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Chapter 1
BUSINESS COMBINATIONS
Answers to Questions
1 A business combination is a union of business entities in which two or more previously separate and independent companies are brought under the control of a single management team. FASB Statement No. 141R describes three situations that establish the control necessary for a business combination, namely, when one or more corporations become subsidiaries, when one company transfers its net assets to another, and when each combining company transfers its net assets to a newly formed corporation.
2 The dissolution of all but one of the separate legal entities is not necessary for a business combination. An example of one form of business combination in which the separate legal entities are not dissolved is when one corporation becomes a subsidiary of another. In the case of a parent-subsidiary relationship, each combining company continues to exist as a separate legal entity even though both companies are under the control of a single management team.
3 A business combination occurs when two or more previously separate and independent companies are brought under the control of a single management team. Merger and consolidation in a generic sense are frequently used as synonyms for the term business combination. In a technical sense, however, a merger is a type of business combination in which all but one of the combining entities are dissolved and a consolidation is a type of business combination in which a new corporation is formed to take over the assets of two or more previously separate companies and all of the combining companies are dissolved.
4 Goodwill arises in a business combination accounted for under the acquisition method when the cost of the investment (fair value of the consideration transferred) exceeds the fair value of identifiable net assets acquired. Under FASB Statement No. 142, goodwill is no longer amortized for financial reporting purposes and will have no effect on net income, unless the goodwill is deemed to be impaired. If goodwill is impaired, a loss will be reocnized.
5 A bargain purchase occurs when the acquisition price is less than the fair value of the identifiable net assets acquired. The acquirer records the gain from a bargain purchase
Journal entries on IceAge’s books to record the acquisition
Investment in Jester 2,550,000Common stock, $10 par 1,200,000Additional paid-in capital 1,350,000
To record issuance of 120,000 shares of $10 par common stock with a fair value of $2,550,000 for the common stock of Jester in a business combination.
Additional paid-in capital 15,000Investment expenses 45,000
Other assets 60,000To record costs of registering and issuing securities as a reduction of paid-in capital, and record
direct and indirect costs of combination as expenses.
Current assets 1,100,000Plant assets 2,200,000
Liabilities 300,000Investment in Jester 3,000,000
To record allocation of the $2,550,000 cost of Jester Company to identifiable assets and liabilities according to their fair values, computed as follows:Cost $2,550,000Fair value acquired 3,000,000Bargain purchase amount $ 450,000
Investment in Jester 450,000 Gain from bargain purchase 450,000 To record gain from bargain purchase.
Journal entries on the books of Danders Corporation to record merger with Harrison Corporation
Investment in Harrison 530,000Common stock, $10 par 180,000Additional paid-in capital 150,000Cash 200,000To record issuance of 18,000 common shares and payment of cash in the acquisition of Harrison Corporation in a merger.
Investment expenses 70,000Additional paid-in capital 30,000
Cash 100,000To record costs of registering and issuing securities and additional
direct costs of combination.
Cash 40,000Inventories 100,000Other current assets 20,000Plant assets — net 280,000Goodwill 160,000
Current liabilities 30,000Other liabilities 40,000Investment in Harrison 530,000
To record allocation of cost to assets received and liabilities assumed on the basis of their fair values and to goodwill computed as follows:
Cost of investment $530,000Fair value of assets acquired 370,000Goodwill $160,000
Preliminary computationsFair Value: Cost of investment in Sain at January 2 (30,000 shares ´ $20) $600,000Book value (440,000)Excess fair value over book value $160,000
Excess allocated to:Current assets $ 40,000Remainder to goodwill 120,000Excess fair value over book value $160,000
Note: $25,000 direct costs of combination are expensed. The excess fair value of Pine’s buildings is not considered.
Pine CorporationBalance Sheet at January 2, 2009
Assets
Current assets ($130,000 + $60,000 + $40,000 excess - $40,000 direct costs) $ 190,000
Land ($50,000 + $100,000) 150,000
Buildings — net ($300,000 + $100,000) 400,000
Equipment — net ($220,000 + $240,000) 460,000
Goodwill 120,000Total assets $1,320,000
Liabilities and Stockholders’ Equity
Current liabilities ($50,000 + $60,000) $ 110,000
Common stock, $10 par ($500,000 + $300,000) 800,000
Additional paid-in capital [$50,000 + ($10 ´ 30,000 shares) — $15,000 costs of issuing and registering securities]
Persis issues 25,000 shares of stock for Sineco’s outstanding shares
1a Investment in Sineco 750,000Capital stock, $10 par 250,000Other paid-in capital 500,000To record issuance of 25,000, $10 par shares with a market price of $30 per share in a business combination with Sineco.
Investment expenses 30,000Other paid-in capital 20,000
Cash 50,000To record costs of combination in a business combination with Sineco.
Cash 10,000Inventories 60,000Other current assets 100,000Land 100,000Plant and equipment — net 350,000Goodwill 180,000
Liabilities 50,000Investment in Sineco 750,000
To record allocation of investment cost to identifiable assets and liabilities according to their fair values and the remainder to goodwill. Goodwill is computed: $750,000 cost - $570,000 fair value of net assets acquired.
Persis issues 15,000 shares of stock for Sineco’s outstanding shares
2a Investment in Sineco (15,000 shares ´ $30) 450,000Capital stock, $10 par 150,000Other paid-in capital 300,000To record issuance of 15,000, $10 par common shares with a market price of $30 per share.
Investment expense 30,000Other paid-in capital 20,000
Cash 50,000To record costs of combination in the acquisition of Sineco.
Cash 10,000Inventories 60,000Other current assets 100,000Land 100,000Plant and equipment — net 350,000
Liabilities 50,000Investment in Sineco 570,000To record Sineco’s net assets at fair values.
Investment in Sineco 120,000 Gain on bargain purchase 120,000
To record gain on bargain purchase and adjust Investment inSineco to reflect total fair value.
Fair value of net assets acquired $570,000Investment cost (Fair value of consideration) 450,000
Gain on Bargain Purchase $120,000
2b Persis CorporationBalance Sheet
January 2, 2009 (after business combination)
AssetsCash [$70,000 + $10,000] $ 80,000Inventories [$50,000 + $60,000] 110,000Other current assets [$100,000 + $100,000] 200,000Land [$80,000 + $100,000] 180,000Plant and equipment — net [$650,000 + $350,000] 1,000,000Total assets $1,570,000
Liabilities and stockholders’ equityLiabilities [$200,000 + $50,000] $ 250,000
1 Journal entries to record the acquisition of Dawn Corporation
Investment in Dawn 2,500,000Capital stock, $10 par 1,000,000Other paid-in capital 1,000,000Cash 500,000To record acquisition of Dawn for 100,000 shares of common stock and $500,000 cash.
Investment expense 100,000Other paid-in capital 50,000
Cash 150,000To record payment of costs to register and issue the shares of stock ($50,000) and other costs of combination ($100,000).
Accounts payable 300,000Mortgage payable, 10% 600,000Investment in Dawn 2,700,000
To record the net assets of Dawn at fair value.Investment in Dawn 200,000 Gain on bargain purchase 200,000 To adjust Investment account to total fair value and recognize the gain from the bargain purchase.
Gain on Bargain Purchase CalculationAcquisition price $2,500,000Fair value of net assets acquired 2,700,000
1. Journal entry to record the acquisition (in millions of $)
Investment in Target 50,000Common stock, $0.10 par 100Additional paid-in capital 49,900To record acquisition of Target for 1 billion shares of common stock having a fair value of $50 per share.
Accounts payable 300,000Mortgage payable, 10% 600,000Investment in Target 2,600,000
Assign the excess of fair value over book value of assets and liabilities as shown in the following allocation schedule:
Acquisition price $50,000Excess fair value of assets acquired Inventory (10%) 625 Land (20%) 987 Buildings and improvements (20%) 3,222 Fixtures and equipment (20%) 711 Computer hardware and software (20%) 438
Total liabilities and shareholders' investment 201,193 37,349 50,000 50,0
00 238,542
Chapter 2
STOCK INVESTMENTS — INVESTOR ACCOUNTING AND REPORTING
Answers to Questions
1 Only the investor’s accounts are affected when outstanding stock is acquired from existing stockholders. The investor records the investment at its cost. Since the investee company is not a party to the transaction, its accounts are not affected.
Both investor and investee accounts are affected when unissued stock is acquired directly from the investee. The investor records the investment at its cost and the investee adjusts its asset and owners’ equity accounts to reflect the issuance of previously unissued stock.
2 Goodwill arising from an equity investment of 20 percent or more is not recorded separately from the investment account. Under the equity method, the investment is presented on one line of the balance sheet in accordance with the one-line consolidation concept.
3 Dividends received from earnings accumulated before an investment is acquired are treated as decreases in the investment account balance under the fair value/cost method. Such dividends are considered a return of a part of the original investment.
4 The equity method of accounting for investments increases the investment account for the investor’s share of the investee’s income and decreases it for the investor’s share of the investee’s losses and for dividends received from the investee. In addition, the investment and investment income accounts are adjusted for amortization of any investment cost-book value differentials related to the interest acquired. Adjustments to the investment and investment income accounts are also needed for unrealized profits and losses from transactions between the investor and investee companies. A fair value adjustment is optional under SFAS No. 159.
5 The equity method is referred to as a one-line consolidation because the investment account is reported on one line of the investor’s balance sheet and investment income is reported on one line of the investor’s income statement (except when the investee has extraordinary or cumulative-effect type adjustments). In addition, the investment income is computed such that the parent company’s income and stockholders’ equity are equal to the consolidated net income and consolidated stockholders’ equity that would result if the statements of the investor and investee were consolidated.
6 If the equity method of accounting is applied correctly, the income of the parent company will generally equal the controlling interest share of consolidated net income.
7 The difference in the equity method and consolidation lies in the detail reported, but not in the amount of income reported. The equity method reports investment income on one
line of the income statement whereas the details of revenues and expenses are reported in the consolidated income statement.
8 The investment account balance of the investor will equal underlying book value of the investee if (a) the equity method is correctly applied, (b) the investment was acquired at book value which was equal to fair value, the pooling method was used, or the cost-book value differentials have all been amortized, and (c) there have been no intercompany transactions between the affiliated companies that have created investment account-book value differences.
9 The investment account balance must be converted from the cost to the equity method when acquisitions increase the interest held to 20 percent or more. The amount of the adjustment is the difference between the investment income reported under the cost method in prior years and the income that would have been reported if the equity method of accounting had been used. Changes from the cost to the equity method of accounting for equity investments are changes in the reporting entity that require restatement of prior years’ financial statements when the effect is material.
10 The one-line consolidation is adjusted when the investee’s income includes extraordinary items, gains or losses from discontinued operations, or cumulative-effect type adjustments. In this case, the investor’s share of the investee’s ordinary income is reported as investment income under a one-line consolidation, but the investor’s share of extraordinary items, cumulative-effect type adjustments, and gains and losses from discontinued operations is combined with similar items of the investor.
11 The remaining 15 percent interest in the investee is accounted for under the fair value/cost method, and the investment account balance immediately after the sale becomes the new cost basis.
12 Yes. When an investee has preferred stock in its capital structure, the investor has to allocate the investee’s income to preferred and common stockholders. Then, the investor takes up its share of the investee’s income allocated to common stockholders in applying the equity method. The allocation is not necessary when the investee has only common stock outstanding.
13 Goodwill impairment losses are calculated by business reporting units. For each reporting unit, the company must first determine the fair values of net assets. The fair value of the reporting unit is the amount at which it could be purchased in a current market transaction. This may be based on market prices, discounted cash flow analyses, or similar current transactions. This is done in the same manner as is done to originally record a combination. Any excess measured fair value is the fair value of goodwill. The company then compares the goodwill fair value estimate to the carrying value of goodwill to determine if there has been an impairment during the period.
14 Yes. Impairment losses for subsidiaries are computed as outlined in the solution to question 13. Companies compare fair values to book valuers for equity method investments as a whole. Firms may recognize impairments for equity method investments as a whole, but perform no separate goodwill impairment.
15 Initial impairment losses recorded upon adoption of SFAS 142 are treated as the cumulative effect of an accounting change. Impairment losses resulting from subsequent annual reviews are included in the calculation of income from operations.
Grade’s investment is reported at its $300,000 cost because the equity method is not appropriate and because Grade’s share of Medium’s income exceeds dividends received since acquisition [($260,000 ´ 15%) > $20,000].
5 cDividends received from Zafacon for the two years were $10,500 ($70,000 ´ 15% - all in 2009), but only $9,000 (15% of Zafacon’s income of $60,000 for the two years) can be shown on Torquel’s income statement as dividend income from the Zafacon investment. The remaining $1,500 reduces the investment account balance.
6 c[$50,000 + $150,000 + ($300,000 ´ 10%)]
7 a8 d
Investment balance January 2 $250,000Add: Income from Pod ($100,000 ´ 30%) 30,000Investment in Pod December 31 $280,000
Share of Oakey’s reported income ($800,000 ´ 30%) $ 240,000Less: Excess allocated to inventory (100,000)Less: Depreciation of excess allocated to building ($200,000/4 years)
(50,000)
Income from Oakey $ 90,000
2 Investment account balance at December 31
Cost of investment in Oakey $2,000,000Add: Income from Oakey 90,000Less: Dividends ($200,000 x 30%) (60,000) Investment in Oakey December 31 $2,030,000
Alternative solutionUnderlying equity in Oakey at January 1 ($1,500,000/.3) $5,000,000Income less dividends 600,000Underlying equity December 31 5,600,000Interest owned 30%Book value of interest owned December 31 1,680,000Add: Unamortized excess 350,000Investment in Oakey December 31 $2,030,000
Solution E2-6
Journal entry on Martin’s books
Investment in Neighbors ($300,000 x 40%) 120,000Loss from discontinued operations 20,000
Income from Kelly 140,000
To recognize income from 40% investment in Neighbors.
Excess dividends received over share of income $ 3,000
Investment in Bennett January 3, 2008 $ 50,000Less: Excess dividends received over share of income (3,000)
Investment in Bennett December 31, 2009 $ 47,000
2 bCost of 10,000 of 40,000 shares outstanding $1,400,000Book value of 25% interest acquired ($4,000,000 stockholders’ equity at December 31, 2008 + $1,400,000 from additional stock issuance) ´ 25% 1,350,000
Excess fair value over book value(goodwill) $ 50,000
3 dThe investment in Monroe balance remains at the original cost.
4 cIncome before extraordinary item $ 200,000Percent owned 40%
Income from Krazy Products $ 80,000
Solution E2-8
Preliminary computationsCost of 40% interest January 1, 2008 $2,400,000Book value acquired ($4,000,000 ´ 40%) (1,600,000)
Excess fair value over book value $ 800,000
Excess allocated toInventories $100,000 ´ 40% $ 40,000Equipment $200,000 ´ 40% 80,000Goodwill for the remainder 680,000
Alternative computationRaython’s share of the change in Treaton’s stockholders’ equity ($1,500,000 ´ 40%) $ 600,000Less: Excess allocated to inventories ($40,000 ´ 100%) (40,000)Less: Excess allocated to equipment ($80,000/4 years ´ 4 years) (80,000)Increase in investment account 480,000Original investment 2,400,000Investment balance December 31, 2012 $2,880,000
1 Income from RunnerShare of income to common ($400,000 - $30,000 preferred dividends) ´ 30% $ 111,000
2 Investment in Runner December 31, 2009NOTE: The $50,000 direct costs of acquiring the investment must be expensed when incurred. They are not a part of the cost of the investment. Investment cost $1,200,000Add: Income from Runner 111,000Less: Dividends from Runner ($200,000 dividends - $30,000 dividends to preferred) ´ 30% (51,000)Investment in Runner December 31, 2009 $1,260,000
Solution E2-10
1 Income from Tree ($300,000 – $200,000) ´ 25%Investment income October 1 to December 31 $ 25,000
2 Investment balance December 31Investment cost October 1 $ 600,000Add: Income from Tree 25,000Less: Dividends ---Investment in Tree at December 31 $ 625,000
Preliminary computationsGoodwill from first 10% interest:Cost of investment $ 50,000Book value acquired ($420,000 ´ 10%) (42,000)
Excess fair value over book value $ 8,000Goodwill from second 10% interest:Cost of investment $ 100,000Book value acquired ($500,000 ´ 10%) (50,000)
Excess fair value over book value $ 50,000
1 Correcting entry as of January 2, 2009 to convert investment to the equity basisAccumulated gain/loss on stock available for Sale 50,000
Valuation allowance to record SAS at fair value
50,000
To remove the valuation allowance entered on December 31, 2009 under the fair value method for an available for sale security.Investment in Twizzle 8,000
Retained earnings 8,000To adjust investment account to an equity basis computed as follows:
Share of Twizzle’s income for 2009 $ 20,000Less: Share of dividends for 2009 (12,000)
$ 8,000
2 Income from Twizzle for 2009
Income from Twizzle on original 10% investment $ 10,000
Income from Twizzle on second 10% investment 10,000Income from Twizzle $ 20,000
Preliminary computationsStockholders’ equity of Tall on December 31, 2008 $380,000Sale of 12,000 previously unissued shares on January 1, 2009 250,000Stockholders’ equity after issuance on January 1, 2009 $630,000
Cost of 12,000 shares to River $250,000Book value of 12,000 shares acquired
$630,000 ´ 12,000/36,000 shares 210,000Excess fair value over book value $ 40,000
Excess is allocated as followsBuildings $60,000 ´ 12,000/36,000 shares $ 20,000Goodwill 20,000
Excess fair value over book value $ 40,000
Journal entries on River’s books during 2009
January 1Investment in Tall 250,000
Cash 250,000To record acquisition of a 1/3 interest in Tall.
During 2009Cash 30,000
Investment in Tall 30,000To record dividends received from Tall ($90,000 ´ 1/3).
December 31Investment in Tall 38,000
Income from Tall 38,000To record investment income from Tall computed as follows:Share of Tall’s income ($120,000 ´ 1/3) $ 40,000Depreciation on building ($20,000/10 years) (2,000)Income from Tall $ 38,000
To record dividends received from Crown($100,000 ´ 30%).
Investment in Crown (30%) 60,000Extraordinary loss (from Crown) 6,000
Income from Crown 66,000To record investment income from Crown computed as follows:
Share of income before extraordinary item $170,000 ´ 30% $ 51,000
Add: Excess fair value over cost realized in 2009 $50,000 ´ 30% 15,000
Income from Crown before extraordinary loss $ 66,000
2 Investment in Crown balance December 31, 2009
Investment cost $ 195,000Add: Income from Crown after extraordinary loss 60,000Less: Dividends received from Crown (30,000)Investment in Crown December 31 $225,000
Check: Investment balance is equal to underlying book value ($700,000 + $150,000 - $100,000) ´ 30% = $225,000
3 BIP CorporationIncome Statement
for the year ended December 31, 2009Sales $1,000,000Expenses 700,000
Operating income 300,000Income from Crown (before extraordinary item) 66,000
Income before extraordinary item 366,000Extraordinary loss (net of tax effect) 6,000
Since the total value of Steele has declined by $60,000 while the fair value of the net identifiable assets is unchanged, the $60,000 decline is the impairment in goodwill for the period. Assuming this is not the initial adoption of SFAS 142, the $60,000 impairment loss is deducted in calculating Park’s income from continuing operations.
Solution E2-16
Goodwill impairments are calculated at the business reporting unit level. Increases and decreases in fair values across business units are not offsetting. Flash must report an impairment loss of $5,000 in calculating 2009 income from continuing operations.
SOLUTIONS TO PROBLEMS
Solution P2-1
1 GoodwillCost of investment in Telly on April 1 $ 343,000Book value acquired:
Net assets at December 31 $1,000,000Add: Income for 1/4 year ($120,000 ´ 25%) 30,000Less: Dividends paid March 15 (20,000)Book value at April 1 1,010,000Interest acquired 30% 303,000
Goodwill from investment in Telly $ 40,000
2 Income from Telly for 2009Equity in income before extraordinary item
($120,000 ´ 3/4 year ´ 30%) $ 27,000Extraordinary gain from Telly ($40,000 ´ 30%) 12,000Income from Telly $ 39,000
3 Investment in Telly at December 31, 2009Investment cost April 1 $ 343,000Add: Income from Telly plus extraordinary gain 39,000Less: Dividends ($20,000 ´ 3 quarters) ´ 30% (18,000)Investment in Shelly December 31 $ 364,000
4 Equity in Telly’s net assets at December 31, 2009Telly’s stockholders’ equity January 1 $1,000,000Add: Net income 160,000Less: Dividends (80,000)Telly’s stockholders’ equity December 31 1,080,000Investment interest 30%Equity in Telly’s net assets $ 324,000
Investment in Siegel July 1, 2009 (at cost) $110,000Dividends charged to investment (2,400)Investment in Siegel balance at December 31, 2009
$107,600
July 1, 2009Investment in Siegel 110,000
Cash 110,000To record initial investment for 80% interest.
November 1, 2009Cash 6,400
Dividend income 6,400To record receipt of dividends ($8,000 ´ 80%).
December 31, 2009Dividend income 2,400
Investment in Siegel 2,400To reduce investment for dividends in excess of earnings ($8,000 dividends - $5,000 earnings) ´ 80%.
2 Equity method
Investment in Siegel July 1, 2009 $110,000Add: Share of reported income 4,000Deduct: Dividends charged to investment (6,400)Deduct: Excess Depreciation (1,100)Investment in Siegel balance at December 31, 2009
$106,500
July 1, 2009Investment in Siegel 110,000
Cash 110,000To record initial investment for 80% interest of Siegel.
November 1, 2009Cash 6,400
Investment in Siegel 6,400To record receipt of dividends ($8,000 ´ 80%).
Investment in Siegel 2,900Income from Siegel 2,900
To record income from Siegel computed as follows: Share of Siegel’s income ($10,000 ´ 1/2 year ´ 80%) less excess depreciation ($22,000/10 years ´ 1/2 year).
Preliminary computationsCost of investment in Zelda $331,000Book value acquired ($1,000,000 ´ 30%) 300,000
Excess fair value over book value $ 31,000
Excess allocatedUndervalued inventories ($30,000 ´ 30%) $ 9,000Overvalued building (-$60,000 ´ 30%) (18,000)Goodwill for the remainder 40,000
Excess fair value over book value $ 31,000
1 Income from ZeldaShare of Zelda’s reported income ($100,000 ´ 30%) $ 30,000Less: Excess allocated to inventories sold in 2009 (9,000)Add: Amortization of excess allocated to overvalued
building $18,000/10 years 1,800Income from Zelda — 2009 $ 22,800
2 Investment balance December 31, 2009Cost of investment $331,000Add: Income from Zelda 22,800Less: Share of Zelda’s dividends ($50,000 ´ 30%) (15,000)Investment in Zelda balance December 31 $338,800
3 Vatter’s share of Zelda’s net assetsShare of stockholders’ equity ($1,000,000 + $100,000 income - $50,000 dividends) ´ 30% $315,000
1 Schedule to allocate fair value — book value differentialsInvestment cost January 1 $1,680,000Book value acquired ($3,900,000 net assets ´ 30%) 1,170,000
Excess fair value over book value $ 510,000
Allocation of excessFair Value — Percent Book Value Acquired Allocation
Inventories $200,000 30% $ 60,000Land 800,000 30% 240,000Buildings — net 500,000 30% 150,000Equipment — net (700,000) 30% (210,000)Bonds payable (100,000) 30% (30,000)Assigned to identifiable net assets 210,000Remainder to goodwill 300,000Excess fair value over book value $ 510,000
2 Income from Tremor for 2009Equity in income ($1,200,000 ´ 30%) $ 360,000Less: Amortization of differentials
Inventories (sold in 2009) (60,000)Buildings — net ($150,000/10 years) (15,000)Equipment — net ($210,000/7 years) 30,000Bonds payable ($30,000/5 years) 6,000
Income from Tremor $ 321,000
3 Investment in Tremor balance December 31, 2009Investment cost $1,680,000Add: Income from Tremor 321,000Less: Dividends ($600,000 ´ 30%) (180,000)Investment in Tremor December 31 $1,821,000
1 Income from StapletonInvestment in Stapleton July 1, 2009 at cost $96,000Book value acquired ($130,000 ´ 60%) 78,000
Excess fair value over book value $18,000
Pauly’s share of Stapleton’s income for 2009($20,000 ´ 1/2 year ´ 60%) $ 6,000
Less: Excess Depreciation ($18,000/10 years ´ 1/2 year) 900Income from Stapleton for 2009 $ 5,100
2 Investment balance December 31, 2009Investment cost July 1 $96,000Add: Income from Stapleton 5,100Less: Dividends ($12,000 ´ 60%) (7,200)Investment in Stapleton December 31 $93,900
Solution P2-7
Dill CorporationPartial Income Statement
for the year ended December 31, 2011
Investment incomeIncome from Larkspur (equity basis) $45,000
Income before extraordinary item 45,000
Extraordinary gainShare of Larkspur’s operating loss carryforward 30,000
1 Investment income — 2011Income from 10% investment:
Share of income ($70,000 ´ 10%) ´ 1 year $7,000Less: Excess depreciation ($20,000 - $15,000) ´ 10% ´ 1 year (500) $ 6,500
Income from 20% investment:Share of income ($70,000 ´ 20%) ´ 1/2 year $7,000Less: Excess depreciation ($50,000 - $47,000) ´ 10% ´ 1/2 year (150) 6,850
Investment income $13,350
2 Prior period adjustment and other journal entries to record additional purchase of Brady stock
The 10% interest is converted to the equity method as of January 1, 2011 with the following entry:
Investment in Brady 4,000Retained earnings 4,000
The adjustment is equal to $50,000 retained earnings increase for 2008 and 2009 times 10% interest, less excess depreciation of $1,000 for 2008 and 2009.
Unrealized gains on available for sale 5,000Valuation allowance - available for sale 5,000This entry reverses the cumulative fair value adjustment made in prior periods. Since the security was available for sale rather than a trading security, the adjustment has had no impact on prior income statements.
Investment in Brady 50,000Cash 50,000
Record the purchase of the additional 20% interest in Brady.
3 Investment in Brady at December 31, 2011Share of Brady’s underlying equity at December 31, 2011* ($290,000 stockholders’ equity ´ 30%) $87,000Add: Unamortized equipment excess on 10% interest 3,000Add: Unamortized equipment excess on 20% interest 2,550Investment account balance December 31 $92,550
* Equity at 1/1/2008 $150,0002008 Net income - Dividedns 20,0002009 Net income - Dividends 30,0002010 net income - Dividends 40,0002011 net income - Dividends 50,000
4 Adjustment for Hazel’s purchase of additional stock from Brady
Hazel increases its investment in Brady account by $70,000, the amount of the additional investment. The new balance of the investment in Brady account will be $162,550.
1 Investment income for 2009Share of reported income ($250,000 ´ 1/2 year ´ 90%) $ 112,500Add: Depreciation on overvalued plant assets
(($500,000 x 90%) / 9 years) ´ 1/2 year 25,000Less: 90% of Undervaluation allocated to inventories (45,000)Income from Sigma — 2009 $ 92,500
2 Investment balance at December 31, 2010Underlying book value of 90% interest in Sigma(Sigma’s December 31, 2010 equity of $2,700,000 ´ 90%) $2,430,000Less: Unamortized overvaluation of plant assets
($50,000 per year ´ 7 1/2 years) (375,000)Investment balance December 31, 2010 $2,055,000
3 Journal entries to account for investment in 2011Cash (or Dividends receivable) 135,000
Investment in Sigma 135,000To record receipt of dividends ($150,000 ´ 90%).
Investment in Sigma 230,000Income from Sigma 230,000To record income from Sigma computed as follows: Provo’s share of Sigma’s reported net income ($200,000 ´ 90%) plus $50,000 amortization of overvalued plant assets.
Check: Investment balance December 31, 2010 of $2,055,000 + $230,000 income from Sigma - $135,000 dividends = $2,150,000 balance December 31, 2011
Alternatively, Sigma’s underlying equity ($2,000,000 paid-in capital + $750,000 retained earnings) ´ 90% interest - $325,000 unamortized excess allocated to plant assets = $2,150,000 balance December 31, 2011.
1 Market price of $12 for Creape’s shares Cost of investment in Tantani (40,000 shares ´ $12) The $40,000 direct costs must be expensed. $ 480,000Book value acquired ($1,000,000 net assets ´ 40%) 400,000
Excess fair value over book value $ 80,000
Allocation of excess Fair Value — Percent
Book Value Acquired AllocationInventories $ 100,000 40% $ 40,000Land 200,000 40% 80,000Buildings — net (200,000) 40% (80,000)Equipment — net 100,000 40% 40,000
Assigned to identifiable net assets 80,000Remainder assigned to goodwill 0
Total allocated $ 80,000
2 Market price of $8 for Creape’s sharesCost of investment in Tantani(40,000 shares ´ $8) Other direct costs are $0 $ 320,000Book value acquired ($1,000,000 net assets ´ 40%) 400,000
Excess book value over fair value $ (80,000)
Excess allocated to Fair Value — Percent
Book Value Acquired AllocationInventories $100,000 40% $40,000Land 200,000 40% 80,000Buildings — net (200,000) 40% (80,000)Equipment — net 100,000 40% 40,000Bargain purchase (160,000)
1 Income from Spandix — 2008Prudy’s share of Spandix’s income for 2008
$40,000 ´ 1/2 year ´ 15% $ 3,000
2 Investment in Spandix balance December 31, 2008Investment in Spandix at cost $ 48,750Add: Income from Spandix 3,000Less: Dividends from Spandix November 1 ($15,000 ´ 15%) (2,250)Investment in Spandix balance December 31 $ 49,500
3 Income from Spandix — 2009Prudy’s shares of Spandix’s income for 2009:
$60,000 income ´ 15% interest ´ 1 year $ 9,000$60,000 income ´ 30% interest ´ 1 year 18,000$60,000 income ´ 45% interest ´ 1/4 year 6,750Prudy’s share of Spandix’s income for 2009 $ 33,750
4 Investment in Spandix December 31, 2009Investment balance December 31, 2008 (from 2) $ 49,500Add: Additional investments ($99,000 + $162,000) 261,000Add: Income for 2009 (from 3) 33,750Less: Dividends for 2009 ($15,000 ´ 45%) + ($15,000 ´ 90%) (20,250)Investment in Spandix balance at December 31 $324,000
Alternative solutionInvestment cost ($48,750 + $99,000 + $162,000) $309,750Add: Share of reported income
2008 — $40,000 ´ 1/2 year ´ 15% $ 3,0002009 — $60,000 ´ 1 year ´ 45% 27,0002009 — $60,000 ´ 1/4 year ´ 45% 6,750 36,750
Note: Since Prudy’s investment in Spandix consisted of 9,000 shares (a 45% interest) on January 1, 2009, Prudy correctly used the equity method of accounting for the 15% investment interest held during 2008. The alternative of reporting income for 2008 on a fair value/cost basis and recording a prior period adjustment for 2009 is not appropriate in view of the overwhelming evidence of an ability to exercise significant influence by the time 2008 income is recorded.
1 Schedule to allocate excess cost over book valueInvestment cost (14,000 shares ´ $13) $10,000 direct costs must be expensed.
$182,000
Book value acquired $190,000 ´ 70% 133,000Excess fair value over book value $ 49,000
Excess allocatedInterest
Fair Value — Book Value ´ Acquired = AllocationInventories $ 50,000 $60,000 70% $ (7,000)Land 50,000 30,000 70% 14,000Equipment — net 135,000 95,000 70% 28,000Remainder to goodwill 14,000
Excess fair value over book value $ 49,000
2 Investment income from Samaritan
Share of Samaritan’s reported income $60,000 ´ 70% $ 42,000Add: Overvalued inventory items 7,000Less: Depreciation on undervalued equipment
($28,000/4 years) ´ 3/4 year (5,250)Investment income from Samaritan $ 43,750
3 Investment in Samaritan account at December 31, 2008
Investment cost $182,000Add: Income from Samaritan 43,750Less: Dividends received (14,000 shares ´ $2) (28,000)Investment in Samaritan balance December 31 $197,750
CheckUnderlying equity at December 31, 2008 ($210,000 ´ 70%)* $147,000Add: Unamortized excess of cost over book value
AN INTRODUCTION TO CONSOLIDATED FINANCIAL STATEMENTS
Answers to Questions
1 A corporation becomes a subsidiary when another corporation either directly or indirectly acquires a controlling financial interest (generally over 50 percent) of its outstanding voting stock.
2 Amounts allocated to identifiable assets and liabilities in excess of recorded amounts on the books of the subsidiary are not recorded separately by the parent. Instead, the parent records the fair value/purchase price of the interest acquired in an investment account. The allocation to identifiable asset and liability accounts is made through working paper entries when the parent and subsidiary financial statements are consolidated.
3 The land would be shown in the consolidated balance sheet at $100,000, its fair value, assuming that the purchase price is equal to or greater than the total fair value of the subsidiary. If the parent had acquired an 80 percent interest and the purchase price was equal to or greater than the fair value of the interest acquired, the land would still appear in the consolidated balance sheet at $100,000. Under SFAS No. 141R, the noncontrolling interest is also reported based on fair values at the acquisition date.
4 Parent company—a corporation that owns a controlling interest in the outstanding voting stock of another corporation (its subsidiary).
Subsidiary company—a corporation that is controlled by a parent company that owns a controlling interest in its outstanding voting stock, either directly or indirectly.
Affiliated companies—companies that are controlled by a single management team through parent-subsidiary relationships. (Although the term affiliate is a synonym for subsidiary, the parent company is included in the total affiliation structure.)
Associated companies—companies that are controlled through parent-subsidiary relationships or whose operations can be significantly influenced through equity investments of 20 percent to 50 percent.
5 A noncontrolling interest is the equity interest in a subsidiary company that is owned by stockholders outside of the affiliation structure. In other words, it is the equity interest in a subsidiary (recorded at fair value) that is not held by the parent company or subsidiaries of the parent company.
6 Under the provisions of FASB Statement No. 94, “Consolidation of All Majority-owned Subsidiaries,” a subsidiary will not be consolidated if control is temporary or if control does not rest with the majority owner, such as in the case of a subsidiary in reorganization or bankruptcy, or when the subsidiary operates under severe foreign exchange restrictions or other governmentally imposed restrictions.
7 Consolidated financial statements are intended primarily for the stockholders and creditors of the parent company, according to SFAS No. 160 (and ARB No. 51).
8 The amount of capital stock that appears in a consolidated balance sheet is the total par or stated value of the outstanding capital stock of the parent company.
9 Goodwill from consolidation may appear in the general ledger of the surviving entity in a merger or consolidation accounted for as an acquisition. But goodwill from consolidation would not appear in the general ledger of a parent company or its subsidiary. Goodwill is entered in consolidation working papers when the reciprocal investment and equity amounts are eliminated. Working paper entries affect consolidated financial statements, but they are not entered in any general ledger.
10 The parent company’s investment in subsidiary does not appear in a consolidated balance sheet if the subsidiary is consolidated. It would appear in the parent company’s separate balance sheet under the heading “investments” or “other assets.” Investments in unconsolidated subsidiaries are shown in consolidated balance sheets as investments or other assets. They are accounted for under the equity method if the parent can exercise significant influence over the subsidiary; otherwise, they are accounted for by the fair value / cost method.
11 Parent’s books: Reciprocal accounts on subsidiary’s books:Investment in subsidiary Capital stock and retained earningsSales PurchasesAccounts receivable Accounts payableInterest income Interest expenseDividends receivable Dividends payableAdvance to subsidiary Advance from parent
12 Reciprocal accounts are eliminated in the process of preparing consolidated financial statements in order to show the financial position and results of operations of the total economic entity that is under the control of a single management team. Sales by a parent to a subsidiary are internal transactions from the viewpoint of the economic entity and the same is true of interest income and interest expense and rent income and rent expense arising from intercompany transactions. Similarly, receivables from and payables to affiliated companies do not represent assets and liabilities of the economic entity for which consolidated financial statements are prepared.
13 The stockholders’ equity of a parent company under the equity method is the same as the consolidated stockholders’ equity of a parent company and its subsidiaries provided that the noncontrolling interest, if any, is reported outside of the consolidated stockholders’ equity. If noncontrolling interest is included in consolidated stockholders’ equity, it represents the sole difference between the parent company’s stockholders’ equity under the equity method and consolidated stockholders’ equity.
14 No. The amounts that appear in the parent company’s statement of retained earnings under the equity method and the amounts that appear in the consolidated statement of retained earnings are identical, assuming that the noncontrolling interest is included as a separate component of stockholders’ equity.
15 Income attributable to noncontrolling interest is not an expense, but rather it is an allocation of the total income to the consolidated entity between controlling and noncontrolling stockholders. From the viewpoint of the controlling interest (the stockholders of the parent company), income attributable to noncontrolling interest has the same effect on consolidated net income as an expense. This is because consolidated net income is income to the parent company stockholders. Alternatively, you can view total consolidated net income as being allocated to the controlling and noncontrolling interests.
16 The computation of noncontrolling interest is comparable to the computation of retained earnings. It is computed:
Noncontrolling interest beginning of the period
XX
Add: Income attributable to noncontrolling interest
XX
Deduct: Noncontrolling interest dividends –XXNoncontrolling interest end of the period XX
17 It is acceptable to consolidate the annual financial statements of a parent company and a subsidiary with different fiscal periods, provided that the dates of closing are not more than three months apart. Any significant developments that occur in the intervening three-month period should be disclosed in notes to the financial statements. In the situation described, it is acceptable to consolidate the financial statements of the subsidiary with an October 31 closing date with the financial statements of the parent with a December 31 closing date.
18 The acquisition of shares held by noncontrolling stockholders does not constitute a business combination. Rather, it must be accounted for as a treasury stock transaction. It is not possible, by definition, to acquire a controlling interest from noncontrolling stockholders.
SOLUTIONS TO EXERCISES
Solution E3-1 Solution E3-2
1 b 1 d2 c 2 b3 d 3 d4 d 4 d5 b 5 a6 a 6 d
7 c
Solution E3-3 [AICPA adapted]
1 c Advance to Hill $75,000 + receivable from Ward $200,000 = $275,000
2 a Goodwill has an indeterminate life and is not amortized.
3 a Owen accounts for Sharp using the equity method, therefore, consolidated retained earnings is equal to Owen’s retained earnings, or $1,240,000.
4 d All intercompany receivables and payables are eliminated.
Solution E3-4
1 Implied fair value of Santa Maria ($900,000 / 90%) $1,000,000Less: Book value of Santa Maria (900,000)Excess fair value over book value $ 100,000Equipment undervalued 30,000 Goodwill at January 1, 2009 $ 70,000 Goodwill at December 31, 2009 = Goodwill from consolidation $ 70,000 Since goodwill is not amortized
2 Consolidated net income
Pinto’s reported net income $490,000Less: Correction for depreciation on excess allocated
to equipment ($30,000/3 years) (10,000)Consolidated net income $480,000
Solution E3-5
1 $600,000, the dividends of Panderman
2 $330,000, equal to $300,000 dividends payable of Panderman plus $30,000 (30% of $100,000) dividends payable to noncontrolling interests of Sadisman.
Total consolidated income 227Less: Noncontrolling interest share [($70 ´ 30%)+ ($6 depreciation x 30%)] (22.8) Controlling interest share of cnsolidated net income $ 204.2
Supporting computations
Depreciation of excess allocated to overvalued equipment:$30/5 years = $6
The capital stock appearing in the consolidated balance sheet at December 31, 2009 is $1,800,000, the capital stock of Poball, the parent company.
2 Goodwill at December 31, 2009
Investment cost at January 2, 2009 (80% interest) $700,000Implied total fair value of Softcan ($700,000 / 80%) $875,000Book value of Softcan(100%) (600,000)Excess is considered goodwill since no other fair value information is given. $275,000
3 Consolidated retained earnings at December 31, 2009
Poball’s retained earnings January 2 (equal to beginning consolidated retained earnings $800,000Add: Net income of Poball (equal to controlling share of consolidated net income) 300,000Less: Dividends declared by Poball (180,000)
Consolidated retained earnings December 31 $920,000
4 Noncontrolling interest at December 31, 2009
Capital stock and retained earnings of Softcan on January 2 $600,000Add: Softcan’s net income 90,000Less: Dividends declared by Softcan (50,000)
Softcan’s stockholders’ equity December 31 640,000Noncontrolling interest percentage 20%
Noncontrolling interest December 31 $128,000
5 Dividends payable at December 31, 2009
Dividends payable to stockholders of Poball $ 90,000Dividends payable to noncontrolling stockholders ($25,000 ´ 20%)
5,000Dividends payable to stockholders outside the Consolidated entity $ 95,000
Paskey Corporation and SubsidiaryPartial Balance Sheetat December 31, 2010
Stockholders’ equity:Capital stock, $10 par $300,000Additional paid-in capital 50,000Retained earnings 65,000 Equity of controlling stockholders 415,000Noncontrolling interest 41,000 Total stockholders’ equity $456,000
Supporting computationsComputation of consolidated retained earnings:Paskey’s December 31, 2009 retained earnings $ 35,000Add: Paskey’s reported income for 2010 55,000Less: Paskey’s dividends (25,000)
Consolidated retained earnings December 31, 2010 $ 65,000
Computation of noncontrolling interest at December 31, 2010Salam’s December 31, 2009 stockholders’ equity $200,000Income less dividends for 2010 ($20,000 - $15,000) 5,000Salam’s December 31, 2010 stockholders’ equity 205,000Noncontrolling interest percentage 20%Noncontrolling interest December 31, 2010 $ 41,000
Peekos Corporation and SubsidiaryConsolidated Income Statement
for the year ended December 31, 2011(in thousands)
Sales $2,100Cost of goods sold 1,100 Gross profit 1,000Deduct: Operating expenses 560 Total consolidated income 440Deduct: Noncontrolling interest share 14 Controlling interest share of consolidated net income $ 426
Supporting computations
Investment cost January 2, 2009 (90% interest) $ 810Implied total fair value of Slogger ($810,000 / 90%) $ 900Slogger’s Book value acquired (100%) (700)
Excess of fair value over book value $ 200
Excess allocated to:Inventories (sold in 2009) $ 30Equipment (4 years remaining use life) 40Goodwill 130
Excess of fair value over book value $ 200
Operating expenses:Combined operating expenses of Peekos and Slogger $ 550Add: Depreciation on excess allocated to equipment ($40,000/4 years) 10 Consolidated operating expenses $ 560
Cost of investment in Softback Books January 1, 2009 $2,700,000Implied fair value of Softback ($2,700,000 / 80%) $3,375,000Book value of Softback 2,500,000 Excess of fair value over book value $ 875,000
Schedule to Allocate Fair Value — Book Value Differential
* After recognizing acquired assets and liabilities at their fair values, we are left with a negative excess of $625,000. Under SFAS No. 141R, this difference is recorded as a gain in the consolidated income statement in the year of acquisition. The gain is attributable entirely to the controlling interest, and is recorded on the parent’s books by a debit to the Investment account and a credit to a Gain from bargain Purchase account. An alternative calculation of this amount takes the difference between the fair values of the net assets ($4,000,000) and their fair value implied by the acquisition price ($3,375,000), which equals $625,000.
Solution P3-4
Noncontrolling interest of $65,000 (it’s fair value) plus $260,000 (fair value of Pharm’s investment) equals total fair value of $325,000. Therefore, Pharm’s interest is 80% ($260,000 / $325,000), and noncontrolling interest is 20% ($65,000 / $325,000).
Total fair value $ 325,000Book value of Specht (260,000)Excess fair value over book value $ 65,000
Excess allocated to
Fair Value - Book ValuePlant assets — net $210,000 - $200,000 $ 10,000Goodwill 55,000 Total $ 65,000
Supporting computationsSorrel’s net income ($400 - $300 - $50) $ 50Less: Excess allocated to inventories that were sold in 2009 (20)Less: Depreciation on excess allocated to plant assets ($40 /4 years) (10)Income from Sorrel $ 20
Plant assets ($500 + $300 + $40 - $10) $ 830
Palmer’s retained earnings:Beginning retained earnings $ 340Add: Operating income 100Add: Income from Sorrel 20Deduct: Dividends (50)Retained earnings December 31, 2009 $ 410
Perry Corporation and SubsidiaryConsolidated Balance Sheet Working Papers
at December 31, 2009(in thousands)
Perryper books
Simper books
Adjustments andEliminations
ConsolidatedBalance Sheet
Cash $ 42 $ 20 $ 62
Receivables — net 50 130 b 9 171
Inventories 350 50 400
Land 150 200 350
Equipment — net 600 100 700
Investment in Sim 459 a 459
Goodwill a 100 100
Total assets $1,651 $ 500 $1,783
Accounts payable $ 410 $ 80 $ 490
Dividends payable 60 10 b 9 61
Capital stock 1,000 300 a 300 1,000
Retained earnings 181 110 a 110 181
Noncontrolling interest a 51 51
Total equities $1,651 $ 500 $1,783
a To eliminate reciprocal investment and equity accounts, record goodwill ($100), and enter noncontrolling interest [($410 equity + $100 goodwill) ´ 10%)].
b To eliminate reciprocal dividends receivable (included in receivables — net) and dividends payable amounts ($10 dividends ´ 90%).
Preliminary computationsCost of 80% investment January 3, 2009 $280,000Implied total fair value of Slender ($280,000 / 80%) $350,000Book value of Slender (250,000)
Excess fair value over book value on January 3 = Goodwill $100,000
1 Noncontrolling interest share of income:Slender’s net income $50,000 ´ 20% noncontrolling interest $ 10,000
2 Current assets:Combined current assets ($204,000 + $75,000) $279,000Less: Dividends receivable ($10,000 ´ 80%) (8,000) Current assets $271,000
3 Income from Slender: None Investment income is eliminated in consolidation.
4 Capital stock: $500,000 Capital stock of the parent, Portly Corporation.
5 Investment in Slender: None The investment account is eliminated.
6 Excess of fair value over book value $100,000
7 Controlling share of consolidated net income: Equals Portly’s net income, or:Consolidated sales $600,000Less: Consolidated cost of goods sold (370,000)Less: Consolidated expenses (80,000)Consolidated net income $150,000Less: Noncontrolling interest share (10,000) Controlling share of consolidated net income $140,000
9 Consolidated retained earnings December 31, 2010Equal to Portly’s ending retained earnings:Beginning retained earnings $200,000Add: Controlling share of consolidated net income 140,000Less: Portly’s dividends for 2010 (60,000)
Ending retained earnings $280,000
10 Noncontrolling interest December 31, 2010Slender’s capital stock and retained earnings $300,000Add: Net income 50,000
Less: Dividends (25,000)Slender’s equity December 31, 2010 at fair value 325,000Noncontrolling interest percentage 20%Noncontrolling interest December 31, 2010 using book value $ 65,000Add: Noncontrolling interest share of Goodwill 20,000Noncontrolling interest December 31, 2010 at fair value $ 85,000
2 Noncontrolling interest December 31, 2009 *Meadow Van
Common stock $50,000 $60,000Capital in excess of par 20,000Retained earnings 40,000 19,000Equity December 31 90,000 99,000Noncontrolling interest percentage 20% 30% Noncontrolling interest December 31 $18,000 $29,700
* Fair value equals book value.
3 Consolidated retained earnings December 31, 2009
Consolidated retained earnings is reported at $304,600, equal to the retained earnings of Todd Corporation, the parent, at December 31, 2009.
4 Investment balance December 31, 2009:Meadow Van
Investment cost January 1 $56,000 $84,000Add (deduct): Income (loss) 28,800 (8,400)Deduct: Dividends received (12,800) (6,300) Investment balances December 31 $72,000 $69,300
Check: Investment balances should be equal to the underlying book value
Preliminary computations (in thousands)Cost of 90% investment January 1, 2009 $3,600Implied total fair value of Snowdrop ($3,600 / 90%) $4,000Book value of Snowdrop (2,700)
Excess fair value over book value on January 1 $1,300Allocation to equipment $ 800Remainder is Goodwill $ 500Additional annual depreciation on equipment ($800 / 8 years) $ 100
Pansy Corporation and SubsidiaryConsolidated Balance Sheet Working Papers
at December 31, 2009(in thousands)
Pansy90%
SnowdropAdjustments and
EliminationsConsolidatedBalance Sheet
Cash $ 300 $ 200 $ 500
Receivables — net 600 400 1,000
Dividends receivable 90 B 90
Inventory 700 600 1,300
Land 600 700 1,300
Buildings — net 2,000 1,000 3,000
Equipment — net 1,500 800 a 700 3,000
Investment in Snowdrop 3,780 a 3,780
Goodwill a 500 500
Total assets $9,570 $3,700 $10,600
Accounts payable $ 300 $ 600 $ 900
Dividends payable 500 100 b 90 510
Capital stock 7,000 2,000 a 2,000 7,000
Retained earnings 1,770 1,000 a 1,000 1,770
Noncontrolling interest a 420 420
Total equities $9,570 $3,700 $10,600
a To eliminate reciprocal investment and equity accounts, enter unamortized excess allocated to equipment, record goodwill, and enter noncontrolling interest (at fair value).
b To eliminate reciprocal dividends receivable and dividends payable amounts.
1 Purchase price of investment in Snaplock (in thousands)
Underlying book value of investment in Snaplock:Equity of Snaplock January 1, 2009 $220Add: Excess investment fair value over book value:
Goodwill at December 31, 2013 60Fair value of Snaplock January 1, 2009 $280
Purchase price of 80% investment at fair value $224
2 Snaplock’s stockholders’ equity on December 31, 2013 (in thousands)
20% noncontrolling interest at fair value $ 6220% goodwill (12)20% noncontrolling interest’s equity at book value $ 50Total equity = Noncontrolling interest’s equity $50 / 20% = $250
3 Pandora’s investment in Snaplock account balance at December 31, 2013(in thousands)Underlying book value in Snaplock December 31, 2013 ($250 ´ 80%) $200Add: 80% of Goodwill December 31, 2013 (20% is attributable to the noncontrolling interest) 48
Investment in Snaplock December 31, 2013 $248
Alternative solution:Investment cost January 1, 2009 $224Add: 80% of Snaplock’s increase since acquisition ($250 - $220) ´ 80% 24Investment in Snaplock December 31, 2013 $248
4 Pandora’s capital stock and retained earnings December 31, 2013(in thousands)Capital stock $400Retained earnings $ 30
Amounts are equal to capital stock and retained earnings shown in the consolidated balance sheet.
