95 × (300,000 + 60,000 – 150,000)] Equity in Subsidiary Income

199,500

B. Equity in Subsidiary Income Dividends Declared—Salt Investment in Salt Company

48,000

57,000

199,500

199,500 57,000 142,500

Common Stock 1/1 Retained Earnings—Salt Difference Between Implied and Book Value Investment in Salt Company Noncontrolling Interest in Equity

240,000 150,000 60,000

Land

60,000 Difference Between Implied and Book Value

430,500 19,500

60,000

Chapter 8 Changes in Ownership Interest 8-13

8-2 A.

Loss from Subsidiary Issuance of Shares Investment in Singapore Company

15,000* 15,000*

Panel Company’s share of Singapore Company’s equity before the new issue (0.90 × 800,000) Panel Company’s share of Singapore Company’s equity after the new issue 0.75 × (800,000 + 140,000) Decrease in Panel Company’s interest B.

Investment in Singapore Company (300,000 – 200,000) × 0.90 1/1 Retained Earnings—Panel

$720,000 705,000 $ 15,000

90,000 90,000

Common Stock Other Contributed Capital Retained Earnings Difference Between Implied and Book Value Investment in Singapore Company (650,000 – 15,000 + 90,000) Noncontrolling Interest in Equity

600,000 40,000 300,000 20,000

Land

20,000

725,000 235,000

Difference Between Implied and Book Value

20,000

8-3 A.

Selling price $460,000 Carrying value sold ($860,000 × 12,000/40,000) 258,000 Gain on sale of investment $202,000

Investment in Silas Company (0.56 × $200,000) 1/1 Retained Earnings—Pratt Company

112,000

Gain on Sale of Investments 1/1 Retained Earnings—Pratt Company

48,000

112,000

48,000

0.8 × $200,000 × 12/40

Gain on Sale of Investments Subsidiary Income Sold

57,600 57,600

(8/12 × $360,000 = $240,000 × 0.8 × 12/40)

Common Stock—Silas Company 1/1 Retained Earnings—Silas Company Difference Between Implied and Book Value (28/40 × $220,000) Investment in Silas Company Noncontrolling Interest in Equity

500,000 500,000 154,000 714,000 440,000

8-14

Test Bank to accompany Jeter and Chaney Advanced Accounting Land

154,000 Difference Between Implied and Book Value

8-4

154,000

Cash (14,000 × $22) Investment in Smarte Company Gain on Sale of Investments

308,000 200,000* 108,000

*14,000/70,000 × $1,000,000

Investment in Smarte Company Retained Earnings 1/1—Poole

44,800 44,800

[0.7 × 0.8 × ($380,000 - $300,000)]

Gain on Sale of Investments Retained Earnings 1/1—Poole ($80,000 × 0.7 × 0.2)

11,200

Gain on Sale of Investments ($70,000 × 0.7 × 0.2) Subsidiary Income Sold

9,800

Dividend Income (0.66 × $40,000) Dividends Declared—Smarte

26,400

Common Stock—Smarte Retained Earnings—Smarte Difference Between Implied and Book Value Investment in Smarte Company

11,200

9,800

26,400 1,000,000 380,000 94,000 1,004,800

*$1,000,000 + 160,000 - $200,000 + $44,800

Noncontrolling Interest in Equity Land

469,200 94,000

Difference Between Implied and Book Value C.

$1,480,000 × 0.34 = $503,200 noncontrolling interest

94,000

Chapter 8 Changes in Ownership Interest 8-15

8-5

Percentage on 1/1/2010 Percentage on 1/2/2013

96,000 / 120,000 = 80% 96,000 / 100,000 = 96%

P Company’s share of S Company’s equity: Before reacquisition of treasury stock (80% × $1,600,000) = $1,280,000 After reacquisition of treasury stock [96% × ($1,600,000 - $300,000)= 1,248,000 Decrease in P Company’s share $ 32,000 Elimination entries determinable: Common Stock—S Retained Earnings—S Difference Between Cost and Book Value Treasury Stock—S (96% × $300,000) Investment in S Company

600,000 1,000,000 112,000 288,000 1,360,000 64,000

($1,200,000 + $160,000)

Noncontrolling Interest in Equity (600,000 + 1,000,000) x .04

Goodwill* Difference Between Implied and Book Value

112,000 112,000

*Original difference $1,200,000 – (80% × $1,400,000) = Plus: Decrease from treasury stock transaction

8-6

$80,000 32,000 $112,000

Investment in Silt Company* Gain from Issuance of Subsidiary Shares

4,480

Equity Income ($30,000 × 0.64) Investment in Silt Company

19,200

Common Stock—Silt Company Other Contributed Capital—Silt Company Retained Earnings—Silt Difference Between Implied and Book Value Investment in Silt Company Noncontrolling Interest in Equity

450,000 45,000 152,000 36,000

Land

36,000 Difference Between Implied and Book Value

4,480

19,200

450,080 232,920

36,000

*Pamela Company’s share of Silt Company’s equity: Before sale to noncontrolling shareholders (0.8 × $512,000) $409,600 After sale to noncontrolling shareholders (0.64* × ($512,000 + $135,000) 414,080 Increase in Pamela Company’s share $ 4,480 *(0.80 × 180,000) / (180,000 + 45,000) = 0.64

8-16 8-7

Test Bank to accompany Jeter and Chaney Advanced Accounting A.

2012 Investment in Simplex Company Cash

735,000

Cash

18,000

735,000

Investment in Simplex Company (0.60 × $30,000 subsidiary dividend) Investment in Simplex Company Equity in Subsidiary Income (0.60 × $69,000 subsidiary income) 2013 Investment in Simplex Company Cash

18,000 41,400 41,400

330,000 330,000

Investment in Simplex Company Equity in Subsidiary Income (0.85 × $22,000 income for 1st three months)

18,700

Cash

390,000

18,700

Investment in Simplex Company* Gain on Sale of Investment

231,480 158,520

*Cost of first purchase (60%) $735,000 2012 subsidiary income (0.60 × $69,000) 41,400 2012 subsidiary dividends (0.60 × $30,000) (18,000) 2013 subsidiary income to April 1 (0.60 × $22,000) 13,200 Total 771,600 Portion sold (32,400 ÷ 108,000) × 0.30 Carrying value of investment sold $231,480 Cash

25,460 Investment in Simplex Company (0.67* × $38,000 subsidiary dividend)

25,460

**0.67 = (108,000 + 45,000 - 32,400)  180,000

Investment in Simplex Company 45,560 Equity in Subsidiary Income [0.67 × ($90,000 – $22,000)]

45,560

Chapter 8 Changes in Ownership Interest 8-17

Equity in Subsidiary Income ($18,700 + $45,560) 64,260 Subsidiary Income Sold ($22,000 × 0.60 × 0.30) Dividends Declared—Simplex ($38,000 × 0.67) Investment in Simplex Company

3,960 25,460 34,840

Common Stock—Simplex 1/1 Retained Earnings—Simplex Difference Between Implied and Book Value Investment In Simplex Company Noncontrolling Interest in Equity

900,000 302,000 55,540 860,880 396,660

Land

55,540 Difference Between Implied and Book Value

55,540

Short Answer 1. A parent’s ownership percentage in a subsidiary may change because (a) additional shares of the subsidiary may be purchased on the open market, (b) some of the shares held by the parent company may be sold; or (c) the subsidiary may enter into capital transactions with the parent or outside parties that change the parent’s ownership percentage. 2. (a) If the shares issued by the subsidiary are purchased ratably by the parent and noncontrolling stockholders the percentage of stock owned by the parent and noncontrolling stockholders after the new issue would be the same as their respective interests prior to the issue. (b) If the new shares are purchased entirely by the noncontrolling shareholders, the parents ownership percentage is reduced. The book value of the parent’s interest in the subsidiary may increase, decrease, or remain the same depending on the relationship of the issue price to book value per share of stock. Short Answer Questions from Textbook Solutions 1. The three types of transactions that result in a change in a parent company’s ownership interest are: a. The parent company may buy additional shares of subsidiary stock or sell a portion of its holdings; b. The subsidiary may issue additional shares of stock to outsiders; c. The subsidiary may acquire or reissue treasury shares from or to the noncontrolling shareholders or the parent company 2. The date of acquisition of subsidiary stock is important under the purchase method because subsidiary retained earnings accumulated prior to the date of acquisition constitute a portion of the equity acquired by the parent company, whereas the parent’s share of subsidiary retained earnings accumulated after acquisition is a part of consolidated retained earnings. 3. On the date that control is achieved, all previous purchases are revalued to reflect the market value on the “acquisition date,” which is the date that control is achieved. Thus, they all have the same basis. 4. The correct accounting depends on whether the parent retains control, or maintains some ownership but surrenders control. If the parent retains control, no gain or loss is reflected in the Income Statement. Instead, an adjustment is made to contributed capital. If the parent surrenders control, the entire interest

8-18

Test Bank to accompany Jeter and Chaney Advanced Accounting

is adjusted to fair value, and a gain or loss reflected in the Income Statement on all shares owned prior to the sale. 5. A loss would be reported because the total of the $5 per share gain related to (1) the undistributed profits of EZ Company from the date of acquisition to the beginning of the year of sale and (2) the undistributed profit of EZ Company from the beginning of the year of sale to the date of sale exceeds the $5 per share overall gain. Thus, the total assigned to the first two components of gain exceed the total gain. The other market factors effect (the third component) produced a loss.need adjust to prices at question 6. If a parent company owns less than 100% of a subsidiary and purchases an entire new issue of common stock directly from the subsidiary, either (1) the preemptive right has been waived previously, or (2) the noncontrolling stockholders elected not to exercise their rights. 7. Regardless of whether the issuance results in an increase or a decrease in the book value of the parent’s share of the subsidiary’s equity, the correct accounting is to adjust the contributed capital of the controlling interest 8.

Noncontrolling Interest Situation (a) (b) (c) (d)

Total Book Value No Change Decrease Increase Increase

Percent of Ownership Decrease Decrease Decrease Increase

Business Ethics Question from Textbook Solution 1. delete or add a 2.This is an awkward situation. One strategy would be to wait a reasonable period of time, and check to see if anything has changed (have the entries been documented, adjusted, reversed, etc.?) If nothing has been done, mention it to the supervisor again. If he (she) is unresponsive this time, tactfully bring up your concern with a higher-level supervisor.

Chapter 9 Intercompany Bond Holdings and Miscellaneous Topics— Consolidated Financial Statements Multiple Choice 1.

Which of the following methods of allocating the gain or loss on an intercompany bond retirement is the soundest conceptually? a. The gain (loss) is allocated to the company that issued the bonds. b. The gain (loss) is allocated to the company that purchased the bonds. c. The gain (loss) is allocated to the parent company. d. The gain (loss) is allocated between the purchasing and issuing companies.

The constructive gain or loss on an intercompany bond retirement is recognized in the consolidated income statement _________ the recognition of the gain or loss on the individual companies' books. a. after b. before c. at the same time as d. before or after

The constructive gain or loss to the purchasing company is the difference between the a. book value of the bonds and their par value. b. book value of the bonds and their purchase price. c. cost of the bonds and their par value. d. cost of the bonds and their purchase price.

The workpaper eliminating entry for a stock dividend declared by the subsidiary includes a a. debit to Stock Dividends Declared - S Co. b. debit to Noncontrolling interest. c. credit to Stock Dividends Declared - S Co. d. debit to Dividend Income.

The parent company records the receipt of shares from a subsidiary's stock dividend as a. dividend income. b. a reduction of the investment account. c. an increase in the investment account. d. none of these.

If the book value of preferred stock is greater than its implied value, the difference is accounted for as an increase in a. consolidated retained earnings. b. consolidated net income. c. other contributed capital. d. investment in subsidiary preferred stock.

9-2 7.

Test Bank to accompany Jeter and Chaney Advanced Accounting If a subsidiary has both common and preferred stock outstanding, a parent must own a controlling interest in a. both the subsidiary's common and preferred stock to justify consolidation. b. the subsidiary's common stock to justify consolidation. c. the subsidiary's common stock and at least 20% of the subsidiary's preferred stock to justify consolidation. d. the subsidiary's common stock and more than 50% of the subsidiary's preferred stock to justify consolidation.

Use the following information to answer Questions 8, 9, and 10. I believe dates are off - bought before they were issued? Pallet Corporation owns 90% of the outstanding common stock of Stealth Company. On January 1, 2014, Stealth Company issued $500,000, 12%, ten-year bonds. On January 1, 2013, Pallet Corporation paid $412,000 for Stealth Company bonds with a par value of $400,000 and a carrying value of $393,600. Both companies use the straight-line method to amortize bond premiums and discounts. Pallet Corporation accounts for the investment using the cost method of accounting. 8.

The total gain or loss on the constructive retirement of the debt to be reported in the 2013 consolidated income statement is a. $12,000 loss. b. $12,000 gain. c. $18,400 loss. d. $18,400 gain. e. $6,400 loss.

Pallet Corporation would report a balance in the Investment in Stealth Company Bonds account on December 31, 2013, of a. $412,000. b. $393,600. c. $410,500. d. $400,000. e. none of these.

10.

Compute the noncontrolling interest in the 2013 consolidated income assuming that Pallet Corporation reported a net income of $300,000 (includes dividend income from Stealth Company). Stealth Company reported net income of $180,000 and declared and paid cash dividends of $100,000. a. $18,000 b. $17,440 c. $17,360 d. $18,560 e. none of these.

Chapter 9 Intercompany Bond Holdings and Miscellaneous Topics—Consolidated Financial Statements

9-3

11.

Soren Corporation is an 80% owned subsidiary of Passia Company. Soren purchased bonds of Passia Company for $103,000. Passia Company reported the bond liability on the date of purchase at $100,000 less unamortized discount of $5,000. Assuming that the constructive gain or loss is material, the consolidated income statement should report an a. ordinary loss of $8,000. b. ordinary gain of $8,000. c. extraordinary loss of $8,000 adjusted for income tax effects. d. extraordinary gain of $8,000 adjusted for income tax effects.

12.

From a consolidated entity point of view, the constructive gain or loss on the open market purchase of a parent company's bonds by a subsidiary company is a. considered realized at the date of the open market purchase. b. realized in future periods through discount and premium amortization on the books of the individual companies. c. realized only to the extent of the parent company's interest in the subsidiary. d. deferred and recognized in the consolidated income statement when the bonds are retired.

13.

Search Company is a 90% owned subsidiary of Passage Company. On January 1, 2013, Search Company purchased for $680,000 bonds of Passage Company that had a carrying value of $725,000 (par value $700,000). The bonds mature on December 31, 2014. Both companies use the straightline method of amortization and have a December 31 year-end. The increase in 2013 consolidated income (i.e., income before subtracting noncontrolling interest) is a. $45,000. b. $44,000. c. $54,000. d. $36,000. e. $46,000.

Use the following information to answer Questions 14 and 15. Polish Company acquired 90% of Sandwich Company's common stock for $780,000 and 40% of its preferred stock for $180,000. On January 1, 2013, the date of acquisition, the companies reported the following account balances: Polish Company Sandwich Company Preferred stock, $100 par value $ 500,000 $ 360,000 Common stock, $10 par value 1,200,000 600,000 Other contributed capital 190,000 140,000 Retained earnings 210,000 110,000 Total stockholders' equity $2,100,000 $1,200,000 The preferred stock is 10%, cumulative, nonparticipating, and has a liquidation value equal to 104% of par value. Dividends were not paid during 2012. During 2013, Sandwich Company reported net income of $120,000 and declared and paid cash dividends in the amount of $70,000. 14.

The difference between the implied value of the preferred stock and its book value is a. $40,000. b. $39,600. c. $34,400. d. $26,000. e. 15,840.

9-4

Test Bank to accompany Jeter and Chaney Advanced Accounting

15.

Noncontrolling interest in the 2013 reported net income of Sandwich Company is a. $29,500. b. $12,000. c. $34,000. d. $21,000. e. $30,000.finally used E as answer - I would adjust and go with just 4 choices

16.

Constructive gains and losses from intercompany bond transactions are: a. treated as extraordinary items on the consolidated income statement b. included as other revenues and expenses on the consolidated income statement. c. excluded from the consolidated income statement until realized. d. eliminated from the consolidated income statement.

17.

Pointe Company purchased bonds from Sentient Company on the open market at a premium. Sentient Company is a 100% owned subsidiary of Pointe Company. Pointe intends to hold the bonds until maturity. In a consolidated balance sheet, the difference between the bond carrying values in the two companies would be: a. included as a decrease to retained earnings. b. included as an increase to retained earnings. c. reported as a deferred debit to be amortized over the remaining life of the bonds. d. reported as a deferred credit to be amortized over the remaining life of the bonds.

18.

On January 1, 2013, Pale Company has $700,000 of 6%, 10-year bonds with an unamortized discount of $28,000. Slugg Company, an 80% subsidiary, purchased $350,000 of these bonds at 102. The gain or (loss) on the retirement of Pale’s bonds is: a. $14,000 loss. b. $14,000 gain. c. $21,000 loss. d. $21,000 gain.

19.

On a consolidated balance sheet, subsidiary preferred stock will be shown: a. as part of consolidated stockholder’s equity. b. combined with any preferred stock of the parent. c. as part of the noncontrolling interest amount to the extent such balance represents preferred stock held by the parent. d. as part of the noncontrolling interest amount to the extent such balance represents preferred stock held by outside interests.

20.

Pinta Company has total stockholders’ equity of $2,000,000 consisting of $400,000 of $1 par value common stock, $400,000 of other contributed capital, and $1,200,000 of retained earnings. Pinta owns 80% of Santa Maria Company purchased at book value. Santa Maria has $800,000 of 5% cumulative preferred stock outstanding. Pinta acquired 40% of the preferred stock of Santa Maria for $200,000. After this transaction the balances in Pinta’s retained earnings and other contributed capital accounts are: a. $1,200,000 and $400,000. b. $1,200,000 and $520,000. c. $1,320,000 and $400,000. d. $1,080,000 and $400,000.

Chapter 9 Intercompany Bond Holdings and Miscellaneous Topics—Consolidated Financial Statements

9-5

Use the following information to answer Questions 21-23. Parker Company owns 90% of the outstanding common stock of Stagger Company. On January 1, 2014, Stagger Company issued $500,000, 12%, ten-year bonds. On January 1, 2013, Parker Company paid $315,000 for Stagger Company bonds with a par value of $300,000 and a carrying value of $297,600. Both companies use the straight-line method to amortize bond premiums and discounts. Parker Company accounts for the investment using the cost method of accounting. 21.

The total gain or loss on the constructive retirement of the debt to be reported in the 2013 consolidated income statement is a. $15,000 loss. b. $15,000 gain. c. $17,400 loss. d. $17,400 gain. e. $ 2,400 loss.

22.

Parker Company would report a balance in the Investment in Stagger Company Bonds account on December 31, 2013, of a. $315,000. b. $297,600. c. $313,125. d. $300,000 e. None of these.

23.

Compute the noncontrolling interest in the 2013 consolidated income assuming that Parker Company reported a net income of $240,000 (includes dividend income from Stagger Company). Stagger Company reported net income of $150,000 and declared and paid cash dividends of $90,000. a. $15,000. b. $14,790. c. $14,760. d. $15,210. e. None of these.

Use the following information to answer Questions 24 and 25. Pentagon Company acquired 90% of Smoker Company's common stock for $1,300,000 and 40% of its preferred stock for $300,000. On January 1, 2013, the date of acquisition, the companies reported the following account balances: Pentagon Company Smoker Company Preferred stock, $100 par value $ 800,000 $ 600,000 Common stock, $10 par value 2,000,000 1,000,000 Other contributed capital 320,000 230,000 Retained earnings 350,000 180,000 Total stockholders' equity $3,470,000 $2,010,000 The preferred stock is 10%, cumulative, nonparticipating, and has a liquidation value equal to 102% of par value. Dividends were not paid during 2012. During 2013, Smoker Company reported net income of $200,000 and declared and paid cash dividends in the amount of $120,000.

9-6

Test Bank to accompany Jeter and Chaney Advanced Accounting

24.

The difference between the implied value of the preferred stock and its book value is a. $60,000. b. $78,000 c. $55,200. d. $36,000. e. none of these.

25.

Noncontrolling interest in the 2013 reported net income of Smoker Company is a. $50,000. b. $20,000. c. $80,000. d. $56,000. e. none of these.

Chapter 9 Intercompany Bond Holdings and Miscellaneous Topics—Consolidated Financial Statements

9-7

Problems 9-1

On January 1, 2013, Pultey Company acquired an 80% interest in Saucey Company for $1,070,000. Saucey reported common stock of $1,000,000 and retained earnings of $400,000 on this date. Any difference between implied value and the book value interest acquired is attributable to land. Other information available for Saucey Company is shown below:

2013

Net Income $130,000

Cash Dividends $160,000

Pultey Company uses the cost method to account for its investment in Saucey Company. Required: A. Prepare the general journal entries for 2013 to record the receipt of the cash dividends. B. Prepare in general journal form the workpaper entries necessary in the consolidated statements workpaper for the year end December 31, 2013. 9-2

Stemberger Company issued 10-year, 8% bonds with a par value of $1,000,000 on January 2, 2012, for $1,040,000. Interest is payable semiannually on June 30 and December 31. On December 31, 2013, Putter Company purchased $700,000 of Stemberger par value bonds for $670,000. Stemberger is an 80% owned subsidiary of Putter. Both companies use the straight-line method to amortize bond discounts and premiums. Stemberger declared cash dividends of $100,000 in 2013 and reported net income of $220,000 for the year. Putter reported net income of $350,000 for 2013 and paid dividends of $160,000 during 2013. Required: A. Compute the total gain or loss on the constructive retirement of the debt. B. Allocate the total gain or loss between Stemberger Company and Putter Company. C. Compute the controlling interest in consolidated net income for 2013. D. Prepare in general journal form the intercompany bond elimination entries for the consolidated statements workpaper prepared on December 31, 2013.

9-8 9-3

Test Bank to accompany Jeter and Chaney Advanced Accounting Pratt Company, who owns an 80% interest in Smurfe Company, purchased $2,000,000 of Smurfe’s 8% bonds at 106 on December 31, 2013. The bonds pay interest on January 1 and July 1 and mature on December 31, 2013. Pratt Company uses the cost method to account for its investment in Smurfe. Selected balances from December 31, 2013 accounts of the two companies are as follows: Pratt Investment in Smurfe 8% bonds Bond discount Interest payable 8% bonds payable Interest expense Gain or loss on constructive retirement of bonds

$2,120,000 ----------------

_____Smurfe____ $

---300,000 800,000 20,000,000 1,700,000 ----

Required: Prepare in general journal form the workpaper eliminations related to the bonds to consolidated the financial statements of Pratt and its subsidiary for the year ended December 31, 2013 and 2014.

9-4

On January 1, 2013, Power Company purchased 80% of the common stock of Stuckey Company for $400,000. Stuckey Company reported common stock of $200,000 ($10 par value), other contributed capital of $60,000, and retained earnings of $120,000 on this date. The difference between implied value and the book value interest acquired is attributable to the under-valuation of land held by Stuckey Company. Stuckey Company reported net income for 2013 of $100,000. During 2013 Stuckey Company declared and paid a 20% stock dividend and a $24,000 cash dividend. Stuckey Company stock had a market value of $30 per share on the date the stock dividend was declared. Power Company uses the cost method to account for its investment in Stuckey Company. Required: A. Prepare the journal entries required in the books of Power Company to account for the investment in Stuckey Company. B. Prepare in general journal form the workpaper entries necessary in the consolidated statements workpaper for the year ended December 31, 2013. C. Prepare the workpaper entry to establish reciprocity in the 2014 consolidated statements workpaper.

Chapter 9 Intercompany Bond Holdings and Miscellaneous Topics—Consolidated Financial Statements 9-5

9-9

On January 1, 2013, Prosser Company acquired 90% of the common stock of Simone Company for $720,000 and 20% of the preferred stock for $70,000. On this date, Simone Company reported the following account balances: Common stock ($10 par value) Preferred stock ($100 par value, 8%, cumulative, nonparticipating, liquidation value equal to par value) Other contributed capital - premium on common stock Retained earnings

$600,000

300,000 120,000 80,000

Simone Company did not declare a cash dividend during 2012. Prosser Company uses the cost method. Required: A. During 2013 Simone Company reported net income of $360,000 and declared cash dividends of $160,000. Calculate the 2013 noncontrolling interest in net income and the amount of the cash dividends Prosser Company should have received during the year from each of the stock investments. B. Prepare, in general journal form, the workpaper entries that would be made in the preparation of the December 31, 2013, consolidated statements workpaper. The difference between the implied value of the common stock and the book value interest acquired is attributable to an undervaluation in the land of Simone Company. Any difference between the implied value of the preferred stock and its book value is allocated to other contributed capital. 9-6

On January 1, 2013, Pippert Company acquired 80% of Skyler Company's common stock for $210,000 and 70% of Skyler's preferred stock for $80,000. Skyler Company reported the following stockholders' equity on this date: Preferred stock, 8%, Par value $20 Common stock, Par value $50 Premium on common stock Retained earnings Total

$ 100,000 200,000 30,000 80,000 $410,000

The preferred stock is cumulative, nonparticipating, and callable at 104% of par value plus dividends in arrears. On January 1, 2013, dividends were in arrears for one year. Any difference between the implied value of the preferred stock and its book value interest is to be allocated to other contributed capital. Changes in Skyler Company's retained earnings during 2013 and 2014 were as follows: January 1, 2013 Balance 2013 net income 2014 net income 2014 cash dividends December 31, 2014 Balance

$ 80,000 20,000 16,000 (30,000) $ 86,000

9-10 Test Bank to accompany Jeter and Chaney Advanced Accounting Required: A. Compute the difference between the implied value and book value interest acquired for the investment in preferred stock. B. Compute the balance in the Investment in Preferred Stock account on December 31, 2014. C. Compute the amount of Skyler Company's net income that will be included in the controlling interest in consolidated net income for 2014. 9-7

On January 2, 2013, Porous, Inc. acquired an 80% interest in Simtex Corporation for $2,250,000. Simtex reported total stockholders’ equity of $2,500,000 on this date. An examination of Simtex’s books revealed that book value was equal to fair value for all assets and liabilities except for inventory, which was undervalued by $150,000. All of the undervalued inventory was sold during 2013. Porous also purchased 30% of the $1,250,000 par value outstanding bonds of Simtex Corporation for $350,000 on January 2, 2013. The bonds mature in 10 years, carry an 11% annual interest rate payable on June 30 and December 31, and had a carrying value of $1,270,000 on the date of purchase. Both companies use the straight-line method to amortize bond discounts and premiums. Porous reported net income of $750,000 for 2013 and paid dividends of $325,000 during 2013. Simtex Corporation reported net income of $800,000 for 2013 and paid dividends of $225,000 during the year. Required: Compute the following items at December 31, 2013. 1. Carrying value of the debt. 2. Interest revenue reported by Porous, Inc. 3. Interest expense reported by Simtex Corporation. 4. Balance in the Investment in Simtex Bonds account. 5. Controlling interest in consolidated net income for 2013 using the t-account approach. 6. Noncontrolling interest in consolidated income for 2013.

9-8

On January 2, 2013, Palomine Corporation purchased 80% of the outstanding common stock and 30% of the outstanding cumulative, nonparticipating, preferred stock of Sour Company for $800,000 and $140,000, respectively. At this date, Sour Company reported account balances of $800,000 in common stock, $400,000 in preferred stock and $200,000 in retained earnings. No other contributed capital accounts exist. The difference between implied and book value of the common stock is attributable to under- or overvalued land. Dividends on the 12% cumulative preferred stock (par $10) were not paid during 2012.

1/2/2013 Retained Earnings 2013 Reported Net Income 2013 Dividends Declared

Palomine Corporation $ 90,000 169,200 50,000

Sour Company $200,000 180,000 100,000

Chapter 9 Intercompany Bond Holdings and Miscellaneous Topics—Consolidated Financial Statements

9-11

Required: A. Prepare the journal entries made by Palomine Corporation in 2013 to account for the investments assuming the partial equity method is used. B. Compute the noncontrolling interest in Sour Company’s net income. C. Prepare the 2013 workpaper entries related to the foregoing investments assuming the partial equity method is used to account for the investment. Short Answer Questions from Textbook 1. Define “constructive retirement of debt.” How is the total constructive gain or loss computed? 2. The gain or loss on the constructive retirement of debt is recognized subsequently by the individual companies. Explain. 3. Allocating the gain or loss on constructive bond retirement between the purchasing and issuing

companies is preferred conceptually. Describe how this allocation would be made. 4. Give the primary argument(s) in favor of assigning the total gain or loss on constructive bond retirement to the company that issued the bonds. 5. Under the allocation method followed in this text, how is the noncontrolling interest in consolidated income affected by intercompany bondholdings? 6. Investor Company purchased 70% of the$500,000 par value outstanding bonds of Investee Company, a 70% owned subsidiary. The bonds cost $338,000 and had a carrying value of$360,000 on the date of purchase. a. What portion of the gain or loss resulting from the constructive bond retirement should be allocated to Investor Company? b. What portion of the constructive gain or loss should be allocated to Investee Company? 7. An outside party issued a note to Affiliate X, who then sold the note to Affiliate Y. Y discounted the note at an unaffiliated bank, endorsing it with recourse. Which party is primarily liable and which party is contingently liable for the note? 8. Cash dividends are viewed as a distribution of the most recent earnings. How are stock dividends viewed? 9. Explain how the reciprocity calculation is modified in periods after the declaration of a stock dividend for firms using the cost method. 10. What journal entry, if any, would the parent company make to record the receipt of a stock dividend? 11. What effect does a stock dividend have on the consolidated statements work paper in the year of declaration? In subsequent periods? 12. How does the existence of preferred stock affect the calculation of noncontrolling interest? 13. Explain how to account for the difference between implied and book value interest of an investment in preferred stock of a subsidiary.

9-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 14. What effect would cumulative preferred stock have on the allocation of a net loss to the common stockholders? Business Ethics Question from the Textbook The company that you work for is a subsidiary of a larger company. At the beginning of each year, the subsidiary prepares a budget for the year that includes a forecast of revenues for the coming year. The subsidiary sells a significant amount of inventory to the parent to be used in the manufacture of another product. The subsidiary’s revenues for the current year are short of the budgeted amount. An error in the books has misclassified an intercompany sale as an ordinary sale. The manager of the subsidiary asks you not to fix the error until after the books are closed. What is your responsibility? What action, if any, should you take? Why?

Chapter 9 Intercompany Bond Holdings and Miscellaneous Topics—Consolidated Financial Statements

9-13

ANSWER KEY

Multiple Choice 1. 2. 3. 4. 5. 6. 7.

d b c c d c b

8. 9. 10. 11. 12. 13. 14.

c? due to dates 15. c? due to dates 16. b? due to dates 17. a 18. a 19. a 20. b 21.

e b a c d b c

22. 23. 24. 25.

c b b a

Problems 9-1

A. Cash (160,000 × 0.8) Dividend Income (130,000 × 0.8) Investment in Saucey Company

128,000

B. Dividend Income Dividends Declared

104,000

104,000 24,000

104,000

Investment in Saucey Company Dividends Declared

24,000 24,000

Common Stock–Saucey 1,000,000 Beginning R/E–Saucey 400,000 Difference Between Implied and Book Value Investment in Saucey Company Noncontrolling Interest in Equity Difference Between Implied and Book Value Land 9-2

A. Cost of bond investment Par value Unamortized prem. (40,000 × 16/20) Carrying value of bonds Percent of bonds purchased (700/1,000) Total constructive gain B.

