SOLUTION MANUAL FOR Advanced Financial Accounting 11TH EDITION. Theodore Christensen David Cottrell by welldoneassistant

CHAPTER 1 INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES ANSWERS TO QUESTIONS Q1-1 Complex organizational structures often result when companies do business in a complex business environment. New subsidiaries or other entities may be formed for purposes such as extending operations into foreign countries, seeking to protect existing assets from risks associated with entry into new product lines, separating activities that fall under regulatory controls, and reducing taxes by separating certain types of operations. Q1-2 The split-off and spin-off result in the same reduction of reported assets and liabilities. Only the stockholders’ equity accounts of the company are different. The number of shares outstanding remains unchanged in the case of a spin-off and retained earnings or paid-in capital is reduced. Shares of the parent are exchanged for shares of the subsidiary in a split-off, thereby reducing the outstanding shares of the parent company. Q1-3 The management of Enron appears to have used special-purpose entities to avoid reporting debt on its balance sheet and to create fictional transactions that resulted in reported income. It also transferred bad loans and investments to special-purpose entities to avoid recognizing losses in its income statement. Q1-4 (a) A statutory merger occurs when one company acquires another company and the assets and liabilities of the acquired company are transferred to the acquiring company; the acquired company is liquidated, and only the acquiring company remains. (b) A statutory consolidation occurs when a new company is formed to acquire the assets and liabilities of two combining companies. The combining companies dissolve, and the new company is the only surviving entity. (c) A stock acquisition occurs when one company acquires a majority of the common stock of another company and the acquired company is not liquidated; both companies remain as separate but related corporations. Q1-5 A noncontrolling interest exists when the acquiring company gains control but does not own all the shares of the acquired company. The non-controlling interest is made up of the shares not owned by the acquiring company. Q1-6 Goodwill is the excess of the sum of (1) the fair value given by the acquiring company, (2) the fair value of any shares already owned by the parent and (3) the acquisition-date fair value of any noncontrolling interest over the acquisition-date fair value of the net identifiable assets acquired in the business combination. Q1-7 The level of ownership acquired does not impact the amount of goodwill reported under the acquisition method.

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

Q1-8 The total difference at the acquisition date between the sum of (1) the fair value given by the acquiring company, (2) the fair value of any shares already owned by the parent and (3) the acquisition-date fair value of any noncontrolling interest and the book value of the net identifiable assets acquired is referred to as the differential. Q1-9 The purchase of a company is viewed in the same way as any other purchase of assets. The acquired company is owned by the acquiring company only for the portion of the year subsequent to the combination. Therefore, earnings are accrued only from the date of purchase forward. Q1-10 None of the retained earnings of the subsidiary should be carried forward under the acquisition method. Thus, consolidated retained earnings immediately following an acquisition is limited to the balance reported by the acquiring company. Q1-11 Additional paid-in capital reported following a business combination is the amount previously reported on the acquiring company's books plus the excess of the fair value over the par or stated value of any shares issued by the acquiring company in completing the acquisition less any sock issue costs. Q1-12 When the acquisition method is used, all costs incurred in bringing about the combination are expensed as incurred. None are capitalized. However, costs associated with the issuance of stock are recorded as a reduction of additional paid-in capital. Q1-13 When the acquiring company issues shares of stock to complete a business combination, the excess of the fair value of the stock issued over its par value is recorded as additional paid-in capital. All costs incurred by the acquiring company in issuing the securities should be treated as a reduction in the additional paid-in capital. Items such as audit fees associated with the registration of the new securities, listing fees, and brokers' commissions should be treated as reductions of additional paid-in capital when stock is issued. Q1-14 If the fair value of a reporting unit acquired in a business combination exceeds its carrying amount, the goodwill of that reporting unit is considered unimpaired. On the other hand, if the carrying amount of the reporting unit exceeds its fair value, impairment of goodwill is implied. An impairment must be recognized if the carrying amount of the goodwill assigned to the reporting unit is greater than the implied value of the carrying unit’s goodwill. The implied value of the reporting unit’s goodwill is determined as the excess of the fair value of the reporting unit over the fair value of its net identifiable assets. Q1-15 When the fair value of the consideration given in a business combination, along with the fair value of any equity interest in the acquiree already held and the fair value of any noncontrolling interest in the acquiree, is less than the fair value of the acquiree’s net identifiable assets, a bargain purchase results. Q1-16 The acquirer should record the clarification of the acquisition-date fair value of buildings as a reduction to buildings and addition to goodwill. . Q1-17 The acquirer must revalue the equity position to its fair value at the acquisition date and recognize a gain. A total of $250,000 ($25 x 10,000 shares) would be recognized in this case assuming that the $65 per share price is the appropriate fair value for all shares (i.e. there is no control premium for the new shares purchased).

