Advanced Financial Accounting 9e Richard Baker


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Questions LO1

Q3-1
What is the basic idea underlying the preparation of consolidated financial statements? LO1

Q3-2
How might consolidated statements help an investor assess the desirability of purchasing shares of the parent company? LO1

Q3-3
Are consolidated financial statements likely to be more useful to the owners of the parent company or to the noncontrolling owners of the subsidiaries? Why? LO2

Q3-4
What is meant by “parent company”? When is a company considered to be a parent? LO1

Q3-5
Are consolidated financial statements likely to be more useful to the creditors of the parent company or the creditors of the subsidiaries? Why? LO2

Q3-6
Why is ownership of a majority of the common stock of another company considered important in consolidation? LO2

Q3-7
What major criteria must be met before a company is consolidated? LO3

Q3-8
When is consolidation considered inappropriate even though the parent holds a majority of the voting common shares of another company? LO3

Q3-9
How has reliance on legal control as a consolidation criterion led to off-balance sheet financing? LO3

Q3-10
What types of entities are referred to as special-purpose entities, and how have they generally been used? LO3

Q3-11
How does a variable interest entity typically differ from a traditional corporate business entity? LO3

Q3-12
What characteristics are normally examined in determining whether a company is a primary beneficiary of a variable interest entity? LO2

Q3-13
What is meant by “indirect control”? Give an illustration. LO4

Q3-14
What means other than majority ownership might be used to gain control over a company? Can consolidation occur if control is gained by other means?  

Q3-15
Why must intercompany receivables and payables be eliminated when consolidated financial statements are prepared? LO7

Q3-16
Why are subsidiary shares not reported as stock outstanding in the consolidated balance sheet? LO8

Q3-17
What must be done if the fiscal periods of the parent and its subsidiary are not the same? LO7

Q3-18
What is the noncontrolling interest in a subsidiary? LO6

Q3-19
What is the difference between consolidated and combined financial statements? LO6

Q3-20
How does the proprietary theory of consolidation differ from current accounting practice? LO6

Q3-21
How does the entity theory of consolidation differ from current accounting practice? LO6

Q3-22
Which theory of consolidation is closest to current accounting practice?

Cases
LO3, LO5

C3-1
Computation of Total Asset Values
A reader of Gigantic Company’s consolidated financial statements received from another source copies of the financial statements of the individual companies included in the consolidation. He is confused by the fact that the total assets in the consolidated balance sheet differ rather substantially from the sum of the asset totals reported by the individual companies.

Required

 
Will this relationship always be true? What factors may cause this difference to occur? LO3

C3-2
Accounting Entity [AICPA Adapted]
The concept of the accounting entity often is considered to be the most fundamental of accounting concepts, one that pervades all of accounting.

Required

a. (1) What is an accounting entity? Explain. (2) Explain why the accounting entity concept is so fundamental that it pervades all of accounting.

b.
For each of the following, indicate whether the entity concept is applicable; discuss and give illustrations.
(1) A unit created by or under law.
(2) The product-line segment of an enterprise.
(3) A combination of legal units.
(4) All the activities of an owner or a group of owners.
(5) The economy of the United States.
LO5

C3-3
Recognition of Fair Value and Goodwill
March Corporation acquired 65 percent of Ember Corporation’s ownership on January 2, 2008, for $708,500. At that time, Ember’s net assets had a book value of $810,000 and a fair value of $960,000. The difference between the book value and fair value of Ember’s net assets all related to depreciable assets. The total fair value of Ember’s shares not acquired by March Corporation was $381,500. FASB Statement No. 141R (ASC 805), which was not in effect at the time of Ember’s acquisition, requires recognition of 100 percent of the fair value of the assets and liabilities of an acquired company and 100 percent of the implied goodwill, even in less-than-100-percent acquisitions. Because March’s top managers are considering additional acquisitions, they are concerned with how to account for those acquisitions under the FASB’s current standards.

Required

 
Analyze how March’s consolidated financial statements would have been different if March had acquired Ember after FASB Statement No. 141R (ASC 805) became effective. Prepare a memo to Mr. R. U. Cleer, CFO of March Corporation, explaining how the amounts appearing in the consolidated financial statements relating to Ember would differ between the prior reporting standards and those established by FASB No. 141R (ASC 805). Include in your memo citations to and quotations from the appropriate accounting literature.  

C3-4
Joint Venture Investment
Dell Computer Corp. and CIT Group, Inc., established Dell Financial Services L.P. (DFS) as a joint venture to provide financing services for Dell customers. Dell originally purchased 70 percent of the equity of DFS and CIT purchased 30 percent. In the initial agreement, losses were allocated entirely to CIT, although CIT would recoup any losses before any future income was allocated. At the time the joint venture was formed, both Dell and CIT indicated that they had no plans to consolidate DFS.

Required

a. How could both Dell and CIT avoid consolidating DFS?

b.
Does Dell currently employ off-balance sheet financing? Explain. LO5

C3-5
Need for Consolidation [AICPA Adapted]
Sharp Company will acquire 90 percent of Moore Company in a business combination. The total consideration has been agreed on, but the nature of Sharp’s payment has not. It is expected that on the date the business combination is to be consummated, the fair value will exceed the book value of Moore’s assets minus liabilities. Sharp desires to prepare consolidated financial statements that will include Moore’s financial statements.

Required

a. Explain how the amount of goodwill is determined.

b.
From a theoretical standpoint, why should consolidated financial statements be prepared?

c.
From a theoretical standpoint, what is usually the first necessary condition to be met before consolidated financial statements can be prepared? LO1

C3-6
What Company Is That?
Many well-known products and names come from companies that may be less well known or may be known for other reasons. In some cases, an obscure parent company may have well known subsidiaries, and often familiar but diverse products may be produced under common ownership.

Required

a. Viacom is not necessarily a common name easily identified because it operates through numerous subsidiaries, but its brand names are seen every day. What are some of the well-known brand names from Viacom’s subsidiaries? What changes occurred in its organizational structure in 2006? Who is Sumner Redstone?

b.
ConAgra Foods, Inc., is one of the world’s largest food processors and distributors. Although it produces many products with familiar names, the company’s name generally is not well known. What are some of ConAgra’s brand names?

c.
What type of company is Yum! Brands, Inc.? What are some of its well-known brands? What is the origin of the company, and what was its previous name? LO1

C3-7
Subsidiaries and Core Businesses
During previous merger booms, a number of companies acquired many subsidiaries that often were in businesses unrelated to the acquiring company’s central operations. In many cases, the acquiring company’s management was unable to manage effectively the many diverse types of operations found in the numerous subsidiaries. More recently, many of these subsidiaries have been sold or, in a few cases, liquidated so the parent companies could concentrate on their core businesses.