Putter Company ---------------Cost of bond investment $670,000 Par value Constructive gain

700,000 $ 30,000

62,500 1,070,000 267,500

62,500 62,500 $670,000 $1,000,000 32,000 1,032,000 0.70

722,400 $52,400

Stemberger Company --------------Carrying value of bonds purchased $722,400 Par value 700,000 Constructive gain $ 22,400

9-14 Test Bank to accompany Jeter and Chaney Advanced Accounting C. 2013 Reported net income – Putter - Dividend income ($100,000 × 0.8) Net income from independent oper. – Putter + Constructive gain on bond retirement Putter's contribution to consolidated income Reported net income – Stemberger $220,000 + Constructive gain on bond retirement 22,400 Stemberger’s contribution to consolidated income 242,400 × 0.8 Controlling interest in consolidated net income D. December 31, 2013 Investment in Stemberger Co. Bonds Constructive Gain on Bond Retirement

9-3

2013

2014

$350,000 - 80,000 270,000 30,000 300,000

193,920 $493,920

30,000 30,000

Premium on Bonds Payable ($32,000 × 0.70) Constructive Gain on Bond Retirement

22,400

Bonds Payable Investment in Stemberger Co. Bonds

700,000

Loss on Constructive Retirement of Bonds Investment in Smurfe Company Bonds

120,000

Loss on Constructive Retirement of Bonds Bond Discount

30,000

22,400

700,000

120,000

30,000

Bonds Payable Investment in Smurfe Company Bonds

2,000,000

Beginning Retained Earnings-Pratt Investment in Smurfe Company Bonds

120,000

Beginning Retained Earnings-Pratt ($30,000 × 0.80) Noncontrolling interest Bond Discount

24,000 6,000

Investment in Smurfe Company Bonds ($120,000/3) Interest Revenue

40,000

Bond Discount [($300,000/3) × 0.10] Interest Expense

10,000

Interest Revenue Interest Expense

160,000

2,000,000

120,000

30,000

40,000

10,000

160,000

Chapter 9 Intercompany Bond Holdings and Miscellaneous Topics—Consolidated Financial Statements 6.

9-4

Bonds Payable Investment in Smurfe Company Bonds Interest Payable Interest Receivable

2,000,000 2,000,000 80,000 80,000

A. Investment in Stuckey Company 400,000 Cash 400,000 Memorandum entry – Received stock dividend of 3,200 shares of Stuckey Company stock (16,000 × 0.20) Cash

19,200 Dividend Income

B. Common Stock – Stuckey Other Contributed Capital – Stuckey Stock Dividends Declared – Stuckey

19,200 32,000 64,000 96,000

Dividend Income Dividends Declared

19,200

Beginning Retained Earnings – Stuckey Common Stock – Stuckey Other Contributed Capital – Stuckey Difference Between Implied and Book Value Investment in Stuckey Company Noncontrolling Interest in Equity

120,000 200,000 60,000 120,000

Land

9-5

9-15

19,200

400,000 100,000

120,000 Difference Between Implied and Book Value

120,000

C. Investment in Stuckey Company 28,800 Beginning Retained Earnings – Power Company

28,800

A. Noncontrolling interest in net income Net income reported by Simone Allocated to preferred stock ($300,000 × 0.08) Residual to common stock Noncontrolling interest in income

$360,000 24,000 × 0.80 = 19,200 336,000 × 0.10 = 33,600 $52,800

Cash dividends to Prosser Company Preferred stock dividend ($24,000 × 2) Residual to common stock Total dividends received by Prosser Company

$ 48,000 × 0.20 = $ 9,600 112,000 × 0.90 = 100,800 $110,400

9-16 Test Bank to accompany Jeter and Chaney Advanced Accounting B. Dividend Income Dividends Declared – Preferred Stock Dividends Declared – Common Stock

110,400 9,600 100,800

Beginning Retained Earnings - Simone Company 24,000 Preferred Stock - Simone Company 300,000 Difference Between Implied and Book Value 26,000 Investment in Simone Company Preferred Stock Noncontrolling Interest in Equity

70,000 280,000

Other Contributed Capital—Prosser Company 5,200 Noncontrolling Interest in Equity 20,800 Difference Between Implied and Book Value

26,000

Beginning Retained Earnings – Simone Company 56,000 Common Stock – Simone Company 600,000 Other Contributed Capital – Simone Company 120,000 Difference Between Implied and Book Value 24,000 Investment in Simone Company Common Stock Noncontrolling Interest in Equity

720,000 80,000

Land

24,000 Difference Between Implied and Book Value

9-6

24,000

A. Preferred stock Call premium ($100,000 × 4%) Dividends in arrears ($100,000 × 0.08) Book value interest of preferred stock Implied value ($80,000/.7) Difference between implied and book value

$100,000 4,000 8,000 112,000 114,286 $ 2,286

B. Cost of investment Less: Liquidating dividend ($8,000 × 0.70) Balance – 12/31/10

$80,000 5,600 $74,400

C. Preferred stock Common stock ($16,000 - $8,000) Total

Net Income $ 8,000 8,000 $16,000

Percentage Controlling interest in Interest Consolidated Income 70 $ 5,600 80

6,400 $12,000

Chapter 9 Intercompany Bond Holdings and Miscellaneous Topics—Consolidated Financial Statements 9-7

Carrying value of debt – 1/2/2013 $1,270,000 Less: Premium amortization – [($20,000/20) × 2 periods) 2,000 Carrying value of debt – 12/31/2013 $1,268,000

Stated interest (30% of $1,250,000 × 0.11) Add: Discount amortization [($25,000/20) × 2 periods)] Interest revenue

$41,250 2,500 $43,750

Stated interest ($1,250,000 × 0.11) Less: Premium amortization [($20,000/20) × 2] Interest expense

$137,500 2,000 $135,500

Cost of bond investment (1/2/2013) Add: Discount amortization* Investment account balance – 12/31/2013

$350,000 2,500 $352,500

9-17

*$1,250,000 par × 30% less $350,000 paid divided by 10 years = $2,500. 5.

Reported net income – Porous Less: Dividend income ($225,000 × 0.80) Independent net income Add: Constructive gain on bond retirement Less: Constructive gain recorded during year Contribution of Porous to consolidated income Reported net income – Simtex Less: Amortization of difference between implied and book value: Cost of goods sold Add: Constructive gain on bond retirement [($1,270,000 - $1,250,000) × 0.30] = Less: Constructive gain recorded during year Income after adjustment in constructive gain

$750,000 180,000 570,000 25,000 (2,500) 592,500 $800,000

(150,000) 650,000 6,000 (600) 655,400 × 0.80

Porous’s share of adjusted income Controlling interest in consolidated net income

524,320 $1,116,820

Implied value of investment ($2,250,000/0.80) Book value of equity acquired Difference between implied and book value Allocated to inventory Goodwill (Excess implied value over fair value)

$2,812,500 2,500,000 312,500 150,000 $ 162,500

Noncontrolling interest in consolidated income ($2,250,000/0.80) – $2,250,000 = $562,500

9-18 Test Bank to accompany Jeter and Chaney Advanced Accounting 9-8

Investment in Sour Company Preferred Stock Investment in Sour Company Common Stock Cash

140,000 800,000

Cash (preferred stock) Equity in Subsidiary Income – Preferred Stock Investment in Sour Company Common Stock

28,800

Cash

3,200

940,000

14,400 14,400

Investment in Sour Company Common Stock

3,200

Investment in Sour Company Common Stock Equity in Subsidiary Income {[($180,000 – ($400,000 × 0.12)] × (.80)}

105,600

Preferred Stock $48,000 48,000 96,000 0.30 $28,800

Common Stock

Arrears Current year Total Percentage interest

105,600

$4,000 4,000 0.80 $3,200

Reported net income – 2013 Allocation to preferred stock interest ($400,000 × 0.12) Residual to common stock interest Noncontrolling interest in 2013 net income

Investment in Sour Company Preferred Stock Investment in Sour Company Common Stock Dividends Declared – Preferred Stock

14,400 14,400

Equity in Subsidiary Income Dividends Declared – Common Stock Investment in Sour Company Common Stock

105,600

Beginning Retained Earnings – Sour Company Preferred Stock Other Contributed Capital (or Retained Earnings) Investment in Sour Company Preferred Stock Noncontrolling Interest in Equity*

48,000 400,000 5,600

$180,000 48,000 × 0.70 = $33,600 $132,000 × 0.20 = 26,400 $60,000

28,800

3,200 102,400

140,000 313,600

*($400,000 + $48,000)] × 0.7 = $313,600 Beginning Retained Earnings – Sour Company Common Stock Difference between Implied and Book Value Investment in Sung Company Common Stock Noncontrolling Interest in Equity

152,000 800,000 48,000 800,000 200,000

Chapter 9 Intercompany Bond Holdings and Miscellaneous Topics—Consolidated Financial Statements

9-19

Short Answer Questions from the Textbook Solutions 1.

Constructive retirement refers to the purchase of an affiliate's outstanding bonds from outsiders. From a consolidated entity viewpoint, the consolidated entity has retired its outstanding debt, and is thus treated as an early extinguishment of debt. The difference between the carrying value of the bonds and the purchase price to the purchasing affiliate is the constructive gain or loss on bond retirement.

The gain or loss is composed of two elements: (1) the discount or premium on the books of the issuer, and (2) the discount or premium paid by the purchaser. Discounts and/or premiums on the books of the two affiliates will be subsequently amortized to income. The cumulative effect on income of the amortization of the discount or premium by the two affiliates is equal to the constructive gain or loss.

The allocation of a gain or loss would be made to each affiliate based on whether the affiliate paid or issued the bonds for more or less than book value or par value. A discount (premium) to the issuer would be allocated to the issuing company as a loss (gain), whereas a discount (premium) to the purchasing affiliate would be a gain (loss). The sum of the two is the total constructive gain or loss.

Support for allocating the total gain or loss to the issuing company is based on the contention that the purchasing affiliate is acting as an agent for the issuing company. Since both companies are under the control of the management of the parent company, the bonds could be transferred to the issuing company. Thus, the purchase is in substance a retirement by the issuing company.

The noncontrolling interest is affected by the portion of the constructive gain or loss allocated to the subsidiary. Because the loss is recognized in the consolidated income statement in the year the bonds are purchased, a discount or premium amortization related to bonds that is made subsequent to the purchase is added back or is subtracted from the subsidiary's reported income. Such adjustments will increase or decrease the noncontrolling interest in the income of the subsidiary.

a. Investor Company Purchase price Par value Constructive gain

$338,000 350,000 $ 12,000

b. Investee Company Carrying value Par value Constructive gain

$360,000 350,000 $ 10,000

The outside party (the maker of the note) is primarily liable; and Affiliate Y, who discounted the note with an outside party, is contingently liable for it.

Stock dividends are viewed as a distribution of the earliest earnings accumulated in the retained earnings account.

The retained earnings balance at the date of acquisition is reduced since the issuance of a stock dividend is viewed as a distribution of the earliest earnings accumulated. 10. A memorandum entry is required to recognize the number of shares received since a dividend in stock is not considered income to the recipient. 11. In the year of declaration, one additional elimination entry is required to eliminate the effects of the dividend. In subsequent periods the amounts of this entry are combined with the investment elimination entry.

9-20 Test Bank to accompany Jeter and Chaney Advanced Accounting

12. Preferred stock of a controlled corporation held by others not in the controlled group represents noncontrolling interest in the controlled corporation. The rights of these shareholders depend on the stock's preference; possibilities are an interest in net assets, earnings, and retained earnings of the controlled corporation. 13. Excess of cost over book value is debited to Other Contributed Capital or to Retained Earnings; excess of book value acquired over cost is credited to Other Contributed Capital. 14. The preferred stock's cumulative preference would increase the net loss allocable to the common stockholders. Business Ethics Case from the Textbook Solution The responsibility of the management of the company is to present accurately the financial statements to the shareholders and investors. Accordingly if an error is detected in the books, it should be rectified as soon as it is discovered so that shareholders and investors are not misled. Intercompany sales are eliminated in the consolidating process. Failure to do so is a material omission, particularly when the inventories in question have not been sold to outsiders but remain in the inventories of the consolidated entity. You should not succumb to the pressure exerted by the manager of the subsidiary.

Chapter 10 Insolvency – Liquidation and Reorganization Multiple Choice 1.

A corporation that is unable to pay its debts as they become due is: a. bankrupt. b. overdrawn. c. insolvent. d. liquidating.

When a business becomes insolvent, it generally has three possible courses of action. Which of the following is not one of the three possible courses of action? a. The debtor and its creditors may enter into a contractual agreement, outside of formal bankruptcy proceedings. b. The debtor continues operating the business in the normal course of the day-to-day operations. c. The debtor or its creditors may file a bankruptcy petition, after which the debtor is liquidated under Chapter 7. d. The debtor or its creditors may file a petition for reorganization under Chapter 11.

Assets transferred by the debtor to a creditor to settle a debt are transferred at: a. book value of the debt. b. book value of the transferred assets. c. fair market value of the debt. d. fair market value of the transferred assets.

A composition agreement is an agreement between the debtor and its creditors whereby the creditors agree to: a. accept less than the full amount of their claims. b. delay settlement of the claim until a later date. c. force the debtor into a liquidation. d. accrue interest at a higher rate.

In a troubled debt restructuring involving a modification of terms, the debtor’s gain on restructuring: a. will equal the creditor’s gain on restructuring. b. will equal the creditor’s loss on restructuring. c. may not equal the creditor’s gain on restructuring. d. may not equal the creditor’s loss on restructuring.

A bankruptcy petition filed by a firm is a: a. chapter petition. b. involuntary petition. c. voluntary petition. d. chapter 11 petition.

When a bankruptcy court enters an “order for relief” it has: a. accepted the petition. b. dismissed the petition. c. appointed a trustee. d. started legal action against the debtor by its creditors.

10-2 Test Bank to accompany Jeter and Chaney Advanced Accounting 8.

An involuntary petition filed by a firm’s creditors whereby there are twelve or more creditors must be signed by at least: a. two creditors. b. three creditors. c. five creditors. d. six creditors.

The duties of the trustee include: a. appointing creditors’ committees in liquidation cases. b. approving all payments for debts incurred before the bankruptcy filing. c. examining claims and disallowing any that are improper. d. calling a meeting of the debtor’s creditors.

10.

Which of the following items is not I would be consistent and use just bold, no underline or italics a specified priority for unsecured creditors in a bankruptcy petition? a. Administration fees incurred in administering the bankrupt’s estate. b. Unsecured claims for wages earned within 90 days and are less than $4,650 per employee. c. Unsecured claims of governmental units for unpaid taxes. d. Unsecured claims on credit card charges that do not exceed $3,000.

11.

Which statement with respect to gains and losses on troubled debt restructuring is correct? a. Creditors losses on restructuring are extraordinary. b. Debtor’s gains and losses on asset transfers and debtor’s gains on restructuring are combined and treated as extraordinary. c. Debtor gains and creditor losses on restructuring are extraordinary, if material in amount. d. Debtor losses on asset transfers and debtor gains on restructuring are reported as a component of net income.

12.

When fresh-start reporting is used according to Statement of Position (SOP) 90-7 (now incorporated in FSB ASC topic 852), the implication is that a new firm exists. Which of the following statements is not same comment as ta #10 correct about fresh-start accounting? a. Assets are reported at fair values. b. Beginning retained earnings is reported at zero. c. The fair value of the assets must be less than the post liabilities and allowed claims. d. The original owners must own less than 50% of the voting stock after reorganization.

13.

A Statement of Affairs is a report designed to show: a. an estimated amount that would be received by each class of creditor’s claims in the event of liquidation. b. a balance sheet prepared on the going-concern assumption. c. assets and liabilities classified as current and noncurrent. d. assets and liabilities reported at their current book values.

14.

When a secured claim is not fully settled by the selling of the underlying collateral, the remaining portion: a. of the claim cannot be collected by the creditor. b. remains as a secured claim. c. is classified as an unsecured priority claim. d. is classified as an unsecured nonpriority claim.

Chapter 10 Insolvency – Liquidation and Reorganization

10-3

15.

Lyme Corporation entered into a troubled debt restructuring agreement with their local bank. The bank agreed to accept land with a carrying amount of $360,000 and a fair value of $540,000 in exchange for a note with a carrying amount of $765,000. Ignoring income taxes, what amount should Lyme report as a gain on its income statement? a. $0. b. $180,000. c. $225,000. d. $405,000.

16.

The following information pertains to the transfer of real estate in regards to a troubled debt restructuring by North Co. to Bell Co. in full settlement of North’s liability to Bell: Carrying amount of liability settled Carrying amount of real estate transferred Fair value of real estate transferred

$450,000 $300,000 $330,000

What amount should North report as ordinary gain (loss) on transfer of real estate? a. $(30,000). b. $30,000. c. $120,000. d. $150,000. 17.

$450,000 $300,000 $330,000

What amount should Bell report as a gain or (loss) on restructuring? a. $120,000 ordinary loss. b. $120,000 extraordinary loss. c. $150,000 ordinary loss. d. $150,000 extraordinary loss. 18.

Dobby Corporation was forced into bankruptcy and is in the process of liquidating assets and paying claims. Unsecured claims will be paid at the rate of thirty cents on the dollar. Carson holds a note receivable from Dobby for $75,000 collateralized by an asset with a book value of $50,000 and a liquidation value of $25,000. The amount to be realized by Carson on this note is: a. $25,000. b. $40,000. c. $50,000. d. $75,000.

10-4 Test Bank to accompany Jeter and Chaney Advanced Accounting

19.

Splat Company filed a voluntary bankruptcy petition, and the statement of affairs reflected the following amounts: Estimated Assets Book Value Current Value Assets pledged with fully secured creditors $ 900,000 $ 1,110,000 Assets pledged partially secured creditors 540,000 360,000 Free assets 1,260,000 960,000 $2,700,000 $2,430,000 Liabilities Liabilities with priority $ 210,000 Fully secured creditors 780,000 Partially secured creditors 600,000 Unsecured creditors 1,620,000 $3,210,000 Assume the assets are converted to cash at their estimated current values. What amount of cash will be available to pay unsecured nonpriority claims? a. b. c. d.

$720,000. $840,000. $960,000. $1,080,000.

20.

The final settlement with unsecured creditors is computed by dividing: a. total net realizable value by total unsecured creditor claims. b. net free assets by total secured creditor claims. c. total net realizable value by total secured creditor claims. d. net free assets by total unsecured creditor claims.

21.

Ford Corporation entered into a troubled debt restructuring agreement with their local bank. The bank agreed to accept land with a carrying value of $200,000 and a fair value of $300,000 in exchange for a note with a carrying amount of $425,000. Ignoring income taxes, what amount should Ford report as a gain on its income statement? a. $0. b. $100,000. c. $125,000. d. $225,000.

22.

The following information pertains to the transfer of real estate in regards to a troubled debt restructuring by MSG Co. to Beta Co. in full settlement of MSG’s liability to Beta: Carrying amount of liability settled Carrying amount of real estate transferred Fair value of real estate transferred

$375,000 $250,000 $275,000

What amount should MSG report as ordinary gain (loss) on transfer of real estate? a. $(25,000). b. $25,000. c. $100,000. d. $125,000.

Chapter 10 Insolvency – Liquidation and Reorganization 23.

10-5

$375,000 $250,000 $275,000

What amount should Beta report as a gain or (loss) on restructuring? a. $100,000 ordinary loss. b. $100,000 extraordinary loss. c. $125,000 ordinary loss. d. $125,000 extraordinary loss. 24.

Poor Company filed a voluntary bankruptcy petition, and the settlement of affairs reflected the following amounts:

Assets Assets pledged with fully secured creditors Assets pledged partially secured creditors Free assets

Liabilities Liabilities with priority Fully secured creditors Partially secured creditors Unsecured creditors

Book Value $ 450,000 270,000 630,000 $1,350,000

Estimated Current Value $ 555,000 180,000 480,000 $1,215,000

$ 105,000 390,000 300,000 810,000 $1,605,000

Assume the assets are converted to cash to their estimated current values. What amount of cash will be available to pay unsecured nonpriority claims? a. $360,000. b. $420,000. c. $480,000. d. $540,000. 25.

Target Corporation was forced into bankruptcy and is in the process of liquidating assets and paying claims. Unsecured claims will be paid at the rate of thirty cents on the dollar. Arrow holds a note receivable from Target for $90,000 collateralized by an asset with a book value of $60,000 and a liquidation value of $30,000. The amount to be realized by Arrow on this note is: a. $30,000. b. $48,000. c. $60,000. d. $90,000.

10-6 Test Bank to accompany Jeter and Chaney Advanced Accounting Problems as with earlier chapters, there appears to be many spacing issues - at least in the way it printed out for me 10-1 On January 1, 2014, Deal Mart owed Money Bank $1,600,000, under an 8% note with three years remaining to maturity. Due to financial difficulties, Deal Mart was unable to pay the previous year’s interest. Money Bank agreed to settle Deal Mart’s debt in exchange for land having a fair market value of $1,310,000. Deal Mart purchased the land in 2003 for $1,000,000. Required: Prepare the journal entries to record the restructuring of the debt by Deal Mart. 10-2

On January 1, 2013, Terminator, Inc. owed 9th National Bank $12 million on a 10% note due December 31, 2014. Interest was last paid on December 31, 2008. Terminator was experiencing severe financial difficulties and asked 9th National Bank to modify the terms of the debt agreement. After negotiation 9th National Bank agreed to: - Forgive the interest accrued for the year just ended, - Reduce the remaining two years interest payments to $900,000 each and delay the first payment until December 31, 2014, and - Reduce the unpaid principal amount to $9,600,000.

Required: Prepare the journal entries for Terminator, Inc. necessitated by the restructuring of the debt at (1) January 1, 2013, (2) December 31, 2014, and (3) December 31, 2012. 10-3

On January 2, 2014 Cretin Co., was indebted to Fourth National Bank under a $12 million, 10% unsecured note. The note was signed January 2, 2008, and was due December 31, 2017. Annual interest was last paid on December 31, 2012. Cretin Co. negotiated a restructuring of the terms of the debt agreement due to financial difficulties.

Required: Prepare all journal entries for Cretin Co., to record the restructuring and any remaining transactions relating to the debt under each independent assumption. A. Fourth National Bank agreed to settle the debt in exchange for land which cost Cretin Co. $8,500,000 and has a fair market value of $10,000,000. B. Fourth National Bank agreed to (1) forgive the accrued interest from last year (2) reduce the remaining four interest payments to $600,000 each, and (3) reduce the principal to $9,000,000. 10-4

On December 31, 2014, Pilot’s Credit Union agreed to restructure a $900,000, 8% loan receivable from Norma Corporation because of Norma’s financial problems. At December 31 there was $36,000 of accrued interest for a six-month period. Terms of the restructuring agreement are as follows: - Reduce the loan from $900,000 to $600,000; - Extend the maturity date by 2 years from December 31, 2014 to December 31, 2016; - Reduce the interest rate on the loan from 8% to 6%. Present value assumptions: Present value of $1 for 2 years at 6% = Present value of $1 for 2 years at 8% = Present value of an ordinary annuity of $1 for 2 years at 6% = Present value of an ordinary annuity of $1 for 2 years at 8% =

Required:

0.8900 0.8573 1.8334 1.7833

Chapter 10 Insolvency – Liquidation and Reorganization

10-7

Compute the gain or loss that will be reported by Pilot’s Credit Union. 10-5 O’Donnell Corporation incurred major losses in 2013 and entered into voluntary Chapter 7 bankruptcy in the early part of 2014. By June 1, all assets were converted into cash, the secured creditors were paid, and $150,000 in cash was left to pay the remaining claims as follows. Accounts payable Claims prior to the trustee’s appointment Property taxes payable Wages payable (all under $4,650 per employee) Unsecured note payable Accrued interest on the note payable Administrative expenses of the trustee Total

$ 48,000 21,000 18,000 54,000 60,000 6,000 30,000 $237,000

Required: Classify the claims by their Chapter 7 priority ranking, and analyze which amounts will be paid and which amounts will be written off. 10-6

Down Dog Corporation filed a petition under Chapter 7 of the U.S. Bankruptcy Act on June 30, 2014. Data relevant to its financial position as of this date are: Estimated Net Book Value Realizable Values Cash $ 3,000 $ 3,000 Accounts receivable-net 72,000 48,000 Inventories 60,000 72,000 Equipment-net 165,000 87,000 Total assets $300,000 $210,000 Accounts payable Rent payable Wages payable Note payable plus accrued interest Capital stock Retained earnings (deficit) Total liabilities and equity

$ 72,000 21,000 45,000 96,000 180,000 (120,000) $300,000

Required: A. Prepare a statement of affairs assuming that the note payable and interest are secured by a mortgage on the equipment and that wages are less than $4,650 per employee. B. Estimate the amount that will be paid to each class of claims if priority liquidation expenses including trustee fees are $24,000 and estimated net realizable values are actually realized.

10-8 Test Bank to accompany Jeter and Chaney Advanced Accounting 10-7

The following data are taken from the statement of affairs of Motor Sports Company. Assets pledged with fully secured creditors (Realizable value, $635,000) Assets pledged with partially secured creditors (realizable value, $300,000) Free assets (Realizable value, $340,000) Fully secured creditor claims Partially secured creditor claims Unsecured creditor claims with priority General unsecured creditor claims

$800,000 365,000 535,000 316,000 400,000 100,000 1,165,000

Required: Compute the amount that will be paid to each class of creditor. 10-8

On February 1, 2014, Hillary Company filed a petition for reorganization under the bankruptcy statutes. The court approved the plan on September 1, 2014, including the following provisions: 1. 2.

3. 4.

Accrued expenses of $21,930, representing priority items, are to be paid in full. Hillary Company is to exchange accounts receivable in the face amount of $138,000 and an allowance for uncollectible accounts of $29,200 for the full settlement of $198,600 owed on open account to one of its major unsecured creditors. The estimated fair value of the receivables is $104,000. Unsecured creditors of open accounts amounting to $91,600 and paid 40 cents on the dollar in full settlement. Hillary Company’s only other major unsecured creditor agreed to a five-year extension of the $500,000 principal owed him on a 10% note payable. Accrued interest on the note on September 1, 2014, amounts to $45,000, one-third of which is to be paid in cash and the remainder canceled. In addition, no interest is to be charged during the remaining five years to maturity of the note.

Required: Prepare journal entries on the books of Hillary Company to give effect to the preceding provisions.

Short Answer 1.

The Bankruptcy Reform Act assigns priorities to certain unsecured claims, and each rank must be satisfied in full before the next–lower rank is paid. Identify the five categories of unsecured creditor claims.

Creditors are classified by law as either secured or unsecured. Distinguish among fully secured, partially secured, and unsecured creditors.

Chapter 10 Insolvency – Liquidation and Reorganization

10-9

Short Answer Questions from the Textbook 1.

List the primary types of contractual agreements between a debtor company and its creditors and briefly explain what is involved in each of them.

Distinguish between a voluntary and involuntary bankruptcy petition.

Distinguish among fully secured, partially se-cured, and unsecured claims of creditors.

Five priority categories of unsecured claims must be paid before general unsecured creditors are paid. Briefly describe what makes up each category.

What are “dividends” in a bankruptcy proceeding?

For each of the following debt restructurings, indicate whether a gain is recognized and, if so, how the gain is measured and reported. (a)Transfer of assets by the debtor to the creditor.(b)Grant of an equity interest by the debtor to the creditor.(c)Modification of the terms of the payable.

What is the purpose of a Statement of Affairs?

One of the officers of a corporation that had just received a discharge in bankruptcy said, “Good, now we don’t owe anyone.” Is he correct?

What are the duties of a trustee in a liquidation proceeding?

10.

What is the purpose of a combining work paper prepared by a trustee?

11.

What is the purpose of a realization and liquidation account?

Business Ethics Question from Textbook From an ethical perspective, some believe that it is never justifiable for an individual or business to declare bankruptcy. Others believe that some actions are appropriate only in extreme circumstances. Without question, as stated in the Journal of Accountancy, November 2005, page 51, “the ease with which debtors have been able to walk away from debt has frustrated creditors for years.” 1. Describe the differences between Chapter 7 (liquidations) and Chapter 11 (reorganizations)from an ethical standpoint. Who is most likely to be hurt by a Chapter 7 bankruptcy? 2. Discuss the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Do you believe the changes wrought by this act will serve to protect creditors? 3. The Protection Act of 2005 requires individuals, but not businesses, to undergo a “means” test before they can seek Chapter 7 relief. Do you believe this change should be applied to businesses as well? Why or why not? 4. Do you think that you would ever resort to filing for bankruptcy relief yourself? Why or why not?

10-10 Test Bank to accompany Jeter and Chaney Advanced Accounting ANSWER KEY 1. 2. 3. 4. 5. 6. 7.

c b d a d c a

8. 9. 10. 11. 12. 13. 14.

b c d d c a d

15. 16. 17. 18. 19. 20. 21.

Problems 10-1 Land

c b a b d d c

22. 23. 24. 25.

310,000 Gain on Disposal of Land

Note Payable Interest Payable Land Gain on Debt Restructuring

10-2

b a d b

Carrying amount: $12,000,000 + $1,2000,000 = Future payments: ($900,000 × 2) + 9,600,000 = Gain to debtor/Loss to creditor

310,000 1,600,000 128,000 1,310,000 418,000

$13,200,000 11,400,000 $ 1,800,000

January 1, 2013 Interest Payable Note Payable Gain on Debt Restructuring

1,200,000 600,000 1,800,000

December 31, 2014 Note Payable Cash December 31, 2015 Note Payable Cash (Interest) Note Payable Cash (Principal)

900,000 900,000

900,000 900,000 9,600,000 9,600,000

Chapter 10 Insolvency – Liquidation and Reorganization

10-3

January 2, 2014 Land Gain on Disposal of Land

1,500,000 1,500,000

Interest Payable Note Payable Land Gain on Debt Restructuring B.

1,200,000 12,000,000 10,000,000 3,200,000

Carrying amount $12,000,000 + $1,200,000 = Future payments ($600,000 × 4) + $9,000,000 = Gain to debtor/Loss to creditor January 2, 2014 Interest Payable Note Payable Gain on Debt Restructuring

1,200,000 600,000

December 31, 2014, 2015, 2016, 2017 Note Payable (Interest) Cash

600,000

1,800,000

December 31, 2017 Note Payable Cash 10-4

$13,200,000 11,400,000 $ 1,800,000

600,000

9,000,000 9,000,000

A.delete - no A in text Pilot’s Credit Union’s loss on restructuring: Carrying value of the loan before restructuring Present value of $600,000 due in 2 years at 8% historical rate: ($600,000 × 0.8573) = Present value of $36,000 interest for 2 years at 8% historical rate: ($36,000 × 1.7833) = Carrying value of the loan Loss on restructuring

$936,000 $514,380 64,199 $578,579

(578,579) $357,421

10-5 Unsecured priority claims:

Administrative expenses Claims prior to the trustee’s appointment Wages payable Property taxes payable

Claim Amount

To be Paid

$30,000 21,000 54,000 18,000

Cash Left $150,000 120,000 99,000 45,000 27,000

10-11

10-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 10-5

(Continued) Unsecured Nonpriority Claims:

Accounts payable Unsecured note Accrued interest on the note

Claim Amount

To be Paid

Written Off

$ 48,000 60,000 6,000

$12,000* 15,000** 0

$36,000 45,000 6,000

$27,000 / ($48,000 + $60,000) = .25 * $48,000 × 0.25 = $12,000 **$60,000 × 0.25 = $15,000

10-6 A. Down Dog Corporation Statement of Affairs June 30, 2014

Book Value $165,000

3,000 72,000 60,000

______ $300,000

Assets Pledged with partially secured creditors Equipment-net Less: Note payable and accrued interest Unsecured amount (See below) Free Assets Cash Accounts receivable-net Inventories Total net realizable value Less: Priority liabilities – wages payable Total available for unsecured creditors Estimated deficiency to unsecured creditors

Deficiency Account Realizable Value (Loss/Gain) $87,000 (96,000) (9,000)

3,000 48,000 72,000 123,000 <45,000> 78,000 30,000 $108,000

(78,000) $

(24,000) 12,000

______ (90,000)

Chapter 10 Insolvency – Liquidation and Reorganization 10-6

(Continued)

Book Value

Unsecured Liabilities

Equities

$ 45,000

96,000

72,000 27,000

180,000 (120,000) $300,000

Priority liabilities Wages payable (assumed under $4,650 per employee)

$ 45,000

Partially secured creditors Note payable and accrued interest Less: Equipment pledged as security

$ 96,000 (87,000)

Unsecured creditors Accounts payable Rent payable Stockholders’ equity Capital stock Retained earnings (deficit)

$ 9,000

72,000 27,000

______ $108,000

Estimated Deficiency B.