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Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

SOLUTIONS TO CASES C1-1 Assignment of Acquisition Costs MEMO To:

Vice-President of Finance Troy Company

From: Re:

, CPA Recording Acquisition Costs of Business Combination

Troy Company incurred a variety of costs in acquiring the ownership of Kline Company and transferring the assets and liabilities of Kline to Troy Company. I was asked to review the relevant accounting literature and provide my recommendations as to what was the appropriate treatment of the costs incurred in the acquisition of Kline Company. Current accounting standards require that acquired companies be valued under ASC 805 at the fair value of the consideration given in the exchange, plus the fair value of any shares of the acquiree already held by the acquirer, plus the fair value of any noncontrolling interest in the acquiree at the combination date [ASC 805]. All other acquisition-related costs directly traceable to an acquisition should be accounted for as expenses in the period incurred [ASC 805]. The costs incurred in issuing common or preferred stock in a business combination are required to be treated as a reduction of the recorded amount of the securities (which would be a reduction to additonal paid-in capital if the stock has a par value or a reduction to common stock for no par stock). A total of $720,000 was paid in completing the Kline acquisition. The $200,000 finders’ fee and $90,000 legal fees for transferring Kline’s assets and liabilities to Troy should be recorded by Kline as acquisition expense in 20X7. The $60,000 payment for stock registration and audit fees should be recorded as a reduction of paid-in capital recorded when the Troy Company shares are issued to acquire the shares of Kline. The only cost potentially at issue is the $370,000 legal fees resulting from the litigation by the shareholders of Kline. If this cost is considered to be a direct acquisition cost, it should be included in acquisition expense. If, on the other hand, it is considered to be related to the issuance of the shares, it should be debited to paid-in capital. Primary citation ASC 805 C1-2 Evaluation of Merger Page numbers refer to the page in the 3M 2005 10-K report. a. The CUNO acquisition improved 3M’s product mix by adding a comprehensive line of filtration products for the separation, clarification and purification of fluids and gases (p. 4). The CUNO acquisition added 5.1 percent to Industrial sales growth (p.13), and was the primary reason for a 1.0 percent increase in total sales in 2005 (p. 15). Copyright © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website in whole or part.