Required

a. In 1986, General Electric acquired nearly all of the common stock of the large brokerage firm Kidder, Peabody Inc. Unfortunately, the newly acquired subsidiary’s performance was very poor. What ultimately happened to this subsidiary of General Electric?

b.
What major business has Sears, Roebuck been in for many decades? What other businesses was it in during the 1980s and early 1990s?
What were some of its best-known subsidiaries during that time? Does Sears still own those subsidiaries?
What additional acquisitions have occurred?

 

c.
PepsiCo is best known as a soft-drink company. What well-known subsidiaries did PepsiCo own during the mid-1990s? Does PepsiCo still own them?

d.
When a parent company and its subsidiaries are in businesses that are considerably different in nature, such as retailing and financial services, how meaningful are their consolidated financial statements in your opinion? Explain. How might financial reporting be improved in such situations? LO4

C3-8
International Consolidation Issues
The International Accounting Standards Board (IASB) is charged with developing a set of highquality standards and encouraging their adoption globally. Standards promulgated by the IASB are called International Financial Reporting Standards (IFRS). The European Union (EU) requires statements prepared using IFRS for all companies that list on the EU stock exchanges. While the United States does not yet accept IFRS, the SEC has indicated that it is working toward allowing international companies that list on U.S. exchanges to use IFRS for financial reporting in the United States. The differences between U.S. GAAP and IFRS are described in many different publications. For example, PricewaterhouseCoopers has a publication available for download on its Web site ( http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaap-similarities-anddifferences- september-2009.jhtml ) entitled “IFRS and U.S. GAAP: Similarities and Differences: September 2009” that provides a topic-based comparison. Based on the information in this publication or others, answer the following questions about the preparation of consolidated financial statements.

Required

a. Under U.S. GAAP, a two-tiered consolidation model is applied, one focused on voting rights and the second based on a party’s exposure to risks and rewards associated with the entity’s activities (the VIE model). Upon what is the IFRS framework based?

b.
U.S. GAAP requires a two-step process to evaluate goodwill for potential impairment (as discussed in Chapter 1). What is required by IFRS with respect to goodwill impairment?

c.
Under U.S. GAAP, noncontrolling interests are measured at fair value. What is required by IFRS? LO3

C3-9
Off-Balance Sheet Financing and VIEs
A variable interest entity (VIE) is a structure frequently used for off-balance sheet financing. VIEs have become quite numerous in recent years and have been the subject of some controversy.

Required

a. Briefly explain what is meant by off-balance sheet financing.

b.
What are three techniques used to keep debt off the balance sheet?

c.
What are some legitimate uses of VIEs?

d.
How can VIEs be used to manage earnings to meet financial reporting goals? How does this relate to the importance of following the intent of the guidelines for consolidations? LO6

C3-10
Alternative Accounting Methods
The use of proportionate or pro rata consolidation generally has not been acceptable in the United States. Normally, a significant investment in the common stock of another company must be either fully consolidated or reported using the equity method.

Required

a. What method does Amerada Hess use to account for its investments in affiliates and joint ventures?

b.
What method does EnCana Corporation use to account for its investments in jointly controlled ventures? In what country is EnCana based? Does this make a difference?

c.
Should the method used to account for investments in affiliates be different depending on whether the affiliate is a corporation or an unincorporated partnership? Explain. LO5

C3-11
Consolidation Differences among Major Companies
A variety of organizational structures are used by major companies, and different approaches to consolidation are sometimes found. Two large and familiar U.S. corporations are Union Pacific and ExxonMobil.  

Required

a. Many large companies have tens or even hundreds of subsidiaries. List the significant subsidiaries of Union Pacific Corporation.

b.
Exxon Mobil Corporation is a major energy company. Does Exxon Mobil consolidate all of its majority-owned subsidiaries? Explain. Does Exxon Mobil consolidate any entities in which it does not hold majority ownership? Explain. What methods does Exxon Mobil use to account for investments in the common stock of companies in which it holds less than majority ownership?


Exercises
LO1

E3-1
Multiple-Choice Questions on Consolidation Overview [AICPA Adapted]
Select the correct answer for each of the following questions. 1. When a parent–subsidiary relationship exists, consolidated financial statements are prepared in recognition of the accounting concept of

a.
Reliability.

b.
Materiality.

c.
Legal entity.

d.
Economic entity.

2. Consolidated financial statements are typically prepared when one company has a controlling interest in another unless


a.
The subsidiary is a finance company.

b.
The fiscal year-ends of the two companies are more than three months apart.

c.
Circumstances prevent the exercise of control.

d.
The two companies are in unrelated industries, such as real estate and manufacturing.

3. Penn Inc., a manufacturing company, owns 75 percent of the common stock of Sell Inc., an investment company. Sell owns 60 percent of the common stock of Vane Inc., an insurance company. In Penn’s consolidated statements, should consolidation accounting or equitymethod accounting be used for Sell and Vane?


a.
Consolidation used for Sell and equity method used for Vane.

b.
Consolidation used for both Sell and Vane.

c.
Equity method used for Sell and consolidation used for Vane.

d.
Equity method used for both Sell and Vane.

4. Shep Company has a receivable from its parent, Pep Company. Should this receivable be separately reported on Shep’s balance sheet and in Pep’s consolidated balance sheet?
Sheps Balance Sheet Peps Consolidated Balance Sheet a. Yes No b. Yes Yes c. No No d. No Yes

5. Which of the following is the best theoretical justification for consolidated financial statements?


a.
In form the companies are one entity; in substance they are separate.

b.
In form the companies are separate; in substance they are one entity.

c.
In form and substance the companies are one entity.

d.
In form and substance the companies are separate. LO3

E3-2
Multiple-Choice Questions on Variable Interest Entities
Select the correct answer for each of the following questions.