10-13

180,000 (120,000) $ 60,000 $(30,000)

Estimated payments per dollar for unsecured creditors

Cash available Distribution to partially secured and unsecured priority creditors: Note payable and interest Administrative expenses Wages payable Available to unsecured nonpriority creditors Note payable and interest (unsecured portion) Accounts payable Rent payable Unsecured nonpriority claims ($54,000 / $108,000 = $0.50 per dollar)

$210,000

$87,000 24,000 45,000

< 156,000> $ 54,000 $ 9,000 72,000 27,000 $108,000

10-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 10-6

(Continued)

Expected recovery for each class of claims

Partially secured Note payable and interest Secured portion Unsecured portion ($9,000 × 0.50)

$87,000 4,500

$91,500

Unsecured priority Administrative expenses Wages payable

$24,000 45,000

69,000

Unsecured nonpriority Accounts payable ($72,000 × 0.50 Rent payable ($27,000 × 0.50) Total payments

$36,000 13,500

49,500 $210,000

10-7 Realizable value of all assets ($635,000 + $300,000 + $340,000) Allocated to: Fully secured creditors Partially secured creditors Unsecured creditors with priority Remainder available to general unsecured creditors Payment rate to general unsecured creditors (Including balance due to partially secured creditors) $559,000 / ($1,165,000 + ($400,000 - $300,000))

$1,275,000 (316,000) (300,000) (100,000) $559,000

44.2%

Realizable value of assets: Assets pledged to fully secured creditors Assets pledged to partially secured creditors Free assets Total realizable value

$635,000 300,000 340,000 $1,275,000

Amounts to be paid to: Fully secured creditors Partially secured creditors [$300,000 + (0.442 × $100,000)] Unsecured creditors with priority General unsecured creditors (0.442 × $1,165,000) Total

$316,000 344,200 100,000 514,800* $1,275,000

*Rounded $130

Chapter 10 Insolvency – Liquidation and Reorganization

10-15

10-8 1.

Accrued Expenses Cash

21,930

Allowance for Uncollectible Accounts Loss on Transfer of Assets Accounts Receivable ($138,000 - $104,000)

29,200 4,800

Accounts Payable Accounts Receivable Gain on Restructuring of Debt ($198,600 - $104,000)

198,600

Accounts Payable Cash ($91,600 × 0.40) Gain on Restructuring of Debt

91,600

Notes Payable Accrued Interest Payable Cash Restructured Debt Gain on Restructuring of Debt ($545,000 - $515,000)

500,000 45,000

21,930

34,000

104,000 94,600

36,640 54,960

15,000 500,000 30,000

Short Answer 1.

The five categories of unsecured creditor claims are: a. Administration expenses and fees incurred in administering the bankrupt’s estate. b. Unsecured claims for wages and salaries earned within 90 days before the date of filing of the petition. c. Unsecured claims for contributions to employee benefit plans from services provided within 180 days before the date of filing of the petition. d. Unsecured claims of individuals arising from deposits for the purchase, lease, or rental of property or services that were not delivered. e. Unsecured claims of governmental units for unpaid taxes.

Fully secured creditor claims are those with liens against assets whose realizable value is equal to or in excess of the claim. Partially secured claims are those with liens against assets whose realizable value is less than the amount of the claim. Unsecured creditors are paid from whatever proceeds remain from the realization process.

Short Answer Questions from the Textbook Solutions 1. Extension of payment periods. The debtor continues to manage the business, and the creditors merely extend the payment due date(s) for existing debts. Composition agreements. A composition agreement is an agreement between the debtor company and its creditors under which the creditors agree to accept less than the full amount of their claims.

10-16 Test Bank to accompany Jeter and Chaney Advanced Accounting Formation of a creditor’s committee. The debtor company and its creditors agree to form a committee of creditors responsible for managing the debtor’s business affairs for the period during which plans are developed to rehabilitate, reorganize, or liquidate the business. Voluntary assignment of assets. An insolvent debtor elects to voluntarily place his property under the control of a trustee for the benefit of his creditors. 2. In a voluntary petition, the debtor files a petition with a bankruptcy court for liquidation under Chapter 7 or for reorganization under Chapter 11. The bankruptcy judge may refuse a voluntary petition if refusal is considered to be in the best interest of the creditors. In an involuntary petition, creditors initiate the action by filing a petition for liquidation or reorganization with the bankruptcy court. If there are twelve or more creditors, the petition must be signed by three or more of such creditors whose claims aggregate at least $5,000 more than the value of any liens on the property of the debtor. If there are fewer than twelve creditors, the petition may be filed by one or more of such creditors whose claims aggregate at least $5,000 more than the value of any liens on the debtor’s property. 3. Fully secured claims. Those claims with liens against specific assets whose realizable value is equal to or in excess of the claim. Partially secured claims. Those claims with liens against specific assets whose realizable value is less than the amount of the claim. Unsecured claims. Those claims that are not secured by liens against specific assets and are, therefore, paid from whatever total money remains after secured creditors are satisfied. Some unsecured claims take priority over others under federal bankruptcy law.

Chapter 10 Insolvency – Liquidation and Reorganization

10-17

4. The five categories of unsecured claims with priority are: a. Administrative expenses, fees, and charges incurred in administering the bankrupt’s estate. b. Unsecured claims for wages, salaries, or commissions earned by an employee within 90 days before the date of filing a petition in bankruptcy, limited to the extent of $4,650 per employee. c. Claims for contributions to employee benefit plans from services rendered within 180 days before the date of filing a petition in bankruptcy, but subject to certain limitations. d. Unsecured claims of individuals, to the extent of $2,100 for each such individual, arising from the deposit of money in connection with the purchase, lease, or rental of property or services that were not delivered or performed. e. Claims of governmental units for unpaid taxes. 5. Dividends represent the final distribution made to general unsecured creditors. 6. a. Transfer of Assets: The transfer of assets by a debtor to a creditor generally produces two types of gain or loss. A gain on restructuring of debt is recognized for the excess of the carrying value of the payable over the fair value of the assets transferred. This gain is reported as a compoNortht of operating income. In addition, a gain or loss on transfer of assets is recognized for the difference between the fair value and book value of the assets transferred. This gain (loss) is reported as a compoNortht of operating income also. b. Grant of an Equity Interest: A debtor who grants an equity interest to a creditor will report a gain for the difference between the fair value of the equity interest issued and the carrying amount of the payable settled. c. Modification of Terms: In a modification of terms, the debtor will report a gain on restructuring only if the total future cash payments specified by the new terms are less than the carrying value of the payable. The amount of gain is measure as the difference between the total future cash payments specified by the new terms and the carrying value of the payable. 7. The statement of affairs is an accounting report that is designed to permit interested parties to determine the total expected amounts that could be realized from the disposition of a company’s assets, the priorities in the use of the realization proceeds in satisfying claims, and the potential net deficiency that would result if the assets were realized and claims liquidated. 8. The officer is incorrect. Some claims, such as for taxes, fines, and penalties are not discharged.

10-18 Test Bank to accompany Jeter and Chaney Advanced Accounting 9. The primary duties of a trustee are: a. To be accountable of all property received. b. To examine proofs of claims and object to the allowance of any claim that is improper. c. To furnish such information concerning the estate and the estate’s administration as is requested by a party in interest. d. If the business of the debtor is authorized to be operated, file with the court and with any governmental unit charged with responsibility for collection of any tax arising out of such operation, periodic reports and summaries of the operation of the business. e. If the debtor has not done so, file with the court a list of creditors, a schedule of assets and liabilities, and a statement of the debtor’s financial affairs. f. If applicable, file a plan of reorganization, and, if the plan is accepted, file such reports as are required by the court. 10. The purpose of a combining workpaper is to serve as a means by which the trustee’s accounts are united with the debtor company’s accounts in order to prepare appropriate financial statements. 11. The purpose of a realization and liquidation account is to report summary realization and distribution activities of a trustee or receiver to the court. It reports the changes that have occurred during a period in the monetary items because that is what the court officials are primarily interested in. Business Ethics Question from the Textbook Solution 1. In chapter 7 bankruptcy liquidation, firms are assumed to be past the stage of reorganization and must sell off any un-exempt assets to pay creditors. In contrast, Chapter 11 bankruptcy allows the firm the opportunity to reorganize its debt and to try to re-emerge as a healthy organization. In both cases, the creditors and other claim-holders suffer losses as they will be most likely getting less return on investment than expected at the time of the initial decision to invest in the company. From an ethical perspective, a chapter 11 bankruptcy provides the creditors and other claim-holders a better chance of recovering higher value for their investments than under chapter 7 as the firm strives to recover and reorganize under chapter 11 but not under chapter 7. 2. The new law makes sweeping changes to American bankruptcy laws and makes it more difficult for individuals to file bankruptcy under chapter 7. The new law requires a means test to determine whether the borrowers have enough resources to pay for their debts. For additional information, see the following link: http://en.wikipedia.org/wiki/Bankruptcy_Abuse_Prevention_and_Consumer_Protection_Act]

In addition the new law laid down the following requirements • Mandatory credit counseling and debtor education • Additional filing requirements and fees • Increased attorney liability and costs • Fewer automatic protections for filers • Increased compliance requirements for small businesses • Increased amount of debt repayment under Chapter 13 • Increased length of time between discharges These changes provide more safety for the creditors, who should consequently be better protected. Individuals who fail the means test may opt instead for Chapter 13, which involves a repayment of their debt over time.

Chapter 10 Insolvency – Liquidation and Reorganization

10-19

3. Applying this test to businesses would benefit the creditors and other claim-holders, as they would feel a slight buffer to their risk, which might stimulate new business as a result of easier fund raising. It may also prevent businesses from venturing into unduly risky areas as they would not be able to bail out as easily by filing under chapter 7 if things went wrong (hence becoming somewhat more risk averse). It would seem to shift the risk balance somewhat to the shoulders of the entrepreneur from those of the investor. 4. Filing for bankruptcy is never a desirable or ethical option, but sometimes circumstances may arise that seem to force a business or an individual into this tough situation. Whether the individual finds another way at such a time or not is a personal issue and an ethical dilemma, and there is not necessarily a correct answer to this question. The purpose of this discussion is to get the student to thinking about his or her personal position, and where his ethical stance would be before the situation arises. Ideally, of course, the student will never find himself or herself in such a position, but, as the old saying goes, until you’ve walked a mile in another’s shoes…

CHAPTER 11: INTERNATIONAL FINANCIAL REPORTING STANDARDS

Multiple Choice 1.

The goals of the International Accounting Standards Committee include all of the following except: a. To improve international accounting. b. To formulate a single set of auditing standards to be applied in all countries. c. To promote global acceptance of its standards. d. To harmonize accounting practices between countries.

Which of the following is true about the FASB after the mandatory adoption of IFRS by US companies? a. The FASB will serve in an advisory capacity to the IASB. b. The FASB will remain the designated standard-setter for US companies, but incorporate IFRS into US GAAP. c. The role of the FASB post-IFRS adoption has not been determined. d. The FASB will cease to exist.

Milestones in the transition plan for mandatory adoption of IFRS by US companies include all of the following except: a. Improvements in accounting standards. b. Limited early adoption of IFRS in an effort to enhance comparability for US investors c. Mandatory use of IFRS by US entities. d. All of the above are milestones in the transition plan for mandatory adoption of IFRS by US companies.

The roles of the IASC Foundation include a. establishing global standards for financial reporting. b. coordinating the filing requirements of stock exchange regulatory agencies. c. financing IASB operations. d. all of the above are roles of the IASC Foundation.

Which of the following statements is true regarding the IASC? a. The IASC is a public-sector, not-for-profit organization. b. The IASC is accountable to an international securities regulator. c. The IASC is a stand-alone, private-sector organization. d. The IASC funds the operations of the IASB through filing fees paid to national securities regulators.

6. .delete . Concerns of the SEC with regard to the mandatory adoption of IFRS by US entities include all of the following except: a. the extent to which the standard-setting process addresses emerging issues in a timely manner. b. the security and stability of IASC funding. c. the enhancement of IASB independence through a system of voluntary contributions from firms in the accounting profession. d. the degree to which due process is integrated into the standard-setting process .

7. .delete . Which statement below is correct under the currently anticipated future rulemaking by the SEC for the transition to mandatory adoption of IFRS? a. Large, accelerated filers would begin IFRS filings for fiscal years beginning on or after December 31, 2014. b. non-accelerated filers would begin IFRS filings for fiscal years beginning on or after December 31, 2015. c. Issuers would be allowed to choose between IFRS AND U.S. GAAP. d. 2015 would be the earliest possible date for the required use of IFRS by U.S. public companies. 8.

Which statement below concerning the accountability and funding of the IASC Foundation is correct? a. The IASC Foundation independence is assured through a system of voluntary contributions from firms in the accounting profession. b. The IASC Foundation is not controlled by any national securities regulators. c. The SEC considers the accountability and funding mechanisms for the IASC Foundation to be satisfactory. d. Appointments of IASC Foundation Trustees must be approved by the SEC.

Benefits of the FASB Accounting Standards Codification (ASC) include all of the following except: a. increases the independence of the FASB. b. aids in the convergence of US GAAP with IFRS. c. reduces time and effort required to research accounting issues. d. clearly distinguishes between authoritative and non-authoritative guidance.

10.

SFAS No.162, the Accounting Standards Codification, is directed to a. auditors. b. Boards of Directors. c. securities regulators. d. entities.

11.

IFRS and US GAAP differ with regard to financial statement presentation in all of the following except: a. IFRS generally requires that assets be listed in order of increasing liquidity while US GAAP requires that assets be listed in order of decreasing liquidity. b. US GAAP requires expenses to be listed by function while IFRS requires expenses to be listed by nature. c. IFRS prohibits extraordinary items which are allowed by US GAAP. d. IFRS requires two years of comparative income statements while under US GAAP, three years of income statements are required.

12.

The major difference between IFRS and US GAAP in accounting for inventories is that a. US GAAP prohibits the use of specific identification. b. IFRS requires the use of the LIFO cost flow assumption. c. US GAAP prohibits the use of the LIFO cost flow assumption d. US GAAP allows the use of the LIFO cost flow assumption.

13.

One difference between IFRS and GAAP in valuing inventories is that a. IFRS, but not GAAP, allows reversals so that inventories written down under lower-of-costor-market can be written back up to the original cost . b. GAAP defines market value as replacement cost where IFRS defines market as the selling price. c. GAAP strictly adheres to the historical cost concept and does not allow for write-downs of inventory values while IFRS embraces fair value. d. IFRS, but not GAAP, requires that inventories be valued at the lower of cost or market.

14.

In accounting for research and development costs. a. the general rule under both US GAAP and IFRS is that research and development costs should be expensed as incurred . b. IFRS generally expenses all research and development costs while US GAAP expenses research costs as incurred but capitalizes development costs once technological and economic feasibility has been demonstrated. c. US GAAP generally expenses all research and development costs while IFRS expenses research costs as incurred but capitalizes development costs once technological and economic feasibility has been demonstrated. d. both US GAAP and IFRS expense research costs as incurred but capitalize development costs once technological and economic feasibility has been demonstrated.

15.

Property, plant and equipment are valued at a. historical cost under both IFRS and US GAAP. b. historical cost or revalued amounts under both IFRS and US GAAP. c. revalued amounts under IFRS. d. historical cost under US GAAP while IFRS allows the assets to be valued at either historical cost or revalued amounts.

16.

The amount of a long-lived asset impairment loss is generally determined by comparing a. the asset’s carrying amount and its fair value under US GAAP. b. the asset’s carrying amount and its discounted future cash flows less cost to sell under IFRS. c. the asset’s carrying amount and its undiscounted future cash flows under US GAAP. d. the asset’s carrying amount and its undiscounted future cash flows less disposal cost under IFRS.

17.

In accounting for liabilities, IFRS interprets “probable” as a. likely. b. more likely than not. c. somewhat possible. d. possible and not remote.

18.

Accounting under IFRS and US GAAP is similar for all of the following topics except: a. changes in estimates. b. related party transactions. c. research and development costs. d. changes in methods.

Use the following information to answer the next three questions. On January 1, 2013, BelgianAir purchases an airplane for €14,400,000. The components of the airplane and their useful lives are as follows: Component Frame Engine Other

Cost €7,200,000 4,800,000 2,400,000

Useful life 24 years 20 years 10 years

BelgianAir uses the straight-line method of depreciation. The asset is assumed to have no salvage value. 19.

Under IFRS, the entry to record the acquisition of the airplane would include a. a debit to Asset/ Airplane of €14,400,000. b. a debit to Asset/ Airplane frame of €14,400,000. c. a debit to Asset/ Airplane engine of €4,800,000. d. cannot be determined from the information given.

20.

Under US GAAP, the entry to record depreciation expense on the asset at December 31, 2014 will include a. a credit to accumulated depreciation of €1,200,000. b. a debit to depreciation expense of €1,440,000 c. a debit to depreciation expense of €800,000. d. a credit to accumulated depreciation of €600,000.

21.

Under IFRS, the entry to record depreciation expense on the asset at December 31, 2014 will include a credit to accumulated depreciation of a. €1,440,000. b. €1,200,000 c. €800,000. d. €600,000.

22.

Accounting terminology that differs between IFRS and US GAAP include all of the following except: a. the use by IFRS of “turnover” for revenue. b. the use by IFRS of “share premium” for additional paid-in-capital. c. the use by IFRS of “other capital reserves” for retained earnings. d. the use by IFRS of “issued capital” for common stock.

23.

New terminology introduced under the joint IFRS- US GAAP Customer Consideration (Allocation) Model includes all of the following except: a. revenue recognition voids. b. contract rights. c. net contract asset/ liability. d. performance obligations.

24.

Under IFRS, the criteria to determine whether a lease should be capitalized include a. the present value of the minimum lease payments is 90% or more of the fair value of the asset at the inception of the lease. b. the term of the lease is 75% or more of the economic life of the asset. c. the term of the lease is equal to substantially all of the economic life of the asset. d. the present value of the minimum lease payments is equal to substantially all of the fair value of the asset at the inception of the lease. Use the following information to answer the next three questions. Bruges Electronics Inc. offers one model of laptop computer for £1000 and a two-year warranty for £250. The retailer, as part of a Boxing Day promotion, offers a limited-time offer for the laptop, including delivery and the two-year warranty for £1,180. The cost of the computer to Bruges is £700. Any warranty repairs are assumed to be done ratably over time. Bruges accounts for transactions using the customer consideration model. In the first twelve months following the sale, Bruges incurred £980 of costs servicing the computers under warranty.

25.

Bruges sells ten laptops to Brussels Inc. under the limited-time promotion. Upon delivery of the laptops to Brussels, Bruges will recognize revenue of a. £9,300. b. £9,440 c. £10,000. d. £11,800.

26.

In the first twelve months following the sale, Bruges would reduce the Contract liability – warranty account by a. £784. b. £980 c. £1,180. d. £1,380.

27.

In the first twelve months, Bruges would record warranty expense of a. £784. b. £980 c. £1,180. d. £1,380.

28.

Significant differences between IFRS and Chinese GAAP include all of the following except: a. Chinese GAAP allows the use of LIFO while IFRS prohibits it. b. Chinese GAAP has different related party disclosure requirements. c. Chinese GAAP follows the cost principle while IFRS allows for revaluations and recoveries of impairment losses. d. Chinese GAAP uses the equity method of accounting for jointly controlled entities while IFRS also allows proportionate consolidation.

29.

All of the following are options for non-US companies who wish to list securities on a US exchange except:

a. The company can use either IFRS or their local GAAP. b. If a company uses their local GAAP they must reconcile net income and shareholders’ equity or fully disclose all financial information required of US companies. c. If a company uses their local GAAP they must reconcile net income and shareholders’ equity and fully disclose all financial information required of US companies d. The company must file a form 20-F with the SEC. 30.

All of the following are true regarding American Depository Receipts (ADRs) except: a. Most ADRs are unsponsored, meaning that the DR bank creates a DR program without a formal agreement with the issuing non-US company. b. An ADR is a derivative instrument traded in the US that usually represents a fixed number of publicly traded shares of a non-US company. c. ADRs are denominated in US dollars. d. A Level 1 sponsored ADR is the easiest way for a non-US company to access US markets.

Questions from the Textbook 1. As mentioned in Chapter 1, the project on business combinations was the first of several joint projects undertaken by the FASB and the IASB in their move to converge standards globally. Nonetheless, complete convergence has not yet occurred, and there are those who believe it to be a poor idea. Discuss the reasons for and against global convergence. 2. In recent months, virtually every topic that has come to the attention of the standard setters has been undertaken as a joint effort of the FASB and the IASB rather than as an individual effort by one of the two boards. List and discuss some of the joint projects that fall into this category. 3. What is the rationale for the harmonization of international accounting standards? 4. Why is the SEC, once so reluctant to accept IAS, now very willing to allow firms using IFRS to is-sue issue securities in the U.S. stock market without reconciling to U.S. GAAP? 5. Discuss the types of ADRs that non-U.S. companies might use to access the U.S. markets. 6. Describe the attitude of the FASB toward the IASB (International Accounting Standards Board). 7. How does the FASB view its role in the development of an international accounting system? Currently, two members of the IASB board were affiliated with the FASB. Comment on what effect this might have on the likelihood that the U.S. standard setters will accept the new IASB statements, if any? 8. List some of the major differences in accounting between IFRS and U.S. GAAP.

Business Ethics Question from the Textbook A vice president of marketing for your company has been charged with embezzling nearly $100,000 from the company. The vice president allegedly submitted fraudulent vendor invoices in order to receive payments. As the vice president of marketing for the company, the vice president is authorized to approve the payment of invoices submitted by third-party vendors who did work for the company. After the activities were uncovered, the company responded by stating: “All employees are accountable to our ethics guidelines and procedures. We do not tolerate violations of our ethics policy and will consistently enforce these policies and procedures.” 1. How would you evaluate the internal controls of the company? 2. Do you think there are companies that develop comprehensive ethics and compliance pro-grams programs for mid- and lower-level employees and ignore upper-level executives and managers? 3. Is it an ethical issue if companies are not forth-coming concerning fraudulent activities of top executives in an effort to minimize negative publicity?

4. SOLUTIONS

Question 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Answer B C A C C C D B A D B D A C D

Question 16 17 18 19 20 21 22 23 24 25 27 27 28 29 30

Answer A B C C D C C A D B C B A C A

Solutions to Questions from the Textbook 1.

There might be considerable training costs in switching to IFRS because U.S. investors and accountants will need to learn how to apply and interpret IFRS. The use of IFRS might also reduce the quality of financial reports and impede comparability as the IFRS GAAP allows more judgment by management. Managers may choose to use methods that make them look better. Finally, it is not clear who will handle the enforcement of the international rules and how violators might be punished.

Three major projects are accounting for leases, revenue recognition and financial statement presentation. Currently, U.S. GAAP adopts a “rules-based” approach to accounting for leases, while IFRS uses a “principles based” approach. In the area of revenue recognition, GAAP provides significant guidance for revenue recognition, specifically with regards to some industries. It is hoped that the joint effort can lead to a joint revenue recognition standard that might eliminate guidance required for different industries. A third joint project is the financial statement presentation project. This project would provide consistent presentation of the financial statement and eliminate alternative reporting options.

The interest in harmonizing international accounting standards is due to many factors. Currently, most countries have their own accounting standard setting bodies resulting in a divergence of accounting practices in the world. In addition, the application of principles varies. As international trade and cross-border financing increase, it is difficult to evaluate the financial status of firms. The divergent accounting standards reduce the efficiency of the capital markets.

The SEC has been reluctant to accept IAS because they are more general and often provide little guidance on applying the methods. The SEC believes that the efficiency of the US markets is partly due to the high level of reporting required in the US and that any reduction in this quality would result in less efficient markets. However, over the last several years, the international rules and the U.S. rules have been converging and many of the significant differences that existed in the past have been eliminate.

ADRs are classified as either sponsored or unsponsored. Unsponsored ADRs are becoming less popular. These occur when a bank offers a DRan ADR? program without an agreement with the issuing non-US company. Sponsored programs require an exclusive agreement between a bank and the non-US company. There are four types of sponsored ADR programs: for firms not issuing capital there are Level I and Level II ADR programs, and for firms issuing capital, there are Level III and Rule 144 A programs.

In a 1998 report of the FASB regarding the future of international accounting, the FASB described its vision of a successful international accounting system. The FASB stated its belief that the worldwide use of a single set of accounting standards is desirable and eventually attainable, but that the ideal outcome will result from “pursuing the overall objective of increasing international compatibility while maintaining the highest quality accounting standards in the United States.” Over the last five years, the FASB has worked jointly with the IASB on issuing new standards and converging accounting standards.

FASB is committed to the development of high quality, compatible accounting standards to be used for both domestic and cross-border financial reporting. FASB and the IASB have reaffirmed their commitment to the convergence of US GAAP and IFRS. The IASB and FASB have issued joint

progress reports and a timetable for completion of nine major joint projects striving toward convergence of the respective conceptual frameworks. Much is yet to be worked out in terms of actual adoption of IFRS in the U. S. including FASB’s role after convergence is achieved. The SEC is considering a “condorsement” framework, with FASB continuing to work with IFRS to eliminate differences between GAAP and IFRS during a transitional period. Afterwards, FASB would continue to participate in the standard setting process by providing input to the IASB from a U.S. perspective and would possibly remain as the standard-setting body in the U.S. It is highly likely that FASB will accept new IFRS standards, as the convergence process has the two boards working together to develop new standards.. 8.

• • • • • • • • • •

Major differences between IFRS and US GAAP include: Principles-based vs. rule-based standards Sources of accounting principles The framework for selecting the principles to be used Revenue recognition Accounting for leases Financial statement presentation LIFO inventories Financial periods presented Reporting of extraordinary and unusual items Classification of deferred taxes

Solution to Business Ethics Question from the Textbook

The separation of duties is an important feature of maintaining adequate internal controls. In this case, the individual submitting invoices should not be the same individual that approves the invoices. This departure from standard internal control procedures is an indication of weak or non-existent internal controls.

Unfortunately there are instances where ethics and compliance programs are designed for mid- and lower-level employees. Since enactment of Sarbanes-Oxley, public companies are required to extend application of their ethics and compliance programs to top level executives and managers.

These situations create public relations nightmares for companies. It is very important for companies finding themselves in such situations to manage the flow of information in order to avoid the effects of adverse publicity. Companies should have contingency plans ready to go in the event such a disaster strikes. Managers of these companies do not want stockholders and other users of the financial statements to have mistaken beliefs based on false or inaccurate information, rumors, and innuendo concerning the issues at hand. If the necessary information is not quickly disclosed, there will usually be an adverse impact on the price of the company’s stock as the rumors take hold. Management can’t appear to be hiding information because the users might believe that more significant issues are being hidden., The negative reaction will be elevated as the public perceives there to be ethics issues with management.

Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk Multiple Choice 1.

A discount or premium on a forward contract is deferred and included in the measurement of the related foreign currency transaction if the contract is classified as a: a. hedge of a net investment in a foreign entity. b. hedge of an exposed asset or liability position. c. hedge of an identifiable foreign currency commitment. d. contract acquired to speculate in the movement of exchange rates.

The discount or premium on a forward contract entered into as a hedge of an exposed asset or liability position should be: a. included as a separate component of stockholders’ equity. b. amortized over the life of the forward contract. c. deferred and included in the measurement of related foreign currency transaction. d. none of these.

An indirect exchange rate quotation is one in which the exchange rate is quoted: a. in terms of how many units of the domestic currency can be converted into one unit of foreign currency. b. for the immediate delivery of currencies exchanged. c. in terms of how many units of the foreign currency can be converted into one unit of domestic currency. d. for the future delivery of currencies exchanged.

A transaction gain is recorded when there is an: a. importing transaction and the exchange rate increases. b. exporting transaction and the exchange rate increases. c. exporting transaction and the exchange rate decreases. d. none of these.

During 2014, a U.S. company purchased inventory from a foreign supplier. The transaction was denominated in the local currency of the seller. The direct exchange rate increased from the date of the transaction to the balance sheet date. The exchange rate decreased from the balance sheet date to the settlement date in 2015. For the years 2014 and 2015, transaction gains or losses should be recognized as: 2014 2015 a. gain gain b. gain loss c. loss loss d. loss gain

12-2

Test Bank to accompany Jeter and Chaney Advanced Accounting

A transaction gain or loss is reported currently in the determination of income if the purpose of the forward contract is to: a. hedge a net investment in a foreign entity. b. hedge an identifiable foreign currency commitment. c. speculate in foreign currency. d. none of these.

On November 1, 2014, American Company sold inventory to a foreign customer. The account will be settled on March 1 with the receipt of $500,000 foreign currency units (FCU). On November 1, American also entered into a forward contract to hedge the exposed asset. The forward rate is $0.70 per unit of foreign currency. American has a December 31 fiscal year-end. Spot rates on relevant dates were:

Date November 1 December 31 March 1

Per Unit of Foreign Currency $0.73 0.71 0.74

The entry to record the forward contract is a. FCU Receivable 350,000 Premium on Forward Contract 15,000 Dollars Payable

365,000

b. Dollars Receivable 365,000 Discount on Forward Contract FCU Payable

15,000 350,000

c. FCU Receivable 365,000 Discount on Forward Contract Dollars Payable

15,000 350,000

d. Dollars Receivable Discount on Forward Contract FCU Payable

365,000

350,000 15,000

Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk 8.

12-3

On November 1, 2014, American Company sold inventory to a foreign customer. The account will be settled on March 1 with the receipt of $450,000 foreign currency units (FCU). On November 1, American also entered into a forward contract to hedge the exposed asset. The forward rate is $0.70 per unit of foreign currency. American has a December 31 fiscal year-end. Spot rates on relevant dates were:

Date November 1 December 31 March 1

Per Unit of Foreign Currency $0.73 0.71 0.74

What will be the adjusted balance in the Accounts Receivable account on December 31, and how much gain or loss was recorded as a result of the adjustment? Receivable Balance a. $319,500 b. $319,500 c. $333,000 d. $333,000 9.

Gain/Loss Recorded $9,000 gain $9,000 loss $4,500 gain $18,000 gain

A transaction gain or loss at the settlement date is: a. a change in the exchange rate quoted by a foreign exchange trader. b. synonymous with the translation of foreign currency financial statements into dollars. c. the difference between the recorded dollar amount of an account receivable denominated in a foreign currency and the amount of dollars received. d. the difference between the buying and selling rate quoted by a foreign exchange trader at the settlement date. 10.

From the viewpoint of a U.S. company, a foreign currency transaction is a transaction: a. measured in a foreign currency. b. denominated in a foreign currency. c. measured in U.S. currency. d. denominated in U.S. currency.

11.

The exchange rate quoted for future delivery of foreign currency is the definition of a(n): a. direct exchange rate. b. indirect exchange rate. c. spot rate. d. forward exchange rate.

12.

A transaction loss would result from: a. an increase in the exchange rate applicable to an asset denominated in a foreign currency. b. a decrease in the exchange rate applicable to a liability denominated in a foreign currency. c. the import of merchandise when the transaction is denominated in a foreign currency. d. a decrease in the exchange rate applicable to an asset denominated in a foreign currency.

12-4

Test Bank to accompany Jeter and Chaney Advanced Accounting

13.

The forward exchange rate quoted for the remaining term of a forward contract is used to account for the contract when the forward contract: a. extends beyond one year or the current operating cycle. b. is a hedge of an identifiable foreign currency commitment. c. is a hedge of an exposed net liability position. d. was acquired to speculate in foreign currency.

14.

A transaction gain or loss on a forward contract entered into as a hedge of an identifiable foreign currency commitment may be: a. included as a separate item in the stockholders’ equity section of the balance sheet. b. recognized currently in the determination of net income. c. deferred and included in the measurement of the related foreign currency transaction. d. none of these.

15.

Greco, Inc. a U.S. corporation, bought machine parts from Franco Company of Germany on March 1, 2014, for 70,000 marks, when the spot rate for marks was $0.5395. Greco’s year-end was March 31, 2014, when the spot rate for marks was $0.5445. Greco bought 70,000 marks and paid the invoice on April 20, 2014, when the spot rate was $0.5495. How much should be shown in Greco’s income statements as foreign exchange (transaction) gain or loss for the years ended March 31, 2014 and 2015?

a. b. c. d.

2014 $0 $0 $350 loss $350 loss

2015 $0 $350 loss $0 $350 loss

16.