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

b. The acquisition was funded primarily by debt (p.27): The Company generates significant ongoing cash flow. Net debt decreased significantly in 2004, but increased in 2005, primarily related to the $1.36 billion CUNO acquisition. c. As of December 31, 2005, the CUNO acquisition increased accounts receivable by $88 million (p. 27). d. At December 31, 2005, the CUNO acquisition increased inventories by $56 million. Currency translation reduced inventories by $89 million year-on-year (p. 27). C1-3 Business Combinations It is very difficult to develop a single explanation for any series of events. Merger activity in the United States is impacted by events both within the U.S. economy and those around the world. As a result, there are many potential answers to the questions posed in this case. a. The most commonly discussed factors associated with the merger activity of the 1990s relate to the increased profitability of businesses. In the past, increases in profitability typically have been associated with increases in sales. The increased profitability of companies in the 1990s, however, more commonly has been associated with decreased costs. Even though sales remained relatively flat, profits increased. Nearly all business entities appear to have gone through one or more downsizing events during the 1990s. Fewer employees now are delivering the same amount of product to customers. Lower inventory levels and reduced investment in production facilities now are needed due to changes in production processes and delivery schedules. Thus, less investment in facilities and fewer employees have resulted in greater profits. Companies generally have been reluctant to distribute the increased profits to shareholders through dividends. The result has been a number of companies with substantially increased cash reserves. This, in turn, has led management to look about for other investment alternatives, and cash buyouts have become more frequent in this environment. In addition to high levels of cash on hand providing an incentive for business combinations, easy financing through debt and equity also provided encouragement for acquisitions. Throughout the nineties, interest rates were very low and borrowing was generally easy. With the enormous stock-price gains of the mid-nineties, companies found that they had a very valuable resource in shares of their stock. Thus, stock acquisitions again came into favor. b. One factor that may have prompted the greater use of stock in business combinations in the middle and late 1990s is that many of the earlier combinations that had been effected through the use of debt had unraveled. In many cases, the debt burden was so heavy that the combined companies could not meet debt payments. Thus, this approach to financing mergers had somewhat fallen from favor by the mid-nineties. Further, with the spectacular rise in the stock market after 1994, many companies found that their stock was worth much more than previously. Accordingly, fewer shares were needed to acquire other companies.

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

c. Two of major factors appear to have had a significant influence on the merger movement in the mid-2000s. First, interest rates were very low during that time, and a great amount of unemployed cash was available worldwide. Many business combinations were effected through significant borrowing. Second, private equity funds pooled money from various institutional investors and wealthy individuals and used much of it to acquire companies. Many of the acquisitions of this time period involved private equity funds or companies that acquired other companies with the goal of making quick changes and selling the companies for a profit. This differed from prior merger periods where acquiring companies were often looking for long-term acquisitions that would result in synergies. In late 2008, a mortgage crisis spilled over into the credit markets in general, and money for acquisitions became hard to get. This in turn caused many planned or possible mergers to be canceled. In addition, the economy in general faltered toward the end of 2008 and into 2009. d. Establishing incentives for corporate mergers is a controversial issue. Many people in our society view mergers as not being in the best interests of society because they are seen as lessening competition and often result in many people losing their jobs. On the other hand, many mergers result in companies that are more efficient and can compete better in a global economy; this in turn may result in more jobs and lower prices. Even if corporate mergers are viewed favorably, however, the question arises as to whether the government, and ultimately the taxpayers, should be subsidizing those mergers through tax incentives. Many would argue that the desirability of individual corporate mergers, along with other types of investment opportunities, should be determined on the basis of the merits of the individual situations rather than through tax incentives. Perhaps the most obvious incentive is to lower capital gains tax rates. Businesses may be more likely to invest in other companies if they can sell their ownership interests when it is convenient and pay lesser tax rates. Another alternative would include exempting certain types of intercorporate income. Favorable tax status might be given to investment in foreign companies through changes in tax treaties. As an alternative, barriers might be raised to discourage foreign investment in United States, thereby increasing the opportunities for domestic firms to acquire ownership of other companies. e. In an ideal environment, the accounting and reporting for economic events would be accurate and timely and would not influence the economic decisions being reported. Any change in reporting requirements that would increase or decrease management's ability to "manage" earnings could impact management's willingness to enter new or risky business fields and affect the level of business combinations. Greater flexibility in determining which subsidiaries are to be consolidated, the way in which intercorporate income is calculated, the elimination of profits on intercompany transfers, or the process used in calculating earnings per share could impact such decisions. The processes used in translating foreign investment into United States dollars also may impact management's willingness to invest in domestic versus international alternatives.