Investment balance at January 1, 2009 $ 700Share of Stubb’s retained earnings increase ($60 ´ 70%) 42Less: Amortization
70% of excess allocated to inventories (sold in 2009) (14)70% of excess allocated to plant assets ($80 /8 years) (7)
Investment balance at December 31, 2009 $ 721
Noncontrolling interest at December 3130% of Stubb’s book value at December 31 ($860 x 30%) $25830% of Goodwill 3030% Unamortized excess for plant assets 30% x ($80 - $10 amortization) 21Noncontrolling at December 31 (fair value) $309
Pope Corporation and SubsidiaryConsolidated Balance Sheet Working Papers
Preliminary computations (in thousands)80% Investment in Shasti at cost January 1, 2009 $ 760Implied total fair value of Shasti ($760 / 80%) $ 950Shasti book value 900
Excess fair value over book value recorded as goodwill $ 50
ShastiDividends
ShastiNet Income
80% ofNet Income
2009 $ 40 $ 80 $ 642010 50 100 802011 60 120 96
$150 $300 $240
1 Shasti’s dividends for 2010 ($40 / 80%) $ 50
2 Shasti’s net income for 2010 ($50 dividends ´ 2) $ 100
3 Goodwill — December 31, 2010 $ 40
4 Noncontrolling interest share of income — 2011Shasti’s income for 2011 ($48 dividends received/80%) ´ 2 $ 120Noncontrolling interest percentage 20%
Noncontrolling interest share $ 24
5 Noncontrolling interest December 31, 2011Equity of Shasti January 1, 2009 $ 900Add: Income for 2009, 2010 and 2011 300Deduct: Dividends for 2009, 2010 and 2011 (150)Equity book value of Shasti December 31, 2011 1,050Goodwill 50Equity fair value of Shasti December 31, 2011 $1,100 Noncontrolling interest percentage 20%
Noncontrolling interest December 31, 2011 $ 220
6 Controlling share of consolidated net income for 2011Pendleton’s separate income $ 280Add: Income from Shasti 96
Controlling share of consolidated net income $ 376
Preliminary computations80% Investment in Sidney (cost) January 2, 2010 $300Implied total fair value of Sidney ($300 / 80%) $375Book value of Sidney (100%) (250)
Excess fair value over book value $125
Excess allocated toBuildings (fair value $170 - book value $150) $ 20Remainder to goodwill 105
Excess fair value over book value $125
Part 1
a Total current assetsCash ($50 + $20) $ 70Other current assets ($150 + $80) 230
Total current assets $300
b Plant and equipment net of depreciationLand ($300 + $50) $350Buildings — net ($400 + $150) 550Excess allocated to buildings 20
Plant and equipment — net $920
c Common stockPar value of Peyton’s stock December 31, 2009 $600Add: Par value of shares issued for Sidney 100
Common stock $700
d Additional paid-in capitalAdditional paid-in capital of Peyton December 31, 2009 $ 60Add: Increase from shares issued from Sidney 200
Additional paid-in capital $260
e Retained earningsConsolidated retained earnings = Peyton’s retained earnings December 31, 2009 $140
a Income from Sidney — 2010Sidney’s reported net income $ 40Less: Depreciation on excess — buildings ($20 /5 years) (4)Adjusted Net Income of Sidney $ 36.8
80% of Sidney’s Net Income = Income from Sidney $ 28.8
b Investment in Sidney December 31, 2010Cost January 2 $300Add: Income from Sidney 28.8Less: Dividends from Sidney ($20 ´ 80%) (16)
Investment in Sidney December 31 $312.8
c Controlling share of consolidated net income — 2010Separate income of Peyton $ 90Add: Income from Sidney 28.8
Controlling share of consolidated net income $118.8
d Consolidated retained earnings December 31, 2010Retained earnings of Peyton December 31, 2009 $140Add: Consolidated net income 118.8Less: Peyton’s dividends (50)
Consolidated retained earnings December 31 $208.8
e Noncontrolling interest December 31, 2010Equity of Sidney December 31, 2009 $250Add: Net income 40Less: Dividends (20)Equity book value of Sidney December 31 270Unamortized excess for buildings 16Goodwill 105Equity fair value of Sidney December 31 $391Noncontrolling interest percentage 20%
Noncontrolling interest fair value - December 31 $ 78.2
1 Schedule to allocate the investment fair value — book value differential: (in thousands)80% Investment cost January 2, 2009 $2,760Implied total fair value ($2,760 / 80%) $3,450Book value of interest acquired ($2,300 ´ 80%) (2,300)
Excess fair value over book value $1,150
Excess allocated
Fair Value - Book Value = Allocated
Inventories $ 500 $ 400 $ 100Other current assets 200 150 50Land 600 500 100Buildings — net 1,800 1,000 800Equipment — net 600 800 (200)Other liabilities 560 610 50Remainder to goodwill 250
Total stockholders’ equity 17,190Total liabilities and stockholders’ equity $19,850
* Noncontrolling interestSidney’s equity at book value $2,300Unamortized excess fair value 1,150Sidney’s equity at fair value $3,45020% Noncontrolling interest $ 690
1 Consolidated financial statements are not affected by the method used by the parent company in accounting for its subsidiary investments. Such statements are the same regardless of whether the parent company uses the cost method, the equity method, or an incomplete equity method in accounting for its subsidiary. The working paper adjustments will differ, however, depending on how the parent accounts for its subsidiary.
2 The standard method of accounting for equity investments of 20 percent or more is the equity method. But if the parent issues only consolidated financial statements as the statements of the primary reporting entity, and the consolidated financial statements are correct, it makes no difference how the records of the parent company are maintained. The Financial Accounting Standards Board (and its predecessor organization) established standards for external reporting but not for maintenance of internal accounting records.
3 Under the equity method, a parent amortizes patents from its subsidiary investments by adjusting its subsidiary investment and income accounts. Since patents and patent amortization accounts are not recorded on the parent’s books, they are created for consolidated statement purposes through working paper entries.
4 Noncontrolling interest share is entered in the consolidation working papers by preparing a working paper adjusting entry in which noncontrolling interest share is debited and noncontrolling interest is credited. The noncontrolling interest share (debit) is carried to the consolidated income statement as a deduction, and the credit to noncontrolling interest for noncontrolling interest share is added to the beginning noncontrolling interest. The noncontrolling interest share is calculated based on the subsidiary’s reported net income adjusted to reflect fair value through the amortization of the excess of fair value over book value. This is the approach illustrated throughout this text.
5 Working paper procedures for the investment in subsidiary, income from subsidiary, and subsidiary equity accounts are alike in regard to the objectives of consolidation. Regardless of the configuration of the working paper entries, the final result of adjustments for these items is to eliminate them through working paper entries. In other words, the investment in subsidiary, income from subsidiary, and the capital stock, additional paid-in capital, retained earnings, and other stockholders’ equity accounts of the subsidiary never appear in consolidated financial statements.
6 When the parent company does not amortize fair value/book value differentials on its separate books, the parent company’s income from subsidiary and investment in subsidiary accounts are overstated in the year of acquisition. In subsequent years, the income from the subsidiary, investment in subsidiary, and parent’s beginning retained
By entering a correcting entry, all other working paper entries are the same as if the parent provided for amortization on its separate books.
If the errors are not corrected through the working paper entries suggested above, the entry to eliminate the income from subsidiary in the year of acquisition is prepared in the usual manner without further complications because neither the beginning investment nor retained earnings accounts are affected by the omission. In subsequent years the entry to eliminate income from subsidiary and dividends from subsidiary will have to be changed to correct the beginning-of-the-period retained earnings as follows:
Income from subsidiary XXXRetained earnings — parent XXX
Dividends (subsidiary) XXXInvestment in subsidiary XXX
7 No. Working paper adjustments are not entered in the general ledger of the parent company or any other entity. They are used in the preparation of consolidated financial statements for a conceptual entity for which there are no formal accounting records.
8 Working papers are tools of the accountant that facilitate the consolidation of parent and subsidiary financial statements. Given the tools available, the accountant should select those that are most convenient in the circumstances. If financial statements are to be consolidated, the financial statement approach is the appropriate tool. The trial balance approach is most convenient when the data are presented in the form of a trial balance. The accountant needs to be familiar with both approaches to perform the work as efficiently as possible.
9 Working paper adjustment and elimination entries as illustrated in this text are exactly the same when the trial balance approach is used as when the financial statement approach is used. This is possible through a check-off system that nullifies the closing process when the financial statement approach is used.
10 The retained earnings of the parent company will equal consolidated retained earnings if the equity method of accounting has been correctly applied. In consolidating the financial statements of affiliated companies, the beginning retained earnings of the parent are used as beginning consolidated retained earnings. If the equity method has not been correctly applied, parent beginning retained earnings will not equal beginning consolidated retained earnings. In this case, retained earnings of the parent are adjusted to a correct equity basis in order to establish the correct amount of beginning consolidated retained earnings. Thus, working paper adjustments to beginning retained earnings of the parent are needed whenever the beginning retained earnings of the parent do not correctly reflect the equity method.
11 The noncontroling interest that appears in the consolidated balance sheet can be checked first adjusting the the equity of the subsidiary on the consolidated balance sheet date to fair value (i.e., adjusting for any unamortized excess of fair value over book value) and then multiplying by the noncontrolling interest percentage. Consolidated retained
earnings at a balance sheet date can be checked by comparing the amount with the parent’s retained earnings on the same date. If consolidated retained earnings and parent retained earnings are not equal, either consolidated retained earnings have been computed incorrectly, or parent retained earnings do not reflect a correct equity method of accounting.
12 Consolidated assets and liabilities are reported for all equity holders—noncontrolling as well as controlling. Therefore, the change in net assets from operations for a period results from noncontrolling interest share and consolidated net income.
13 No. It relates to all interests in the consolidated entity. This difference is one of many inconsistencies in the concepts underlying consolidated financial statements. Consider, for example, the error that could result from dividing cash provided by operations by outstanding parent company shares to get a computation of cash flow per share.
SOLUTIONS TO EXERCISES
Solution E4-11 d 6 d2 a 7 b3 a 8 b4 d 9 a5 b 10 b
Solution E4-2Preliminary computationsInvestment cost January 2 $300,000Implied total fair value of Sally Forth ($300,000 / 80%) $375,000Less: Book value (250,000)
Excess fair value over book value $125,000Excess allocated to:Inventory $ 12,500Remainder to goodwill 112,500
Excess fair value over book value $125,000
1 Income from Sally ForthSally Forth’s reported net income $ 70,000Less: Excess allocated to inventory (sold in 2009) (12,500)Sally Forth adjusted income $ 57,500Ponder’s 80% share $ 46,000
Sally Forth’s equity book value $260,000Add: Unamortized excess (Goodwill) 112,500Sally Forth’s equity fair value $372,50020% noncontrolling interest $ 74,500
4 Investment in Sally Forth December 31Investment cost January 2 $300,000Add: Income from Sally Forth (given)* 50,000Less: Dividends ($60,000 ´ 80%) (48,000)
Investment in Sally Forth December 31 $302,000* Assumes this is based on Sally Forth’s adjusted income
5 Consolidated net incomeNoncontrolling interest shareControlling interest share equals Parent NI under equity method.
Preliminary computations for 2 and 3Investment cost on January 1, 2009 $14,000Implied total fair value of Starman ($14,000 / 70%) $20,000Book value of Starman 15,000Excess allocated entirely to Goodwill $ 5,000
2 Primrose’s separate income for 2011 $12,000Loss from investment in Starman ($500 ´ 70%) (350)Controlling share of consolidated net income $11,650
3 Investment cost January 1, 2009 $14,000Add: Share of income less dividends 2009 — 2011
($700 income - $500 dividends) ´ 70% 140Investment balance December 31, 2011 $14,140
Solution E4-4
Preliminary computationsInvestment cost $580,000Implied total fair value of Stine ($580,000 / 80%) $725,000Book value 600,000
Income from Stine 2010 2011 Stine’s reported net income $120,000 $150,000Less: Depreciation of excess allocated to equipment (10,000) (10,000)Less: Amortization of patents (7,500) (7,500)Stine’s adjusted income $102,500 $132,500
Income from Stine (80%) $82,000 $106,000
1a Consolidated net income for 2010Penair’s net income = controlling share of consolidated net income under equity method $340,000
1b Investment in Stine December 31, 2010Cost January 1 $580,000Add: Income from Stine — 2010 82,000Less: Dividends from Stine — 2010 ($80,000 ´ 80%) (64,000)
1d Noncontrolling interest December 31, 2011Stine’s equity book value at acquisition date $600,000Add: Income less dividends for 2010 and 2011 (see note) 100,000Stine’s equity book value at December 31, 2011 700,000Unamortized excess at December 31, 2011 90,000Stine’s equity fair value at December 31, 2011 $790,000Noncontrolling interest percentage 20%
Noncontrolling interest December 31, 2011 $158,000Solution E4-4 (continued)
Note: Stine’s income less dividends:
2010 Net Income $ 1202010 Dividends (80)2011 Net Income 1502011 Dividends (90) Total $ 100
Solution E4-5
1 c2 a3 b4 c5 d
Solution E4-6
Party Corporation and SubsidiaryPartial Consolidated Cash Flows Statement
for the year ended December 31,
Cash Flows from Operating ActivitiesControlling interest share of consolidated net income $75,000
Adjustments to reconcile net income to cash provided by operating activities:Noncontrolling interest share $25,000Undistributed income of equity investees (2,500)Loss on sale of land 5,000Depreciation expense 60,000
Patents amortization 8,000Increase in accounts receivable (52,500)Increase in inventories (22,500)Decrease in accounts payable (10,000) 10,500
Net cash flows from operating activities $85,500
Solution E4-7Prolax Corporation and Subsidiary
Partial Consolidated Cash Flows Statementfor the year ended December 31,
Cash Flows from Operating ActivitiesCash received from customers $322,500Dividends received from equity investees 7,000
Less: Cash paid to suppliers $182,500Cash paid to employees 27,000Cash paid for other operating items 23,500Cash paid for interest expense 12,000 245,000
Preliminary computationsInvestment in Seine (75%) January 1, 2009 $2,400Implied fair value of Seine ($2,400 / 75%) $3,200Book value of Seine (2,400)
Total excess of fair value over book value $ 800Excess allocated:10% to inventories (sold in 2009) $ 8040% to plant assets (use life 8 years) 32050% to goodwill 400
Total excess of fair value over book value $ 800
1 Goodwill at December 31, 2013 (not amortized) $ 400
2 Noncontrolling interest share for 2013Net income ($1,000 sales - $600 expenses) $ 400Less: Amortization of excess Plant assets ($320 / 8 yrs.) (40)Adjusted Seine income $ 36025% Share $ 90
3 Consolidated retained earnings December 31, 2012Equal to Pearl’s December 31, 2012 retained earningsSince this a trial balance, reported retained earnings equals beginning of 2013 retained earnings. $1,670
4 Consolidated retained earnings December 31, 2013Pearl’s retained earnings December 31, 2012 $1,670Add: Pearl’s net income for 2013 1,085Less: Pearl’s dividends for 2013 (500)Consolidated retained earnings December 31 $2,255
5 Consolidated net income for 2013Consolidated sales $5,000Less: Consolidated expenses ($3,785 + $40 depreciation) (3,825)Total consolidated income 1,175Less: Noncontrolling interest share (90)Controlling share of consolidated net income for 2013 $1,085
6 Noncontrolling interest December 31, 2012Seine’s stockholders’ equity at book value $2,400 Unamortized excess after four years: Inventory 0
Plant assets ($320 - $160) 160 Goodwill 400Seine’s stockholders’ equity at fair value $2,96025% Seine’s stockholders’ equity at fair value $ 740
7 Noncontrolling interest December 31, 2013Seine’s stockholders’ equity at book value $2,600 Unamortized excess after five years: Inventory 0 Plant assets ($320 - $200) 120 Goodwill 400Seine’s stockholders’ equity at fair value $3,12025% Seine’s stockholders’ equity at fair value $ 780
2 Palm Corporation and SubsidiaryConsolidated Income Statement
for the year ended December 31, 2009Sales $410,000Less: Cost of goods sold 265,000
Gross profit 145,000Operating expenses 97,000 Total consolidated income 48,000Less: Noncontrolling interest share 4,500 Controlling share of consolidated net income $ 43,500
Palm Corporation and SubsidiaryConsolidated Retained Earnings Statement
for the year ended December 31, 2009Consolidated retained earnings January 1 $ 65,000Add: Controlling share of onsolidated net income 43,500Less: Dividends of Palm (30,000)
Consolidated retained earnings December 31 $ 78,500
Palm Corporation and SubsidiaryConsolidated Balance Sheet
at December 31, 2009AssetsCurrent assets:
Cash $ 60,500Receivables — net 90,000Inventories 44,000 $194,500
Pan Corporation and SubsidiaryConsolidation Working Papers
for the year ended December 31, 2009(in thousands)
Pan Saf 75%Adjustments and
EliminationsConsolidatedStatements
Income StatementSales $400 $100 $500Income from Saf 13.8 a 13.8Cost of sales 250* 50* 300*
Other expenses 97* 26* c 5.6 128.6*
Consolidated Net Income $ 71.4Noncontrolling share f 4.6 4.6*
Controlling shae of NI $ 66.8 $ 24 $ 66.8
Retained EarningsRetained earnings — Pan $180 $180Retained earnings — Saf $ 34 b 34Controlling share of NI 66.8 24 66.8Dividends 50* 16* a 12
f 4* 50*
Retained earnings December 31 $196.8 $ 42 $196.8
Balance SheetCash $ 53 $ 15 $ 68Accounts receivable 86 20 106Dividends receivable from Saf 6 e 6Inventories 95 10 105Note receivable from Pan 5 d 5Land 65 30 95Buildings — net 170 80 250Equipment — net 130 50 180Investment in Saf 181.8 a 1.8
b 180Patents b 56 c 5.6 50.4
$786.8 $210 $854.4
Accounts payable $ 85 $ 10 $ 95Note payable to Saf 5 d 5Dividends payable 8 e 6 2Capital stock, $10 par 500 150 b 150 500Retained earnings 196.8 42 196.8
$786.8 $210
Noncontrolling interest January 1 b 60Noncontrolling interest December 31 f .6 60.6
Saf’s value at acquisitionBook value at December 31, 2009 $192Less: 2009 Net income (24)Add: 2009 Dividends 16Book value on January 1, 2009 $184Fair value of patents 56Saf’s fair value on January 1, 2009 $240
Supporting CalculationsSun’s value at acquisition:Book value at December 31, 2009 $192Less: 2009 Net income (24)Add: 2009 Dividends 16Book value on January 1, 2009 $184
Purchase price of Pal’s 75% share $180Implied fair value of Sun ($180 / 75%) $240Sun’s book value 184Excess allocated to Goodwill $ 56Noncontrolling interest (25% x $240) $ 60
Saf’s Adjusted IncomeSaf’s net income $24Less: Amortization of Goodwill (0) Saf’s adjusted income $24Pan’s 75% share $18Noncontrolling interest 25% share $ 6
Solution P4-5
Preliminary computations
Allocation of excess fair value over book valueCost of 70% interest January 1 $490,000Implied fair value of Soul ($490,000 / 70%) $700,000Book value of Soul (600,000)
Excess fair value over book value $100,000Noncontrolling interest – 30% of fair value at acquisition $210,000
Excess allocatedUndervalued inventory items sold in 2009 $ 5,000Undervalued buildings (7 year life) 14,000Undervalued equipment (3 year life) 21,000Patents 40,000
Remainder to Goodwill 20,000Excess fair value over book value $100,000
Calculation of income from SoulSoul’s net income $100,000Less: Undervalued inventories sold in 2009 (5,000)Less: Additional Depreciation on building ($14,000/7 years) (2,000)Less: Additional Depreciation on equipment ($21,000/3 years) (7,000)
Investment cost (13,500 shares ´ $15) $202,500Implied fair value of Syn ($202,500 / 90%) $225,000Book value of Syn 165,000
Excess fair value over book value $ 60,000
Excess allocated toLand $ 20,000Remainder to patents 40,000
Excess fair value over book value $ 60,000
Income from SynSyn’s reported net income $ 24,000Less: Patents amortization (4,000)Syn’s adjusted income $ 20,000
Pen’s share of Syn’s income (90%) $ 18,000Noncontrolling interest share (10%) $ 2,000
Investment in Syn December 31, 2010Cost January 1, 2009 $202,500Pen’s share of the change in Syn’s retained earnings ($42,000 - $15,000) ´ 90% 24,300Less: Pen’s share (90%) of Patents amortization for 2 years (7,200)
Allocation of excess fair value over book valueCost of 70% interest January 1 $490,000Implied fair value of Sol ($490,000 / 70%) $700,000Book value of Sol (600,000)
Excess fair value over book value $100,000
Excess allocatedUndervalued inventory items sold in 2009 $ 5,000Undervalued buildings (7 year life) 14,000Undervalued equipment (3 year life) 21,000Remainder to goodwill 60,000Excess fair value over book value $100,000
Calculation of income from SolSol’s reported net income $100,000Less: Undervalued inventories sold in 2009 (5,000)Less: Depreciation on building ($14,000/7 years) (2,000)Less: Depreciation on equipment ($21,000/3 years) (7,000)Adjusted income from Soul $ 86,000Par’s 70% controlling share $ 60,20030% Noncontrolling interest share $ 25,800
Working paper entries for 2009a Income from Sol 60,200
Dividends (Sol) 35,000Investment in Sol 25,200
b Capital stock (Sol) 500,000Retained earnings (Sol) - January 1 100,000Unamortized excess 100,000
Investment in Sol 500,000Noncontrolling interest - January 1 200,000
c Cost of sales (for inventory items) 5,000Buildings — net 14,000Equipment — net 21,000Goodwill 60,000
Investment cost (13,500 shares ´ $15) $202,500Implied fair value of Son ($202,500 / 90%) $225,000Book value of Son 165,000
Excess fair value over book value $ 60,000
Excess allocated toLand $ 20,000Remainder to goodwill 40,000
Excess fair value over book value $ 60,000
Income from SonPun’s share of Son’s income ($24,000 ´ 90%) $ 21,600
Investment in Son December 31, 2010Cost January 1, 2009 $202,500Pun’s share of the change in Son’s retained earnings ($42,000 - $15,000) ´ 90% 24,300Investment in Son December 31 $226,800
Noncontrolling interest at December 31, 2010 (10% of fair value)(($225,000 + $42,000 - $15,000) x 10%)
Supporting computationsInvestment cost January 1, 2009 $210,000Implied fair value of Sel ($210,000 / 80%) $262,500Book value of Sel 200,000Excess fair value over book value $ 62,500Excess allocated:
Undervalued inventory $ 12,500Undervalued equipment 25,000Remainder to patents 25,000
Supporting computationsInvestment cost January 1, 2009 $210,000Implied fair value of Seldane ($210,000 / 80%) $262,500Book value of Seldane 200,000Excess fair value over book value $ 62,500Excess allocated:
Undervalued inventory $ 12,500Undervalued equipment 25,000Remainder to goodwill 25,000
Excess fair value over book value $ 62,500
Income from SeldaneSeldane’s reported net income $ 40,000Less amortization of excess fair value: Inventory (12,500) Depreciation ($25,000 / 5 years) ( 5,000)Seldane’s adjusted income $ 22,500
Preliminary computationsInvestment cost $240,000Implied fair value Sci ($240,000 / 80%) $300,000Book value of Sci 225,000
Excess fair value over book value $ 75,000
Allocation of differentialPlant assets $ 50,000Goodwill 25,000Excess fair value over book value $ 75,000
AmortizationPlant assets $50,000/4 years = $12,500 per year
Investment account balance at December 31, 2010Underlying book value $290,000Add: Unamortized excess allocated to plant assets ($50,000 - $25,000 depreciation) 25,000Add: Unamortized goodwill 25,000Fair value of Sci at December 31 $340,000Investment account balance at December 31 (80%) $272,000Noncontrolling interest at December 31 (20%) $ 68,000
The investment account balance is overstated at $280,000 forthe $8,000 dividend receivable.
Supporting computationsInvestment cost January 1, 2009 $ 80,000Implied fair value of Ski ($80,000 / 80%) $100,000Book value of Ski 90,000
Excess fair value over book value $ 10,000
Excess allocated toInventory (sold in 2009) $ 1,000Machinery (4-year remaining use life) 4,000Intangibles (40-year amortization period) 5,000
Excess fair value over book value $10,000
Income from Ski for 2009Ski’s net income $ 15,000Less: Excess allocated to inventories (1,000)Less: Amortization of excess allocated to machinery ($4,000/4 years) (1,000)Less: Amortization of intangibles ($5,000/40 years) (125)Ski’s adjusted income for 2009 $ 12,875
Income from Ski for 2010Ski’s net income $ 20,000Less: Amortization of excess allocated to machinery ($4,000/4 years) (1,000)Less: Amortization of intangibles ($5,000/40 years) (125)Ski’s adjusted income for 2010 $ 18,875
Note: Since the prior year’s income is not affected by the current year’s error of omission, the working papers for 2010 are easier to prepare without an additional conversion-to-equity entry.
Fair value of Simple January 5, 2009 $110,000Add: 90% of change in retained earnings from January 5, 2009 to December 31, 2011 50,000Less: Amortization of excess
Allocated to inventories and amortized in 2009 (10,000)Allocated to patents and amortized over 10 years ($20,000/10 years) ´ 3 years (6,000)
Fair value at December 31, 2011 144,000Add: Income from Simple for 2012 18,000Less: Dividends in 2012 (10,000)Fair value at December 31, 2012 $152,000
Investment in Simple on December 31, 2011 (90% fair value) $129,600Investment in Simple on December 31, 2012 (90% fair value) $136,800Noncontrolling interest on Dec. 31, 2011 (10% fair value) $ 14,400Noncontrolling interest on Dec. 31, 2012 (10% fair value) $ 15,200
Noncontrolling interest share($18,000 adj. inc. x 10%) d 1,800 1,800*
Controlling share of NI $ 41,200 41,200
Consolidated retained earnings $ 92,800 92,800
Noncontrolling interest Dec 31, 2012 d 800 15,200
$478,000* Deduct
a To eliminate income from subsidiary and dividends received and reduce the investment account to its beginning-of-the-period balance.
b To eliminate reciprocal investment and subsidiary equity amounts, establish beginning noncontrolling interest, and adjust patents for the unamortized excess as of the beginning of the period.
c To amortize excess allocated to patents for 2012.d To enter noncontrolling interest share of subsidiary income and dividends.
Cash 18,000To record purchase of 90% of Super’s stock for cash.
July 1, 2009Investment in Ellen (25%) 7,000
Cash 7,000To record purchase of 25% of Ellen’s stock for cash.
November 2009Cash 2,700
Investment in Super (90%) 2,700To record receipt of 90% of Super’s $3,000 dividends.
November 2009Cash 1,250
Investment in Ellen (25%) 1,250To record receipt of 25% of Ellen’s $5,000 dividends.
December 31, 2009Investment in Super (90%) 4,500
Income from Super 4,500To record Share of Super’s reported income ($28,000 - $23,000) ´ 90%
December 31, 2009Investment in Ellen (25%) 700
Income from Ellen 700To record investment income from Ellen for 2009 computed as:Share of Ellen’s reported income $ 750($30,000-$24,000)´1/2 year ´ 25%Less: Amortization of excess [$7,000 – ($24,000 ´ 25%)] ¸ 10 years ´ 1/2 year (50)
Partial consolidated statement of cash flows using the direct methodPillory Corporation and Subsidiaries
Partial Consolidated Statement of Cash Flowsfor the current year
Cash Flows from Operating ActivitiesCash received from customers $1,600,000Dividends from equity investees 40,000Interest received from short-term loan 5,000Cash paid for other expenses (450,000)Cash paid to suppliers (630,000) Cash flow from operating activities $ 565,000
Pesek Corporation and SubsidiaryConsolidated Statement of Cash Flowsfor the year ended December 31, 2011
Cash Flows from Operating ActivitiesCash received from customers $670,000Cash paid to suppliers $348,000Cash paid for operating expenses 157,500 (505,500)Net cash flows from operating activities 164,500
Cash Flows from Investing ActivitiesPurchase of equipment (125,000)Net cash flows from investing activities (125,000)
Cash Flows from Financing ActivitiesPayment of cash dividends — controlling (36,000)Payment of cash dividends — noncontrolling (2,000)Payment of long-term liabilities (11,000)Net cash flows from financing activities (49,000)
Decrease in cash for the year (9,500)Cash on January 1 65,000Cash on December 31 $ 55,500
Reconciliation of net income to cash provided by operating activities
Controlling share of NI $130,000Adjustments to reconcile net income to cash provided by operating activities:
Noncontrolling interest share $ 5,000Depreciation expense 51,000Patents amortization 500Increase in accounts payable 22,000Increase in accounts receivable (5,000)Increase in inventories (20,000)Increase in other current assets (19,000) 34,500Net cash flows from operating activities $164,500
Pesek Corporation and SubsidiaryConsolidated Statement of Cash Flowsfor the year ended December 31, 2011
Cash Flows from Operating ActivitiesControlling share of NI $130,000Noncontrolling interest share 5,000 $135,000Noncash expenses, revenue, gains and losses included in income:
Depreciation $ 51,000Patents amortization 500Increase in accounts receivable (5,000)Increase in inventories (20,000)Increase in other current assets (19,000)Increase in accounts payable 22,000 29,500
Net cash flows from operating activities 164,500Cash Flows from Investing Activities
Purchase of equipment (125,000)Net cash flows from investing activities (125,000)
Cash Flows from Financing ActivitiesPayment of cash dividends — controlling (36,000)Payment of cash dividends — noncontrolling (2,000)Payment of long-term liabilities (11,000)Net cash flows from financing activities (49,000)
Decrease in cash for the year (9,500)Cash on January 1 65,000Cash on December 31 $ 55,500
Note: The cash flows from investing activities and cash flows from financing activities sections of the statement of cash flows are the same under the direct and indirect method.
Push, Inc. and SubsidiaryStatement of Cash Flows (Indirect Method)
for the year ended December 31, 2009
Cash Flows from Operating ActivitiesControlling share of NI $ 198,000Adjustments to reconcile net income to cash provided by operating activities:
Noncontrolling interest share $ 33,000Depreciation expense 82,000Patents amortization 3,000Decrease in accounts receivable 22,000Increase in accounts payable 121,000Increase in deferred income taxes 12,000Increase in inventories (70,000)Gain on marketable equity securities (11,000)Gain on sale of equipment (6,000) 186,000
Net cash flows from operating activities 384,000Cash Flows from Investing Activities
Purchase of equipment $(127,000)Proceeds from sale of equipment 40,000
Net cash flows from investing activities (87,000)Cash Flows from Financing Activities
Cash received from sale of treasury stock 44,000Payment of cash dividends — controlling (58,000)Payment of cash dividends — noncontrolling (15,000)Payment on long-term note (150,000)
Net cash flows from financing activities (179,000)Increase in cash for the year 118,000Cash on January 1 195,000Cash on December 31 $ 313,000
Listing of non-cash investing and financing activities:
Issued common stock in exchange for land with a fair value of $215,000.
Pilgrim Corporation and SubsidiaryConsolidated Statement of Cash Flowsfor the year ended December 31, 2010
Cash Flows from Operating ActivitiesCash received from customers $2,390,000Cash received from equity investees 30,000Cash paid to suppliers $1,433,000Cash paid for operating expenses 460,000 (1,893,000)
Net cash flows from operating activities 527,000Cash Flows from Investing Activities
Purchase of equipment $ (500,000)Net cash flows from investing activities (500,000)Cash Flows from Financing Activities
Cash received from long-term note $ 200,000Payment of cash dividends — controlling (137,000)Payment of cash dividends — noncontrolling (20,000)
Net cash flows from financing activities 43,000Increase in cash for the year 70,000Cash on January 1 360,000Cash on December 31 $ 430,000
Reconciliation of net income to cash provided by operating activitiesControlling share of NI $ 500,000Adjustments to reconcile net income to cash provided by operating activities:
Noncontrolling interest share $ 40,000Income less dividends — equity investee (30,000)Depreciation expense 200,000Patents amortization 10,000Increase in accounts payable 17,000Increase in accounts receivable (210,000) 27,000
Net cash flows from operating activities $ 527,000
1 Profits and losses on sales between affiliated companies are realized for consolidated statement purposes when the purchasing affiliate resells the merchandise to parties outside of the consolidated entity. If all merchandise sold to affiliates is resold to outside parties in the same period, there will be no unrealized profit to eliminate in preparing the consolidated financial statements.
2 Gross profit, rather than net profit, is the concept that should be used in computing unrealized inventory profits according to SFAS No. 160 (This treatment was also prescribed by ARB No. 51).
3 The amount of unrealized profit to be eliminated in the preparation of consolidated financial statements is not affected by the existence of a noncontrolling interest. All unrealized profit must be eliminated. In the case of upstream sales, however, the unrealized profit should be allocated between controlling and noncontrolling interests.
4 The elimination of intercompany sales and purchases does not affect consolidated net income. This is because equal amounts are deducted from sales and cost of sales and the net effect on consolidated net income is nil. The importance of the elimination lies in a correct statement of consolidated sales and cost of sales.
5 Consolidated working capital is not affected by the elimination of intercompany accounts receivable and accounts payable balances. Since equal amounts are deducted from current assets and current liabilities, the effect on the computation "current assets less current liabilities" is nil.
6 Upstream sales are sales from subsidiary to parent company. Downstream sales are sales from parent company to subsidiary. The importance of this designation lies in the fact that the profit or loss on such transactions is the selling affiliate's profit or loss. In the case of unrealized profit or loss on downstream sales, all the profit or loss is assigned to the parent company-seller. But unrealized profit or loss on upstream sales is profit or loss of the subsidiary-seller and is assigned to the parent company and noncontrolling interest in relation to their proportionate holdings.
7 Yes. If unrealized profits are not eliminated at year end, consolidated net income will be overstated. The ending inventory of one year becomes the beginning inventory of the next year, and unrealized profits in the beginning inventory will understate consolidated net income. The analysis of the effect of unrealized inventory profits on consolidated net income is basically the same as the analysis for inventory errors. Like inventory errors,
errors in eliminating unrealized profits are self-correcting over any two accounting periods. Consolidated net income for 2011 is not affected.
8 The noncontrolling interest share is affected by upstream sales if the merchandise has not been resold by the parent company to outside parties by the end of the accounting period. This is because the noncontrolling interest share is based on the income of the subsidiary. If the subsidiary has unrealized profit from intercompany sales, its realized income will be less than its reported income. The noncontrolling interest share should be based on the realized income of the subsidiary.
9 A parent company's investment income and investment accounts are adjusted for unrealized profits on intercompany sales to subsidiaries in accordance with the one-line consolidation concept. The parent company reduces its investment and investment income accounts for the full amount of the unrealized profits in the year of intercompany sale. When the goods are sold to outside parties by the subsidiary, the profits of the parent company are realized and the parent company increases its investment and investment income accounts.
10 Combined cost of goods sold is overstated when there are unrealized profits in the beginning inventory and understated when there are unrealized profits in the ending inventory. The elimination of unrealized profits in the beginning inventory reduces (credits) cost of goods sold and the elimination of unrealized profits in the ending inventory increases (debits) cost of goods sold.
11 The effect of unrealized profits on consolidated cost of goods sold is not affected either by a noncontrolling interest or by the direction of the intercompany sales. All unrealized profit from both upstream and downstream sales is eliminated from consolidated cost of goods sold.
12 Unrealized profit in the beginning inventory is reflected in an overstatement of cost of sales and is eliminated by reducing (crediting) cost of sales and debiting the investment account if a correct equity method has been used and the intercompany sales are downstream. In the case of upstream sales, cost of sales is credited and the noncontrolling interest and the investment account are debited proportionately. When the parent company does not adjust its investment account for unrealized profits from intercompany sales, the above debits to the investment account would be to retained earnings.
13 There are two equally good approaches for computing noncontrolling interest share when there are unrealized profits from upstream sales in both beginning and ending inventories. One approach is to compute realized income of the subsidiary by adding unrealized profits in the beginning inventory to reported subsidiary net income and deducting unrealized profits in the ending inventory. The noncontrolling interest share is then equal to the realized income of the subsidiary multiplied by the noncontrolling interest percentage.
The other approach is to compute the noncontrolling interest percentage in reported subsidiary net income, in unrealized profits in beginning inventory, and in unrealized profits in ending inventory. Noncontrolling interest share is then computed by adding the noncontrolling interest percentage in unrealized profits in the beginning inventory to the noncontrolling interest share of reported income, and subtracting the noncontrolling interest percentage relating to the unrealized profits in the ending inventory.
14 The assumption that unrealized profits in an ending inventory are realized in the succeeding period is a convenience, but it does not result in incorrect measurements of consolidated net income as long as the unrealized profits at any statement date are correctly determined. This is because any unrealized profits in beginning inventory that
are considered realized are credited to cost of sales. The same items will appear as unrealized profits in the ending inventory if they remain unsold, and the elimination of these items results in debiting cost of sales for the same amount. Thus, the working paper effects are offsetting as illustrated in the following working paper entries, which assume $5,000 unrealized profits from downstream sales.
Investment in subsidiary (retained earnings) 5,000Cost of sales 5,000
To eliminate unrealized profit in beginning inventory.
Cost of sales 5,000
Inventory 5,000
To eliminate unrealized profit in ending inventory.
2 cUnrealized profits from intercompany sales with Kent are eliminated from the ending inventory: $320,000 combined current assets less $12,000 unrealized profit ($60,000 ´ 20%).
3 cCombined cost of sales of $750,000 less $250,000 intercompany sales
Solution 5-3
1 dPhilly's separate income (in thousands) $1,000Add: Share of Silvio's income ($500 ´ 100%) 500
Add: Realization of profit deferred in 2009
$1,500 - ($1,500/150%) 500
Less: Unrealized profit in 2010 inventory
$1,200 - ($1,200/150%) (400)
Controlling share of consolidated net income $1,600
Note: The excess fair value over book value is fully amortized. Therefore, the investment balance of $3,264,000 plus the noncontrolling interest of $2,176,000 is equal to the $5,440,000 realized equity at the balance sheet date.
Unrealized profit in ending inventory ($48,000 ´ 1/4) = $12,000
Seal's income of $100,000 plus $20,000 profit in beginning inventory, less $12,000 profit in ending inventory, and less $6,000 patents amortization equals $102,000 income from Seal.
Preliminary computationsInvestment cost $270,000Implied fair value of San ($270,000 / 90%) $300,000
Less: Book value of San 250,000Goodwill $ 50,000
Upstream salesUnrealized profit in December 31, 2011 inventory of Po $28,000 - ($28,000 ¸ 1.4) = $8,000Unrealized profit in December 31, 2012 inventory of Po $42,000 - ($42,000 ¸ 1.4) = $12,000
Income from SanSan's reported net income $100,000Less: Unrealized profit in ending inventory (12,000)
Add: Unrealized profit in beginning inventory 8,000
San’s adjusted and realized income $ 96,000
Po’s 90% controlling interest share of San’s income $ 86,40010% noncontrolling interest share of San’s income $ 9,600
Investment balanceInitial investment cost $270,000Increase in San's net assets from December 31, 2009
to December 31, 2012 ($70,000 ´ 90%) 63,000
Unrealized profit in December 31, 2012 inventory (90%) (10,800)
Answers to Questions1 The objective of eliminating the effects of intercompany sales of plant assets is to reflect
plant assets and related depreciation amounts in the consolidated financial statements at cost to the consolidated entity.
2 Consolidation procedures for eliminating unrealized profit on plant assets are affected by the direction of the sale. The full amount of unrealized profit or loss on downstream sales (parent to subsidiary) is charged or credited to the controlling interest. In the case of upstream sales, however, unrealized profit or loss is allocated between controlling and noncontrolling interests. Because there is no allocation to noncontrolling interests in the case of a 100 percent owned subsidiary, consolidation procedures are the same for upstream sales as for downstream sales.
3 Unrealized gains and losses from intercompany sales of land are realized from the viewpoint of the selling affiliate when the purchasing affiliate resells the land to parties outside the consolidated entity. This is also the point at which the consolidated entity recognizes gain or loss on the difference between the selling price to outside parties and the cost to the consolidated entity.
4 Noncontrolling interest share is not affected by downstream sales of land because the realized income of the subsidiary is not affected by downstream sales. In the case of upstream sales of land, the reported income of the subsidiary is adjusted downward for
unrealized profits and upward for unrealized losses to determine realized income. Since noncontrolling interest share is computed on the basis of realized subsidiary income, the computation of noncontrolling interest share is affected by upstream sales of land.
5 Consolidation procedures are designed to eliminate 100 percent of all unrealized profit or loss on all intercompany transactions. The issue is not whether 100 percent of the unrealized profit or loss is eliminated, but if the amount eliminated is allocated between controlling and noncontrolling interests. In the case of an upstream sale of land, 100 percent of the unrealized profit from the sale is eliminated, but the amount is allocated between controlling and noncontrolling interests in relation to their ownership holdings.
6 Unrealized gains and losses from intercompany sales of depreciable assets are realized through use if the assets are held within the consolidated entity and through sale if the assets are sold to outside parties. The process of recognizing previously unrealized gains and losses through use is a piecemeal recognition over the remaining use life of the depreciable asset.
7 The computation of noncontrolling interest share in the year of an upstream sale of depreciable plant asset is as follows:
Unrealized UnrealizedGain on Sale Loss on Sale
Income of subsidiary as reported XXX XXXDeduct: Gain on sale of plant assets - XXAdd: Loss on sale of plant assets + XXAdd: Piecemeal recognition of gain on sale of plant assets + XDeduct: Piecemeal recognition of loss on sale of plant assets - XRealized subsidiary income XXX XXXNoncontrolling nterest percentage X% X%Noncontrolling interest share XXX XXX
8 The effects of unrealized gains on intercompany sales of plant assets are charged against the parent company’s income from subsidiary account in the year of the intercompany sale, with equal amounts being deducted from the investment in subsidiary account. In subsequent years, the income from subsidiary and investment in subsidiary accounts are increased for depreciation on the unrealized gain that is recorded on the subsidiary books for downstream sales or for the parent’s proportionate share for upstream sales. If the unrealized gain relates to land, no entries are needed until the land is sold to entities outside of the affiliation structure.
9 Accounting procedures are designed to eliminate the effects of intercompany sales of plant assets on both parent company income and consolidated net income until the gains and losses on such sales are realized through use or through sale to outside parties. In years subsequent to intercompany sales of depreciable plant assets, the effect on parent company income is eliminated by adjusting depreciation expense to a cost basis for the consolidated entity.
10 Consolidation working paper entries to eliminate the effect of a gain on sale of depreciable plant assets from a downstream sale are illustrated as follows:
Year of saleGain on saleAccumulated depreciation
Depreciation expensePlant assets
To reduce plant assets and related depreciation amounts to a cost basis to the consolidated entity and to eliminate unrealized gain on intercompany sale.
Subsequent yearsInvestment in subsidiaryAccumulated depreciation
Depreciation expensePlant assets
To reduce plant assets and related depreciation amounts to a cost basis to the consolidated entity and to adjust the investment account for unrealized profits at the beginning of the current year.
1 Parsen’s income from Samit will be decreased by $25,000 as a result of the following entry:
Income from Samit 25,000Investment in Samit 25,000
To eliminate unrealized gain on downstream sale of land.
Parsen’s net income for 2012 will not be affected by the sale since the $25,000 gain will be offset by a $25,000 decrease in income from Samit. The investment in Samit account at December 31, 2012 will be $25,000 less as a result of the sale as indicated by the above entry. (The total balance sheet effect is to reduce land to its cost, reduce the investment account for the profit, and increase cash or other assets for the proceeds.)
2 The consolidated financial statements will not be affected because the gain on the sale is eliminated in the consolidated income statement and the land is reduced to its cost basis to the consolidated entity. A working paper adjustment would show:
Gain on sale of land 25,000Land 25,000
3 Neither Parsen’s income from Samit or net income for 2013 will be affected by the 2012 sale of land. The investment in Samit account, however, will still be $25,000 less than if the land had not been sold, even though there are no changes in the investment account during 2013.
4 The sale of the land will not affect Samit’s net income since it is being sold at Samit’s cost. However, the sale triggers recognition of the postponed gain on the original sale from Parsen to Samit.
Investment in Samit 25,000Income from Samit 25,000
To recognize the gain deferred in 2006.
Consolidated income will also feel the same impact of the recognition of the deferred gain.
Investment in Samit 25,000Gain on sale of land 25,000
Gain on sale of land (10,000) ---Consolidated net income $ 362,000 $ 454,000
1b Noncontrolling interest share
Silverman’s net income ´ 10% $ 8,000 $ 6,000
2a Consolidated net income
Pruitt’s separate income $ 300,000 $ 400,000Add: Equity in Silverman’s income 72,000 54,000Less: Gain on land ´ 90% (9,000) ---Consolidated net income $ 363,000 $ 454,000
2b Noncontrolling interest share
Silverman’s net income ´ 10% $ 8,000 $ 6,000Less: Gain on land ´ 10% (1,000) ---Noncontrolling interest share $ 7,000 $ 6,000
Solution E6-4
1 Entries for 2009
Cash 90,000Investment in Salmark 90,000
To record dividends received from Salmark.
Investment in Salmark 108,000Income from Salmark 108,000
To record income from Salmark computed as follows:Share of Salmark’s reported income ($150,000 ´ 90%) $ 135,000Less: Gain on building sold to Salmark (30,000)Add: Piecemeal recognition of gain on building ($30,000/10 years) 3,000Income from Salmark $ 108,000
1 dThe equipment must be shown at its $1,400,000 book value to the consolidated entity and d is the only choice that provides a $1,400,000 book value. Ordinarily, the equipment would be shown at $1,500,000, its book value at the time of transfer, less the $100,000 depreciation after transfer.
2 cReciprocal receivables and payables accounts and purchases and sales accounts must always be eliminated. But dividend income (parent) and dividends paid (subsidiary) accounts are reciprocals only when the cost method is used.
3 aAmount to be eliminated from consolidated net income in 2009:Intercompany gain on downstream sale of machinery $10,000Less: Realized through depreciation of intercompany gain on machinery ($10,000/5 years) (2,000)
Decrease in consolidated net income from intercompany sale
$ 8,000
Amount to be added to consolidated net income in 2010 for realization through depreciation of intercompany gain on machinery $ 2,000
4 bOne-third of the unrealized intercompany profit is recognized through depreciation for 2009.
Solution E6-6
1 aSelling price in 2017 $ 55,000Cost to consolidated entity 15,000
Gain on sale of land $ 40,000
2 bGain on equipment $ 30,000 Less: Depreciation on gain (10,000)
Net effect on investment account $ 20,000 The investment account will be $20,000 less than the underlying equity interest.
3 bCombined equipment — net $ 800,000 Less: Unrealized gain (20,000)Add: Piecemeal recognition of gain 5,000
4 bThe working paper entry to eliminate the unrealized profit is:Gain on sale of equipment 1,500
Equipment 1,500
5 cInvestment income will be decreased by $12,000 gain less $3,000 piecemeal recognition of the gain.
6 cSartin’s net income $1,000,000 Less: Unrealized gain (50,000)Add: Piecemeal recognition 5,000 Realized income 955,000 Noncontrolling interest percentage 40%
Noncontrolling interest share $ 382,000
Solution E6-7
Pod Corporation and SubsidiaryConsolidated Income Statement
for the year ended December 31, 2009
Sales ($500,000 + $300,000) $800,000Gain on sale of machinerya 20,000
Total revenue 820,000
Cost of sales ($200,000 + $130,000) 330,000Depreciation expense ($50,000 + $30,000 - $5,000 from depreciation on intercompany profit for 2009) 75,000Other expenses ($80,000 + $40,000) 120,000
Total expenses 525,000Consolidated net income $295,000Noncontrolling share ($100,000+$5,000 piecemeal recognition from depreciation + $10,000 remaining deferred gain) ´ 25% noncontrolling interest 28,750
Controlling interest share $266,250
a Selling price of machinery at December 28, 2009 $ 36,000Book value on Pod’s books $65,000 – ($65,000/5 years ´ 3 years) 26,000
Gain on sale of machinery $ 10,000
Original intercompany profit $ 25,000Piecemeal recognition of gain $25,000/5 years ´ 3 years 15,000
Unamortized gain from intercompany sales $ 10,000
Gain on sale of machinery to outside entity $ 20,000
Solution E6-8Preliminary computations:Investment in Salt (40%) at cost $100,000 Implied total fair value of Salt ($100,000 / 40%) $250,000Book value (200,000)
Excess allocated to patents $ 50,000 Annual amortization of patents ($50,000/5 years) $ 10,000
1 Income from Salt — 2009
Share of Salt’s net income ($40,000 ´ 1/2 year ´ 40%) $ 8,000 Amortization of patents ($10,000 ´ 1/2 year ´ 40%) (2,000)Unrealized inventory profit from upstream sale ($4,000 ´ 40%) (1,600)Unrealized gain from downstream sale of land ($2,000 ´ 100%) (2,000)
Salt’s net income $ 60,000 Amortization of patents (10,000)Unrealized inventory profits from upstream sales:
Recognition of profit in beginning inventory 4,000 Deferral of profit in ending inventory (6,000)
Salt’s adjusted and realized income $ 48,000Income from Salt (40% share) $ 19,200
Solution E6-9
1 Income from Simple, net income and consolidated net income:Simple’s reported net income $100,000 Less: Amortization of excess allocated to buildings ($500,000 - $400,000)/20 years (5,000)Less: $20,000 unrealized profit on equipment (20,000)Simple’s adjusted and realized income $ 75,000
Income from Simple (80% share) — 2011 $ 60,000 Add: Separate income of Plain for 2011 500,000
Net income of Plain — 2011 $560,000
Simple’s reported net income $110,000
Less: Amortization of excess allocated to buildings (5,000)Add: Piecemeal recognition of unrealized gain on equipment ($20,000/4 years) 5,000 Simple’s adjusted and realized income $110,000
Income from Simple (80%) — 2012 $ 88,000
Add: Separate income of Plain 600,000 Net income of Plain — 2012 $688,000
Consolidated net income for 2011 and 2012 = Plain’s net incomeAlternatively, 2011 2012 Separate incomes combined $600,000 $710,000 Less: Amortization of excess (buildings) (5,000) (5,000)Less: Unrealized gain on equipment in 2011 (20,000)Add: Piecemeal recognition of gain in 2012 5,000 Consolidated net income $575,000 $710,000Less: Noncontrolling interest share:
2 Investment in SimpleCost of investment July 1, 2009 $400,000 Add: Plain’s share of Simple’s retained earnings increase from July 1, 2009 to December 31, 2010 ($150,000 - $100,000) ´ 80% 40,000 Less: 80% Amortization of excess ($4,000 ´ 1.5 years) (6,000)
Investment in Simple December 31, 2010 434,000 Add: 2011 income less dividends [$80,000 - ($50,000 ´ 80%)] 40,000
Investment in Simple December 31, 2011 474,000 Add: 2012 income less dividends [$88,000 - ($60,000 ´ 80%)] 40,000
Investment in Simple December 31, 2012 $514,000 Solution E6-9 (continued)
Alternative solution for check at December 31, 2012:
Share of Simple’s equity December 31, 2012 ($550,000 ´ 80%) $440,000 Add: 80% Unamortized excess on buildings
Original excess $100,000 - ($4,000 ´ 3.5 years) 86,000 Less: Unrealized profit on equipment ($20,000 gain - $5,000 recognized) ´ 80% (12,000)
Investment in Simple December 31, 2012 $514,000
Solution E6-10
Preliminary computationsTransfer price of inventory to Spano ($180,000 ´ 2) $360,000Cost to consolidated entity (180,000)
Unrealized profit on January 3 $180,000Amortization of unrealized profit from consolidated view: $180,000/6 years = $30,000 per year
1 Consolidated balance sheet amounts:2009Equipment (at transfer price) $360,000Less: Unrealized profit (180,000)Less: Depreciation taken by Spano ($360,000/6 years) (60,000)Add: Depreciation on unrealized profit ($180,000/6 years) 30,000Equipment — net to be included on consolidated balance sheet $150,000
Alternatively:Equipment (at cost to the consolidated entity) $180,000Less: Depreciation based on cost ($180,000/6 years) (30,000)Equipment — net $150,000
2010 Year after intercompany saleEquipment — net beginning of the period on cost basis $150,000
Less: Depreciation (based on cost) (30,000)Equipment — net $120,000
2 Consolidation working paper entries:2009
Sales 360,000Cost of goods sold 180,000Equipment — net 150,000Depreciation expense 30,000
To eliminate intercompany inventory sale, return equipment to its cost to the consolidated entity, and eliminate depreciation on the intercompany profit.
2010Investment in Spano 150,000
Equipment — net 120,000Depreciation expense 30,000
To eliminate unrealized profit from the equipment account and the current year’s depreciation on the unrealized profit and establish reciprocity between the investment account and beginning-of-the-period subsidiary equity accounts.
Pasco Corporation and SubsidiarySchedule for Computation of Consolidated Net Income
2009 2010 2011 2012 Combined separate incomes $260,000 $220,000 $120,000 $210,000Add: Amortization of negative differential assigned to plant assets ($50,000/10 years)* 5,000 5,000 5,000 5,000Unrealized gain on land (Note That Pasco’s $5,000 gain is included in Pasco’s separate income) (5,000) 5,000Unrealized gain on machinery (25,000)Piecemeal recognition of Gain on machinery 5,000 5,000 5,000Unrealized inventory profits (8,000) 8,000 Consolidated net income 260,000 205,000 122,000 233,000Less: Noncontrolling interest share2009 ($60,000-$5,000+$5,000) ´ 20% (12,000)2010 ($70,000+$5,000) ´ 20% ( 15,000)2011 ($80,000-$8,000+$5,000)) ´ 20% (15,400)2012 ($90,000 + $8,000 +
$5,000 + $5,000)) ´ 20% (21,600)Controlling share of NI $248,000 $190,000 $106,600 $211,400
Alternative Solution:Pasco’s separate income $200,000 $150,000 $ 40,000 $120,000Add: 80% of Slocum’s income 48,000 56,000 64,000 72,000Amortize the negative differential assigned to plant asset ´ 80%) 4,000 4,000 4,000 4,000Unrealized profit on upstream Sale of land ($5,000 ´ 80%) (4,000) 4,000Unrealized profit on downstream Sale of machinery (25,000)Piecemeal recognition of gain ($25,000/5 years) 5,000 5,000 5,000Unrealized profit on upstream Sale of inventory items $8,000 ´ 80% (6,400) 6,400Pasco’s net income and controlling share of consolidated net income $248,000 $190,000 $106,600 $211,400
* Note: Since Pasco paid $40,000 more than book value for its 80% share, the implied total fair value minus book value of Slocum is $50,000.