With respect to disclosure requirements for fair value measurements, which of the following is not be consistent with indicating negatives - I suggest bold and not underlining one of the three levels in the hierarchy of classifying fair value measurements? a. a reconciliation of beginning and ending balances b. significant unobservable inputs c. significant other observable inputs d. quoted prices in active markets for identical assets or liabilities

17.

Montana Corporation a U.S. company, contracted to purchase foreign goods. Payment in foreign currency was due one month after delivery. Between the delivery date and the time of payment, the exchange rate changed in Montana’s favor. The resulting gain should be reported in the financial statements as a(n): a. component of other comprehensive income. b. component of income from continuing operations. c. extraordinary income. d. deferred income.

Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk 18.

12-5

Madison Paving Company purchased equipment for 350,000 British pounds from a supplier in London on July 7, 2014. Payment in British pounds is due on Sept. 7, 2014. The exchange rates to purchase one pound is as follows: July 7 August 31, (year end) September 7 Spot-rate 2.08 2.05 2.04 30-day rate 2.07 2.03 -60-day rate 2.06 1.99 -On its August 31, 2014 income statement, what amount should Madison Paving report as a foreign exchange transaction gain: a. $14,000. b. $7,000. c. $10,500. d. $0.

19.

On September 1, 2014, Mudd Plating Company entered into two forward exchange contracts to purchase 250,000 euros each in 90 days. The relevant exchange rates are as follows:

September 1, 2014 September 30, 2014 (year-end)

Spot rate 1.46 1.50

Forward Rate For Dec. 1, 2014 1.47 1.48

The first forward contract was to hedge a purchase of inventory on September 1, payable on December 1. On September 30, what amount of foreign currency transaction loss should Mudd Plating report in income? a. $0. b. $2,500. c. $5,000. d. $10,000. 20.

On September 1, 2014, Mudd Plating Company entered into two forward exchange contracts to purchase 250,000 euros each in 90 days. The relevant exchange rates are as follows:

September 1, 2014 September 30, 2014 (year-end)

Spot rate 1.46 1.50

Forward Rate For Dec. 1, 2014 1.47 1.48

The second forward contract was strictly for speculation. On September 30, 2014, what amount of foreign currency transaction gain should Mudd Plating report in income? a. $0. b. $2,500. c. $5,000. d. $10,000.

12-6

Test Bank to accompany Jeter and Chaney Advanced Accounting

21.

On November 1, 2014, Cone Company sold inventory to a foreign customer. The account will be settled on March 1 with the receipt of 250,000 foreign currency units (FCU). On November 1, Cone also entered into a forward contract to hedge the exposed asset. The forward rate is $0.90 per unit of foreign currency. Cone has a December 31 fiscal year-end. Spot rates on relevant dates were:

Date November 1 December 31 March 1

Per Unit of Foreign Currency $0.93 0.91 0.94

The entry to record the forward contract is a. FCU Receivable 225,000 Premium on Forward Contract 7,500 Dollars Payable

232,500

b. Dollars Receivable 232,500 Discount on Forward Contract FCU Payable

7,500 225,000

FCU Receivable 232,500 Discount on Forward Contract Dollars Payable

d. Dollars Receivable Discount on Forward Contract FCU Payable 22.

7,500 225,000

225,000 7,500 232,500

On November 1, 2014, National Company sold inventory to a foreign customer. The account will be settled on March 1 with the receipt of 200,000 foreign currency units (FCU). On November 1, National also entered into a forward contract to hedge the exposed asset. The forward rate is $0.80 per unit of foreign currency. National has a December 31 fiscal year-end. Spot rates on relevant dates were:

Date November 1 December 31 March 1

Per Unit of Foreign Currency $0.83 0.81 0.84

What will be the adjusted balance in the Accounts Receivable account on December 31, and how much gain or loss was recorded as a result of the adjustment?

a. b. c. d.

Receivable Balance $170,000 $162,000 $168,000 $164,000

Gain/Loss Recorded $4,000 gain $4,000 loss $2,000 gain $2,000 loss

Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk 23.

12-7

Kettle Company purchased equipment for 375,000 British pounds from a supplier in London on July 3, 2014. Payment in British pounds is due on Sept. 3, 2014. The exchange rates to purchase one pound is as follows: July 3 August 31, (year end) September 3 Spot-rate 1.58 1.55 1.54 30-day rate 1.57 1.53 -60-day rate 1.56 1.49 -On its August 31, 2014, income statement, what amount should Kettle report as a foreign exchange transaction gain: a. $18,750. b. $3,750. c. $11,250. d. $0.

24.

On April 1, 2014, Manatee Company entered into two forward exchange contracts to purchase 300,000 euros each in 90 days. The relevant exchange rates are as follows:

April 1, 2014 April 30, 2014 (year-end)

Spot rate 1.16 1.20

Forward Rate For Aug. 1, 2014 1.17 1.18

The first forward contract was to hedge a purchase of inventory on April 1, payable on December 1. On April 30, what amount of foreign currency transaction loss should Manatee report in income? a. $0. b. $3,000. c. $9,000. d. $12,000. 25.

On April 1, 2014, Manatee Company entered into two forward exchange contracts to purchase 300,000 euros each in 90 days. The relevant exchange rates are as follows:

April 1, 2014 April 30, 2014 (year-end)

Spot rate 1.16 1.20

Forward Rate For Aug. 1, 2014 1.17 1.18

The second forward contract was strictly for speculation. On April 30, 2014, what amount of foreign currency transaction gain should Manatee report in income. a. $0. b. $3,000. c. $9,000. d. $12,000.

12-8

Test Bank to accompany Jeter and Chaney Advanced Accounting

Problems 12-1

On November 1, 2013, Jagged Company sold inventory to a company in England. The sale was for 600,000 British pounds and payment will be received on February 1, 2014. On November 1, Jagged entered into a forward contract to sell 600,000 British pounds on February 1 at the forward rate of $1.65. Spot rates for the British pound are as follows: November 1 $1.61 December 31 1.67 February 1 1.62 Jagged has a December 31 fiscal year-end.

Required: Compute each of the following: 1.

The dollars to be received on February 1, 2014, from selling the 600,000 pounds to the exchange dealer.

The dollars that would have been received from the account receivable if Jagged had not indicate the negative hedged the sale contract with the forward contract.

The discount or premium on the forward contract.

The transaction gain or loss on the exposed asset related to the sale in 2013 and 2014.

The transaction gain or loss on the forward contract in 2013 and 2014.

The amount of the discount or premium on the forward contract amortized in 2013 and 2014.

12-2

On December 1, 2013, Dorn Corporation agreed to purchase a machine to be manufactured by a company in Brazil. The purchase price is 1,150,000 Brazilian reals. To hedge against fluctuations in the exchange rate, Dorn entered into a forward contract on December 1 to buy 1,150,000 reals on April 1, the agreed date of machine delivery, for $0.375 per real. The following exchange rates were quoted: Forward Rate Date Spot Rate (Delivery on 4/1) December 1 0.390 0.375 December 31 0.370 0.373 April 1 0.385 --

Required: Prepare journal entries necessary for Dorn during 2013 and 2014 to account for the transactions described above.

Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk 12-3

12-9

Imperial Corp., a U.S. corporation, entered into a contract on November 1, 2013, to sell two machines to Crown Company, for 95,000 foreign currency units (FCU). The machines were to be delivered and the amount collected on March 1, 2014. In order to hedge its commitment, Imperial entered into a forward contract for 95,000 FCU delivery on March 1, 2014. The forward contract met all conditions for hedging an identifiable foreign currency commitment. Selected exchange rates for FCU at various dates were as follows: November 1, 2013 – Spot rate Forward rate for delivery on March 1, 2014 December 31, 2013 – Spot rate Forward rate for delivery on March 1, 2014 March 1, 2014 – Spot rate

$1.3076 1.2980 1.3060 1.3150 1.2972

Required: Prepare all journal entries relative to the above on the books of Imperial Corp. on the following dates: 1. November 1, 2013. 2. Year-end adjustments on December 31, 2013. 3. March 1, 2014. (Include all adjustments related to the forward contract.)

12-4

On October 1, 2013, Philly Company purchased inventory from a foreign customer for 750,000 units of foreign currency (FCU) due on January 31, 2014. Simultaneously, Philly entered into a forward contract for 750,000 units of FC for delivery on January 31, 2014, at the forward rate of $0.75. Payment was made to the foreign customer on January 31, 2014. Spot rates on October 1, December 31, and January 31, were $0.72, $0.73, and $0.76, respectively. Philly amortizes all premiums and discounts on forward contracts and closes its books on December 31.

Required: A. B. C.

Prepare all journal entries relative to the above to be made by Philly on October 1, 2013. Prepare all journal entries relative to the above to be made by Philly on December 31, 2013. Compute the transaction gain or loss on the forward contract that would be recorded in 2014. Indicate clearly whether the amount is a gain or loss.

12-5

On October 1, 2013, Kill Company shipped equipment to a foreign customer for a foreign currency (FC) price of FC 3,000,000 due on January 31, 2014. All revenue realization criteria were satisfied and accordingly the sale was recorded by Kill Company on October 1. Simultaneously, Kill entered into a forward contract to sell 3,000,000 FCU on January 31, 2014 for $1,200,000. Payment was received from the foreign customer on January 31, 2014. Spot rates on October 1, December 31, and January 31 were $0.42, $0.425, and $0.435, respectively. Kill amortizes all premiums and discounts on forward contracts and closes its books on December 31.

Required: Prepare all journal entries relative to the above to be made by Kill during 2013 and 2014.

12-10 Test Bank to accompany Jeter and Chaney Advanced Accounting 12-6

On July 15, Pinta, Inc. purchased 88,500,000 yen Pinta of parts from a Tokyo company paying 20% down, and the balance is due in 90 days. Interest is payable at a rate of 8% on the unpaid balance. The exchange rate on July 15, was $1.00 = 118 Japanese yen. On October 13, the exchange rate was $1.00 = 114 Japanese yen.

Required: Prepare journal entries to record the purchase and payment of this foreign currency transaction in U.S. dollars.

12-7

On November 1, 2013, Platte Corporation, a calendar-year U.S. Corporation, invested in a speculative contract to purchase 700,000 euros on January 31, 2014, from a German brokerage firm. Platte agreed to buy 700,000 euros at a fixed price of $1.46 per euro. The brokerage firm agreed to send 700,000 euros to Platte on January 31, 2014. The spot rates for euros are: November 1, 2013 December 31, 2013 January 31, 2014

1 euro = 1.45 1 euro = 1.43 1 euro = 1.44

Required: Prepare the journal entries that Platte would record on November 1, December 31, and January 31.

12-8

Consider the following information: 1.

On November 1, 2014, a U.S. firm contracts to sell equipment (with an asking price of 500,000 pesos) in Mexico. The firm will take delivery and will pay for the equipment on February 1, 2015.

On November 1, 2014, the company enters into a forward contract to sell 500,000 pesos for $0.0948 on February 1, 2015.

Spot rates and the forward rates for February 1, 2015, settlement were as follows (dollars per peso):

November 1, 2014 Balance sheet date (12/31/11) February 1, 2015 4.

Spot Rate $0.0954 0.0949 0.0947

Forward Rate for 2/1/12 $0.0948 0.0944

On February 1, the equipment was sold for 500,000 pesos. The cost of the equipment was $20,000.

Required: Prepare all journal entries needed on November 1, December 31, and February 1 to account for the forward contract, the firm commitment, and the transaction to sell the equipment.

Chapter 12 Accounting for Foreign Currency Transactions 12-11 And Hedging Foreign Exchange Risk Short Answer 1.

Accounting for a foreign currency transaction involves the terms measured and denominated. Describe a foreign currency transaction and distinguish between the terms measured and denominated.

There are a number of business situations in which a firm may acquire a forward exchange contract. Identify three common situations in which a forward exchange contract can be used as a hedge.

Short Answer Questions from the Textbook 1.

Define currency exchange rates and distinguish between “direct” and “indirect” quotations.

Explain why a firm is exposed to an added risk when it enters into a transaction that is to be settled in a foreign currency.

Name the three stages of concern to the accountant in accounting for import–export transactions. Briefly explain the accounting for each stage.

How should a transaction gain or loss be reported that is related to an unsettled receivable recorded when the firm’s inventory was exported?

A U.S. firm carried a receivable for 100,000 yen. Assuming that the direct exchange rate declined from $.009 at the date of the transaction to $.006 insert space at the balance sheet date, compute the transaction gain or loss. What balance would be reported for the receivable in the firm’s balance sheet?

Explain what is meant by the “two-transaction method” in recording exporting or importing transactions. What support is given for this method?

Describe a forward exchange contract.

Explain the effects on income from hedging a foreign currency exposed net asset position or net liability position.

What criteria must be satisfied for a foreign currency transaction to be considered a hedge of an identifiable foreign currency commitment?

10.

The FASB classifies forward contracts as those acquired for the purpose of hedging and those acquired for the purpose of speculation. What main differences are there in accounting for these two classifications?

11.

How are foreign currency exchange gains and losses from hedging a forecasted transaction handled?

12.

What is a put option, and how might it be used to hedge a forecasted transaction?

13.

Define a derivative instrument, and describe the keystones identified by the FASB for the accounting for such instruments.

14.

Differentiate between forward-based derivatives and option-based derivatives.

12-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 15.

List some of the criteria laid out by the FASB that are required for a gain or loss on forecasted transactions (a cash flow hedge) to be excluded from the income statement. If these criteria are satisfied, where are the gains or losses reported, and when (if ever) are they shown in the income statement? What is the rationale for this treatment?

Business Ethics Question from Textbook Executive stock options (ESOs) are used to provide incentives for executives to improve company performance. ESOs are usually granted “at-the-money,” meaning that the exercise price of the options is set to equal the market price of the underlying stock on the grant date. Clearly, executives would prefer to be granted options when the stock price (and thus the exercise price) is at its lowest. Backdating options is the practice of choosing a past date when the market price was particularly low. Backdating has not, in the past, been illegal if no documents are forged, if communicated to the shareholders, and if properly reflected in earnings and in taxes. 1.

Since backdating gives the executive an “instant” profit, why wouldn’t the firm simply grant an option with the exercise price lower than the cur-rent current market price?

Suppose the executive was not involved in back-dating backdating the ESOs. Does the executive face any ethical issues?

Chapter 12 Accounting for Foreign Currency Transactions 12-13 And Hedging Foreign Exchange Risk

ANSWER KEY Multiple Choice 1. 2. 3. 4. 5. 6. 7.

c b c b d c d

8. 9. 10. 11. 12. 13. 14.

b c b d d d c

15. 16. 17. 18. 19. 20. 21.

d a b c d b d

22. 23. 24. 25.

b c d b

Problems 12-1

Dollars received = 600,000 × $1.65 = $990,000

Dollars received = 600,000 × $1.62 = $972,000

Premium on forward contract = ($1.65 - $1.61) × 600,000 = $24,000

2013 transaction gain = ($1.67 - $1.61) × 600,000 = $36,000 2014 transaction loss = ($1.67 - $1.62) × 600,000 = $(30,000)

2013 transaction loss = ($1.67 - $1.61) × 600,000 = ($36,000) 2014 transaction gain = ($1.67 - $1.62) × 600,000 = $30,000

12-2

Premium amortized in 2013 = $24,000 × 2/3 = $16,000 Premium amortized in 2014 = $24,000 × 1/3 = $8,000

2013 Dec. 1

FC Receivable from Exchange Dealer Deferred Transaction Adjustment Dollars Payable to Exchange Dealer

Dec. 31 Deferred Transaction Adjustment FC Receivable from Exchange Dealer ($0.39 - $0.37) × 1,150,000)

448,500 17,250 431,250 23,000 23,000

12-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 12-2

12-3

(Continued) 2014 Apr. 1 FC Receivable from Exchange Dealer Deferred Transaction Adjustment ($0.385 - $0.370) × 1,150,000)

17,250 17,250

Investment in Foreign Currency FC Receivable from Exchange Dealer

442,750

Dollars Payable to Exchange Dealer Cash

431,250

Machine Investment in Foreign Currency

442,750

Deferred Transaction Adjustment Machine

11,500

November 1, 2013 Dollars Receivable from Exchange Dealer Deferred Transaction Adjustment FC Payable to Exchange Dealer ($1.2980 × 95,000 = $123,310) [($1.3076 - $1.2980) × 95,000 = $912) ($1.3076 × 95,000 = $124,222) December 31, 2013 FC Payable to Exchange Dealer Deferred Transaction Adjustment [($1.3076 - $1.3060) × 95,000 = $152] March 1, 2014 FC Payable to Exchange Dealer Deferred Transaction Adjustment [($1.3060 - $1.2972) × 95,000 = $836]

442,750

431,250

442,750

11,500

123,310 912 124,222

152 152

836 836

Investment in Foreign Currency Sales ($1.2972 × 95,000 = $123,234)

123,234

FC Payable to Exchange Dealer Investment in Foreign Currency ($1.2972 × 95,000 = $123,234)

123,234

Cash

123,310

123,234

Dollars Receivable from Exchange Dealer ($1.2980 × 95,000 = $123,310) Deferred Transaction Adjustment Sales [($1.2980 - $1.2972) × 95,000 = $76]

123,310

76 76

Chapter 12 Accounting for Foreign Currency Transactions 12-15 And Hedging Foreign Exchange Risk 12-4

October 1 Purchases Accounts Payable ($0.72 × 750,000 = $540,000) FC Receivable from Exchange Dealer Premium on Forward Contract Dollars Payable to Exchange Dealer ($0.72 × 750,000 = $540,000) ($0.75 - $0.72) × 750,000 = $22,500) ($0.75 × 750,000 = $562,500)

12-5

December 31 Transaction Loss Accounts Payable [($0.73 - $0.72) × 750,000 = $7,500]

540,000 540,000

540,000 22,500 562,500

7,500 7,500

FC Receivable from Exchange Dealer Transaction Gain [($0.73 - $0.72) × 750,000 = $7,500]

7,500

Amortization Expense Premium on Forward Contract [($0.75 - $0.72) × 750,000 × (3/4) = $16,875]

16,875

Value of FC receivable – January 31 $0.76 × 750,000 Carrying value – December 31 Transaction gain

October 1 Accounts Receivable Sales Dollars Receivable from Exchange Dealer Discount on Forward Contract FC Payable to Exchange Dealer December 31 Accounts Receivable Transaction Gain (3,000,000 × 0.425) = 1,275,000 – 1,260,000

7,500

16,875

$570,000 547,500 $ 22,500

1,260,000 1,260,000 1,200,000 60,000 1,260,000

15,000 15,000

Transaction FC Payable to Exchange Dealer

15,000

Amortization Expense (60,000 × 3/4) Discount on Forward Contract

45,000

15,000

45,000

12-16 Test Bank to accompany Jeter and Chaney Advanced Accounting 12-5

(Continued) January 31 Accounts Receivable Transaction Gain ($3,000,000 × 0.435) = $1,305,000 – $1,275,000 Transaction Loss FC Payable to Exchange Dealer Investment in FC Accounts Receivable Cash FC Payable to Exchange Dealer Dollars Receivable from Exchange Dealer Investment in FC Amortization Expense Discount on Forward Contract

30,000 30,000

30,000 30,000 1,305,000 1,305,000 1,200,000 1,305,000 1,200,000 1,305,000 15,000 15,000

12-6 July 15

Oct. 13

Purchases Accounts Payable Cash (88,500,000 yen / 118)

750,000

Accounts Payable Transaction Loss Cash (70,800,000 yen / 114)

600,000 21,053

600,000 150,000

621,053

Interest Expense 12,421 Cash (70,800,000 yen × (90/360) × 8% = 1,416,000 yen / 114 = 12,421)

12-7 Nov. 1, 2013

Dec. 31, 2013

FC Receivable from Exchange Dealer Dollars Payable to Exchange Dealer (700,000 × $1.46)

1,022,000

Transaction Loss FC Receivable from Exchange Dealer (700,000 × ($1.44 – $1.46))

14,000

12,421

1,022,000

14,000

Chapter 12 Accounting for Foreign Currency Transactions 12-17 And Hedging Foreign Exchange Risk 12-7

(Continued)

Jan. 31, 2014

Dollars Payable to Exchange Dealer Investment in FC Cash FC Receivable from Exchange Dealer

1,022,000 1,008,000

Cash

1,008,000

1,022,000 1,008,000

Investment in FC

1,008,000

12-8 Nov. 1

Dollars Receivable from Exchange Dealer (500,000 × $0.0948) FC Payable to Exchange Dealer

47,400 47,400

Dec. 31 FC Payable from Exchange Dealer Foreign Exchange Gain [(500,000 × ($0.0948 - $0.0944)]

200

Foreign Exchange Loss Firm Commitment [(500,000 × ($0.0948 - $0.0944)]

200

Foreign Exchange Loss FC Payable from Exchange Dealer [(500,000 × ($0.0944 - $0.0947)]

150

Firm Commitment Foreign Exchange Gain [(500,000 × ($0.0944 - $0.0947)]

150

Feb. 1

200

150

Investment in FC Firm Commitment Sales (500,000 × $0.0948)

47,350 50

Cash FC Payable to Exchange Dealer Investment in FC Dollars Receivable from Exchange Dealer

47,400 47,350

Cost of Goods Sold Inventory

20,000

47,400

47,350 47,400

20,000

12-18 Test Bank to accompany Jeter and Chaney Advanced Accounting Short Answer 1.

A foreign currency transaction is a transaction that requires settlement in a foreign currency, not in U.S. dollars. Transactions are normally measured and recorded in terms of the currency in which the reporting entity prepares its financial statements. Assets and liabilities are denominated in a currency if their amounts are fixed in terms of that currency. Forward exchange contracts can be used as a hedge of a (an): a. foreign currency transaction. b. unrecognized firm commitment (a fair value hedge). c. foreign-currency-denominated “forecasted” transaction (a cash flow hedge). d. net investment in foreign operations. (Note: question only asked for 3 situations)

Short Answer Textbook Question Solutions

An exchange rate is the ratio between a unit of one currency and the amount of another currency for which that unit can be exchanged at a particular time. A direct quotation is one in which the exchange rate is quoted in terms of how many units of the domestic currency can be converted into one unit of foreign currency. An indirect quotation is stated in terms of converting one unit of domestic currency into units of foreign currency.

When a transaction is to be settled in a foreign currency, a change in the exchange rate increases or decreases the expected cash flow to be received or paid when the account is settled.

(1) Transaction Date -- at this date, the transaction is recorded. If the transaction is stated in foreign currency units, the exchange rate prevailing at this date is used to convert the foreign currency units to domestic units. (2) Balance Sheet Date -- at this date, recorded dollar balances (or other domestic currency, if applicable) representing receivables or payables that are to be settled in foreign currency units are revalued at the exchange rate on this date. The adjustment is recorded as a transaction gain or loss. (3) Settlement Date -- the foreign currency received or paid is converted into domestic currency at the spot rate. A difference between the conversion and the carrying value of the receivable or payable is a transaction gain or loss.

A transaction gain (loss) related to an unsettled receivable should be included in the determination of net income for the current period.

Receivable recorded at the transaction date Receivable recorded at the balance sheet date Transaction loss Receivable is reported at $600 in the balance sheet.

100,000  $.009 $900 100,000  $.006 600 $300

Chapter 12 Accounting for Foreign Currency Transactions 12-19 And Hedging Foreign Exchange Risk

A purchase (sale) is viewed as a transaction separate from the method of settlement. Once the purchase (sale) is made, a firm has the choice of settling at the transaction date, thus incurring no gain or loss from subsequent changes in the exchange rate; or purchasing a forward contract, and also avoiding a gain or loss from holding foreign currency commitments. The choice of settlement rests with management, and their decision should have no effect on the valuation of a purchase or sales transaction.

A forward exchange contract is an agreement to buy or sell foreign currency units at a particular time for an agreed upon exchange rate. This rate will usually be the forward rate at the time the contract is entered into and any difference between the forward rate and the spot rate is amortized to income over the life of the contract.

A forward contract to buy (sell) foreign currency has an opposite effect on income compared to the gain or loss associated with translation of a payable (receivable) to be settled in the foreign currency units. In other words, as the exchange rate fluctuates, the forward contract will gain or lose the same amount as the payable or receivable will lose or gain. Therefore, no net transaction gain or loss will be incurred.

The transaction must be designated as, and is effective as, a hedge of a foreign currency commitment, and the foreign currency commitment is firm.

10. Forward contracts are valued using changes in forward rates and generally any gains or losses are recognized in the same period as changes in value of hedged item (Fair Value hedges). Gains or losses in Cash Flow hedges are deferred until the hedged item is included in income. A forward contract held for speculation is recorded at the transaction date using the forward rate. There is no separate accounting for a discount or premium. Subsequent valuations (at balance sheet dates) are based on the forward rate available for the remaining life of the forward contract. 11. Foreign currency exchange gains (losses) from hedging a forecasted transaction are deferred and included in the determination of the foreign currency transaction at transaction date. 12. A put option is a contract that gives the holder the right to sell an asset (such as a unit of foreign currency) at a specified price within a specified time period. Firms use these options to protect against expected unfavorable changes in exchange rates. If a company has a contract to sell inventory and is expected to receive a foreign currency, the company can use the option to sell the foreign currency received from the sale to deliver on the option, thus locking into a foreign exchange rate. 13. A derivative instrument may be defined as a financial instrument that by its terms at inception or upon occurrence of a specified event, provides the holder (or writer) with the right (or obligation) to participate in some or all of the price changes of another underlying value of measure, but does not require the holder to own or deliver the underlying value of measure. Thus its value is derived from the underlying value of measure. In SFAS No. 133, the FASB identified the following as keystones for the accounting for derivative instruments:

12-20 Test Bank to accompany Jeter and Chaney Advanced Accounting

* Derivative instruments represent rights or obligations that meet the definitions of assets or liabilities and should be reported in financial statements. * Fair value is the most relevant measure for financial instruments and the only relevant measure for derivative instruments. * Only items that are assets or liabilities should be reported as such in the balance sheet. * Special accounting for items designated as being hedged should be provided only for qualifying items, as demonstrated by an assessment of the expectation of effective offsetting changes in fair values or cash flows during the term of the hedge for the risk being hedged. 14. Derivative instruments can be divided into two broad categories: a) Forward-based derivatives, such as forwards, futures, and swaps, in which either party can potentially have a favorable or unfavorable outcome, but not both simultaneously (e.g., both will not simultaneously have favorable outcomes). b) Option-based derivatives, such as interest rate caps, option contracts, and interest rate floors, in which only one party can potentially have a favorable outcome and it agrees to a premium at inception for this potentiality; the other party is paid the premium, and can potentially have only an unfavorable outcome. 15. The FASB allows deferral of the income statement recognition of the gains and losses on forecasted transactions if certain criteria are met. Like other gains and losses that are excluded from the income statement, they must be included as components of “other comprehensive income” and reported in the stockholders’ equity section of the balance sheet. The criteria for this treatment include: • The forecasted transaction is specifically identifiable at the time of the designation as a single transaction or a group of individual transactions. • The forecasted transaction is probable and it presents exposure to price changes that are expected to affect earnings and cause variability in cash flows. • The forecasted transaction involves an exchange with an outside (unrelated) party (intercompany foreign currency transactions are excluded) • The forecasted transaction does not involve a business combination. They are reclassified into earnings when the forecasted transaction occurs and the item is recorded in earning. Business Ethics 1. Stock options, in theory, are used to create incentives for the firm’s executives to increase operating performance. The practice of backdating options defeats this purpose. The point of backdating options is to avoid issuing ‘in the money’ stock options which would have had both accounting and tax consequences not favorable to the firm. Backdating avoids accounting recognition. 2. Executives always have the right not to exercise options if they feel that there is an ethical issue. Back dating Backdating options is illegal (except in rare instances where proper disclosures are made).

Chapter 12 Accounting for Foreign Currency Transactions 12-21 And Hedging Foreign Exchange Risk

Chapter 13 Translation of Financial Statements of Foreign Affiliates Multiple Choice 1.

When translating foreign currency financial statements for a company whose functional currency is the U.S. dollar, which of the following accounts is translated using historical exchange rates?

a. b. c. d.

Notes Payable Yes Yes No No

Equipment Yes No No Yes

Under the temporal method, monetary assets and liabilities are translated by using the exchange rate existing at the: a. beginning of the current year. b. date the transaction occurred. c. balance sheet date. d. None of these.

The process of translating the accounts of a foreign entity into its functional currency when they are stated in another currency is called: a. verification. b. translation. c. remeasurement. d. None of these.

Which of the following would be restated using the average exchange rate under the temporal method? a. cost of goods sold b. depreciation expense c. amortization expense d. None of these

Paid-in capital accounts are translated using the historical exchange rate under: a. the current rate method only. b. the temporal method only. c. both the current rate and temporal methods. d. neither the current rate nor temporal methods.

Which of the following would be restated using the current exchange rate under the temporal method? a. Marketable securities carried at cost. b. Inventory carried at market. c. Common stock. d. None of these.

13-2 Test Bank to accompany Jeter and Chaney Advanced Accounting 7.

The translation adjustment that results from translating the financial statements of a foreign subsidiary using the current rate method should be: a. included as a separate item in the stockholders' equity section of the balance sheet. b. included in the determination of net income for the period it occurs. c. deferred and amortized over a period not to exceed forty years. d. deferred until a subsequent year when a loss occurs and offset against that loss.

Average exchange rates are used to translate certain items from foreign financial statements into U.S. dollars. Such averages are used in order to: a. smooth out large translation gains and losses. b. eliminate temporary fluctuation in exchange rates that may be reversed in the next fiscal period. c. avoid using different exchange rates for some revenue and expense accounts. d. approximate the exchange rate in effect when the items were recognized.

When the functional currency is identified as the U.S. dollar, land purchased by a foreign subsidiary after the controlling interest was acquired by the parent company should be translated using the: a. historical rate in effect when the land was purchased. b. current rate in effect at the balance sheet date. c. forward rate. d. average exchange rate for the current period.

10.

The appropriate exchange rate for translating a plant asset in the balance sheet of a foreign subsidiary in which the functional currency is the U.S. dollar is the: a. current exchange rate. b. average exchange rate for the current year. c. historical exchange rate in effect when the plant asset was acquired or the date of acquisition, whichever is later. d. forward rate.

11.

The following balance sheet accounts of a foreign subsidiary at December 31, 2014, have been translated into U.S. dollars as follows: Translated at Current Rates Historical Rates Accounts receivable, current $ 600,000 $ 660,000 Accounts receivable, long-term 300,000 324,000 Inventories carried at market 180,000 198,000 Goodwill 190,000 220,000 $1,270,000 $1,402,000 What total should be included in the translated balance sheet at December 31, 2014, for the above items? Assume the U.S. dollar is the functional currency. a. $1,270,000 b. $1,288,000 c. $1,300,000 d. $1,354,000

Chapter 13 The Translation of Financial Statements of Foreign Affiliates 13-3 12.

A foreign subsidiary's functional currency is its local currency which has not experienced significant inflation. The weighted average exchange rate for the current year would be the appropriate exchange rate for translating

a. b. c. d. 13.

Wages expense Yes Yes No No

Sales to customers Yes No No Yes

A wholly owned subsidiary of a U.S. parent company has certain expense accounts for the year ended December 31, 2014, stated in local currency units (LCU) as follows: LCU Depreciation of equipment (related assets were purchased January 1, 2012) 375,000 Provision for doubtful accounts 250,000 Rent 625,000 The exchange rates at various dates are as follows:

December 31, 2014 Average for year ended December 31, 2014 January 1, 2012

Dollar equivalent of 1 LCU $0.50 0.55 0.40

Assume that the LCU is the subsidiary's functional currency and that the charges to the expense accounts occurred approximately evenly during the year. What total dollar amount should be included in the translated income statement to reflect these expenses? a. b. c. d.

$687,500 $625,000 $550,000 $500,000

14.

If the functional currency is determined to be the U.S. dollar and its financial statements are prepared in the local currency, SFAS 52, requires which of the following procedures to be followed? a. Translate the financial statements into U.S. dollars using the current rate method. b. Remeasure the financial statements into U.S. dollars using the temporal method. c. Translate the financial statements into U.S. dollars using the temporal method. d. Remeasure the financial statements into U.S. dollars using the current rate method.