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

C1-4 Determination of Goodwill Impairment MEMO TO: Chief Accountant Plush Corporation From:

, CPA

Re:

Determining Impairment of Goodwill

Once goodwill is recorded in a business combination, it must be accounted for in accordance with current accounting literature. Goodwill is carried forward at the original amount without amortization, unless it becomes impaired. The amount determined to be goodwill in a business combination must be assigned to the reporting units of the acquiring entity that are expected to benefit from the synergies of the combination. [ ASC 350-20-35-41] This means the total amount assigned to goodwill may be divided among a number of reporting units. Goodwill assigned to each reporting unit must be tested for impairment annually and between the annual tests in the event circumstances arise that would lead to a possible decrease in the fair value of the reporting unit below its carrying amount [ ASC 350-20-35-30]. As long as the fair value of the reporting unit is greater than its carrying value, goodwill is not considered to be impaired. If the fair value is less than the carrying value, a second test must be performed. An impairment loss must be reported if the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill. [ASC 350-20-35-11] At the date of acquisition, Plush Corporation recognized goodwill of $20,000 ($450,000 $430,000) and assigned it to a single reporting unit. Even though the fair value of the reporting unit increased to $485,000 at December 31, 20X5, Plush Corporation must test for impairment of goodwill if the carrying value of Plush’s investment in the reporting unit is above that amount. That would be the case if the carrying value is $500,000. In the second test, the fair value of the reporting unit’s net assets, excluding goodwill, is deducted from the fair value of the reporting unit ($485,000) to determine the amount of implied goodwill at that date. If the fair value of the net assets is less than $465,000, the amount of implied goodwill is more than $20,000 and no impairment of goodwill is assumed to have occurred. On the other hand, if the fair value of the net assets is greater than $465,000, the amount of implied goodwill is less than $20,000 and an impairment of goodwill must be recorded. With the information provided, we do not know if there has been an impairment of the goodwill involved in the purchase of Common Corporation; however, Plush must follow the procedures outlined above in testing for impairment at December 31, 20X5. Primary citations ASC 350-20-35-11 ASC 350-20-35-30 ASC 350-20-35-41

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

C1-5 Risks Associated with Acquisitions Google discloses on page 21 of its 2006 Form 10-K that it does not have significant experience acquiring companies. It also notes that most acquisitions the company has already completed have been small companies. The specific risk areas identified include: •

The potential need to implement controls, procedures, and policies appropriate for a public company that were not already in place in the acquired company

•

Potential difficulties in integrating the accounting, management information, human resources, and other administrative systems.

•

The use of management time on acquisitions-related activities that may temporarily divert attention from operating activities

•

Potential difficulty in integrating the employees of an acquired company into the Google organization

•

Retaining employees who worked for companies that Google acquires

•

Anticipated benefits of acquisitions may not materialize.

•

Foreign acquisitions may include additional unique risks including potential difficulties arising from differences in cultures and languages, currencies, and from economic, political, and regulatory risks.

C1-6 Numbers Game a. A company is motivated to keep its stock price high. However, stock price is very sensitive to information about company performance. When the company reports lower earnings than the market anticipated, the stock price often falls significantly. A desire to increase reported earnings to meet the expectations of Wall Street may provide a company with incentives to manipulate earnings to achieve this goal. b. Levitt discusses 5 specific techniques: (1) "big bath" restructuring charges, (2) creative acquisition accounting, (3) "cookie jar reserves," (4) improper application of the materiality principal, and (5) improper recognition of revenue. Following Levitt’s speech, the FASB subsequently dealt with each of these issues. Accounting standards since that time have limited these earnings management techniques. c. Levitt notes meaningful disclosure to investors about company performance is necessary for investors to trust and feel confident in the information they are using to make investing decisions. Levitt believes this trust is the bedrock of our financial markets and is required for the efficient functioning of U.S. capital markets.