NOTE: Since Pal paid a price $45,000 in excess of book value for its 90% share, the implied total excess of fair value over book is $50,000 ($45,000 / 90%).
Computation of income from Sim:Share of Sim’s reported income ($40,000 ´ .9) $36,000Add: Realization of deferred profits in beginning inventory 5,000Less: Unrealized profits in ending inventory (4,000)Less: Unrealized profit on intercompany sale of equipment ($30,000 - $21,000) (9,000)Add: Piecemeal recognition of deferred profit in equipment ($9,000/3 years) 3,000Income from Sim $31,000
Consolidation working paper entries
A Cash 2,000Accounts receivable 2,000
To record cash in transit from Sim on account.
B Sales 20,000Cost of sales 20,000
To eliminate intercompany purchases and sales.
C Investment in Sim 5,000Cost of sales 5,000
To recognize previously deferred profit from beginning inventory.
D Cost of sales 4,000Inventory 4,000
To defer unrealized profit from ending inventory.
E Investment in Sim 3,000Land 3,000
To reduce land to its cost basis and adjust the investment account to establish reciprocity with Sim’s beginning of the period equity accounts.
F Gain on sale of equipment 9,000Equipment — net 9,000
To eliminate gain on intercompany sale of equipment and reduce equipment to a cost basis.
Investment in Sim 153,000Noncontrolling interest — January 1 17,000
To eliminate reciprocal investment and equity amounts, establish beginning noncontrolling interest, and enter beginning-of-the-period fair value — book value differential (goodwill).
Cost January 1, 2009 $270,000Implied fair value of Stor ($270,000 / 90%) $300,000Book value of Stor (240,000)Excess of fair value over book value - Goodwill $ 60,000
Cost January 1, 2009 $270,000Add: Income from Stor for 2009
Equity in income ($40,000 ´ 90%) $ 36,000Less: Unrealized inventory profit (10,000)
Less: Unrealized profit on machinery (selling price $35,000 - book value $28,000) (7,000)Add: Piecemeal recognition of profit on machinery ($7,000/3.5 years ´ .5 year) 1,000
Income from Stor for 2009 20,000Less: Dividends $10,000 ´ 90% (9,000)
Investment balance January 1, 2010 281,000Add: Income from Stor for 2010
Equity in income ($50,000 ´ 90%) $ 45,000Add: Unrealized profit in beginning inventory 10,000Less: Unrealized profit in ending inventory (12,000)Add: Piecemeal recognition of profit on machinery ($7,000/3.5 years) 2,000Less: Gain on sale of land (5,000)
Income from Stor for 2010 40,000Less: Dividends ($20,000 ´ 90%) (18,000)
Cost January 1, 2009 $270,000Add: Income from Stor for 2009
Equity in income ($40,000 ´ 90%) $36,000Less: Patent amortize. ($60,000/10 years)x 90% (5,400)Less: Unrealized inventory profit (10,000)Less: Unrealized profit on machinery (selling price $35,000 - book value $28,000) (7,000)Add: Piecemeal recognition of profit on machinery ($7,000/3.5 years ´ .5 year) 1,000
Income from Stor for 2009 14,600Less: Dividends $10,000 ´ 90% (9,000)
Investment balance January 1, 2010 275,600Add: Income from Stor for 2010
Equity in income ($50,000 ´ 90%) $45,000Less: Patent amortization (90%) (5,400)Add: Unrealized profit in beginning inventory 10,000Less: Unrealized profit in ending inventory (12,000)Add: Piecemeal recognition of profit on machinery ($7,000/3.5 years) 2,000Less: Gain on sale of land (5,000)
Income from Stor for 2010 34,600Less: Dividends ($20,000 ´ 90%) (18,000)
Investment balance December 31, 2010 $292,200
Noncontrolling interest share of Stor’s income (10%) 2009 2010
Stor’s reported net income $40,000 $50,000 Less: Patent amortization (6,000) (6,000)Stor’s adjusted income $34,000 $44,00010% Noncontrollling interest share $ 3,400 $ 4,400
Preliminary computationsInvestment cost $290,000Implied fair value of Sank ($290,000 / 80%) $362,500Book value of Sank (300,000)
Excess fair value over book value $ 62,500 - allocated 50% to Patents with a ten-year life ($31,250) - allocated 50% to Inventory sold in 2007 ($31,250)
Reconciliation of income from Sank:Pill’s share of Sank’s net income ($50,000 ´ 80%) $ 40,000Less: 80% of Patent amortization ($31,250/10 years) (2,500)Add: Depreciation on deferred gain on equipment ($15,000/5 years) ´ 80% 2,400Less: Unrealized profit on upstream sale of land ($10,000 ´ 80%) (8,000)
Income from Sank $ 31,900
Reconciliation of investment account:Share of Sank’s underlying equity ($400,000 ´ 80%) $320,000Add: 80% of Unamort. patent ($31,250 - ($3,125 ´ 3 years)) x 80% 17,500Less: Unrealized gain on equipment [$15,000 - ($3,000 ´ 2 years)] ´ 80% (7,200)Less: Share of unrealized gain on land (8,000)Investment in Sank December 31, 2009 $322,300
Noncontrolling interest share:Sank’s reported income $ 50,000Add: Piecemeal recognition of gain on sale of machinery 3,000Less: Patent amortization ( 3,125)Less: Unrealized gain on upstream sale of land (10,000)Realized income 39,875Noncontrolling percentage 20%Noncontrolling interest share $ 7,975
Investment cost for 100% of Skip, April 1, 2009 $15,000Book value acquired (7,000)Excess fair value over book value $ 8,000
Excess allocated:Undervalued inventory items (sold in 2009) $ 500Undervalued buildings (7-year remaining useful life) 3,500Goodwill 4,000Excess fair value over book value $ 8,000
Reconciliation of investment account balance:
Investment cost April 1, 2009 $15,000Add: Increase in Skip’s retained earnings 3,000Less: Excess allocated to inventories sold in 2009 (500)Less: Depreciation on excess allocated to buildings ($3,500/7 years) ´ 4.75 years (2,375)Less: Unrealized inventory profits December 31, 2013 (120)Less: Unrealized profit on equipment ($800 intercompany profit - $200 recognized) (600)Investment balance December 31, 2013 $14,405
Reconciliation of investment income balance:
Share of Skip’s income (100%) $ 2,000Add: Unrealized profit in beginning inventory 100Add: Realization of previously deferred profit on land 500Less: Unrealized profit in ending inventory (120)Less: Depreciation on excess allocated to buildings (500)Less: Unrealized profit on equipment (600)Income from Skip $ 1,380
Preliminary computationsInvestment cost January 1, 2009 $136,000Implied fair value of Sic ($136,000 / 80%) $170,000Book value of Sic (170,000)
Excess fair value over book value 0
Analysis of investment in Sic account on Pic’s books:
Investment cost $136,000Share of Sic’s 2009 reported income ($30,000 ´ 80%) 24,000Investment in Sic as reported on Pic’s books at December 31, 2009 $160,000Share of Sic’s 2010 reported income ($40,000 ´ 80%) 32,000Investment in Sic as reported on Pic’s books at December 31, 2010 $192,000
Note that Pic has not eliminated intercompany profits from its investment income from Sic for either 2009 or 2010.
Investment balance as reported on Pic’s books December 31, 2009 $160,000Gain on machinery ($5,000 ´ 80%) (4,000)Piecemeal recognition of gain ($1,000 ´ 80%) 800Investment account balance under the equity method at December 31, 2009 $156,800Share of Sic’s 2010 reported income 32,000Piecemeal recognition of gain in 2010 ($1,000 ´ 80%) 800Investment account balance under the equity method at December 31, 2010 $189,600
Noncontrolling interest share for 2009:
Sic’s reported net income $ 30,000Less: Gain on sale of machinery (5,000)Add: Piecemeal recognition of gain on machinery through Depreciation 1,000Sic’s realized income $ 26,000Noncontrolling interest percentage 20%Noncontrolling interest share for 2009 $ 5,200
Noncontrolling interest share for 2010:
Sic’s reported net income $ 40,000Add: Piecemeal recognition of unrealized gain on machinery through depreciation 1,000
Investment cost January 1, 2009 $108,000Implied fair value of Spin ($108,000 / 80%) $135,000Book value of Spin (110,000)Excess fair value over book value allocated to patent $ 25,000Patent amortization: $25,000/10 years $ 2,500
Reconciliation of investment income:
Spin’s reported income $ 50,000Less: Patent amortization (2,500)Less: Unrealized profit in ending inventory (1,000)Add: Unrealized profit in beginning inventory 2,000Add: Piecemeal recognition of deferred profit on plant assets ($20,000 / 5 years) 4,000Spin’s adjusted income $ 52,500
Preliminary computationsInvestment cost $290,000Implied fair value of Sank ($290,000 / 80%) $362,500Book value of Sank (300,000)
Excess fair value over book value $ 62,500Excess allocated:Inventories (50%)- Sold in 2007 $ 31,250Goodwill 31,250
Excess fair value over book value $ 62,500
Reconciliation of income from Sank:Sank’s reporte4d net income $ 50,000Add: Depreciation on deferred gain on equipment ($15,000/5 years 3,000Less: Unrealized profit on upstream sale of land (10,000)Sank’s adjusted and realized income $ 43,000
Pill’s 80% controlling share $ 34,400
20% Noncontrolling interest share $ 8,600
Reconciliation of investment account:Share of Sank’s underlying equity ($400,000 ´ 80%) $320,000Add: 80% of unamortized goodwill 25,000Less: Unrealized gain on equipment [$15,000 - ($3,000 ´ 2 years)] ´ 80% (7,200)Less: Share of unrealized gain on land (8,000)Investment in Sank December 31, 2009 $329,800
c. ($4,600 noncontrolling interest share ¸ ($50,000 net income of Sach less $4,000 patent amortization) = 10%
2 Yes. Pape’s net income of $200,400 equals the controlling interest share consolidated net income of $200,400. Pape’s retained earnings of $350,400 equals consolidated retained earnings.
5 Reconciliation of combined and consolidated cost of sales
Combined cost of sales (given) $350,000Less: Intercompany sales (see 3 above) (84,000)Add: Unrealized profits in ending inventory (see 4 above) 14,000Less: Unrealized profits in beginning inventory (solve for this)
(5,000)
Consolidated cost of sales (given) $275,000
6 Reconciliation of combined and consolidated equipment — net
Combined equipment — net of $565,000 less consolidated equipment — net of $550,000 shows a difference of $15,000. The working paper entry to eliminate the effects of an intercompany sale of equipment must have been:
Gain on equipment 20,000Depreciation expense 5,000Equipment — net 15,000
7 Yes. Intercompany receivables and payables are as follows:
10% of unamortized patent at January 1 3,600 Add: Noncontrolling interest share for 2010 4,600Less: Noncontrolling interest dividends ($30,000 ´ 10%) (3,000)Noncontrolling interest December 31, 2010 $ 37,200
9 Patent at December 31, 2009
Patent December 31, 2010 $ 32,000Add: Patent amortization ($141,000 consolidated other expenses - $137,000 combined other expenses) 4,000
Patent December 31, 2009 $ 36,000
10 Analysis of investment in Sach account
Book value (Sach’s stockholders’ equity $340,000 ´ 90%) $306,000Less: Unrealized profit in ending inventory (14,000)Less: Unrealized profit in equipment (15,000)Add: 90% of Unamortized patent 28,800
1 Intercompany borrowing gives rise to notes or advances receivable from and payable to affiliates, as well as reciprocal interest receivable and interest payable accounts and interest income and interest expense accounts.
2 Direct lending and borrowing transactions do not give rise to unrealized gains and losses. Any income reported by the lender is precisely reciprocal to an expense reported by the borrower, and the transactions are complete on the date consummated. Similarly, direct lending and borrowing transactions do not give rise to unrecognized gains and losses since intercompany amounts received and paid are both realized and recognized from the viewpoint of the separate legal entities.
3 Constructive gains and losses are gains and losses from the viewpoint of the consolidated entity but not from the viewpoint of the separate affiliated companies involved. The purchase of a parent company’s outstanding bonds by its subsidiary at a price below the book value of the bonds on the parent company’s books results in a constructive gain. Although the bonds are not actually retired, they are constructively retired from the viewpoint of the consolidated entity because they are no longer liabilities of the consolidated entity to outside parties.
4 The book value of the liability is $1,004,700, computed as $1,000,000 plus $10,000 minus $5,300. If an affiliated company purchases half of the bonds at 98, it will record a bond investment of $490,000. From the viewpoint of the consolidated entity, the purchase of the bonds results in a constructive retirement of $500,000 par of bonds payable. The constructive gain on the bonds is $12,350 [($1,004,700 ´ 50%) – $490,000].
5 A constructive gain on bonds is a gain for consolidated statement purposes that is not recorded on the books of the separate affiliated companies. The affiliated companies continue to carry the bonds as a liability (issuer) and investment (purchaser) on their separate books. Alternatively, an unrealized gain on the sale of land is recorded on the books of the selling affiliate, but it is not recognized as a gain for consolidated statement purposes because the land is still held within the consolidated entity. Thus, a constructive gain on bonds is realized and recognized from the viewpoint of the consolidated entity but it is not recognized on the books of the affiliated companies. An unrealized gain on the sale of land is recognized on the books of the selling affiliate but is not realized or recognized from the viewpoint of the consolidated entity.
6 Constructive gains on intercompany bonds are realized and recognized through the interest income and interest expense reported on the separate books of the affiliated companies. The difference between the interest income reported by the investing affiliate
and the interest expense reported by the issuing affiliate on the intercompany bonds is the amount of constructive gain recognized in each period. Constructive gains and losses are recognized in the consolidated financial statements before they are recognized on the books of the affiliated companies.
7 If a subsidiary purchases parent company bonds in excess of their book value, a constructive loss results. The loss is attributed to the parent company since it is the parent company bonds that are constructively retired. This approach of associating constructive gains and losses on intercompany bonds with the issuing company is consistent with the procedures used in earlier chapters of associating gains and losses on intercompany sales transactions with the selling affiliates.
8a Assume bonds were purchased at the beginning of the current year
10% bonds payable 52,000Interest income 5,250Interest payable 2,500
Investment in S bonds 49,000Interest expense 4,500Interest receivable 2,500Constructive gain on bonds 3,750
To eliminate reciprocal bond investment and bond liability amounts, reciprocal interest income and interest expense amounts, reciprocal interest receivable and interest payable amounts, and enter the constructive gain on bonds. The constructive gain is computed as the $52,500 book value of bonds that were retired for $48,750.
8b Assume bonds were purchased one year earlier
10% bonds payable 52,000Interest income 5,250Interest payable 2,500
Investment in S bonds 49,000Interest expense 4,500Interest receivable 2,500Investment in S stock (90%) 3,375Noncontrolling interest 375
To eliminate reciprocal bond investment and bond liability amounts, reciprocal interest income and interest expense amounts, reciprocal interest receivable and interest payable amounts, and adjust controlling and noncontrolling interest holdings for constructive gain less piecemeal recognition. The constructive gain is computed as: $53,000 book value - $48,500 cost = $4,500 of which $750 was recognized on the books of the separate affiliated companies in the prior year.
9 Separate entries are as follows:
Investment in S 40,000Income from S 40,000
To recognize income equal to 80% of reported subsidiary income.
Investment in S 4,000Income from S 4,000
To recognize gain on constructive retirement of bonds (parent’s books).
The full amount of the constructive gain on bonds is recognized as investment income because the full amount is assigned to the parent company issuer.
10 Investment income from subsidiary75% of subsidiary’s $100,000 reported income $75,000Less: 75% of $8,000 constructive loss on retirement of subsidiary bonds
11a A constructive gain will result when interest income exceeds interest expense on the bonds that are constructively retired.
11b The constructive gain is associated with the parent company since the issuer reports interest expense.
11c The $200 difference between interest income and interest expense represents a piecemeal recognition of the constructive gain on the books of the separate companies.
12 Intercompany receivables and payables of associated companies (equity investees) are generally aggregated with the investments in such companies. In other words, receivables from associates are usually added to the investments in associates and payables are generally deducted from the investments in order to show the equity of the investor in its equity investees in a single amount, with separate disclosure of the components of such equity, either parenthetically or in statement notes.
SOLUTIONS TO EXERCISES
Solution E7-11 C 3 D2 A 4 A
Solution E7-21 A
Book value of Pavone bond’s acquired by Showalter ($900,000 + $48,000) ´ 2/3 $632,000Cost to Showalter 602,000Constructive gain $ 30,000
2 DNominal interest on Pavone’s remaining outstanding bonds $300,000 ´ 8% $ 24,000Less: Amortization of premium ($48,000 ´ 1/3)/ 4 years 4,000Interest expense on consolidated income statement $ 20,000
Solution E7-31 C
Cost of $80,000 par of Palmer bonds January 1, 2009 $ 76,000Book value acquired ($400,000 par - $8,000 discount) ´ 20% 78,400Constructive gain $ 2,400
2 DPar value of bonds payable $400,000Less: Unamortized discount ($8,000 - $2,000) (6,000)Book value of bonds 394,000Percent outstanding 80%Bonds payable $315,200
a Parent’s bond interest expense $50,000 less interest on bonds held intercompany $20,000 = $30,000.b Book value of parent’s bonds purchased $200,000 less purchase price $194,000 = $6,000 gain on constructive retirement.
Cost paid to retire 1/2 of Smedley’s bonds $503,000Book value of bonds retired ($990,000 ´ .5) 495,000
Constructive loss on bond retirement $ 8,000
2 Income from Smedley
Share of Smedley’s reported income $14,000 ´ 70% $ 9,800Less: Constructive loss $8,000 ´ 70% (5,600)Add: Piecemeal recognition of constructive loss ($8,000/4 years) ´ 70% 1,400
Income from Smedley $ 5,600
Solution E7-7
1 aJanuary 1, 2009 cost of $200,000 par bonds $195,500Book value acquired ($1,000,000 + $45,000 premium) ´ 20% 209,000Constructive gain $ 13,500
2 bConstructive gain $13,500/5 years ´ 4 years $ 10,800
3 cBook value $1,036,000 ´ 80% outstanding $828,800
Solution E7-8
1a Constructive gain
Book value of bonds January 1, 2010 $970,000Amortization for 6 months ($30,000/5 years ´ 1/2 year) 3,000Book value of bonds July 1, 2010 973,000Percent purchased by Saydo 60%
Book value of bonds purchased $583,800Purchase price 574,800
Par Discount Book ValueJanuary 1, 2010 $1,000,000 $30,000 $970,000Amortization 2010 - 6,000 + 6,000December 31, 2010 $1,000,000 $24,000 $976,000
Consolidated bond liability $976,000 ´ 40% outstanding $390,400
2 The amounts would not be different if Saydo had been the issuer and Partie the purchaser. However, the constructive retirement gains would ‘belong’ to Saydo and would have been allocated to both Partie and the noncontrolling interests in Saydo.
Solution E7-9(amounts in thousands)
Subsidiary purchases parent company bonds:1a Gain on constructive retirement of bonds
Book value of Picker’s bonds constructively retired ($5,000 - $100 unamortized discount) ´ 40% $1,960Purchase price of $1,000 par bonds 1,900Gain on constructive bond retirement $ 60
1 Gain from constructive retirement of bondsBook value of bonds purchased by Shelly ($2,000,000 + $60,000) ´ 25% $515,000Price paid by Shelly 490,000Gain from constructive retirement of bonds $ 25,000
2 Working paper entry to eliminate effect of intercompany bond holdings12% bonds payable 512,000Interest incomea 62,000Interest payable 30,000
Investment in Perdue bonds 492,000Gain on retirement of bonds 25,000Interest expenseb 57,000Interest receivable 30,000
Book value of Sandwood bonds on January 1, 2010 $1,000,000Purchase price paid by Parrish 783,000
Gain on constructive retirement of Sandwood bonds $ 217,000
Amortization of discount on bonds ($217,000/7 years) $ 31,000
Computation of noncontrolling interest share:Share of Sandwood’s reported income ($140,000 ´ 20%) $ 28,000Add: Share of constructive gain ($217,000 ´ 20%) 43,400Less: Piecemeal recognition of constructive gain ($31,000 ´ 20%) (6,200)
Noncontrolling interest share $ 65,200
Parrish Corporation and SubsidiaryConsolidated Income Statement
for the year ended December 31, 2010(in thousands)
Sales $1,800Less: Cost of sales 950
Gross profit 850Add: Gain from constructive retirement of Sandwood 217Less: Operating expenses 400
Consolidated net income $ 667Less: Noncontrolling interest share 65.2Controlling interest share of NI $ 601.8
Solution E7-12
1 Public Corporation and Subsidiary, December 31, 2009Amounts Appearing
a Computation of loss on intercompany bondsBalance of investment in bonds at December 31, 2009 $105,000Add: Amount amortized for July 1 to December 31, 2009 ($5,000 balance at December 31 ¸ 30/36 months = $6,000 unamortized at July 1) 1,000Investment cost July 1, 2009 $106,000Less: Book value acquired [$1,000,000 - ($15,000 unamortized discount at December 31 ¸ 30/36 months)] ´ 10% 98,200
Loss on constructive retirement of bonds $ 7,800
2 Consolidation working paper entries at December 31, 2009Interest income 3,0008% bonds payable 98,500Loss on retirement of bonds 7,800
Investment in Spede bonds 105,000Interest expense 4,300
To eliminate intercompany bonds and record constructive loss on retirement of bonds, and eliminate intercompany interest income and interest expense.
Interest payable 4,000Interest receivable 4,000
To eliminate reciprocal interest payable and interest receivable amounts.
3 Consolidation working paper entries at December 31, 2010Investment in Spede (90%) 5,850Noncontrolling interest 650Interest income 6,0008% bonds payable 99,100
Investment in Spede bonds 103,000Interest expense 8,600
To eliminate intercompany bonds, interest income and interest expense, and to charge the unrecognized portion of the constructive loss at the beginning of the period 90% to the investment in Spede and 10% to the noncontrolling interest.
Interest payable 4,000Interest receivable 4,000
To eliminate reciprocal interest payable and interest receivable amounts.
Purchase price of $50,000 par bonds April 1, 2009 $53,600Book value of bonds acquired:
Par value $100,000Less: Unamortized discount $1,800 for 27 of 36 months ($1,800 ¸ .75) 2,400Book value of bonds 97,600Intercompany bonds 50% 48,800
Loss on constructive retirement of bonds $ 4,800
2 Interest income and interest expense
Interest income in consolidated income statement — 2009 0Interest expense in consolidated income statement — 2009 $8,800 - ($8,800 ´ 3/4 year ´ 50%) $ 5,500
3 Interest receivable and interest payable
Interest receivable in consolidated balance sheet at December 31, 2009 0
Interest payable in consolidated balance sheet at December 31, 2009 $ 1,000
4 Consolidation working paper entries
Loss on constructive retirement of bonds 4,8008% bonds payable 49,100Interest income 2,100
Investment in Pongo bonds 52,700Interest expense 3,300
To eliminate reciprocal interest income and interest expense amounts and reciprocal bond investment and bond liability amounts and enter unrecognized constructive loss.
Pewter Corporation and Steel CorporationSchedule to Determine Pewter’s Net Income and Consolidated Net Income
2009 2010 2011 2012 Total Pewter’s separate income $500,000 $375,000 $460,000 $510,000 $1,845,000
80% of Steel’s net income + 80,000 + 96,000 + 88,000 + 96,000 + 360,000
$5,000 unrealized profit in Steel’s December 31, 2009 Inventory - 5,000 + 5,000
$10,000 unrealized profit in Steel’s December 31, 2010 Inventory - 10,000 + 10,000
$15,000 unrealized profit in 2011 on sale of land upstream ´ 80% - 12,000 - 12,000
$30,000 unrealized profit on sale of equipment in 2011 - 30,000 - 30,000
$7,500 depreciation on unrealized profit on equipment in 2011 and 2012 + 7,500 + 7,500 + 15,000
$8,000 constructive loss on purchase of Pewter’s bonds in 2012 - 8,000 - 8,000
$2,000 piecemeal recognition of constructive loss in 2012 + 2,000 + 2,000
Pewter’s net income $575,000 $466,000 $523,500 $607,500 $2,172,000
Solution P7-3
Income from Storm for 2009:
Share of reported income of Storm ($200,000 ´ 75%) $ 150,000Add: Unrealized profit in beginning inventory of Storm 24,000Less: Unrealized profit in ending inventory of Storm (30,000)Add: Piecemeal recognition of gain on sale of equipment to Paar ($48,000/6 years) ´ 75% 6,000Less: Unrealized gain on sale of land to Storm (20,000)Less: Unrealized gain on sale of building to Storm less piecemeal recognition through depreciation ($40,000 - $2,000) (38,000)Add: Gain on constructive retirement of Paar bonds ($200,000 - $188,000) 12,000
Underlying equity in Storm ($1,040,000 ´ 75%) $780,000Less: Unrealized profit in Storm’s ending inventory (30,000)Less: Unrealized gain on equipment sold to Placid ($48,000 - $24,000 recognized) ´ 75% (18,000)Less: Unrealized gain on sale of land to Storm (20,000)Less: Unrealized gain on sale of building to
Storm ($40,000 - $2,000 recognized) (38,000)Add: Gain on constructive retirement of Placid’s bonds 12,000
Investment in Storm December 31 $686,000
Noncontrolling interest share:
Net income of Storm $200,000Add: Piecemeal recognition of gain on equipment ($48,000/6 years) 8,000Storm’s realized income 208,000Noncontrolling interest percentage 25%
Solution P7-3 (continued)Placid Corporation and Subsidiary
Consolidation Working Papersfor the year ended December 31, 2009
(in thousands)
Placid Storm 75%Adjustments and
EliminationsConsolidatedStatements
Income StatementSales $ 1,260 $ 1,000 b 100 $2,160Gain on land 20 f 20Gain on building 40 f 40Income from Sahl 104 h 104Gain on bonds g 12 12Cost of sales 700* 600* d 30 b 100
c 24 1,206*
Depreciation expense 152* 80* e 8f 2 222*
Interest expense 40* 40*
Operating expense 92* 120* 212*
Consolidated NI 492Noncontrolling int. share k 52 52*
Controlling share of NI $ 440 $ 200 $ 440
Retained EarningsRetained earnings — Placid $ 300 $ 300Retained earnings — Storm $ 200 i 200Controlling share of NI 440 200 440Dividends 320* 160* h 120
k 40 320*
Retained earnings December 31 $ 420 $ 240 $ 420
Balance SheetCash $ 54 $ 162 a 20 $ 236Bond interest receivable 10 j 10Other receivables 80 60 a 20 120Inventories 160 100 d 30 230Land 180 140 f 20 300Buildings — net 300 360 f 38 622Equipment — net 280 180 e 24 436Investment in Storm stock 686 c 24 i 750
e 24h 16
Investment in Placid bonds 188 g 188$1,740 $1,200 $1,944
Preliminary Computations:Acquisition price $ 320,000Implied fair value of Sher ($320,000 / 80%) $ 400,000Sher’s book value (300,000)Excess allocated to plant & equipment with 8 year life $ 100,000
Annual depreciation of excess ($100,000 / 8 years) $ 12,500
1 Loss is from the constructive retirement of bondsPurchase price of bonds $106,000Book value of bonds ($100,000 + $3,000 premium) 103,000
7 Noncontrolling interest shareSher’s reported net income $ 30,000Less: Depreciation of excess (12,500)Add: Unrealized profit in beginning inventory 20,000Less: Unrealized profit in ending inventory (10,000)Sher’s realized income 27,500
Noncontrolling interest December 31, 2011 $ 80,500
9 Investment in Sher stock at December 31, 2010Investment in Sher stock at cost $320,000Add: Changes in retained earnings to December 31, 2010 ($135,000 - $100,000) ´ 80% 28,000Less: 80% of Excess of (($100,000/8 years x 80%) = $10,000 per year ´ 2 years) (20,000)Less: Unrealized profit in beginning inventory ($20,000 ´ 80%) (16,000)
Investment in Sher stock December 31, 2010 $312,000
Alternative computation:Investment in Sher stock December 31, 2011 $320,000Less: Income from Sher for 2011 (20,000)Add: Dividends from Sher ($15,000 ´ 80%) 12,000
Investment in Sher stock December 31, 2010 $312,000
10 Income from SherShare of Sher’s reported net income $ 30,000Less: Depreciation on excess ($100,000/8 years) (12,500)Add: Unrealized profit in beginning inventory 20,000Less: Unrealized profit in ending inventory (10,000)Sher’s adjusted and realized income $ 27,500Peter’s 80% controlling share $ 22,000Less: Constructive loss on retirement of bonds ($3,000 - $1,000) (2,000)
8 Gain on retirement of bonds (Book value of Shaw’sbonds acquired by Poe $100,000 less acquisition costof $91,000. Since bonds were acquired on December 31,2006, none of the $9,000 gain has been amortized.) $ 9,000
9 Cost of goods sold ($860,000 combined - $60,000intercompany sales + $10,000 unrealized profit in ending inventory) $810,000
10 Interest expense (Shaw paid interest for the entire year tooutside entities so all of Shaw’s interest is reported) $ 16,000
11 Depreciation expense ($45,000 combined - depreciation on the unrealized gain $7,000) $ 38,000
Solution P7-6
Income from Sahl for 2010:
Share of reported income of Sahl ($100,000 ´ 75%) $ 75,000Add: Unrealized profit in beginning inventory of Sahl 12,000Less: Unrealized profit in ending inventory of Sahl (15,000)Add: Piecemeal recognition of gain on sale of equipment to Paar ($24,000/6 years) ´ 75% 3,000Less: Unrealized gain on sale of land to Sahl (10,000)Less: Unrealized gain on sale of building to Sahl less piecemeal recognition through depreciation ($20,000 - $1,000) (19,000)
Underlying equity in Sahl ($520,000 ´ 75%) $390,000Less: Unrealized profit in Sahl’s ending inventory (15,000)Less: Unrealized gain on equipment sold to Paar ($24,000 - $12,000 recognized) ´ 75% (9,000)Less: Unrealized gain on sale of land to Sahl (10,000)Less: Unrealized gain on sale of building to
Sahl ($20,000 - $1,000 recognized) (19,000)Add: Gain on constructive retirement of Paar’s bonds 6,000
Investment in Sahl December 31 $343,000
Noncontrolling interest share:
Net income of Sahl $100,000Add: Piecemeal recognition of gain on equipment ($24,000/6 years) 4,000Sahl’s realized income 104,000Noncontrolling interest percentage 25%
Solution P7-6 (continued)Paar Corporation and Subsidiary
Consolidation Working Papersfor the year ended December 31, 2010
(in thousands)
Paar Sahl 75%Adjustments and
EliminationsConsolidatedStatements
Income StatementSales $ 630 $ 500 b 50 $1,080Gain on plant 30 f 30Income from Sahl 52 h 52Gain on bonds g 6 6Cost of sales 350* 300* d 15 b 50
c 12 603*
Depreciation expense 76* 40* e 4f 1 111*
Interest expense 20* 20*
Operating expense 46* 60* 106*
Consolidated NI 246Noncontrolling int. share k 26 26*
Controlling share of NI $ 220 $ 100 $ 220
Retained EarningsRetained earnings — Paar $ 150 $ 150Retained earnings — Sahl $ 100 i 100Controlling share of NI 220 100 220Dividends 160* 80* h 60
k 20 160*
Retained earnings December 31 $ 210 $ 120 $ 210
Balance SheetCash $ 27 $ 81 a 10 $ 118Bond interest receivable 5 j 5Other receivables 40 30 a 10 60Inventories 80 50 d 15 115Land 90 70 f 10 150Buildings — net 150 180 f 19 311Equipment — net 140 90 e 12 218Investment in Sahl stock 343 c 12 i 375
1 Preacquisition earnings and dividends are the earnings and dividends applicable to an investment interest prior to its acquisition during an accounting period. Assume that P purchases an 80 percent interest in S on July 1, 2009 and that S has earnings of $100,000 between January 1 and July 1, 2009 and pays $50,000 dividends on May 1, 2009. In this case, preacquisition earnings and dividends are $80,000 and $40,000, respectively. Historically, preacquisition earnings purchased were shown as a deduction on the income statement to arrive at consolidated net income. Under SFAS No. 160, this is no longer the case. Instead, the consolidated income statement should only report revenues, expenses, gains and losses subsequent to the combination date. For example, in a Mmarch 31 acquisition, the consolidated income statement would only include income of the subsidiary from April 1 through December 31. The FASB reasons that acquirers purchase assets and assume liabilities, based on their fair values. Acquirers do not “purchase” preacquisition earnings, although fair values of net assets should reflect earning power of the acquired firm.
2 Preacquisition earnings are not recorded by a parent company under the equity method because the investor only recognizes income subsequent to acquisition on the interest acquired. Historically, preacquisition earnings purchased were shown as a deduction on the income statement to arrive at consolidated net income. Under SFAS No. 160, this is no longer the case. Instead, the consolidated income statement should only report revenues, expenses, gains and losses subsequent to the combination date. For example, in a Mmarch 31 acquisition, the consolidated income statement would only include income of the subsidiary from April 1 through December 31.
3 Noncontrolling stockholders of Sub Company held a 20 percent interest during the first half year and a 10 percent interest during the last half year and at year-end. But noncontrolling interest share for the year and total noncontrolling interest at year-end are computed for the 10 percent interest held by noncontrolling stockholders throughout the year.
4 Preacquisition income is similar to noncontrolling interest share because it represents the income of a subsidiary attributable to stockholders outside the consolidated entity. But preacquisition income is not income of the noncontrolling stockholder group at the date of the financial statements. In fact, preacquisition income relates to a previous controlling stockholder group when the interest acquired exceeds 50 percent. In such a case, it seems improper to report this as a deduction in the consolidated income statement. Rather, the fair value of net assets acquired should reflect the acquiree’s earnings history.
5 Under FASB Statement No. 160, a gain or loss is only recorded when the sold interest results in deconsolidation of the subsidiary, i.e., the parent no longer holds a controlling interest. The gain or loss on the sale of an equity interest is the difference between the proceeds from the sale (the fair value) and the recorded book value of the interest sold, provided that the investment is accounted for as a one-line consolidation. If another method of accounting has been used, the investment account must be converted to the equity method so that any gain or loss on sale is the same as if a one-line consolidation had been used previously.
When the parent maintains a controlling interest after the sale, the sale is treated as an equity transaction, with no gain or loss recognition. The parent debits cash or other consideration received in the sale, credits the investment account based on percent of carrying value sold, and records the difference as an adjustment to other paid-in capital.
6 Conceptually, the income applicable to an equity interest sold during an accounting period should be included in investment income and consolidated net income. In this case, the gain or loss on sale is computed on the basis of the book value of the interest at the time of sale, and income is assigned to the increased noncontrolling interest only after the date of sale. As a practical expedient, a beginning-of-the-period sale date can be used such that no income is recognized on the interest sold up to the time of sale, and the gain or loss is computed on the book value at the beginning of the period. When this expedient is used, income must be assigned to the increased noncontrolling interest for the entire year of sale. The combined investment income and gain or loss on sale are the same under both approaches provided that the assumptions (beginning of the year and time of sale) are followed consistently. As noted in question 5, gain or loss on the sale of the equity interest is only recognized when the subsidiary is donconsolidated. Other wise, the gain or loss is an adjustment to other paid-in capital.
7 Assuming that no gain or loss is recognized, no adjustment of the parent’s investment account is necessary when the subsidiary sells additional shares to outside parties at book value because the parent’s share of underlying book value does not change. If additional shares are sold above book values, the parent’s share of the underlying equity of the subsidiary increases. This increase is recorded by the parent company as follows:
Investment in subsidiary XXAdditional paid-in capital XX
If the subsidiary sells additional shares below book value, the parent’s interest is decreased and the parent company records decreases in its investment and additional paid-in capital accounts. In all three cases (book value, above book value, or below book value), the parent company’s ownership percentage decreases from 80 percent (8,000 of 10,000 shares) to percent (8,000 of 12,000 shares).
No gain or loss is recognized, the change in underlying book value, adjusted for one-sixth [(80% – %) ¸ 80%] of any unamortized cost book value differential is
reported as adjustment to additional paid-in capital, since the parent maintains its controlling interest. An alternative computation is to assume that the parent sold one-sixth of its interest for percent of the proceeds, the difference being the amount of adkustment to additional paid-in capital.
8 The acquisition of the 2,000 shares directly from the subsidiary increases the parent’s percentage interest from 80 percent (8,000 of 10,000 shares) to 5/6 (10,000 of 12,000 shares, or 83 1/3%). The change in the interest held does not affect the way in which the parent company records its additional investment. The parent company in all cases increases its investment account by the amount of cash paid or other consideration given for the additional investment. It makes no difference if the purchase price is above or below book value.
9 Treasury stock transactions by a subsidiary change the parent company’s proportionate interest in the subsidiary. Any changes in the parent’s share of the underlying book value of the subsidiary require adjustments in the parent company’s investment in subsidiary and additional paid-in capital accounts.
10 Gains and losses to a parent company (or equity investor) do not result from the treasury stock transactions of its subsidiaries (or equity investees). Although the parent’s investment interest may increase or decrease from such transactions, the predominate view is that such changes are of a capital nature and should be accounted for by additional paid-in capital adjustments rather than by recorded gains and losses.
11 Stock splits and stock dividends by a subsidiary do not affect the amounts that appear in the consolidated financial statements. But stock dividends by a subsidiary result in capitalization of subsidiary retained earnings and the amounts involved in eliminations for the subsidiary’s stockholders’ equity accounts are affected.
Preacquisition income ($100,000 ´ 20% ´ 1/2 year) $ 10,000Note: This does not appear on the consolidated income statement. Companies only include subsidiary earnings subsequent to the acquisition date.
Allocation of Sweet’s dividends:
Dividends to Pie ($30,000 ´ 70%) + ($30,000 ´ 90%) $ 48,000
Noncontrolling interest ($60,000 ´ 10%) $ 6,000
Preacquisition interests ($30,000 ´ 20%) $ 6,000
Solution E8-2
1 Income from Superstore for 2009:
60% interest ´ $240,000 ´ 1/3 year $ 48,000
2 Preacquisition income:Under SFAS No. 160, no preacquisition income appears on the consolidated income statement. The income statement only includes income of the subsidiary earned after the parent obtains its controlling interest. Control was established on September 1, when Pinnacle’s interest increased from 40% to 60%, so the consolidated income statement includes Superstore income of $80,000 ($240,000 x 1/3 of year).
3 Noncontrolling interest share for 2009:$80,000 ´ 40% $ 32,000
To record sale of 15% interest in Swamp. No gain or loss on sale is recognized
since Peat maintains an 85% controlling interest.
Entry to record investment income for 2009:Investment in Swamp($600 ´ 85%) 510
Income from Swamp 510To record income from Swamp.
Check:Investment balance January 1, 2009 $4,400Less: Book value of interest sold (660)Add: Income from Swamp 510Investment balance December 31, 2009 $4,250Underlying equity ($4,600 ´ 85%) $3,910Add: 85% of Goodwill * 340Investment balance December 31, 2009 $4,250* Note that implied total goodwill is $400 ($340 / 85%).
Solution E8-4 (amounts in thousands)
1 Gain on sale of 20% interest: No gain or loss is recognized since Pauley maintains a 60% controlling interest.Beginning of the period sale assumptionSelling price $130Book value of interest ($436 investment account balance ´ 20%/80%) 109Adjustment to other paid-in capital $ 21
Actual sale date assumptionSelling price $130Book value of interest sold:
Beginning of the period balance $436Add: Income ($150 ´ 1/3 year ´ 80%) 40
476Interest sold 25% 119
Adjustment to increase additional paid-in capital $ 11
Beginning of the period sale assumptionIncome from Savage($150 ´ 60%) $ 90Actual sale date assumptionJanuary 1 to May 1:Share of Savage’s income ($150 ´ 80% ´ 1/3 year) $ 40May 1 to December 31:Share of Savage’s income ($150 ´ 60% ´ 2/3 year) 60Income from Savage $100
Beginning of ActualPeriod Sale Sale DateAssumption Assumption
Investment balance January 1 $436 $436Book value of interest sold (109) (119)Income from Savage 90 100Dividends (48) (48)Investment balance December 31, 2009 $369 $369
Solution E8-5
(amounts in thousands)
1a Fair value — book value differential
Cost $1,274Implied fair value of Stork ($1,274 / 70%) $1,820Book value ($1,480 January 1 balance + $100 income for 5 months - $60 dividends in January and April) (1,520)Goodwill $ 300
1b Income from Stork (Note: Only include earnings subsequent to the acquisition date).
Income from Stork ($240,000 ´ 7/12 year ´ 70%) $ 98
1c Investment in Stork at December 31
Investment cost $1,274Add: Income from Stork 98Deduct: Dividends ($60,000 ´ 70%) (42)Investment in Stork December 31, 2009 $1,330
2 Consolidation working paper entries:
a Income from Stork 98Investment in Stork 56Dividends 42
To eliminate income and dividends from Stork and adjust investment account to its cost on June 1.
Investment in Stork 1,274Noncontrolling interest 564Dividends 42
To eliminate reciprocal investment and equity balances, record preacquisition income and beginning noncontrolling interest, and eliminate preacquisition dividends.
Investment balance December 31, 2009 ($9,000 ´ 80%) $ 7,200Cost of new shares ($25 ´ 60,000 shares) 1,500
Investment in Sower after new investment $ 8,700
2 Goodwill from new investment
Sower’s stockholders’ equity after issuance ($9,000 + $1,500) $10,500Petal’s ownership percentage (480,000 + 60,000 shares)/660,000 shares .8182Petal’s book value after issuance 8,591.1Less: Petal’s book value before issuance (7,200)
Increase in book value from purchase (book value acquired) $ 1,391.1
Cost of 60,000 shares $ 1,500Book value acquired (1,391.1)
Goodwill from acquisition of new shares* $ 108.9
* This implies total goodwill is equal to $136,125.
Solution E8-7
1 Sod issues 30,000 shares to Pod at $20 per sharePod’s ownership interest before issuance: 176,000/220,000 shares = 80%Pod’s ownership interest after issuance: 206,000/250,000 shares = 82.4%
2 Sod sells 30,000 shares to the public at $20 per sharePod’s ownership interest after issuance: 176,000/250,000 shares = 70.4%
3 Sod sells 30,000 shares to the public; no gain or loss recognized:
Investment in Sod 115,200Additional paid-in capital 115,200
To record increase in investment in Sod computed as follows:
Book value before issuance ($3,200,000 ´ 80%) $2,560,000Book value after issuance ($3,800,000 ´ 70.4%) 2,675,200Additional paid-in capital $ 115,200
1a Percentage ownership after additional investment:
700,000/1,000,000 = 70%
1b Goodwill from additional investment (in thousands):
Book value of interest after sale$2,600 ´ 70% $1,820
Book value of interest before sale$2,100 ´ 2/3 1,400
Book value of interest acquired 420Cost of interest 500Goodwill from additional investment * $ 80
* This implies total goodwill is now equal to $114,286.
Outsiders buy shares
2a Percentage ownership after sale:
600,000/1,000,000 = 60%
2b Change in underlying book value of investment in Satellite:
Satellite’s underlying equity after sale $2,600,000Primetime’s interest 60%Book value of Primetime’s investment in Satellite after the sale 1,560,000Less: Book value before the sale 1,400,000Increase in book value of investment $ 160,000
2c Entry to adjust investment account:
Investment in Satellite 160,000Additional paid-in capital 160,000
Preliminary computations of fair value — book value differentials:April 1, 2009 acquisitionCost of 4,000 shares (20% interest) $ 64,000Implied total fair value of Sum ($64,000 / 20%) $320,000Book value of Sum on april 1 acquisition date:
Beginning stockholders’ equity $280,000Add: Income for 3 months ($80,000 ´ ¼ year) 20,000Stockholders’ equity April 1 300,000
Goodwill $ 20,000
July 1, 2010 acquisitionCost of 8,000 shares (40% interest) $164,000Implied total fair value of Sum ($164,000 / 40%) $410,000Book value on July 1 acquisition date:
Beginning stockholders’ equity $360,000Add: Income for 6 months ($80,000 ´ 1/2 year) 40,000Less: Dividends May 1 (10,000)Stockholders’ equity July 1 390,000
Goodwill (amount is unchanged by this transaction) $ 20,000
1 Income from Sum
2009Income from Sum for 2009 ($80,000 ´ 20% ´ 3/4 year) $ 12,000
2010 Income from Sum for 201020% share of reported income ($80,000 ´ 20%) $ 16,00040% share of reported income ($80,000 ´ 40% ´ 1/2 year) 16,000
Income from Sum $ 32,000
2 Noncontrolling interest December 31, 2010 (($420,000 book value + $20,000 goodwill)´ 40%) $176,000
3 Preacquisition income (does not appear in come statement)
Sum income $ 80,000Time before acquisition 1/2Percent acquired in 2010 40%Preacquisition income ($80,000 ´ .5 ´ .4) $ 16,000
4 Investment balance at December 31, 2010
Cost of 20% investment $ 64,000Income from Sum for 2009 12,000
Implied total fair value of Sandridge ($675,000 / 90%) $750,000Less: Book value of Sandridge at acquisition:
Equity of Sandridge Mines December 31, 2009 $700,000Add: Income for 1/2 year 50,000Equity of Sandridge Mines July 1, 2010 750,000
Excess (book value = underlying equity) 0
1 Investment income from Sandridge Mines
Income from Sandridge — 2010 ($100,000 ´ 1/2 year ´ 90%) $ 45,000
Income from Sandridge — 2011:January 1 to July 1 ($80,000 ´ 1/2 year ´ 90%) $ 36,000July 1 to December 31 ($80,000 ´ 1/2 year ´ 80%) 32,000
$ 68,000
Investment in Sandridge Mines Cost July 1, 2010 $675,000Add: Income from Sandridge — 2010 45,000Less: Dividends paid in December ($50,000 ´ 90%) (45,000)
Investment balance December 31, 2010 675,000
Less: Book value of 1/9 interest sold on July 1, 2011a (79,000)Add: Income from Sandridge — 2011 68,000Less: Dividends paid in December ($30,000 ´ 80%) (24,000)
Investment balance December 31, 2011 $640,000
a Sale of 10% interest July 1, 2011:Equity of Sandridge Mines December 31, 2009 $700,000
Add: Income less dividends — 2010 50,000
Add: Income for 1/2 year — 2011 40,000
Equity of Sandridge Mines July 1, 2011 790,000Interest sold 10%
Underlying equity of interest sold $ 79,000
Gain on sale of 1/9 interest ($85,000 proceeds - $79,000)Since Piccolo maintains a controlling interest, the gain is not recorded, but shown as an adjustment to additional paid-in capital.
Noncontrolling interest share — 2011: ($80,000 ´ 1/2 year ´ 10%) + ($80,000 ´ 1/2 year ´ 20%) $ 12,000
Noncontrolling interest December 31, 2010Equity of Sandridge Mines January 1 $700,000Add: Income less dividends for 2010 50,000Equity of Sandridge Mines December 31 750,000Noncontrolling interest percentage 10%
Noncontrolling interest December 31 $ 75,000
Noncontrolling interest December 31, 2011Equity of Sandridge Mines January 1 $750,000Add: Income less dividends for 2011 50,000Equity of Sandridge Mines December 31 800,000Noncontrolling interest percentage 20%
Noncontrolling interest December 31 $160,000
Solution E8-11
Preliminary computations:Investment cost January 1, 2010 $ 690,000
Implied total fair value of Sanyo ($690,000 / 75%) $ 920,000Book value of Sanyo (800,000)Excess fair value over book value = Goodwill $ 120,000
1 Underlying book value December 31, 2010
$1,000,000 equity ´ 75% $ 750,000
2 Percentage ownership before purchase of additional shares
Investment cost January 1, 2009 $ 690,000Add: Share of Sanyo’s income less dividends for 2009 ($200,000 ´ 75%) 150,000Investment in Sanyo December 31, 2009 840,000Add: Additional investment — January 3, 2011 (10,000 shares ´ $30) 300,000
Investment in Sanyo balance January 3, 2011 $1,140,000
Investment in Sanyo December 31, 2009 (see 3 above) $ 840,000Add: Increase in book value from change in ownership interest:Book value after additional 10,000 shares
were issued ($1,300,000 equity ´ 60%) $780,000Book value before additional 10,000 shares
were issued ($1,000,000 equity ´ 75%) (750,000) 30,000Investment in Sanyo balance - January 3, 2011 $ 870,000
Solution E8-12
Preliminary computations:Cost of additional investment (2,000 shares ´ $80) $160,000
Implied total fair value of Saton $160,000 / (2,000/12,000) $960,000Less: Book value of Saton after issuance 710,000Excess fair value over book value $250,000
January 2, 2010Investment in Saton 160,000
Cash 160,000To record purchase of additional 2,000 shares of Saton.
December 2010Cash 50,000
Investment in Saton 50,000To record receipt of dividends ($60,000 ´ 10,000/12,000 shares).
December 31, 2010Investment in Saton 75,000
Income from Saton 75,000To record income from Saton($90,000 ´ 10,000/12,000).
1 Investment in Striper (in thousands)Cost $1,800Add: 90% of $300 increase in equity since 2009 270
Investment in Striper January 1, 2011 $2,070
2 Entry on Patrick’s books (no gain or loss recognized)
Investment in Striper 180Additional paid-in capital 180
To recognize change in book value of investment from Striper’s sale of additional shares, computed as follows:Underlying equity after issuance ($2,400 ´ 75%) $1,800Underlying equity before issuance ($1,800 ´ 90%) (1,620)
$ 180
SOLUTIONS TO PROBLEMS
Solution P8-1
Preliminary computations (in thousands):Cost of 40,000 shares July 1, 2009 $620
Implied total fair value of Spindle ($620 / 80%) $775Book value of Spindle ($550 + $50 income) (600)Excess fair value over book value $175
Cost of 10,000 shares January 1, 2010 $162Book value after issuance ($762 ´ 5/6) $635Book value before issuance ($600 ´ 80%) (480) (155)Excess fair value over book value of 10,000 shares acquired $ 7
1 Investment in Spindle — December 31, 2009Investment cost $620Add: Income from Spindle- $100 ´ 1/2 year ´ 80% 40Less: Dividends ($50 ´ 80%) (40)
Investment in Spindle December 31, 2009 $620
2 Income from Spindle — 2010Share of Spindle’s income ($150 ´ 5/6) $125
3 Investment in Spindle — December 31, 2010Investment balance December 31, 2009 $620Add: Additional investment 162
3 No gain or loss recognized on issuance of additional sharesInvestment in Smithtown 2,000
Other paid-in capital 2,000To recognize change in ownership interest computed as: Underlying equity after sale ($38,000 ´ 60%) less underlying equity before sale of additional shares ($26,000 ´ 80%).
Solution P8-3
1 Journal entry to record sale as of actual sale dateCash 120,000Additional paid-in capital 1,500
Investment in Shawnee 121,500To record sale of 1/9 of investment in Shawnee. Book value of interest sold is computed as follows:
Investment balance December 31, 2008 $1,039,500Add: Income from Shawnee for one-half year
($280,000 ´ 1/2 year ´ 90%) 126,000Less: Dividends ($80,000 ´ 90%) (72,000)Book value of investment on July 1, 2009 $1,093,500Book value of interest sold ($1,093,500/9) $ 121,500
2 Journal entry to record sale as of January 1, 2009Cash 120,000
Additional paid-in capital 12,500Investment in Shawnee 107,500
To record sale of 1/9 of investment in Shawnee. Book value of interest sold is computed as follows:
Investment balance December 31, 2008 $1,039,500Less: Dividends (72,000)Book value adjusted for dividends $ 967,500Book value of interest sold ($967,500/9) $ 107,500
Less: Book value of interest sold (121,500) (107,500)Balance December 31, 2009 $1,020,000 $1,020,000
Solution P8-4
(in thousands)
Entries on Panama’s books to reflect the change in ownership interest:
Option 1 Panama sells 30,000 shares of Shenandoah
Cash 1,500Investment in Shenandoah 870Additional paid-in capital 630
To record sale of 30,000 shares at $50 per share. No gain or loss is recognized since parent maintains a controlling interest.
Option 2 Shenandoah issues and sells 40,000 shares to the public
Investment in Shenandoah 630Additional paid-in capital 630
To record adjustment in ownership computed as follows:Book value after sale of 40,000 shares ($12,440 ´ 75%) $9,330Book value before sale of 40,000 shares ($10,440 ´ 5/6) (8,700)Increase in book value of investment from sale $ 630
Option 3 Shenandoah reissues 40,000 shares of treasury stock
Investment in Shenandoah 630Additional paid-in capital 630
To record adjustment in ownership computed the same as 2 above.