15.

P Company acquired 90% of the outstanding common stock of S Company which is a foreign company. The acquisition was accounted for using the purchase method. In preparing consolidated statements, the paid-in capital of S Company should be converted at the: a. exchange rate effective when S Company was organized. b. exchange rate effective on the date of purchase of the stock of S Company by P Company. c. average exchange rate for the period S Company stock has been upheld by P Company. d. current exchange rate.

13-4 Test Bank to accompany Jeter and Chaney Advanced Accounting 16.

In preparing consolidated financial statements of a U.S. parent company and a foreign subsidiary, the foreign subsidiary’s functional currency is the currency: a. of the country the parent is located. b. of the country the subsidiary is located. c. in which the subsidiary primarily generates and spends cash. d. in which the subsidiary maintains its accounting records.

17.

Gains from remeasuring a foreign subsidiary’s financial statements from the local currency, which is not the functional currency, into the parent company’s currency should be reported as a(n): a. other comprehensive income item. b. extraordinary item (net of tax). c. part of continuing operations. d. deferred credit.

18.

Assuming no significant inflation, gains resulting from the process of translating a foreign entity’s financial statements from the functional currency to U.S. dollars should be included as a(n): a. other comprehensive income item. b. extraordinary item (net of tax). c. part of continuing operations. d. deferred credit.

19.

A foreign subsidiary’s functional currency is its local currency and inflation of over 100 percent has been experienced over a three-year period. For consolidation purposes, SFAS No. 52 requires the use of: a. the current rate method only. b. the temporal method only c. both the current rate and temporal methods. d. neither the current rate or the temporal method.

20.

The objective of remeasurement is to: a. produce the same results as if the books were maintained in the currency of the foreign entity’s largest customer. b. produce the same results as if the books were maintained solely in the local currency. c. produce the same results as if the books were maintained solely in the functional currency. d. None of the above.

Chapter 13 The Translation of Financial Statements of Foreign Affiliates 13-5 Problems 13-1

Dakota, Inc. owns a company that operates in France. Account balances in francs for the subsidiary are shown below:

Cash and Receivables Supplies Property, Plant, and Equipment Accounts Payable Long-term Notes Payable Common Stock Retained Earnings Dividends-Declared & Paid on Dec 31 Revenues Operating Expenses Totals

January 1 24,000 1,000 52,500 (11,500) (19,000) (30,000) (17,000) ----------0-

2014 December 31 26,000 500 49,000 (5,500) (11,000) (30,000) (17,000) 3,000 (30,000) 15,000 -0

Exchange rates for 2014 were as follows: January 1 $0.22 Average for the year 0.19 December 31 0.18 Revenues were earned and operating expenses, except for depreciation and supplies used, were incurred evenly throughout the year. No purchases of supplies or plant assets were made during the year. Required: A. Prepare a schedule to compute the translation adjustment for the year, assuming the subsidiary's functional currency is the franc. B.

Prepare a schedule to compute the translation gain or loss, assuming the subsidiary's functional currency is the U.S. dollar.

13-6 Test Bank to accompany Jeter and Chaney Advanced Accounting 13-2

Stiff Sails Corporation, a U.S. company, operates a 100%-owned British subsidiary, SeaBeWe Corporation. The U.S. dollar is the functional currency of the subsidiary. Financial statements for the subsidiary for the fiscal year-end December 31, 2014, are as follows: SeaBeWe Corporation Income Statement Pounds 650,000

Sales Cost of Goods Sold Beginning Inventory Purchases Goods Available For Sale Less: Ending Inventory Cost of Goods Sold Depreciation Selling and Admin. Expenses Income Taxes Net Income

310,000 265,000 575,000 285,000 290,000 79,000 155,000 32,000

556,000 94,000

SeaBeWe Corporation Partial Balance Sheet Current Assets Cash Accts. Rec. Inventories

155,000 171,000 285,000 611,000

Current Liabilities Notes Payable Accts. Payable Other Current Liab. Long-term Liab. (issued July 1, 2012)

78,000 165,000 51,000 294,000 250,000

Other Information: 1. Equipment costing 340,000 pounds was acquired July 1, 2012, and 38,000 was acquired June 30, 2014. Depreciation for the period was as follows: Equipment – 2012 acquisitions 66,000 – 2014 acquisitions 6,000 2. The beginning inventory was acquired when the exchange rate was $1.77. The inventory is valued on a FIFO basis. Purchases and the ending inventory were acquired evenly throughout the period. 3. Dividends were paid by the subsidiary on June 30 amounting to 156,000 pounds. 4. Sales were made and all expenses were incurred uniformly throughout the year. 5. Exchange rates for the pound on various dates were: July 1, 2012 Jan. 1, 2014 June 30, 2014 Dec. 31, 2014 Average for 2014

$1.79 1.75 1.74 1.71 1.73

Chapter 13 The Translation of Financial Statements of Foreign Affiliates 13-7 13-2 (Continued) Required: A. Prepare a schedule to determine the translation gain or loss for 2013, assuming the net monetary liability position on January 1, 2014, was 180,000 pounds. B.

Compute the dollar amount that each of the following would be reported at in the 2014 financial statements: 1. Cost of Goods Sold. 2. Depreciation Expense. 3. Equipment.

13-3

Accounts are listed below for a foreign subsidiary that maintains its books in its local currency. The equity interest in the subsidiary was acquired in a purchase transaction. In the space provided, indicate the exchange rate that would be used to translate the accounts into dollars assuming the functional currency was identified (a) as the U.S. dollar and (b) as the foreign entity's local currency. Use the following letters to identify the exchange rate: H – Historical exchange rate C – Current exchange rate A – Average exchange rate for the current period

Account 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

Bonds Payable (issued 01/01/11) Office Supplies Dividends Declared Common Stock Additional Paid-In Capital Inventory Carried at Cost Short-term Notes Payable Accumulated Depreciation Cash Marketable Securities (carried at market) Cost of Goods Sold Sales Accounts Receivable Depreciation Expense Income Tax Expense

Exchange rate if the functional currency is: U.S. Dollar Local currency ___________ ___________ ___________ ___________ ___________ ___________ ___________ ___________ ___________

______________ ______________ ______________ ______________ ______________ ______________ ______________ ______________ ______________

___________ ___________ ___________ ___________ ___________ ___________

______________ ______________ ______________ ______________ ______________ ______________

13-8 Test Bank to accompany Jeter and Chaney Advanced Accounting Use the following information to answer Problems 13-4 and 13-5. On January 2, 2014, Design Inc., a U.S. parent company, purchased a 100% interest in Perfect Company, a subdivision located in Switzerland. The purchase method of accounting was used to account for the acquisition. The 2014 financial statements for Perfect Company, the subsidiary, in Swiss francs were as follows: Comparative Balance Sheets Jan. 2 Cash 15,000 Accounts receivable 45,000 Plant and equipment (net) (purchased 6/30/11) 75,000 Land (purchased 6/30/11) 45,000 Total 180,000

Dec. 31 33,000 49,500 67,500 45,000 195,000

Accounts payable Long-term notes payable (issued 6/30/11) Common stock (issued 6/30/11) Retained earnings Total

18,000 27,000 90,000 60,000 195,000

13,500 31,500 90,000 45,000 180,000

Income Statement Revenues Operating expenses including depreciation of 7,500 francs Net income Beginning retained earnings Dividends declared and paid Ending retained earnings

180,000 135,000 45,000 45,000 90,000 30,000 60,000

Sales were earned and operating expenses were incurred evenly during the year. Exchange rates for the franc at various dates are: January 2, 2014 December 31, 2014 Average for 2014 December 10, 2014, dividend payment date June 30, 2011 13-4

0.8600 0.8830 0.8715 0.8810 0.8316

Use the above information to answer the following question:

Required: Translate the year-end financial statements of Perfect Company, the foreign subsidiary, using the temporal method. Round numbers to the nearest dollar. 13-5

Use the above information to answer the following question:

Required: Prepare a schedule to compute the translation gain or loss for Perfect Company, assuming the temporal method of translation. Round numbers to the nearest dollar.

Chapter 13 The Translation of Financial Statements of Foreign Affiliates 13-9 13-6

Pike Corporation, a U.S. Company, formed a subsidiary with a new company in London on January 1, 2014, by investing 500,000 British pounds in exchange for all of the subsidiary’s common stock. The subsidiary purchased land for 100,000 pounds and a building for 300,000 pounds on July 1, 2014. The building is being depreciated over a 40-year life by the straight-line method. The inventory is valued on an average cost basis. The British pound is the subsidiary’s functional currency and its reporting currency and has not experienced any abnormal inflation. Exchange rates for the pound on various dates were: January 1, 2014 July 1, 2014 December 31, 2014 2014 average rate

1 pound = 1.81 1 pound = 1.86 1 pound = 1.83 1 pound = 1.82

The subsidiary’s adjusted trial balance is presented below for the year ended December 31, 2014. Debits Cash Accounts receivable Inventory Land Building Depreciation expense Cost of goods sold Other expenses Total debits

In Pounds 200,000 60,000 80,000 100,000 300,000 3,750 213,750 90,000 1,047,500

Credits Accumulated depreciation Accounts payable Accrued liabilities Common stock Retained earnings Sales revenue Total credits

3,750 84,000 16,750 500,000 - 0 443,000 1,047,500

Required: Prepare the subsidiary’s: A. Translated workpapers (round to the nearest dollar) B. Translated income statement C. Translated balance sheet 13-7

Using the information provided in Problem 13-6, use the temporal method instead of the current rate method. Required: Prepare the subsidiary’s: A. Translated workpapers (round to the nearest dollar) B. Translated income statement C. Translated balance sheet

13-10 Test Bank to accompany Jeter and Chaney Advanced Accounting 13-8 On January 1, 2014, Roswell Systems, a U.S.-based company, purchased a controlling interest in Bern Management Consultants located in Bern, Switzerland. The acquisition was treated as a purchase transaction. The 2014 financial statements stated in Swiss francs are given below. BERN MANAGEMENT CONSULTANTS Comparative Balance Sheets January 1 and December 31, 2014 Jan. 1

Dec. 31

Cash and Receivables Net Property, Plant, and Equipment Totals

30,000 60,000 90,000

84,000 56,000 140,000

Accounts and Notes Payable Common Stock Retained Earnings Totals

45,000 30,000 15,000 90,000

50,000 30,000 60,000 140,000

BERN MANAGEMENT CONSULTANTS Consolidated Income and Retained Earnings Statement For the Year Ended December 31, 2014 Revenues Operating Expenses including depreciation of 5,000 francs Net income Dividends Declared and Paid Increase in Retained Earnings

112,000 45,000 67,000 22,000 45,000

Direct exchange rates for Swiss franc are:

January 1, 2014 December 31, 2014 Average for 2014 Dividend declaration and payment date

U.S. Dollars per Franc $0.9987 0.9321 0.9654 0.9810

Required: A. Translate the year-end balance sheet and income statement of the foreign subsidiary using the current rate method of translation. B. Prepare a schedule to verify the translation adjustment. Short Answer 1. To accomplish the objectives of translation, two translation methods are used depending on the functional currency of the foreign entity. Describe the two translation methods. 2.

The translation process can be done using either the current rate method or the temporal method. Explain under what circumstances each of the methods is appropriate.

Chapter 13 The Translation of Financial Statements of Foreign Affiliates 13-11 Short Answer Questions from the Textbook 1.

What requirements must be satisfied if a foreign subsidiary is to be consolidated?

What is meant by an entity’s functional currency and what are the economic indicators identified by the FASB to provide guidance in selecting the functional currency?

The __________is the functional currency of a foreign subsidiary with operations that are relatively self-contained and integrated within the country in which it is located. In such cases, the__________ method of translation would be used to translate the accounts into dollars.

The __________is the functional currency of a foreign subsidiary that is a direct and integral component or extension of a U.S. parent company. In such cases, the __________method of translation is used to translate (remeasure) the accounts into dollars.

Which method of translation is used to convert the financial statements when a foreign subsidiary operates in a highly inflationary economy?

Define remeasurement.

Under the current rate method, how are assets and liabilities that are stated in a foreign currency translated?

Under the current rate method, describe how the various balance sheet accounts are translated (including the equity accounts) and how this translation affects the computation of various ratios (such as debt to equity or the current ratio). In particular, discuss whether or not the ratios will change when computed in local currencies and compared to their calculations (after translation) using the parent’s currency.

What is the objective of the temporal method of translation?

10.

Assuming that the temporal method is used, how are revenue and expense items in foreign currency financial statements converted?

11.

A translation adjustment results from the process of translating financial statements of a foreign subsidiary from its functional currency into dollars. Where is the translation adjustment reported in the financial statements if the current rate method is used to translate the accounts?

Business Ethics Question from the Textbook spacing is off below The Shady Tree Company is preparing to announce their quarterly earnings numbers. The company expects to beat the analysts’ forecast of earnings by at least5cents a share. In anticipation of the increase in stock value and before the release of the earnings numbers, the company issued stock options to the top executives in the firm, with the option price equal to today’s market price. 1. This type of executive stock option is often referred to as “spring-loading.” Do you think this practice should be allowed? Does it provide in-formation information about the integrity of the firm or is this just good business practice? 2. Do you think this practice violates the insider trading rules?

13-12 Test Bank to accompany Jeter and Chaney Advanced Accounting

ANSWER KEY Multiple Choice 1. 2. 3. 4. 5. 6. 7.

d c c d c b a

8. 9. 10. 11. 12. 13. 14.

d a c c a a b

15. 16. 17. 18. 19. 20.

b c c a b c

Problems 13-1

A. Francs 47,000

Exposed net asset position – 1/1 Adjustment for changes in net asset position during the year Add: Revenues 30,000 Less: Operating expenses (15,000) Dividends (3,000) Net asset position translated using ------rate in effect at date of transactions Exposed net asset position – 12/31 59,000 Translation adjustment – loss B. Exposed net monetary liability position – 1/1 Adjustments for changes in net monetary position during the year Add: increase in cash and receivables – revenues Less: decrease in monetary assets or increase in monetary liabilities Operating expenses Dividends paid Net monetary asset position translated using rate in effect at date of transactions Exposed net monetary asset position – 12/31 Translation loss

Translation Rate 0.22

0.19 0.19 0.18

0.18

$ 10,340

5,700 (2,850) (540) -----12,650 10,620 2,030

Francs (6,500)

Translation Rate 0.22

$ (1,430)

30,000

0.19

5,700

(11,000) (3,000)

0.19 0.18

(2,090) (540)

9,500

0.18

1,640 1,710 70

Chapter 13 The Translation of Financial Statements of Foreign Affiliates 13-13 13-2

A. Beginning Net Monetary Liab. Pos. +Sales - Purchases - Selling & Admin. Expenses - Income Taxes - Equipment Purchased - Dividends Paid Net Monetary Liab. Pos. Trans. - Ending Net Monetary Liab. Pos. Translation Gain B. 1. Beginning Inventory Purchases Goods Available Ending Inventory Cost of Goods Sold

13-3 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

(180,000) × $1.75 = 650,000 × 1.73 = (265,000) × 1.73 = (155,000) × 1.73 = (32,000) × 1.73 = (38,000) × 1.74 = (156,000) × 1.74 = (176,000) × 1.71 =

$(315,000) 1,124,500 (458,450) (268,150) (55,360) (66,120) (271,440) $(310,020) (300,960) $ 9,060

310,000 × $1.77 = 265,000 × 1.73 = 575,000 285,000 × 1.73 = 290,000

$548,700 458,450 1,007,150 <493,050> $514,100

2. Depr. on 2012 equipment: Depr. on 2014 equipment: 2014 Depreciation Expense

66,000 × $1.79 = 6,000 × 1.74 =

$118,140 10,440 $128,580

3. 2012 equipment: 2014 equipment:

340,000 × $1.79 = 38,000 × 1.74 =

$608,600 66,120 $674,720

U.S. Dollar C H H H H H C H C C H A C H A

Local Currency C C H H H C C C C C A A C A A

13-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 13-4

Temporal method Francs

Translation Rate

U.S. $

Balance Sheet Cash Accounts Receivable Plant and Equipment (net) Land Total

33,000 49,500 67,500 45,000 195,000

0.8830 0.8830 0.8600 0.8600

29,139 43,709 58,050 38,700 169,598

Accounts Payable Notes Payable Common Stock Retained Earnings Total

18,000 27,000 90,000 60,000 195,000

0.8830 0.8830 0.8600 Bal. Amt.

15,894 23,841 77,400 52,463 169,598

180,000 (127,500) (7,500)

0.8715 0.8715 0.8600

156,870 (111,116) (6,450) 889 40,193 38,700 78,893 (26,430) 52,463

Income Statement Revenues Operating Expenses Depreciation Expense Translation Gain (loss) Net Income Retained Earnings – 1/1 Dividends Declared Retained Earnings – 12/31

45,000 45,000 90,000 (30,000) 60,000

0.8600 0.8810

13-5 Exposed net monetary asset position – 1/1 (60,000 - 45,000) Add: Increases in net monetary assets – Revenues Less: Decreases in net monetary assets – Operating expenses Dividends Net monetary position translated using the rate in effect at date of transaction Exposed net monetary asset position – 12/31 Translation gain (loss)

Francs

Translation Rate

U.S. $

15,000

0.8600

12,900

180,000

0.8715

156,870

(127,500) (30,000)

0.8715 0.8810

(111,116) (26,430) 32,224

37,500

0.8830

33,113 889

Chapter 13 The Translation of Financial Statements of Foreign Affiliates 13-15 13-6 A. Subsidiary Corporation Translated Workpapers Debits Cash Accounts receivable Inventory Land Building Depreciation expense Cost of goods sold Other expenses Total debits

200,000 × 1.83 = 60,000 × 1.83 = 80,000 × 1.83 = 100,000 × 1.83 = 300,000 × 1.83 = 3,750 × 1.82 = 213,750 × 1.82 = 90,000 × 1.82 =

Credits Accumulated depreciation 3,750 × 1.83 = Accounts payable 84,000 × 1.83 = Accrued liabilities 16,750 × 1.83 = Common stock 500,000 × 1.81 = Retained earnings Sales revenue 443,000 × 1.82 = Total credits Cumulative Translation Adjustment-Credit balance

$366,000 109,800 146,400 183,000 549,000 6,825 389,025 163,800 $1,913,850 $ 6,863 153,720 30,653 905,000 - 0 806,260 1,902,496 11,354 $1,913,850

B. Subsidiary Corporation Translated Income Statement For the Year Ended December 31, 2014

Sales revenue Expenses: Cost of goods sold Depreciation expense Other expenses Net income Beginning retained earnings, Jan. 1, 2014 Ending retained earnings, Dec. 31, 2014

$806,260 (389,025) (6,825) (163,800) $246,610 - 0 $ 246,610

13-16 Test Bank to accompany Jeter and Chaney Advanced Accounting

C. Subsidiary Corporation Translated Balance Sheet December 31, 2014 Assets: Cash Accounts receivable Inventory Land Building-net Total Assets

$366,000 109,800 146,400 183,000 542,137 $1,347,337

Equities: Accounts payable Accrued liabilities Common stock Retained earnings Other comprehensive income-translation adj. Total liabilities and equity

$153,720 30,653 905,000 246,610 11,354 $1,347,337

13-7 A. Subsidiary Corporation Translated Workpapers Debits Cash Accounts receivable Inventory (average cost method) Land Building Depreciation expense Cost of goods sold Other expenses Total debits Credits Accumulated depreciation Accounts payable Accrued liabilities Common stock Retained earnings Sales revenue Total credits Cumulative translation remeasurement gain-credit balance

200,000 × 1.83 = 60,000 × 1.83 = 80,000 × 1.82 = 100,000 × 1.86 = 300,000 × 1.86 = 3,750 × 1.86 = 213,750 × 1.82 = 90,000 × 1.82 =

$366,000 109,800 145,600 186,000 558,000 6,975 389,025 163,800 $1,925,200

3,750 × 1.86 = 84,000 × 1.83 = 16,750 × 1.83 = 500,000 × 1.81 =

$ 6,975 153,720 30,653 905,000 - 0 806,260 $1,902,608

443,000 × 1.82 =

22,592 $1,925,200

Chapter 13 The Translation of Financial Statements of Foreign Affiliates 13-17 B. Subsidiary Corporation Translated Income Statement For the Year Ended December 31, 2014 Sales revenue Expenses: Cost of goods sold Depreciation expense Other expenses Translation remeasurement gain Net income Beginning retained earnings, Jan. 1, 2014 Ending retained earnings, Dec. 31, 2014

$806,260 (389,025) (6,975) (163,800) 22,592 269,052 - 0 -. $ 269,052

C. Subsidiary Corporation Translated Balance Sheet December 31, 2014 Assets: Cash Accounts receivable Inventory Land Building-net Total Assets

$366,000 109,800 145,600 186,000 551,025 $1,358,425

Equities: Accounts payable Accrued liabilities Common stock Retained earnings Total liabilities and equity

153,720 30,653 905,000 269,052 $1,358,425

13-18 Test Bank to accompany Jeter and Chaney Advanced Accounting 13-8 Part A

Swiss Francs

Translation Rate $0.9654 0.9654

Dividends Retained Earnings – 12/31

112,000 (45,000) 67,000 15,000 82,000 (22,000) 60,000

Balance Sheet Cash and Receivables Net Property, Plant and Equipment Total

84,000 56,000 140,000

0.9321 0.9321

78,296 52,198 130,494

50,000 30,000 60,000 140,000 --140,000

0.9321 0.9987

46,605 29,961 58,081 134,647 (4,153) 130,494

Consolidated Income and Retained Earnings Statement Revenues Operating Expenses Net Income Retained Earnings – 1/1

Accounts and Notes Payable Common Stock Retained Earnings Cumulative Translation Adjustment (debit) Total Part B

Swiss Francs 45,000

Exposed net asset position – 1/1 Adjustment for changes in the net asset position during the year: Net income 67,000 Dividends (22,000) Net asset position translated using rate in effect at date of transactions ---Exposed net asset position – 12/31 90,000 Cumulative translation adjustment (debit)

0.9987 0.9810

Balancing amt.

$ 108,125 43,443 64,682 14,981 79,663 (21,582) 58,081

Translation Rate $0.9987

$ 44,942

0.9654 0.9810

64,682 (21,582)

0.9321

88,042 83,889 4,153

Short Answer 1. Under the current rate method, all assets and liabilities are translated using the current exchange rate on the balance sheet date. Revenue and expense transactions are translated at the exchange rate existing on the date each underlying transaction occurred. Under the temporal method, monetary assets and liabilities are translated at the current exchange rate. Assets and liabilities carried at historical cost are translated at historical exchange rates while those carried at current values are translated at the current exchange rate. Revenues and expenses, except those related to assets and liabilities translated at historical rates, are translated at exchange rates in effect on the dates the underlying transaction occurred.

Chapter 13 The Translation of Financial Statements of Foreign Affiliates 13-19 2.

The current rate method is appropriate when the functional currency is the local currency. The temporal method is appropriate when the functional currency is the U.S. dollar or when the foreign environment is highly inflationary. If the functional currency is the currency of a third country, the accounts are first remeasured into the functional currency using the temporal method and then translated into U.S. dollars using the current rate method.

Short Answer Questions in Textbook Solutions 1.

(1) The parent company must control more than 50 percent of the voting stock of the subsidiary. (2) The intent of control should be permanent. (3) The control should rest with the majority owners.

The functional currency of an entity is the currency of the primary economic environment in which the entity operates. The FASB provided the following six economic indicators: a. The impact on the parent’s cash flow; b. The short-term responsiveness of the sales price to changes in the exchange rate; c. The sales market for the firm’s products; d. The currency in which labor, materials, and other factor inputs are primarily obtained; e. The currency in which debt is denominated and the ability of the foreign entity’s operations to generate amounts of that currency sufficient to service the debt; f. The volume of transactions between the foreign entity and its parent.

Local currency, current rate

U.S. dollar, temporal

The temporal method is used when a foreign subsidiary operates in a highly inflationary economy.

Remeasurement is the process of translating the accounts of a foreign entity into its functional currency when they are stated in another currency.

All assets and liabilities are translated using the current rate at the balance sheet date when the current rate method of translation is used.

8. Assets and liabilities are translated at the rate in effect at the balance sheet date. Common stock is translated at the historical rate when the stock was issued. Retained earnings consists of various period’s net income (translated at the yearly average rates) less dividends converted at the historical rates on the declaration dates. The cumulative translation adjustment is a balancing amount in equity, which results in total equity (including the cumulative adjustment) being driven back to the rate in effect at the balance sheet date. Thus, the ratios will not change from their calculations using the local currency.

Application of the temporal method produces translated amounts that reflect transactions as if they had been measured in dollars originally rather than in the local currency.

10. Revenues and expenses are translated using the exchange rate in effect when they were recognized during the period except for expenses associated with nonmonetary items which are translated using historical rates. Because it is impractical to translate numerous transactions, the use of an appropriate average is permitted.

13-20 Test Bank to accompany Jeter and Chaney Advanced Accounting

11. The translation adjustment is reported as a separate component of stockholders’ equity when the current rate method is used to translate the accounts. Business Ethics Solutions 1. Spring-loading is a contentious issue, and the following points are among those that may be considered in a discussion or debate of whether it should be allowed or not: • Though granting options is intended to motivate and incentivize the employees to generate more profits, granting an award that is already known (or strongly suspected) before-the-fact to be in the money very soon seems counter to this intent. • Companies engaged in spring-loading mislead investors by not disclosing that options are awarded with foreknowledge of the impending good news. • Spring-loading is legal as long as the compensation committee awarding the options knows the same information as the recipient, and the company informs shareholders that it does not withhold granting options when undisclosed, positive company information is pending. • Companies suspected of spring-loading cannot be said to have advantage of prior market reactions that have not actually taken place, and executives can argue, truthfully, that there is no way to know for certain how the market will react to impending news. Option manipulation is generally more likely to occur in circumstances in which the company executives like CEOs have greater influence on the company’s pay-setting and governance processes, which suggests a lack of board oversight. 2. Whether or not this practice violates the insider trading rules seems to be a matter upon which reasonable persons sometimes disagree. Spring-loaded grants might violate insider-trading rules, particularly if managers with knowledge of the information gives options to themselves, or if executives conceal good news from directors while urging them to grant options. The insider trading law and rules need to be improved to clearly prohibit the spring-loading of options. Also, see the following link: http://www.cfo.com/article.cfm/7880157/1/c_2984338

Chapter 14 Reporting for Segments and for Interim Financial Periods 1.

A component of an enterprise that may earn revenues and incur expenses, and about which management evaluates separate financial information in deciding how to allocate resources and assess performance is a(n) a. identifiable segment. b. operating segment. c. reportable segment. d. industry segment.

An entity is permitted to aggregate operating segments if the segments are similar regarding the a. nature of the production processes. b. types or class of customers. c. methods used to distribute products or provide services. d. all of these.

Which of the following is not a segment asset of an operating segment? a. Assets used jointly by more than one segment. b. Assets directly associated with a segment. c. Assets maintained for general corporate purposes. d. Assets used exclusively by a segment.

SFAS No. 131 requires the disclosure of information on an enterprise's operations in different industries for 1. each annual period presented. 2. each interim period presented. 3. the current period only. a. 1 b. 2 c. 3 d. both 1 and 2

Which of the following is not required to be disclosed by SFAS No. 131? a. Information concerning the enterprise's products. b. Information related to an enterprise's foreign operations. c. Information related to an enterprise's major suppliers. d. All of the above are required disclosures.

To determine whether a substantial portion of a firm's operations are explained by its segment information, the combined revenue from sales to unaffiliated customers of all reportable segments must constitute at least a. 10% of the combined revenue of all operating segments. b. 75% of the combined revenue of all operating segments. c. 10% of the combined revenue from sales to unaffiliated customers of all operating segments. d. 75% of the combined revenue from sales to unaffiliated customers of all operating segments.

14-2 Test Bank to accompany Jeter and Chaney Advanced Accounting 7.

A segment is considered to be significant if its 1. reported profit is at least 10% of the combined profit of all operating segments. 2. reported profit (loss) is at least 10% of the combined reported profit of all operating segments not reporting a loss. 3. reported profit (loss) is at least 10% of the combined reported loss of all operating segments that reported a loss. a. 1 b. 2 c. 3 d. both 2 and 3

Which of the following disclosures is not required to be presented for a firm's reportable segments? a. Information about segment assets b. Information about the bases for measurement c. Reconciliation of segment amounts and consolidated amounts for revenue, profit or loss, assets, and other significant items. d. All of these must be presented.

Current authoritative pronouncements require the disclosure of segment information when certain criteria are met. Which of the following reflects the type of firm and type of financial statement for which this disclosure is required? a. Annual financial statements for publicly held companies. b. Annual financial statements for both publicly held and nonpublicly held companies. c. Annual and interim financial statements for publicly held companies. d. Annual and interim financial statements for both publicly held and nonpublicly held companies.

10.

An enterprise determines that it must report segment data in annual reports for the year ended December 31, 2014. Which of the following would not be an acceptable way of reporting segment information? a. Within the body of the financial statements, with appropriate explanatory disclosures in the footnotes b. Entirely in the footnotes to the financial statements. c. As a special report issued separately from the financial statements. d. In a separate schedule that is included as an integral part of the financial statements.

11.

Selected data for a segment of a business enterprise are to be separately reported in accordance with SFAS No. 131 when the revenues of the segment is 10% or more of the combined a. net income of all segments reporting profits. b. external and internal revenue of all reportable segments. c. external revenue of all reportable segments. d. revenues of all segments reporting profits.

Chapter 14 Reporting for Segments and for Interim Financial Periods 14-3 12.

Long Corporation's revenues for the year ended December 31, 2014, were as follows Consolidated revenue per income statement $800,000 Intersegment sales 105,000 Intersegment transfers 35,000 Combined revenues of all operating segments $940,000 Long has a reportable segment if that segment's revenues exceed a. $80,000. b. $90,500. c. $94,000. d. $14,000.

13.

Sales to unaffiliated customers Sales – intersegment Loan interest income – intersegment Loan interest income – unaffiliated Income from equity method investees

Revenue test (dollars in thousands) Wholesale Retail Finance Segment Segment Segment $3,600 $1,500 $-0400 240 -0-0120 900 -0240 80 -0280 -0-

Determine the amount of revenue for each of the three segments that would be used to identify the reportable industry segments in accordance with the revenues test specified by SFAS 131.

a. b. c. d. 14.

Wholesale $3,600 4,000 4,000 4,000

Retail $1,500 1,740 1,980 2,380

Finance $ -0-0980 980

Which of the following is not part of the information about foreign operations that is required to be disclosed? a. Revenues from external customers b. Operating profit or loss, net income, or some other common measure of profitability c. Capital expenditures d. Long-lived assets

14-4 Test Bank to accompany Jeter and Chaney Advanced Accounting 15.

An entity is permitted to aggregate operating segments that have similar economic characteristics under certain circumstances. Which of the following circumstances would allow aggregation of a Entity A into Segment B? a. Entity A is expected to be included in Segment Z, an new segment, in future periods. b. Entity A was spun off from Entity C and is now owned directly by the parent entity. c. Entity A has recently filed bankruptcy and will be liquidated. d. Segment B consists of retail and wholesale operations and Entity A was primarily a retail establishment but is now engaged primarily in rendering services to the parent entity.

16.

Pale Company has four manufacturing divisions, each of which has been determined to be a reportable segment. Common operating costs are appropriately allocated on the basis of each division's sales in relation to Pale’s aggregate sales. Pale’s Delta division accounted for 40% of Pale's total sales in 2014. For the year ended December 31, 2014, Delta had sales of $5,000,000 and traceable costs of $3,600,000. In 2014, Pale incurred operating costs of $350,000 that were not directly traceable to any of the divisions. In addition, Pale incurred interest expense of $360,000 in 2014. In reporting supplementary segment information, how much should be shown as Delta's operating profit for 2014? a. $1,400,000 b. $1,256,000 c. $1,260,000 d. $1,116,000

17.

For external reporting purposes, it is appropriate to use estimated gross profit rates to determine the ending inventory value for

a. b. c. d. 18.