1. Special-purpose entities generally


a.
Have a much larger portion of assets financed by equity shareholders than do companies such as General Motors.

b.
Have relatively large amounts of preferred stock and convertible securities outstanding.

c.
Have a much smaller portion of their assets financed by equity shareholders than do companies such as General Motors.

d.
Pay out a relatively high percentage of their earnings as dividends to facilitate the sale of additional shares.

2. Variable interest entities may be established as


a.
Corporations.

b.
Trusts.

c.
Partnerships.

d.
All of the above.

3. An enterprise that will absorb a majority of a variable interest entity’s expected losses is called the


a.
Primary beneficiary.

b.
Qualified owner.

c.
Major facilitator.

d.
Critical management director.

4. In determining whether or not a variable interest entity is to be consolidated, the FASB focused on


a.
Legal control.

b.
Share of profits and obligation to absorb losses.

c.
Frequency of intercompany transfers.

d.
Proportionate size of the two entities. LO5

E3-3
Multiple-Choice Questions on Consolidated Balances [AICPA Adapted]
Select the correct answer for each of the following questions.

1. Par Corporation owns 60 percent of Sub Corporation’s outstanding capital stock. On May 1, 20X8, Par advanced Sub $70,000 in cash, which was still outstanding at December 31, 20X8. What portion of this advance should be eliminated in the preparation of the December 31, 20X8, consolidated balance sheet?


a.
$70,000.

b.
$42,000.

c.
$28,000.

d.
$0. Items 2 and 3 are based on the following: On January 2, 20X8, Pare Company acquired 75 percent of Kidd Company’s outstanding common stock. Selected balance sheet data at December 31, 20X8, are as follows: Pare Company Kidd Company Total Assets $420,000 $180,000 Liabilities $120,000 $ 60,000 Common Stock 100,000 50,000 Retained Earnings 200,000 70,000 $420,000 $180,000

2. In Pare’s December 31, 20X8, consolidated balance sheet, what amount should be reported as minority interest in net assets?


a.
$0.

b.
$30,000.

c.
$45,000.

d.
$105,000.

3. In its consolidated balance sheet at December 31, 20X8, what amount should Pare report as common stock outstanding?


a.
$50,000.

b.
$100,000.

c.
$137,500.

d.
$150,000.

4. At the time Hyman Corporation became a subsidiary of Duane Corporation, Hyman switched depreciation of its plant assets from the straight-line method to the sum-of-the-years’-digits method used by Duane. As to Hyman, this change was a


a.
Change in an accounting estimate.

b.
Correction of an error.

c.
Change of accounting principle.

d.
Change in the reporting entity.

5. Consolidated statements are proper for Neely Inc., Randle Inc., and Walker Inc., if


a.
Neely owns 80 percent of the outstanding common stock of Randle and 40 percent of Walker; Randle owns 30 percent of Walker.

b.
Neely owns 100 percent of the outstanding common stock of Randle and 90 percent of Walker; Neely bought the Walker stock one month before the foreign country in which Walker is based imposed restrictions preventing Walker from remitting profits to Neely.

c.
Neely owns 100 percent of the outstanding common stock of Randle and Walker; Walker is in legal reorganization.

d.
Neely owns 80 percent of the outstanding common stock of Randle and 40 percent of Walker; Reeves Inc. owns 55 percent of Walker. LO2, LO5

E3-4
Multiple-Choice Questions on Consolidation Overview [AICPA Adapted]
Select the correct answer for each of the following questions.

1. Consolidated financial statements are typically prepared when one company has


a.
Accounted for its investment in another company by the equity method.

b.
Accounted for its investment in another company by the cost method.

c.
Significant influence over the operating and financial policies of another company.

d.
The controlling financial interest in another company.

2. Aaron Inc. owns 80 percent of the outstanding stock of Belle Inc. Compare the consolidated net earnings of Aaron and Belle (X) and Aaron’s net earnings if it does not consolidate Belle (Y).


a.
X is greater than Y.

b.
X is equal to Y.

c.
X is less than Y.

d.
Cannot be determined.

3. On October 1, X Company acquired for cash all of Y Company’s outstanding common stock. Both companies have a December 31 year-end and have been in business for many years. Consolidated net income for the year ended December 31 should include net income of


a.
X Company for three months and Y Company for three months.

b.
X Company for 12 months and Y Company for 3 months.

c.
X Company for 12 months and Y Company for 12 months.

d.
X Company for 12 months, but no income from Y Company until Y Company distributes a dividend.

4. Ownership of 51 percent of the outstanding voting stock of a company would usually result in


a.
The use of the cost method.

b.
The use of the lower-of-cost-or-market method.

c.
The use of the equity method.

d.
A consolidation. LO7

E3-5
Balance Sheet Consolidation
On January 1, 20X3, Guild Corporation reported total assets of $470,000, liabilities of $270,000, and stockholders’ equity of $200,000. At that date, Bristol Corporation reported total assets of $190,000, liabilities of $135,000, and stockholders’ equity of $55,000. Following lengthy negotiations, Guild paid Bristol’s existing shareholders $44,000 in cash for 80 percent of the voting common shares of Bristol.

Required

 
Immediately after Guild purchased the Bristol shares

a.
What amount of total assets did Guild report in its balance sheet?

b.
What amount of total assets was reported in the consolidated balance sheet?

c.
What amount of total liabilities was reported in the consolidated balance sheet?

d.
What amount of stockholders’ equity was reported in the consolidated balance sheet? LO7

E3-6
Balance Sheet Consolidation with Intercompany Transfer
Potter Company acquired 90 percent of the voting common shares of Stately Corporation by issuing bonds with a par value and fair value of $121,500 to Stately’s existing shareholders. Immediately prior to the acquisition, Potter reported total assets of $510,000, liabilities of $320,000, and stockholders’ equity of $190,000. At that date, Stately reported total assets of $350,000, liabilities of $215,000, and stockholders’ equity of $135,000. Included in Stately’s liabilities was an account payable to Potter in the amount of $15,000, which Potter included in its accounts receivable.