Preliminary computations:Cost of 9,000 shares (90% interest) January 1, 2009 $ 810,000
Implied total fair value of Sala ($810,000 / 90%) $ 900,000Book value of Sala ($500,000 + $300,000) (800,000)
Excess fair value over book value = Goodwill $ 100,000
1 Investment balance December 31, 2009
Cost January 1, 2009 (9,000 shares ´ $90) $ 810,000Add: Share of Sala’s 2009 income ($50,000 ´ 90%) 45,000
Investment in Sala December 31 $ 855,000
2 Goodwill at December 31, 2010(Pallo purchased additional shares)
Goodwill from January 1, 2009 purchase $ 100,000Goodwill from January 1, 2010 purchase: Book value before purchase $ 850,000 Book value after purchase (1,350,000) Book value acquired (500,000) Cost of additional 5,000 shares 500,000 Goodwill from January 1, 2010 $ 0 Goodwill at December 31, 2010 $ 100,000
3 Additional paid-in capital (outsider purchased additional shares)
Book value after issuance ($1,350,000 ´ 60%) $ 810,000Book value before issuance ($850,000 ´ 90%) (765,000)
Additional paid-in capital (gain is not recognized) $ 45,000
4 Noncontrolling interest December 31, 2010 (outsider purchased shares)
Subsidiary equity January 1, 2009 $ 800,000Increase for 2009 50,000Increase for 2010 70,000Sale of additional shares 500,000 Book value $1,420,000Goodwill 100,000 Fair value of Subsidiary equity December 31, 2010 $1,520,000
1 Investment in Stake December 31, 2010Investment in Stake January 2, 2009 $ 98,000Increase for 2009 ($30,000 retained earnings increase ´ 70%) 21,000Purchase of additional 20% interest June 30, 2010 37,000Increase 2010: ($30,000 ´ 1/2 year ´ 70%) + ($30,000 ´ 1/2 year ´ 90%) 24,000Dividends 2010: ($10,000 ´ 90%) (9,000)
Investment in Stake December 31, 2010 $171,000
2 Goodwill December 31, 2010January 2, 2009 purchase:Cost of 70% interest $ 98,000
Implied fair value of Stake ($98,000 / 70%) $140,000Less: Book value of Stake 120,000Goodwill $ 20,000
June 30, 2010 purchase:Cost of 20% interest $ 37,000
Implied fair value of Stake ($37,000 / 20%) $185,000Less: Book value of Stake 165,000Goodwill - December 31, 2010 $ 20,000
3 Consolidated net incomeSales $600,000Cost of sales (400,000)Expenses (70,000)Consolidated net income 130,000Noncontrolling interest share * 6,000Controlling share of net income $124,000
* Noncontrolling share is 10% for full year plus 20% for ½ year. Alternative:Post’s reported income = Controlling share of net income $124,000
4 Consolidated retained earnings December 31, 2010Beginning retained earnings $200,000Add: Controlling share of Consolidated net income — 2010 124,000Less: Dividends (64,000)
5 Noncontrolling interest December 31, 2010Equity of Stake December 31, 2010 $170,000Goodwill 20,000Fair value of Stake $190,000Noncontrolling interest percentage 10%
Noncontrolling interest December 31, 2010 $ 19,000
Preliminary computationsCost October 1, 2009 $ 82,400
Implied fair value of Sat ($82,400 / 80%) $103,000Book value on Octobwer 1 acquisition date:
Book value on January 1, 2009 $70,000Add: Income January 1 to October 1 ($24,000 ´ 3/4 year) 18,000Deduct: Dividends March 15 (5,000)Book value October 1 83,000
Goodwill $ 20,000
Income from Sat for 2009Share of Sat’s net income ($24,000 ´ 1/4 year ´ 80%) $ 4,800Less: Unrealized profit in Sat’s ending inventory (1,000)Income from Sat $ 3,800
* Under SFAS No. 160, preacquisition earnings are not shown as a reduction of consolidated net income. Rather, we only include earnings and dividends subsequent to the acquisition date. Preacquistion amounts are disclosed in required pro-forma disclosures for acquisitions. The worksheet on the following page reflects these adjustments.
Solution P8-8 (continued)
Pop Corporation and SubsidiaryConsolidation Working Papers
for the year ended December 31, 2009
Pop Sat 80%Adjustments and
EliminationsConsolidatedStatements
Income StatementSales $ 112,000 $ 50,000 a 12,000
c 37,500$ 112,500
Income from Sat 3,800 b 3,800
Cost of sales 60,000* 20,000* d 1,000 a 12,000c 15,000
54,000*
Operating expenses 25,100* 6,000* c 4,500 26,600*
Consolidated net income 31,900
Noncontrolling int. share f 1,200 1,200*
Controlling share of NI $ 30,700 $ 24,000 $ 30,700
Retained EarningsRetained earnings — Pop $ 30,000 $ 30,000
Retained earnings — Sat $ 20,000 e 20,000
Net income 30,700 24,000 30,700
Dividends 20,000* 10,000* b 4,000c 5,000f 1,000 20,000*
Retained earnings December 31 $ 40,700 $ 34,000 $ 40,700
Implied total fair value of Sid ($175,000 / 70%) $250,000Less: Book value of Sid ($250,000 equity on January 1 plus $10,000 net income (1/4 year) less $10,000 dividends) 250,000Fair value — book value differential 0
Allocation of Sid’s reported net income
Parent company ($40,000 ´ 3/4 year ´ 70%) $ 21,000Preacquisition income ($40,000 ´ 1/4 year ´ 70%) 7,000Noncontrolling interest share ($40,000 ´ 1 year ´ 30%) 12,000
Sid’s net income $ 40,000
Pal’s income from Sid
Equity in Sid’s income $ 21,000
Constructive gain on parent’s bondsNote that bonds payable has a book value of $105,400 on December 31, 2009. A half-year of premium amortization ($300) yields a book value of $105,700 at July 1, 2009. ( $105,700 book value on July 1 less $102,850 on December 31) 2,850
Recognition of constructive gain on separate books ($2,850 ´ 6/114 months) (150)
Gain on intercompany sale of equipment — downstream [$30,000 - ($36,000/2)] (12,000)
Piecemeal recognition of gain on equipment — downstream ($12,000/3 years ´ 1/2 year) 2,000
Gain on intercompany sale of land — upstream ($10,000 - $8,000 cost) ´ 70% (1,400)
a Income from Sid 12,300 Dividends - Sid 7,000 Investment in Sid common 5,300Eliminate intercompany post-acquisition earnings and dividends and return Investment to beginning balance.
b Sales * 37,500 Cost of sales * 27,500 Dividends – Sid* 10,000Retained earnings - Sid 50,000Common stock - Sid 200,000 Investment in Sid - common 175,000 Noncontrolling interest 75,000Eliminate preacquisition earnings and dividends. Eliminate Sid’s equity accounts, the investment account and establish beginning noncontrolling interest.
c Gain on plan assets 12,000 Plan assets 12,000Eliminate intercompany gain on sale of equipment.
d Gain on plan assets 2,000 Plan assets 2,000Eliminate intercompany gain on sale of land.
e Interest income 5,850 Interest expense 5,700 Gain on bond retirement 2,850 Investment in Pal bonds 102,700Bonds payable 100,000Premium on bonds 5,400Record constructive retirement of bonds payable.
f Interest payable 6,000 Interest receivable 6,000Eliminate reciprocal interest accounts.
g Other current liabilities 7,000 Other current assets 7,000Eliminate reciprocal for unpaid intercompany dividends.
h Noncontrolling interest share 8,400 Dividends - Sid 3,000 Noncontrolling interest 5,400Record noncontrolling interest share of earnings and post-acquisition dividends.
Implied total fair value of Sam ($420,000 / 70%) $600,000Book value of Sam 500,000
Goodwill $100,000
Investment cost of 10% interest $ 67,500
Implied total fair value of Sam ($67,500 / 10%) $675,000Book value of Sam:
Beginning equity January 1, 2010 $550,000Add: Income for 1/2 year 50,000Less: June dividends (25,000)Book value at July 1, 2010 575,000
Goodwill (unchanged) $100,000
Investment in Sam account:Investment cost January 1, 2009 $420,000Add: 2009 share of retained earnings increase ($50,000 ´ 70%) $ 35,000Less: Unrealized profit in ending inventory (5,000)Less: Unrealized gain on land (8,000) 22,000Investment balance December 31, 2009 $442,000Add: Investment cost of 10% interest 67,500Add: Income from Sam for 2010
$100,000 ´ 70% interest ´ 1 year $ 70,000$100,000 ´ 10% interest ´ 1/2 year 5,000Add: Beginning inventory profits 5,000Less: Ending inventory profits (6,000)Less: Gain: intercompany sale machinery (40,000)Add: Piecemeal recognition of gain
($40,000/5 ´ 1/2 year) 4,000 38,000Less: Dividends from Sam
Investment cost of 85% of Sly August 1, 2009 $522,750
Implied fair value of Sly ($522,750 / 85%) $615,000Book value August 1, 2009:
Capital stock $500,000Retained earnings 100,000Add: Income for 7 months 35,000Less: Dividends for 1/2 year (20,000)Stockholders’ equity August 1, 2009 615,000
Fair value – book value differential $ 0
Investment cost August 1, 2009 $522,750
Equity in income $60,000 ´ 5/12 year ´ 85% $ 21,250Less: Deferred inventory profit from upstream sale $5,000 ´ 85% (4,250)Less: Deferred profit from sale of equipment $10,000 profit - ($2,000 ´ 1/4 year) (9,500)
Income from Sly 2009 7,500Less: Dividends from Sly $20,000 ´ 85% (17,000)Investment in Sly December 31, 2009 $513,250
Noncontrolling interest share of post-acquisition income, adjusted for the inventory profit: ($25,000 - $5,000) ´ 15% = $3,000
Preacquisition earnings ($35,000 ´ 85%) = $29,750Under SFAS No. 160, pre-acquisition earnings and dividends are closed to retained earnings, and the consolidated income statement reports only post-acquisition earnings.
Working paper entries:
a Sales 60,000Cost of sales 60,000
To eliminate intercompany sales.
b Cost of sales 5,000Inventories 5,000
To defer unrealized inventory profits.
c Sales 50,000Cost of sales 40,000Plant assets — net 10,000
To eliminate reciprocal equity and investment balances, and enter beginning noncontrolling interest (* adjusted for preacquisition earnings and dividends).
g Dividends payable 17,000Dividends receivable 17,000
To eliminate reciprocal dividends receivable and payable amounts.
h Noncontrolling Interest Share 3,000Dividends 3,000
To enter Noncontrolling Interest share of subsidiary post-acquisition income and dividends.
Poff Corporation and SubsidiaryConsolidated Statement of Cash Flowsfor the year ended December 31, 2010
Cash Flows from Operating ActivitiesConsolidated net income – controlling share $300,000
Adjustments to reconcile net income to cash provided by operating activities:
Noncontrolling interest share $ 22,000Depreciation expense 528,000Decrease in accounts receivable 2,500Decrease in prepaid expenses 20,000Decrease in accounts payable (203,500)Increase in inventories (130,000)Gain on sale of 10% interest * (5,700) 233,300
Net cash flows from operating activities 533,300
Cash Flows from Investing ActivitiesPurchase of equipment $(100,000)Sale of 10% interest in subsidiary 72,700
Net cash flows from investing activities (27,300)
Cash Flows from Financing ActivitiesCash paid on long-term note $(300,000)Payment of cash dividends — controlling (200,000)Payment of cash dividends — noncontrolling (10,000)
Net cash flows from financing activities (510,000)
Decrease in cash for 2010 (4,000)Cash on hand January 1, 2010 50,500
Cash on hand December 31, 2010 $ 46,500
* Note: Since Poff maintains a controlling interest in Sato, no gain or loss should have been recognized on sale of the 10 interest. Rather, this amount should appear as an increase in other paid-in capital. The net effect on the statement of cash flows is the same.
Asset ChangesCash (4,000)Accounts receivable — net (2,500) e 2,500Inventories 130,000 k 130,000Prepaid expenses (20,000) l 20,000Equipment 90,000 h 10,000 g 100,000Accumulated depreciation
(498,000) f 500,000 h 2,000
Land and buildings 0Accumulated depreciation
(28,000) f 28,000
Total asset changes (332,500)
Changes in EquitiesAccounts payable (203,500) i 203,500Dividends payable 0Long-term note payable
(300,000) j 300,000
Common stock 0Retained earnings 100,000 a 300,000 c 200,000
Noncontrol. int. 20% 71,000 b 22,000 d 10,000
h 59,000Changes in equities (332,500)
Consolidated net income a 300,000 300,000
Noncontrolling int. share b 22,000 22,000
Purchase of equipment g 100,000 (100,000)
Depreciation — equipment
and buildings f 528,000 528,000Gain - sale of 10% subsidiary Interest h 5,700 (5,700)Decrease in accounts receivable e 2,500 2,500Increase in inventories k 130,000 (130,000)Decrease in prepaid expenses l 20,000 20,000Decrease in accounts payable i 203,500 (203,500)Cash paid on long-term note j 300,000 (300,000)
Paid dividends — controlling c 200,000 (200,000)
Paid dividends —noncontrol. d 10,000 (10,000)
Sale of 10% interest in Subsidiary h 72,700 72,700
Cash decrease for 2010 = $533,300 - $27,300 - $510,000 = $(4,000).* Note: Since Poff maintains a controlling interest in Sato, no gain or loss should have been recognized on sale of the 10 interest. Rather, this amount should appear as an increase in other paid-in capital. The net effect on the statement of cash flows is the same.
1 An indirect holding of the stock of an affiliated company gives the investor an ability to control or significantly influence the decisions of an investee not directly owned through an investee that is directly owned. Two primary types of indirect ownership situations are the father-son-grandson relationship and the connecting affiliates relationship.
2 No. Only 40 percent of T’s stock is held within the affiliation structure and P owns indirectly only 24 percent (60% ´ 40%) of T. T should be included as an equity investment in the consolidated statements of P Company and Subsidiaries.
3a Father-son-grandson b Connecting affiliates
Controlling stockholdersDirect ownership, 70% interest in Y. Indirect ownership, 42% interest in Z (70% ´ 60%).
Controlling stockholdersDirect ownership, 30% interest in B and 70% interest in A. Indirect ownership, 21% interest in B (70% ´ 30%)
Noncontrolling stockholdersDirect ownership, 30% interest in Y and 40% interest in Z. Indirect ownership, 18% interest in Z (30% ´ 60%).
Noncontrolling stockholdersDirect ownership, 30% interest in A and 40% interest in B. Indirect ownership, 9% interest in B (30% ´ 30%).
4 An indirect holding involves the ability of one corporation to control another corporation by virtue of its control over one or more other corporations. A mutual holding affiliation structure is a special type of indirect holding where affiliates indirectly own themselves.
5 The parent’s direct and indirect ownership of Subsidiary B is 49 percent (70% ´ 70%). However, consolidation of Subsidiary B is still appropriate because 70 percent of B’s stock is held within the affiliation structure and only 30 percent is held by the noncontrolling stockholders of B.
Combined separate earnings of Pat, Sam, and Stan ($100,000 + $80,000 + $50,000) $230,000Less: Noncontrolling interest share computed as follows:
Direct noncontrolling interest in Stan’s income ($50,000 ´ 30%) (15,000)
Indirect noncontrolling interest in Stan’s income ($50,000 ´ 70% ´ 20%) (7,000)Direct noncontrolling interest in Sam’s income
($80,000 ´ 20%) (16,000)Pat’s net income and consolidated net income $192,000
Approach B Pat Sam Stan
Separate earnings $100,000 $80,000 $50,000Allocate Stan’s income to Sam ($50,000 ´ 70%) + 35,000 -35,000Allocate Sam’s income to Pat ($115,000 ´ 80%) + 92,000 -92,000 0Consolidated net income $192,000Noncontrolling interest share $ 23,000 $15,000
7 When the schedule approach for allocating income is used, investment income from the lowest subsidiary must be added to the separate income of the next subsidiary to determine that subsidiary’s net income before it can be allocated to the next subsidiary, and so on.
Separate realized earnings 20,000 9,000 5,000Allocate S2’s income + 3,500 -3,500Allocate S1’s income +10,000 -10,000 0P’s net income $30,000Noncontrolling int. share $ 2,500 $1,500
S1’s investment in S2 account was not adjusted for the unrealized profits because this would create a disparity between S1’s investment in S2 account and S1’s share of S2’s equity.
9 A mutual holding situation exists because two affiliated companies hold ownership interests in each other.
10 The treasury stock approach considers parent company stock held by a subsidiary to be treasury stock of the consolidated entity. Accordingly, the subsidiary investment account is maintained on a cost basis and is deducted at cost from stockholders’ equity in the consolidated balance sheet.
11 In situations in which a subsidiary holds stock in the parent, both the conventional and treasury stock approaches are acceptable, but they do not result in equivalent consolidated financial statements. The consolidated retained earnings and noncontrolling interest amounts will usually be different because of different amounts of investment income. The treasury stock approach is not applicable when the mutually held stock involves subsidiaries holding the stock of each other.
12 No. Parent company dividends paid to the subsidiary are eliminated.
13 The theory is that parent company stock purchased by a subsidiary is, in effect, returned to the parent company and constructively retired. By recording the constructive retirement of the parent company stock on parent company books, parent company equity will reflect the equity of stockholders outside the consolidated entity. Also, recording the constructive retirement, by reducing parent company stock and retained earnings to reflect amounts applicable to controlling stockholders outside the consolidated entity, will establish consistency between capital stock and retained earnings for the parent’s outside stockholders and parent company net income, dividends, and earnings per share which also relate to the outside stockholders of the parent.
14 Consolidated net income is computed as follows:
P = $50,000 + .8SS = $20,000 + .1PP = $50,000 + .8($20,000 + .1P)P = $71,739Consolidated net income = $71,739 ´ 90% = $64,565
15 For eliminating the effect of mutually held parent company stock, two generally accepted approaches are used—the treasury stock approach and the traditional approach. But when the mutually held stock involves subsidiaries holding stock of each other, the treasury stock approach is not applicable.
16 By adding beginning noncontrolling interest and noncontrolling interest share (determined by multiplying the company’s net income by the noncontrolling interest percentage) and subtracting the noncontrolling interest’s percentage of dividends, the noncontrolling interest can be determined without use of simultaneous equations.
SOLUTIONS TO EXERCISES
Solution E9-1
Pent Sal Terp Separate earnings of the three affiliates (in thousands) $ 800 $500 $200Add: Dividend income from Sal’s investment in Wint accounted for by
Consolidated net income – Contr. Share $354 Noncontrolling interest share $ 30 $ (34)
Solution E9-3Place Corporation and Subsidiaries
Income Allocation Schedulefor the year 2009
Place Lake Marsh Separate incomes $200,000 $80,000 $ 70,000Less: Unrealized profit on land (20,000)Separate realized incomes 200,000 60,000 70,000Allocate Lake’s income
60% to Place 36,000 (36,000)20% to Marsh (12,000) 12,000
Allocate Marsh’s income70% to Place 57,400 (57,400)
Consolidated net income – Contr. Share $293,400Noncontrolling interest share $12,000 $ 24,600
Solution E9-4
1 cIncome from Seron is equal to:
70% of Seron’s $160,000 income $112,00070% of Seron’s 80% interest in Trane’s $100,000 income 56,000
Income from Seron $168,000
2 dNoncontrolling interest share is equal to:
30% direct noncontrolling interest in Seron’s $160,000 income $ 48,00020% direct noncontrolling interest in Trane’s $100,000 income 20,000
3 dConsolidated net income is equal to:Combined separate incomes of $360,000 + $160,000 + $100,000 $620,000Less: Noncontrolling interest share 92,000Controlling interest share of Consolidated net income $528,000
Alternative computation: Paine’s separate income $360,000Add: 70% of Seron’s $160,000 income 112,000Add: (70% ´ 80%) of Trane’s $100,000 income 56,000Controlling interest share of Consolidated net income $528,000
Solution E9-5
Pal Sal Tall Ulti Val Separate earnings $ 50,000 $30,000 $35,000 $(20,000) $40,000Less: Unrealized profit - 5,000Separate realized earnings 50,000 30,000 30,000 (20,000) 40,000Allocate Val’s income
70% to Tall +28,000 - 28,000Allocate Ulti’s income
10% to Tall - 2,000 + 2,00060% to Sal -12,000 + 12,000
Allocate Tall’s income80% to Pal + 44,800 -44,80010% to Sal + 5,600 - 5,600
Allocate Sal’s income80% to Pal + 18,880 -18,880
Pal’s net income (or consolidated net income) $113,680Noncontrolling interest share $ 4,720 $ 5,600 $ (6,000) $12,000
1 bSeparate income of Savoy (net income) $ 80,000Separate income of Trent $40,000 - ($80,000 ´ 10%) 32,000Separate income of Pasko $240,000 - ($40,000 ´ 70%) - ($80,000 ´ 80%) 148,000Total separate income $260,000
2 d Pasko Savoy Trent
Separate income $148,000 $80,000 $32,000Unrealized profit on inventory (10,000)Unrealized profit on land (15,000)Separate realized income $148,000 $70,000 $17,000
3 aPasko’s separate income $148,000Add: Investment income from Savoy ($70,000 ´ 80%) 56,000Add: Investment income from Trent [$17,000 + ($70,000 ´ 10%)] ´ 70% 16,800Parent’s income (consolidated net income) $220,800
4 dTotal separate realized income $235,000Less: Consolidated net income 220,800
Noncontrolling interest share $ 14,200
Alternative solutionDirect noncontrolling interest in Savoy ($70,000 ´ .1) $ 7,000Indirect noncontrolling interest in Savoy ($70,000 ´ .3 ´ .1) 2,100Direct noncontrolling interest in Trent ($17,000 ´ .3) 5,100Noncontrolling interest share $ 14,200
P = Income of Pant on a consolidated basis (including mutual income) S = Income of Solo on a consolidated basis (including mutual income) P = Separate income of $3,000,000 + 80% of S S = Separate income of $1,500,000 + 30% of P P = $3,000,000 + .8($1,500,000 + .3P) = $3,000,000 + $1,200,000 + .24P.76P = $4,200,000 P = $5,526,316Consolidated net income = $5,526,316 ´ 70% = $3,868,421
1 dCombined separate income $160,000Less: Noncontrolling interest share 6,750Consolidated net income $153,250
Alternatively:Petty’s separate income $100,000Add: Soma’s net income of $67,500 ´ 90% 60,750Less: Dividends received from Petty ($50,000 ´ 15%) (7,500)Controlling interest share of Consolidated net income $153,250
2 b P = $100,000 + .9($60,000 + .15P).865P = $154,000 P = $178,035 S = $60,000 + $26,705 = $86,705
Consolidated net income = $178,035 ´ .85 = $151,330Noncontrolling interest share = $86,705 ´ .10 = 8,670Total income $160,000
Investment in Scat balance December 31, 2009Investment balance December 31, 2008 $245,700Add: Income from Scat 26,900Less: Dividends received from Scat (24,000)Add: Dividends paid to Scat 6,000Investment in Scat December 31, 2009 $254,600
Supporting computationsComputation of income from Scat:Scat’s separate income $ 50,000Add: Scat’s dividend income from Pumel 6,000Scat’s net income 56,000Pumel’s ownership interest 70%Pumel’s equity in Scat’s income 39,200Less: Dividends paid to Scat ($60,000 ´ 10%) (6,000)Less: Excess amortization ($9,000 x 70%) (6,300)Income from Scat $ 26,900
2 Conventional approach
Pumel’s net income and consolidated net income
P = ($120,000 + .7S) - $6,300 S = $50,000 + .1P
P = $120,000 + .7($50,000 + .1P) - $6,300 P = $120,000 + $35,000 + .07P - $6,300.93P = $148,700 P = $159,892
S = $50,000 + .1($159,892) S = $65,989
Pumel’s net income and consolidated net income ($159,892 ´ 90%) $143,903Noncontrolling interest share ($65,989 ´ 30%) 19,797
Total income $163,700
Income from ScatConsolidated net income $143,903Less: Pumel’s separate income 120,000
Pida Corporation and SubsidiariesSchedule to Compute Consolidated Net Income and Noncontrolling Interest Share
for the year 2009
Pida Staley Axel Bean Separate income (loss) $500,000 $300,000 $150,000 $(20,000)
Less: Unrealized profit (20,000)
Separate realized income (loss) 500,000 300,000 130,000 (20,000)Allocate Bean’s loss 70% to Staley (14,000) 14,000
Allocate Axel’s income 60% to Staley 78,000 (78,000)Patent (12,000)
352,000Allocate Staley’s income 90% to Pida 316,800 (316,800)Patent (40,000)
Controlling share of net income $776,800
Noncontrolling interest income $ 35,200 $ 52,000 $ (6,000)
Check:
Income allocated: $776,800 consolidated net income + $35,200 noncontrolling interest share in Staley + $52,000 noncontrolling interest share in Axel - $6,000 noncontrolling interest share (loss) in Bean = $858,000
Income to allocate: $500,000 Pida income + $300,000 Staley income + $130,000 realized income of Axel - $20,000 loss of Bean - $52,000 patent = $858,000
Investment in Thayer (70%) 147,000Cash 147,000To record purchase of a 70% interest in Thayer Corporation.
Cash 7,000Investment in Thayer (70%) 7,000To record dividends received from Thayer ($10,000 ´ 70%).
Investment in Thayer (70%) 17,500Income from Thayer 17,500To record investment income computed as follows:Share of Thayer’s net income ($30,000 ´ 70%) $ 21,000Less: Unrealized profit from upstream sale of inventory items ($5,000 ´ 70%) (3,500)
$ 17,500
Posey’s books
Cash 24,000Investment in Seaton (80%) 24,000To record dividends received from Seaton ($30,000 ´ 80%).
Investment in Seaton (80%) 44,000Income from Seaton 44,000To record investment income computed as follows:
Share of Thayer’s net income($50,000 + $17,500) ´ 80% $ 54,000Less: Unrealized gain on land sold to Thayer (10,000)
Total liabilities and equity $1,144,000 $387,500 $270,000
Note: Posey’s assets other than investments consist of $800,000 assets at the beginning of the year, plus separate earnings of $150,000 and dividend income of $24,000, less dividends paid of $50,000.
Seaton’s assets other than investments consist of $350,000 assets at the beginning of the period, plus separate earnings of $50,000 and dividend income of $7,000, less investment cost of $147,000 and dividends paid of $30,000.
Check on consolidated net income Pony Star Teel Total
Net income as stated $184,500 $90,000 $25,000 $299,500Less: Investment income (84,500) (10,000) (94,500)Separate income 100,000 80,000 25,000 205,000Add: Unrealized profit in beginning inventory 8,000 8,000Less: Unrealized profit in ending inventory (20,000) (20,000)Separate realized incomes 108,000 80,000 5,000 193,000Allocate Teel’s income
50% to Pony 2,500 (2,500)40% to Star 2,000 (2,000)
Star’s net income 82,000Allocate Star’s income
80% to Pony 65,600 (65,600)Less: Depreciation on excess allocated to plant and Equipment (5,000) ( 1,250) (6,250)Total income of consolidated Entity $186,750Controlling share of NI $171,100 171,100Noncontrolling int. share $ 15,150 $ 500 15,650
$186,750
Investment in Star (80%) $420,000
Implied total fair value of Star ($420,000 / 80%) $ 525,000Book value of Star (500,000)Excess of fair value over book value $ 25,000
Excess allocated to equipment wit a four year lfe Amortization ($25,000 / 4 yrs) $ 6,250
Investment in Teel (50%) $ 75,000
Implied total fair value of Teel ($75,000 / 50%) $ 150,000Book value of Star (120,000)Excess of fair value over book value – Goodwill $ 30,000
Income allocationConsolidated net income = P = $320,408Noncontrolling interest share in Swift ($112,245 ´ .1) 11,225Noncontrolling interest share in Tolbert ($61,224 ´ .3) 18,367
Income allocationConsolidated net income = P = $293,673.48Noncontrolling interest share in Swift ($110,204.08 ´ 10%) 11,020.40Noncontrolling interest share in Tolbert ($51,020.41 ´ 30%) 15,306.12
Dividend income 10,000Dividends 28,000Investment in Skill 9,000To eliminate income from Skill, dividend income, and 90% of Skill’s dividends, and return the investment in Skill account to the beginning-of-the-period balance under the equity basis.
b Capital stock — Skill 200,000Retained earnings — Skill 200,000Goodwill 50,000
Investment in Skill 405,000Noncontrolling interest — beginning 45,000To eliminate reciprocal investment and equity accounts, and enter beginning-of-the-period patent and noncontrolling interest.
c Treasury stock 80,000Investment in Prill 80,000To reclassify investment in Prill to treasury stock.
d Noncontrolling Interest Share 3,000Dividends 2,000Noncontrolling Interest 1,000To record noncontrolling interest share of subsidiary income and dividends.
Income from ScimpParoll separate income (140,000 - 80,000) $ 60,000Scimp separate income (100,000 + 3,000 - 60,000) $ 43,000
Formula:P income = Adjusted Paroll income + % interest ´ S incomeAdjusted Paroll income = $60,000 + $2,000 delayed gain on land
- $4,000 patent amortization (80%)S income = Scimp income + % interest ´ P incomeP income = $58,000 + 80% ´ ($43,000 + 20% ´ P income)P income = $92,400 + .16 ´ P incomeP income = $110,000S income = $43,000 + 20% ´ $110,000S income = $65,000Controlling share of consolidated net income = P income ´ % outstandingControlling share = $88,000Noncontrolling share = S income ´ % outstandingNoncontrolling share = $12,000 [($65,000 - $5,000 amortiz.) x 20%]Income from Scimp = consolidated income less P separate incomeIncome from Scimp = $28,000 ($88,000-$60,000)
Working paper entriesa Investment in Scimp 2,000
Gain on sale of land 2,000To recognize previously deferred gain on sale of land.
b Dividend income 4,000Investment in Scimp 4,000To eliminate intercompany dividends paid to Scimp
c Income from Scimp 28,000Dividends 16,000Investment in Scimp 12,000To eliminate income from Scimp and 80% of Scimp’s dividends, and return the investment in Scimp account to the beginning-of-the-period balance under the equity basis.
d Investment in Scimp 100,000Investment in Paroll 100,000To eliminate reciprocal investments.
e Capital stock — Scimp 50,000Retained earnings — Scimp 180,000Patent 20,000
Noncontrolling interest — beginning 54,290To eliminate reciprocal investment and equity accounts, and enter beginning-of-the-period patent and noncontrolling interest.
f Expenses 5,000Patent 5,000
To record current year’s amortization of patent.
g Noncontrolling Interest Share 12,000Dividends 4,000Noncontrolling Interest 8,000To record the noncontrolling interest share of subsidiary income and dividends.
To record income from Stoco computed as follows: 80%($54,348) - 10%($143,478) = $29,130. Alternatively $129,130 - $100,000 separate income = $29,130.
Cash 16,000Investment in Stoco 16,000To record receipt of 80% of Stoco’s dividends.
Investment in Stoco (80%) 5,000Dividends 5,000To eliminate dividends on stock that was constructively retired and to adjust the investment in Stoco account for the transfer equal to 10% of Panco’s dividends.
a Income from Panco 14,348Dividends 5,000Investment in Panco 9,348To eliminate investment income and dividends from Panco and return the investment account to its beginning-of-the-period balance.
b Investment in Stoco 80,000Investment in Panco 80,000To eliminate investment in Panco balance and increase the investment in Stoco for the constructive retirement of Panco’s stock that was charged to the investment in Stoco account.
c Dividends 5,000Investment in Stoco 5,000To eliminate dividends.
d Income from Stoco 29,130Dividends 16,000Investment in Stoco 13,130To eliminate income and dividends from Stoco and return the investment in Stoco to its beginning-of-the-period balance.
e Capital stock — Stoco 150,000Retained earnings — Stoco 100,000Patent 12,500
Investment in Stoco 208,000Noncontrolling interest 54,500To eliminate Stoco’s equity account balances and the investment in Stoco, enter beginning-of-the-period patent and noncontrolling interest.
f Noncontrolling interest share 10,870Dividends 4,000Noncontrolling Interest 6,870To record the noncontrolling interest share of subsidiary income and dividends.
SUBSIDIARY PREFERRED STOCK, CONSOLIDATED EARNINGS PER SHARE,AND CONSOLIDATED INCOME TAXATION
Answers to Questions
1 Flora’s investment incomeArom’s net income $ 300,000Less: Preferred income ($500,000 ´ 10%) (50,000)
Income to common stockholders 250,000Flora’s percentage owned 60%
Investment income $ 150,000Flora’s investment account balance (equal to book value):Arom’s stockholders’ equity $2,500,000Less: Preferred equity (no arrearages or call premiums) (500,000)
Common equity 2,000,000Flora’s percentage ownership 60%
Investment account balance $1,200,000
2 The payment of two years preferred dividend requirements would not have affected Flora’s investment income. Since the preferred stock is cumulative, the preferred dividend requirements are deducted from net income each year regardless of whether preferred dividends are declared.
3 The preferred stock of a subsidiary does not appear in a consolidated balance sheet. If there is a noncontrolling interest in the preferred stock, it is reported as a noncontrolling interest in the consolidated balance sheet. In part a, the investment in preferred is eliminated against the preferred equity and there is no noncontrolling interest in preferred. When 50 percent of the stock is held by the parent (part b), the investment in preferred is eliminated against 50 percent of the preferred equity and the other 50 percent is reported as a noncontrolling interest. In part c, all of the preferred stock is reported as a noncontrolling interest.
4 Assuming that the parent does not hold any of the subsidiary’s preferred stock, the computation of noncontrolling interest share for an 80 percent owned subsidiary is 100 percent of the income allocated to preferred plus 20 percent of the income allocated to common.
5 There is no difference between the controlling share of consolidated and parent company EPS.
6 An investor company’s EPS computations must reflect the potential dilution of an equity investee’s common stock equivalents and other potentially dilutive securities if the effect is material.
7 Procedures applied in computing a parent company’s EPS computations are the same as those for a corporation without equity investments except when the subsidiary has outstanding common stock equivalents or other potentially dilutive securities.
8 Subsidiary EPS computations are only needed when computing diluted EPS, never for basic EPS, and then it is only needed when the subsidiary has potentially dilutive securities convertible into subsidiary common stock.
9 If a subsidiary has dilutive securities convertible into subsidiary common stock, the parent’s diluted earnings are adjusted by replacing the parent’s equity in subsidiary realized income with its equity in subsidiary diluted EPS. Alternatively, when subsidiary securities are convertible into the parent’s common stock, the parent’s diluted earnings and common shares are adjusted as if the dilutive securities had been issued by the parent company.
10 The replacement computation does not involve unrealized profits from downstream sales because these items relate solely to parent company operations and do not affect the noncontrolling interest. In the case of unrealized profits from upstream sales, however, unrealized profits are deducted in the replacement computation which involves subtracting the parent’s equity in subsidiary realized income and adding back the parent’s equity in subsidiary primary or fully diluted EPS (also based on subsidiary realized income).
11 Consolidated tax returns are not required for a consolidated entity, but a consolidated entity that qualifies as an “affiliated group” may elect to file consolidated tax returns. Once consolidated returns are elected, it may be difficult to obtain IRS permission to file separate returns.
12 Yes. Consolidated entities that meet the requirements of an affiliated group can and often do elect to file separate income tax returns.
13 The primary advantages of filing consolidated tax returns are (1) losses of affiliates are offset against gains of other members of the affiliated group, (2) intercompany profits between group members are eliminated from taxable income until realized, and (3) intercorporate dividends are fully excluded from taxable income. (But note that 3 is not a unique advantage of filing a consolidated return.)
14 Dividends received by a member of an affiliated group from other group members are excluded from federal income taxation regardless of whether the affiliated group elects to file consolidated tax returns.
15 Temporary differences result because investors that are not members of an affiliated group record income from equity investments as it is earned, but pay taxes only when dividends are actually received.
16 In providing for income taxes on undistributed earnings of equity investees, the parent company/investor debits income tax expense and credits deferred income taxes as part of the determination of all income taxes for the period. The investment and investment income accounts are not affected.
17 Unrealized and constructive gains and losses give rise to temporary differences unless the consolidated entity is a member of an affiliated group and elects to file consolidated tax returns.
SOLUTIONS TO EXERCISES
Solution E10-1 [AICPA adapted]
1 aMoss income to preferred $10,000 ´ 20% owned $ 2,000Moss income to common $50,000 ´ 80% owned 40,000Income from Moss $ 42,000
2 b$180,000 ´ 20% taxable ´ 30% tax rate
3 dAll dividend income is excluded from a consolidated group.
4 dIntercompany profit is deferred in the consolidated tax return until realized through sale to an outside entity.
1 Cost/fair value differentialTotal stockholders’ equity January 1, 2010 $8,000,000Less: Preferred equity (10,000 shares ´ $115) 1,150,000Common equity $6,850,000
Cost $8,100,000
Implied total fair ($8,100,000 / 90%) $9,000,000Book value of investment 6,850,000Excess fair over book value – Goodwill $2,150,000
2 Income from Star for 2010Star’s net income $1,200,000Less: Preferred dividends for 2010 100,000Income to common $1,100,000Income from Star ($1,100,000 ´ 90%) $ 990,000
3 Investment in Star at December 31, 2010Investment cost January 1, 2010 $8,100,000Add: Income from Star 990,000Less: Dividends ($600,000 - $200,000 preferred) ´ 90% (360,000)Investment in Star $8,730,000
4 Noncontrolling interest for 2010Beginning stockholders’ equity $8,000,000Add: Net income 1,200,000Less: Dividends (600,000)Stockholders’ equity December 31, 2010 $8,600,000
Implied total fair value ($1,536,000 / 80%) $1,920,000Less: Book value ($2,500,000 total equity - $630,000 preferred equity) (1,870,000)Excess fair value over book value - Goodwill $ 50,000
Sommerfeld’s net loss $ 100,000Add: Income to preferred stockholders 72,000Loss to common stockholders 172,000Percent owned 80%Loss on investment in Sommerfeld $ 137,600
Net income $ 500,000Less: Income to preferred stockholders (72,000)Income to common stockholders 428,000Percent owned 80%Income from investment in Sommerfeld $ 342,400
4 Parnell’s investment in Sommerfeld account
Total stockholders’ equity at December 31, 2010 ($2,500,000 - $100,000 loss in 2009 + $500,000 income in 2010 - $344,000 dividends in 2010) $2,556,000Less: Preferred equity (630,000)Common equity 1,926,000Percent owned 80%Underlying equity 1,540,800Add: 80% of Unamortized excess 40,000Investment in Sommerfeld at December 31, 2010 $1,580,800
Check: Cost of investment $1,536,000Loss — 2009 (137,600)Income — 2010 342,400Dividends 2010 ($344,000 - $144,000) ´ 80% (160,000)Investment in Sommerfeld at December 31, 2010 $1,580,800
Solution E10-4 [Preferred stock]
1 Investment cost (fair value equals book value)
Total stockholders’ equity of Sandalwood $4,000,000Less: Preferred equity 10,000 shares ´ ($100 + $5 + $12) 1,170,000Common equity 2,830,000Percent owned 80%Investment cost (fair value and book value) $2,264,000
2 Consolidated net income and noncontrolling interest share
Penzance separate income $3,000,000Add: Income from Sandalwood ($500,000 - $120,000) ´ 80% 304,000Consolidated net income $3,304,000
Noncontrolling interest share ($380,000 common income ´ 20%) + $120,000 preferred income $ 196,000
Preliminary computationsTotal equity of Shoshone at December 31, 2009 $3,500,000Less: Preferred equity (10,000 shares ´ $115) (1,150,000)Common equity December 31, 2009 $2,350,000
1 Entries to record preferred stock investment
Investment in Shoshone — preferred 600,000Cash 600,000
To record purchase of 50% of Shoshone’s preferred stock.
Additional paid-in capital 25,000Investment in Shoshone — preferred 25,000
To adjust investment in preferred account to underlying equity: $600,000 cost - ($1,150,000 underlying equity ´ 50%) = $25,000.
2 Excess of fair value over book value from common stock investmentCost of 80% investment in common stock $2,000,000
Implied total fair value ($2,000,000 / 80%) $2,500,000Book value (2,350,000)Excess fair value over book value $ 150,000
3 Pimlico’s income from Shoshone preferred — 2010$1,000,000 par ´ 15% ´ 50% owned $ 75,000
4 Pimlico’s income from Shoshone common — 2010Equity in Shoshone’s common income ($400,000 income - $150,000 preferred dividends) ´ 80% owned $ 200,000Amortization of excess ($150,000/10 years) ´ 80% owned (12,000)Income from Shoshone common $ 188,000
5 Noncontrolling interest at December 31, 2010Total equity at December 31 ($3,500,000 + $400,000 income - $300,000 dividends) $3,600,000Less: Preferred equity (1,000,000)Common equity $2,600,000Plus 20% of unamortized differential (20% ´ $135,000) 27,000Common equity plus excess fair value $2,627,000
Noncontrol. Int. — preferred ($1,000,000 ´ 50%) $500,000Noncontrol. interest — common ($2,627,000 ´ 20%) 525,400Total noncontrolling interest December 31 $1,025,400
Cost of preferred stock $ 6,500,000Book value of preferred 60,000 shares ´ ($100 par + $5 call premium + $10 dividend arrearage) (6,900,000)Excess book value of preferred stock over cost $ (400,000)
Cost of common stock $35,000,000
Implied total fair value ($35,000,000 / 70%) $50,000,000Book value of common ($60,000,000 total equity - $11,500,000 preferred equity) 48,500,000Excess fair value over book value of common $ 1,500,000
2 The $400,000 negative differential should be treated as an increase in the preferred investment and other paid-in capital accounts on Perry’s books. Perry will record its investment in Sketch preferred as follows:
Investment in Sketch preferred 6,500,000Cash 6,500,000
To record purchase of 60% of Sketch’s preferred stock.
Investment in Sketch preferred 400,000Other paid-in capital 400,000
To adjust other paid-in capital for the constructive retirement of 60% of Sketch’s preferred shares.
Solution E10-7 [EPS]
1 d2 c3 d
Solution E10-8 [EPS]1 a Solaid’s diluted earnings for consolidated EPS purposes
Polar’s equity in Solaid’s income $176,000/.8 $ 220,000
2 cSolaid’s outstanding shares 50,000 sharesAdd: Incremental shares 10,000 shares - ($100,000 assumed proceeds/$20 average market price) 5,000 sharesSolaid’s common shares and common share equivalents 55,000 shares
Income to common (equal to Sheridan’s net income) = a $18,000 $18,000
Common shares and common share equivalents:Outstanding shares 5,000 5,000Additional shares using treasury stock method: 1,000 - (1,000 ´ $9)/$15 400
Common shares and common share equivalents = b 5,000 5,400Sheridan’s EPS = a/b $ 3.60 $ 3.33
Putman’s basic and diluted EPS
Income to common (equal to Putman’s net income) $20,000 $20,000
Replacement of Putman’s equity in Sheridan’s realized income with Putman’s equity in Sheridan’s diluted earnings: Equity in Sheridan’s income to common ($18,000 ´ 80%) (14,400)
Equity in Sheridan’s diluted earnings (4,000 shares ´ $3.33) 13,320
Putman’s basic and diluted earnings = a $20,000 $18,920Outstanding common shares = b 8,000 8,000Putman’s EPS = a/b $ 2.50 $ 2.37
Solution E10-10 [EPS]
Basic Diluted Stanley’s earnings per share
a Net income $26,400 $26,400Stanley’s common shares outstanding 20,000 20,000Incremental shares from warrantsDiluted: 5,000 — ($120,000 assumed proceeds/$30 average price) 1,000
b Common shares and equivalents 20,000 21,000Earnings per share $ 1.32 $ 1.26
Prince’s basic and diluted EPSPrince’s income to common ($80,467 - $12,000 to preferred) $68,467 $68,467Replacement computation:
Equity in Stanley’s income (21,120)Equity in Stanley’s EPS
Deferred income taxes: $17,500 share of undistributed earnings ´ 20%
taxable ´ 34% tax rate = $1,190
5 aNo income tax is assessed on dividends received from a 100% owned domestic subsidiary
Solution E10-14 [Tax]
1 Separate company tax returnsPruit’s income taxes currently payable:
Pretax accounting income $300,000 ´ 34% tax rate = $102,000Solo’s income taxes currently payable:
Pretax accounting income $100,000 ´ 34% tax rate = 34,000Income taxes currently payable 136,000Less: Increase in deferred tax asset ($200,000 ´ 34%) (68,000)Consolidated income tax expense $ 68,000
2 Consolidated tax returnCombined pretax accounting income $400,000Less: Unrealized gain on downstream sale of land (200,000)Taxable income 200,000Tax rate 34%Consolidated income tax expense $ 68,000
3 Separate tax returnsPruit’s income taxes currently payable:
Pretax accounting income $300,000 ´ 34% tax rate = $102,000Solo’s income taxes currently payable:
Pretax accounting income $100,000 ´ 34% tax rate = 34,000Income taxes currently payable 136,000
Consolidated tax returnCombined pretax accounting income $400,000Less: Unrealized gain on downstream sale of land (200,000)Taxable income 200,000Tax rate 34%Income taxes currently payable $ 68,000
1 One-line consolidation entriesSeparate tax returns are filedIncome from Sullivan 40,000
Investment in Sullivan 40,000To eliminate unrealized profit on downstream sale of merchandise. Computation: $50,000 gross profit ´ 80% unrealized.
Note: that the tax effect of the unrealized profit is $13,600, but that amount is a deferred tax asset to be included in the computation of Peddicord’s income tax expense. The deferred tax asset may be reduced by a valuation allowance following FIN 48.
Consolidated income tax returns are filedIncome from Sullivan 40,000
Investment in Sullivan 40,000To eliminate unrealized profit on downstream sale of merchandise. Computation: $50,000 gross profit ´ 80% unrealized.
Note: since no tax is paid on the inventory profit, no income tax adjustment is necessary.
2 Consolidation working paper entriesSeparate Income Tax
Returns Filed Consolidated Income Tax Returns Filed
Sales 100,000 100,000Cost of goods sold 100,000 100,000To eliminate reciprocal sales and purchases.
Cost of goods sold 40,000 40,000Inventory 40,000 40,000To eliminate unrealized profits in ending inventory.
Note: No adjustments for tax effects are needed because consolidated income tax is equal to combined separate company income taxes under FASB Statement No. 109.
Solution E10-17 [Tax]
1 One-line consolidation entry
Income from Sweeney 80,000Investment in Sweeney 80,000To eliminate unrealized profit on upstream sale. Computation: $100,000 unrealized profit ´ 80% owned.
Net income of Sweeney (includes the tax effect of the gain) $800,000Less: Unrealized profit (100,000)Realized income of Sweeney 700,000Noncontrolling interest percentage 20%Noncontrolling interest share $140,000
Solution E10-18
Possible EstimatedOutcome
Individual Probabilityof Occurring (%)
Cumulative Probabilityof Occurring (%)
$500,000 10 10
400,000 25 35
300,000 25 60
200,000 20 80
100,000 10 90
0 10 100
Because $300,000 is the largest amount of benefit that is greater than 50 percent likely of being realized, Pax would recognize a tax benefit of $300,000. in the financial statements (Deferred tax asset of $500,000 less a valuation allowance of $200,000).
Solution E10-19
Possible EstimatedOutcome
Individual Probabilityof Occurring (%)
Cumulative Probabilityof Occurring (%)
$150,000 50 50
125,000 20 70
100,000 10 80
50,000 10 90
0 10 100
Because $125,000 is the largest amount of benefit that is greater than 50 percent likely of being realized, Pony would recognize a tax benefit of $125,000. in the financial statements (Deferred tax asset of $150,000 less a valuation allowance of $25,000).
Excess fair value = Goodwill $1,000* Preferred equity at liq. Pref. (!0,000 ´ $105) + Div. in arrears ($100,000)
2 Income from StanleyStanley’s reported income $ 500Less: Preferred dividend for 2009 ( 100)Stanley’s adjusted income to common $ 40090% of Stanley’s adjusted income $ 360
3 Noncontrolling interest share for 2009Income allocable to preferred $ 100Stanley’s adjusted income $400Noncontrol. common interest share (10%) $ 40Noncontrolling interest share $ 140
4 Noncontrolling interest December 31, 2009Total stockholders’ equity ($4,150,000 + $500,000 net income - $400,000 dividends) $4,250Less: Preferred equity (No div. in arrears) 1,050 ´ 100% $1,050Common equity – book value $3,200Plus Unamortized fair value at 12/31 1,000Common equity at fair value $4,200 ´ 10% 420Noncontrolling interest December 31 $1,470
5 Investment in Stanley December 31, 2009Investment cost $3,600Add: Income from Stanley 360Less: Dividends ($400,000 - $100,000 preferred dividends in arrears - $100,000 current preferred dividends) ´ 90% (180)Investment in Stanley December 31 $3,780
Preliminary computationsStockholders’ equity July 1, 2009 $900,000 - ($46,000 income ´ 1/2 year) $877,000Less: Preferred equity July 1, 2009
Par value with call premium $210,000Dividend arrearage — 2008 ($200,000 ´ 9%) 18,000Dividend arrearage — 2009 ($200,000 ´ 9% ´ 1/2 year) 9,000 237,000
Common equity July 1, 2009 $640,000
Cost of 90% interest in Starky’s common stock $630,000
Implied total fair value ($630,000 / 90%) $700,000Book value of common equity (640,000)Goodwill $ 60,000
Cost of 80% interest in Starky’s preferred stock $175,000Book value acquired ($237,000 ´ 80%) (189,600)Book value over cost of preferred $(14,600)
1 Investment account balances at December 31, 2009 Common Preferred
Investment cost $630,000 $175,000Adjust preferred to book value and recognize a constructive retirement 14,600Income to preferred ($18,000 ´ 1/2 year ´ 80%) 7,200Income to common ($28,000 ´ 1/2 year ´ 90%) 12,600Investment balances December 31 $642,600 $196,800
2 Consolidated balance sheet working paper entries
9% preferred stock, $100 par 200,000Retained earnings — Starky 46,000
Investment in Starky — preferred 196,800Noncontrolling interest — preferred 49,200To eliminate reciprocal preferred equity and investment balances and enter noncontrolling interest. The preferred stockholders’ claim on Starky’s retained earnings consists of $18 per share preferred dividends in arrears plus a $5 per share call premium. Computations: Investment in Starky preferred = $123 ´ 1,600 shares. Noncontrolling interest — preferred = $123 ´ 400 shares.
Capital stock, $10 par — Starky 500,000Paid-in capital in excess of par — Starky 40,000Retained earnings — Starky 114,000
Goodwill 60,000Investment in Starky — common 642,600Noncontrolling interest — common 71,400
To eliminate reciprocal common equity and investment amounts and enter goodwill and noncontrolling interest in common.NOTE: Noncontrolling interest includes 10% of Goodwill.