Interim Reporting No No Yes Yes

Annual Reporting No Yes No Yes

Inventory losses from market declines that are expected to be temporary a. should be recognized in the interim period in which the decline occurs. b. should be recognized in the last (fourth) quarter of the year in which the decline occurs. c. should not be recognized. d. none of these.

Chapter 14 Reporting for Segments and for Interim Financial Periods 14-5 19.

Gains and losses that arise in an interim period should be a. recognized in the interim period in which they arise. b. recognized in the last quarter of the year in which they arise. c. allocated equally among the remaining interim periods. d. deferred and included only in the annual income statement.

20.

If a cumulative effect type accounting change is made during the first interim period of a year a. no cumulative effect of the change should be included in net income of the period of change. b. the cumulative effect of the change on retained earnings at the beginning of the year should be included in net income of the first interim period. c. the cumulative effect of the change should be allocated to the current and remaining interim periods of the year. d. none of these.

21.

Which of the following does not have to be disclosed in interim reports? a. Seasonal costs or expenses. b. Significant changes in estimates. c. Disposal of a segment of a business. d. All of these must be disclosed.

22.

For interim financial reporting, the effective tax rate should reflect Anticipated Tax Credits a. Yes b. Yes c. No d. No

Extraordinary Items Yes No Yes No

23.

Companies using the LIFO method may encounter a liquidation of base period inventories at an interim date that is expected to be replaced by the end of the year. In these cases, cost of goods sold should be charged with the a. cost of the most recent purchases. b. average cost of the liquidated LIFO base. c. expected replacement cost of the liquidated LIFO base. d. none of these.

24.

In considering interim financial reporting, how did the Accounting Principles Board conclude that each reporting should be viewed? a. As a "special" type of reporting that need not follow generally accepted accounting principles. b. As useful only if activity is evenly spread throughout the year so that estimates are unnecessary. c. As reporting for a basic accounting period. d. As reporting for an integral part of an annual period.

25.

When a company issues interim financial statements, extraordinary items should be a. allocated to the current and remaining interim periods of the current year on a pro rata basis. b. deferred and included only in the annual income statement. c. included in the determination of net income in the interim period in which they occur. d. charged or credited directly to retained earnings so that comparisons of interim results of operations will not be distorted.

14-6 Test Bank to accompany Jeter and Chaney Advanced Accounting 26.

If annual major repairs made in the first quarter and paid for in the second quarter clearly benefit the entire year, when should they be expensed? a. An allocated portion in each of the last three quarters b. An allocated portion in each quarter of the year c. In full in the first quarter d. In full in the second quarter

27.

During the second quarter of 2014, Clearwater Company sold a piece of equipment at a gain of $90,000. What portion of the gain should Clearwater report in its income statement for the second quarter of 2014? a. $90,000 b. $45,000 c. $30,000 d. $ -0-

28.

In January 2014, Cain Company paid $200,000 in property taxes on its plant for the calendar year 2014. Also in January 2014, Cain estimated that its year-end bonuses to executives for 2014 would be $800,000. What is the amount of expenses related to these two items that should be reflected in Cain's quarterly income statement for the three months ended June 30, 2014 (second quarter)? a. $ -0b. $250,000 c. $ 50,000 d. $200,000

29.

For interim financial reporting, a company's income tax provision for the second quarter of 2014 should be determined using the a. statutory tax rate for 2014. b. effective tax rate expected to be applicable for the full year of 2014 as estimated at the end of the first quarter of 2014. c. effective tax rate expected to be applicable for the full year of 2014 as estimated at the end of the second quarter of 2014. d. effective tax rate expected to be applicable for the second quarter of 2014.

30.

Which of the following reporting practices is permissible for interim financial reporting? a. Use of the gross profit method for interim inventory pricing. b. Use of the direct costing method for determining manufacturing inventories. c. Deferral of unplanned variances under a standard cost system until year-end. d. Deferral of inventory market declines until year-end.

31.

Which of the following statements most accurately describes interim period tax expense? a. The best estimate of the annual tax rate times the ordinary income (loss) for the quarter. b. The best estimate of the annual tax rate times income (loss) for the year to date less tax expense (benefit) recognized in previous interim periods. c. Average tax rate for each quarter, including the current quarter, times the current income (loss). d. The previous year's actual effective tax rate times the current quarter's income.

Chapter 14 Reporting for Segments and for Interim Financial Periods 14-7 32.

The computation of a company's third quarter provision for income taxes should be based upon earnings a. for the quarter at an expected annual effective income tax rate. b. for the quarter at the statutory rate. c. to date at an expected annual effective income tax rate less prior quarters' provisions. d. to date at the statutory rate less prior quarters' provisions.

33.

Bjork, a calendar year company, has the following income before income tax provision and estimated effective annual income tax rates for the first three quarters of 2014:

Quarter First Second Third

Income Before Estimated Effective Income Tax Annual Tax Rate Provision at the End of Quarter $120,000 25% 160,000 25% 200,000 30%

Bjork's income tax provision in its interim income statement for the third quarter should be a. $74,000. b. $60,000. c. $50,000. d. $144,000. 34.

An inventory loss from a market price decline occurred in the first quarter. The loss was not expected to be restored in the fiscal year. However, in the third quarter the inventory had a market price recovery that exceeded the market decline that occurred in the first quarter. For interim reporting, the dollar amount of net inventory should a. decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the market price recovery. b. decrease in the first quarter by the amount of the market price decline and increase in the third quarter by the amount of the decrease in the first quarter. c. not be affected in the first quarter and increase in the third quarter by the amount of the market price recovery that exceeded the amount of the market price decline. d. not be affected in either the first quarter or the third quarter.

35.

Advertising costs may be accrued or deferred to provide an appropriate expense in each period for Interim Annual Reporting Reporting a. Yes No b. Yes Yes c. No No d. No Yes

14-8 Test Bank to accompany Jeter and Chaney Advanced Accounting Problems 14-1

The following information is available for Pink Company for 2014: a. In early April Pink made major repairs to its equipment at a cost of $90,000. These repairs will benefit the remainder of 2014 operations. b. At the end of May, Pink sold machinery with a book value of $35,000 for $45,000. c. An inventory loss of $60,000 from market decline occurred in July. In the fourth quarter the inventory had a market value recovery that exceeded the market decline by $30,000. Required: Compute the amount of expense/loss that would appear in Pink Company's June 30, September 30, and December 31, 2014, quarterly financial statements.

14-2

Stein Corporation's operations involve three industry segments, X, Y, and Z. During 2014, the operating profit (loss) of each segment was: Operating Segment Profit (Loss) X $ 600 Y 8,100 Z (6,300) Required: Determine which of the segments are reportable segments.

14-3

Walleye Industries operates in four different industries. Information concerning the operations of these industries for the year 2014 is: Revenue Industry Segment A B C D

Total $ 24,000 18,000 90,000 168,000 $300,000

Operating Intersegment Profit (Loss) $4,200 $ 2,700 2,200 (2,000) 14,000 3,600 -023,700 $28,000

Segment Assets $ 22,400 25,200 70,000 162,400 $280,000

Required: Complete the following schedule to determine which of the above segments must be treated as reportable segments. 10% Test For Segment Revenue Op. Profit (Loss) Segment Assets Reportable? A B C D

Chapter 14 Reporting for Segments and for Interim Financial Periods 14-9 14-4

Morgan Company prepares quarterly financial statements. The following information is available concerning calendar year 2014: Estimated full-year earnings Full-year permanent differences: Penalty for pollution Estimated dividend income exclusion Actual pretax earnings, 1/1/11 to 3/31/11 Nominal income tax rate

$3,000,000 150,000 60,000 480,000 40%

Required: Compute the income tax provision for the first quarter of 2014. 14-5

XYZ Corporation has eight industry segments with sales, operating profit and loss, and identifiable assets at and for the year ended December 31, 2014, as follows:

Steel Auto Parts Coal Mine Textiles Paint Lumber Leisure Time Electronics Total

Sales to Unaffiliated Customers $1,350,000 1,200,000 600,000 530,000 1,120,000 710,000 690,000 600,000 $6,800,000

Sales to Affiliated Customers $150,000 --450,000 220,000 380,000 ------$1,200,000

Profit or (Loss)

Segment Assets

$265,000 450,000 (300,000) 150,000 300,000 (75,000) 110,000 300,000 $1,200,000

$2,250,000 1,430,000 1,200,000 750,000 1,050,000 600,000 450,000 670,000 $8,400,000

Required:

A. B.

Identify the segments, which are reportable segments under one or more of the 10 percent revenue, operating profit, or assets tests. After reportable segments are determined under the 10 percent tests, they must be reevaluated under a 75 percent revenue test before a final determination of reportable segments can be made. Under this 75 percent test, identify if any other segments may have to be reported.

14-10 Test Bank to accompany Jeter and Chaney Advanced Accounting

14-6

Blink Company, which uses the FIFO inventory method, had 508,000 units in inventory at the beginning of the year at a FIFO cost per unit of $20. No purchases were made during the year. Quarterly sales information and end-of-quarter replacement cost figures follow: End-of- Quarter Quarter Unit Sales Replacement Cost 1 200,000 $17 2 60,000 18 3 85,000 13 4 61,000 18 The market decline in the first quarter was expected to be nontemporary. Declines in other quarters were expected to be permanent. Required: Determine cost of goods sold for the four quarters and verify the amounts by computing cost of goods sold using the lower-of-cost-or-market method applied on an annual basis.

14-7

Itchy Company’s actual earnings for the first two quarters of 2014 and its estimate during each quarter of its annual earnings are: Actual first-quarter earnings Actual second-quarter earnings First-quarter estimate of annual earnings Second-quarter estimate of annual earnings

$ 800,000 1,020,000 2,700,000 2,830,000

Itchy Company estimated its permanent differences between accounting income and taxable income for 2014 as: Environmental violation penalties Dividend income exclusion

$ 45,000 320,000

These estimates did not change during the second quarter. The combined state and federal tax rate for Itchy Company for 2014 is 40%. Required: Prepare journal entries to record Itchy Company’s provisions for income taxes for each of the first two quarters of 2014.

Chapter 14 Reporting for Segments and for Interim Financial Periods 14-11

Short Answer 1. In SFAS No. 131, the FASB requires all public companies to report a variety of information for reportable segments. Define a reportable segment and identify the information to be reported for each reportable segment. 2.

Publicly owned companies are usually required to file some type of quarterly (interim) report as part of the agreement with the stock exchanges that list their stock. Indicate two problems with interim reporting and GAAP’s position on this reporting.

Short Answer Questions from the Textbook 1. For what types of companies would segmented financial reports have the most significance? Why? 2. Why do financial statement users (financial analysts, for example) need information about seg need hyphen ments of a firm? 3. Define the following: (a)Operating segment.(b)Reportable segment. 4. Describe the guidelines to be used in determining (a) what constitutes an operating segment, and (b) whether a specific operating segment is a significant segment. 5. List the three major types of enterprise wide information disclosures required by SFAS No. 131[ASC 280], and explain how the firm’s designation of reportable segments affects these disclosures. 6. What segmental disclosures are required, if any, for interim reports? 7. What type of disclosure is required of a firm when the major portion of its operations takes place within a single reportable segment? 8. List the types of information that must be presented for each reportable segment of a company under the rules of SFAS No. 131 [ASC 280]. 9. Describe the methods that might be used to disclose reportable segment information. 10. What types of information must be disclosed about foreign operations under SFAS No. 131[ASC 280–10–50–40]? 11. How are foreign operations defined under SFASNo. 131 [ASC 280]? 12. If the operations of a firm in some foreign countries are grouped into geographic areas, what factors should be considered in forming the groups?

14-12 Test Bank to accompany Jeter and Chaney Advanced Accounting

13. When must a firm present segmental disclosures for major customers? What is the reason for this requirement? 14. What is the purpose of interim financial reporting? 15. Some accountants hold the view that each interim period should stand alone as a basic accounting period, whereas others view each interim period as essentially an integral part of the annual period. Distinguish between these views. 16.Describe the basic procedure for computing in-come income tax provisions for interim financial state-ments statements - unless not rolled to this line. 17.Describe how changes in estimates should be treated in interim financial statements. 18.What are the minimum disclosure requirements established ASC 270 for interim financial reports? 19.What is the general rule regarding the treatment of costs and expenses associated directly with revenues for interim reporting purposes? Business Ethics Question from Textbook SMC Inc. operates restaurants based on various themes, such as Mex-delight, Chinese for the Buffet, and Steak-it and Eat-it. The Steak-it and Eat-it restaurants have not been performing well recently, but SMC prefers not to disclose these details for fear that competitors might use the information to the detriment of SMC. The restaurants are located in various geographical locations, and management currently measures profits and losses and asset allocation by restaurant concept. How-ever, when preparing the segmental disclosures under SFAS No. 131 [ASC 280], the company reports the segment information by geographical location only. The company recently hired you to review the financial statements. 1.What disclosures should the company report for segment purposes? 2.The company’s CEO believed that the rules in SFAS No. 131 [ASC 280] are vague and that the company could easily support its decision to dis-close disclose the segment data by geographic regions. What would you recommend to the CEO and how would you approach the issues?

Chapter 14 Reporting for Segments and for Interim Financial Periods 14-13

ANSWER KEY Multiple Choice 1. 2. 3. 4. 5. 6. 7. 8. 9.

b d c d c d d d c

10. 11. 12. 13. 14. 15. 16. 17. 18.

c b c c c b c c c

19. 20. 21. 22. 23. 24. 25. 26. 27.

Problems 14-1 June 30 Major repairs $30,000 Gain on Sale (10,000) Inventory loss/(gain) ________ $20,000 14-2

28. 29. 30. 31. 32. 33. 34. 35.

b c a b c a b b

Sept. 30 $30,000

Dec. 31 $30,000

60,000 $90,000

(60,000) $(30,000)

Both segments Y and Z are reportable segments because the amount of their operating profit (loss) is more than 10% of $8,700 ($600 + 8,100) - the combined operating profit of segments that did not incur a loss. Any segment with an operating profit (loss) of $870 or more is a reportable segment.

14-3 Segment A B C D (1) (2) (3) (4) (5) (6) 14-4

a b d b c d c b a

Revenue 8% (1) 6% (2) 30% (3) 56% (4) 24,000/300,000 18,000/300,000 90,000/300,000 168,000/300,000 2,700/30,000 (2,000)/30,000

10% Test For Op. Profit (Loss) 9% (5) 7% (6) 12% (7) 79% (8) (7) (8) (9) (10) (11) (12)

Segment Assets 8% (9) 9% (10) 25% (11) 58% (12)

3,600/30,000 23,700/30,000 22,400/280,000 25,200/280,000 70,000/280,000 162,400/280,000

Estimated pretax full-year income Add: Pollution penalty Less: Estimated dividend income inclusion Estimated full-year taxable income

$3,000,000 150,000 (60,000) $3,090,000

Estimated income tax payable ($3,090,000 × 0.40)

$1,236,000

Estimated effective tax rate ($1,236,000/$3,000,000) First quarter tax provision ($480,000 × 0.412)

41.2% $197.760

Reportable? No No Yes Yes

14-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 14-5 A. ($6,800,000 + $1,200,000) = $700,000 800,000 Steel, Auto Parts, Coal Mine, Paint Operating Profit – 10% ($1,575,000) = $157,500 Steel, Auto Parts, Coal Mine, Paint, Electronics Segment Assets – 10% ($8,400,000) = $840,000 Steel, Auto Parts, Coal Mine, Paint

Revenue Test – 10%

Reportable segments applying the 10% tests are: Steel, Auto Parts, Coal Mine, Paint and Electronics. B.

75% Revenue Test – 75% ($6,800,000) = $5,100,000 Since the 75% revenue test only applies to “Sales to Unaffiliated Customers” only, the five reportable segments from Part A only include $4,870,000 ($1,350,000 + $1,200,000 + $600,000 + $1,120,000 + $600,000) worth of sales. Because the 75% test is not met, one of the segments that did not qualify as a reportable segment under the previous tests must be included as a reportable segment.

14-6 Computation 1. Sold 200,000 units @ $20 Write down of ending inventory of 308,000 units to market (308,000 × [$20 – 17])

Cost of Goods Sold Quarter Cumulative $4,000,000 924,000

4,924,000

2. Sold 60,000 units @ $17 1,020,000 Less write down recovery on ending inventory of 248,000 (248,000 × [$18 - $17]) 248,000

772,000

5,696,000

2,345,000

8,041,000

283,000

8,324,000

3. Sold 85,000 units @ $18 Write down of ending inventory of 163,000 units to market (163,000 × [$18 - $13])

1,530,000

4. Sold 61,000 units @ $13 Less write down recovery on ending inventory of 102,000 (102,000 × [$18 - $13])

793,000

815,000

510,000

Verification Units Sold During Year FIFO Cost per Unit 406,000 × $20 Add: Write down of ending inventory to the lower of cost or market (102,000 × [$20 - $18]) Total cost of goods sold for the year

Amount $8,120,000 204,000 $8,324,000

Chapter 14 Reporting for Segments and for Interim Financial Periods 14-15 14-7 First Quarter Estimated Annual Earnings Add: Environmental Violation Penalties

$2,700,000 45,000 2,745,000 <320,000> $2,425,000

Deduct: Dividend Income Exclusion Estimated Taxable Income Estimated Annual Income Tax Payable ($2,425,000 × 0.40)

970,000

Estimated Effective Combined Annual Tax Rate ($970,000 / $2,700,000)

35.9%

Income Tax Expense Income Tax Payable ($800,000 × 0.359)

287,200 287,200

Second Quarter Estimated Annual Earnings Less: Net Permanent Differences ($320,000 - $45,000) Estimated Taxable Income

$2,830,000 <275,000> $2,555,000

Estimated Annual Income Tax Payable (2,555,000 × 0.40)

1,022,000

Estimated Effective Combined Annual Tax Rate ($1,022,000/$2,830,000) Cumulative Income to Date ($800,000 + $1,020,000) Estimated Income Tax Rate: Cumulative Tax Provision Needed Tax Provision in 1st Quarter Tax Provision in 2nd Quarter Income Tax Expense Income Tax Payable

36.1% $1,820,000 0.361 657,020 <287,200> $ 369,820

369,820 369,820

Short Answer 1. A reportable segment is a segment that has passed one of three 10% tests (combined revenues, reported profit/loss and assets) or has been identified as being reportable through other criteria (i.e. aggregation). The information reported includes information about (a) segment operating profit/loss; (b) segment assets, and (c) bases for measurement. In addition, a reconciliation of segment amounts to the consolidated amounts for revenue, profit/loss, assets and other significant items is presented. Enterprisewide disclosures regarding products or services, geographic areas, and major customers are also made. 2. Problems associated with interim reporting include the seasonal nature of many industries’ operations that can cause wide fluctuations in revenues, expenses and net income from one interim period to another. In addition, the short time period available to determine interim results and the added cost of determining accurate figures for accruals and deferrals result in the use of a variety of estimation techniques, some of which proved to be highly inaccurate. GAAP (APB Opinion No. 28) supports the integral view for interim reporting. The APB stated that each interim period should be viewed primarily as an integral part of an annual period.

14-16 Test Bank to accompany Jeter and Chaney Advanced Accounting

Short Answer Questions from the Textbook

1. Segmented financial reports would have the most significance for a highly diversified company because the industries in which the company operates may have widely different rates of profitability, degrees of risk, and opportunities for growth. Thus, investors need information about these operating segments in order to make informed decisions. 2. Financial statement users need information about segments of a firm to aid in evaluating prospective investments. Different industries may have different rates of profitability, opportunities for growth, and types of risk. Segmented financial data aid the investor in determining the uncertainties surrounding the timing and amount of expected future cash flows and, therefore, aid in assessing the related risk of an investment. 3. Operating segment. A component of an enterprise that may earn revenues and incur expenses, about which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Reportable segment. A segment considered to be significant to an enterprise’s operations; specifically, one that has passed one of three 10% tests or has been identified as being reportable through other criteria (aggregation, for example). 4. A segment is an operating segment if it possesses the following characteristics. It engages in business activities that may earn revenues and incur expenses (including transactions with other components of the entity). The entity’s chief operating decision maker (may be one individual or a group of executives) regularly reviews the component’s operating results to assess its performance and make decisions about resources to be allocated to it. Discrete financial information is available. An operating segment is a significant segment if it meets one or more of the following tests: a) Its combined external and internal revenue is 10% or more of the combined external and internal revenue of all reportable segments. b)The absolute amount of its reported profit or loss is 10% or more of the greater absolute amount of: - the combined reported profit of all operating segments not reporting a loss. - the combined reported loss of all operating segments that reported a loss. c) Its assets are 10% or more of the combined assets of all operating segments. 5. (a) Product or service disclosures: revenues from external customers for each product or service or group of products or services, on the same basis as the general-purpose financial statements. This disclosure is not required if the reportable segments are structured around products or services. (b) Geographic area disclosures: revenues from external customers and long-lived assets for the firm’s country of domicile and for all other countries in total, also on the same basis as the general purpose financial statements; and revenues from external customers and long-lived assets for each foreign country or group of foreign countries, if material, along with the basis for allocating revenues (location of customer, where shipped, etc.). These disclosures are

Chapter 14 Reporting for Segments and for Interim Financial Periods 14-17

generally not required if the company’s reportable segments have been organized around geographic area. (c) Major customer disclosures: information about major customers for each customer representing 10% or more of total enterprise revenues, including the amount of revenues and the segment(s) to which the revenue is traceable. A group of customers under common control is treated as a single customer, as are the various agencies of a government. 6. SFAS No. 131 requires that segmental disclosures be included in interim reports. The extent of the disclosures depends upon whether the firm presents a complete set of financial statements for the interim period, or condensed financial statements. If the firm presents a complete set of statements, the interim disclosures are the same as presented above for reportable segments. If condensed statements are presented for interim periods, they should include the following for each reportable segment: revenues, including intersegment sales; profit or loss; disclosures of any changes in measurement bases for segmentation or components of profit or loss since the most recent annual report; any material changes in assets since the most recent annual report; and a reconciliation of income from continuing operations for the consolidated entity and for the total of the reportable segments. 7. Although the normal segment information disclosures need not be made, the financial statements should identify the industry in which the major portion of the firm’s operations takes place. 8. The following items are disclosed only if they are included in the measures reviewed by the chief operating decision maker: revenues from external customers, revenues from other segments, interest revenue and expense, depreciation, depletion, and amortization expense, income tax expense, equity income from investments, extraordinary items, other unusual items, and other significant noncash items. 9. Information about the reportable segments of a firm may be included in its financial statements in any of the following ways: a. Within the body of the financial statements, with appropriate explanatory disclosures in the footnotes to the financial statements. b. Entirely in the footnotes to the financial statements. c. In a separate schedule that is included as an integral part of the financial statements. 10. The types of information that must be disclosed for each foreign country or geographic area (and for domestic operations) are: a. Revenue, with separate disclosure of sales to nonaffliliates and intracompany sales or transfers, along with the basis of accounting for intracompany sales and transfers and the nature and effect of any change in method. b. Operating profit or loss, or some other measure of profitability. A common measure of profitability must be used for all countries and/or geographic areas presented. c. Identifiable assets, using the same procedures for presenting operating segment information. 11. Foreign operations are defined as those located outside the United States (or other “home country”) that produce revenue from sales to unaffiliated customers or from intra-enterprise sales or transfers between countries or geographic areas. Foreign operations do not, however,

14-18 Test Bank to accompany Jeter and Chaney Advanced Accounting

include unconsolidated subsidiaries and investees. If operations are conducted in two or more foreign countries or geographic areas, information must be presented separately for each significant foreign country or geographic area and in the aggregate for all other foreign operations. Where the operations of some foreign countries are grouped into geographic areas, the groupings should be made on the basis of a consideration of (1) proximity, (2) economic affinity, (3) similarities of business environments, and (4) the nature, scale, and degree of interrelationship of the operations in the various countries. 12. Factors to be considered in grouping foreign operations into geographic areas are (1) proximity, (2) economic affinity, (3) similarities of business environments, and (4) the nature, scale, and degree of interrelationship of the operations in the various countries. 13. To provide information about the potential effects of dependency on one or more major customers, if 10% or more of the revenue of a firm is derived from sales to any single customer, that fact and the amount of revenue from each such customer must be disclosed. Also, if 10% or more of the revenue is derived from sales to the federal government, a state government, a local government or a foreign government, that fact and the amount of revenue must be disclosed. Disclosure should include the amount of sales to each customer and the reportable segment making the sales. Customer's names, however, need not be disclosed. These disclosures are required even if the firm has only one reportable segment. 14. The purpose of interim financial reporting is to present timely information for use by external users of financial statements. Publicly owned companies prepare quarterly reports that must be filed with the stock exchanges on which their stock is listed, and with the Securities and Exchange Commission. 15. Accountants who support the view that each interim period should stand alone as a basic accounting period believe that deferrals, accruals, and estimates at the end of each interim period should be determined by following essentially the same principles and judgments that apply to annual periods. Accountants who view interim periods as integral parts of annual periods believe that deferrals, accruals, and estimates at the end of each interim period should be affected by judgments made at the interim date as to results of operations for the balance of the annual period. 16. At the end of each interim period, the company should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The rate determined should be used in providing for income taxes on a current year-to-date basis, giving effect to expected investment tax credit, foreign tax rates, percentage depletion, capital gain rates, and other available tax planning alternatives. 17. Change in estimates should be accounted for in the interim period in which the change is made.

Chapter 14 Reporting for Segments and for Interim Financial Periods 14-19

18. Minimum disclosure requirements for interim reports are: (a) Sales or gross revenues, provisions for income taxes, extraordinary items, cumulative effect of a change in accounting principle, and net income; (b) Basic and diluted earnings per share; (c) Seasonal revenue, cost and expenses; (d) Changes in estimates; (e) Effect of a disposal of a segment; (f) Contingencies; (g) Changes in accounting principles; (h) Significant changes in financial position. 19. The general rule is that costs and expenses that are associated directly with or allocated to the products sold or to the services rendered for annual reporting purposes should be treated in a similar manner for interim reports. BUSINESS ETHICS SOLUTION 1. Information to be presented for each of a firm’s reportable segments: • General information • Information about segment operating profit or loss • Information about segment assets • Information about the bases for measurement • Reconciliation (IAS 14 vs. SFAS 131) of segment amounts and consolidated amounts for revenue, profit or loss, assets, and significant other items. • Interim disclosures • Enterprise-wide disclosures 1. Product or service disclosures 2. Geographic area disclosures 3. Major customer disclosures 2. Since the management currently measures profit and losses and asset allocation by restaurant concept, an abrupt change to presenting the segment information by geographical location only could be viewed as unethical. If management has a motivation for preferring to keep the information about the poorly performing restaurant private that is not counter to the objectives of the shareholders and other claim-holders (for example, prefers not to expose that information to competitors while a restructuring plan is implemented), then there could be ethical reasons for a shift in disclosure choices. According to SFAS No. 131, firms should segment their disclosures along the same lines that management uses in decision-making. This does not appear to be the case here. Thus, the CEO’s decision to present the segment information by geographical location seems to be counter to the intent of segmental reporting, i.e., the unveiling of information that has been merged or buried in the consolidated data.

Chapter 15 Partnerships: Formation, Operation, and Ownership Changes Multiple Choice 1.

When a partner retires and withdraws assets in excess of his book value, the remaining partners absorb the excess a. equally. b. in their profit-sharing ratio. c. based on their average capital balances. d. based on their ending capital balances.

In a partnership, interest on capital investment is accounted for as a(n) a. return on investment. b. expense. c. allocation of net income. d. reduction of capital.

A partnership in which one or more of the partners are general partners and one or more are not is called a(n) a. joint venture. b. general partnership. c. limited partnership. d. unlimited partnership.

Which of the following is an advantage of a partnership? a. mutual agency b. limited life c. unlimited liability d. none of these

Bob and Fred form a partnership and agree to share profits in a 2 to 1 ratio. During the first year of operation, the partnership incurs a $20,000 loss. The partners should share the losses a. based on their average capital balances. b. in a 2 to 1 ratio. c. equally. d. based on their ending capital balances.

When the goodwill method is used to record the admission of a new partner, total partnership capital increases by an amount a. equal to the new partner’s investment. b. greater than the new partner’s investment. c. less than the new partner’s investment. d. that may be more or less than the new partner’s investment.

15-2

Test Bank to accompany Jeter and Chaney Advanced Accounting

The bonus and goodwill methods of recording the admission of a new partner will produce the same result if the: 1. new partner’s profit-sharing ratio equals his capital interest 2. old partners’ profit-sharing ratio in the new partnership is the same relatively as it was in the old partnership. a. 1 b. 2 c. both 1 and 2 are met. d. none of these.

When the goodwill method is used and the book value acquired is less than the value of the assets invested, total implied capital is computed by a. multiplying the new partner’s capital interest by the capital balances of existing partners. b. dividing the total capital balances of existing partners by their collective capital interest. c. dividing the new partner’s investment by his (her) capital interest. d. dividing the new partner’s investment by the existing partners’ collective capital interest.

The partnership of Abel and Caine was formed on February 28, 2014. At that date the following assets were invested: Abel Caine Cash $ 120,000 $200,000 Merchandise -0320,000 Building -0840,000 Furniture and equipment 200,000 -0The building is subject to a mortgage loan of $280,000, which is to be assumed by the partnership. The partnership agreement provides that Abel and Caine share profits or losses 30% and 70%, respectively. Caine’s capital account at February 28, 2014, should be a. $1,080,000. b. $1,360,000. c. $1,176,000. d. $952,000.

10.

The following balance sheet information is for the partnership of Abele, Boule, and Cayman: Cash Other assets

$ 210,000 1,500,000

$1,710,000

Liabilities $ 510,000 Abele, Capital (40%) 300,000 Boule, Capital (40%) 480,000 Cayman, Capital (20%) 420,000 $1,710,000

Figures shown parenthetically reflect agreed profit and loss sharing percentages. If the assets are fairly valued on the above balance sheet and the partnership wishes to admit Dann as a new 1/5 partner without recording goodwill or bonus, Dann should invest cash or other assets of a. $427,500. b. $240,000. c. $300,000. d. $342,000.

Chapter 15 Partnerships: Formation, Operation, and Ownership Changes 15-3 11.

The following balance sheet information is for the partnership of Abel, Boule, and Cayman: Cash Other assets

$ 210,000 1,500,000

$1,710,000

Liabilities $ 510,000 Abele, Capital (40%) 300,000 Boule, Capital (40%) 480,000 Cayman, Capital (20%) 420,000 $1,710,000

Figures shown parenthetically reflect agreed profit and loss sharing percentages. If assets on the initial balance sheet are fairly valued, Abele and Boule consent and Dann pays Cayman $225,000 for his interest; the revised capital balances of the partners would be a. Abele, $315,000; Boule, $495,000; Dann, $450,000. b. Abele, $315,000; Boule, $495,000; Dann, $420,000. c. Abele, $300,000; Boule, $570,000; Dann, $450,000. d. Abele, $300,000; Boule, $480,000; Dann, $420,000. 12.

Pink desires to purchase a one-fourth capital and profit and loss interest in the partnership of Brown, Greene, and Red. The three partners agree to sell Pink one-fourth of their respective capital and profit and loss interests in exchange for a total payment of $100,000. The payment is made directly to the individual partners. The capital accounts and the respective percentage interests in profits and losses immediately before the sale to Pink follow

Brown Greene Red Total

Capital Accounts $168,000 104,000 48,000 $320,000

Percentage Interests in Profits and Losses 50% 35 15

All other assets and liabilities are fairly valued and implied goodwill is to be recorded prior to the acquisition by Pink. Immediately after Pink’s acquisition, what should be the capital balances of Brown, Greene, and Red, respectively? a. $126,000; $78,000; $36,000 b. $156,000; $99,000; $45,000 c. $178,000; $111,000; $51,000 d. $208,000; $132,000; $60,000 13.

At December 31, 2014, Mick and Keith are partners with capital balances of $250,000 and $150,000, and they share profits and losses in the ratio of 2:1, respectively. On this date, Jumpin Jack invests $125,000 cash for a one-fifth interest in the capital and profit of the new partnership. The partners agree that the implied partnership goodwill is to be recorded simultaneously with the admission of Jumpin Jack. The total implied goodwill of the firm is a. $25,000. b. $20,000. c. $45,000. d. $100,000.