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

C1-7 MCI: A Succession of Mergers The story of MCI WorldCom (later, MCI) is the story of the man who is largely responsible for both the rise and fall of MCI WorldCom. Bernard Ebbers was Chief Executive Officer of MCI until he resigned under pressure from the Board of Directors in April 2002. He put together over five dozen acquisitions in the two decades prior to stepping down. In 1983, he and three friends bought a small phone company which they named LDDS (Long Distance Discount Services); he became CEO of the company in 1985 and guided its growth strategy. In 1989, LDDS combined with Advantage Co., keeping the LDDS name, to provide long-distance service to 11 Southern and Midwestern states. LDDS merged with Advanced Telecommunications Corporation in 1992 in an exchange of stock accounted for as a pooling of interests. In 1993, LDDS merged with Metromedia Communications Corporation and Resurgens Communications Group, with the combined company maintaining the LDDS name and LDDS treated as the surviving company for accounting purposes (although legally Resurgens was the surviving company). In 1994, the company merged with IDB Communications Group in an exchange of stock accounted for as a pooling. In 1995, LDDS purchased for cash the network services operations of Williams Telecommunications Group. Later in 1995, the company changed its name to WorldCom, Inc. In 1996, WorldCom acquired the large Internet services provider UUNET by merging with its parent company, MFS Communications Company, in an exchange of stock. In 1997, WorldCom purchased the Internet and networking divisions of America Online and CompuServe in a threeway stock and asset swap. In 1998, the Company acquired MCI Communications Corporation for approximately $40 billion, and subsequently the name of the company was changed to MCI WorldCom. This merger was accounted for as a purchase. In 1998, the Company also acquired CompuServe for 56 million MCI WorldCom common shares in a business combination accounted for as a purchase. In 1999, MCI WorldCom acquired SkyTel for 23 million MCI WorldCom common shares in a pooling of interests. An attempt to acquire Sprint in 1999, in a deal billed as the biggest in corporate history, was scuttled due to antitrust concerns. MCI WorldCom’s long distance and other businesses experienced major declines in 2000 and profits began to fall. Continued deterioration of operations and cash flows and disclosure of a massive accounting fraud in June 2002, led MCI WorldCom to file for bankruptcy protection in July 2002, in the largest Chapter 11 case in U.S. history at that time.1 Subsequent discoveries of additional inappropriate accounting activities and restatements of financial statements further blemished the company’s reputation. In April 2003, WorldCom filed a plan of reorganization with the SEC and changed the company name from WorldCom to MCI. The company went through a period of retrenchment, and in early 2006 merged with Verizon Communications. Thus, MCI is no longer a separate company but rather is part of Verizon’s wireline business. Criminal charges were filed against Bernard Ebbers and five other former executives of WorldCom in connect with a major fraud investigation. The company also was charged and eventually reached a settlement with the SEC, agreeing to pay $500 million of cash and 10 million shares of common stock of MCI. Bernard Ebbers was tried for an $11 billion accounting fraud and in 2005 was found guilty of all nine counts with which he was charged. He was sentenced to 25 years in prison, with confiscation of nearly all of his assets. Ebbers is currently in the Oakdale Federal Correctional Complex in Louisiana.

1 Since this time, Lehman Brothers and Washington Mutual have had bigger bankruptcy filings.

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Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

C1-8 Leveraged Buyouts a. A leveraged buyout (LBO) involves acquiring a company in a transaction or series of planned transactions that include using a very high proportion of debt, often secured by the assets of the target company. Normally, the investors acquire all of the stock or assets of the target company. A management buyout (MBO) occurs when the existing management of a company acquires all or most of the stock or assets of the company. Frequently, the investors in LBOs include management, and thus an LBO may also be an MBO b. The FASB has not dealt with leveraged buyouts in either current pronouncements or exposure drafts of proposed standards. The Emerging Issues Task Force has addressed limited aspects of accounting for LBOs. In EITF 84-23, “Leveraged Buyout Holding Company Debt,” the Task Force did not reach a consensus. In EITF 88-16, “Basis in Leveraged Buyout Transactions,” the Task Force did provide guidance as to the proper basis that should be recognized for an acquiring company’s interest in a target company acquired through a leveraged buyout. c. Whether an LBO is a type of business combination is not clear and probably depends on the structure of the buyout. The FASB has not taken a position on whether an LBO is a type of business combination. The EITF indicated that LBOs of the type it was considering are similar to business combinations. Most LBOs are effected by establishing a holding company for the purpose of acquiring the assets or stock of the target company. Such a holding company has no substantive operations. Some would argue that a business combination can occur only if the acquiring company has substantive operations. However, neither the FASB nor EITF has established such a requirement. Thus, the question of whether an LBO is a business combination is unresolved. d. The primary issue in deciding the proper basis for an interest in a company acquired in an LBO, as determined by EITF 88-16, is whether the transaction has resulted in a change in control of the target company (a new controlling shareholder group has been established). If a change in control has not occurred, the transaction is treated as a recapitalization or restructuring, and a change in basis is not appropriate (the previous basis carries over). If a change in control has occurred, a new basis of accounting may be appropriate.