Preliminary computationsCost of 70% interest in Sal January 1, 2008 $490,000Implied total fair value of Sal ($490,000 / 70%) $700,000 Book value acquired of common equity 700,000
Excess of fair value over book value $ 0
Cost of 20% interest in Sal April 1, 2009 $152,000
Implied total fair value of Sal ($152,000 / 20%) $760,000Book value of Sal($850,000 + $22,500 - $12,500 - $100,000) 760,000
Excess of fair value over book value $ 0
Pat’s investment income from Sal for 2009Sal’s net income $ 90,000Less: Preferred income ($100,000 ´ 10%) 10,000
Income to common $ 80,000Income from Sal($80,000 ´ 70% ´ 1 year)+($80,000 ´ 20% ´ 3/4 year) $ 68,000
Fair value — book value differentialInvestment cost $240,000
Implied total fair value of Sak ($240,000 / 80%) $300,000Less: Book value acquired
Sak’s stockholders’ equity January 1, 2008 $325,000Less: Preferred equity 100,000Sak’s common equity 225,000Excess fair value over book value = Goodwill $ 75,000
Income from Sak for 2009Equity in Sak’s income ($60,000 - $10,000 pf) ´ 80% $ 40,000Add: Intercompany profits beginning inventory ($50,000 ´ 40% ´ 3/5) 12,000Less: Intercompany profits ending inventory ($60,000 ´ 40% ´ 4/6) (16,000)Add: Realization of 80% of $10,000 profit deferred on land from 2005 8,000Add: Constructive gain on bonds ($9,000 ´ 80%) 7,200Less: Piecemeal recognition of gain ($9,000/3 years ´ 1/2 year ´ 80%) (1,200)
Income from Sak $ 50,000
Investment in Sak December 31, 2009Underlying book value ($390,000 - $100,000) ´ 80% $232,000Add: 80% of Goodwill 60,000Less: Unrealized inventory profit (16,000)Add: Constructive gain less 1/2 year piecemeal recognition ($9,000 - $1,500) ´ 80% 6,000
Investment in Sak December 31 $282,000
Noncontrolling interest share — commonSak’s reported income less income to preferred ($60,000 - $10,000) $ 50,000Recognition of previously deferred gain on land 10,000Constructive gain on bonds less 1/2 year piecemeal recognition of gain ($9,000 - $1,500) 7,500Sak’s realized income to common 67,500Noncontrolling interest percentage 20%
Skinner’s net income (equal to income to common stockholders) $ 60,000 $ 60,000Add: Net-of-tax interest on convertible bonds 6,000 NASkinner’s earnings = a $ 66,000 $ 60,000
Skinner’s outstanding common shares 50,000 50,000Add: Shares from assumed conversion of bonds 10,000 NACommon shares and common share equivalents = b 60,000 50,000Skinner’s EPS = a/b $ 1.10 $ 1.20
Palace’s EPSPalace’s net income (equal to income to common stockholders) $150,000 $150,000Add: Net-of-tax interest on convertible bonds of Skinner 6,000Replacement of Palace’s equity in Skinner’s income with Palace’s equity in Skinner’s diluted (42,000) (42,000)a
EPS (35,000 shares ´ $1.10) and convertible 38,500 to Palace securities (35,000 shares ´ $1.20) 42,000a
Palace’s earnings = a $146,500 $156,000
Palace’s outstanding common shares 100,000 100,000Add: Shares from assumed conversion of bonds 10,000Common shares and common share equivalents = b 100,000 110,000Palace’s EPS = a/b $ 1.47 $ 1.42
a When subsidiary securities are convertible into parent company common stock, the replacement calculation is not needed. The replacement is included in this solution only to show that it has no effect on the calculation.
Income to common $ 45,000 $ 45,000Income to preferred assumed converted 10,000
a Earnings $ 45,000 $ 55,000Common shares and common share equivalents:Common shares outstanding 10,000 10,000Add: Common shares issuable on preferred 3,000Add: Incremental shares issuable on options2,000 - [($2,000 ´ $15)/$30] 1,000
b Common and common equivalent shares 10,000 14,000EPS a/b $ 4.50 $ 3.93Pensacola’s earnings per shareIncome to common $150,000 $150,000Replacement calculation
Equity in Sheridan’s income to common ($45,000 ´ 80%) (36,000)a (36,000)Equity in Sheridan’s EPS 8,000 ´ $4.50 basic EPS 36,000a
a A replacement calculation is never needed when calculating basic earnings per share. It is only included here to illustrate the point that the replacement will have no impact on the earnings per share calculation.
1 Basic Diluted Starch’s earnings per shareIncome to common $50,000 - $14,000 $36,000 $ 36,000Add: Income to preferred assumed converted 14,000
a Earnings $36,000 $ 50,000Common shares outstanding 6,000 6,000Common shares from conversion of preferred 4,000
b Common and common equivalent shares 6,000 10,000
EPS a/b $ 6.00 $ 5.00
Consolidated earnings per shareNet income to Protein $93,800 $ 93,800Replacement calculation for diluted EPS $36,000 ´ 80% share of realized income (28,800) $5.00 diluted EPS ´ 4,800 shares 24,000
a Earnings $93,800 $ 89,000b Outstanding common shares 20,000 20,000
EPS a/b $ 4.69 $ 4.45
2 Net income of Protein $93,800 $ 93,800Add: Income to preferred 14,000
a Earnings $93,800 $107,800Common stock of Protein 20,000 20,000Common shares from conversion of preferred 5,000
b Common and common share equivalents 20,000 25,000EPS a/b $ 4.69 $ 4.312
Solution P10-8 [EPS]
Premble’s net income $1,262,000Replacement calculation:
Premble’s equity in Smithfield’s realized income ($500,000 - $60,000) ´ 80% $352,000Premble’s equity in Smithfield’s diluted EPS (40,000 shares ´ $7.44) 297,600 54,400
Consolidated diluted earnings = a $1,207,600Premble’s outstanding common shares = b 100,000Consolidated diluted EPS = a/b $ 12.08
Basic Diluted Sim’s earnings per shareIncome to common $200,000 $200,000Less: Unrealized profit — upstream sale (20,000) (20,000)Add: Income to preferred 100,000
a Earnings $180,000 $280,000Common shares outstanding 50,000 50,000Add: Shares from conversion of preferred 30,000
Add: Incremental shares from warrants10,000 - ($150,000/$20) 2,500
b Common and common equivalent shares 50,000 82,500EPS a/b $ 3.60 $ 3.3939
Consolidated (and Pike’s) earnings per sharePike’s income to common $450,000 $450,000Replacement calculation
Equity in Sim’s realized income ($200,000 - $20,000) ´ 80% (144,000)
Equity in Sim’s diluted EPS 40,000 ´ $3.39 135,600a Earnings $450,000 $441,600b Outstanding common shares 100,000 100,000
EPS a/b $ 4.50 $ 4.42
Solution P10-10 [Tax]Pactor Corporation
Income Statementfor the current year
(a) (b)Assuming Separate Assuming Consolidated
Tax Returns Tax Return Sales $1,200,000 $1,200,000Gain on sale of land 50,000 50,000Income from Shrama 49,000 49,000Cost of sales (600,000) (600,000)Operating expenses (350,000) (350,000)
Income before income taxes 349,000 349,000Income tax expenseb (85,000) (85,000)
Net income $ 264,000 $ 264,000
Supporting computationsa Income from Shram
Equity in Shram’s income ($150,000 - $51,000 income taxes) ´ 100% $ 99,000 $99,000Less: Unrealized profit (50,000) (50,000)Income from Shram $ 49,000 $49,000
Consolidated net income checkStewart’s net income of $66,000 ´ 70% $ 46,200Less: Unrealized inventory profit (10,000)Income from Stewart — equity basis 36,200Less: Stewart’s income — cost basis (28,000)Cost — equity method difference 8,200Add: Pulaski’s reported net income 141,778Controlling share of NI $149,978
Controlling share of NI $221,430 $ 62,700 $ 221,430
a Pen’s income tax expense is calculated:Sales 800,000Cost of Sales (400,000)Expenses (150,000)Pretax income 250,000Tax rate .34Income tax expense 85,000
Preliminary computationsIncome from Soo for 2009Share of Soo’s net income ($62,700 ´ 90%) $ 56,430Less: Unrealized profit on intercompany sale of land (20,000)
Income from Soo $ 36,430Investment in Soo account December 31, 2009Cost of 90% interest in Soo January 1 $900,000Add: Income from Soo 36,430Less: Dividends from Soo (45,000)
Investment December 31 $891,430
a Gain on sale of land 20,000Land 20,000To eliminate unrealized intercompany profit from downstream sale of land.
b Income from Soo 36,430Investment in Soo 8,570
Dividends from Soo 45,000To eliminate investment income and dividends and return the investment in Soo account to its beginning of the period balance.
c Capital stock — Soo 500,000Retained earnings — Soo 400,000Goodwill 100,000
Investment in Soo 900,000Noncontrolling interest January 1 100,000To eliminate reciprocal beginning of the period investment and equity balances, establish beginning noncontrolling interest, and enter goodwill.
1 Allocation scheduleCost of investment = Fair value (100% purchase) $280,000Book value 170,000
Excess fair value over book value $110,000
Excess allocatedLand $ 40,000Buildings — net 30,000 (10 year life)Equipment — net 10,000 (2 year life)Goodwill for the remainder 30,000
Excess fair value over book value $110,000
Note: In a taxable combination transaction there are no deferred tax liabilities since the tax basis and book basis are the same. A current tax deduction will affect the future recognized income from Studio Corporation.
2 Allocation scheduleCost (fair value) of investment $280,000Book value 170,000
Excess fair value over book value $110,000
Excess allocated:Land $ 40,000Buildings — net 30,000 (10 year life)Equipment — net 10,000 (2 year life)Deferred tax liability
($80,000 ´ 35%) (28,000)a
Goodwill for the remainder 58,000Excess fair value over book value $110,000
a On a tax-free reorganization a deferred tax liability must be set up for all the tax basis/book basis differentials, other than goodwill. Since the transaction is recorded at purchase price on the books but has no change in tax basis from the original books, differences in basis occur and are equal to any fair value write-ups of the assets.
3 Parson’s income from Studio for 2009
TaxableStudio’s reported income $ 50,000Less: Depreciation on excess allocated to buildings — net ($30,000/10 years) (3,000)Less: Depreciation on excess allocated to equipment — net ($10,000/2 years) (5,000)Add: Income tax reductions due to the prior adjustments 2,800a
Tax freeStudio’s reported income $50,000Less: Depreciation on excess allocated to buildings — net ($30,000/10 years) (3,000)Add: Amortization of deferred tax liability allocated to buildings ($3,000 ´ .35) 1,050Less: Depreciation on excess allocated to equipment — net ($10,000/2 years) (5,000)Add: Amortization of deferred tax liability allocated to equipment ($5,000 ´ .35) 1,750Income from Studio $44,800
Solution P10-15
1 Income tax expense Pommer Sooner
Income taxes currently payable:Taxes on operating income $1,400,000 ´ 34% $476,000 $800,000 ´ 34% $272,000Tax on dividends received: $280,000 ´ 20% taxable ´ 34% tax rate 19,040Income taxes currently payable 495,040 272,000
Tax on undistributed income: $128,000 ´ 70% ´ 20% taxable ´ 34% tax rate 6,093Less: Deferred tax on gain on equipment $400,000 ´ 34% tax rate (136,000)
Income tax expense $365,133 $272,000
2 Loss from Sooner
Income from Sooner on an equity basisSooner’s net income of $528,000 ´ 70% $ 369,600Less: Unrealized gain ($500,000 - $100,000) (400,000)
Income from Sooner — equity basis (loss) $ (30,400)
3 Pommer Corporation and SubsidiaryConsolidated Income Statement
for the year ended December 31, 2009Sales $12,000,000Cost of sales (7,000,000)Gross profit 5,000,000Other expenses ($2,100,000 + $1,200,000 - $100,000) (3,200,000)Income before income taxes 1,800,000
Taxes currently payable ($430,000 ´ 34%) $146,200Less: Deferred tax asset — land ($30,000 ´ 34%) (10,200) (136,000)
Selica’s net income $ 294,000
2 Phoenix’s income from Selica
Share of Selica’s net income ($294,000 ´ 90%) $ 264,600Less: Unrealized gain on upstream sale of land ($30,000 ´ 90%) (27,000)Less: Unrealized inventory profit (15,000)Income from Selica on an equity basis $ 222,600
3 Phoenix’s net income
Sales $3,815,000Income from Selica 222,600Less: Cost of sales and expenses (3,200,000)Income before income taxes 837,600Income tax expense ($209,100 currently payable less $5,100a deferred tax asset) (204,000)Net income $ 633,600
a The deferred tax asset is $5,100 deferral for the inventory profit.
1 Parent company theory views consolidated financial statements from the viewpoint of the parent company and entity theory views consolidated financial statements from the viewpoint of the business entity under which all resources are controlled by a single management team. By contrast, traditional theory sometimes reflects the parent company viewpoint and at other times it reflects the viewpoint of the business entity. A detailed comparison of these theories is presented in Exhibit 11–1 of the text.
2 Only contemporary theory is changed by current pronouncements of the Financial Accounting Standards Board. While such pronouncements can and do change the current accounting and reporting practices, they do not change the logic or the consistency of either parent company or entity theory. For example, SFAS Nos. 141R and 160, replaced traditional theory with an almost pure entity approach to preparation of consolidated financial statements.
3 The valuation of subsidiary assets on the basis of the price paid for the controlling interest seems justified conceptually when substantially all of the subsidiary stock is acquired by the parent. But the conceptual support for this approach is less when only a slim majority of subsidiary stock is acquired. In addition, the valuation of the noncontrolling interest based on the price paid by the parent company has practical limitations because noncontrolling interest does not represent equity ownership in the usual sense. The ability of noncontrolling stockholders to participate in management is limited and noncontrolling shares do not possess the usual marketability of equity securities.
4 Consolidated assets are equal to their fair values under entity theory only when the book values of parent company assets are equal to their fair values. Otherwise, consolidated assets are not equal to their fair values under either parent company or entity theories.
5 The valuation of the noncontrolling interest at book value might overstate the equity of noncontrolling shareholders because of the limited marketability of shares held by noncontrolling stockholders and because of the limited ability of noncontrolling stockholders to share in management through their voting rights. Valuation of the noncontrolling interest at book value also overstates or understates the noncontrolling interest unless the subsidiary assets are recorded at their fair values.
6 Consolidated net income under parent company theory and income to the controlling stockholders under entity theory should be the same. This is illustrated in Exhibit 11–5, which shows different income statement amounts for cost of sales, operating expenses, and income allocated to noncontrolling stockholders, but the same income to controlling
stockholders. Note that consolidated net income under parent company and traditional theories reflects income to controlling stockholders.
7 Income to the parent company stockholders under the equity method of accounting is the same as income to the controlling stockholders under entity theory. But income to controlling stockholders is not identified as consolidated net income as it would be under parent company or traditional theories.
8 Consolidated income statement amounts under entity theory are the same as under contemporary theory when subsidiary investments are made at book value because contemporary theory follows entity theory in eliminating the effects of intercompany transactions from consolidated financial statements.
9 Traditional theory corresponds to entity theory in matters relating to unrealized and constructive gains and losses from intercompany transactions. In other words, unrealized and constructive gains and losses are allocated between controlling and noncontrolling interests in the same manner under these two theories.
10 Push-down accounting simplifies the consolidation process. The push-down adjustments are recorded in the subsidiary’s separate books at the time of the business combination; thus, it is not necessary to allocate the unamortized fair value-book value differentials in the consolidation working papers.
11 A joint venture is an entity that is owned, operated, and jointly controlled by a small group of investor-venturers to operate a business for the mutual benefit of the venturers. Some joint ventures are organized as corporations, while others are organized as partnerships or undivided interests. Each venturer typically participates in important decisions of a joint venture irrespective of ownership percentage.
12 Investors in corporate joint ventures use the equity method of accounting and reporting for their investment earnings and investment balances as required by APB Opinion No. 18. The cost method would be used only if the investor could not exercise significant influence over the corporate joint venture.
Alternatively, investors in unincorporated joint ventures use the equity method of accounting and reporting as explained in Interpretation No. 2 of APB Opinion No. 18 or proportional consolidation for undivided interests specified as a special industry practice.
SOLUTIONS TO EXERCISES
Solution E11-1
1 A 5 B2 A 6 C3 C 7 D4 A
Solution E11-2
1 B 4 D2 B 5 C3 D
Solution E11-3
1 cTotal value of Smith implied by purchase price ($720,000/.8)
4 aImplied fair value — $840,000 = patents at acquisitionBook value of 100% of identifiable net assets $840,000Add: Patents at acquisition ($54,000/90%) 60,000Total implied value 900,000Percent acquired 80%Purchase price under entity theory $720,000
5 bPurchase price — ($840,000 ´ 80%) = patents at acquisitionBook value $840,000 ´ 80% = underlying equity $672,000Add: Patents at acquisition ($54,000/90%) 60,000Purchase price (traditional theory) $732,000
Solution E11-4
1 GoodwillParent company theoryCost of investment in Staff $ 500,000Fair value acquired ($400,000 ´ 80%) 320,000Goodwill $ 180,000Entity theoryImplied value based on purchase price ($500,000/.8) $ 625,000Fair value of Staff’s net assets 400,000Goodwill $ 225,000
2 Noncontrolling interestParent company theoryBook value of Staff’s net assets $ 260,000Noncontrolling interest percentage 20%Noncontrolling interest $ 52,000Entity theoryTotal valuation of Staff $ 625,000Noncontrolling interest percentage 20%Noncontrolling interest $ 125,000
3 Total assetsParent company theory
Pond Staff Adjustment Total Current assets $ 20,000 $ 50,000 $ 40,000 ´ 80% $ 102,000Plant assets — net 480,000 250,000 110,000 ´ 80% 818,000Goodwill 180,000
Combined separate incomes of Palumbo and Seal $800,000Less: Palumbo’s share of unrealized profits from upstream inventory sales ($30,000 ´ 80%) (24,000)Less: Noncontrolling interest share ($300,000 ´ 20%) (60,000)Consolidated net income $716,000
2 Entity theory
Combined separate incomes $800,000Less: Unrealized profits from upstream sales (30,000)Total consolidated income $770,000
Income allocated to controlling stockholders ($500,000 + [$270,000 ´ 80%]) $716,000
Income allocated to noncontrolling stockholders ($300,000 - $30,000) ´ 20% $ 54,000
Solution E11-8 Parent
Traditional Company Entity Theory Theory Theory
Combined separate incomes $180,000 $180,000 $180,000Less: Unrealized inventory profits from downstream sales ($60,000 - $30,000) ´ 50% (15,000) (15,000) (15,000)Less: Unrealized profit on upstream sale of land ($96,000 - $70,000) ´ 100% (26,000) (26,000) ($96,000 - $70,000) ´ 80% (20,800)Less: Noncontrolling interest share ($60,000 - $26,000) ´ 20% (6,800) $60,000 ´ 20% (12,000)Controlling share of net income $132,200 $132,200
Total consolidated income $139,000 Allocated to controlling stockholders $132,200 Allocated to noncontrolling Stockholders ($60,000 - $26,000) ´ 20% $ 6,800
1 Push down under parent company theoryRetained earnings 800,000Inventories 90,000Land 450,000Buildings — net 270,000Goodwill 360,000
Equipment 180,000Other liabilities 90,000Push down equity 1,700,000
To record revaluation of 90% of the net assets and elimination of retained earnings as a result of a business combination with Pioneer Corporation. Push down equity = ($600,000 fair value — book value differential ´ 90%) + $360,000 goodwill + $800,000 retained earnings.
2 Push down under entity theoryRetained earnings 800,000Inventories 100,000Land 500,000Buildings — net 300,000Goodwill 400,000
Equipment — net 200,000Other liabilities 100,000Push down equity 1,800,000
To record revaluation of 100% of the net assets and elimination of retained earnings as a result of a business combination with Pioneer. Push down equity = $600,000 fair value — book value differential + $400,000 goodwill + $800,000 retained earnings.
Solution E11-10
Each of the investments should be accounted for by the equity method as a one-line consolidation because the joint venture agreement requires consent of each venturer for important decisions. Thus, each venturer is able to exercise significant influence over its joint venture investment irrespective of ownership interest.
The 40 percent venturer:Income from Sun-Belt ($500,000 ´ 40%) $ 200,000Investment in Sun-Belt ($8,500,000 ´ 40%) $3,400,000
The 15 percent venturerIncome from Sun-Belt ($500,000 ´ 15%) $ 75,000Investment in Sun-Belt ($8,500,000 ´ 15%) $1,275,000
In general, VIE accounting follows normal consolidation principles. Under that approach, the noncontrolling interest share would be 90% of VIE earnings, or $450,000. However, the intercompany fees must be allocated to the primary beneficiary, not to noncontrolling interests. Therefore, in this case, noncontrolling interest share would be 90% of $460,000, or $414,000.
As primary beneficiary, Paxel must include Polo in its consolidated financial staements. Additionally, Paxel must make the following disclosures: (a) the nature, purpose, size, and activities of the variable interest entity, (b) the carrying amount and classification of consolidated assets that are collateral for the variable interest entity’s obligations, and (c) lack of recourse if creditors (or beneficial interest holders) of a consolidated variable interest entity have no recourse to the general credit of the primary beneficiary.
Darden will not consolidate Polo, since they are not the primary beneficiary. As in traditional consolidations, only one firm consolidates a subsidiary. However, since Darden has a significant interest in Polo, they must disclose: (a) the nature of its involvement with the variable interest entity and when that involvement began, (b) the nature, purpose, size, and activities of the variable interest entity, and (c) the enterprise’s maximum exposure to loss as a result of its involvement with the variable interest entity.
Solution E11-13
According to FIN 46(R), if an enterprise absorbs a majority of a variable interest entity’s expected losses and another receives a majority of expected residual returns, the enterprise absorbing the losses is the primary beneficiary and must consolidate the variable interest entity. The contractual arrangement makes Laura the primary beneficiary.
Preliminary computationImplied value of Pisces based on purchase price ($160,000/.8) $200,000Book value 170,000Excess to undervalued equipment $ 30,000
1 Pisces Corporation and SubsidiaryConsolidated Income Statement
Allocation of income to:Noncontrolling interestb $ 4,100
Controlling interest $ 56,400
a $75,000 depreciation - $500 piecemeal recognition of gain on equipment through depreciation + ($30,000 excess ¸ 6 years) excess depreciation
b ($30,000 reported income - $5,000 unrealized gain on equipment + $500 piecemeal recognition of gain on equipment - $5,000 excess depreciation) ´ 20% interest
2 Pisces Corporation and SubsidiaryConsolidated Balance Sheet
at December 31, 2009
AssetsCurrent assets $241,600Plant and equipment — net ($595,000 - $199,500 + 25,000) 420,500Total assets $662,100
Liabilities and equityLiabilities $150,000Capital stock 300,000Retained earningsa 170,000Noncontrolling interestb 42,100Total liabilities and stockholders’ equity $662,100
a Pisces beginning retained earnings $163,600 + Pisces net income $56,400 - Pisces dividends of $50,000b ($190,000 stockholders’ equity + $25,000 excess - $4,500 unrealized gain on equipment) ´ 20%
Preliminary computationsParent company theoryInvestment in Smedley $224,000Fair value of 80% interest acquired ($240,000 ´ 80%) 192,000
Goodwill $ 32,000
Entity TheoryImplied value of Smedley ($224,000/.8) $280,000Fair value of identifiable net assets 240,000
Goodwill $ 40,000
Pierre used an incomplete equity method in accounting for its investment in Smedley. It ignored the intercompany upstream sales of inventory. Income from Smedley on an equity basis would be:Share of Smedley’s income ($50,000 ´ .8) $ 40,000Less: Unrealized profits in ending inventory from upstream sale ($8,000 ´ 50% ´ 80%) (3,200)Income from Smedley $ 36,800
Pierre Corporation and SubsidiaryComparative Consolidated Income Statements
for the year ended December 31, 2010
ParentTraditional Company Entity Theory Theory Theory
Sales $1,000,000 $1,000,000 $1,000,000Less: Cost of sales (575,000) (575,000) (575,000)
Gross profit 425,000 425,000 425,000
Expenses (200,000) (200,000) (200,000)
Less: Unrealized profit on upstream sale of inventory ($23,000 - $15,000) ´ 50% ´ 100% (4,000) (4,000) ($23,000 - $15,000) ´ 50% ´ 80% (3,200)Noncontrolling interest share ($50,000 - $4,000) ´ 20% (9,200) $50,000 ´ 20% (10,000)Consolidated net income $ 211,800 $ 211,800Total consolidated income $ 221,000
Allocated to controlling Stockholders $ 211,800Allocated to noncontrolling Stockholders
Pierre Corporation and SubsidiaryComparative Statements of Retained Earnings
for the year ended December 31, 2010
Parent Traditional Company Entity Theory Theory Theory
Retained earnings December 31, 2009 $360,000 $360,000 $ 360,000Add: Consolidated net income 211,800 211,800Add: Net income to controlling stockholders 211,800
571,800 571,800 571,800Less: Dividends to controlling stockholders (120,000) (120,000) (120,000)Retained earnings December 31, 2010 $ 451,800 $ 451,800 $ 451,800
Pierre Corporation and SubsidiaryComparative Consolidated Balance Sheets
at December 31, 2010
Parent Traditional Company Entity Theory Theory Theory
1 X carries its investment in Y on a cost basis. This is evidenced by the appearance of dividend revenue in X Company’s income statement and by the absence of income from subsidiary.
2 X holds 1,400 shares of Y. X Company’s percentage ownership is 70%, as determined by the relationship of X Company’s dividend revenues and Y Company’s dividends paid ($11,200/$16,000). Y has 2,000 outstanding shares ($200,000/$100) and X holds 70% of these, or 1,400 shares.
3 Y Company’s retained earnings at acquisition were $100,000.
Imputed value of Y ($245,000 cost/70%) $ 350,000Less: Patents (applicable to 100%) (50,000)Book value and fair value of Y’s identifiable net assets 300,000Less: Capital stock (200,000)Retained earnings $ 100,000
4 The nonrecurring loss is a constructive loss on the purchase of X bonds by Y Company.
Working paper entry:Mortgage bonds payable (5%) 100,000Loss on retirement of X bonds 3,000
X bonds owned 103,000To eliminate intercompany bond investment and bonds payable and to recognize a loss on the constructive retirement of X bonds.
5 Intercompany sales X to Y are $240,000 computed as follows:
7 Adjustment to determine consolidated cost of goods sold:
Consolidated Cost of Goods SoldCombined cost of goods sold
$640,000 $240,000 Intercompany purchases
Unrealized profit in ending inventory 8,000 5,000
Unrealized profit in beginning inventory
403,000 To balance$648,000 $648,000
Consolidated cost of goods sold $403,000
Unrealized profit in ending inventory is equal to the combined less consolidated inventories ($130,000 - $122,000).Unrealized profit in beginning inventory is plugged as follows: ($640,000 + $8,000) - ($240,000 + $403,000) = $5,000
8 Noncontrolling interest share of $8,700 is computed as follows:
Net income of Y $ 34,000Less: Patent amortization ($50,000/10 years) 5,000Adjusted income of Y 29,000Noncontrolling interest percentage 30%Noncontrolling interest share $ 8,700
9 Noncontrolling interest of $117,000 at the balance sheet date is computed:
Stockholders’ equity of Y Company $360,000Add: Unamortized patents 30,000Equity of Y plus unamortized patents 390,000Noncontrolling interest percentage 30%Noncontrolling interest on balance sheet date $117,000
10 Consolidated retained earnings
Retained earnings of X end of year $200,000Add: X’s share of increase in Y’s retained earnings since acquisition ($160,000 - $100,000) ´ 70% 42,000Less: Unrealized profit in Y’s ending inventory (8,000)Less: X’s patent amortization since acquisition $20,000 ´ 70% (14,000)Less: Loss on constructive retirement of X’s bonds (3,000)Consolidated retained earnings — end of year $217,000
To push down fair value — book value differentials.
2 Splash CorporationBalance Sheet
at January 1, 2010AssetsCash $ 30,000Accounts receivable — net 70,000Inventories 80,000
Total current assets $180,000Land $ 75,000Buildings — net 150,000Equipment — net 75,000
Total plant assets 300,000Goodwill 20,000
Total assets $500,000
Liabilities And Stockholders’ EquityAccounts payable $ 40,000Other liabilities 60,000
Total liabilities $100,000Capital stock $200,000Push-down capital 200,000
Total stockholders’ equity 400,000Total liabilities and stockholders’ Equity $500,000
3 If Splash reports net income of $90,000 under the new push-down system for the calendar year 2010, Played’s income from Splash will also be $90,000 under a one-line consolidation.
1 Parent company theoryPreliminary computation:Cost of 80% interest in Sanue $3,000,000Book value acquired ($2,000,000 ´ 80%) 1,600,000
Excess cost over book value acquired $1,400,000Excess allocated to:Inventories $1,600,000 ´ 80% $1,280,000Equipment — net $(500,000) ´ 80% (400,000)Goodwill for the remainder 520,000
Excess fair value over book value acquired $1,400,000
Entry on Sanue’s books to reflect 80% push down:Inventories 1,280,000Goodwill 520,000Retained earnings 1,200,000
Equipment — net 400,000Push-down capital 2,600,000
2 Entity theoryPreliminary computation:Implied value of net assets ($3,000,000/.8) $3,750,000Book value of net assets 2,000,000
Total excess $1,750,000Excess allocated to:Inventories $1,600,000Equipment — net (500,000)Goodwill for remainder 650,000
Total excess $1,750,000
Entry on Sanue’s books to reflect 100% push down:Inventories 1,600,000Goodwill 650,000Retained earnings 1,200,000
1 Derivative is the name given to a broad range of financial securities. Their common characteristic is that the derivative contract’s value to the investor is directly related to fluctuations in price, rate, or some other variable that underlies it. Interest rate, foreign currency exchange rate, commodity prices and stock prices are common types of prices and rate risks that companies hedge.
2 Hedge accounting refers to accounting designed to record changes in the value of the hedged item and the hedging instrument in the same accounting period. This enhances transparency because the hedged item and hedging instrument accounting are linked. Prior to hedge accounting, the financial statement effect of the hedged item and hedging instrument were not linked. Since companies enter into hedges to mitigate risks, the accounting should reflect the effect of this strategy and should clearly communicate the strategy. The accounting and footnote disclosures required for derivatives attempt to do this.
3 An option is a contract that allows the holder to buy or sell a security at a particular date. The holder is not obligated to buy or sell the security. They may allow the contract to expire. Typically, the holder must pay an upfront fee to the writer of the option.
A forward contract and futures contract are similar because both sides of the contract are obligated to perform. A forward contract is negotiated between two parties, they agree upon delivering a certain quantity of goods or currency at a specific date in the future. Many allow net settlement which means the “winner” of the contract receives cash consideration for the difference between the market price of the commodity and the contracted amount on the date the contract expires. The initial amount exchanged at the date the contract is entered into is negligible.
A futures contract is traded on a market. The amount of commodity to be exchanged and the date of delivery are standardized. The futures rate is determined by the market at the date the contract is entered into. These contracts are settled daily.
4 Hedge effectiveness involves assessing how well the hedge mitigates the gains or losses of the asset, liability and/or anticipated transaction that it is entered into to mitigate.
The most common approaches to determining hedge effectiveness are critical term analysis and statistical analysis.
Under critical term analysis, the nature of the underlying variable, the notional amount of the derivative and the item being hedged, the delivery date of the derivative and the settlement date for the item being hedged are examined. If the critical terms of the derivative and the hedged item are identical, then an effective hedge is assumed.
A statistical approach is used if critical terms don’t match. One such approach involves comparing the correlation between changes in the price of the item being hedged and the derivative. While the FASB does not specify a specific benchmark correlation coefficient, correlations of between 80% and 125% are considered to be highly effective. Outside of these ranges, the hedge would not be considered highly effective.
5 Under a firm purchase or sales commitment, if the hedge is considered to be effective, then it would qualify as a fair value hedge.
6 A company that has an existing loan that involves a variable or floating interest rate enters into a pay-fixed, receive variable swap. The company is swapping its variable interest rate payments for fixed ones. These contracts are typically settled net. For example, if the fixed rate agreed upon is 10% for the term of the swap agreement and in one year the variable rate is 9%, then the company with the variable rate loan must pay the difference in rates multiplied by the notional amount of the loan to the other party. If the variable rate is 12%, then the company will receive the difference in rates multiplied by the notional amount of the loan. Regardless of the movement in interest rates over the term of the swap, the company will pay the fixed rate, net. This type of swap is aimed at reducing the variability in cash flows related to the debt therefore it is designated as a cash flow hedge.
7 A receive fixed, pay variable swap is entered into if a company has an existing loan that involves a fixed interest rate and desires to swap those fixed payments for variable payments. For example, a company has a loan with an 8% fixed rate and enters into a swap arrangement so that it will pay LIBOR + 1%. If the variable rate for a year is 9%, then the company will pay 1% multiplied by the notional amount as well as the 8% for the loan. Thus, the company has paid 9%, the floating rate.
If the variable rate is 6% (5% LIBOR + 1%), then the company will pay 8% on the loan, but will receive 2% related to the swap. Thus, the company will pay 6%, the floating rate.
This type of swap is aimed at reducing the variability in the fair value of the underlying loan therefore it is designated as a fair value hedge.
8 Fair value hedge accounting is used when the company is attempting to reduce the price risk of an existing asset/liability or firm purchase/sale commitment. Cash flow hedge accounting is appropriate when the company is attempting to reduce the variability in cash flows thus it is appropriate when hedging anticipated purchases and sales.
Under certain circumstances, hedges of existing foreign currency denominated receivables and payables are accounted for as cash flow hedges instead of fair value hedges. See question 18’s solution for these cases.
9 A transaction is measured in a particular currency if its magnitude is expressed in that currency. Assets and liabilities are denominated in a currency if their amounts are fixed in terms of that currency.
10 Direct quotation: 1.20/1 = $1.20Indirect quotation: 1/1.20 = .83 euros per dollar
11 Official or fixed rates are set by a government and do not change as a result of changes in world currency markets. Free or floating exchange rates are those that reflect fluctuating market prices for currency based on supply and demand factors in world currency markets. The United States changed from fixed to floating (free) exchange rates in 1971. But the U.S. dollar is sometimes described as a “filthy float” because the United States has frequently engaged in currency transactions to support or weaken the dollar against other currencies. Such action is taken for economic reasons, such as to make U.S. goods more competitive in world markets. Both Japan and Germany have engaged in currency transactions in an attempt to support the U.S. dollar. In February 1987, the United States and six other industrial nations (the Group of 7 or G-7) entered the Louvre accord to cooperate on economic and monetary policies in support of agreed upon exchange rate levels.
12 Spot rates are the exchange rates for immediate delivery of currencies exchanged. The current rate for foreign currency transactions is the spot rate in effect for immediate settlement of the amounts denominated in foreign currency at the balance sheet date. Historical rates are the rates that were in effect on the date that a particular event or transaction occurred. Spot rates could be fixed rates if the currency was a fixed rate currency as determined by the government issuing the currency.
13 The transaction is a foreign transaction because it involves import activities, but it is not a foreign currency transaction for the U.S. firm because it is denominated in local currency. It is a foreign currency transaction for the Japanese company.
14 At the transaction date, assets and liabilities denominated in foreign currency are translated into dollars by use of the exchange rate in effect at that date, and they are recorded at that amount.
At the balance sheet date, cash and amounts owed by or to the enterprise that are denominated in foreign currency are adjusted to reflect the current rate. Assets carried at market whose current market price is stated in a foreign currency are adjusted to the equivalent dollar market price at the balance sheet date.
15 Exchange gains and losses occur because of changes in the exchange rates between the transaction date and the date of settlement. Both exchange gains and exchange losses can
occur in either foreign import activities or foreign export activities. The statement is erroneous.
16 Exchange gains and losses on foreign currency transactions are reflected in income in the period in which the exchange rate changes except for hedges of an identifiable foreign currency commitment where deferral is possible if certain requirements are met. Also hedges of a net investment in a foreign entity are treated as equity adjustments from translation. Intercompany foreign currency transactions of a long-term nature are also treated as equity adjustments.
17 There will be a $20 exchange loss in the period of purchase and a $10 exchange gain in the period of settlement:
Billing datePurchases $1,450
Accounts payable (fc) $1,450Year-end adjustment
Exchange loss $ 20Accounts payable (fc) $ 20
Settlement dateAccounts payable (fc) $1,470
Cash $1,460Exchange gain 10
18 Cash flow hedge accounting can be used when hedging recognized currency denominated assets and liabilities if the variability of cash flows is completely eliminated by the hedge. This criterion is generally met if all of the critical terms of the hedged item and the hedge match such as the settlement date, currency type and currency amounts. If these don’t match then it must be accounted for as a fair value hedge.
The key difference between this situation and the more general cash flow hedge case is that an existing asset or liability is being accounted for here. Under the more general case, the recognition of gains and losses is deferred because an anticipated transaction is being hedged. The foreign currency asset or liability is marked to fair value at year-end and the resulting gain or loss account is recognized, however, the gain or loss is offset by reclassifying an equal amount from other comprehensive income. Thus, the asset and liability are marked to fair value, but no gain or loss related to that adjustment is included in current period income.
The premium or discount related to the hedge contract is amortized to income over the length of the contract using the effective interest method. For example, if a 100,000 euro foreign currency receivable due in 60 days is recorded at the spot rate of $1.20/euro or $120,000 and at the same date, a forward contract is entered into to deliver 100,000 euros in 60 days at a forward rate of $1.18, the company knows that it will lose $2,000. This $2,000 must be amortized to income over the 60 day period.
19 International Accounting Standards No. 32 and 39 prescribe the accounting for derivatives. Their requirements are similar to SFAS No. 133 and 138 in terms of determining when hedge accounting can be used. The requirements for determining hedge effectiveness are very similar. Both fair value and cash flow hedge definitions and general requirements are similar. However, under IAS 39, firm sale or purchase commitments can be accounted for as either fair value or cash flow hedges which differs from the FASB requirement that they must be accounted for as fair value hedges.
20 A forward contract of an anticipated foreign currency transaction is accounted for as a cash flow hedge. The contract is marked to fair value at each financial date and the corresponding gain or loss is included in other comprehensive income. Any premium or discount must be amortized to income over the contract term using an effective interest rate method. The gain (loss) credit (debit) is offset by a debit (credit) from other comprehensive income.
When the anticipated transaction occurs and the forward contract is settled, the resulting other comprehensive income balance is amortized to income in the same period as the underlying transaction is recognized in income.
b. December 31, 2008Other Comprehensive Income (-SE) $9,901
Forward Contract (+L) $9,901
Forward contract value at 12/31/08($1,000 - $980)*500 = $10,000/(1.005)2= $9,901 liability
c. Settlement date February 28, 2009
Forward Contract (-L) $9,901Forward Contract (+A) 2,500 Other Comprehensive Income (+SE) $12,401
Forward contract value at 2/28/09($1,000 - $1,005)*500 = $2,500 asset. The forward contract liability at 12/31/08 is eliminated and the asset established. Accordingly, the corresponding credit to other comprehensive income, $12,401, will result in an ending balance of $2,500 credit in other comprehensive income.
Cost of Goods Sold $500,000Other Comprehensive Income 2,500 Inventory $502,500
Solution E12-2
1 a. December 1, 2008 No entry is necessary
b. December 31, 2008Loss on forward contract $9,901 Forward Contract $9,901Forward contract value at 12/31/08($1,000 - $980)*500 = $10,000/(1.005)2= $9,901 liability
Gain on forward contract $149,751($6-$5= 1.00 x 100,000)
(To record the change in fair value of the forward contract attributable to the discounted change in the forward price
3 Firm Sales Commitment $149,751Gain on firm sales commitment $149,751
(To record the change in fair value of the firm commitment to sell)
3 Cash from firm sales commitment $500,000Widget inventory (B/S) $500,000COGS $500,000Gain on firm sales commitment $100,000
Cash for forward contract purchase $500,000Widget inventory (B/S) $500,000Sales $600,000
To record the settlement of the forward contract at January 31, 2009, and purchase of 100,000 widgets and sale pursuant to the contract
Solution E12-4 (Using a mixed attribute model; other solutions are acceptable)
October 1, 20081 Earnings $49,012
Forward contract $49,012(100,000 x ($2.00 - $1.50))/(1.05)^4
To record the change in fair value of the forward contract attributable to the discounted change in the forward price
1 Inventory $50,000Earnings $50,000
To record inventory marked to market
December 31, 20082 Forward contract $49,751
Earnings $49,751(100,000 x ($2.00 - $2.50))/(1.05)To record the change in fair value of the forward contract attributable to the discounted change in the forward price
2 On December 31, 2008 Yumi Corp. adjusts its account payable denominated in euros from $12,000 (10,000*.$1.20) to $12,400 (10,000 ´ $1.24) and recognizes a loss of $400 [10,000 LCU ´ ($1.24 - $1.20)]
275,000 C$ ´ $0.68 187,000 8,250Net exchange gain for 2008 $ 6,750
2 Exchange gain or loss in 2009:Account receivable adjusted 12/31 $102,000Account receivable 1/15/09 101,250 $ (750)Account payable adjusted 12/31 $187,000Account payable 1/30/09 188,375 (1,375)Net exchange loss for 2009 $(2,125)
Solution E12-12
1 December 12, 2008Inventory $375,000 Accounts payable (yen) $375,000
Purchase from Toko Company (50,000,000 yen ´ $.00750).
December 15, 2008Accounts receivable (pounds) $ 66,000
Sales $ 66,000Sale to British Products Company (40,000 pounds ´ $1.65).
2 December 31, 2008Exchange loss $ 5,000 Accounts payable (yen) $ 5,000
To adjust accounts payable denominated in yen for exchange rate change: 50,000,000 yen ´ ($.00760 - $.00750).
Exchange loss $ 2,000 Accounts receivable (pounds) $ 2,000
To adjust accounts receivable denominated in pounds for exchange rate change: 40,000 pounds ´ ($1.65 - $1.60).
3 January 11, 2009Accounts payable (yen) $380,000Exchange loss 2,500 Cash $382,500
To record payment to Toko Company (50,000,000 yen ´ $.00765).
January 14, 2009Cash $ 65,200
Accounts receivable (pounds) $ 64,000 Exchange gain 1,200
To record receipt from British Products Company: 40,000 pounds ´ $1.63.
Solution E12-13
March 1, 2008Inventory $16,300
Accounts payable (pesos) $16,300To record purchase of inventory items denominated in pesos:100,000 pesos ´ $.1630.
Forward contract—no entry is necessary
May 30, 2008Cash (pesos) $16,000Exchange loss 500
Cash $16,500To record receipt of 100,000 pesos from the exchange broker when the exchange rate is $.1600. Exchange loss: 100,000 pesos ´ ($.1650 - $.1600).
Accounts payable (pesos) $16,300Cash (pesos) $16,000Exchange gain 300
To record payment to Cavilier of 100,000 pesos. Gain: 100,000 pesos ´ ($.1630 - $.1600).
Solution E12-141 December 1, 2008
Inventory $5,500 Accounts Payable (yen) $5,500
Spot rate is $.00055*10,000,000 = $5,500
No entry is necessary related to the forward contract is necessary at this date.
December 31, 2008Exchange Loss $100 Accounts Payable (yen) $100Entry to mark the accounts payable to the spot rate at year-end.
Other Comprehensive Income $100 Exchange gain $100Amount reclassified out of other comprehensive income in order to offset
the exchange loss since this is a cash flow hedge situation.
Exchange Loss $99.10 Other comprehensive income $99.10
The discount resulting from the forward contract is amortized to income over the contract’s term. To solve for the effective interest rate $5,500*(1+r)2= $5,700. $5,700 = the forward rate .00057*10,000,000 = $5,700. Solving for r= 1.80195%. The discount amortization for this is .0180195*$5,500 = $99.10.
Summary: A loss of $99.10 is reflected in 2008 income.
2 January 30, 2009Exchange Loss $100
Accounts Payable $100To mark Accounts Payable to spot rate
Cash (yen) $5,700Cash $5,700
To record receipt of 10,000,000 pesos from the exchange broker.
Exchange Loss $100.90Other Comprehensive Income $100.90
To record amortization of discount for the last portion of the forward contract’s term.
Summary: A loss of $100.90 is reflected in 2009 income. Notice that the balance in Other Comprehensive Income is now $0. (12/31/08 $100 debit – $99.10 credit = $.90 debit 12/31/08. $.90 debit + 100 debit - $100.90 credit = $0 balance at 1/30/09).
Solution E12-15 [AICPA adapted]
1 Assuming that this is a fair value hedge. At 12/31/08, $3,000 is the forward contract fair value [100,000*($.90 forward rate contracted - $.93 Forward contract rate at 12/31/08) = $3,000].
Since this contract will not be settled for 72 days, the present value of the contract is $2,929 using .03288% [i=12%/365 days] , n=72 and future value of $3,000. The exchange gain related to this contract is recorded at 12/31/08 and the forward contract asset account is debited. December 31, 2008Forward Contract $2,929 Exchange Gain $2,929
To record forward contract at market
Exchange Loss $10,000 Accounts Payable $10,000
To mark accounts payable to fair value at 12/31/08 (this assumes that the accounts payable was marked to market on 12/12/08, the date the forward contract was entered into)
2 This firm purchase commitment would be accounted for as a fair value hedge. December 31, 2008Forward Contract $2,929 Exchange Gain $2,929
Exchange Loss $2,929 Firm purchase commitment $2,929
3 The forward contract would again be recorded at fair value throughout the life of the contract. Therefore, a $2,929 gain would be reported at 12/31/08.
Contract payable (fc) $35,250To record forward contract to sell 50,000 Canadian dollars to the exchange broker at the forward rate of .705 for delivery on May 31 for $35,250.
May 31, 2008Cash (fc) $36,250
Sales $36,250To record sale of fittings to Windsor for 50,000 Canadian dollars: ($.725 ´ 50,000 Canadian)
Contract payable (fc) $35,250Exchange loss on forward contract 1,000
Cash (fc) $36,250To record payment of the contract denominated in Canadian dollars to the exchange broker.
Cash $35,250Contract receivable $35,250
To record receipt of the $35,250 from the exchange broker to settle the account receivable denominated in U.S. dollars.
Sales $ 1,000Exchange loss $ 1,000
To reclassify exchange loss on forward contract as an adjustment of the selling price.
Alternative solution:On April 1, 2008, no entry is necessary if the forward contract allowed net settlement. If this is the case, the May 31, 2008 entries would be:
May 31, 2008Cash $36,250
Sales $36,250To record sale of fittings to Windsor for 50,000 Canadian dollars: ($.725 ´ 50,000 Canadian). Assuming immediate conversion of the Canadian dollars to U.S. dollars at the current exchange rate.
Exchange loss on forward contract 1,000Cash $1,000
To record net settlement of the exchange contract.
To record contract to purchase 1,000,000 yen in 90 days at the future rate.
If this contract allowed for net settlement, then no entry would be necessary on November 2.
2 No journal entry needed as the 30-day future rate at the end of the year is at $.0078 which was the same rate as the 90-day rate on November 2.
Solution E12-18Comment: The contract receivable and payable are both recorded instead of recording the contract net because Martin must deliver the euros to the exchange broker, net settlement is not allowed.
October 2, 2008Contract receivable $653,000
Contract payable (fc) $653,000To record contract to sell 1,000,000 euros to exchange broker in 180 days for the forward rate of $.6530.
December 31, 2008Contract payable (fc) $ 12,000
Exchange gain $ 12,000To adjust contract payable in euros to the 90-day forward rate of $.6410.
March 31, 2009Contract payable (fc) $641,000Exchange loss 14,000
Cash (fc) $655,000To record payment of 1,000,000 euros to exchange broker when spot rate is $.6550.
Cash $653,000Contract receivable $653,000
To record receipt of U.S. dollars from exchange broker in settlement of account.
1. This hedge is designed to mitigate the impact of price changes on natural gas. Since one would expect that natural gas price changes and futures market prices of natural gas to be highly correlated, this is likely to be a highly effective hedge.
2. This would be accounted for as a cash flow hedge since this is a hedge of an anticipated transaction.
3. November 2, 2008Futures contract $100,000
Cash $100,000Deposit is $5,000 * 20 contracts = $100,000
December 31, 2008Other Comprehensive Income $50,000
Futures Contract $50,000At 12/31/08, the futures contract price for delivery on the same date as our contract is
$6.75 - $7.00 = $.25 loss per MMBtu * 10,000 * 20 contracts = $50,000 loss.
February 2, 2009Futures contract $20,000
Other Comprehensive Income $20,000$6.85 - $6.75 = $.10 * 10,000 * 20 contract = $20,000 gain
Cash $70,000Futures contract $70,000
To record final settlement of futures contract.
Gas Inventory $1,370,000Cash $1,370,000
To record the purchase of natural gas at market rates.
February 3, 2009Cash $1,600,000
Gas Revenue $1,600,000To record gas sale at $8.00 per MMBtu
Cost of Goods Sold $1,370,000Gas Inventory $1,370,000
Cost of Goods Sold $30,000Other Comprehensive Income $30,000
To record cost of goods sold so that it reflects the futures contract rate per the hedging contract, $7.00 per MMBtu.
Solution P12-2
NOTE: Parts 4 and 5 below are computed using the corrected market prices of $9 per troy ounce on December 31, 2008 (part 4) and $9.50 on February 1, 2009 (part 5). The market prices listed in the problem are incorrect.
1. Yes, because the terms of the purchase commitment and the hedge instrument match.
2. This is a fair value hedge because a firm purchase commitment is being hedged instead of an anticipated purchase.
3.Silver options $1,000
Cash $1,000
4. December 31, 2008Loss on firm purchase commitment $1,194,030 Change in value of firm purchase commitment $1,194,030
Silver options $1,193,030Gain $1,193,030
1,200,000 * $1 change ($10-$9) = $1,200,000 which will occur in 1 month (purchase and option expiration). $1,200,000/1.005 = $1,194,030. This is the present value of the firm purchase commitment and the option at 12/31/08 assuming 6% annual interest.
Since the option already has a $1,000 balance, $1,193,030 will need to be recorded.
5. Change in value of firm purchase commitment $594,030
Gain $594,030To record the change in the firm purchase commitment. ($9 - $9.50)* 1,200,000. The ending balance is $600,000 after this adjustment.
Loss $594,030Silver option $594,030
The silver options value has also declined. However, the company will still exercise the option.
Silver option $600,000To record exercise of option.
Silver inventory $11,400,000Change in value of firm purchase commitment 600,000
Cash $12,000,000To record purchase of silver inventory.
Solution P12-3
1 The purpose of this hedge is to reduce variability in cash flows in the future since the firm entered into a variable interest loan and is swapping that for a fixed interest rate. This is therefore a cash flow hedge.
2 One would expect that this is a highly effective hedge because the notional amount, $400,000 and the length of the term of the swap agreement agree.
3 a. The LIBOR rate at 12/31/08 is 5%, thus 2009’s interest rate on the variable loan will be 5% + 2% = 7%. The swap fixed rate is 8%. Campion will pay .01 percent more than the variable rate. The fair value of the swap is the present value of the estimated future net payments.
Date of payment Estimated payment based on 12/31/08 LIBOR rate
To record the change in fair value of the interest rate swap.
The new variable rate for 2010 which is set at 12/31/09 is 5.5% + 2%. As a result, the estimated amount that Campion would pay is reduced from 1% to .5%.
Date of payment Estimated payment based on 12/31/08 LIBOR rate
The unadjusted Interest Rate Swap liability is $13,547 credit, the adjusted is $5,200 credit, the Interest Rate Swap Liability must be reduced by $8,347.
Solution P12-4
1, 2 Per Balance Exchange Gain Books Sheet or (Loss)
3 The company would need to enter into a contract to deliver 250,000 euros (sell them) since it would be receiving euros and would need to convert them into US dollars.
Solution P12-6
1. This is a fair value hedge because the fixed rate loan’s fair value fluctuates over time as market interest rates change. By entering into this swap agreement that fluctuation is eliminated. So while the interest rate fluctuates, the loan’s fair value remains constant reflecting the fixed rate in the swap.
2. Like P12-6, the terms match, thus this is considered to be a highly effective hedge.
To record the interest rate swap at fair value, computations below.
Notice that the carrying value of the loan is now $387,040 ($400,000 - $12,960). This agrees with the present value of the loan at the market rate of 9%.Proof: $400,000/(1.09)4 = $283,370 <= the present value of the maturity value. The present value of the interest payments is $32,000*PVIFA(i=9,n=4)= $103,670. The total market value of the loan is $283,370 + $103,670 = $387,041.
To adjust interest rate swap to fair value, $5,108.
Notice that now the loan payable carrying value is: $400,000 – 12,960 + 7,852 = $394,892. This amount agrees with the present value of the loan at the market rate on this date, 8.5%. Proof: $400,000/(1.085)3 = $313,163—Present value of the maturity value of the loan.
The present value of the interest payments = $32,000*PVIFA(i=8.5,n=3)= $81,729.The present value of the loan at a market rate of 8.5% is therefore $313,163 + $81,729 = $394,892.
Solution P12-7
1 Entries on April 1Accounts receivable (pesos) $33,060
Sales $33,060To record sales on account denominated in pesos: 200,000 pesos / 6.0496 LCUs
No entry to record the contract is necessary
2 Entries on May 30Cash (pesos) $33,378
Accounts receivable (pesos) $33,060Exchange gain 318
To record collection of receivable in LCUs: 200,000 LCUs / 5.992 LCUs
Cash $33,228Exchange loss 150
Cash (pesos) $33,378To record delivery of 200,000 pesos to the exchange broker.
Solution P12-8
1 Entry on October 2, 2008Contract receivable (euros) $31,750
Contract payable $31,750To record forward contract to purchase 50,000 euros at $.6350 as a hedge of a firm commitment.
2 December 31, 2008 adjustmentContract receivable (euros) $ 350
Exchange gain $ 350To adjust the contract receivable for 50,000 euros to the $.6420 future exchange rate at December 31, 2008: 50,000 euros ´ ($.6420 - $.6350).