15-4

Test Bank to accompany Jeter and Chaney Advanced Accounting

14.

Shrek, Donkey, and Muffin are partners with capital balances of $135,000, $90,000, and $60,000, respectively. The partners share profits and losses equally. For an investment of $120,000 cash, Fiona is to be admitted as a partner with a one-fourth interest in capital and profits. Based on this information, the amount of Fiona’s investment can best be justified by which of the following? a. Fiona will receive a bonus from the other partners upon his admission to the partnership. b. Assets of the partnership were overvalued immediately prior to Fiona’s investment. c. The book value of the partnership’s net assets were less than their fair value immediately prior to Fiona’s investment. d. Fiona is apparently bringing goodwill into the partnership and her capital account will be credited for the appropriate amount.

15.

The partnership of Gilligan, Skipper, and Ginger had total capital of $570,000 on December 31, 2014 as follows: Gilligan, Capital (30%) Skipper, Capital (45%) Ginger, Capital (25%) Total

$180,000 255,000 135,000 $570,000

Profit and loss sharing percentages are shown in parentheses. The partnership has no liabilities. If Mary Ann purchases a 25 percent interest from each of the old partners for a total payment of $270,000 directly to the old partners a. total partnership net assets can logically be revalued to $1,080,000 on the basis of the price paid by Mary Ann. b. the payment of Mary Ann does not constitute a basis for revaluation of partnership net assets because the capital and income interests of the old partnership were not aligned. c. total capital of the new partnership should be $760,000. d. total capital of the new partnership will be $840,000 assuming no revaluation. 16.

The partnership of Gilligan, Skipper, and Ginger had total capital of $570,000 on December 31, 2014 as follows: Gilligan, Capital (30%) Skipper, Capital (45%) Ginger, Capital (25%) Total

$180,000 255,000 135,000 $570,000

Profit and loss sharing percentages are shown in parentheses. Assume that Mary Ann became a partner by investing $150,000 in the Gilligan, Skipper, and Ginger partnership for a 25 percent interest in capital and profits and that partnership net assets are not revalued. Mary Ann’s capital credit using the bonus method should be a. $180,000. b. $142,500. c. $150,000. d. $190,000.

Chapter 15 Partnerships: Formation, Operation, and Ownership Changes 15-5 17.

The partnership of Gilligan, Skipper, and Ginger had total capital of $570,000 on December 31, 2014 as follows: Gilligan, Capital (30%) Skipper, Capital (45%) Ginger, Capital (25%) Total

$180,000 255,000 135,000 $570,000

Profit and loss sharing percentages are shown in parentheses. Assume that Professor became a partner by investing $190,000 in the Gilligan, Skipper, and Ginger partnership for a 25 percent interest in the capital and profits, and the partnership assets are revalued. Under this assumption a. Professor’s capital credit will be $150,000. b. Gilligan’s capital will be increased to $147,000. c. total partnership capital after Professor’s admission to the partnership will be $600,000. d. net assets of the partnership will increase by $190,000, including Professor’s interest. 18.

In the absence of an agreement among the partners a. interest is allowed on capital investments. b. interest is charged on partners’ drawings. c. interest is allowed on advances to the firm made by partners beyond agreed investments. d. compensation is allowed partners for extra time devoted to the partnership.

19.

The profit and loss sharing ratio should be a. in the same ratio as the percentage interest owned by each partner. b. based on relative effort contributed to the firm by the partners. c. a weighted average of capital and effort contributions. d. based on any formula that the partners choose.

20.

The partnership agreement of Powell, Gaunt, and Holl allows Gaunt a bonus of 10% of income after the bonus, salaries of $30,000 per partner and interest of 6% on average capital balances of $120,000, $150,000, and $180,000 for Powell, Gaunt, and Holl, respectively. The amount of Gaunt’s bonus, assuming income before bonus, salaries, and interest of $315,000, is a. $18,000. b. $22,000. c. $19,800. d. $31,500.

21.

Mack and Ruben are partners operating an electronics repair shop. For 2014, net income, after salaries expense of $150,000 was $50,000. Mack and Ruben have salary allowances of $90,000 and $60,000, respectively, and remaining profits and losses are shared 6:4. The division of salaries and profits in total to Mack and Ruben would be: a. $30,000 and $20,000 b. $50,000 and $-0c. $120,000 and $80,000 d. $25,000 and $25,000

15-6

Test Bank to accompany Jeter and Chaney Advanced Accounting

22.

Robbie and Ruben are partners operating a portable toilet lease and maintenance operation. For 2014, net income was $50,000 (without taking into consideration the salary allowances). Robbie and Ruben have salary allowances of $90,000 and $60,000, respectively, and remaining profits and losses are shared 6:4. If their agreement specifies that salaries are allowed only to the extent of income, based on a prorata share of their salary allowances, the division of profits would be: a. $20,000 and $30,000 b. $50,000 and $-0c. $30,000 and $20,000 d. $25,000 and $25,000

23.

Ross, Joey, and Chandler are partners in a janitorial service. The business reported net income of $54,000 before taking partner salary allowances into consideration for 2014. The partnership agreement provides that profits and losses are to be divided equally after Joey receives a $60,000 salary, Chandler receives a $24,000 salary, and each partner receives 10% interest on his beginning capital balance. Beginning capital balances were $40,000 for Ross, $48,000 for Joey, and $32,000 for Chandler. Chandler’s share of partnership income for 2014 is: a. $38,000 b. $18,000 c. $21,200 d. $14,000 I get 13,200 for C, <10,000> for R and 50,800 for J? Letterman and Conan are partners who share profits and losses 3:7. The capital accounts on January 1, 2014, are $120,000 and $160,000, respectively. Leno is to be admitted as a partner with a onefourth interest in the capital and profits and losses by investing $80,000. Goodwill is not notto be recorded. The capital balances after admission should be: a. Letterman, $117,000; Conan, $153,000; Leno, $90,000 b. Letterman, $120,000; Conan, $160,000; Leno, $90,000 c. Letterman, $123,000; Conan, $160,000; Leno, $80,000 e. Letterman, $120,000; Conan, $167,000; Leno, $80,000

24.

25.

The balance sheet for the partnership of Nina, Pinta, and Santa Maria at January 1, 2014 follows. The partners share profits and losses in the ratio of 3:2:5, respectively. Assets at cost

$480,000

Liabilities Nina, capital Pinta, capital Santa Maria, capital

$135,000 75,000 120,000 150,000 $480,000

Nina is retiring from the partnership. By mutual agreement, the assets are to be adjusted to their fair value of $540,000 at January 1, 2014. Pinta and Santa Maria agree that the partnership will pay Nina $135,000 cash for hers her partnership interest. There is no goodwill is to be recorded. What is the balance of Pinta’s capital account after Nina’s retirement? a. $138,000 b. $108,000 c. $120,000 d. $132,000

Chapter 15 Partnerships: Formation, Operation, and Ownership Changes 15-7 26.

The following balance sheet information is for the partnership of Professor, Mary Ann, and Skipper: Cash Other assets

$ 210,000 1,500,000

$1,710,000

Liabilities $ 510,000 Professor, Capital (40%) 300,000 Mary Ann, Capital (40%) 480,000 Skipper, Capital (20%) 420,000 $1,710,000

Figures shown parenthetically reflect agreed profit and loss sharing percentages. If the assets are fairly valued on the above balance sheet and the partnership wishes to admit Mrs. Howell as a new 1/5 partner without recording goodwill or bonus, Mrs. Howell should invest cash or other assets of a. $427,500. b. $240,000. c. $300,000. d. $342,000. 27.

Donkey desires to purchase a one-fourth capital and profit and loss interest in the partnership of Shrek, Fiona, and Muffin. The three partners agree to sell Donkey one-fourth of their respective capital and profit and loss interests in exchange for a total payment of $125,000. The payment is made directly to the individual partners. The capital accounts and the respective percentage interests in profits and losses immediately before the sale to Donkey follow

Shrek Fiona Muffin Total

Capital Accounts $210,000 130,000 60,000 $400,000

Percentage Interests in Profits and Losses 60% 25 15

All other assets and liabilities are fairly valued by Donkey. Immediately after Donkey’s acquisition, what should be the capital balances of Shrek, Fiona, and Muffin, respectively? a. $157,500; $97,500; $45,000 b. $195,000; $123,750; $56,250 c. $222,500; $138,750; $63,750 d. $260,000; $165,000; $75,000

15-8

Test Bank to accompany Jeter and Chaney Advanced Accounting

28.

The partnership of Gamma, Ginger, and Gert had total capital of $1,140,000 on December 31, 2014, as follows: Gamma, Capital (30%) Ginger, Capital (45%) Gert, Capital (25%) Total

$360,000 510,000 270,000 $1,140,000

Profit and loss sharing percentages are shown in parentheses. Assume that Grizelda became a partner by investing $300,000 in the Gamma, Ginger, and Gert partnership for a 25 percent interest in capital and profits and that partnership net assets are not revalued. Grizelda’s capital credit should be a. $360,000. b. $285,000. c. $300,000. d. $380,000. 29.

The partnership of Ned, Fred, and Ted had total capital of $1,140,000 on December 31, 2014, as follows: Ned, Capital (30%) Fred, Capital (45%) Ted, Capital (25%) Total

$360,000 510,000 270,000 $1,140,000

Profit and loss sharing percentages are shown in parentheses. Assume that Ed became a partner by investing $300,000 in the Ned, Fred, and Ted partnership for a 25 percent interest in the capital and profits, and the partnership assets are revalued. Under this assumption a. Ed’s capital credit will be $300,000. b. Ned’s capital will be increased to $394,000. c. total partnership capital after Ed’s admission to the partnership will be $1,200,000. d. net assets of the partnership will increase by $380,000 including Ed’s interest. 30.

Garlic, Pepper, and Salt are partners in a plumbing service. The business reported net income of $108,000 for 2014. The partnership agreement provides that profits and losses are to be divided equally after Pepper receives a $60,000 salary, Salt receives a $24,000 salary, and each partner receives 10% interest on his beginning capital balance. Beginning capital balances were $40,000 for Garlic, $48,000 for Pepper, and $32,000 for Salt. Pepper’s share of partnership income for 2014 is: a. $68,800. b. $36,000. c. $31,200. d. $27,200.

Chapter 15 Partnerships: Formation, Operation, and Ownership Changes 15-9 Problems 15-1

Portney, Grey, and Ross are partners with capital balances of $80,000, $200,000, and $120,000, respectively. Profits and losses are shared in a 3:2:1 ratio. Grey decided to withdraw and the partnership revalued its assets. The value of inventory was decreased by $20,000 and the value of land was increased by $50,000. Portney and Ross then agreed to pay Grey $230,000 for his withdrawal from the partnership. Required: Prepare the journal entry to record Grey’s withdrawal under the A. bonus method. B. full goodwill method.

15-2

Carter and Gore are partners in an automobile repair business. Their respective capital balances are $425,000 and $275,000, and they share profits in a 3:2 ratio. Because of growth in their repair business, they decide to admit a new partner. Bush is admitted to the partnership, after which Carter, Gore, and Bush agree to share profits in a 3:2:1 ratio. Required: Prepare the necessary journal entries to record the admission of Bush in each of the following independent situations:

15-3

Bush invests $300,000 for a one-fourth capital interest, but will not accept a capital balance of less than his investment.

Bush invests $150,000 for a one-fifth capital interest. The partners agree that assets and the firm as a whole should be revalued.

Bush purchases a 20% capital interest from each partner. Carter receives $100,000 and Gore receives $50,000 directly from Bush.

Dante, Milton, and Cervantes formed a partnership and agreed to share profits in a 3:1:2 ratio after recognition of 5% interest on average capital balances and monthly salary allowances of $3,750 to Milton and $3,000 to Cervantes. Average capital balances were as follows: Dante Milton Cervantes

300,000 240,000 180,000

Required: Compute the net income (loss) allocated to each partner assuming the partnership incurred a $27,000 net loss.

15-10 Test Bank to accompany Jeter and Chaney Advanced Accounting 15-4

Rodgers and Michael formed a partnership on January 2, 2014. Michael invested $120,000 in cash. Rodgers invested land valued at $30,000, which he had purchased for $20,000 in 2005. In addition, Rodgers possessed superior managerial skills and agreed to manage the firm. The partners agreed to the following profit and loss allocation formula: a. Interest —8% on original capital investments. b. Salary — $5,000 a month to Rodgers. c. Bonus — Rodgers is to be allocated a bonus of 20% of net income after subtracting the bonus, interest, and salary. d. Remaining profit is to be divided equally. At the end of 2014 the partnership reported net income before interest, salaries, and bonus of $168,000. Required: Calculate the amount of bonus to be allocated to Rodgers.

15-5

Joey and Rachel are partners whose capital balances are $400,000 and $300,000 and who share profits 3:2. Due to a shortage of cash, Joey and Rachel agree to admit Ross to the firm. Required: Prepare the journal entries required to record Ross’s admission under each of the following assumptions: (a) Ross invests $200,000 for a 1/4 interest. The total firm capital is to be $900,000. (b) Ross invests $300,000 for a 1/4 interest. Goodwill is to be recorded. (c) Ross invests $150,000 for a 1/5 interest. Goodwill is to be recorded. (d) Ross purchases a 1/4 interest in the firm, with 1/4 of the capital of each old partner transferred to the account of the new partner. Ross pays the partners cash of $250,000, which they divide between themselves.

15-6

The partners in the ABC partnership have capital balances as follows: A. $70,000; B. $70,000 C. $105,000 Profits and losses are shared 30%, 20%, and 50%, respectively. On this date, C withdraws and the partners agree to pay him $140,000 out of partnership cash. Required: A. Prepare journal entries to show three acceptable methods of recording the withdrawal. (Tangible assets are already stated at values approximating their fair market values.) B.

15-7

Which alternative would you recommend if you determined that the agreement to pay C $140,000 was not the result of arms length bargaining between C and the other partners? Why?

Agler, Bates and Colter are partners who share income in a 5:3:2 ratio. Colter, whose capital balance is $150,000, retires from the partnership. Required: Determine the amount paid to Colter under each of the following cases: (1) $50,000 is debited to Agler capital account; the bonus approach is used. (2) Goodwill of $60,000 is recorded; the partial goodwill approach is used.

Chapter 15 Partnerships: Formation, Operation, and Ownership Changes 15-11 (3) $66,000 is credited to Bates’ capital account; the total goodwill approach is used. 15-8

The partnership agreement of Sleeter, Frisco, and Kinney provides for annual distribution of profit and loss in the following sequence: – Frisco, the managing partner, receives a bonus of 10% of net income. – Each partner receives 5% interest on average capital investment. – Residual profit or loss is to be divided 4:2:4. Average capital investments for 2014 were: Sleeter Frisco Kinney

$270,000 $180,000 $120,000

Required: A. Prepare a schedule to allocate net income, assuming operations for the year resulted in: 1. Net income of $75,000. 2. Net income of $15,000. 3. Net loss of $30,000. B.

Prepare the journal entry to close the Income Summary account for each situation above.

Short Answer 1. The principal types of partnerships are general partnerships, limited partnerships, and joint ventures. Describe the characteristics of each type of partnership. 2. There are two methods of recording changes in the membership of a partnership – the bonus method and the goodwill method. Describe these two methods of recording changes in partnership membership. Short Answer from the Textbook 1. Describe the tax treatment of partnership income. 2. Distinguish between a partner’s interest in capital and his interest in the partnership’s income and losses. Also, make a general distinction between a partner’s capital account and his drawing account. 3. Explain why a partnership is viewed in accounting as a “separate economic entity.” 4. What are some of the methods commonly used in allocating income and losses to the partners? 5. Explain the distinction between the terms “withdrawals” and “salaries.” 6. List some of the alternative methods of calculating a bonus that may appear in a partnership agreement. 7. What is meant by dissolution and what are its causes? 8. Discuss the methods used to record changes in partnership membership. 9. Differentiate between the admission of a new partner through assignment of an interest and through investment in the partnership. 10. Under what two conditions will the bonus and goodwill methods of recording the admission of a partner yield the same result?

15-12 Test Bank to accompany Jeter and Chaney Advanced Accounting

11. Describe the circumstances where neither the goodwill nor the bonus method should be used to record the admission of a new partner. 12. How might a partner withdrawing in violation of the partnership agreement and without the con-sent of the other partners be treated? What about a partner who is forced to withdraw? Business Ethics Question from Textbook Many companies with defined benefit plans are curtailing or eliminating the plans altogether. With a defined benefit plan, the company guarantees some set amount(or formula-determined payment) when the employee retires. Because most pension assets are invested in the stock market, whether a pension plan is fully funded of-ten depends on the strength of the stock market. Be-cause of this volatility, companies often find themselves unexpectedly in a position where they must either in-crease funding or disclose significant underfunding. Because of this, many companies simply reduce or eliminate the plan. Consider the pension plan of Golden Years Company (GYC). Historically, GYC has been a great company to work for, with strong employee benefits. GYC’s pension liability is approximately $15 million. However, recently the company has been experiencing minor financial troubles in a decreasing stock market and, consequently, announced the termination of the pension plan in an effort to save costs. However, the pension plan was fully funded by$9 million (the fair value of assets exceeded the expected liability). 1.delete 1. How does the firm reconcile the trade-off between financial performance and the responsibility to its employees?

Chapter 15 Partnerships: Formation, Operation, and Ownership Changes 15-13 ANSWER KEY Multiple Choice 1. 2. 3. 4. 5. 6. 7.

b c c d b b c

8. 9. 10. 11. 12. 13. 14.

c a c d b d c

15. 16. 17. 18. 19. 20.

a a d c d a

21. 22. 23. 24. 25. 26.

c c c??? a c c

27. 28. 29. 30.

Problems 15-1

A. Grey, Capital $200,000 + ($30,000 × 2/6) Portney, Capital ($20,000 × 3/4) Ross, Capital ($20,000 × 1/4) Cash

210,000 15,000 5,000

B. Goodwill ($20,000 ÷ 2/6) Portney, Capital Grey, Capital Ross, Capital

60,000

Grey, Capital Cash 15-2

A. Goodwill [($300,000 ÷ .25) - $1,000,000] Carter, Capital ($200,000 × 3/5) Gore, Capital ($200,000 × 2/5) Cash

230,000

30,000 20,000 10,000 230,000 230,000 200,000 120,000 80,000 300,000

Bush, Capital

300,000

B. Cash Goodwill [($700,000 ÷ .80) - $850,000] Bush, Capital

150,000 25,000

C. Carter, Capital ($425,000 × .20) Gore, Capital ($275,000 × .20) Bush, Capital

85,000 55,000

175,000

140,000

b a c a

15-14 Test Bank to accompany Jeter and Chaney Advanced Accounting

15-3 Salary Interest Residual Total

Dante --$15,000 (72,000) $(57,000)

Milton $45,000 12,000 (24,000) $33,000

Cervantes $ 36,000 9,000 (48,000) $ (3,000)

15-4

B = Bonus to Rodgers B = 0.20(Net Income - interest - salary - bonus) B = 0.20($168,000 - [0.08($150,000)] - $60,000 – B) B = 0.20($96,000 - B) B = $19,200 - 0.20B 1.20B = $19,200 B = $16,000

15-5

(a) Cash Joey, Capital ($25,000 × 0.60) Rachel, Capital ($25,000 × 0.40) Ross, Capital ($900,000 × 0.25)

Total $ 81,000 36,000 (144,000) $(27,000)

200,000 15,000 10,000 225,000

(b) Implied goodwill - 1/4X = $300,000; X = $1,200,000 Goodwill - $1,200,000 - $1,000,000 = $200,000 Goodwill Joey, Capital Rachel, Capital

200,000

Cash

300,000

120,000 80,000

Ross, Capital

300,000

(d) Joey, Capital (1/4 of $400,000) Rachel, Capital (1/4 of $300,000) Ross, Capital

25,000 150,000 175,000

100,000 75,000 175,000

Chapter 15 Partnerships: Formation, Operation, and Ownership Changes 15-15 15-6

A. 1) C, Capital A, Capital B, Capital Cash

105,000 21,000 14,000 140,000

2) Goodwill C, Capital

35,000

C, Capital Cash

140,000

35,000

140,000

3) 0.5X = $35,000 X = $70,000 Goodwill A, Capital B, Capital C, Capital

70,000

C, Capital Cash

140,000

21,000 14,000 35,000

140,000

B. The bonus method is more objective. That is, the bonus method does not require the allocation of a subjective value to goodwill. Since this is not an arm’s length transaction, there is no objective basis to revalue the firm as a whole.

15-7

(1) Since a debit was made to Agler’s capital account, a bonus was paid to the retiring partner of $80,000 (5/8 goodwill = $50,000), resulting in a total payment to Colter of $230,000. The entry would be: Agler, Capital 50,000 Bates, Capital 30,000 Colter, Capital 150,000 Cash 230,000 (2) Under the partial goodwill approach, only the goodwill attributed to the retiring partner is recorded. Thus, the payment to Colter was $210,000 ($150,000 + $60,000). (3) Since $66,000 was credited, total goodwill of $220,000 ($66,000/0.3) is recorded. Colter is allocated $44,000 ($220,000 × 0.20). Thus, the payment to Colter was $194,000 ($150,000 + $44,000).

15-16 Test Bank to accompany Jeter and Chaney Advanced Accounting 15-8

A. 1. Bonus Interest Residual Total 2. Bonus Interest Residual Total

3. Bonus Interest Residual Total

Sleeter $ --13,500 13,500 15,600 $29,100

Frisco $ 7,500 9,000 16,500 7,800 $24,300

Kinney $ --6,000 6,000 15,600 $21,600

Total $ 7,500 28,500 36,000 39,000 $75,000

$ --13,500 13,500 (6,000) $7,500

$1,500 9,000 10,500 (3,000) $7,500

--6,000 6,000 (6,000) -0-

$ 1,500 28,500 30,000 (15,000) $15,000

--6,000 6,000 (23,400) $(17,400)

--28,500 28,500 (58,500) $(30,000)

$ ----13,500 9,000 13,500 9,000 (23,400) (11,700) $(9,000) <9,900>$(2,700)

B. 1. Income Summary Sleeter, Capital Frisco, Capital Kinney, Capital

75,000

2. Income Summary Sleeter, Capital Frisco, Capital

15,000

3. Sleeter, Capital Frisco, Capital Kinney, Capital Income Summary

9,900 2,700 17,400

29,100 24,300 21,600

7,500 7,500

30,000

Short Answer from the Textbook Solutions 1. In a general partnership, the partners can bind the partnership into contracts – each partner is an agent of both the partnership and every other partner. The primary difference between a general partnership and a limited partnership is that general partners are personally liable for the debts of the partnership, while limited partners are only liable for the amount invested in the partnership. A joint venture is an arrangement entered into be two or more parties to accomplish a single or limited purpose for the mutual benefit of the members of the group. 2.

Under the bonus method of recording changes in partnership membership, the assets of the partnership are increased by the amount of the assets invested by the partner being admitted. Any difference between the assets invested and the credit to the new partner’s capital account

Chapter 15 Partnerships: Formation, Operation, and Ownership Changes 15-17

is adjusted to the existing partners’ capital accounts. When a partner withdraws from a partnership, any difference between the recorded value of the assets withdrawn and the withdrawing partner’s capital account is adjusted to the remaining partner’s capital accounts. Under the goodwill method, a new asset is recorded that is based on the difference between the value implied by the amount of consideration negotiated in the admission or withdrawal of a partner and the values reported in the partnership books. Under this method, the firm is revalued, using the amount invested by the new partner or the amount paid to the withdrawing partner.

1. A partnership is not subject to an income tax, but the individual partners report their share of partnership income, whether distributed or not, on their respective individual tax returns. 2. A partner's capital balance represents his or her interest in the net assets of the partnership, whereas a partner's interest in income and loss represents how his or her interest in capital will be affected by the subsequent operations of the partnership. Generally, a partner's capital account is used to recognize asset investments and withdrawals which are not considered temporary. The partner's drawing account is generally used to record withdrawals of assets in anticipation of profitable operations of the partnership or any payments of a partner's personal expenses from partnership assets. 3. A partnership is viewed as a "separate economic entity" in accounting because it has a "separable and definable existence". The assets, liabilities, and residual capital interest, as well as the economic events which affect the various partnership accounts, require a "separable accounting" to provide necessary information to the partners and to others interested in the partnership's performance. 4. Some common methods used in allocating income and loss to partners are: fixed ratio, a ratio based on capital balances, interest on capital, and payment for time devoted to partnership operations, salary and/or bonus. 5. A withdrawal is a reduction in assets, not a distribution of income. A salary is a determinate in the allocation of income and is a reward to the partner for the amount of time devoted to the partnership's operations. 6. A bonus may be calculated in several ways. Some of these are: (1) net income before any income allocations are made; (2) net income after income allocations are made, but before subtracting the bonus; (3) net income after subtracting the bonus, but before any other income allocations are made; and (4) net income after all income allocations are made, including the bonus. 7. The UPA defines "dissolution" as a "change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business."

15-18 Test Bank to accompany Jeter and Chaney Advanced Accounting

8. The two methods used to record changes in partnership membership are (1) the bonus method and (2) the goodwill method. Under the bonus method, assets of the partnership are increased by the amount of the assets invested by the new partner or decreased by the amount of the assets paid to a withdrawing partner. The new (withdrawing) partner's capital account is debited (credited) for the capital interest acquired (the balance in the capital account). Any balancing amount is adjusted to the other partners' capital accounts. Under the goodwill method, an intangible asset is recorded based on the difference between the value implied by the amount of consideration exchanged in the admission or withdrawal of a partner and the capital interest of the new or withdrawing partner. 9. An interest in a partnership can be acquired either (1) by purchasing all or part of an interest directly from one or more partners (outside the partnership), called an assignment of partnership interest, or (2) by investing assets in the firm to acquire an interest in the partnership. 10. The bonus and goodwill methods will yield the same result when two conditions relating to the new profit and loss agreement are met. These are: (1) the new partner's profit sharing interest equals his or her initial interest in capital; and (2) the old partners' profit sharing ratio is in the same relative ratio as in the old partnership. 11. Neither the goodwill method nor the bonus method should be used to record the admission of a new partner when (1) the book value of the interest acquired is equal to the value of assets invested, or (2) the net assets of the firm are overvalued. 12. A partner withdrawing in violation of the partnership agreement and without the other partners' approval is entitled only to his or her interest in the firm, without consideration made for any goodwill. The withdrawing partner is also liable to the remaining partners for any damages created by his breach of the partnership agreement. A partner forced to withdraw, however, is entitled to his full interest in the partnership, including any goodwill.

Business Ethics from the Textbook Solutions 1.delete 1. The defined benefit plan creates a challenge for a firm in a fluctuating market. If the firm is simultaneously struggling with other financial issues, its manager may indeed consider reducing or eliminating the plan. However, such a decision should not be taken lightly, as it would remove an important and valuable benefit to its employees. Certainly, there would be no reason, particularly when the plan is fully funded as it is here, to eliminate any of the previously accrued benefits. However, the firm may wish to revisit the types of benefits offered in the future. One alternative is to switch to a defined contribution plan. This plan is somewhat less appealing to the employee, but it is certainly more desirable than no pension plan and it greatly reduces the volatility and risk to the employer. It is crucial that the employer take into account the manner in which a change in its pension plan will affect its ability to attract and keep top quality employees over the long run, as this is essential to the long-term viability of the company. Changing market dynamics have made firms realize that

Chapter 15 Partnerships: Formation, Operation, and Ownership Changes 15-19

in order to maximize long-term profits, they have to be socially responsible. Firms, therefore, engage in social responsibility by responding to market demands, legal regulation, including consumer, employment and environmental laws, and by going beyond the letter of the law. Laws combined with markets are often adequate to make profit-maximizing and socially responsible behavior converge. The following points are among those to be considered in reconciling the tradeoffs between financial performance and responsibility to a firm’s employees: •

Employees can insist on socially responsible behavior, both by contract and by deciding where to work. Employees can contract not only about wages and working conditions, but also concerning social responsibility of firms. A corporation’s reputation for social responsibility can attract and retain employees.

•

Employees derive satisfaction from being associated with, and expect better treatment from, responsible firms.

•

The more difficult the skill set and knowledge requirements for the employees’ position are to fill, the more likely that employee is to be influenced by such benefits as pension plans and such considerations as social responsibility of the firm.

•

Workers are also investors and, more importantly, consumers. The firms must not only hire and contract with its employees, but also motivate them to perform at their maximum level of effort. Disgruntled workers can erode a firm’s goodwill. As discussed above, unions and other groups prefer to deal with worker-friendly firms.

Chapter 16 Partnership Liquidation Multiple Choice 1.

Which of the following statements is correct? 1. Personal creditors have first claim on partnership assets. 2. Partnership creditors have first claim on partnership assets. 3. Partnership creditors have first claim on personal assets. a. 1 b. 2 c. 3 d. Both 2 and 3

The first step in the liquidation process is to a. convert noncash assets into cash. b. pay partnership creditors c. compute any net income (loss) up to the date of dissolution. d. allocate any gains or losses to the partners.

A schedule prepared each time cash is to be distributed is called a(n) a. advance cash distribution schedule. b. marshaling of assets schedule. c. loss absorption potential schedule. d. safe payment schedule.

An advance cash distribution plan is prepared a. each time cash is distributed to partners in an installment liquidation. b. each time a partnership asset is sold in an installment liquidation. c. to determine the order and amount of cash each partner will receive as it becomes available for distribution. d. none of these.

The first step in preparing an advance cash distribution plan is to a. determine the order in which partners are to participate in cash distributions. b. compute the amount of cash each partner is to receive as it becomes available for distribution. c. allocate any gains (losses) to the partners in their profit-sharing ratio. d. determine the net capital interest of each partner.

Offsetting a partner's loan balance against his debit capital balance is referred to as the a. marshaling of assets. b. right of offset. c. allocation of assets. d. liquidation of assets.

If a partner with a debit capital balance during liquidation is personally solvent, the a. partner must invest additional assets in the partnership. b. partner's debit balance will be allocated to the other partners. c. other partners will give the partner enough cash to absorb the debit balance. d. partnership will loan the partner enough cash to absorb the debit balance.

16-2

Test Bank to accompany Jeter and Chaney Advanced Accounting

The following condensed balance sheet is presented for the partnership of Shrek, Donkey, and Fiona who share profits and losses in the ratio of 4:3:3, respectively: Cash Other assets Shrek, receivable

$ 180,000 1,940,000 60,000 $ 2,180,000

Accounts payable Donkey, loan Shrek, capital Donkey, capital Fiona, capital

$ 480,000 80,000 720,000 440,000 460,000 $2,180,000

Assume that the assets and liabilities are fairly valued on the balance sheet and that the partnership decides to admit Dragon as a new partner, with a 25% interest. No goodwill or bonus is to be recorded. How much should Dragon contribute in cash or other assets? a. $270,000 b. $405,000 c. $540,000 d. $520,000 Does this item (#8) belong in Chapter 15 rather than here? 9.

The partnership of Larry, Moe, and Curly shares profits and losses 60%, 30%, and 10%, respectively. On January 1, 2014, the partners voted to dissolve the partnership, at which time the assets, liabilities, and capital balances were as follows: Assets Cash Other Assets

400,000 1,200,000

Total assets $1,600,000 All of the partners are personally insolvent.

Liabilities and Capital Accounts Payable Larry, Capital Moe, Capital Curly, Capital Total liabilities

580,000 440,000 380,000 200,000 $1,600,000

Assume that all noncash assets are sold for $840,000 and all available cash is distributed in final liquidation of the partnership. Cash should be distributed to the partners as follows a. Larry, $744,000; Moe, $372,000; Curly, $124,000. b. Larry, $440,000; Moe, $380,000; Curly, $200,000. c. Larry, $224,000; Moe, $272,000; Curly, $164,000. d. Larry, $396,000; Moe, $198,000; Curly, $66,000.

Chapter 16 Partnership Liquidation 10.