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

SOLUTIONS TO EXERCISES E1-1 Multiple-Choice Questions on Complex Organizations 1. b – As companies grow in size and respond to their unique business environment, they often develop complex organizational and ownership structures. (a) Incorrect. The need to avoid legal liability is not a direct result of increased complexity. (c) Incorrect. Part of the reason the business environment is complex is due to the increased number and type of divisions and product lines in companies. (d) Incorrect. This statement is false. There has been an impact on organizational structure and management. 2. d – A transfer of product to a subsidiary does not constitute a sale for income purposes and as such would not increase profit for the parent. (a) Incorrect. Shifting risk is a common reason for establishing a subsidiary. (b) Incorrect. Corporations often establish subsidiaries in other regulatory environments so that the parent company is not explicitly affected by the regulatory control. (c) Incorrect. Corporations will often establish subsidiaries to take advantage of tax benefits that exist in different regions. 3. a – When a merger occurs, all the assets and liabilities are transferred to the purchasing company and any excess of the purchase price over the fair value of the net assets is recorded as goodwill on the purchaser’s books. (b) Incorrect. This combination results in a parent-subsidiary relationship in which an investment in Penn would be recorded. In the event that goodwill were present in this transaction, it would be reported on the consolidated books and not Randolph’s books. (c) Incorrect. In a spin-off, no change to net assets occurs, and consequently no goodwill is recorded. (d) Incorrect. In a split-off, no change to net assets occurs, and consequently no goodwill is recorded. 4. b – In an internal expansion in which the existing company creates a new subsidiary, the assets and liabilities are recorded at the carrying values of the original company. (a) Incorrect. This is not in accordance with GAAP; assets are transferred at the parent’s book (carrying) value. (c) Incorrect. Not in accordance with US GAAP; no gain or loss is permitted because the assets are transferred at the parent’s book value. (d) Incorrect. Not in accordance with US GAAP – Goodwill is not created when a company creates a subsidiary through internal expansion. 5. d – This is the proper impairment test required under US GAAP, according to FASB 142/ASC 350. (a) Incorrect. This is not the proper test for impairment under US GAAP. (b) Incorrect. This is not the proper test for impairment under US GAAP. (c) Incorrect. This is not the proper test for impairment under US GAAP. Copyright © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website in whole or part.