Required

 
Immediately after Potter acquired Stately’s shares

a.
What amount of total assets did Potter report in its balance sheet?

b.
What amount of total assets was reported in the consolidated balance sheet?

c.
What amount of total liabilities was reported in the consolidated balance sheet?

d.
What amount of stockholders’ equity was reported in the consolidated balance sheet? LO7

E3-7
Subsidiary Acquired for Cash
Fineline Pencil Company acquired 80 percent of Smudge Eraser Corporation’s stock on January 2, 20X3, for $72,000 cash. Summarized balance sheet data for the companies on December 31, 20X2, are as follows:
Fineline Pencil Company Smudge Eraser Corporation Book Value Fair Value Book Value Fair Value Cash $200,000 $200,000 $ 50,000 $ 50,000 Other Assets 400,000 400,000 120,000 120,000 Total Debits $600,000 $170,000 Current Liabilities $100,000 100,000 $ 80,000 80,000 Common Stock 300,000 50,000 Retained Earnings 200,000 40,000 Total Credits $600,000 $170,000

Required

 
Prepare a consolidated balance sheet immediately following the acquisition.


E3-8
Subsidiary Acquired with Bonds
Byte Computer Corporation acquired 75 percent of Nofail Software Company’s stock on January 2, 20X3, by issuing bonds with a par value of $50,000 and a fair value of $67,500 in exchange for the shares. Summarized balance sheet data presented for the companies just before the acquisition are as follows: Byte Computer Corporation Nofail Software Company Book Value Fair Value Book Value Fair Value Cash $200,000 $200,000 $ 50,000 $ 50,000 Other Assets 400,000 400,000 120,000 120,000 Total Debits $600,000 $170,000 Current Liabilities $100,000 100,000 $ 80,000 80,000 Common Stock 300,000 50,000 Retained Earnings 200,000 40,000 Total Credits $600,000 $170,000

Required

 
Prepare a consolidated balance sheet immediately following the acquisition. LO7

E3-9
Subsidiary Acquired by Issuing Preferred Stock
Byte Computer Corporation acquired 90 percent of Nofail Software Company’s common stock on January 2, 20X3, by issuing preferred stock with a par value of $6 per share and a market value of $8.10 per share. A total of 10,000 shares of preferred stock was issued. Balance sheet data for the two companies immediately before the business combination are presented in

E3-8.


Required

 
Prepare a consolidated balance sheet for the companies immediately after Byte obtains ownership of Nofail by issuing the preferred stock.

E3-10
Reporting for a Variable Interest Entity
Gamble Company convinced Conservative Corporation that the two companies should establish Simpletown Corporation to build a new gambling casino in Simpletown Corner. Although chances for the casino’s success were relatively low, a local bank loaned $140,000,000 to the new corporation, which built the casino at a cost of $130,000,000. Conservative purchased 100 percent of the initial capital stock offering for $5,600,000, and Gamble agreed to supply 100 percent of the management and guarantee the bank loan. Gamble also guaranteed a 20 percent return to Conservative on its investment for the first 10 years. Gamble will receive all profits in excess of the 20 percent return to Conservative. Immediately after the casino’s construction, Gamble reported the following amounts: Cash $ 3,000,000 Buildings and Equipment 240,600,000 Accumulated Depreciation 10,100,000 Accounts Payable 5,000,000 Bonds Payable 20,300,000 Common Stock 103,000,000 Retained Earnings 105,200,000 The only disclosure that Gamble currently provides in its financial reports about its relationships to Conservative and Simpletown is a brief footnote indicating that a contingent liability exists on its guarantee of Simpletown Corporation’s debt.

Required

 
Prepare a balance sheet in good form for Gamble immediately following the casino’s construction.

E3-11
Consolidation of a Variable Interest Entity Teal Corporation is the primary beneficiary of a variable interest entity with total assets of $500,000, liabilities of $470,000, and owners’ equity of $30,000. Because Teal owns 25 percent of the VIE’s voting stock, it reported a $7,500 investment in the VIE in its balance sheet. Teal reported total assets of $190,000 (including its investment in the VIE), liabilities of $80,000, common stock of $15,000, and retained earnings of $95,000 in its balance sheet.

Required

 
Prepare a condensed balance sheet in good form for Teal, taking into consideration that it is the primary beneficiary of the variable interest entity. LO5, LO7

E3-12
Computation of Subsidiary Net Income
Frazer Corporation owns 70 percent of Messer Company’s stock. In the 20X9 consolidated income statement, the noncontrolling interest was assigned $18,000 of income.

Required

 
What amount of net income did Messer Company report for 20X9? LO5, LO7

E3-13
Incomplete Consolidation
Belchfi re Motors’ accountant was called away after completing only half of the consolidated statements at the end of 20X4. The data left behind included the following:
Item Belchfire Motors Premium Body Shop Consolidated
Cash $ 40,000 $ 20,000 $ 60,000 Accounts Receivable 180,000 30,000 200,000 Inventory 220,000 50,000 270,000 Buildings and Equipment (net) 300,000 290,000 590,000 Investment in Premium Body Shop 150,000 Total Debits $890,000 $390,000 $1,120,000 Accounts Payable $ 30,000 $ 40,000 Bonds Payable 400,000 200,000 Common Stock 200,000 100,000 Retained Earnings 260,000 50,000 Total Credits $890,000 $390,000

Required

a. Belchfire Motors acquired shares of Premium Body Shop at underlying book value on January 1, 20X1. What portion of the ownership of Premium Body Shop does Belchfire apparently hold?

b.
Compute the consolidated totals for each of the remaining balance sheet items. LO5, LO7

E3-14
Noncontrolling Interest
Sanderson Corporation acquired 70 percent of Kline Corporation’s common stock on January 1, 20X7, for $294,000 in cash. At the acquisition date, the book values and fair values of Kline’s assets and liabilities were equal, and the fair value of the noncontrolling interest was equal to 30 percent of the total book value of Kline. The stockholders’ equity accounts of the two companies at the date of purchase are: Sanderson Corporation Kline Corporation Common Stock ($10 par value) $400,000 $ 180,000 Additional Paid-In Capital 222,000 65,000 Retained Earnings 358,000 175,000 Total Stockholders Equity $980,000 $420,000

Required

a. What amount will be assigned to the noncontrolling interest on January 1, 20X7, in the consolidated balance sheet?

b.
Prepare the stockholders’ equity section of Sanderson and Kline’s consolidated balance sheet as of January 1, 20X7.

c.
Sanderson acquired ownership of Kline to ensure a constant supply of electronic switches, which it purchases regularly from Kline. Why might Sanderson not feel compelled to purchase all of Kline’s shares? LO7

E3-15
Computation of Consolidated Net Income
Ambrose Corporation owns 75 percent of Kroop Company’s common stock, acquired at underlying book value on January 1, 20X4. At the acquisition date, the book values and fair values of Kroop’s assets and liabilities were equal, and the fair value of the noncontrolling interest was equal to 25 percent of the total book value of Kroop. The income statements for Ambrose and Kroop for 20X4 include the following amounts:
Ambrose Corporation Kroop Company Sales $528,000 $150,000 Dividend Income 9,000 Total Income $537,000 $150,000 Less: Cost of Goods Sold $380,000 $ 87,000 Depreciation Expense 32,000 20,000 Other Expenses 66,000 23,000 Total Expenses $478,000 $130,000 Net Income $ 59,000 $ 20,000 Ambrose uses the cost method in accounting for its ownership of Kroop. Kroop paid dividends of $12,000 in 20X4.