16-3

The partnership of Peter, Paul, and Mary share profits and losses in the ratio of 4:4:2, respectively. The partners voted to dissolve the partnership when its assets, liabilities, and capital were as follows: Assets Cash $ 250,000 Other assets 1,000,000 $1,250,000 Liabilities and Capital Liabilities Peter, Capital Paul, Capital Mary, Capital

$ 200,000 300,000 350,000 400,000 $1,250,000

The partnership will be liquidated over a prolonged period of time. As cash is available, it will be distributed to the partners. The first sale of noncash assets having a book value of $600,000 realized $475,000. How much cash should be distributed to each partner after this sale? a. Peter, $90,000; Paul, $140,000; Mary, $295,000 b. Peter, $210,000; Paul, $290,000; Mary, $145,000 c. Peter, $290,000; Paul, $210,000; Mary, $105,000 d. Peter, $150,000; Paul, $175,000; Mary, $200,000 11.

In a partnership liquidation, the final cash distribution to the partners should be made in accordance with the: a. partners' profit and loss sharing ratio. b. balances of the partners' capital accounts. c. ratio of the capital contributions by the partners. d. ratio of capital contributions less withdrawals by the partners.

12.

In an advance plan for installment distributions of cash to partners of a liquidating partnership, each partner's loss absorption potential is computed by a. dividing each partner's capital account balance by the percentage of that partner's capital account balance to total partners' capital. b. multiplying each partner's capital account balance by the percentage of that partner's capital account balance to total partners' capital. c. dividing the total of each partner's capital account less receivables from the partner plus payables to the partner by the partner's profit and loss percentage. d. some other method.

13.

Under the Uniform Partnership Act a. partnership creditors have first claim (Rank I) against the assets of an insolvent partnership. b. personal creditors of an individual partner have first claim (Rank I) against the personal assets of all partners. c. partners with credit capital balances share (Rank I) the personal assets of an insolvent partner that has a debit capital balance with personal creditors of that partner. d. personal creditors of the partners of an insolvent partnership share partnership assets on a pro rata basis (Rank I) with partnership creditors.

16-4

Test Bank to accompany Jeter and Chaney Advanced Accounting

14.

During the liquidation of the partnership of Karr, Rice, and Long. Karr accepts, in partial settlement of his interest, a machine with a cost to the partnership of $150,000, accumulated depreciation of $70,000, and a current fair value of $110,000. The partners share net income and loss equally. The net debit to Karr's account (including any gain or loss on disposal of the machine) is a. $90,000. b. $100,000. c. $110,000. d. $150,000.

15.

X, Y, and Z have capital balances of $90,000, $60,000, and $30,000, respectively. Profits are allocated 35% to X, 35% to Y, and 30% to Z. The partners have decided to dissolve and liquidate the partnership. After paying all creditors, the amount available for distribution is $60,000. X, Y, and Z are all personally solvent. Under the circumstances, Z will a. receive $18,000. b. receive $30,000. c. personally have to contribute an additional $6,000. d. personally have to contribute an additional $36,000.

16.

The ABC partnership has the following capital accounts on its books at December 31, 2014: Credit A, Capital $400,000 B, Capital 240,000 C, Capital 80,000 All liabilities have been liquidated and the cash balance is zero. None of the partners have personal assets in excess of his personal liabilities. The partners share profits and losses in the ratio of 3:2:5. If the noncash assets are sold for $400,000, the partners should receive as a final payment: a. A, $304,000; B, $176,000; C, $80,000 b. A, $256,000; B, $144,000; C, $-0c. A, $304,000; B, $176,000; C, $-0d. A, $120,000; B, $80,000; C, $200,000

17.

The summarized balances of the accounts of MNO partnership on December 31, 2014, are as follows: Assets Cash Noncash

Total Assets

$ 15,000 90,000

$105,000

Liabilities and Capital Liabilities $ 15,000 M, Capital 45,000 N, Capital 30,000 O, Capital 15,000 Total Equities $105,000

The agreed upon profit/loss ratio is 50:40:10, respectively. Using the information given above, which one of the following amounts, if any, is the loss absorption potential of partner N as of December 31, 2014? a. $20,000 b. $35,000 c. $75,000 d. $120,000

Chapter 16 Partnership Liquidation 18.

16-5

Gilligan, Skipper, and Professor are partners with a profit and loss ratio of 4:3:3. The partnership was liquidated and, prior to the liquidation process, the partnership balance sheet was as follows: GILLIGAN, SKIPPER, AND PROFESSOR Balance Sheet January 1, 2014 Assets Cash Other assets

$ 60,000 540,000

Total Assets

$600,000

Liabilities and Equity Gilligan, Capital Skipper, Capital Professor, Capital Total Liabilities & Equities

$216,000 240,000 144,000 $600,000

After the partnership was liquidated and the cash was distributed, Skipper received $96,000 in cash in full settlement of his interest. The liquidation loss must have been: a. $360,000 b. $144,000 c. $504,000 d. $480,000 19.

The partnership of Mick, Keith, and Charlie has been dissolved and is in the process of liquidation. On July 1, 2014, just before the second cash distribution, the assets and equities of the partnership along with residual profit sharing ratios were as follows: Assets Cash Receivables-net Inventories Equipment-net Total assets

$ 200,000 50,000 150,000 100,000 $ 500,000

Liabilities & Equities Liabilities $ Mick, Capital 50% Keith, Capital 30% Charlie, Capital 20% Total Lia & Equity

150,000 100,000 175,000 75,000 500,000

Assume that the available cash is distributed immediately, except for a $25,000 contingency fund that is withheld pending complete liquidation of the partnership. How much cash should be paid to each of the partners? Mick a. $87,500 b. 12,500 c. -0d. -0-

Keith $52,500 7,500 25,000 15,000

Charlie $35,000 10,000 -010,000

16-6

Test Bank to accompany Jeter and Chaney Advanced Accounting

20.

$ 200,000 50,000 150,000 100,000 $ 500,000

Liabilities & Equities Liabilities $ Mick, Capital 50% Keith, Capital 30% Charlie, Capital 20% Total Lia & Equity

150,000 100,000 175,000 75,000 500,000

Assume that Mick takes equipment with a fair value of $40,000 and a book value of $50,000 in partial satisfaction of his equity in the partnership. If all the $200,000 cash is then distributed, the partners should receive: Mick Keith Charlie a. $100,000 $60,000 $40,000 b. 25,000 15,000 10,000 c. -0 45,000 5,000 d. -0 50,000 -0 21.

The partnership of Homer, Marge, and Bart share profits and losses in the ratio of 4:4:2, respectively. The partners voted to dissolve the partnership when its assets, liabilities, and capital were as follows: Assets Cash Other assets

Total assets

$150,000 600,000

$750,000

Liabilities and Equity Liabilities $120,000 Homer, Capital 180,000 Marge, Capital 210,000 Bart, Capital 240,000 Total Lia & Equity $750,000

The partnership will be liquidated over a prolonged period of time. As cash is available, it will be distributed to the partners. The first sale of noncash assets having a book value of $360,000 realized $285,000. How much cash should be distributed to each partner after this sale? a. Homer, $54,000; Marge, $84,000; Bart, $177,000. b. Homer, $174,000; Marge, $174,000; Bart, $87,000. c. Homer, $126,000; Marge, $126,000; Bart, $63,000. d. Homer, $90,000; Marge, $105,000; Bart, $120,000. 22.

A, B, and C have capital balances of $90,000, $60,000, and $30,000, respectively. Profits are allocated 35% to A, 35% to B and 30% to C. The partners have decided to dissolve and liquidate the partnership. After paying all creditors the amount available for distribution is $60,000. A, B, and C are all personally solvent. Under the circumstances, C will a. receive $18,000. b. receive $30,000. c. personally have to contribute an additional $6,000. d. personally have to contribute an additional $36,000. #22 is identical to #15 except ABC is XYZ???

Chapter 16 Partnership Liquidation 23.

16-7

The ABC partnership has the following capital accounts on its books at December 31, 2014:

A, Capital B, Capital C, Capital

Credit $200,000 120,000 40,000

All liabilities have been liquidated and the cash balance is zero. None of the partners have personal assets in excess of his personal liabilities. The partners share profits and losses in the ratio of 3:2:5. If the noncash assets are sold for $150,000, the partners should receive as a final payment: a. A, $152,000; B, $88,000 C, $40,000 b. A, $128,000; B, $72,000; C, $ - 0 c. A, $152,000; B, $88,000; C, $ - 0 d. A, $60,000; B, $40,000; C, $100,000 for #23 I get 98,000; 52,000; -0-??? 24.

The summarized balances of the accounts of RST partnership on December 31, 2014, are as follows: Assets Liabilities and Equity Cash $ 30,000 Liabilities $ 30,000 Noncash 180,000 R, Capital 90,000 S, Capital 60,000 T, Capital 30,000 Total Assets $210,000 Total Lia & Equities $210,000 The agreed upon profit/loss ratio is 50:40:10, respectively. Using the information given above, which one of the following amounts, if any, is the loss absorption potential of partner S as of December 31, 2014? a. $60,000 b. $70,000 c. $150,000 d. $240,000

25.

The partnership of Stan, Kenney, and Cartman has been dissolved and is in the process of liquidation. On July 1, 2014, just before the second cash distribution, the assets and equities of the partnership along with residual profit sharing ratios were as follows: Assets Liabilities and Equity Cash $ 80,000 Liabilities $ 60,000 Receivables-net 20,000 Stan, Capital 50% 40,000 Inventories 60,000 Kenney, Capital 30% 70,000 Equipment-net 40,000 Cartman, Capital 20% 30,000 Total assets $200,000 Total Lia & Equity $200,000 Assume that the available cash is distributed immediately, except for a $10,000 contingency fund that is withheld pending complete liquidation of the partnership. How much cash should be paid to each of the partners? Stan Kenney Cartman a. $35,000 $21,000 $14,000 b. $5,000 $3,000 $4,000 c. $0 $10,000 $0 d. $0 $6,000 $4,000

16-8

Test Bank to accompany Jeter and Chaney Advanced Accounting

Problems 16-1

The NOR Partnership is being liquidated. A balance sheet prepared prior to liquidation is presented below: Assets Cash Other Assets

Total Assets

$240,000 300,000

$540,000

Liabilities & Equities Liabilities $ 160,000 Rice, Loan 60,000 Nutt, Capital 180,000 Ohm, Capital 60,000 Rice, Capital 80,000 Total Equities $540,000

Nutt, Ohm, and Rice share profits and losses in a 40:40:20 ratio. All partners are personally insolvent. Required: A. Prepare the journal entries necessary to record the distribution of the available cash. B.

Prepare the journal entries necessary to record the completion of the liquidation process, assuming the other assets are sold for $120,000.

16-2 The trial balance for the ABC Partnership is as follows just before liquidation: names do match ANS, and this is not in balance to start - needs to be redone

CASH 180,000

OTHER ASSETS 625,000

BALL RECEIVABLE = 90,000

LIABILITIES 150,000

ADLER CAPITAL 420,000

BALL CAPITAL 270,000

CARL CAPITAL 180,000

Partners share profits a 50:30:20 ratio. Required: Prepare an advance cash distribution plan showing how available cash would be distributed. 16-3

Lennon, Newman, and Ott operate the LNO Partnership. The partnership agreement provides that the partners share profits in the ratio of 40:40:20, respectively. Unable to satisfy the firm's debts, the partners decide to liquidate. Account balances just prior to the start of the liquidation process are as follows: Debit Credit Cash $ 90,000 Other Assets 330,000 Liabilities $165,000 Ott, Loan 36,000 Lennon, Capital 165,000 Newman, Capital 36,000 Ott, Capital 39,000 Ott, Drawing 21,000 _______ Totals $441,000 $441,000

Chapter 16 Partnership Liquidation

16-9

During the first month of liquidation, other assets with a book value of $150,000 are sold for $165,000, and creditors are paid. In the following month unrecorded liabilities of $12,000 are discovered and assets carried on the books at a cost of $90,000 are sold for $36,000. During the third month the remaining other assets are sold for $42,000 and all available cash is distributed. Required: Prepare a schedule of partnership realization and liquidation. A safe distribution of cash is to be made at the end of the second and third months. The partners agreed to hold $30,000 in cash in reserve to provide for possible liquidation expenses and/or unrecorded liabilities. All of the partners are personally insolvent. 16-4

Due to the fact that the partnership had been unprofitable for the past several years, A, B, C, and D decided to liquidate their partnership. The partners share profits and losses in the ratio of 40:30:20:10, respectively. The following balance sheet was prepared immediately before the liquidation process began: A B C D Partnership Balance Sheet Cash Other Assets

Total Assets

$ 100,000 350,000

$450,000

Liabilities A, Capital B, Capital C, Capital D, Capital Total Lia & Equities

The personal status of each partner is as follows: Personal _Assets_ A $165,000 B 100,000 C 180,000 D 60,000

$250,000 55,000 60,000 50,000 35,000 $450,000

Personal Liabilities $ 120,000 140,000 160,000 70,000

The partnership's other assets are sold for $100,000 cash. The partnership operates in a state which has adopted the Uniform Partnership Act. Required: A. Complete the following schedule of partnership realization and liquidation. Assume that a partner makes additional contributions to the partnership when appropriate based on their individual status.

CASH $100,000

OTHER ASSETS $350,000

LIABILITIES $250,000

__A__ 55,000

__B__ 60,000

CAPITAL __C__ 50,000

__D__ 35,000

16-10 Test Bank to accompany Jeter and Chaney Advanced Accounting B. Complete the following schedule to show the total amount that will be paid to the personal creditors. From Personal _Assets_

Distribution from _Partnership_

Total Paid to Personal _Creditors_

A B C D

16-5

A trial balance for the DEF partnership just prior to liquidation is given below:

Cash Noncash Assets Nonpartner Liabilities Dugan, Loan Dugan, Capital Elston, Capital Flynn, Capital Totals

Debit $ 75,000 750,000

$825,000

Credit

$240,000 75,000 225,000 153,000 132,000 $825,000

The partners share income and loss on the following basis: Dugan 50% Elston 30% Flynn 20% Required: Prepare an advance cash distribution plan for the partners. 16-6

David, Paul, and Burt are partners in a CPA firm sharing profits and losses in a ratio of 2:2:3, respectively. Immediately prior to liquidation, the following balance sheet was prepared: Assets

Liabilities & Equities

Cash Noncash assets

$ 100,000 580,000

Total Assets

_______ $680,000

Liabilities David, Capital Paul, Capital Burt, Capital Total Liabilities & Equities

$280,000 160,000 160,000 80,000 $680,000

Chapter 16 Partnership Liquidation 16-11 Required: Assuming the noncash assets are sold for $300,000, determine the amount of cash to be distributed to each partner. Complete the worksheet and clearly indicate the amount of cash to be distributed to each partner in the spaces provided. No cash is available from any of the three partners.

Beginning Bal.

Cash 100,000

Noncash Assets 580,000

Liabilities 280,000

David Capital 160,000

Paul Capital 160,000

Burt Capital 80,000

16-7

Using the information from Problem 16-6, assume the noncash assets are sold for $160,000. Determine the amount of cash to be distributed to each partner assuming all partners are personally solvent.

16-8

The December 31, 2013, balance sheet of the Deng, Danielson, and Gibson partnership, along with the partners’ residual profit and loss sharing ratios, is summarized as follows: Assets Cash Receivables Inventories Other Assets Total Assets

$ 150,000 300,000 375,000 475,000 $1,300,000

Liabilities & Equities Accounts Payable $ 225,000 Loan from Danielson 50,000 Deng, Capital (20%) 250,000 Danielson, Capital (30%) 400,000 Gibson, Capital (50%) 375,000 Total Lia & Equities $1,300,000

The partners agree to liquidate their partnership as soon as possible after January 1, 2014 and to distribute all cash as it becomes available. Required: Prepare an advance cash distribution plan to show how cash will be distributed as it becomes available.

16-12 Test Bank to accompany Jeter and Chaney Advanced Accounting Short Answer 1.

The Uniform Partnership Act specifies specific steps in distributing available partnership assets in liquidation. Describe the steps used to distribute partnership assets during the liquidation process.

An advance cash distribution plan specifies the order in which each partner will receive cash and the dollar amount each will receive as it becomes available for distribution. Identify the four steps in the preparation of an advance cash distribution plan.

Short Answer Questions from the Textbook 1. Why are realization gains or losses allocated to partners in their profit and loss ratios? 2. In what manner should the final cash distribution be made in partnership liquidation? 3. Why does a debit balance in a partners’ capital account create problems in the UPA order of payment for a partnership liquidation? 4. Is it important to maintain separate accounts for a partner’s outstanding loan and capital accounts? Explain why or why not. 5. Discuss the possible outcomes in the situation where the equity interest of one partner is inadequate to absorb realization losses. 6. During a liquidation, at which point may cash be distributed to any of the partners? 7. What is “marshaling of assets”? 8. To what extent can personal creditors seek re-covery recovery from partnership assets? 9. In an installment liquidation, why should the partners view each cash distribution as if it were the final distribution? 10. Discuss the three basic assumptions necessary for calculating a safe cash distribution. How is this safe cash distribution computed? 11. How are unexpected costs such as liquidation expenses, disposal costs, or unrecorded liabilities covered in the safe distribution schedule? 12. What is the objective of the procedures used for the preparation of an advance cash distribution plan? 13. What is the “loss absorption potential”? 14. In what order must partnership assets be distributed?

Chapter 16 Partnership Liquidation 16-13

Business Ethics Question from the Textbook You and two of your former college friends, Freeman and Oxyman, formed a partnership called FOB, which builds and installs fabricated swimming pools. The business has been operating for 15 years and has become one of the top swimming pool companies in the area. Typically, you have been providing the on-site estimates for the pools, while your partners do most of the onsite construction. While visiting one of the sites, you hear a conversation between one of your partners and a customer. Your partner is explaining that the cost will increase by $10,000 because of unexpected rock removal. You are a bit surprised by this, since you had tested the area for rocks. Later, back at the office, you review the core-sample results done on that job, which did not reveal any rock. You decide to talk to the partner when he returns to the office. When the partner returns to the office, he is arguing with someone from a local bank concerning an outstanding personal loan. 1.What do you see as your duty with respect to the partnership? 2.What should you do? Explain your reasoning.

16-14 Test Bank to accompany Jeter and Chaney Advanced Accounting ANSWER KEY Multiple Choice 1. 2. 3. 4. 5. 6. 7.

b c d c d b a

8. 9. 10. 11. 12. 13. 14.

c c a b c a b

15. 16. 17. 18. 19. 20. 21.

c b c d c d a

22. c 23.b ??? 24. c 25. c

Ohm $(60,000) 120,000 60,000 (60,000) $ -0-

Rice_ $(140,000) 60,000 (80,000) 20,000 $(60,000)

Problems 16-1

A. Net interest Potential loss–$300,000 Potential loss–$60,000 Cash distribution

Nutt $(180,000) 120,000 (60,000) 40,000 $(20,000)

Liabilities Cash

160,000

Rice, Loan Nutt, Capital Cash

60,000 20,000

B. Cash Nutt, Capital ($180,000 × .40) Ohm, Capital ($180,000 × .40) Rice, Capital ($180,000 × .20) Other Assets Nutt, Capital ($12,000 × [40/60]) Rice, Capital ($12,000 × [20/60]) Ohm, Capital ($72,000 - $60,000) Nutt, Capital Rice, Capital Cash

160,000

80,000

120,000 72,000 72,000 36,000 300,000 8,000 4,000 12,000 80,000100,000 40,000100,000 120,000200,000

Chapter 16 Partnership Liquidation 16-15 16-2 see notes in text - could not verify __Alder__ Net capital interest $420,000 Profit-loss ratio / .50 Loss absorption potential $840,000 Order of cash distribution 2

__Bell__ $180,000 / .30 $600,000 3

__Cone__ $180,000 / .20 $900,000 1

Profit-Loss Ratio Loss absorption potential Distribution to Cole Balances after distribution Distribution to Adams & Cole Balances after distribution

Loss Absorption Potential Alder Bell Cone .50 .30 .20 $840,000 $600,000 $900,000 60,000 840,000 600,000 840,000 240,000 240,000 $600,000 $600,000 $600,000

Profit-Loss Ratio Net capital interest Distribution to Cole Balances after distribution Distribution to Adams & Cole Balances after distribution

Asset Distribution Bell Cone .30 .20 $180,000 $180,000 12,000 180,000 168,000 _ 48,000 $180,000 $120,000

Remainder of asset distributions

Order of Cash Distribution 1. First $150,000 2. Next $12,000 3. Next $168,000 4. Remainder

Alder .50 $420,000 420,000 _120,000 $300,000 .50

.30

Cash Distribution Plan Alder Liabilities .5 100% 71% 50%

.20

Bell .3

Cone .2

30%

100% 29% 20%

16-16 Test Bank to accompany Jeter and Chaney Advanced Accounting 16-3 Balances Sale of assets Distribute cash to creditors

Cash 90,000 165,000 255,000 (165,000) 90,000

Assets 330,000 (150,000) 180,000

90,000 36,000 126,000 (96,000) 30,000 42,000 72,000

180,000 (90,000) 90,000

72,000 (72,000) -0-

-0-

-0-__

180,000

Record liabilities Sale of assets Distribute cash Sale of assets

90,000 (90,000) -0-

= Liabilities = (165,000) = (165,000) 165,000 = -0(12,000) = (12,000) (12,000) 12,000 -0-0-

Allocate Newman's deficit Distribute cash Balances

Balances Sale of assets

Lennon (165,000) (6,000) (171,000)

Capital Interest Newman =* Ohm Ott (36,000) =* (54,000) (6,000) (3,000) (42,000) =* (57,000)

Distribute cash to creditors Record liabilities Sale of assets Distribute cash Sale of assets Allocate Newman's deficit Distribute cash Balances

Capital interest Potential loss plus cash reserve (120,000)

(171,000) 4,800 (166,200) 21,600 (144,600) 75,000 (69,600) 19,200 (50,400) 2,400 (48,000) 48,000 -0-

(42,000) 4,800 (37,200) 21,600 (15,600)

Lennon (144,600)

Newman (15,600)

48,000 (96,600) Allocate potential deficit(2/3) 14,40021,600 Cash distribution (75,000) * - delete the =

(15,600) 19,200 3,600 (3,600) -0-0-

=* (57,000) 2,400 =* (54,600) 10,800 (43,800) 9,000 (34,800) 9,600 (25,200) 1,200 (24,000) 24,000 -0Ohm Ott (43,800)

48,000 32,00024,000 32,400 (19,800) (21,600)<32,400>(1/3) 10,800 -0( 9,000)

Chapter 16 Partnership Liquidation 16-17 16-4

A. Cash 100,000 100,000 200,000

Account Balances Sale of Assets Allocated Debit Balance of B* Investment from C Investment from A

Other Assets = 350,000 = (350,000) -0=

200,000 10,000 45,000 255,000 (255,000) -0-

Distribute Cash

Account Balances Sale of Assets

-0-0-

(250,000) (250,000)

(250,000) 250,000 -0-

A .4 (55,000) 100,000 45,000

Capital B C .3 .2 (60,000) (50,000) 75,000 50,000 15,000 -0-

D .1 (35,000) 25,000 (10,000)

45,000

(15,000) -0-

10,000 10,000 (10,000)

5,000 (5,000)

(45,000) -0-

-0-

(5,000) 5,000 -0-

Allocate Debit Balance of B* Investment from C Investment from A

-0-

Liabilities (250,000)

Distribute Cash

*Allocate only to C and D, since A is able to contribute only $45,000 from personal assets. B.

From Personal Assets A B C D

120,000 100,000 160,000 60,000

Distribution from Partnership

Total Paid to Personal Creditors

5,000

120,000 100,000 160,000 65,000

16-18 Test Bank to accompany Jeter and Chaney Advanced Accounting 16-5 Capital balances Loan balances Net capital interest Profit and loss ratio Loss absorption potential Order of cash distribution

Profit & loss ratio Loss absorption potential Net cap. interest Distrib. to Flynn (60,000 × .2)

Elston $153,000

Flynn $132,000

153,000 / .3 $510,000 3

132,000 / .2 $660,000 1

Loss Absorption Potential Dugan Elston Flynn .5 .3 .2 $600,000

$510,000

Asset Distribution Dugan Elston .5 .3

Flynn .2

$660,000 $300,000

$153,000

$132,000

153,000

12,000 120,000

60,000 600,000

Distrib. to Dugan and Flynn (90,000 × .2) (90,000 × .5)

Dugan $225,000 75,000 300,000 / .5 $600,000 2

510,000

90,000

600,000

300,000

90,000 18,000

$510,000

Remainder

45,000 $255,000 .5

$153,000 .3

$102,000 .2

Cash Distribution Plan Order of cash distribution after creditors have been paid: First $12,000 Next $63,000 Remainder

Dugan

Elston

5/7 50%

30%

Flynn 100% 2/7 20%

16-6

Beginning Balance Sale of Assets Balances Pay Liabilities Balances Allocate deficit Balances

Cash 100,000 300,000 400,000 (280,000) 120,000 120,000

Noncash Assets Liabilities 580,000 280,000 (580,000) -0280,000 (280,000) -0-0-0-

-0-

Cash payment to partners (120,000)

Balances

-0-

David Capital 160,000 (80,000) 80,000 80,000 (20,000) 60,000 (60,000) -0-

Paul Burt Capital Capital 160,000 80,000 (80,000) (120,000 80,000 (40,000) 80,000 (20,000) 60,000 (60,000) -0-

(40,000) 40,000 -0-0-

Chapter 16 Partnership Liquidation 16-19 16-7 Cash Beginning Balance 100,000 Sale of Assets 160,000 Balances 260,000 Cash payment from Burt 100,000 Balances 360,000 Pay Liabilities (280,000) Balances 80,000 Cash payment to partners (80,000) Balances -0-

Noncash Assets Liabilities 580,000 280,000 (580,000) -0280,000 -0-0-

280,000 (280,000) -0-

-0-

David Capital 160,000 (120,000) 40,000 40,000

Paul Burt Capital Capital 160,000 80,000 (120,000) (180,000) 40,000 (100,000) 100,000 40,000 -0-

40,000 (40,000) -0-

-0-0-

16-8

Net capital interest Profit/Loss ratio Loss absorption potential Order of cash distribution

Deng $250,000 / .20 $1,250,000 2

Danielson $450,000 / .30 $1,500,000 1

Gibson $375,000 / .50 $750,000 3

Loss Absorption Potential Loss absorption potential Distribution to Danielson Balances Distribution to Deng & Danielson Balances

Deng Danielson Gibson $1,250,000 $1,500,000 $750,000 (250,000)move right________ ________ $1,250,000 $1,250,000 $750,000 (500,000) (500,000) _ ______ $750,000 $ 750,000 $750,000

Asset Distribution Net capital interest Distribution to Danielson Balances Distribution to Deng & Danielson Balances Remainder of asset distributions

Deng $250,000 250,000 (100,000) $150,000 0.20

Danielson $450,000 __<75,000> 375,000 (150,000) $225,000 0.30

Gibson $375,000 ___ ___ 375,000 _______ $375,000 0.50

16-20 Test Bank to accompany Jeter and Chaney Advanced Accounting Cash Distribution Plan

Order of Cash Distribution 1. First $225,000 2. Next $75,000 3. Next $250,000 4. Remainder

Liabilities 100%

Deng 0.20

Danielson __0.30__

Gibson __0.50__

40% 20%

100% 60% 30%

50%

Short Answer 1. The first step in the liquidation process is to compute any net income/loss up to the date of dissolution. Any net income/loss is allocated to the partners according to their profit and loss agreement. In the next step, the assets that are not acceptable for distribution in their present form are converted into cash, and any gains/losses realized are allocated according to the profit and loss ratio. The last step is to distribute the available cash to creditors and partners. 2.

Steps in the preparation of an advance cash distribution plan include: a. Determine the net capital interest of each partner by combining partners’ capital accounts with any loans to or receivables from the partners. b. Determine the order in which the partners are to participate in cash distributions. c. Compute the amount of cash each partner is to receive as it becomes available for distribution. d. Prepare the cash distribution plan.

Short Answer Questions from the Textbook Solutions 1. Realization gains or losses are allocated to partners in their profit and loss ratio because the changes in asset values are the result of risk assumed by the partnership. Also, because it may be difficult to separate gains and losses that result from liquidation from the under- or over-statement in book values that result from accounting policies followed in prior years. 2. The final cash distribution is based on capital balances, not on profit and loss ratios, since the capital balance represents the partners' "residual claims" to the assets remaining after settlement of partnership obligations. 3. Because the UPA order of payment ranks partnership obligations to a partner ahead of asset distributions to a partner for capital investments, a debit balance in a partner's capital account will create problems when that partner has an outstanding loan balance. Other partners will have a claim against this partner for the amount of his/her debit balance which is considered to be an asset of the partnership by the UPA. If the partner with a debit balance settles his/her obligation with the partnership, there is no problem. However, if he/she can't cannot settle, the other partners must absorb the deficit as a loss, even though the partner with the debit balance had received cash for his/her outstanding loan balance. To avoid this inequity, the courts have recognized the right of the partnership to offset the loan balance against the debit capital balance. 4. Maintaining separate accounts for outstanding loan and capital accounts recognizes the legal distinction between the two. This would be important if the liquidation is carried on over an extended period, since the UPA provides that a partner is entitled to accrued interest on the loan balance. 5. When the equity interest of one partner is inadequate to absorb realization losses several alternative outcomes are possible. If the partner is personally solvent, he may pay the partnership for the amount he

Chapter 16 Partnership Liquidation 16-21 is liable. If he/she is personally insolvent then the other partners must absorb his/her debit balance in their respective profit and loss ratio. If the other partners are unsure of what the partner with the debit balance will do, but still wish to distribute cash, they can assume the worst (absorbing their share of the debit balance) to determine what amount of cash can be safely distributed. 6. Cash should not be distributed to any partner until all liquidation losses are recognized in the accounts or are provided for in determining a safe cash payment. 7. The classification of assets into personal and partnership categories in recognition of the rights of both partnership creditors and creditors of the individual partners is referred to as "marshalling of assets." 8. To the extent that personal creditors do not recover from personal assets they can seek recovery from those partnerships assets still available after partnership obligations have been met. This recovery, however, is limited to the extent that the partner involved has a credit interest in partnership assets.

9. Because in an installment liquidation the amount of cash to be received from the unsold assets and the resulting gain or loss is unknown, the partners should view each cash distribution as if it were the final distribution. 10. The three assumptions upon which a safe cash distribution is determined are (1) any loan balances to partners are offset against their capital accounts, (2) the remaining noncash assets will not generate any more cash, and (3) any partner with a deficit capital balance will not settle his/her obligation to the partnership. In other words, assume the worst. The safe cash balance is computed as the difference between the current capital balances and the balance required to maintain the above assumptions. 11. Unexpected costs are added to the book value of noncash assets. When the potential loss on the noncash assets is allocated in the determination of a safe payment, these costs are also included. 12. The objective of the procedure is to bring the balance of the partners' capital accounts into the agreed profit and loss ratio as soon as possible so that no one partner is placed in a better position than any other partner. 13. The "loss absorption potential" is determined by dividing the partners' net capital balances by their respective profit ratio. This determines the maximum amount of loss each partner can absorb. 14. The Uniform Partnership Act provides that the liabilities of the partnership shall rank in order of payment as follows: (1) Those owing to creditors other than partners, (2) Those owing to partners other than for capital and profits, (3) Those owing to partners in respect of capital, (4) Those owing to partners in respect of profits. Business Ethics from the Textbook Solution 1) Partnership laws grant each partner the right to information about the firm’s business. This allows each partner to monitor the firm’s activities. Given the circumstances of the case, it would be your duty to inspect any questionable transaction. Furthermore, you should ask the partner to explain the reason for increasing the cost by $10,000. This would give you the opportunity to raise the concern

16-22 Test Bank to accompany Jeter and Chaney Advanced Accounting regarding the presence of the previously undetected rock. If the additional charge is not based on fact, the cost should be removed. 2) In the present scenario, it appears that the partner might be experiencing personal financial pressures. However, the firm’s reputation and future implications of the action must be considered for the benefit of the partnership. Your loyalty to your partner does not alter these responsibilities. You may wish to find other, more constructive ways to offer assistance to your partner in meeting his personal obligations, and surviving what may be a difficult time in his life. However, ignoring the situation is dishonest to the client and is likely to result in more serious long-term consequences. Reference: http://www.lrc.ky.gov/KRS/362-01/403.PDF