Exchange loss $ 350Change in value of firm commitment $ 350
To record the change in the value of the underlying firm commitment hedged.
To pay exchange broker for 50,000 euros at the forward rate of $.6350 established on October 2, 2008.
Cash (euros) $32,800Contract receivable (euros) $32,100Exchange gain 700
To record receipt of 50,000 euros from exchange broker when spot rate is $.6560.
Exchange Loss $ 700Change in value of firm commitment $ 700
To record the change in the value of the underlying firm commitment hedged.
Purchases $32,800Cash (euros) $32,800
To record purchase and payment in euros at $.6560 spot rate.
Change in value of firm commitment $ 1,050Purchases 1,050
To record the adjustment of purchases for the change in the value of the firm commitment. This effectively fixes the purchase at the original forward rate.
Solution P12-9We will assume that the hedge contract is to be settled net.
December 2, 2008No entry
December 31, 2008Other comprehensive income: exchange loss $ 4,950
Forward contract $ 4,950Forward contract, 12/31/08, $1.69 – contract rate $1.68 = $.01 * 500,000 = $5,000. This is to be paid in two months so the present value assuming 6% annual interest rate is: $5,000/(1.005)2 = $4,950.
Exchange Loss $ 3,346Other comprehensive income $ 3,346
To record discount amortization. See table below
March 1, 2009Cash (fc) $855,000
Sales $855,000To record delivery of equipment to Ramsay Ltd. and collection of 500,000 pounds at the $1.71 spot rate.
Other comprehensive income: exchange loss $10,050Forward contract $10,050
To increase the forward contract to the final liability amount: $1.71-$1.68 = $.03*500,000 = $15,000 - $4,950 = $10,050 adjustment.
Exchange Loss $6,653Other comprehensive income $6,653
To record discount amortization. (See table below)
Forward contract $15,000 Cash $15,000
To record forward contract payment.
Sales $10,000Other comprehensive income $10,000
Discount amortization:The spot rate at the date the forward contract was entered into $1.70*500,000 = $850,000. $1.68 * 500,000 = $840,000. The discount of $10,000 must be amortized over the contract period. The effective interest rate equates these two amounts using a 3 month time period, that rate is .3937%.
Other Comprehensive Income $ 7,980Forward Contract $ 7,980
To record the forward contract loss at 12/31/08
Exchange loss $ 8,000Other Comprehensive Income $ 8,000
To reclassify an amount from Other Comprehensive Income to offset the gain on the accounts payable
Exchange Loss $ 1,994Other Comprehensive Income $ 1,994
To amortize the premium. The premium is the difference between the $668,000 spot price for pounds at the date the contract was entered into and $672,000, the contracted amount. This difference must be amortized to income over the 30 day period. The effective interest rate is computed as follows:$672,000 = $668,000* (1+r)30, solving for r (the daily interest rate) = .0199025%. $668,000*.000199025*15= $1,994.
December 31, 2008 account balances:Accounts Payable $660,000Forward Contract 7,980 creditOther comprehensive income 2,014 credit
Exchange loss (net) 1,994
3 January 15, 2009
Accounts payable (fc) $4,000Exchange gain $ 4,000
To mark the accounts payable to fair value.
Other comprehensive income $8,020Forward contract $ 8,020
To mark the forward contract to fair value.
Exchange loss $4,000Other Comprehensive Income $ 4,000
To record the reclassification from OCI to offset the exchange gain on the accounts payable
Exchange loss $2,006Other Comprehensive Income $2,006
1 A company’s functional currency is the currency of the primary economic environment in which it operates. It is normally the currency in which it receives most of its payments from customers and in which it pays most of its liabilities. Other factors that are considered in determining the functional currency include whether its sales prices are
determined primarily by local competition or local government regulation instead of short-run exchange rate changes or worldwide markets.
The functional currency determination (local currency or parent currency or some other currency) is critical in determining what approach to converting financial statements to the ultimate reporting currency is used: the current rate or the temporal method. If the functional currency is the local currency, the current rate method is used. If it is the parent currency, the temporal method is used. If it is some other currency, then both approaches may need to be used.
2 A highly inflationary economy under Statement 52 is one that has cumulative inflation of approximately 100 percent or more over a three-year period. The functional currency is assumed to be the reporting currency (for U.S. companies, the dollar) which means that the foreign currency financial statements must be remeasured into the dollar using the temporal method. The effect of the hyperinflation is then reflected in the current year’s consolidated income statement which would not be the case if the current rate method were used. Judgment must be exercised in applying this rule to avoid changing functional currencies frequently due to minor differences in the inflation rate.
3 The functional currency of a foreign subsidiary does not affect the original recording of the business combination. This is because all assets, liabilities, and equities of the foreign subsidiary are converted into U.S. dollars at the current exchange rate in effect on the date of consummation of the business combination. As a result, no special procedure must be applied at the date of original recording of a foreign subsidiary.
4 The current rate method is used when the foreign subsidiary’s currency is determined to be the subsidiary’s functional currency. The subsidiary’s financial statements must be translated using the current rate method into the reporting entity’s currency (typically the parent’s currency).
5 The temporal method is used when the foreign subsidiary’s currency is determined to be the reporting entity’s currency (typically the parent’s currency). The subsidiary’s financial statements must be remeasured using the temporal method into the reporting entity’s currency.
6 Since the functional currency is not the parent’s, no direct impact on the reporting entity’s (parent’s) cash flows is expected due to exchange rate changes. The effects of exchange rate changes are reflected in the consolidated statement’s accumulated comprehensive income account instead of being included in the income statement.
7 Since the functional currency is assumed to be the reporting entity’s (or parent’s), a direct impact on the parent’s cash flows is expected due to exchange rate changes. The effects of exchange rate changes are reflected in the consolidated income statement.
8 A foreign subsidiary’s financial statements could be both translated and remeasured if the entity’s books are maintained in a different currency than the functional currency and the
functional currency is not the reporting entity’s currency. In this case, the entity’s financial statements must be remeasured into the functional currency using the temporal method. The gain or loss on remeasurement is included in income. The functional currency financial statements are then translated into the reporting entity’s currency using the current rate method. The gain or loss on the translation is included in accumulated other comprehensive income. In this situation, the consolidated financial statements would include both a remeasurement gain or loss in income and the a translation adjustment included in accumulated other comprehensive income.
9 No, it would not be appropriate to use the annual average exchange rate. Theoretically, the exchange rate at the date each transaction occurs should be used. Given that this is not practical, reasonable assumptions are made concerning what exchange rate to use. The use of an average exchange rate is appropriate when sales are earned evenly during the year and expenses are incurred evenly during the year. A reasonable assumption for a holiday tree grower would be to use the average exchange rate during the quarter from October through December since those are the month’s that trees are typically sold. For expenses, examining the months that are the most labor intensive (such as planting, fertilizing and harvesting) and using a reasonable weighting of those months exchange rates would be a reasonable way of determining the rate for those costs.
10 The parent purchased the subsidiary for an amount in excess of book value. This excess was attributable to an unrecorded patent. Recall that the excess amount would not be included on the subsidiary’s books. The consolidated financial statements, however, would include both the amortization of the patent and the patent. Since the current rate method is being used, the impact of the change in exchange rates on the patent and the amortization is included in the translation adjustment to be included in consolidated comprehensive income. The subsidiary’s translation adjustment would not include this because the patent was not included in the books. Thus, the consolidated translation adjustment is larger than the subsidiary’s translation adjustment.
11 The temporal method requires remeasuring expenses of a foreign subsidiary. Expenses related to monetary items are remeasured at appropriately weighted average exchange rates for the period. Those types of expenses are either paid in cash or recorded as liabilities which will require the eventual payment of cash. Those that relate to nonmonetary items are remeasured at historical exchange rates. Expenses related to nonmonetary items would be those related to inventory and plant assets. [See FASB Statement No. 52, paragraph 48, for examples of nonmonetary items.] Under the current rate method, all accounts are translated at the weighted average rate.
12 If the current rate method is used the gain or loss on the hedge of a net investment in a foreign subsidiary is reported in other comprehensive income. If the temporal method is used, the gain or loss is included in current period income.
13 [Appendix A] Under the current rate method, the noncontrolling interest’s balance includes its share of the accumulated other comprehensive income translation adjustment, however, the noncontrolling interest expense would not be affected. This is logical since
the translation adjustment bypasses the income statement. As one might expect, the remeasurement gain or loss from using the temporal method does affect the noncontrolling interest expense since the gain or loss is included in income.
14 [Appendix B] The translation adjustment of cash is presented on a separate line in the consolidated statement of cash flows immediately below the “cash flows from financing activities.” [See FASB Statement No. 95, “Statement of Cash Flows,” Appendix C, paragraphs 144 and 146.]
15 [Appendix C] Special care must be exercised in applying the lower-of-cost-or-market rule to inventories in remeasured statements because remeasured amounts are affected both by changes in exchange rates and changes in replacement costs. Write-downs to market may be appropriate for both foreign currency statements and translated statements, foreign currency statements but not translated statements, or translated statements but not foreign currency statements.
Preliminary computationsCost of investment in Stanford $163,800Book value acquired (90,000 £ ´ $1.66) 149,400Excess in dollars $ 14,400
Excess allocated to equipment (6,000 £ ´ $1.66) $ 9,960
Patent $ 4,440$ 14,400
1 Equity adjustment from excess allocated to equipment on December 31, 2006
Depreciation of excess based on £ (6,000/3 years) 2,000 £
Undepreciated excess balance at year-end based on £ (4,000 £ ´ $1.64 current rate) $ 6,560Add: Depreciation on excess based on £ — 2006 2,000 £ ´ $1.65 average rate 3,300
9,860Less: Beginning excess based on U.S. dollars 9,960
Equity adjustment from translation of excess allocated to equipment (loss) $ 100
2 Equity adjustment from excess allocated to patent on December 31, 2006.
Patent (must be carried in £) $4,440/$1.66 = 2,675 £ patentPatent amortization is 2,675 £ / 10 years = 267 £
Unamortized excess balance at year-end based on £ (2,408 £ ´ $1.64 current rate) $ 3,949Add: Amortization of patent based on £ (267 £ ´ $1.65 average rate) 441
$ 4,390Less: Beginning patent based on U.S. dollars $ 4,440Equity adjustment from translation of patent (loss) $ 50
Not required: The entry to record the decrease in the equity adjustment related to equipment and patent would be as follows:
Income from Stanford Ltd. $3,741Equity adjustment from translation (equipment) 100Equity adjustment from translation of patent 50
To adjust the income from Stanford for depreciation on the excess allocated to equipment ($3,300) and amortization of patent ($441), and to record a decrease in the equity adjustment from translation for the foreign exchange rate changes.
Preliminary computationsInvestment cost $1,350,000Book value acquired (1,400,000 Eu ´ $.75 exchange rate) 1,050,000Excess cost over book value acquired $ 300,000
Excess allocated to undervalued land (400,000 Eu ´ $.75) $ 300,000
Equity adjustment from translation on excess allocated to land
Excess on land at January 1, 2006 $ 300,000Less: Excess on land at December 31, 2006 (400,000 Eu ´ $.77 current rate at year-end) 308,000Equity adjustment from translation - gain (credit) $ 8,000
Solution E13-8 [AICPA adapted]
1 aExchange loss of $15,000 less an exchange gain on the account payable of $4,000 ($64,000 original payable - $60,000 year-end adjusted balance) = $11,000 loss.
2 bTranslated at historical rate: 25,000/2.2 = $11,364
3 dDepreciation on the property, plant, and equipment is computed as follows:
Property, Plant Exchange Property, Plant Amortization Annual and Equipment Rate and Equipment Period Depreciation
3 bLoan balance measured in pesos on July 1 ($19,000/$.0019) 10,000,000 pesosLoan balance measured in pesos on December 31 ($19,000/$.0016 current exchange rate) 11,875,000
Exchange loss 1,875,000 pesos
4 cLoss in pesos 1,875,000 ´ $.0016 current rate at December 31, 2006 $ 3,000Percentage owned 90%
Equity adjustment from translation $ 2,700
Solution E13-10
Shinhan’s December 31, 2006 inventory
5,000,000 won ending inventory ´ $.00135 historical rate $ 6,750
Shinhan’s cost of sales for 2006
In Won Exchange
Rate In DollarsInventory January 1, 2006 9,000,000 $.0012 H $ 10,800Add: Purchases 2006 86,000,000 $.0013 A 111,800
Goods available for sale 95,000,000 122,600Less: Inventory December 31, 2006 (5,000,000) $.00135 H (6,750)
Beginning balance in U.S. dollars $102,000Less: Amortization for 2006 (9,520)Less: Ending balance (79,560)Equity adjustment from Excess Patent $ 12,920
1 Sooth Company, Ltd.Translation Worksheet for 2006
British Exchange Pounds Rate US Dollars
DebitsCash 20,000 $1.65 C $ 33,000Accounts receivable — net 70,000 1.65 C 115,500Inventories 50,000 1.65 C 82,500Equipment 800,000 1.65 C 1,320,000Cost of sales 350,000 1.63 A 570,500Depreciation expense 80,000 1.63 A 130,400Operating expenses 100,000 1.63 A 163,000Dividends 30,000 1.62 R 48,600
1,500,000 $2,463,500CreditsAccumulated depreciation 330,000 $1.65 C $ 544,500Accounts payable 70,000 1.65 C 115,500Capital stock 400,000 1.60 H 640,000Retained earnings 100,000 measured 160,000Sales 600,000 1.63 978,000Equity adjustment from translation 25,500
1,500,000 $2,463,500
2 Journal entries — 2006
January 1, 2006Investment in Sooth $800,000
Cash $800,000To record purchase of Sooth at book value.
During 2006Cash $ 48,600
Investment in Sooth $ 48,600To record dividends from Sooth.
December 31, 2006Investment in Sooth $139,600
Income from Sooth $114,100Equity adjustment from translation 25,500
To record income from Sooth and enter equity adjustment for currency fluctuations.
Preliminary computationsInvestment cost $3,200,000Less: Book value of interest acquired (7,000,000 euros ´ $.50 exchange rate ´ 80% interest) 2,800,000Patent $ 400,000Patent in euros ($400,000/$.50 exchange rate) = 800,000 eurosPatent amortization based on euros 800,000 euros/10 years = 80,000 euros
1 Schultz CorporationTranslation Worksheet
at and for the year ended December 31, 2006
Exchange Euros Rate U.S. Dollars
DebitsCash 1,000,000 $.6000 C $ 600,000Accounts receivable 2,000,000 .6000 C 1,200,000Inventories 4,000,000 .6000 C 2,400,000Equipment 8,000,000 .6000 C 4,800,000Cost of sales 4,000,000 .5500 A 2,200,000Depreciation expense 800,000 .5500 A 440,000Operating expenses 2,700,000 .5500 A 1,485,000Dividends 500,000 .5400 H 270,000
23,000,000 $13,395,000CreditsAccumulated depreciation — equipment 2,400,000 .6000 C $ 1,440,000Accounts payable 3,600,000 .6000 C 2,160,000Capital stock 5,000,000 .5000 H 2,500,000Retained earnings, January 1 2,000,000 .5000 H 1,000,000Sales 10,000,000 .5500 A 5,500,000Equity adjustment from translation 795,000
23,000,000 $13,395,000
2 Peter’s income from Schultz — 2006
Share of Schultz’s net income ($5,500,000 sales - $2,200,000 cost of sales - $440,000 depreciation - $1,485,000 operating expenses) $ 1,375,000Percentage owned 80%
Equity in Schultz’s net income 1,100,000Less: Patent amortization (80,000 euros ´ $.55 average rate) (44,000)
Investment January 1, 2006 $3,200,000Add: Income from Schultz 1,056,000Add: Equity adjustment from translation ($795,000 ´ 80%) 636,000Add: Equity adjustment from Patent [$400,000 Patent at beginning of the period - $44,000 Patent amortization — (720,000 euros unamortized Patent ´ $.60 current rate)] 76,000Less: Dividends ($270,000 ´ 80%) (216,000)Investment in Schultz December 31, 2006 $4,752,000
Check:Stockholders’ equity of Schultz $5,400,000 ´ 80% $4,320,000Add: Unamortized Patent (720,000 euros ´ $.60 current rate) 432,000
$4,752,000
Solution P13-5
Sari CompanyRemeasurement Worksheet at December 31, 2006
ExchangeBritish £ Rate U.S. Dollars
Cash 50,000 $1.70 C $ 85,000Accounts receivable 200,000 1.70 C 340,000Short-term note receivable 50,000 1.70 C 85,000Inventories 150,000 1.68 H 252,000Land 300,000 1.60 H 480,000Buildings — net 400,000 1.60 H 640,000Equipment — net 500,000 1.60 H 800,000Cost of sales 650,000 * H 1,058,000Depreciation expense 200,000 1.60 H 320,000Other expenses 400,000 1.65 A 660,000Dividends 100,000 1.64 164,000Exchange loss on remeasurement 61,000
3,000,000 $4,945,000
Accounts payable 180,000 $1.70 C $ 306,000Bonds payable — 10% 500,000 1.70 C 850,000Bond interest payable 20,000 1.70 C 34,000Capital stock 500,000 1.60 H 800,000
DebitsCash 15,000 $ 0.65 C $ 9,750Accounts receivable — net 60,000 0.65 C 39,000Inventories 30,000 0.66 H 19,800Prepaid expenses 10,000 0.70 H 7,000Land 45,000 0.70 H 31,500Equipment 60,000 Note 1 M 41,800Cost of sales 120,000 Note 2 M 82,200Depreciation expense 12,000 Note 3 M 8,360Other operating expenses 28,000 Note 4 M 19,000Dividends 20,000 0.66 H 13,200Remeasurement loss 1,450
400,000 $273,060CreditsAccumulated depreciation 22,000 Note 5 M $ 15,360Accounts payable 18,000 $ 0.65 C 11,700Capital stock 150,000 0.70 H 105,000Retained earnings 10,000 M 7,000Sales 200,000 0.67 A 134,000
400,000 $273,060
Note 1 Original equipment (50,000 NZ$ ´ $.70) + equipment purchased in 2006 (10,000 NZ$ ´ $.68)
DebitsCash 40,000 $.30 C $ 12,000Trade receivables 50,000 .30 C 15,000Inventories 150,000 .30 C 45,000Land 160,000 .30 C 48,000Equipment — net 300,000 .30 C 90,000Buildings — net 500,000 .30 C 150,000Expenses 400,000 .32 A 128,000Exchange loss (advance)* 20,000 .32 A 6,400Dividends 100,000 .33 R 33,000Equity adjustment 40,600
Total 1,720,000 $568,000CreditsAccounts payable 120,000 $.30 C $ 36,000Other liabilities 60,000 .30 C 18,000Advance from Pella 140,000 .30 C 42,000Common stock 500,000 .35 H 175,000Retained earnings January 1 300,000 .35 H 105,000Sales 600,000 .32 A 192,000
Total 1,720,000 $568,000* Sapir increased its advance by 20,000 shekels and recognized a 20,000 shekel loss.
2 Journal entries to account for the investment in Sapir:January 1, 2006Investment in Sapir $308,000
Cash $308,000To record the investment in Sapir Co.
January 2, 2006Advance to Sapir $ 42,000
Cash $ 42,000To record advance to Sapir denominated in U.S. dollars.
June 2006Cash $ 33,000
Investment in Sapir $ 33,000To record receipt of dividends (100,000 shekels ´ $.33).
Investment cost of SAA $1,710,000Book value acquired (8,000,000 LCU ´ $.190) (1,520,000)Patent $ 190,000
Patent based on LCU ($190,000/$.190) 1,000,000 LCUAmortization of Patent (1,000,000 LCU/10 years) 100,000 LCU
Patent amortization for 2006 (100,000 LCU ´ $.185) $ 18,500
Unamortized Patent at December 31, 2006 (900,000 LCU ´ $.180) $ 162,000
Equity adjustment for Patent for 2006:Beginning balance $190,000Less: Amortization (18,500)Less: Ending balance (162,000) $ 9,500
Reconciliation of investment account:Investment in SAA January 1, 2006 $1,710,000Add: Income from SAA for 2006
($360,750 - $18,500 Patent amortization) 342,250Equity adjustment from translation ($84,750 ´ 100%) (84,750)Equity adjustment from Patent (9,500)Dividends from SAA (185,000)Investment in SAA December 31, 2006 $1,773,000
1 San CorporationAdjusted Trial Balance Translation Worksheet
at December 31, 2006
LCUs Rate U.S. DollarsDebitsCash 150,000 $.20 C $ 30,000Accounts receivable 180,000 .20 C 36,000Inventories 230,000 .20 C 46,000Land 250,000 .20 C 50,000Buildings 600,000 .20 C 120,000Equipment 800,000 .20 C 160,000Cost of sales 200,000 .22 A 44,000Depreciation expense 100,000 .22 A 22,000Other expenses 120,000 .22 A 26,400Exchange loss 30,000 .22 A 6,600Dividends 100,000 .21 R 21,000Equity adjustment --- 44,000
2,760,000 $606,000
CreditsAccumulated depreciation — buildings 300,000 $.20 C $ 60,000Accumulated depreciation — equipment 400,000 .20 C 80,000Accounts payable 130,000 .20 C 26,000Short-term loan from Par 230,000 .20 C 46,000Capital stock 800,000 .24 H 192,000Retained earnings January 1 200,000 .24 H 48,000Sales 700,000 .22 A 154,000
2,760,000 $606,000
2 Journal entries for 2006 [Par’s books]
January 1, 2006Investment in San $216,000
Cash $216,000To record purchase of 90% interest in San: 1,000,000 LCU ´ $.24 exchange rate ´ 90% interest.
May 1, 2006Advance to San $ 46,000
Cash $ 46,000To record short-term loan to San denominated in U.S. dollars: 200,000 LCU ´ $.23 exchange rate.
Investment in San $ 18,900To record receipt of dividends from San (100,000 LCU ´ $.21 exchange rate ´ 90% interest)
December 31, 2006Investment in San $ 9,900Equity adjustment from translation 39,600
Income from San $ 49,500To record investment income from San of $49,500 computed as [$154,000 revenue – ($44,000 cost of sales + $22,000 depreciation expense + $26,400 other expenses + $6,600 exchange loss)] ´ 90% and to record equity adjustment from translation of $39,600 computed as $44,000 ´ 90%.
Supporting computations
Investment balance January 1, 2006 $216,000Less: Dividends (18,900)Add: Income from San 49,500Less: Equity adjustment from translation (39,600)Investment balance December 31, 2006 $207,000
Noncontrolling interest at January 1, 2006 date of acquisition1,000,000 LCU ´ $.24 ´ 10% $ 24,000
Less: Noncontrolling interest’s share of the equity adjustment from translation for 2006 ($44,000 ´ 10%) (4,400)Beginning Noncontrolling interest in consolidation working papers $ 19,600
Investment balance January 1, 2007 $ 768,000Add: Income from Sevin for 2007 292,050Less: Dividends ($84,000 ´ 90%) (75,600)Add: Equity adjustment from translation for 2007
$59,000 ´ 90% 53,100Add: Equity adjustment from Patent for 2007
Investment in Sevin December 31, 2007 1,040,400Add: Income from Sevin for 2008 215,250Less: Dividends ($89,000 ´ 90%) (80,100)Add: Equity adjustment from translation for 2008
$71,000 ´ 90% 63,900Add: Equity adjustment from Patent for 2008
1 Freeman CorporationTrial Balance at December 31, 2006
Schedule to Remeasure Trial Balance into U.S. Dollars
Australian Exchange U.S. Dollars Rate Dollars
DebitsCash 50,000 $.80 C $ 40,000Accounts receivable 85,000 .80 C 68,000Inventories (FIFO) 170,000 .79 H 134,300Land 200,000 .70 H 140,000Buildings 700,000 .70 H 490,000Equipment 170,000 .70 H 119,000Equipment 60,000 .75 H 45,000Cost of sales 800,000 * 612,300Depreciation expense — buildings 50,000 .70 H 35,000 Depreciation expense — equipment 20,000 .70 H 14,000Depreciation expense — equipment 10,000 .75 H 7,500Other operating expenses 318,000 .78 A 248,040Other operating expenses 2,000 .80 C 1,600Dividends 200,000 .75 H 150,000Remeasurement loss 49,760
2,835,000 $2,154,500CreditsAllowance for bad debts 5,000 $.80 C $ 4,000Accumulated depreciation:
Buildings 200,000 .70 H 140,000Equipment 70,000 .70 H 49,000Equipment 10,000 .75 H 7,500
Accounts payable 150,000 .80 C 120,000Advance from Paragon 300,000 .80 C 240,000Capital stock 400,000 .70 H 280,000Retained earnings 200,000 R 144,000Sales 1,500,000 .78 A 1,170,000
2,835,000 $2,154,500
* Computation of cost of sales:Purchases (800,000 - 250,000 + 170,000) 720,000 ´ $.78 A = $ 561,600Add: Beginning inventory 250,000 ´ $.74 H = 185,000Goods available 746,600Less: Ending inventory 170,000 ´ $.79 H = (134,300)Cost of sales $ 612,300
C = current rateH = historical rateA = average rate
2 Freeman CorporationCombined Statement of Income and Changes in Retained Earnings
for the year ended December 31, 2006
Sales $1,170,000Less: Cost of sales 612,300
Gross profit 557,700Expenses:
Depreciation expense — buildings $ 35,000Depreciation expense — equipment 21,500Other operating expenses 249,640Remeasurement loss 49,760 355,900Net income 201,800
Add: Retained earnings December 31, 2005 144,000 345,800
Less: Dividends 150,000Retained earnings December 31, 2006 $ 195,800
Freeman CorporationBalance Sheet
at December 31, 2006
AssetsCash $ 40,000Accounts receivable (less allowance for bad debts) 64,000Inventories (FIFO) 134,300
Total current assets $ 238,300Land $140,000Buildings (less allowance for depreciation of $140,000) 350,000Equipment (less allowance for depreciation of $56,500) 107,500
Total plant assets 597,500Total assets $ 835,800
Liabilities and Stockholders’ EquityAccounts payable $120,000Advance from Paragon 240,000
Total liabilities $ 360,000Capital stock $280,000Retained earnings 195,800
Total stockholders’ equity 475,800Total equities $ 835,800
Cost of 80% interest in Saussure $2,255,000Book value of interest acquired (5,000,000 Kronas ´ $.55 exchange rate ´ 80%) (2,200,000)Patent in U.S. dollars at acquisition $ 55,000Patent in Kronas ($55,000/$.55 exchange rate) 100,000 Kronas
Patent amortization for 2006:Patent in Kronas 100,000/10 years ´ $.60 average rate $ 6,000
1 Investment in Saussure at December 31, 2006
Investment cost January 1, 2006 $2,255,000Less: Dividends November 1 ($252,000 ´ 80%) (201,600)Add: Equity in Saussure’s income for 2006
($360,000 ´ 80%) 288,000Add: Equity adjustment from translation
($522,000 ´ 80%) 417,600Less: Patent amortization (100,000 Kronas/10 years ´ $.60 average rate) (6,000)Equity adjustment from Patent computed as follows:
Ending balance based on Kronas $58,500Add: Amortization based on Kronas 6,000
64,500Less: Beginning Patent based on dollars (55,000) 9,500
Investment in Saussure December 31, 2006 $2,762,500
2 Unamortized Patent at December 31, 2006
Unamortized Patent in Kronas (90,000) ´ current exchange rate ($.65) $ 58,500
Equity adjustment from translation ($417,600 + $9,500) $ 427,100
Noncontrolling interest December 31, 2006 $ 24,000
2007Capital stock $ 75,000Retained earnings:
Beginning retained earnings $38,100Add: Net income less dividends 14,700 52,800
Equity adjustment from translation 15,000Stockholders’ equity December 31, 2007 142,800Noncontrolling interest percentage 20%Noncontrolling interest December 31, 2007 $ 28,560
Solution P13-14 APPENDIX B
Preliminary computations
Cost of 75% interest in Smithe on January 1, 2006 $1,421,000Book value acquired (1,300,000 LCU ´ $1.40 ´ 75%) (1,365,000)
Patent in dollars $ 56,000
Patent in LCU: $56,000/$1.40 rate = 40,000 LCU
Patent amortization for 200640,000 LCU/10 years ´ $1.43 average rate $ 5,720
Equity adjustment from Patent translation for 2006Beginning balance $56,000Less: Amortization for 2006 (5,720)Less: Unamortized Patent at December 31
36,000 LCU ´ $1.45 current rate (52,200)Equity adjustment from Patent translation $ 1,920
Patent amortization for 200740,000 LCU/10 years ´ $1.48 average rate $ 5,920
Equity adjustment from Patent translation for 2007Beginning balance $52,200Less: Amortization for 2007 (5,920)Less: Unamortized Patent at December 31
32,000 LCU ´ $1.50 current rate (48,000)Equity adjustment from Patent translation $ 1,720
Investment in Smithe accountInvestment in Smithe January 1, 2006 $1,421,000Income from Smithe ($100,100 ´ 75% - $5,720 Patent) 69,355Equity adjustment from translation ($64,900 ´ 75%) 48,675Equity adjustment from Patent 1,920
Capital stock 3,000,000 1,400,000 b 1,400,000 3,000,000
Retained earnings 500,000 449,100 500,000
Equity adjustment+ 48,595 64,900 b 64,900 48,595
$4,000,000 $2,204,000
Noncontrolling interest $1,884,900 ´ 25% b 471,225 471,225
Noncontrolling interest December 31, 2006 $478,500 478,500
$4,710,500
+ Equity adjustment is computed as 75% ´ $64,900 from translation, plus $1,920 from translation of Patent, less $2,000 from translation of the long-term advance.
Capital stock 3,000,000 1,400,000 b 1,400,000 3,000,000
Retained earnings 650,000 597,600 650,000
Equity Adjustment+ 98,940 132,400 b 132,400 98,940
$4,200,000 $2,325,000
Noncontrolling interest $1,981,500 ´ 25% b 495,375 495,375
Noncontrolling interest December 31, 2007 $532,500 532,500
$4,867,500
+ Equity adjustment is computed as 75% ´ $132,400 from translation, plus $3,640 from translation of Patent, less $4,000 from translation of the long-term advance.
($67,500 change ´ 25%) $16,875Equity adjustment of Perry
($67,500 ´ 75%) + $1,720 - $2,000 50,345Effect of translation changes on consolidated stockholders’ equity $67,220
* Average exchange rate of $1.48 - current exchange rate of $1.45 at year end 2006.+ Current exchange rate of $1.50 at year-end 2008 - average exchange rate of $1.48 for the year 2007
Perry Corporation and SubsidiaryConsolidated Statement of Cash Flows for the year ended December 31, 2007
Cash Flow from Operating ActivitiesConsolidated net income $ 400,000Add: Noncontrolling interest income 55,500 $ 455,500Noncash expenses, revenues, losses, and gains included in income:
Depreciation expense $ 472,000Patent amortization 5,920Increase in accounts receivable (222,600)Decrease in accounts payable (105,945)Increase in inventories (24,000) 125,375Cash flow from operating activities 580,875
Cash Flow from Investing ActivitiesPurchase of equipment $ (350,000)Net cash used in investing activities (350,000)
Cash Flow from Financing ActivitiesDividends paid to Perry’s stockholders $ (250,000)Dividends paid to Noncontrolling stockholders (18,375)
Net cash provided by financing activities (268,375)Effect of exchange rate changes on cash 3,200
Decrease in cash for 2007 (34,300)Cash and cash equivalents at December 31, 2006 213,800Cash and cash equivalents at December 31, 2007 $ 179,500
Direct Method [Cash Flow from Operating Activities Section]
Cash Flow from Operating ActivitiesCash received from customers $3,653,400Less: Cash paid to suppliers $2,065,945Cash paid for operating expenses 1,006,580 (3,072,525)
Cash flow from operating activities $ 580,875
[Cash flows from investing activities and cash flows from operating activities are the same as under the indirect method.]
Equity adjustment from Patent for 2006: $36,000 Patent balance January 1, 2007 — $3,800 amortization - $30,000 unamortized balance at December 31, 2007 Debit $ 2,200
Investment in Scheele account:Investment in Scheele January 1, 2006 $2,070,000Income from Scheele ($420,000 ´ 90% - $4,200 Patent) 373,800Equity adjustment from translation ($270,000 ´ 90%) (243,000)Equity adjustment from Patent (4,800)Investment in Scheele December 31, 2006 2,196,000Income from Scheele ($418,000 ´ 90% - $3,800 Patent) 372,400Equity adjustment from translation ($155,500 ´ 90%) (139,950)Equity adjustment from Patent (2,200)Investment in Scheele December 31, 2007 $2,426,250
Check: Stockholders’ equity of Scheele at December 31, 2007 of$2,662,500 ´ 90% interest + $30,000 unamortized Patent = $2,426,250
LCU Rate U.S. DollarsDebitsCash 100,000 $.4000 C $ 40,000Accounts receivable 400,000 .4000 C 160,000Inventories 500,000 .4000 C 200,000Equipment 9,000,000 .4000 C 3,600,000Cost of sales 3,000,000 .4200 A 1,260,000Depreciation expense 900,000 .4200 A 378,000Operating expenses 975,000 .4200 A 409,500Exchange loss 125,000 .4200 A 52,500Equity adjustment — 2006 270,000
15,000,000 $6,370,000
CreditsAccumulated depreciation 1,800,000 .4000 C $ 720,000Accounts payable 1,075,000 .4000 C 430,000Advance from Progress 1,125,000 .4000 C 450,000Capital stock 4,000,000 .4500 H 1,800,000Retained earnings January 1, 2006 1,000,000 M 450,000Sales 6,000,000 .4200 A 2,520,000
15,000,000 $6,370,000
Translation Worksheet for 2007
DebitsCash 600,000 $.3750 C $ 225,000Accounts receivable 1,000,000 .3750 C 375,000Inventories 1,500,000 .3750 C 562,500Equipment 9,000,000 .3750 C 3,375,000Cost of sales 3,600,000 .3800 A 1,368,000Depreciation expense 900,000 .3800 A 342,000Operating expenses 1,325,000 .3800 A 503,500Exchange loss 75,000 .3800 A 28,500Equity adjustment January 1 M 270,000Equity adjustment 2007 155,500
18,000,000 $7,205,000
CreditsAccumulated depreciation 2,700,000 .3750 C $1,012,500
Accounts payable 1,100,000 .3750 C 412,500Advance from Progress 1,200,000 .3750 C 450,000Capital stock 4,000,000 .4500 H 1,800,000Retained earnings January 1, 2007 2,000,000 M 870,000Sales 7,000,000 2,660,000
Accounts payable 1,075,000 $0.020 21,500 1,100,000 0.005 5,500 27,000 Effect of translation changes on consolidated net assets $(186,200)
Reconciliation
Noncontrolling interest translation adjustment ($155,500 change ´ 10%) $ (15,550)Equity adjustment of Progress ($155,500 ´ 90% + $2,200) (142,150)Exchange loss on advance to Scheele (28,500)
Effect of translation changes on consolidated net assets $(186,200)
* Average exchange rate of $.42 - current exchange rate of $.40 at year end 2006.+ Current exchange rate of $.375 at year end 2007 - average exchange rate of $.38 for year 2007.
Progress Corporation and SubsidiaryConsolidated Statement of Cash Flowsfor the year ended December 31, 2007
Cash Flows from Operating ActivitiesConsolidated net income $1,200,000Add: Noncontrolling interest income 41,800 $ 1,241,800Noncash expenses, revenues, losses, and gains included in income:
Depreciation expense $1,042,000Patent amortization 3,800Exchange loss 28,500Increase in accounts receivable (428,000)Decrease in accounts payable (190,500)Increase in inventories (1,230,000) (774,200)Net cash flows from operating activities 467,600
Cash Flows from Investing ActivitiesPurchase of equipment $ (500,000)
Net cash used in investing activities (500,000)Cash Flows from Financing Activities ---Effect of exchange rate changes on cash (5,000)Decrease in cash for 2007 (37,400)Add: Cash and cash equivalents at beginning of year 446,200Cash and cash equivalents at December 31, 2007 $ 408,800
Direct Method [Cash Flows from Operating Activities Section]
Cash Flows from Operating Activities
Cash received from customers $10,759,600Less: Cash paid to suppliers $7,588,500
Cash paid for operating expenses 2,703,500 (10,292,000)Net cash flows from operating activities 467,600
1 An operating segment is a component of an enterprise: (1) that engages in business activities from which it may earn revenues and incur expenses, either internal or external; (2) whose operating results are regularly reviewed by the enterprise’s chief operating decision maker and (3) for which discrete financial information is available.
2 A reportable segment is an operating segment, either single or aggregated, for which information has to be reported under FASB Statement No. 131. An operating segment is a reportable segment if (a) its revenue is 10 percent or more of the combined revenue of all operating segments, (b) its absolute operating profit or loss is 10 percent or more of the greater of combined operating profit of all segments that have operating profit or combined operating losses of all segments that have losses, or (c) its identifiable assets are 10 percent or more of the combined identifiable assets of all operating segments.
3 Segments not meeting one of these tests are subject to a reevaluation, and possible aggregation, if the combined revenue from sales to external customers of all reportable segments is less than 75 percent of consolidated revenue. Segments that are not reportable segments are combined with other business activities and reported under an “all other” category.
4 The 10 percent revenue test applies to the $480,000. Revenue for purposes of FASB Statement No. 131 includes revenue from both external and intersegment customers.
5 An industry segment is a reportable segment under the 10 percent operating profit test if its operating profit or loss, in absolute amount, equals or is greater than the greater of combined operating profits for all operating segments having operating profits or combined operating losses for all operating segments having operating losses.
6 A segment is a reportable segment under the 10 percent asset test if its assets are 10 percent or more of the combined assets of all operating segments. The allocation of general corporate assets depends on the internal operations of the enterprise. The key is the asset figure given to the chief operating decision maker on which he or she evaluates performance. If corporate assets are not allocated, they become part of the reconciliation between the reportable segments’ assets and consolidated assets.
7 A segment is a reportable segment under the 10 percent revenue test if its intersegment and external sales is 10 percent or more of the combined intersegment and external sales of all the operating segments.
8 No. If the combined revenue from sales to external customers is less than 75 percent of total consolidated revenues, additional operating segments must be identified as reportable segments until the 75 percent test is met. Either some of the remaining segments must be aggregated, if they meet the aggregation criteria, so that the combined segment meets the materiality criteria of 10%, or one or more of the five operating segments that were not reportable segments under the 10 percent tests must be identified as reportable segments.
9 The following information must be disclosed for reportable segments and for the remainder of the enterprise’s operating segments and other business activities in the aggregate:a Revenue, with separate amounts to unaffiliated and affiliated customers, and
disclosure of the basis of accounting for intersegment sales.b Operating profit or loss, based on the information reviewed by the chief operating
officer.c Identifiable assets for each reportable segment.d Interest revenuee Interest expensef Aggregate amount of depreciation, depletion, and amortization expense.g Unusual items as described in paragraph 26 of APB Opinion No. 30.h Equity in the net income of investees accounted for by the equity method.i Income tax expense or benefit.j Extraordinary items.k Significant noncash items other than depreciation, depletion, and amortization.
10 If the enterprise is segmented on a geographic basis, complete segment information would be supplied by country of operation. If a different criteria is used for segmentation, more limited geographic information is supplied. Revenues and long lived assets attributed to the country of domicile and all foreign operations are disclosed. Any single country with material operations exist must also be disclosed separately.
11 The fact and amount of revenue from each customer must be disclosed if 10 percent or more of an enterprise’s revenue is derived from that customer. If 10 percent or more of an enterprise’s revenue is derived from sales to the federal government, or to a state, local, or foreign governmental unit, that fact and the amount of revenue must be disclosed. The identity of the segment making such sales must be disclosed, but the customer need not be identified by name.
12 The requirements of FASB Statement No. 131 do apply to interim financial statements. Like other aspects of interim reporting, segment disclosure is more limited in the interim reports than in the annual reports. Required disclosure for each reportable segment in the interim reports include: (1) revenues from external customers, (2) intersegment revenues, (3) a measure of segment profit or loss, (4) total assets for which there has been a material change since the amount disclosed in the annual report, (5) a description of any changes in the basis for segmentation or the basis of measurement of segment profit or loss, (6) a reconciliation of total reportable segment profit or loss and consolidated income before income taxes.
13 An annual effective tax rate is computed as the sum of estimated income taxes for each quarter of the year, divided by the estimated income for the year. This approach spreads any progression in tax rates over the entire year in accordance with the integral theory of interim reporting.
14 The discrete theory assumes that each quarter is a separate and independent accounting period that stands alone. By contrast, the integral theory treats each interim period as an essential part of each annual period. The integral theory is required under GAAP reporting for interim reports.
15 APB Opinion No. 28 specifies that minimum disclosures for interim reports should include gross revenues, provision for income taxes, extraordinary items and cumulative-effect-type changes on a net-of-tax basis, and net income and related EPS amounts as basic reporting items. In addition, disclosures are required of seasonal cost and revenue, significant changes in income tax estimates, or changes in financial position, and material contingencies, extraordinary and unusual or infrequently occurring items.
10% revenue test:Revenue from Affiliated Reportable Segment
and Unaffiliated Customers Test Value $215,000Concrete and stone products $ 200,000 noConstruction 500,000 yesLumber and wood products 900,000 yesBuilding materials 500,000 yesOther 50,000 no
$2,150,000
75% revenue test:Combined Revenue from Combined Revenue fromReportable Segments to All Segments toUnaffiliated Customers Unaffiliated Customers
Concrete and stone products $ 200,000Construction $ 500,000 500,000Lumber and wood products 500,000 500,000Building materials 300,000 300,000Other 50,000
$1,300,000 $1,550,000
Since the $1,300,000 combined revenue from reportable segments to unaffiliated customers is greater than 75% of $1,550,000 revenue for all unaffiliated customers ($1,162,500), no additional segments have to be reported.
Revenue test: 10% of combined revenues (total sales) = $68,800,000
The food service industry, copper mine, and chemical industry are reportable segments under the revenue test because they each have revenue in excess of $68,800,000.
Operating profit test: 10% of the greater of the combined operating profit of all industries having operating profit ($88,500,000) or the combined operating loss of all industries having operating losses ($25,500,000).
The food service industry, copper mine, chemical industry, and agricultural products industry are reportable segments because they each have operating profit or loss in excess of $8,850,000.
Asset test: 10% of combined assets ($638,000,000 total assets less $33,000,000 corporate assets) = $60,500,000.
The food service industry and chemical industry are reportable segments because they have assets in excess of $60,500,000.
Reportable segments (those that meet at least one of the tests): food service industry, copper mine, chemical industry, and agricultural products industry.
Solution E14-4
Worldwide CorporationSegment Revenue for 2008
(in thousands)
United Other
States Canada ForeignSales to unaffiliated customers $50,000 $18,000 $21,000Intersegment sales 15,000 8,000 4,000Total $65,000 $26,000 $25,000
Since revenue from reportable operating segments of $68,000 is greater than 75% of consolidated revenue ($89,000), no additional segments need be reported.
1 cRevenue test value = $3,275 Industries A, B, C, and E
Operating profit test value = $580 Industries A, B, C, and E
Identifiable assets test value = $6,750 Industries A, B, C, D, and E
2 dTen percent of combined revenues of all industry segments.
3 bRevenue test value: 10% of sales to unaffiliated ($2,000) and affiliated ($600) customers = $260
4 bOnly Beck and DG have total revenues ³ 10% of $83,000 combined revenues:
Beck $12,000 total revenue > $8,300DG $59,000 total revenue > $8,300
5 dIf sales to a single customer total 10% or more of Grum’s reported revenues ($50,000,000 ´ 10%), major customer data should be disclosed.
6 aIf revenues generated by foreign operations in one country are material (10% or more) of consolidated revenue, Grum should report information about that country’s foreign operations.
7 cThe materiality criteria for reporting a segment based on revenue is 10 percent of total (both external and intersegment, eliminating b) revenue (not income eliminating a) of all operating segments (not just those reporting a profit, eliminating d).
8 bSales to other segments are always included in segment income. The other three options generally would not be included but any of them could be included. Inclusion would depend on whether it was included in the performance report evaluated by the chief operating decision maker.
1 bThe inventory loss was not expected to be temporary, and therefore, the decline was recognized in the first period. The subsequent recovery to the original cost is recognized in the third period.
2 bThe extraordinary loss of $70,000 has to be disclosed, and the annual insurance premium has to be allocated $25,000 per quarter.
3 dThe full $360,000 loss is included in the second quarter interim report because the loss is permanent.
4 aAn extraordinary loss is allocated to the quarter to which it relates. In this case the $300,000 extraordinary loss is assigned to the third quarter.
5 aUnder the integral theory each quarterly period is an integral part of each annual period. Thus, property taxes of $20,000 ($80,000 ´ 25%) and executive bonuses of $80,000 ($320,000 ´ 25%) should be allocated to each of the four quarters.
Solution E14-10
Current cost to replace 4,000 units at $8 $ 32,000Historical cost of inventory liquidated 4,000 units at $5 20,000
Adjustment to cost of sales [4,000 units ´ ($8 - $5)] 12,000Cost of sales 550,000
Adjusted cost of sales for the first quarter $562,000
Test value is 10% of $1,158,000 total sales, or $115,800. Reportable industry segments include the apparel, furniture, lumber and wood products, and textiles segments.
2 Test value for 75% revenue test is the combined revenue from sales to unaffiliated customers by all industry segments of $892,000 ´ 75% = $669,000
Reportable segments:Apparel $164,000Furniture 208,000Lumber and wood products 175,000Textiles 50,000
Total $597,000
Sales to unaffiliated customers by the reportable industry segments of $597,000 is less than the $669,000 test value. Therefore, additional segments must be identified as reportable segments. The construction industry, as closest to the 10% criteria, should be included as a reportable segment.
3 Under the assumption that tobacco and paper share the majority of their operating characteristics they would be combined into one segment that now meets the 10% test and complies with the 75% criteria. Construction would no longer need to be reported. Note to disclose information about segment data:
Sales to Sales toUnaffiliated Affiliated Customers Customers Total Sales
Revenue:Total revenue of reportable segments $240,000Other revenues 0Elimination of intersegment revenues (50,000)
Total consolidated revenues $190,000
Profit or Loss:Total profit or loss for reportable segments $ 50,000Other profit or loss 0Elimination of intersegment profit and loss 0Unallocated amounts 0Consolidated income before taxes $ 50,000
Assets:Total assets for reportable segments $250,000Other assets 55,000
Since $1,450 < (75% ´ $2,180), other reportable segments must be identified to bring the total revenue from unaffiliated customers for reportable segments up to $1,635.
If no further aggregation is possible, a logical approach is to include cosmetics, the next largest segment in terms of sales to unaffiliated customers.
If further aggregation of some of the otherwise non-reportable segments were possible (they met the majority of the aggregation criteria), a combined segment may then meet the reportability criteria and would be reported instead of cosmetics.
The test: $900 + $550 + $200 = $1,650
Since $1,650 > $1,635, the reportable segments are soft drinks, distilled spirits, and cosmetics.
Since the $47,000 revenue from unaffiliated customers of previously identified reportable operating segments is greater than 75% consolidated revenue (75% ´ $54,000 = $40,500), no additional reportable segments have to be identified.
4Random Choice Company
Schedule of Operations in Different Segmentsfor the year ended December 31, 2008
Reconciliation of revenue:Revenue from reportable segments $ 67,000Revenue from equity investees 9,000Other revenue 7,000Intersegment eliminations (20,000)Consolidated revenue $ 63,000
Reconciliation of income:Reportable segment income $ 14,500Income from equity investees 9,000Other income (500)Interest expense (7,000)Consolidated income before taxes $ 16,000
Reconciliation of assets:Reportable segment assets $ 66,000Other segment assets 6,000Investment in equity affiliates 60,000Corporate assets 4,000
Reconciliation of revenue:Revenue from reportable segments $ 420,000Revenue from equity investees 30,000Interest revenue 10,000Intersegment eliminations (60,000)Consolidated revenue $ 400,000
Reconciliation of income:Reportable segment income $ 115,000Income from equity investees 30,000Interest income 10,000Corporate expense (5,000)Minority interest income (15,000)Intersegment eliminations (30,000)
Consolidated income before taxes $ 105,000
Reconciliation of assets:Reportable segment assets $ 530,000Investment in equity affiliates 300,000Corporate assets 200,000Elimination of intersegment balances (30,000)Consolidated assets $1,000,000
Reconciliation of revenue:Revenue from reportable segments $2,200Other segment revenue 400Intersegment eliminations (200)Income from equity investees 100Consolidated revenue $2,500
Reconciliation of income:Reportable segment income $ 250Other segment income 75Income from equity investees 100Interest expense (20)Corporate expense (25)Consolidated income before taxes $ 380
Reconciliation of assets:Reportable segment assets $1,725Other segment assets 400Investment in equity affiliates 1,000Corporate assets 50Consolidated assets $3,175
PARTNERSHIPS — FORMATION, OPERATIONS, ANDCHANGES IN OWNERSHIP INTERESTS
Answers to Questions
1 Noncash investments of partners should be recorded at their fair values in order to provide equitable treatment to the individual partners. The recording of noncash assets at less than fair value will result in allocating the amount of understatement between the partners in their relative profit and loss sharing ratios as the undervalued assets are used for partnership business or when they are sold by the partnership.
2 Conceptually, there is no difference between the drawings and the withdrawals of partners since both represent disinvestments of resources from the partnership entity. From a practical viewpoint, the distinction between withdrawals and drawings may be important because allowable drawings are not usually deducted in determining the amount of partnership capital to be used for purposes of dividing profits among the partners. Since withdrawals are deducted, the distinction can affect the division of profits and losses.
3 In the absence of an agreement for dividing profits, an equal division among the partners is required by the Uniform Partnership Act. The agreement also applies to losses. And it applies irrespective of the relative investments by the partners.
4 Salary and interest allowances are included in some partnership agreements in order to reward partners for the time and effort that they devote to partnership business (salary allowances) and for capital investments (interest allowances) that they make in the business.
5 Salary allowances to partners are not expenses of a partnership. Rather, they are a means of recognizing the efforts of individual partners in the division of partnership income.
6 When profits are divided in the ratio of capital balances, capital balances should be computed on the basis of weighted average capital balances in the absence of evidence that another interpretation of capital balances is intended by the partners.
7 An individual partner may have a loss from his share of partnership operating activities even though the partnership has income. This situation results if priority allocations to other partners exceed partnership net income. For example, if net income for the A and B Partnership is $5,000 and profits are divided equally after a salary allowance of $8,000 to A, A will have partnership income of $6,500 and B will have a partnership loss of $1,500.
8 Partnership dissolution under the Uniform Partnership Act is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on of the
business, as distinguished from the winding up of the business. Thus, the assignment of a partnership interest to a third party by one of the partners does not, by itself, dissolve the partnership because the assignee does not become a partner unless accepted as a partner by the continuing partners.
9 The sale of a partnership interest to a third party dissolves the old partnership if the continuing partners accept the third party purchaser as their partner. In this case, the relation among the partners is changed and a new partnership agreement is necessary.
10 A partnership is both a legal entity and a business entity. The partnership as a legal entity is dissolved by the death or retirement of a partner as provided by the Uniform Partnership Act. But the partnership as a business entity continues until the business entity is liquidated, irrespective of the changes in the interests held by individual partners.
11 When a new partner acquires an interest by purchase from existing partners, the partnership receives no new assets because the payment for the new partner’s interest is distributed to the old partners. Alternatively, an investment in a partnership increases the net assets of the partnership. This difference is important in accounting for the admission of a new partner.
12 The admission of a new partner may be recorded by the goodwill approach (or revaluation approach) or by the bonus approach (or nonrevaluation approach).
13 The goodwill procedure for recording the admission of a new partner is best described as a revaluation approach because identifiable assets and liabilities that are over or undervalued are adjusted to their fair values before the unidentifiable asset goodwill is recorded. For example, if a new partner’s investment reflects the fact that land owned by the old partnership is undervalued, it would be misleading to record the amount of revaluation as goodwill, rather than as a revaluation of the land account.
14 A bonus procedure for recording an investment in a partnership involves adjusting the partnership capital account to the extent necessary to meet the new partnership agreement without a revaluation of the assets and liabilities of the old partnership.
If a new partner receives a capital credit in excess of his or her investment, the excess is a bonus to the new partner. A bonus to a new partner is charged against the old partners’ capital balances in relation to their old profit sharing ratios.
If a new partner’s investment exceeds his or her capital credit, the excess is a bonus to the old partners. A bonus to the old partners is credited to the old partners’ capital balances in accordance with the old partners’ profit sharing ratios.