Required

a. What amount should Ambrose report in its income statement as income from its investment in Kroop using equity-method accounting?

b.
What amount of income should be assigned to noncontrolling interest in the consolidated income statement for 20X4?

c.
What amount should Ambrose report as consolidated net income for 20X4?

d.
Why should Ambrose not report consolidated net income of $79,000 ($59,000 + $20,000) for 20X4? LO7

E3-16
Computation of Subsidiary Balances
Tall Corporation acquired 75 percent of Light Corporation’s voting common stock on January 1, 20X2, at underlying book value. At the acquisition date, the book values and fair values of Light’s assets and liabilities were equal, and the fair value of the noncontrolling interest was equal to 25 percent of the total book value of Light. Noncontrolling interest was assigned income of $8,000 in Tall’s consolidated income statement for 20X2 and a balance of $65,500 in Tall’s consolidated balance sheet at December 31, 20X2. Light reported retained earnings of $70,000 and additional paid-in capital of $40,000 on January 1, 20X2. Light did not pay dividends or issue stock in 20X2.

Required

a. Compute the amount of net income reported by Light for 20X2.

b.
Prepare the stockholders’ equity section of Light’s balance sheet at December 31, 20X2. LO7, LO8

E3-17
Subsidiary Acquired at Net Book Value
On December 31, 20X8, Banner Corporation acquired 80 percent of Dwyer Company’s common stock for $136,000. At the acquisition date, the book values and fair values of all of Dwyer’s assets and liabilities were equal. Banner uses the equity method in accounting for its investment. Balance sheet information provided by the companies at December 31, 20X8, is as follows: Banner Corporation Dwyer Company Cash $ 74,000 $ 20,000 Accounts Receivable 120,000 70,000 Inventory 180,000 90,000 Fixed Assets (net) 350,000 240,000 Investment in Dwyer Company Stock 136,000 Total Debits $860,000 $420,000 Accounts Payable $ 65,000 $ 30,000 Notes Payable 350,000 220,000 Common Stock 150,000 90,000 Retained Earnings 295,000 80,000 Total Credits $860,000 $420,000

Required

 
Prepare a consolidated balance sheet for Banner at December 31, 20X8. LO6

E3-18
Applying Alternative Accounting Theories
Noway Manufacturing owns 75 percent of Positive Piston Corporation’s stock. During 20X9, Noway and Positive Piston reported sales of $400,000 and $200,000 and expenses of $280,000 and $160,000, respectively.

Required

 
Compute the amount of total revenue, total expenses, and net income to be reported in the 20X9 consolidated income statement under the following alternative approaches:

a.
Proprietary theory.

b.
Parent company theory.

c.
Entity theory.

d.
Current accounting practice. LO6

E3-19
Measurement of Goodwill
Rank Corporation acquired 60 percent of Fresh Company’s stock on December 31, 20X4. In preparing the consolidated financial statements at December 31, 20X4, goodwill of $240,000 was reported. The goodwill is attributable to Rank’s purchase of Fresh shares, and the parent company approach was used in determining the amount of goodwill reported.

Required

 
Determine the amount of goodwill to be reported under each of the following consolidation alternatives:

a.
Proprietary theory.

b.
Entity theory.

c.
Current accounting practice. LO6

E3-20
Assets under Alternative Accounting Theories
Garwood Corporation acquired 75 percent of Zorn Company’s voting common stock on January 1, 20X4. At the time of acquisition, Zorn reported buildings and equipment at book value of $240,000; however, an appraisal indicated a fair value of $290,000.

Required

 
If consolidated statements are prepared, determine the amount at which buildings and equipment will be reported using the following consolidation alternatives:

a.
Entity theory.

b.
Parent company theory.

c.
Proprietary theory.

d.
Current accounting practice. LO6

E3-21
Reported Income under Alternative Accounting Theories
Placer Corporation acquired 80 percent of Billings Company’s voting common stock on January 1, 20X4. Placer and Billings reported total revenue of $410,000 and $200,000 and total expenses of $320,000 and $150,000, respectively, for the year ended December 31, 20X4.

Required

 
Determine the amount of total revenue, total expense, and net income to be reported in the consolidated income statement for 20X4 under the following consolidation alternatives:

a.
Entity theory.

b.
Parent company theory.

c.
Proprietary theory.

d.
Current accounting practice. LO7

E3-22
Acquisition of Majority Ownership
Lang Company reports net assets with a book value and fair value of $200,000 Pace Corporation acquires 75 percent ownership for $150,000. Pace reports net assets with a book value of $520,000 and a fair value of $640,000 at that time, excluding its investment in Lang.

Required

 
For each of the following, compute the amounts that would be reported immediately after the combination under current accounting practice:

a.
Consolidated net identifiable assets.

b.
Noncontrolling interest.

Problems
LO7

P3-23
Multiple-Choice Questions on Consolidated and Combined Financial Statements [AICPA Adapted]
Select the correct answer for each of the following questions.

1. What is the theoretically preferred method of presenting a noncontrolling interest in a consolidated balance sheet?


a.
As a separate item within the liability section.

b.
As a deduction from (contra to) goodwill from consolidation, if any.

c.
By means of notes or footnotes to the balance sheet.

d.
As a separate item within the stockholders’ equity section.

2. Presenting consolidated financial statements this year when statements of individual companies were presented last year is


a.
The correction of an error.

b.
An accounting change that should be reported prospectively.

c.
An accounting change that should be reported by restating the financial statements of all prior periods presented.

d.
Not an accounting change.

3. A subsidiary, acquired for cash in a business combination, owned equipment with a market value in excess of book value as of the date of combination. A consolidated balance sheet prepared immediately after the acquisition would treat this excess as


a.
Goodwill.

b.
Plant and equipment.

c.
Retained earnings.

d.
Deferred credit.

4. Mr. Cord owns four corporations. Combined financial statements are being prepared for these corporations, which have intercompany loans of $200,000 and intercompany profits of $500,000. What amount of these intercompany loans and profits should be included in the combined financial statements?
Intercompany Loans Profits a. $200,000 $ 0 b. $200,000 $500,000 c. $ 0 $ 0 d. $ 0 $500,000 LO7

P3-24
Determining Net Income of Parent Company
Tally Corporation and its subsidiary reported consolidated net income of $164,300 for 20X2. Tally owns 60 percent of the common shares of its subsidiary, acquired at book value. Noncontrolling interest was assigned income of $15,200 in the consolidated income statement for 20X2.

Required

 
Determine the amount of separate operating income reported by Tally for 20X2. LO7

P3-25
Reported Balances Roof Corporation acquired 80 percent of the stock of Gable Company by issuing shares of its common stock with a fair value of $192,000. At that time, the fair value of the noncontrolling interest was estimated to be $48,000 and the fair values of Gable’s identifiable assets and liabilities were $310,000 and $95,000, respectively. Gable’s assets and liabilities had book values of $220,000 and $95,000, respectively.

Required

 
Compute the following amounts to be reported immediately after the combination

a.
Investment in Gable reported by Roof.

b.
Increase in identifiable assets of the combined entity.

c.
Increase in total liabilities of the combined entity.

d.
Goodwill for the combined entity.

e.
Noncontrolling interest reported in the consolidated balance sheet. LO7

P3-26
Acquisition Price
Darwin Company holds assets with a fair value of $120,000 and a book value of $90,000 and liabilities with a book value and fair value of $25,000.

Required

 
Compute the following amounts if Brad Corporation acquires 60 percent ownership of Darwin:

a.
What amount did Brad pay for the shares if no goodwill and no gain on a bargain purchase are reported?

b.
What amount did Brad pay for the shares if the fair value of the noncontrolling interest at acquisition is $54,000 and goodwill of $40,000 is reported?

c.
What balance will be assigned to the noncontrolling interest in the consolidated balance sheet if Brad pays $73,200 to acquire its ownership and goodwill of $27,000 is reported? LO3

P3-27
Consolidation of a Variable Interest Entity
On December 28, 20X3, Stern Corporation and Ram Company established S&R Partnership, with cash contributions of $10,000 and $40,000, respectively. The partnership’s purpose is to purchase from Stern accounts receivable that have an average collection period of 80 days and hold them to collection. The partnership borrows cash from Midtown Bank and purchases the receivables without recourse but at an amount equal to the expected percent to be collected, less a financing fee of 3 percent of the gross receivables. Stern and Ram hold 20 percent and 80 percent of the ownership of the partnership, respectively, and Stern guarantees both the bank loan made to the partnership and a 15 percent annual return on the investment made by Ram. Stern receives any income in excess of the 15 percent return guaranteed to Ram. The partnership agreement provides

Stern total control over the partnership’s activities. On December 31, 20X3, Stern sold $8,000,000 of accounts receivable to the partnership. The partnership immediately borrowed $7,500,000 from the bank and paid Stern $7,360,000. Prior to the sale, Stern had established a $400,000 allowance for uncollectibles on the receivables sold to the partnership. The balance sheets of Stern and S&R immediately after the sale of receivables to the partnership contained the following:
Stern Corporation S&R Partnership Cash $7,960,000 $ 190,000 Accounts Receivable 4,200,000 8,000,000 Allowance for Uncollectible Accounts (210,000) (400,000) Other Assets 5,400,000 Prepaid Finance Charges 240,000 Investment in S&R Partnership 10,000 Accounts Payable 950,000 Deferred Revenue 240,000 Bank Notes Payable 7,500,000 Bonds Payable 9,800,000 Common Stock 700,000 Retained Earnings 6,150,000 Capital, Stern Corporation 10,000 Capital, Ram Company 40,000

Required

 
Assuming that Stern is S&R’s primary beneficiary, prepare a consolidated balance sheet in good form for Stern at January 1, 20X4. LO3

P3-28
Reporting for Variable Interest Entities
Purified Oil Company and Midwest Pipeline Corporation established Venture Company to conduct oil exploration activities in North America to reduce their dependence on imported crude oil. Midwest Pipeline purchased all 20,000 shares of the newly created company for $10 each. Purified Oil agreed to purchase all of Venture’s output at market price, guarantee up to $5,000,000 of debt for Venture, and absorb all losses if the company proved unsuccessful. Purified and Midwest agreed to share equally the profits up to $80,000 per year and to allocate 70 percent of those in excess of $80,000 to Purified and 30 percent to Midwest. Venture immediately borrowed $3,000,000 from Second National Bank and purchased land, drilling equipment, and supplies to start its operations. Following these asset purchases, Venture and Purified Oil reported the following balances: Venture Company Purified Oil Company Cash $ 230,000 $ 410,000 Drilling Supplies 420,000 Accounts Receivable 640,000 Equipment (net) 1,800,000 6,700,000 Land 900,000 4,200,000 Accounts Payable 150,000 440,000 Bank Loans Payable 3,000,000 8,800,000 Common Stock 200,000 560,000 Retained Earnings 2,150,000 The only disclosure that Purified Oil currently provides in its financial statements with respect to its relationship with Midwest Pipeline and Venture is a brief note indicating that a contingent liability exists on the guarantee of Venture Company debt.

Required

 
Assuming that Venture is considered to be a variable interest entity and Purified Oil is the primary beneficiary, prepare a balance sheet in good form for Purified Oil.

P3-29
Consolidated Income Statement Data
Master Products acquired 80 percent ownership of LoCal Bakeries on January 1, 20X3, when the fair value of LoCal’s depreciable assets was equal to book value. Master Products LoCal Bakeries Sales $ 300,000 $ 200,000 Cost of Goods Sold $200,000 $130,000 Depreciation Expense 40,000 (240,000) 30,000 (160,000) Income before Income from Subsidiary $ 60,000 Net Income $ 40,000 During 20X3, Master Products purchased a special imported yeast for $35,000 and resold it to LoCal for $50,000. LoCal did not resell any of the yeast before year-end.