15 The amounts received by the individual partners in final liquidation will be the same under the bonus and goodwill procedures provided that the relative profit and loss sharing ratios of the old partners remain unchanged in the new partnership and that the new partners’ capital interest and profit and loss sharing ratio are aligned.
16 Parts a and b assume that the partnership assets are to be revalued upon the admission of Bob into the partnership.Goodwill would be recorded if identifiable assets and liabilities are equal to their fair values and1. $10,000 ¸ 25% > $10,000 + old capital; or2. Old capital ¸ 75% > $10,000 + old capital; or3. An independent assessment of earning power or other factors indicate goodwill.Old partnership assets would be written down if1. $10,000 ¸ 25% < $10,000 + old capital; or2. Old capital ¸ 75% < $10,000 + old capital; or3. An independent assessment of earning power or other factors indicate that
partnership assets are overvalued.Parts c and d assume that partnership assets are not to be revalued upon the
admission of Bob into the partnership. A bonus to the old partners would be recorded if 25% ´ ($10,000 + old capital) is less than $10,000. A bonus to Bob would be recorded if 25% ´ ($10,000 + old capital) is greater than $10,000.
Let B = bonus B = 10% ´ ($506,000 - B) B = $50,600 - .1B 1.1B = $50,600 B = $46,000
Schedule to Allocate Partnership Income
Arnold Beverly Carolyn Net income to distribute $506,000Bonus to Beverly (46,000) $ 46,000Remainder to divide 460,000Divided 40:40:20 (460,000) $184,000 184,000 $ 92,000Income allocation 0 $184,000 $230,000 $ 92,000
Melanie David 2007 income to divide ($25,000 - $4,000) $21,000Salary to Melanie (18,000) $18,000Remainder to divide 3,000Divided equally (3,000) 1,500 $ 1,500
02006 income understatement $ 4,000Divided in the 2006 60:40 ratio (4,000) 2,400 1,600Income allocation 0 $21,900 $ 3,100
Solution E15-5
Bird, Cage, and Dean PartnershipStatement of Partnership Capital
for the year ended December 31, 2006
Bird Cage Dean Total Capital Capital Capital Capital
Net contributed capital 80,000 100,000 120,000 300,000Add: Net incomea 24,000 24,000 24,000 72,000
Balance December 31 $104,000 $124,000 $144,000 $372,000
a Net income = $372,000 ending capital - $300,000 net contributed capital.
Solution E15-6
1 Batty capital $70,000Peters capital $70,000
To record assignment of half of Batty’s capital account to Peters.
2 The total capital of BIG Entertainment Galley remains at $400,000. The amount paid by Peters to Batty does not affect the partnership and Peters does not become a partner with the assignment of half of Batty’s interest.
Solution E15-7
Capital balances after Ring is admitted when assets are not revalued:
Old Capital Capital Transfer New Capital
Klaxon capital $140,000 x 40% $(56,000) $ 84,000Bell capital 60,000 x 40% (24,000) 36,000Ring capital 80,000 80,000
Total capital $200,000 0 $200,000
Solution E15-8
Journal entries to admit Johnson to the Bowen/Monita partnership:
Goodwill $ 90,000Bowen capital $ 54,000Monita capital 36,000
To record goodwill computed as follows:New capital = $150,000 ¸ 1/3 = $450,000Goodwill = $450,000 new capital - $360,000 old capital = $90,000
1 Investment of $50,000 in partnership with revaluation:
Cash $50,000Goodwill 10,000
Walk capital $60,000The new partnership valuation is computed as: old capital of $240,000/80% retained interest = $300,000 new capital. Goodwill is computed as: new capital of $300,000 - $290,000 (the old capital plus investment) = $10,000 goodwill.
2 Investment of $70,000 in partnership with revaluation:
Goodwill $40,000Sprint capital $12,000Jog capital 20,000Run capital 8,000
New partnership capital is computed on the basis of new investment of $70,000/20% interest = $350,000 new capital. New capital of $350,000 - ($240,000 old capital + $70,000 investment) = $40,000 goodwill.
Cash $70,000Walk capital $70,000
To record Walk’s investment in the partnership.
Solution E15-10
1 Investment of $120,000 in the partnership with no revaluation:
$400,000 old capital + $120,000 additional investment = $520,000Boudreaux’s interest = $520,000 ´ 25% = $130,000Therefore, the old partners are giving a bonus to Boudreaux of $10,000.
Cash $120,000Manda capital 3,600Emeril capital 2,400Fotenot capital 4,000
Boudreaux capital $130,000To record Boudreaux’s admission to a 25% interest in the partnership capital and earnings.
Capital accounts after Boudreaux’s admission to the partnership:
Manda capital ($140,000 - $3,600) $136,400Emeril capital ($100,000 - $2,400) 97,600
Fotenot capital ($160,000 - $4,000) 156,000Boudreaux capital 130,000
$520,000
2 The profit and loss sharing ratios of the new partnership will depend on the provisions of the new partnership agreement. If the old partners wish to maintain their old partnership relationship, one possible division would be to reduce each of the old partners ratio by 25% (in other words, a new ratio of 27:18:30:25). However, if the issue is not addressed in the new partnership agreement, the partners will share profits equally, 25:25:25:25, in accordance with the Uniform Partnership Act.
Solution E15-11
Retirement of Nixon with revaluation:
Goodwill $70,000Nixon capital (30%) $21,000Mann capital (30%) 21,000Peter capital (40%) 28,000
To record goodwill implied by the excess payment to Nixon computed as: ($85,000 - $64,000)/30% = $70,000.
Nixon capital $85,000Cash $85,000
To record payment to Nixon upon his retirement.
Solution E15-12
Entry to write-up assets to fair valueAssets $20,000
Beck capital $10,000Dee capital 8,000Lynn capital 2,000
Entry to record settlement with DeeDee capital $38,000Beck capital (5/6 ´ $3,000 excess payment) 2,500Lynn capital (1/6 ´ $3,000 excess payment) 500
Net income $30,000Bonus to Kathy (1,500) 1,500 1,500Remainder 28,500Salary allowance (25,000) 10,000 15,000 25,000Remainder 3,50050/50 split (3,500) 1,750 1,750 3,500Remainder -0- $13,250 $16,750 $30,000
2 Revenue and Expense Summary $30,000Kathy Capital $13,250Eddie Capital $16,750
Allocate partnership net income for the year to the partners.
Kathy Capital $15,000Kathy Drawing $15,000
Eddie Capital $10,000Eddie Drawing $10,000
Close the drawing accounts to the capital accounts.
3 Capital AccountsK & E Partnership
Statement of Partners’ CapitalFor the year ended December 31 2006
Kathy Eddie Capital balances January 1, 2006 $496,750 $268,250Add: Additional investments 5,000 5,000Deduct: Withdrawals 0 0Deduct: Drawings 15,000 10,000Add: Net income 13,250 16,750Capital balances December 31, 2006 $500,000 $280,000
New capital of $195,000 - (old capital $110,000 + $65,000 investment) = $20,000 goodwill.
Revaluation is recorded: Goodwill (other assets) $20,000
Thomas capital (50%) $ 10,000Mark capital (50%) 10,000
Mark’s capital = $60,000 + $10,000 goodwill = $70,000
Solution E15-15 (continued)
3 cTotal capital ($170,000 + $200,000 + $200,000) = $570,000Zen’s interest $570,000 ´ 1/3 = $190,000Therefore, Tina and Warren receive a $10,000 bonus, shared equally.
4 c$90,000 investment > 25% ´ ($100,000 + $80,000 + $90,000), thus, there is goodwill to the old partners.
New capital $90,000/25% $360,000Old capital + new investment $180,000 + $90,000 (270,000)
Goodwill $ 90,000
Finney capital $100,000 + (50% ´ $90,000 goodwill) $145,000Rhoads capital $80,000 + (50% ´ $90,000 goodwill) 125,000Chesterfield capital 90,000
Total capital $360,000
5 bPayment to Gini at retirement $200,000Capital account before recording share of goodwill 170,000Gini’s share of goodwill $ 30,000
Total goodwill for partnership ($30,000/.3) $100,000
Total assets before Gini’s retirement ($240,000 cash + $360,000 other assets + $100,000 goodwill) $700,000Less: Payment to Gini on retirement 200,000Total assets after Gini retires $500,000
Tony capital $ 30,000 30% 50%Olga capital 70,000 70% 50%
$100,000
Since capital and income interests were not aligned at the time of Shirley’s purchase, the $40,000 payment to Tony does not provide a basis for revaluation. Thus, half of Tony’s $30,000 capital balance should be transferred to Shirley.
2 aImplied total valuation of partnership based on Duncan’s $60,000 payment to partners ($60,000/.4) $150,000
Entry to record goodwill:Goodwill $30,000
Linkous capital $ 15,000Quesenberry capital 15,000
Entry to transfer equal capital amounts to Duncan:Linkous capital $30,000Quesenberry capital 30,000
Duncan capital $ 60,000
Capital accounts after admission of Duncan:Linkous capital ($50,000 + $15,000 - $30,000) $ 35,000Quesenberry capital ($70,000 + $15,000 - $30,000) 55,000Duncan capital 60,000Total capital $150,000
3 cOakes’s investment of $50,000 is less than his capital credit of $56,667 [($120,000 old capital + $50,000 investment) ´ 1/3] under the bonus approach; therefore, goodwill accrues to Oakes.Old capital of $120,000 ¸ 2/3 interest retained by old partners = $180,000 capitalization. $180,000 - $170,000 old capital and new investment = $10,000 goodwill.
3 bWilliam’s $40,000 capital investment > capital credit ($140,000 ´ 25%) Thus, goodwill to old partners.
New capital ($40,000/.25) $160,000Old capital 140,000
Goodwill $ 20,000
Revaluation entry:Goodwill $20,000
Eli capital ($20,000 ´ 60%) $ 12,000George capital ($20,000 ´ 30%) 6,000Dick capital ($20,000 ´ 10%) 2,000
Admission of William:Eli capital ($92,000 ´ 25%) $23,000George capital ($46,000 ´ 25%) 11,500Dick capital ($22,000 ´ 25%) 5,500
William capital $ 40,000
New capital balances:Eli capital ($92,000 - $23,000) $ 69,000George capital ($46,000 - $11,500) 34,500Dick capital ($22,000 - $5,500) 16,500William capital 40,000Total capital $160,000
4 bPurchase price paid by Sidney $132,000Capital transferred to Sidney ($444,000 ´ 20%) 88,800Combined gain to Newton and Sharman $ 43,200
Because capital balances are not aligned with profit and loss sharing ratios, the $88,800 capital transferred to Sidney will be charged to Newton and Sharman by agreement.
5 dOld capital ($60,000 + $20,000) $ 80,000Additional capital invested by Grant 15,000New capital 95,000Grant’s capital interest 20 %Grant’s capital account $ 19,000
Implied goodwill ($24,000 excess payment/.2 profit and loss interest of Dixon) $120,000
7 b20% 20% 60%
Williams Brown Lowe Total Per books $ 70,000 $65,000 $150,000 $285,000Asset revaluationa 12,000 12,000 36,000 60,000Balance after revaluation 82,000 77,000 186,000 345,000Goodwill recognitionb 20,000 20,000 60,000 100,000Balance before retirement 102,000 97,000 246,000 445,000Retirement of Williams (102,000) (102,000)
2 Since old partners transferred 50% of their interests in future profits, profits should be divided: 22.5% to Grosby, 27.5% to Hambone, and 50% to Iota. The partners can, of course, agree to any profit and loss sharing arrangement that they choose.
3 In the absence of a new partnership agreement, profits will be divided equally.
Case capital $140,000Donley capital 9,000Early capital 12,000
Cash $161,000To record Case’s retirement with a $21,000 bonus, shared by Donley and Early in their relative profit and loss sharing ratios (3/7 and 4/7, respectively).
Method 2: Goodwill to retiring partner only
Case capital $140,000Goodwill 21,000
Cash $161,000To record Case’s retirement and to record the $21,000 excess payment to Case as goodwill.
Method 3: Goodwill implied by excess payment
Goodwill $ 70,000Case capital $ 21,000Donley capital 21,000Early capital 28,000
To record goodwill implied by the excess payment to Case on her retirement. Goodwill is computed as the excess payment divided by Case’s profit and loss sharing ratio ($21,000/30%).
Preliminary computationBeginning capital ($69,000 + $85,500 + $245,500) $400,000Capital adjustments: Additional investment less withdrawals (4,000)
396,000Ending capital (481,000)Net income $ 85,000
Ellen, Fargo, and GaryStatement of Partnership Capital
for the year ended December 31, 2006
Ellen Fargo Gary Total Capital balance January 1 $69,000 $85,500 $245,500 $400,000Add: Additional investment 20,000 20,000Deduct: Salary allowances (12,000) (12,000) (24,000)
Net contributed capital 57,000 73,500 265,500 396,000Income allocation (see schedule) 24,200 24,200 36,600 85,000Capital balance December 31 $81,200 $97,700 $302,100 $481,000
Income allocation schedule:Total Ellen Fargo Gary
Income to divide $85,000Salary allowances (24,000) $12,000 $12,000Remainder to divide 61,000Divided 20:20:60 (61,000) 12,200 12,200 $ 36,600Income allocation 0 $24,200 $24,200 $ 36,600
1 Mortin, Oscar, and Trent PartnershipBalance Sheet
at January 2, 2006
Cash ($20,000 + $95,000) $115,000Accounts receivable — net 100,000Inventories 200,000Plant assets — net ($120,000 + $120,000) 240,000Goodwill 40,000a
Total assets $695,000
Accounts payable $ 50,000Mortin capital (1/3 interest) ($120,000 + $85,000b + $20,000) 225,000Oscar capital (1/3 interest) ($100,000 + $85,000b + $20,000) 205,000Trent capital (1/3 interest) 215,000c
Total equities $695,000
a Trent’s $215,000 ¸ 1/3 = $645,000 total capitalization $645,000 - $605,000 fv of old assets + Trent’s investment = $40,000 goodwill $40,000 goodwill is divided equally between Mortin and Oscar
b Revaluation of assets to fair value ($170,000 divided equally between Mortin and Oscar)c Trent’s investment ($95,000 cash + $120,000 building) = $215,000
2 Mortin, Oscar, and Trent PartnershipBalance Sheet
at January 2, 2006
Cash ($20,000 + $95,000) $115,000Accounts receivable — net 100,000Inventories 50,000Plant assets — net ($100,000 + $120,000) 220,000
Total assets $485,000Accounts payable $ 50,000Mortin capital (1/3 interest) ($120,000 + $35,000a) 155,000Oscar capital (1/3 interest) ($100,000 + $35,000a) 135,000Trent capital (1/3 interest) 145,000b
Total equities $485,000
a Trent is paying a bonus to Mortin and Oscar because his investment of $215,000 ($95,000 cash and $120,000 building) is worth more than a 1/3 interest in the book value of the combined assets ($215,000 + $220,000). The $70,000 bonus is evenly divided between Mortin and Oscar based on their profit sharing ratios. The journal entry to record Trent’s admission in the partnership is:Cash 95,000
Building 120,000Trent Capital 145,000Mortin Capital 35,000Oscar Capital 35,000
b Trent’s investment ($95,000 cash + $120,000 building) = $215,000Book value plus Trents investment is $220,000 + $215,000 = $435,000Trent gets a 1/3 interest or $145,000.
Ashe and Barbour PartnershipIncome Distribution Schedule for 2006
Ashe Barbour Total Net income to divide $105,000Interest allowance (9,000) $ 4,000 $ 5,000 $ 9,000Remainder to divide 96,000Salary to Ashe (12,000) 12,000 12,000Remainder to divide 84,000Bonus to Ashe B = .2($84,000 - B) 1.2B = $16,800 B = $14,000 (14,000) 14,000 14,000Remainder to divide 70,000Divided equally (70,000) 35,000 35,000 70,000Income distribution 0 $65,000 $40,000 $105,000
Solution P15-4
1 Profit allocation schedule Alex Carl Erika
Net loss for 2006 $(12,000)Salary to Alex (10,000) $ 10,000Loss to divide (22,000)Interest allowances: Alex $60,000 ´ 10% (6,000) 6,000 Carl $100,000 ´ 10% (10,000) $ 10,000 Erika $110,000 ´ 10% (11,000) $ 11,000Loss to divide (49,000)Divided 30:30:40 49,000 (14,700) (14,700) (19,600)Allocation of loss 0 $ 1,300 $ (4,700) $ (8,600)
2 Alex, Carl, and Erika PartnershipStatement of Partnership Capital
for the year ended December 31, 2006
Alex Carl Erika Total Capital January 1, 2003 $ 60,000 $ 90,000 $110,000 $260,000Add: Additional investments 30,000 20,000 50,000
60,000 120,000 130,000 310,000Deduct: Withdrawals (10,000) (10,000)Deduct: Drawings (8,000) (8,000)Net contributed capital 52,000 120,000 120,000 292,000Net loss for 2003 1,300 (4,700) (8,600) (12,000)
Allocation to Katie: $60,000 net income ´ 9/24 = $22,500Allocation to Lynda: $60,000 net income ´ 7/24 = 17,500Allocation to Molly: $60,000 net income ´ 8/24 = 20,000Net income $60,000
2 Assumptions: Net income = $50,000, 10% bonus to Katie, remainder divided on basis of beginning capital balances.
Profit Katie Lynda Molly Net income $50,000Bonus to Katie (5,000) $ 5,000Remainder to divide 45,000Capital allowances $45,000 ´ $80,000/$250,000 (14,400) 14,400 $45,000 ´ $80,000/$250,000 (14,400) $14,400 $45,000 ´ $90,000/$250,000 (16,200) $16,200Allocation of net income 0 $19,400 $14,400 $16,200
3 Assumptions: Net loss = $35,000, Salary of $12,000 for Molly and a 10% interest on beginning capital balances, and remainder divided equally.
Loss Katie Lynda Molly Net loss $(35,000)Salary allowance (12,000) 12,000Loss to divide $(47,000)Interest on beginning capital (25,000) $ 8,000 $ 8,000 $ 9,000Loss to divide (72,000)Divided equally 72,000 (24,000) (24,000) (24,000)Loss allocation 0 $(16,000) $(16,000) $ (3,000)
2006 2007 2008 Reported income $19,000 $22,000 $29,000Understatement of depreciation (2,000) (2,000) (2,000)Understatement of inventory at December 31, 2008 8,000Corrected income $17,000 $20,000 $35,000
Jones Keller Glade Total Capital per books $68,710 $33,950 $47,340 $150,000Understatement 666 667 667 2,000Capital as corrected $69,376 $34,617 $48,007 $152,000
3 Correcting entry on January 1, 2009:
Inventory $ 8,000
Jones capital $ 666 Keller capital 667 Glade capital 667
Note: Since residual income is divided equally, it is not necessary to recompute the income allocation and capital balances for each of the three years.
Inventories $ 10,000Plant assets — net 15,000Note payable 10,000Goodwill 75,000
Accounts receivable — net $ 5,000Addie capital 63,000Bailey capital 42,000
To revalue assets and liabilities and record goodwill on the basis of the $150,000 paid by Cathy for a 40% interest. Total capital of $375,000 [computed as $150,000/.4] less ($150,000 fair value of recorded net assets plus $150,000 investment by Cathy) equals $75,000 goodwill.
Cash $150,000Cathy capital $150,000
To record Cathy’s investment for a 40% interest in partnership capital and profits.
2 Addie, Bailey, and Cathy PartnershipBalance Sheet
at January 2, 2006
AssetsCash $165,000Accounts receivable — net 40,000Inventories 60,000Plant assets — net 105,000Goodwill 75,000Total assets $445,000
EquitiesAccounts payable $ 30,000Note payable (15%) 40,000Addie capital (33.3%) 127,000Bailey capital (26.7%) 98,000Cathy capital (40%) 150,000Total equities $445,000
1 Cabel sells one-half of her interest to Darling for $90,000:
Capital account balances: Abed capital $ 75,000Batak capital 100,000Cabel capital 62,500Darling capital 62,500
Total capital $300,000
There is no basis for revaluation because the capital balances are not aligned with profit and loss sharing ratios. The entry to admit Darling transfers one-half of Cabel’s capital account to Darling, regardless of the amount Darling pays Cabel:
Cabel capital $62,500Darling capital $ 62,500
To admit Darling to a 25% interest in the partnership.
2 Darling invests $75,000 in the partnership for a 25% interest, and partnership assets are revalued:
Capital account balances: Abed capital $ 75,000Batak capital 100,000Cabel capital 125,000Darling capital 100,000
Total capital $400,000
Since Darling’s investment of $75,000 is less than his capital credit under the bonus procedure [($300,000 + $75,000) ´ 25%] and the assets are to be revalued, goodwill accrues to the new partner. The entry to record the admission of Darling to the partnership is:
Cash $75,000Goodwill 25,000
Darling capital $100,000
To admit Darling to a 25% interest in the partnership and record goodwill computed as follows:Old capital $300,000/.75 interest retained by the old partners = $400,000 new capital.$400,000 new capital - ($300,000 old capital + $75,000 new investment) = $25,000 goodwill to new partner.
3 Darling invests $80,000 for a 20% interest in the partnership and partnership assets are revalued:
Capital account balances: Abed capital $ 80,000Batak capital 105,000Cabel capital 135,000Darling capital 80,000
Total capital $400,000
Since Darlings’s investment of $80,000 is greater than his capital credit under the bonus procedure [($300,000 + $80,000) ´ 20%], and assets are to be revalued, goodwill accrues to the old partners. The entries are as follows:
Goodwill $20,000Abed capital $ 5,000Batak capital 5,000Cabel capital 10,000
To record goodwill and adjust the partners’ capital accounts:Darling’s investment $80,000/20% = $400,000 new capital$400,000 - $380,000 old capital plus new investment = $20,000 goodwill to the old partners.
Cash $80,000Darling capital $ 80,000
To admit Darling to a 20% interest in the partnership for $80,000.
4 Darling invests $90,000 for a 30% interest in the partnership and assets are not revalued:
Capital account balances: Abed capital $ 68,250Batak capital 93,250Cabel capital 111,500Darling capital 117,000
Total capital $390,000
Since Darlings’s investment of $90,000 for a 30% interest is less than his capital credit [($300,000 + $90,000) ´ 30%], and no goodwill is to be recorded, Darling receives the bonus. The entry is as follows:
Cash $90,000Abed capital 6,750Batak capital 6,750Cabel capital 13,500
To record Darling’s $90,000 investment for a 30% interest and allow him a bonus of $27,000 computed as follows:($390,000 total capital ´ 30%) - $90,000 investment = $27,000
Con capital $90,000To record admission of Con and goodwill to Con computed as:Old capital of $450,000 = 5/6 new capitalNew capital = $540,000Con’s capital = $540,000 ´ 1/6 = $90,000Goodwill to Con = $90,000 - $85,080 = $4,920
No revaluation (bonus to new partner)
Cash $85,080Pat capital 1,640Mike capital 2,050Hay capital 410
Con capital $89,180To record admission of Con and bonus to Con computed as:New capital = $450,000 + $85,080 = $535,080Con capital = $535,080 ´ 1/6 interest = $89,180Bonus = $89,180 - $85,080 = $4,100, allocated 40:50:10
2 Revaluation
Goodwill $60,480Pat capital (40%) $24,192Mike capital (50%) 30,240Hay capital (10%) 6,048
To record revaluation of old partnership computed as:New capital = $85,080 ¸ 1/6 = $510,480$510,480 - $450,000 = $60,480 undervaluation
Pat capital $28,032Mike capital 41,040Hay capital 16,008
Con capital $85,080To record capital transfers equal to 1/6 of old partners’ capital balances as adjusted: Pat ($144,000 + $24,192)/6 = $28,032Mike ($216,000 + $30,240)/6 = $41,040 Hay ($90,000 + $6,048)/6 = $16,008
1 Carmen pays $450,000 directly to Aida and Thais for 40% of each of their interests and the bonus procedure is used.
Aida capital $200,000Thais capital 112,000
Carmen capital $312,000Existing capital $780,000 ´ 40% = $312,000.
2 Carmen pays $600,000 directly to Aida and Thais for 40% of each of their interests and goodwill is recorded.
Goodwill $720,000Aida capital $360,000Thais capital 360,000
Goodwill = Payment to old partners $600,000/.4 - $780,000 existing capital = $720,000
Aida capital $344,000Thais capital 256,000
Carmen capital $600,000Aida capital = ($500,000 + $360,000) ´ .4Thais capital = ($280,000 + $360,000) ´ .4
3 Carmen invests $450,000 in the partnership for her 40% interest, and goodwill is recorded.
Cash $450,000Goodwill 70,000
Carmen capital $520,000Old capital $780,000/.6 = $1,300,000 new capitalNew capital $1,300,000 - old capital $780,000 + new investment $450,000 = goodwill $70,000
4 Carmen invests $600,000 in the partnership for her 40% interest, and goodwill is recorded.
Goodwill $120,000Aida capital $ 60,000Thais capital 60,000
Goodwill = new investment $600,000/.4 = $1,500,000 total capital$1,500,000 - $1,380,000 old capital and new investment = $120,000
Net contributed capital 16,000 28,000 20,000 64,000Net income — 2004 4,000 4,000 16,000 24,000
Capital December 31, 2004 20,000 32,000 36,000 88,000Withdrawal — 2005 (4,000) (8,000) (12,000)
Net contributed capital 16,000 24,000 36,000 76,000Net income — 2005 2,727 4,364 16,909 24,000Capital December 31, 2005 $18,727 $28,364 $52,909 $100,000
Computation of net income:Assets $129,500 - liabilities $29,500 = $100,000 capital December 31, 2005Beginning capital $60,000 + investment $8,000 - withdrawals $16,000 = $52,000$100,000 - $52,000 = $48,000 net income for the two year period.
Schedule of Profit and Loss Distribution
Net Income Harry Iona Jerry Income for 2004 $24,000Salary allowance to Jerry (12,000) $ 12,000Remainder to divide 12,000One-third to each partner (12,000) $ 4,000 $ 4,000 4,000
Allocation of income 0 $ 4,000 $ 4,000 $ 16,000
Income for 2005 $24,000Salary allowance to Jerry (12,000) $ 12,000Remainder to divide 12,000Divided in beginning capital ratios: 20/88, 32/88, 36/88 (12,000) $ 2,727 $ 4,364 4,909
Proposal 1. Tom purchases one-half of Peter’s capital from PeterPeter capital $37,500
Tom capital $37,500To record Tom’s admission to the partnership for a one-fourth interest in capital and profits by direct purchase of one-half of Peter’s 50% interest. Tom’s capital credit is equal to capital transferred from Peter to Tom ($75,000 ´ 50%).
Proposal 2. Tom purchases one-fourth of each partners’ capital from partnersPeter capital $18,750Quarry capital 12,500Sherel capital 6,250
Tom capital $37,500To record Tom’s admission to the partnership by direct purchase of one-fourth of each partner’s capital and future profits. Tom’s capital credit is equal to the capital transferred from the other partners: ($75,000 ´ 25%) + ($50,000 ´ 25%) + ($25,000 ´ 25%).
Proposal 3. Tom invests cash in the partnership for a one-fourth interestCash $55,000
Peter capital $ 1,875Quarry capital 1,125Sherel capital 750Tom capital 51,250
To record Tom’s $55,000 investment for a one-fourth interest in capital and future profits. Total capital is $150,000 + $55,000. Tom’s share of total capital is $205,000 ´ 25%, or $51,250. Tom’s investment of $55,000 less Tom’s capital credit of $51,250 equals $3,750 bonus to old partners.
2 Partnership assets are revalued
Proposal 1. Tom purchases one-half of Peter’s capital from PeterGoodwill $90,000
Peter capital $45,000Quarry capital 27,000Sherel capital 18,000
To record goodwill on basis of the price paid by Tom for a one-fourth interest in capital and profits. Total capital is $240,000 ($60,000/25%). Total capital of $240,000 less recorded capital of $150,000 equals $90,000 goodwill.
Proposal 2. Tom purchases one-fourth of partners’ capital from partnersGoodwill $30,000
Peter capital $15,000Quarry capital 9,000Sherel capital 6,000
To record goodwill on the basis of the price paid by Tom for one-fourth of the capital and profits of each of the partners. Total capital is $180,000 ($45,000/25%). Total capital of $180,000 less recorded capital of $150,000 equals $30,000 goodwill.
Peter capital $22,500Quarry capital 14,750Sherel capital 7,750
Tom capital $45,000To record Tom’s admission to a one-fourth interest in partnership capital and profits. Tom’s capital is equal to the capital transferred after revaluation: ($90,000 ´ 25%) + ($59,000 ´ 25%) + ($31,000 ´ 25%).
Proposal 3. Tom invests cash in the partnership for one-fourth interestGoodwill $15,000
Peter capital $ 7,500Quarry capital 4,500Sherel capital 3,000
To record goodwill based on Tom’s investment of $55,000 for a one-fourth interest in partnership capital and profit. Total capital of $220,000 - ($150,000 recorded capital + $55,000 investment) = $15,000 goodwill.
Cash $55,000Tom capital $55,000
To record Tom’s $55,000 investment for a one-fourth interest in capital and profits. Total capital = $220,000; Tom’s capital is $220,000 ´ 25%, or $55,000.
1 Dissolution of a partnership terminates the partnership as a legal entity, but the partnership business may continue under a new agreement. When a partnership is liquidated, however, the partnership is terminated both as a legal and as a business entity. Thus, a partnership may be dissolved without liquidation, but it may not be liquidated without dissolution.
2 A simple partnership liquidation is the liquidation of a solvent partnership in which all partners have equity capital and all gains and losses are realized and recognized before any distributions are made to the partners. In simple partnership liquidations, only one cash distribution is made and the amounts distributed to individual partners are equal to their predistribution capital account balances.
3 The priority ranking for the distribution of assets in liquidation pursuant to RUPA is
Rank I Amounts owed to creditors other than partners andamounts owed to partners other than for capital and profits
Rank II Amounts due to partners after all assets have been liquidated and liabilities paid.
4 The distribution of assets for capital interests (Rank III) prior to the payment of loan balances to the partners (Rank II) is not in accordance with the Revised Uniform Partnership Act. But the partners may agree to distribute cash or other assets for capital interests before all losses on liquidation are known. With agreement among all partners, distributions to the partners would be based on each partner’s equity (combined capital and loan balances) in relation to his share of possible future losses. A partner with sufficient equity to absorb his share of possible future losses would be included in distributions, but a partner with loans to the partnership would not be included in distributions until his equity was sufficient to absorb his share of possible future losses.
5 The assumptions for determining distributions to partners prior to recognition of all gains and losses on liquidation are (1) all partners are personally bankrupt such that no partner could contribute personal assets into the partnership and (2) all noncash assets are possible losses and should be considered actual losses for purposes of determining amounts to be distributed. In addition, liquidation expenses and probable loss contingencies should be estimated and assumed to be actual losses for purposes of determining advance distributions.
6 Capital balances represent one factor in determining a partner’s equity, but loans and advances payable to and receivable from the partnership are factors that must also be considered in calculating safe payments. Partner equities, rather than capital balances, are
used in safe payment schedules in order to avoid making distributions to partners that may end up with debit capital balances; i.e., owing money to the partnership.
7 Safe payment computations per se do not affect ledger account balances. Actual cash distributions based on safe payments computations do reduce partnership assets and equities and require recognition in ledger accounts.
8 A statement of partnership liquidation is a summary of transactions and balances for a partnership during its liquidation stage. Such statements provide continuous records of liquidation events. Interim liquidation statements are particularly helpful in showing the progress that has been made toward liquidation to date and in identifying remaining assets to be liquidated and liabilities to be paid. Interim liquidation statements are helpful to partners and creditors in providing a basis for current decisions as well as future planning. Liquidation statements are important legal documents for partnership liquidations that come under the jurisdiction of a court.
9 Available cash may be distributed to partners according to their profit and loss sharing ratios only when nonpartner liabilities have been satisfied and partner equities (capital and loan balances combined) are aligned with the relative profit and loss sharing ratios of the partners. In the absence of loans or advances payable to or receivables from individual partners, cash can be distributed to partners in their profit and loss sharing ratios when capital balances are in the relative profit and loss sharing ratios of the partners and all nonpartner liabilities have been paid.
10 Vulnerability ranks are an ordering of partners on the basis of the adequacy of their equities in the partnership to absorb possible partnership losses. The ordering is typically from the most vulnerable to the least vulnerable. Vulnerability ranks are used in the preparation of assumed loss absorption schedules, which, in turn, are used in the construction of cash distribution plans.
11 Partnership insolvency occurs when partnership liabilities exceed partnership assets. In this case, all available cash is distributed to partnership creditors. Individual partners will be called upon to use their personal assets to satisfy the remaining claims of the partnership creditors.
12 Partners with credit capital balances after all partnership assets have been distributed in liquidation have a claim against partners with debit capital balances. If the partners with debit balances are personally solvent, they should pay amounts equal to their debit balances into the partnership so that partners with credit balances can receive their partnership claims in full. If partners with debit capital balances are insolvent, the partners with credit balances will absorb the losses of the insolvent partners with debit capital balances in relation to their relative profit and loss sharing ratios.
30% Fred 30% Ethel 40% LucyJanuary 1 balances $85,000 $25,000 $90,000Contingency fund of $10,000 (3,000) (3,000) (4,000)Possible losses on asset disposal ($120,000) (36,000) (36,000) (48,000)
46,000 (14,000) 38,000Loss on Ethel’s possible defaulta divided 3/7 and 4/7 (6,000) 14,000 (8,000)Available cash is distributed 40,000 0 30,000
a Notice that Ethel would have a debit balance in her capital account if the contingencies occurred and if the assets were a total loss. In order to determine how much cash is available for distribution, Fred and Lucy’s balances must absorb Ethel’s debit balance.
(This solution assumes that Joan agrees to a distribution of amounts that can be distributed safely. If she does not agree, no distribution can be made to either Joan or Jill.)
Jerry, Joan, and Jill PartnershipSafe Payments Schedule at November 30, 2008
40% 50% 10%Possible Jerry Joan Jill Losses Equity Equity Equity
Write off of Daniel’s deficit to Eric 2,143 (2,143) 0
0 45,000Payment to Eric (45,000) (45,000)
0 0
a Fred’s personal assets of $100,000 less the $40,000 owed to his personal creditors, and less the $20,000 paid to partnership creditors, equals $40,000 available for his debit capital account balance.
1 Gary, Henry, Ian, and Joseph PartnershipCash Predistribution Plan
Schedule of Vulnerability Ranks:
Gary Henry Ian Joseph Equity Equity Equity Equity
Capital balance $300,000 $320,000 $100,000 $ 110,000Loan to Henry (20,000)Partner equity $300,000 $300,000 $100,000 $ 110,000Divided by profit ratio 40% 30% 20% 10%
Loss absorption potential $750,000 $1,000,000 $500,000 $1,100,000
Vulnerability ranks 2 3 1 4
Schedule of Assumed Loss Absorption:
Gary Henry Ian Joseph Equities $300,000 $300,000 $100,000 $110,000Loss to absorb Ian’s equity (200,000) (150,000) (100,000) (50,000)
Roger, Susan, and Tom PartnershipStatement of Partnership Liquidation
for the period January 1, 2008 through February 28, 2008
30% 30% 40%Noncash Priority Roger Roger Susan Tom
Cash Assets Liabilities Loan Capital Capital CapitalBalances January 1 $20,000 $140,000 $40,100 $5,000 $ 9,900 $45,000 $60,000Offset loan to Susan 10,000* 10,000*Sale of assets 40,000 40,000*Predistribution balances 60,000 90,000 40,100 5,000 9,900 35,000 60,000Cash distribution:
Creditors 40,100* 40,100*
Partners — Schedule A 19,900* 2,814* 17,086*
Balances January 31 0 90,000 0 5,000 9,900 32,186 42,914Sale of remaining assets 21,000 90,000* 20,700* 20,700* 27,600*Offset loan to
Roger capital 5,000* 5,000Predistribution balances 21,000 0 0 5,800* 11,486 15,314Cash distribution:
Partners — Schedule B 21,000* 9,000* 12,000*
Balances February 28 0 $ 5,800* $ 2,486 $ 3,314
Note: Roger owes Susan $2,486 and Tom $3,314. These balances remain on the partnership books until it is determined if Roger is personally solvent and able to pay $5,800 to the other partners.
Schedule A 30% 30% 40%
Possible Roger Susan Tom Losses Equity Equity Equity
Partners’ equity January 1 $14,900 $35,000 $60,000Allocate possible losses $90,000 (27,000) (27,000) (36,000)
(12,100) 8,000 24,000Allocate Roger’s deficit 12,100 (5,186) (6,914)Safe payments to partners January 31 0 $ 2,814 $17,086
Schedule B
Partners’ equity February 28 $(5,800) $11,486 $15,314Allocate Roger’s deficit 5,800 (2,486) (3,314)Safe payments to partners February 28 0 $ 9,000 $12,000
Note: Since cash was distributed to Susan and Tom in January and since Roger has negative equity, the distribution in February is necessarily in the 3/7 and 4/7 relative profit and loss sharing ratio of Susan and Tom.
Noncash 30% Rob 50% Tom 20% Val Cash Assets Liabilities Capital Capital Capital
Balances October 1 $21,000 $348,000 $130,000 $43,600 $150,000 $45,400Write-off Rob’s loan against capital (15,000) (15,000)Collected accounts receivable 40,000 (44,000) (1,200) (2,000) (800)Sale of inventory 50,000 (60,000) (3,000) (5,000) (2,000)Sale of equipment 60,000 (55,000) 1,500 2,500 1,000Payment of bank loan and accrued interest (50,600) (50,000) (180) (300) (120)Payment of accounts payable (80,000) (80,000)Liquidation expenses (2,000) (600) (1,000) (400)Predistribution balances 38,400 174,000 --- 25,120 144,200 43,080October 31 distri- bution 33,400 (33,400)Balance November 1 5,000 174,000 25,120 110,800 43,080Sale of equipment 38,000 (95,000) (17,100) (28,500) (11,400)Accounts receivable 10,000 (19,000) (2,700) (4,500) (1,800)Inventory to Val (20,000) (3,000) (5,000) (12,000)Write-off remaining inventory (40,000) (12,000) (20,000) (8,000)Liquidation expenses (800) (240) (400) (160)Predistribution balances 52,200 --- (9,920) 52,400 9,720Cash distributed (52,200) (45,314) (6,886)Balances --- (9,920) 7,086 2,834
Schedule of Safe Payments 30% Rob 50% Tom 20% Val
October 31Partners’ equity October 31, 2008 $25,120 $144,200 $43,080Possible losses $174,000 (52,200) (87,000) (34,800)Possible loss on contingency fund 5,000 (1,500) (2,500) (1,000)
(28,580) 54,700 7,280Possible loss from Rob allocated 5/7 and 2/7 (rounded) 28,580 (20,414) (8,166)
0 34,286 (886)Possible loss from Val (886) 886Cash distribution 33,400 0November 30Partners’ equity November 30 $(9,920) $ 52,400 $ 9,720Possible loss from Rob’s debit balance 5/7 and 2/7 9,920 (7,086) (2,834)Cash distribution 0 $ 45,314 $ 6,886
1 Equity insolvency occurs when a debtor is unable to pay its debts as they come due. Bankruptcy insolvency occurs when a debtor’s liabilities exceed the fair value of all assets.
2 A bankruptcy proceeding is designated voluntary if the debtor corporation files the petition to place itself under the protection of the bankruptcy court and involuntary if creditors file the petition to bring the debtor into bankruptcy court. An involuntary petition may be filed by a single creditor with an unsecured claim of $12,300 or more if there are fewer than twelve unsecured creditors. Otherwise, three or more entities with unsecured claims totaling at least $12,300 must file in order to commence an involuntary case. The requirements are the same for Chapter 7 and Chapter 11 cases.
3 The duties of the U.S. trustee are to maintain and supervise a panel of private trustees eligible to serve in Chapter 7 cases, to serve as trustee or interim trustee in some bankruptcy cases, to supervise the administration of bankruptcy cases, and to preside over creditor meetings. Bankruptcy judges still supervise cases in districts without U.S. trustees.
4 The debtor corporation in a bankruptcy case has the following duties: (1) to file a list of creditors, a schedule of assets and liabilities, and a statement of the debtor’s financial affairs; (2) to cooperate with the trustee so that the trustee may perform his duties; (3) To surrender all property, including books, documents, records, and so on, to the trustee; and (4) to appear at hearings of the bankruptcy court as required.
5 A trustee is not appointed in all Title 11 cases. In Chapter 7 cases a trustee will be elected by unsecured creditors if a majority vote in amount of holders with at least 20 percent of the claims is obtained. Otherwise, an appointed interim trustee serves as trustee. In Chapter 11 cases a trustee is appointed only if deemed necessary by the court, but otherwise, the debtor remains in possession of the estate and performs the duties of a trustee. Within 30 days from the time the court orders the appointment of a trustee in a Chapter 11 case, a party in interest may request the election of a trustee.
6 The trustee in a liquidation case takes possession of the debtor’s estate, converts estate assets into cash, and distributes the proceeds as directed by the court. He also performs other duties such as investigating the financial affairs of the debtor, providing information about the estate to parties of interest, examining creditor claims and objecting to those that appear improper, operating the debtor’s business if authorized to do so by the court, providing financial reports and summaries about the estate to the court, and filing reports on trusteeship as directed by the court.
7 The priority rankings in a Chapter 7 liquidation case are summarized in Exhibit 17–2 of the text. The priorities recognized for unsecured claims (Rank II) are: (1) administrative expenses, (2) claims incurred between an involuntary filing and appointment of a trustee, (3) salary claims up to $10,000 per individual earned within 90 days of filing, (4) employee benefit plan contribution claims up to $10,000 per individual earned within 180 days of filing, (5) individual claims up to $1,800 for goods and services purchased from, but not provided by the debtor, and (6) claims of governmental units for taxes owed by the debtor (subject to time restrictions), including taxes collected and withheld for which the debtor is liable.
8 Four ranks within the unsecured nonpriority claim category (general unsecured claims) are: (1) claims allowed that were timely filed, (2) claims allowed where proof was filed late, (3) claims allowed for fines, penalties or forfeitures, or damages, and arising before the court order for relief or appointment of a trustee, and (4) claims for interest on unsecured claims.
9 The accountant’s statement of affairs is a financial statement that is designed to provide information about liquidation values and priority rankings for use by the trustee, the court, creditors, and other interested parties in the debtor’s estate. Assets are measured at expected net realizable values in the statement, but book values are also included for reference purposes. (The Bankruptcy Act refers to a statement of affairs, but that statement is a questionnaire that includes various financial and nonfinancial and legal section
10 A debtor corporation’s estate may be liquidated even though the filing is under Chapter 11. This can occur when the case is transferred to Chapter 7 for liquidation. It can also be carried out in accordance with an approved Chapter 11 plan of reorganization that calls for sale and distribution of the proceeds from the debtor corporation’s estate.
11 A debtor in possession reorganization case is a Chapter 11 case in which the bankruptcy court does not appoint a trustee, but instead, allows the debtor corporation to carry out the duties that otherwise would be performed by a trustee.
12 A creditor committee can file a plan of reorganization under a Chapter 11 case after 120 days from the date the court order for relief is granted. The order for relief occurs when the debtor or creditor’s filing petition is approved by the court.
13 The approval of a plan of reorganization requires acceptance of the plan by at least two-thirds in amount and over half in number of claims in each class of claims. Further, each class of claims must accept the plan or not be impaired under it. A class of claims that would receive nothing if the corporation were liquidated is not impaired if it receives nothing under a plan and, accordingly, acceptance by that class of claims is not required.
14 Prepetition liabilities are the liabilities of an enterprise that were incurred prior to a Chapter 11 filing. They are reported at the amounts allowed by the bankruptcy court. Prepetition liabilities subject to compromise are those liabilities that may be impaired by a plan and that are eligible for compromise because they are either unsecured or undersecured.
15 Reorganization value is an estimate of the value of the reconstituted entity that will emerge from reorganization, plus the expected net realizable value of the assets that will be disposed of before reconstitution occurs. It is also described as the fair value of the entity before considering liabilities. Reorganization value approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring.
16 Fresh start reporting should be used by a company emerging from Chapter 11 if the following two conditions are met: (1) the reorganization value of the assets of the emerging entity immediately before the date of confirmation is less than the total of all postpetition liabilities and allowed claims and (2) holders of existing voting shares immediately before confirmation receive less than 50 percent of the voting shares of the emerging entity.
17 Entities not qualifying for fresh start reporting report liabilities compromised by a confirmed reorganization plan in a manner similar to that of a note issued in a noncash transaction under APB Opinion No. 21. Forgiveness of debt should be reported as an extraordinary item.
Solution E17-1 Solution 17-21 b 1 a2 d 2 d3 c 3 c4 d 4 d5 d6 c7 a8 d9 c10 d11 c12 d13 c
Solution E17-3
Note receivable from Patriots Supply $100,000Amount secured by inventory items at expected recoverable value (30,000)
Unsecured portion of note receivable from Patriots Supply 70,000Expected recovery on the dollar for unsecured claims .35
Expected recovery on unsecured portion of note 24,500Add: Secured portion 30,000
Total expected recovery on note from Patriots Supply $ 54,500
Solution E17-4
1 On the basis of the reorganization value, Baxter Hardware qualifies for fresh start reporting because the estimated reorganization value of $2,000,000 is less than the postpetition liabilities and allowed claims.
Estimated reorganization value $2,000,000Liabilities:
Reorganization value $2,000,000Less: Payment to prepetition claimants 150,000
1,850,000Reorganized capital structure:Postpetition liabilities $1,200,000Notes payable 300,000Fully secured debt 900,000New common stock to prepetition claimants 375,000 2,775,000New common stock to old stockholders $ (925,000)
Solution E17-5
Cash available for distribution $100,000Mortgage payable (secured portion) (50,000)
50,000Priority claims (administrative expenses and salaries) (10,000)Available for unsecured, nonpriority claims $ 40,000
Liabilities And DeficitAccounts payable $ 50,000Note payable — unsecured 40,000Revenue received in advance 1,000Wages payable 3,000Mortgage payable 80,000Administrative expenses payable — new 8,200
Total liabilities 182,200Less: Estate deficit (61,600)
Total liabilities less deficit $120,600
Statement of Cash Receipts and Disbursementsfrom March 1 to March 31, 2008
Cash balance, March 1, 2008 $ 4,000
Add: Cash receiptsCollections of receivables $ 7,200Sale of inventories 19,400Sale of land and buildings 90,000 116,600
120,600Less: Cash disbursements (none) 0
Cash balance, March 31, 2008 $120,600
Statement of Changes in Estate Equityfrom March 1 to March 31, 2008
Estate equity, March 1, 2008 $20,000
Less:Loss on uncollectible receivables $ 800Loss on sale of inventories 16,600Loss on sale of land and buildings 30,000Loss on write-off of intangibles 26,000Administrative expenses 8,200 81,600
200,000 Capital stock(100,000) Retained earnings (deficit)$500,000 $165,000
2 Settlement per dollar of rank 1 unsecured creditors is $.6250 ($100,000 available for unsecured/$160,000 accounts and notes payable). No payment is made for the $5,000 unsecured interest claim.
1 The reorganization is eligible for fresh start accounting because the liabilities on June 30, 2008 of $16,500 exceed the reorganization value of $16,000 by $500. Also, the common stock of the new entity is allocated $5,000 to prepetition creditors and $2,000 to Lowstep’s old stockholders, so that the old stockholders have less than a 50 percent interest in the new entity.
2 Entries to adjust Lowstep’s accounts for the reorganization plan:
3 Lowstep CorporationFinal Balance Sheetas of July 8, 2008
AssetsCash $ 6,700Trade receivables — net 1,000Inventories 2,000Land 2,000Buildings — net 1,500Equipment — net 1,800Reorganization value in excess of fair values 1,000
AN INTRODUCTION TO ACCOUNTING FOR STATE AND LOCALGOVERNMENTAL UNITS
Questions
1 The Governmental Accounting Standards Board has primary responsibility for setting standards that provide GAAP for state and local governmental units. The most authoritative literature includes GASB Statements of Standards and GASB Interpretations. The second level of authoritative literature includes GASB Technical Bulletins and those AICPA audit and accounting guides and statements of position that the AICPA intended to make applicable to governments and that the GASB has cleared.
Before 1984, the Municipal Finance Officers Association (MFOA) and its National Committee on Governmental Accounting provided guidance via the publication of Municipal Accounting and Auditing in 1951 and Governmental Accounting, Auditing, and Financial Reporting (GAAFR) in 1968. Since 1974, the AICPA has also issued industry audit guides for audits of state and local governmental units.
2 The Municipal Finance Officers Association (MFOA), now referred to as the Government Finance Officers Association (GFOA), first issued Governmental Accounting, Auditing, and Financial Report (GAAFR) in 1968. For many years, this resource book – often referred to as the Blue Book due to its distinctive blue cover - constituted the most complete frameworks of accounting principles specific to governmental units, and provided standards for preparing and evaluating the financial reports of governmental units. Updated periodically to reflect changes to governmental accounting, the 2005 GAAFR is the most recent version.
3 According to the AICPA’s Audit and Accounting Guide, a governmental entity is generally created for the administration of public affairs and has one or more of the following characteristics:
▪ Popular election of officers or appointment (or approval) of a controlling majority of the members of the organization’s governing body by officials of one or more state or local governments;
▪ The potential for unilateral dissolution by a government with the net assets reverting to a government; or
▪ The power to enact or enforce a tax.
An organization may also be classified as a governmental entity if it possesses the ability to issue debt that is exempt from federal taxation.
4 A fund is a separate fiscal and accounting entity with a self-balancing set of accounts, “segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations.” [GASB Codification] Fund accounting facilitates budgetary control.
A governmental unit may have hundreds of funds, but only eight fund types. The Codification discusses three fund categories (governmental, proprietary, and fiduciary) and eight fund types (general, special revenue, permanent, capital projects, debt service, internal service, enterprise, and trust and agency funds).
5 Governmental funds are “expendable” or “source and disposition” funds through which most governmental functions are financed. These funds are essentially working capital entities. They include the general fund, special revenue funds, permanent funds, capital projects funds, and debt service funds.
Proprietary funds are “nonexpendable” or “commercial type” funds used to account for ongoing activities that are similar to those found in private enterprise. They use the business accounting equation and their reporting parallels that of a business entity in most regards. They include two fund types—enterprise funds and internal service funds.
Fiduciary funds are used to account for assets held by the governmental unit as trustee or agent for individuals, private organizations, and other governmental units. Fiduciary funds include trust funds (pension, investment, and private purpose) and agency funds.
6 The five types of governmental funds are the general fund, permanent funds, special revenue funds, capital projects funds, and debt service funds. Each is a working capital entity, therefore, each is used to account for a portion of a government’s general government working capital. They are distinguished by the purpose for which the resources of each fund may (must) be used. Working capital to be used for construction/acquisition of major general government fixed assets should be accounted for in capital projects funds; that to be used to pay principal and interest on general long-term debt should be accounted for in debt service funds. Special revenue funds are used to account for portions of working capital to be used for other specific general operating purposes. Permanent funds report resources that are legally restricted to the extent that only earnings, and not principal, may be used for purposes that support the reporting government’s programs—that is, for the benefit of the government of its citizenry.
7 The governmental fund accounting equation is:
Current Assets - Current Liabilities = Fund Balance
8 The two types of proprietary funds are enterprise funds and internal service funds. Both charge fees for their services that are intended to recover part, if not all, of the costs of providing goods or services. The key distinction between the two is that the predominant customers of internal service funds are other departments or agencies of the government, whereas the predominant customers of enterprise funds are outside entities or individuals.
9 The accounting equation for a proprietary fund is essentially the business accounting equation—
Current + Noncurrent – Current – Noncurrent = Net Assetsassets assets liabilities liabilities
10 Under the modified accrual basis of accounting, fixed assets are not recorded in the general fund, because general fixed assets do not represent financial resources available for current
expenditures, i.e., they are not working capital items. In the fund financial statements, the general fund is used to account for unrestricted resources that can be expended currently for operating purposes. Since fixed assets result from expending resources for long-term needs, they are not included in the fund financial statements.
With the advent of GASB 34, the general fund is reported in the governmentwide statements under the accrual basis of accounting. General fund fixed assets – which have typically been documented informally in the accounting records and noted in the old general fixed asset account group – will appear in the governmentwide statement of net assets.