Required

 
Determine the amounts to be reported for each of the following items in the consolidated income statement for 20X3:

a.
Sales.

b.
Investment income from LoCal Bakeries.

c.
Cost of goods sold.

d.
Depreciation expense. LO7

P3-30
Parent Company and Consolidated Amounts
Quoton Corporation acquired 80 percent of Tempro Company’s common stock on December 31, 20X5, at underlying book value. The book values and fair values of Tempro’s assets and liabilities were equal, and the fair value of the noncontrolling interest was equal to 20 percent of the total book value of Tempro. Tempro provided the following trial balance data at December 31, 20X5: Debit Credit Cash $ 28,000 Accounts Receivable 65,000 Inventory 90,000 Buildings and Equipment (net) 210,000 Cost of Goods Sold 105,000 Depreciation Expense 24,000 Other Operating Expenses 31,000 Dividends Declared 15,000 Accounts Payable $ 33,000 Notes Payable 120,000 Common Stock 90,000 Retained Earnings 130,000 Sales 195,000 Total $568,000 $568,000

Required

a. How much did Quoton pay to purchase its shares of Tempro?

b.
If consolidated financial statements are prepared at December 31, 20X5, what amount will be assigned to the noncontrolling interest in the consolidated balance sheet?

c.
If Quoton reported income of $143,000 from its separate operations for 20X5, what amount of consolidated net income will be reported for 20X5

d.
If Quoton had purchased its ownership of Tempro on January 1, 20X5, at underlying book value and Quoton reported income of $143,000 from its separate operations for 20X5, what amount of consolidated net income would be reported for 20X5? LO7

P3-31
Parent Company and Consolidated Balances
Exacto Company reported the following net income and dividends for the years indicated: Year Net Income Dividends 20X5 $35,000 $12,000 20X6 45,000 20,000 20X7 30,000 14,000 True Corporation acquired 75 percent of Exacto’s common stock on January 1, 20X5. On that date, the fair value of Exacto’s net assets was equal to the book value. True uses the equity method in accounting for its ownership in Exacto and reported a balance of $259,800 in its investment account on December 31, 20X7.

Required

a. What amount did True pay when it purchased Exacto’s shares?

b.
What was the fair value of Exacto’s net assets on January 1, 20X5?

c.
What amount was assigned to the NCI shareholders on January 1, 20X5?

d.
What amount will be assigned to the NCI shareholders in the consolidated balance sheet prepared at December 31, 20X7? LO2, LO7

P3-32
Indirect Ownership
Purple Corporation recently attempted to expand by acquiring ownership in Green Company. The following ownership structure was reported on December 31, 20X9: Investor Investee Percentage of Ownership Held Purple Corporation Green Company 70 Green Company Orange Corporation 10 Orange Corporation Blue Company 60 Green Company Yellow Company 40 The following income from operations (excluding investment income) and dividend payments were reported by the companies during 20X9: Company Operating Income Dividends Paid Purple Corporation $ 90,000 $60,000 Green Company 20,000 10,000 Orange Corporation 40,000 30,000 Blue Company 100,000 80,000 Yellow Company 60,000 40,000

Required

 
Compute the amount reported as consolidated net income for 20X9.

P3-33
Balance Sheet Amounts under Alternative Accounting Theories
Parsons Corporation purchased 75 percent ownership of Tumble Company on December 31, 20X7, for $210,000. Summarized balance sheet amounts for the companies on December 31, 20X7, prior to the purchase, were as follows: Parsons Corporation Tumble Company Book Value Fair Value Cash and Inventory $300,000 $ 80,000 $ 80,000 Buildings and Equipment (net) 400,000 120,000 180,000 Total Assets $700,000 $200,000 $260,000 Common Stock $380,000 $ 90,000 Retained Earnings 320,000 110,000 Total Liabilities and Stockholders Equity $700,000 $200,000

Required

 
If consolidated financial statements are prepared, determine the amounts that would be reported as cash and inventory, buildings and equipment (net), and goodwill using the following consolidation alternatives:

a.
Proprietary theory.

b.
Parent company theory.

c.
Entity theory.

d.
Current accounting practice. LO7, LO8

P3-34
Consolidated Worksheet and Balance Sheet on the Acquisition Date (Equity Method)
Peanut Company acquired 90 percent of Snoopy Company’s outstanding common stock for $270,000 on January 1, 20X8, when the book value of Snoopy’s net assets was equal to $300,000. Peanut uses the equity method to account for investments. Trial balance data for Peanut and Snoopy as of January 1, 20X8, are as follows: Peanut Company Snoopy Company Assets Cash 55,000 20,000 Accounts Receivable 50,000 30,000 Inventory 100,000 60,000 Investment in Snoopy Stock 270,000 Land 225,000 100,000 Buildings and Equipment 700,000 200,000 Accumulated Depreciation (400,000) (10,000) Total Assets 1,000,000 400,000 Liabilities and Stockholders Equity Accounts Payable 75,000 25,000 Bonds Payable 200,000 75,000 Common Stock 500,000 200,000 Retained Earnings 225,000 100,000 Total Liabilities and Equity 1,000,000 400,000

Required

a. Prepare the journal entry on Peanut’s books for the acquisition of Snoopy on January 1, 20X8.

b.
Prepare a consolidation worksheet on the acquisition date, January 1, 20X8, in good form.

c.
Prepare a consolidated balance sheet on the acquisition date, January 1, 20X8, in good form.

P3-35
Consolidated Worksheet at End of the First Year of Ownership (Equity Method)
Peanut Company acquired 90 percent of Snoopy Company’s outstanding common stock for $270,000 on January 1, 20X8, when the book value of Snoopy’s net assets was equal to $300,000. Peanut uses the equity method to account for investments. Trial balance data for Peanut and Snoopy as of December 31, 20X8, are as follows:
Peanut Company Snoopy Company Debit Credit Debit Credit Cash 158,000 80,000 Accounts Receivable 165,000 65,000 Inventory 200,000 75,000 Investment in Snoopy Stock 319,500 0 Land 200,000 100,000 Buildings and Equipment 700,000 200,000 Cost of Goods Sold 200,000 125,000 Depreciation Expense 50,000 10,000 Selling & Administrative Expense 225,000 40,000 Dividends Declared 100,000 20,000 Accumulated Depreciation 450,000 20,000 Accounts Payable 75,000 60,000 Bonds Payable 200,000 85,000 Common Stock 500,000 200,000 Retained Earnings 225,000 100,000 Sales 800,000 250,000 Income from Snoopy 67,500 0 Total 2,317,500 2,317,500 715,000 715,000

Required

a. Prepare the journal entries on Peanut’s books for the acquisition of Snoopy on January 1, 20X8, as well as any normal equity method entry(ies) related to the investment in Snoopy Company during 20X8.

b.
Prepare a consolidation worksheet for 20X8 in good form. LO7, LO8

P3-36
Consolidated Worksheet at End of the Second Year of Ownership (Equity Method)
Peanut Company acquired 90 percent of Snoopy Company’s outstanding common stock for $270,000 on January 1, 20X8, when the book value of Snoopy’s net assets was equal to $300,000. Problem 3-36 summarizes the first year of Peanut’s ownership of Snoopy. Peanut uses the equity method to account for investments. The following trial balance summarizes the financial position and operations for Peanut and Snoopy as of December 31, 20X9:
Peanut Company Snoopy Company Debit Credit Debit Credit
Cash 255,000 75,000 Accounts Receivable 190,000 80,000 Inventory 180,000 100,000 Investment in Snoopy Stock 364,500 0 Land 200,000 100,000 Buildings and Equipment 700,000 200,000 Cost of Goods Sold 270,000 150,000 Depreciation Expense 50,000 10,000 Selling & Administrative Expense 230,000 60,000

 Peanut Company Snoopy Company Debit Credit Debit Credit
Dividends Declared 225,000 30,000 Accumulated Depreciation 500,000 30,000 Accounts Payable 75,000 35,000 Bonds Payable 150,000 85,000 Common Stock 500,000 200,000 Retained Earnings 517,500 155,000 Sales 850,000 300,000 Income from Snoopy 72,000 0 Total 2,664,500 2,664,500 805,000 805,000

Required

a. Prepare any equity method journal entry(ies) related to the investment in Snoopy Company during 20X9.

b.
Prepare a consolidation worksheet for 20X9 in good form. LO7, LO8

P3-37
Consolidated Worksheet and Balance Sheet on the Acquisition Date (Equity Method)
Paper Company acquired 80 percent of Scissor Company’s outstanding common stock for $296,000 on January 1, 20X8, when the book value of Scissor’s net assets was equal to $370,000. Paper uses the equity method to account for investments. Trial balance data for Paper and Scissor as of January 1, 20X8, are as follows:
 Paper Company Scissor Company
Assets Cash 109,000 25,000 Accounts Receivable 65,000 37,000 Inventory 125,000 87,000 Investment in Scissor Stock 296,000 Land 280,000 125,000 Buildings and Equipment 875,000 250,000 Accumulated Depreciation (500,000) (24,000) Total Assets 1,250,000 500,000 Liabilities and Stockholders Equity Accounts Payable 95,000 30,000 Bonds Payable 250,000 100,000 Common Stock 625,000 250,000 Retained Earnings 280,000 120,000 Total Liabilities and Equity 1,250,000 500,000

Required

a. Prepare the journal entry on Paper’s books for the acquisition of Scissor Co. on January 1, 20X8.

b.
Prepare a consolidation worksheet on the acquisition date, January 1, 20X8, in good form.

c.
Prepare a consolidated balance sheet on the acquisition date, January 1, 20X8, in good form. LO7, LO8

P3-38 Consolidated Worksheet at End of the First Year of Ownership (Equity Method)
Paper Company acquired 80 percent of Scissor Company’s outstanding common stock for $296,000 on January 1, 20X8, when the book value of Scissor’s net assets was equal to $370,000.

Paper uses the equity method to account for investments. Trial balance data for Paper and Scissor as of December 31, 20X8, are as follows: Paper Company Scissor Company Debit Credit Debit Credit
Cash 191,000 46,000 Accounts Receivable 140,000 60,000 Inventory 190,000 120,000 Investment in Scissor Stock 350,400 0 Land 250,000 125,000 Buildings and Equipment 875,000 250,000 Cost of Goods Sold 250,000 155,000 Depreciation Expense 65,000 12,000 Selling & Administrative Expense 280,000 50,000 Dividends Declared 80,000 25,000 Accumulated Depreciation 565,000 36,000 Accounts Payable 77,000 27,000 Bonds Payable 250,000 100,000 Common Stock 625,000 250,000 Retained Earnings 280,000 120,000 Sales 800,000 310,000 Income from Scissor 74,400 0 Total 2,671,400 2,671,400 843,000 843,000

Required

a. Prepare the journal entries on Paper’s books for the acquisition of Scissor on January 1, 20X8, as well as any normal equity method entry(ies) related to the investment in Scissor Company during 20X8.

b.
Prepare a consolidation worksheet for 20X8 in good form. LO7, LO8

P3-39
Consolidated Worksheet at End of the Second Year of Ownership (Equity Method)
Paper Company acquired 80 percent of Scissor Company’s outstanding common stock for $296,000 on January 1, 20X8, when the book value of Scissor’s net assets was equal to $370,000. Problem 3-36 summarizes the first year of Paper’s ownership of Scissor. Paper uses the equity method to account for investments. The following trial balance summarizes the financial position and operations for Paper and Scissor as of December 31, 20X9: Paper Company Scissor Company Debit Credit Debit Credit Cash 295,000 116,000 Accounts Receivable 165,000 97,000 Inventory 193,000 115,000 Investment in Scissor Stock 412,000 0 Land 250,000 125,000 Buildings and Equipment 875,000 250,000 Cost of Goods Sold 278,000 178,000 Depreciation Expense 65,000 12,000 Selling & Administrative Expense 312,000 58,000 Dividends Declared 90,000 30,000 Accumulated Depreciation 630,000 48,000 Accounts Payable 85,000 40,000
Paper Company Scissor Company Debit Credit Debit Credit
Bonds Payable 150,000 100,000 Common Stock 625,000 250,000 Retained Earnings 479,400 188,000 Sales 880,000 355,000 Income from Scissor 85,600 0 Total 2,935,000 2,935,000 981,000 981,000

Required

a. Prepare any equity method journal entry(ies) related to the investment in Scissor Company during 20X9.

b.
Prepare a consolidation worksheet for 20X9 in good form.