11 Modified accrual accounting is the system of accounting in which revenues are recognized in the accounting period in which they become available and measurable and expenditures are recognized in the accounting period in which the related fund liability is incurred and objectively measurable. Unmatured interest on general long-term debt is an exception for which the expenditure is recognized when due. Modified accrual accounting applies to governmental funds (general fund, special revenue funds, permanent funds, debt service funds, and capital projects funds) and to asset and liability accounting for agency funds.
12 Governmental and proprietary funds use different focuses when measuring financial positions and operating results in the fund financial statements. The two types of focuses are the “economic resources” measurement focus and the “flow of current financial resources” measurement focus. The accrual basis (used with proprietary funds and trust funds) refers to recognition of revenues and expenses as in business accounting and follows the economic resources measurement focus, whereby all economic resources, whether current or noncurrent, are reported. The modified accrual basis of accounting (used with governmental funds) is consistent with a flow of current financial resources measurement focus, whereby funds report on current resources and current obligations.
Under GASB 34, both governmental funds and proprietary funds use the accrual basis of accounting and the “economic resources” measurement focus in the governmentwide statements.
13 Governmental revenue sources, addressed in GASB 33, are varied and include taxes, grant receipts, and collections of user fees and fines. Exchange transactions are those “in which each party receives and gives up essentially equal values.” Nonexchange transactions are those “in which a government gives (or receives) value without directly receiving (or giving) equal value in exchange.” Many of the transactions in governmental funds are nonexchange in nature, because general governmental activities often address the needs of the public and are funded by taxpayers who generally do not receive benefits in direct relation to their tax payments.
14 A short term note payable will generally be paid with current resources, thus it is accounted for as a liability of the governmental fund. Long-term debt is not included in the fund financial statements, since it will be repaid with future, not current financial resources. The long term debt will, however, appear as a liability in the governmentwide statement of net assets. This is one of the reconciling items between the fund and governmentwide statements.
15 Interfund transfers are not expenditures or expenses, and they are classified separately from revenues, expenditures, and expenses in the financial statements of the various funds. Interfund transfers are essentially shifts of resources between funds, not costs or liabilities incurred by the
entity. Interfund transfers consist of residual equity transfers (nonrecurring or nonroutine transfers of equity between funds) and operating transfers (all other legally authorized transfers between funds). Interfund transactions that would be treated as revenues, expenditures, or expenses if they involved an external entity are not interfund transfers, but rather are quasi-external transactions and are treated as revenue, expenditures, or expenses in the normal fashion.
16 An appropriation is an authorization from the legislative body to make expenditures for specified purposes. If approval by the legislative body is for each detailed expenditure item in the budget (a line-item budget), the legislative body will have maximum control because each detailed change would require legislative approval. If the budget is approved in total or by major categories but not for each detailed item, the city manager (or other chief executive) can shift resources within the categories approved without legislative approval. An appropriation by department, for example, permits a city manager to shift appropriations for police supplies to police equipment or overtime pay without legislative approval.
17 Under GASB 34, the governmental and proprietary fund financial statements of a general-purpose government include the following:
Fund financial statementsGovernmental Funds
Balance sheet – governmental funds (modified accrual basis)Statement of revenues, expenditures, and changes in fund balances (modified
accrual basis)
Proprietary FundsStatement of net assets (accrual basis)Statement of revenues, expenses, and changes in net assets (accrual basis)Statement of cash flows (accrual basis, direct method)
18 A reciprocal transfer is one which is expected to be repaid by the fund borrowing the money; whereas with a nonreciprocal transfer repayment is not expected.
19 The GAAP Guidelines, listed in descending order of authority are as follows:1. GASB Statements and GASB Interpretations. This category also includes AICPA and
FASB pronouncements made applicable to state and local governments by a GASB Statement or Interpretation.
2. GASB Technical Bulletins. This category also includes AICPA Industry Audit and Accounting Guides and Statements of Position if specifically made applicable to state and local governments by the AICPA and cleared by the GASB.
3. Consensus positions of GASB’s Emerging Issues Task Force (EITF) and AICPA Practice Bulletins if specifically made applicable to state and local governments by the AICPA and cleared by the GASB.
4. Implementations Guides published by the GASB staff and industry practices that are widely recognized and prevalent in state and local government.
5. Other accounting literature (including FASB standards not made applicable to governments by a GASB standard).
20 Interfund loans are loans that are made by one fund to another and must be repaid. Interfund transfers occur when one fund provides resources to another for legally authorized purposes (an operating transfer) or when one fund helps to establish or enhance another (a residual equity transfer). Interfund services provided and used include sales and purchases between funds at approximate external market value. An interfund reimbursement is necessary when an expenditure applicable to one fund is made by a different fund.
21 Expenses reflect the cost of assets or services used by an entity, and they are recognized in the period incurred. Expenditures, unique to government accounting, typically reflect the use of governmental fund working capital. Proprietary funds recognize expenses, whereas governmental funds recognize expenditures.
22 A comprehensive annual financial report (CAFR) contains three major sections—introductory, financial and statistical. The introductory section of a CAFR includes a table of contents, a letter of transmittal, a list of principal officers, and an organizational chart. The financial section includes the management’s discussion and analysis, the auditor’s report, the government-wide financial statements, and the fund financial statements. The statistical section contains statistical tables with comparative data from several periods of time.
23 Fiscal accountability is the responsibility of a government to demonstrate compliance with public decisions regarding the use of financial resources. Operational accountability measures the extent of a government’s success at meeting operating objectives efficiently and effectively and its ability to meet operating objectives in the future.
SOLUTIONS TO EXERCISES
E18-1 E18-2[AICPA adapted]
E18-3
1 c 1 d 1 b2 a 2 c 2 a3 c 3 c 3 a4 d 4 a 4 d5 d 5 c 5 b
E18-4 E18-5 E18-61 c 1 c 1 trust and agency funds2 b 2 b 2 enterprise funds3 d 3 d 3 general funds4 c 4 b 4 debt service funds5 d 5 d 5 permanent funds
6 special revenue funds7 internal service funds8 capital projects funds
E18-7
1 Current assets -30,000Current liabilities +2,500Fund balance -32,500
2 Current assets +98,000Current liabilities --Fund balance +98,000
3 Current assets +60,000Current liabilities +60,000Fund balance --
4 Current assets -63,150Current liabilities -60,000Fund balance -3,150Assumes repayment during the same year borrowed. If the note had not matured by the end of the year of the borrowing, interest expenditures and interest payable would be accrued.
5 Current assets +600,000Current liabilities --Fund balance +600,000At the same time a memo entry will be made noting a liability in the long-term debt records. This is used to prepare the governmentwide statements where long-term debts are recorded in governmental funds.
6 Current assets -25,000Current liabilities --Fund balance -25,000
At the same time a memo entry will be made noting an asset in the fixed asset records. This is used to prepare the governmentwide statements where fixed assets are recorded in governmental funds.
7 Current assets +1,200Current liabilities --Fund balance +1,200At the same time a memo entry will be made removing the asset from the fixed asset records.
8 Current assets --Current liabilities --Fund balance --
At the same time a memo entry will be made noting a liability in the long-term debt records. This is used to prepare the governmentwide statements where long-term debts are recorded in governmental funds.
2 Current assets +98,000Noncurrent assets --Current liabilities --Long-term liabilities --Net Assets +98,000Actually, the net asset increase is reported as a $100,000 increase (revenues) and a $2,000 decrease (uncollectible accounts expense). Further, it is relatively uncommon to have tax revenues in proprietary activities
3 Current assets +60,000Noncurrent assets --Current liabilities +60,000Long-term liabilities --Net Assets --Assumes repayment during the same year borrowed. If the note had not matured by the end of the year of the borrowing, interest expense and interest payable would be accrued.
5 Current assets +600,000Noncurrent assets --Current liabilities --Long-term liabilities +600,000Net Assets --Interest expense should be accrued on proprietary fund long-term debt as well as on proprietary fund short-term debt.
3 enterprise fund4 special revenue fund5 general fund
E18-11
1 pension trust fund2 enterprise fund3 internal service fund4 general fund5 general fund (may also be allocated to other funds after collection)
E18-12
1 General FundCurrent assets -95,000Current liabilities --Fund balance -95,000
2 General FundCurrent assets --Current liabilities +25,000Fund balance -25,000
Year end accrualCurrent assets --Current liabilities ($25,000 ´ .08 ´ .5) +1,000Fund balance -1,000At the same time a memo entry will be made noting an asset in the fixed asset account records.
3 General FundCurrent assets +30,000Current liabilities --Fund balance +30,000At the same time a memo entry will be made removing the asset from the fixed asset records.
4 General FundCurrent assets -27,000Current liabilities -26,000Fund balance -1,000
6 General FundCurrent assets +70,000Current liabilities --Fund balance +70,000
E18-13
1 Capital Projects FundCurrent assets +10,000,000Current liabilities --Fund balance +10,000,000At the same time a memo entry will be made noting a liability in the long-term debt records. This is used to prepare the governmentwide statements where long-term debts are recorded in governmental funds.
2 General FundCurrent assets -22,000Current liabilities --Fund balance -22,000At the same time a memo entry will be made noting an asset in the fixed asset records.
ACCOUNTING FOR STATE AND LOCAL GOVERNMENTAL UNITS — GOVERNMENTAL FUNDS
Questions
1 The governmental fund accounting equation is:
Current Assets – Current Liabilities = Fund Balance
2 Taxpayers are billed the full $200,000. The amount recorded as Revenue would be $194,000 with $6,000 recorded as Allowance for Uncollectible Taxes.
3 Encumbrance means “commitment,” and encumbrance accounting records commitments made for goods on order and for unperformed contracts in order to provide additional control over expenditures.
4 The required governmental fund financial statements include a statement of net assets or balance sheet and a statement of revenues, expenditures, and changes in fund balance. The fund financial statements for the governmental funds are prepared on the modified accrual basis of accounting.
5 Capital projects funds are used to account for the financing and acquisition of major general government capital facilities (general fixed assets) of a governmental unit. They are not used to account for the acquisition of capital facilities financed through internal service or enterprise funds. General fixed assets may be purchased through the general fund or special revenue funds. General fixed assets may be acquired by donation in which case the capital projects fund would not likely be involved.
6 Capital projects funds may receive resources from numerous sources such as the proceeds of general obligation bond issues, state and federal grants, shared revenues, and transfers from other funds. A CPF is terminated when the capital facilities have been acquired and project liabilities settled. This may involve a short period of time in the case of assets acquired by purchase and several years in the case of assets acquired by construction. Assets remaining after a capital project has been completed and paid for are ordinarily transferred to the general fund or to the debt service fund with responsibility for servicing the debt issued to finance the project.
7 A government may treat supply acquisitions as expenditures either when purchased (purchases method) or when used (consumption method), as long as it reports significant amounts of inventory in the balance sheet. While the consumption method is similar to the manner in which commercial businesses record supplies, the purchases method better allows for comparison of expenditures and appropriations. Under the purchases method, a government with significant inventory balances at year end will recognize the balances as assets in the fund balance sheet and establish an accompanying reservation of fund balance to reflect the fact that the supply amount is not an available financial asset. This reservation of fund balance is optional under the consumption method.
8 Debt service funds may be used to account for debt service on any long-term, general government liabilities including debt service on special assessment debt for which the government is obligated in some manner. Debt issued for and intended to be repaid from resources of enterprise, internal service, or trust funds is accounted for in those funds.
9 A transfer of resources by the general fund to the debt service fund to be used to retire all or a portion of the general long-term debt would affect the general fund and the debt service fund at the same time. Assuming that the amount of the transfer is $10,000, the entries would be:
GFNonreciprocal operating transfer to debt service fund 10,000
Cash 10,000
DSFCash 10,000
Nonreciprocal operating transfer from general fund 10,000
10 Special assessment levies are charges made against specific property owners (or citizens) to pay for improvements (or services) that provide special benefits to the property owners. Such improvements are usually requested by those who receive the benefits and agree to pay their share of the cost.
General tax levies are levied against all citizens of the governmental unit on a uniform basis to finance the general cost of government. General tax levies are determined by elected officials, apply to all (or virtually all) property in the jurisdiction, and may have little or no relationship to the actual benefits received by individual taxpayers.
A final difference is that property taxes are levied each year for that year (or sometimes the following year). Special assessment levies often are for amounts to be collected over several years.
11 Capital project funds are used to account for the construction activities of general government special assessment projects and the debt service fund is used to account the related debt service if the government is obligated in some manner. Debt service for special assessment liabilities for which the government is not obligated in any manner is accounted for in agency funds, with the special assessment obligation being disclosed in notes to the financial statements.
12 When governments enter into capital lease agreements, the governmental fund acquiring the general fixed asset records an expenditure and other financing source, as if long-term debt had been issued. At the same time, the town notes a liability (capital lease payable) in the general long-term debt account records for the amount remaining due and adds an asset to the general fixed asset account records at the present value of the minimum lease payments determined by FASB 13 criteria. The asset and liability, as well as associated depreciation, will appear in the government-wide financial statements; however, only an expenditure and other financing source appear in the governmental fund statements. The town may record future capital lease payments as expenditures of principal and interest in the general fund or transfer resources to the debt service fund, which will recognize the expenditures. The notes to the financial statements disclose minimum lease payments for each of the following five years and in five-year increments thereafter.
Supplies Inventory 20,000To adjust the supplies inventory and supplies expenditures accounts.
14 Governments record details of the planned revenues (such as property taxes, sales taxes, and license revenue) and appropriations (such as police supplies, mayor’s office expenses, and maintenance of the town hall) in subsidiary revenue and expenditure ledgers. The detail allows for better control over expenditures, as appropriations can be compared to expenditures and encumbrances at any time.
15 The amount that city officials can order prior to year end is $75,000 ($250,000 – $175,000). If they have not spent the full $250,000 in appropriations prior to year end, depending on the laws of the Village of Lester, all appropriations lapse at the end of the year for which they are made, with the exception of committed appropriations (encumbrances outstanding), which can continue to serve as authorizations for items on order or under contract. Since total expenditure and encumbrance amounts are closed to fund balance at year end, reserve for encumbrance credits remain in the accounting records as reservations of fund balance within the governmental fund statements.
16 Reserve for encumbrances 60,000Reserve for encumbrances – prior year 60,000
To reclassify encumbrances from the prior year
Expenditures – prior year 59,800Vouchers Payable 59,800
To record expenditures for prior year
Reserve for encumbrances – prior year 60,000Expenditures – prior year 59,800Unreserved fund balance 200
To close excess reserve to fund balance.
17 Permanent funds (PF) account for contributions for which the grantor specifies that a principal amount must be maintained but for which interest accumulation or asset appreciation, or both, are to be used for a specified purpose. Funds that are expendable are accounted for in a special revenue fund. If contributions benefit parties external to the government, they are accounted for in private purpose trust funds.
18 The general fund is always a major fund. Other funds are considered major funds if they meet both of the following criteria:1. Total assets, liabilities, revenues, or expenditures/expenses (excluding
extraordinary items) of that individual governmental or enterprise fund are at least 10% of the corresponding total (assets, liabilities, etc.) for all funds of that category or type.
2. Total assets, liabilities, revenues, or expenditures/expenses (excluding extraordinary items) of that individual governmental or enterprise fund are at least 5% of the corresponding total for all governmental and enterprise funds combined.
19 A budgetary comparison schedule, which is required supplementary information for the general fund and for all special revenue funds with legally adopted budgets, includes columns for the original budget, the final budget, actual balances (on the budgetary basis) and variances (optional). The budgetary comparison schedule includes the same classifications as the GAAP operating statement, however, the amounts reported for revenues, expenditures, and fund balances often differ between the two statements.
Differences exist when a government uses a non-GAAP basis of accounting for budgeting purposes.
20 Since the government-wide statements are prepared on the accrual basis of accounting while the fund financial statements for the governmental funds are prepared on the modified accrual basis of accounting, governments must convert governmental fund financial information to the accrual basis of accounting for inclusion in the government-wide statements of activities and net assets. A conversion worksheet is an optional tool that facilitates reconciliation of the two statements.
21 Examples of items that might appear on the reconciliation between the governmental fund balance sheet and the government-wide statement of net assets include:1. Governmental fund fixed assets are recorded as expenditures in the fund
statements and must be recorded at cost in the government-wide statements.2. The depreciation associated with the governmental fixed assets must be recorded
in the government-wide statements.3. Capital project fund construction expenditures should be recorded as
“construction in progress” in the government-wide statements.
Examples of items that might appear on the reconciliation between the governmental fund operating statement and the government-wide statement of activities include:1. Governments must also adjust for instances where revenue recognition differs
between the modified accrual and accrual bases of accounting.2. It is necessary to eliminate interfund balances within the governmental funds.3. Bond proceeds provide current financial resources in the fund statement, but
issuing debt increases long-term liabilities in the statement of net assets.
EXERCISES
E19-1 E19-2 E19-3[AICPA adapted]
1 a 1 c2 b 2 d 1 b 3 b 3 a 2 d4 a 4 a 3 d5 c 5 b 4 d
5 a
E19-4 E19-5[AICPA adapted]
E19-6[AICPA adapted]
1 a 1 c 1 c2 c 2 c 2 b3 d 3 b 3 c, if u/c relates to
1 Journal entries to account for property taxes in the general fund
March 21, 2008Taxes receivable — current 2,500,000
Allowance for uncollectible current taxes 50,000Revenue 2,450,000
To record the property tax levy.
May 4, 2008Cash 1,900,000
Taxes receivable — current 1,900,000To record collection of property taxes.
Taxes receivable-delinquent 600,000Allowance for uncollectible current taxes 50,000
Taxes receivable — current 600,000 Allowance for uncollectible delinquent
taxes 50,000To reclassify uncollected taxes as delinquent.
May 5-December 31, 2008Cash 150,000
Taxes receivable — delinquent 150,000To record collection of property taxes.
November 1, 2008Allowance for uncollectible taxes — delinquent 5,000
Taxes receivable — delinquent 5,000To write off tax receivable determined to be uncollectible.
Adjusting EntryRevenue 312,250
Deferred revenue 312,250To record deferred revenues for taxes not collected within 60 days after year end. ($2,500,000 - $1,900,000 - $150,000 - $5,000 - $45,000 - $87,750)
January 1, 2008 — February 28, 2008Cash 87,750
Taxes receivable — delinquent 87,750To record collection of 2006 taxes.
3 Revenue would equal tax levy less uncollectible amounts less amounts not collected within 60 day period. Since governmental units rarely complete the closing process within 60 days of year end, the amounts collected within 60 days of year end will be known.
($2,500,000 - $50,000 - $312,250 = $2,137,750)
E19-8
Closing entries:
Unreserved fund balance 500Appropriations 17,500
Estimated revenues 18,000To reverse entry to record budget.
Reserve for encumbrances — prior year 2,000Revenues 17,380Nonreciprocal transfer in 3,200
Expenditures — current year 16,450Expenditures — prior year 1,900Encumbrances 1,000Unreserved fund balance 3,230
To close accounts, including the prior year’s reserve for encumbrances.
Expenditures 290,000 5,000 Reserve for encumbrances— prior yearExpenditures—prior year 5,000 305,000 Revenues
Adjust—Reserve for inventory of supplies 2,000
Ending balance 17,000$620,000 $620,000
E19-10
McGwire City General FundStatement of Revenues, Expenditures, and Changes in Fund Balance
for the year ended December 31, 2008
Revenues $101,000Expenditures 98,800
Excess of revenues over expenditures 2,200Other financing sources (uses):
Reciprocal transfers in 27,000Nonreciprocal transfers out (18,000)Excess of revenues and other financing sources over (under) expenditures and other financing uses $ 11,200
Total fund balance, January 1, 2008 25,000Total fund balance, December 31, 2008 $ 36,200
Vouchers payable (or cash) 375,000To record vehicle purchases.
6 GFCash 30,000 Other financing sources – sale of assets 30,000
To record the sale of governmental assets. (This is a governmental fund entry. Under accrual accounting, the asset would be removed and a gain on sale recognized.)
7 GFCash 1,200
Other financing sources – sale of assets 1,200To record the sale of governmental assets. (This is a governmental fund entry. Under accrual accounting, the asset would be removed and a gain on sale recognized.)
8 GF
Other financing uses—nonreciprocal transfer to DSF 50,000Cash 50,000
To record transfer to debt service.
DSFCash 50,000 Other financing sources— nonreciprocal transfer from GF
50,000
To record receipt of transfer from GF.
DSFExpenditures 50,000 Cash 50,000
To record interest payment.
E19-14
Trial Balance Adjustments GW Stmt of Net AssetsDR CR DR CR DR CR
Accumulated depreciation a) 65,000 65,000Long term debt payable b) 100,000 100,000Capital Lease payable c) 75,000 75,000
$315,000 $315,000Total Net Assets $1,050,000 $1,050,000
E19-15
Net change in fund balance—total governmental funds $1,408,950
Amounts reported for governmental activities in the statement of net assets differ from those in the governmental fund balance sheet because: Governmental funds report capital outlays as expenditures; the assets are capitalized and depreciated in the government-wide statements 225,000 Grant revenues in the statement of activities that do not provide current financial resources are not reported as revenues in the funds 165,000 Debt proceeds provide current financial resources in the fund statement, but issuing debt increases long-term liabilities in the statement of net assets (350,000) A capital lease is treated as an expenditure in the governmental funds in the year that the lease agreement is entered into; however, it increases long-term liabilities in the statement of net assets (55,000 )
Change in net assets of governmental activities $1,033,950
AssetsCash $ 40,000Taxes receivable — delinquent (net of $30,000 allowance for uncollectible taxes) 180,000Accounts receivable (net of $2,000 allowance for bad debts) 23,000Supplies on hand 3,000Due from Agency Fund 10,000
$256,000Liabilities and Fund BalanceVouchers payable $155,000Due to Utility Fund 20,000Taxes received in advance 10,000
Liabilities 185,000
Reserve for encumbrances 50,000Reserve for supplies 3,000Unreserved fund balance 18,000
Fund balance 71,000Total liabilities and fund balance $256,000
Supporting computationsAdjusting entry:Supplies on hand 3,000
Reserve for supplies 3,000To record supplies on hand and related reserve.
Closing entriesAppropriations 900,000Unreserved fund balance 10,000
Excess of revenues over expenditures 5,000 5,000 21,960 16,960Budgetary fund balance June 30, 2008 16,000 16,000 16,000 -Less excess prior year’s encumbrance over actual expenditure (9,500) (9,500)Budgetary Fund Balance at June 30, 2008
$ 21,000 $ 21,000 28,460 $ 7,460
Encumbrances outstanding 6,000Fund balance June 30, 2009 $ 34,460
* Actual expenditures on a budgetary basis includes the $6,000 supplies purchase commitment chargeable against the 2008-9 appropriations, but excludes the $9,500 expenditures chargeable against the prior year’s carryover appropriation.
3. Given the limited information, the reconciling items which are certain include the playground equipment in item h and the other equipment in item i.
Contracts payable — current 1,880,000Contracts payable — retained percentage 120,000
To record progress billing on contract with a 6% retained percentage.
Reserve for encumbrances 2,000,000Encumbrances 2,000,000
To reduce encumbrances for amounts billed.
(9) Due to general fund 500,000Cash 500,000
To record repayment of initial financing to the general fund.
June 30, 2009Deferred grant revenue 2,371,000
Revenue 2,371,000To recognize grant revenue earned.
Note that the entry recognizing grant revenue presumes that the first $5 million of expenditures will be recoverable from the state. In some cases, the grantor only agrees to pay a certain percentage of the cost, up to some maximum. If this were the case in this problem, the amount of revenue recognized would be one-third of $2,371,000, or approximately $790,000.
Closing entriesRevenue 2,371,000OFS - Proceeds from bond issue 10,100,000
Expenditures 2,371,000OFU - nonreciprocal transfer to DSF 100,000Encumbrances 10,000,000
AN INTRODUCTION TO ACCOUNTING FOR STATE AND LOCAL GOVERNMENTAL UNITS — PROPRIETARY AND FIDUCIARY FUND
Answers to Questions
1 Enterprise and internal service funds are similar in the sense that their operations are like those of similar business enterprises. They use full accrual accounting practices (including depreciation), have a capital maintenance or profit objective, are financed through user charges, and have the same financial reporting requirements. The primary difference between the two fund types is that an EF provides goods and services to citizens and customers outside the government on a user charge basis, while an ISF provides services to other departments and agencies within the same governmental unit (or occasionally to other governmental units).
2 Typical operations of internal service funds include motor pools, centralized risk financing activities, data processing services, printing shops, centralized purchasing, repair shops, and storage or warehouse operations. Internal service funds may engage in almost any kind of operations that one would find in private enterprise.
3 An EF (and also an ISF) is required to prepare a statement of net assets, a statement of revenues, expenses, and changes in net assets (or fund equity), and a statement of cash flows for fair presentation in accordance with GAAP. The governmentwide statement of net assets and statement of activities both include enterprise fund data.
4 In the fund financial statements, governments include internal service funds with the proprietary funds. They are aggregated into a single column within the proprietary fund statement of net assets, the statement of revenues, expenses, and changes in net assets, and the statement of cash flows. Within the government-wide statements, governments report internal service funds with the governmental activities. The internal service fund asset and liability accounts are generally included in the governmental activity column of the statement of net assets. The statement of activities will include only those internal service fund transactions involving entities other than the primary reporting entity. Governments add external internal service fund revenues and expenditures to the statement of activities, but they exclude internal governmental transactions. (See also Question 7.)
5 Internal service funds are never considered major funds and proprietary fund statements report internal service funds in a single column with the enterprise funds. Major enterprise funds are reported in a single column on the proprietary
fund statement of net assets and statement of revenues, expenses, and changes in net assets.
6 Because proprietary funds account for transactions in much the same manner as commercial business organizations, the GASB allows some reference to FASB statements. GASB Statement No. 20, “Accounting and Financial Reporting for Proprietary Activities,” governs which accounting and reporting standards apply to proprietary activities.
7 It is important to differentiate between revenues generated by interfund transactions and transactions with external parties because of the way that these transactions are reported on the government-wide statements. The statement of activities will include only those internal service fund transactions involving entities other than the primary reporting entity. To avoid double counting of interfund transactions, governments add external service fund revenues and expenditures to the statement of activities, while they exclude internal governmental transactions.
8 First, GASB Statement No. 34 makes the direct method mandatory for statement presentation. Second, GASB Statement No. 9 requires separating financing activities into noncapital and capital related.
9 The fiduciary fund category includes trust funds (private-purpose, investment, and pension) and agency funds. They are reported in the fund financial statements only in a statement of fiduciary net assets and a statement of changes in fiduciary net assets.
10 Governmental units often provide the initial financing of an ISF through a contribution of cash or operating facilities, expecting the ISF to be self-sustaining in future periods. Alternatively, the governmental unit may provide a loan to the ISF to be repaid from future operating flows of the fund. A contribution is classified as a nonreciprocal transfer, which flows through the statement of revenues, expenses, and changes in fund net assets; whereas a loan is recorded as a long-term liability of the ISF in the statement of net assets. A government records short-term interfund loans as due to Fund A and due from Fund B.
11 Private-purpose trust funds are fiduciary funds used to account for resources (other than investment pools and employee benefits) that are held for the benefit of parties outside the governmental entity. Permanent funds are governmental funds which report resources whose use is permanently restricted, but whose earnings are expendable for the benefit of the government or its citizens.
12 The governmentwide statement of net assets would need at least three columns—one for governmental activities (including the general fund, special revenue funds, and internal service funds), one for business-type activities (enterprise funds), and
one for the component unit. Most governments also present optional total and comparative total columns.
13 No. The required financial statements for a pension trust fund are a statement of plan net assets and a statement of changes in plan net assets. Neither of these statements contains information as to the present value of future benefits payable by the plan. Therefore, the statements provide no indication of whether the plan is adequately funded. The statements are designed to reflect the “current status” of the plan—the net assets available to pay pension benefits and changes therein. To determine if the plan is adequately financed, one must review the pension trust fund schedules, particularly the schedule of funding progress, that must be included in a government’s required supplementary information.
14 The accounting equation for an agency fund is Assets = Liabilities.
15 If an enterprise fund issues debt that is backed by its revenue-generating activity (i.e., revenue-backed debt instruments), the government must present certain detailed segment information in the notes to the financial statements.
16 Since the government-wide statement of activities and statement of net assets report all items using the accrual basis of accounting, conversion between the fund and government-wide statements is not necessary. Also, recall that governments report internal service funds with the governmental activities in the government-wide statements.
Solution E20-1 Solution E20-2 Solution E20-31 b 1 d 1 c2 c 2 d 2 d3 d 3 d 3 c4 c 4 c 4 b5 d 5 a 5 c
Solution E20-4 Solution E20-5[AICPA adapted]
1 b 1 d2 a 2 d3 a 3 b4 a 4 b5 c 5 a
6 c
Solution E20-6
City of Laramee Tax Collection Agency FundStatement of Fiduciary Net Assets
Tax Collection Agency Fundat December 31, 2008
AssetsTaxes receivable $50,000 Total assets $50,000 LiabilitiesLiability to Laramee $15,000 Liability to Bloomer County 10,000Liability to Bloomer School District
25,000
Total liabilities $50,000Total Net Assets 0
Schedule of Taxes Receivable
Taxing UnitsAmounts Certified for Collection Collections
Balance at Year End
City of Laramee $ 60,000 $ 45,000 $15,000Bloomer County 40,000 30,000 10,000Bloomer School District 100,000 75,000 25,000
1 Cash 3,000,000Deferred operating grant revenue 3,000,000
To record receipt of grant.
Deferred grant revenue is reported as a liability in the balance sheet. Operating grant revenues are reported as nonoperating revenues in the period qualifying costs are incurred.
2 Expenses — Program A 1,200,000Vouchers payable (or Cash) 1,200,000
To record expenses incurred for the program financed by the grant.
Deferred operating grant revenues 1,200,000Revenues — operating grant 1,200,000
To record revenues earned on the grant.
Nonoperating revenues of $1,200,000 should be reported in the enterprise fund’s statement of revenues, expenses, and changes in retained earnings (fund equity).
3 Cash 7,000,000Deferred capital grant 7,000,000
To record receipt of capital grant.
Deferred capital grants are reported as a liability in the balance sheet. When qualifying costs are incurred, the deferred capital grant liability is reduced and contributed capital from intergovernmental grants, not revenues, is recognized.
4 Construction in progress 4,000,000Cash 4,000,000
To record construction costs incurred on capital grant project.
Deferred capital grant 4,000,000Contributed capital–capital grants 4,000,000
To record increase in contributed capital as a result of incurring qualifying costs under capital grant.
The increase in contributed capital of $4,000,000 is reported as an addition to contributed capital. It does not affect income or retained earnings.
2 Capital Projects Fund and Debt Service Fund3 Capital Projects Fund and Debt Service Fund4 Private PurposeTrust Fund5 Internal Service Fund6 Enterprise Fund7 Special Revenue Fund8 General Fund9 Agency Fund10 Investment Trust Fund
Other Financing Source – Reciprocal transfer from General Fund
50,000
General FundOther Financing Use - Reciprocal transfer to Special Revenue – Highway Beautification
50,000
Cash 50,000
8 General FundTaxes Receivable — current 5,000,000
Allowance for uncollectible taxes — current 50,000Revenue 4,950,000
* An entry recording grants receivable (debit) and deferred grant revenue (credit) is optional.
Solution E20-9 1. decrease in Net Assets Invested in Capital Assets, Net of Related Debt; increase in Unrestricted Net Assets2. decrease in Net Assets Invested in Capital Assets3. There will be no effect on net assets, since the asset debit will be offset by the liability credit. Also the net asset amount is offset by the related debt.4. increase in Net Assets Invested in Capital Assets, Net of Related Debt; decrease in Unrestricted Net Assets5. increase in Unrestricted Net Assets6. decrease in Unrestricted Net Assets
SOLUTIONS TO PROBLEMSSolution P20-1
1 Cash 500,000Equipment 550,000 OFS - Nonreciprocal transfer from General Fund 550,000 OFS - Reciprocal transfer from General Fund 500,000
2 Equipment 200,000Cash 200,000
3 Due from Various Funds 345,000Service Revenue 345,000
Fiedler County Utility PlantAdjusted Trial Balance
Cash $ 8,650,000Accounts Receivable 100,000Building 28,750,000Accumulated Depreciation 1,050,000Interest Payable 100,000Accounts Payable 100,000OFS - Nonreciprocal transfer from General Fund 30,000,000Proceeds from Bond Issue 5,000,000Charges for Services 4,500,000Salaries Expense 700,000Interest Expense 400,000Operating Expenses 1,100,000Depreciation Expense 1,050,000
Douwe County Motor Pool FundStatement of Cash Flows
for the Year Ended June 30, 2008
Cash Flows from Operating ActivitiesCash received from users (plug) $127,000Less: Cash paid to suppliers* $(69,000)
Cash paid for salaries (25,000)Cash paid for utilities (9,000) (103,000)
Net cash provided by operating activities 24,000Cash Flows from Noncapital Financing ActivitiesOperating transfers to general fund (12,000)Cash from Capital and Related Financing ActivitiesPurchase of automobiles (19,000)
Cash Flows from Investing Activities ---Decrease in cash for 2005 (7,000)Add: Cash and cash equivalents June 30, 2007 44,000Cash and cash equivalents June 30, 2008 $ 37,000
* Change in supplies (12,000 beginning + 70,000 [plug] – 68,000 used = 14,000 ending); Cash paid is 70,000 less change in accounts payable (11,000 – 10,000 = 1,000)
Reconciliation of Net Operating Incometo Net Cash Used by Operating Activities
Cash Flows from Operating ActivitiesOperating income $ 2,000
Adjustments for noncash expenses, revenues, losses and gains included in income:
Depreciation 16,000Change in due from general fund 8,000Change in due from electric fund (1,000)Supplies on hand (2,000)Accounts payable 1,000Total adjustments 22,000
Building — net 400,000 donated 20,000 Depreciation 380,000Dividends receivable
60,000 on stock 60,000
Held in trust for student aid
40,000 30,000 60,000 20,000
RentalsBond interestDividend incomeGain on bonds
20,000 Depreciation
130,000
Student Aid Principal Trust FundStatement of Fiduciary Net Assets
at December 31, 2008
Assets Net Assets
Cash $ 90,000Investments 600,000 Held in trust for endowment $1,000,000Building — less accum- ulated depreciation 380,000
Held in trust for student aid 130,000
Dividends receivable 60,000Total assets $1,130,000 Total Net Assets $1,130,000
Student Aid Earnings Trust FundStatement of Changes in Fiduciary Net Assets
For the Year ending December 31, 2006
AdditionsContributions:Cash $100,000Investments 500,000Buildings 400,000 Total contributions $ 1,000,000
Investment earningsRental income 40,000Dividend income 60,000Gain on bonds 20,000Bond interest 30,000Depreciation expense (20,000 ) Total earnings 130,000
Service Revenue 378,000Materials and Supplies Expense 96,000Salaries and Wage Expense 230,000Utility Expense 30,000Depreciation Expense — Building 5,000Depreciation Expense — Machinery and Equipment 8,000Excess of Revenues over Expenses 9,000
To close revenue and expense accounts.
Excess of Revenues over Expenses 9,000Retained Earnings 9,000
To close Excess of Revenues over Expenses to Retained Earnings.
1 The financial statements required for nongovernmental not-for-profit entities include a statement of financial position, a statement of activities, and a cash flow statement. Voluntary health and welfare organizations also provide a statement of functional expenses.
2 Each hospital, college, and voluntary health and welfare organization (and other not-for-profit organizations as well) must be evaluated to determine whether it meets the definition of a government in the authoritative literature. Those that meet the definition of a government must apply the government GAAP hierarchy. GASB standards are the most authoritative guidance for these entities. All other entities are to apply FASB standards.
3 A conditional promise to give depends on the occurrence of a specified future and uncertain event to bind the promisor. An unconditional promise to give depends only on the passage of time or demand by the promisee for performance.
Organizations recognize conditional promises to give as contribution revenue and receivables when the conditions are substantially met (in other words, when the conditional promise to give becomes unconditional); however, they account for a conditional gift of cash or other asset that may have to be returned to the donor if the condition is not met as a refundable advance (liability). Organizations recognize unconditional promises to give as restricted or unrestricted contribution revenue and receivables in the period in which the promise is received.
4 A donor-imposed condition provides that the donor will have his resources returned (or will be released from the promise to give) if the condition is not met. A donor-imposed restriction only limits the purpose or timing of use of the contributed assets.
5 Unconditional promises to give with payments due in the next period are reported as restricted support (net of an appropriate allowance for uncollectible accounts) that increase temporarily restricted net assets, even if the resources are not restricted for specific purposes.
6 When a time restriction is met, temporarily restricted net assets are reclassified as unrestricted net assets. The entry includes a debit to temporarily restricted net assets—reclassifications out and a credit to unrestricted net assets—reclassifications in. (Different account titles, such as amounts released from restrictions, are permitted as well.)
7 Gifts in kind are reported as unrestricted support that increases unrestricted net assets if the not-for-profit entity has discretion over the disposition of the resources and a fair value can be reasonably determined. If fair value cannot be determined, the items are
recorded as sales revenue when they are sold. If the not-for-profit entity has little or no discretion over disposition of the items, the gifts in kind should be accounted for as agency transactions.
8 Program services of voluntary health and welfare organizations are expenses incurred in meeting the social service objectives of the organization. Examples are research, public education, community services, and patient services. Supporting services consist of the organization’s administrative and fund-raising costs, and expenses for these items are so classified in the statement of activities.
9 The statement of functional expenses for voluntary health and welfare organizations is intended to reconcile the functional classification of expenses (which results in highly aggregated data) with basic object-of-expenditure classifications that are less aggregated and easier for many users to understand.
10 Contributed services are recognized only if the services (a) create or enhance nonfinancial assets of the organization or (b) require specialized skills, are provided by individuals possessing those skills, and would typically need to be purchased if not provided by donation.
11 Charity care is excluded from both gross patient service revenue and from expense. The hospital’s policy for providing charity care and the level of charity care provided are disclosed in notes to the financial statements.
12 Net patient service revenues of hospitals are measured by deducting courtesy allowances and contractual adjustments from gross patient revenues. Uncollectible accounts expenses are not deducted in computing net patient service revenues. Net patient service revenues are reported in the statement of activities.
13 The three major revenue groupings used by hospitals are patient service revenues, other operating revenue, and nonoperating gains. Examples are:Patient service revenues—routine care, emergency room, recovery room, pharmacyOther operating revenues—tuition from educational programs, research grants for specific purposes, gift shop salesNonoperating gains—unrestricted gifts, unrestricted endowment income, gain on sale of plant assets, rents from property not used in hospital operations(Premium fees also are significant for many hospitals today. They would be reported as a separate line item under operating revenues.)
14 Both the provision for bad debts (other than for charity care, which is not recorded as revenue) and depreciation are expenses of a hospital. Hospitals use full accrual accounting procedures.
15 FASB Statement No. 117 requires private not-for-profit universities to provide a set of financial statements that includes a statement of financial position, statement of activities, statement of cash flows, and accompanying notes. Governmental universities are
considered special-purpose governments under GASB Statements No. 34 and 35. Special-purpose governments with more than one governmental program or both governmental and business-type activities present both government-wide and fund financial statements, as well as the MD&A, notes, and required supplementary information. Special-purpose governments with only one governmental program may combine fund and government-wide statements, whereas those with only business-type activities should report only the financial statements required for enterprise funds, as well as the MD&A, notes, and required supplementary information.
16 Government colleges and universities no longer have the option of using the AICPA college guide; however, many organizations may have retained AICPA model features for internal accounting and control purposes.
17 Much guidance comes from the Financial Accounting and Reporting Manual, an accounting manual prepared by the National Association of College and University Business Officers (NACUBO) which is available as an online subscription service.
18 GASB Statements No. 34 and 35 require special-purpose government with more than one governmental program or both governmental and business-type activities to present both government-wide and fund financial statements, as well as the MD&A, notes, and required supplementary information. Special-purpose governments with only one governmental program may combine fund and government-wide statements, whereas those with only business-type activities should report only the financial statements required for enterprise funds, as well as the MD&A, notes and required supplementary information.
19 Functional classifications include the following:
Instruction. Expenses for the educational programs Resource. Expenses to produce research outcome Public Service. Expenses for activities to provide noninstructional services to
external groups Academic support. Expenses to provide support for instruction, research, and
publications Student Services. Amounts expended for admissions and registrar, and amounts
expended for students’ emotional, social, and physical well-being Institutional support. Amounts expended for administration and the long-range
planning of the university Operation and maintenance of plant. Expenses for operating and maintaining
the physical plant (net of amounts to auxiliary enterprises and university hospitals)
Student aid. Expenses from restricted or unrestricted funds in the form of grants, scholarships, or fellowships to students.
20 Property, plant, and equipment acquired by a not-for-profit organization with unrestricted or restricted resources may be recorded at acquisition as unrestricted or temporarily restricted. If temporarily restricted, the assets are reclassified when depreciation is recognized.
EXERCISES
E21-1 E21-2 E21-31 d 1 b 1 b2 a 2 a 2 b3 d 3 d 3 c4 c 4 b 4 d5 b 5 c 5 a
E21-4 E21-5 E21-61 a 1 b 1 b2 b 2 b 2 a3 a 3 c 3 a4 a 4 c 4 c5 c 5 d 5 b
Program services:Education $20,400Public Health 15,700Research 12,000 $48,100
Supporting services:Fund raising $11,400Management and general 5,500 $16,900
E21-9
1) Contributions receivable 20,000Allowance for uncollectible contributions 600Unrestricted support — contributions 13,580Restricted support — contributions 5,820
To record contribution revenues and an allowance for uncollectible accounts.
Contributions that are not due until the next period imply a time restriction unless the donor explicitly stipulates that the pledge is for current expenditures. Thus, unrestricted net assets are increased by $13,580 and temporarily restricted net assets are increased by $5,820.
2) Cash 200Restricted support — contributions 200
To record a gift restricted to a special project. (Recall that some NFPs may record as unrestricted if the restriction is met in the same period.)
Expenses — community service [program services] 200Cash 200
To record expenditures for restricted purpose.
Temporarily restricted net assets — reclassifications out 200 Unrestricted net assets — reclassifications in 200
To record satisfaction of temporary restriction.
3) Equipment 6,000Unrestricted support — Contributions 6,000
To record receipt of donated equipment.
Depreciation expense — community services 1,500Accumulated depreciation — equipment 1,500
To record depreciation expense for the year on unrestricted long-lived assets.
The organization may also adopt an accounting policy that implies a time restriction that expires over the useful life of the donated asset. If the gift is reported as restricted support in temporarily restricted net assets, depreciation is recorded as an expense in unrestricted net assets, which results in a reclassification for the amount of the depreciation from temporarily restricted to unrestricted net assets.
4) Cash 8,000Restricted support — contributions 8,000
To record receipt of donation restricted to the purchase of a truck.
Accrued interest receivable 215Restricted revenue — investment income 215
To record accrual of interest on funds restricted for the purchase of a truck.
The contribution of cash restricted for long-lived asset purchases increased temporarily restricted net assets, as did the donor-restricted investment income on those funds.
5) Accounts receivable 735,000Unrestricted revenues — tuition and fees 735,000
To record tuition and fees.
Tuition reduction: unrestricted—student aid 65,000 Accounts receivable 65,000
To record tuition reductions.
Expenses—educational and general—institutional support 7,350 Allowance for uncollectible accounts 7,350 To record allowance for uncollectible accounts.
Gifts in kind are reported as contributions since Share Shop has discretion over their distribution and a fair value is determinable. When gifts in kind are distributed to recipients, they are recorded as program expenses. If fair value cannot be determined, neither the contribution nor distribution would be recorded.
Unrestricted revenues, gains, and other support:Net patient service revenues
($2,500,000 - $400,000 - $100,000) $2,000,000Other operating revenues ($300,000 + $50,000) 350,000Income from investment in affiliate 80,000Investment income 270,000Unrestricted contributions 200,000Net assets released from restrictions for operating purposes 80,000
Total operating revenues, gains, and net assets released from restrictions for operations 2,980,000
Expenses and Losses:Nursing services 1,000,000Other professional services 500,000General services 290,000Administrative services 310,000Uncollectible accounts 150,000Loss on sale of fixed assets 50,000Depreciation 200,000
Total expenses and losses 2,500,000
Excess of revenues, gains, and other support over expenses and losses 480,000
Net assets released from restrictions for acquisitions of fixed assets 97,000Increase in unrestricted net assets $ 577,000
Expenses – auxiliary operations 480,000 Cash 480,000 To record auxiliary expenses.
Cash 90,000 Unrestricted revenues—contributions 20,000 Temporarily restricted revenues— contributions 70,000 To record contributions received.
Cash 380,000 Unrestricted revenues—gifts and grants 80,000 Temporarily restricted revenues—Gifts and grants 300,000 To record gifts and grants received.
Expenses – educational and general - instruction 2,100,000 Expenses – educational and general - research 100,000 Expenses – educational and general – student services 120,000 Expenses – educational and general – operation of plant 180,000 Expenses – educational and general – student aid 200,000 Cash (or payables) 2,700,000 To record educational and general expenses.
Temporarily restricted net assets — reclassifications out 300,000 Unrestricted net assets — reclassifications in 300,000
Changes in Unrestricted Net AssetsRevenues and gainsContributions $3,000,000Membership dues 400,000Investment income 83,000
Total revenue and gains 3,483,000Net assets released from restrictions:
For research $ 500,000For fixed assets 3,789,000 4,289,000Increase in unrestricted net assets 7,772,000
Expenses:Program Services:
Research 2,300,000Education 300,000
Total Program Services 2,600,000Supporting Services:
Management and general 117,000Fund raising 223,000
Total Supporting Services 340,000Total expenses 2,940,000Net increase in unrestricted net assets 4,832,000
Changes in Temporarily Restricted Net AssetsContributions ($438,000 + $409,000) 847,000Investment income 22,500Gain on sale of investments 5,000Net assets released from restrictions * (4,289,000)Decrease in temporarily restricted net assets (3,414,500)
Changes in Permanently Restricted Net AssetsContributions 37,000Increase in permanently restricted net assets 37,000
Increase in net assets 1,454,500Net assets, beginning 5,475,000Net assets, ending $6,929,500
To reclassify revenues equal to qualifying expenditures.
8 Temporarily restricted net assets— reclassifications out 44,000Unrestricted net assets—reclassifications in 44,000To reclassify revenues equal to qualifying expenditures.
Equipment 44,000Cash 44,000
To record equipment purchased.
P21-7
1 Temporarily restricted net assets — reclassifications out 20,000 Unrestricted net assets — reclassifications in 20,000To record satisfaction of time restriction.
2 Pledges receivable 65,000Cash 35,000
Allowance for uncollectible pledges 3,250Unrestricted support — contributions* 96,750
To record contributions.
* To the extent that pledges are not collected by year end a time restriction will be implied. An adjusting entry reducing unrestricted support and recording temporarily restricted support for the net realizable value of the uncollected pledges will be required.
3 Inventory of materials 150,000 Unrestricted support — donated materials 150,000
To record donations of food.
Expenses — Program services 151,200Inventory of materials 151,200
To record expenses for food used.
4 Inventory of supplies 27,000Cash 27,000
To record purchases of supplies.
Expenses — management and general 10,000Expenses — Program services* 100,000
Inventory of supplies 22,000Cash 88,000
To record expenses incurred.* ($8,000 + 70,000 + [27,000 – 5,000 account increase])
1 No, trust accounting is essentially cash basis accounting.
2 Income is earned on the principal amounts of estate and trust assets. Estates frequently realize income from various investments between the time that the property inventory is filed by the executor and the time the estate is fully administered. A primary reason for dividing estate principal and income is that the beneficiaries are likely to be different. Separation of principal and income is also important for trusts, because often a trust’s principal is to be maintained intact until the death of the beneficiary.
3 A devise is a testamentary disposition of real or personal property.
4 If a decedent had a valid will in force at the time of death, he or she is said to have died testate. In the absence of a valid will, the decedent is said to have died intestate.
5 The Uniform Probate Code entitles the surviving spouse to a homestead allowance that is exempt from and has priority over all claims against the estate. The surviving spouse and minor children who were dependent on the deceased are also entitled to a reasonable family allowance to be paid out of estate property during the period in which the estate is being administered. The family allowance is exempt from and has priority over all claims except the homestead allowance. Allowance amounts vary across the states.
6 Yes, the value of the estate is reduced by funeral expenses, settlements of estate liabilities, bequests to qualified charities, a marital deduction, state-level taxes, expenses of estate administration, and a tax exempt amount.
7 The taxable amount of an estate is based on fair values of all estate assets at the date of death.
8 Yes, within certain limitations. Currently any number of annual gifts of $12,000 each can be made, with a lifetime limit of $1,000,000.
9 Income for estates and trusts and applicable tax rates are defined in essentially the same manner as for individuals. Income includes interest and dividends, rent, etc. Deductions and/or exemptions for estate administration fees, charitable donations and distributions to beneficiaries reduce taxable income. The fiduciary of the estate must provide applicable information to the beneficiary on Schedule K-1.
10 An estate may be subject to taxation (referred to as estate or inheritance taxes) at both the state and federal levels. Accountants and attorneys play a vital role in estate planning to minimize these tax burdens for their clients and heirs. Even if the federal tax is permanently repealed, estate planning services will remain critical for larger estates subject to state level taxation.
Federal taxation of estates is currently in a period of flux. The Economic Growth and Tax Relief Reconciliation Act of 2001 proposed reduction of the tax, and a total repeal in 2010. However, unless Congress acts to make the repeal permanent, the tax will return in 2011.
11 A valid will ensures the disposition of estate assets in accordance with the wishes of the deceased. If a valid will is not in place, assets will be distributed in accordance with state probate laws. Preparation of a will is also an important part of overall estate planning and can be useful in reducing estate and inheritance taxes.
12 In addition to federal and state estate and inheritance taxes, estates are also subject to federal (and possibly state) income taxes. An estate is a taxable entity and is subject to tax on income earned from the date of death until final settlement of the estate. The tax may be paid by the estate or by the beneficiary if estate property has already been distributed to the beneficiary.
Melanie Triciao, TestatorInventory of Estate Assets
As of the date of Death on August 15, 2009
Description of Property Fair Value
Cash $ 118,225
Savings accounts 250,000
ViaReggio common stock 225,000
City of Roma municipal bonds 412,000
Mercedes sports car 41,000
Condominium on Italian Riviera 1,265,500
Atlanta personal residence 430,000
Collection of rare hand puppets 85,000
Fully restored Model T Ford 125,000
$2,951,725
Submitted by K. T. Tim, executor
Solution E22-51. Estate Inventory
Jeff Carpenter, TestatorInventory of Estate AssetsAs of the date of death on August 25, 2009
Description of Property Fair Value
Cash in Oxford National Bank $15,000
Certificates of deposit, includes $7,000 accrued interest 807,000
Personal effects* -
$822,000
*The probate court permitted exclusion of Jeff’s personal effects from the estate inventory. Prepared by Ms. Colleen Ryan, Executrix, Oxford National Bank
- To record receipt of property transferred from executor.
Solution E 22-10a.
Fair value of gross estate $5,300,000
2009 Tax Exempt Estate (3,500,000)
Taxable estate $1,800,000
45% Estate Tax Due $810,000
Balance inherited by Emily $4,490,000
b. There were many estate planning options for Mr. Dogbert. For example, he could have given assets to Emily during his lifetime or bequeathed funds to his church or some favorite charities, excluding those amounts from his estate. If the reduced estate value would fall below the federal tax threshold, it would have left a zero inheritance tax. However, all of these options expired with Dogbert’s demise.
Charge-Discharge StatementFor the period of estate administration,
March 1 to April 30, 2009
Estate principal
I charge myself for:
Assets included in estate inventory $1,216,300
Assets subsequently discovered 28,000
Assets included in estate inventory - total estate principal charge $1,244,300
I credit myself for:
Funeral expenses paid $ 2,800
Estate debts paid 13,250
Devise - transfer cash, residence & furnishings to Helen 467,500
Devise - Transferred automobile to Dennis 21,000
Devise - Transferred stocks to Denise 25,000
Transferred bond investments to Wilson Family Trust 200,000
Transferred Land to Wilson Family Trust 28,000
Transferred cash to Wilson Family Trust 486,750
Total estate principal discharge $1,244,300
Estate income
I charge myself for:
Estate income received during estate administration $700
I credit myself for:
Payment of estate income to Denise Wilson $700
Respectfully submitted, Estate Executrix, April 30, 2009.
Required: Prepare the entry to record the creation of the Wilson Family Trust on April 30. Prepare all required entries to account for trust activities through June 30.