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-2 Multiple-Choice Questions on Recording Business Combinations [AICPA Adapted] 1. a – The excess sum of the consideration given over the sum of the fair value of identifiable assets less liabilities equals goodwill. (b) Incorrect. Assets considered only need be identifiable, not just tangible. For example, patents would be identifiable, but not tangible. (c) Incorrect. Assets considered only have to be identifiable. This includes both tangible and intangible identifiable assets. (d) Incorrect. The calculation of goodwill requires a remeasurement of the assets and liabilities at fair value, not book value. 2. c – “Costs of issuing equity securities used to acquire the acquire are treated in the same manner as stock issue costs are normally treated, as a reduction in the paid-in capital associated with the securities” A reduction to the paid-in capital account results in a reduction in the fair value of the securities issued. (a) Incorrect. Stock issue costs are not expensed but are charged as a reduction in paidin capital. (b) Incorrect. Stock issue costs result in a reduction of stockholder’s equity, not an increase. (d) Incorrect. Stock issue costs result in a reduction of equity, and are not capitalized. They are not added to goodwill. 3. d – When a new company is acquired, the assets and liabilities are recorded at fair value. (a) Incorrect. Historical cost is not always reflective of actual value, thus fair values are used. (b) Incorrect. Book value is often different than fair value, thus fair value is the appropriate basis. (c) Incorrect. This method is also unacceptable. Fair value is the appropriate basis. 4. d – This combination would result in a bargain purchase. (a) Incorrect. Deferred credits do not arise as a result of fair value of identifiable assets exceeding fair value of the consideration. (b) Incorrect. The fair value is not reduced, and deferred credits do not arise in this situation. (c) Incorrect. The fair value is not reduced, and deferred credits do not arise in this situation. 5. c – $875,000 – $800,000 = $75,000. Total consideration given – FV of net assets = Goodwill

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-3 Multiple-Choice Questions on Reported Balances [AICPA Adapted] 1. d – $2,900,000. New APIC Balance = existing APIC on Poe’s books + APIC from new stock issuance. (200,000*($18-$10) + $1,300,000 = $2,900,000) 2. d – $600,000. The total balance in the investment account is equal to the total consideration given in the combination. (10,000 *$60 per share = $600,000) 3. c – $150,000. Goodwill = Consideration given – FV of net assets acquired. FV of Net Assets: $80,000 + $190,000 + $560,000 - $180,000 = $650,000. (800,000 – 650,000 = 150,000) 4. c – $4,000,000. The increase in net assets is solely attributable to the FV of the consideration given, the nonvoting preferred stock. (a) Incorrect. This answer only reflects the book value of Master’s net assets. (b) Incorrect. This answer only reflects the fair value of Master’s net assets. (d) Incorrect. The additional stock related to the finder’s fee is not capitalized, but rather expensed. E1-4 Multiple-Choice Questions Involving Account Balances 1. c – When the parent creates the subsidiary, the equipment is transferred at cost with the accompanying accumulated depreciation (which in effect is the book value). ($100,000/10 = $10,000 per year * 4 = $40,000.) (a) Incorrect. When a subsidiary is created internally, the assets are transferred as they were on the parent’s books (carrying value). Fair value is not considered. (b) Incorrect. This is the proper carrying value of the asset, but it should be recorded at cost with the accompanying accumulated depreciation. (d) Incorrect. When a subsidiary is created internally, the assets are transferred as they were on the parent’s books (carrying value). 2. c – The assets are transferred at the carrying value on the parent’s books, and thus no change in reported net assets occurs. (a) Incorrect. No change occurs. (b) Incorrect. No change occurs. (d) Incorrect. No change occurs. 3. b – APIC = $140,000 (BV) – 7,000 * $8 = $84,000. 4. b – $35,000. The implied valued of goodwill is $45,000 ($395,000 - $350,000). Because goodwill is not adjusted upward, the goodwill remains at the carrying value of $35,000 5. b – $30,000. The implied value of goodwill is $60,000 ($560,000 - $500,000). Because the implied goodwill is less than the recorded goodwill, an impairment of $30,000 results ($90,000 - $60,000).

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-5 Asset Transfer to Subsidiary a. Journal entry recorded by Pale Company for transfer of assets to Bright Company: Investment in Bright Company Common Stock Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Cash Inventory Land Buildings Equipment

408,000 24,000 36,000 21,000 37,000 80,000 240,000 90,000

b. Journal entry recorded by Bright Company for receipt of assets from Pale Company: Cash Inventory Land Buildings Equipment Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Common Stock Additional Paid-In Capital

21,000 37,000 80,000 240,000 90,000 24,000 36,000 60,000 348,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-6 Creation of New Subsidiary a. Journal entry recorded by Lester Company for transfer of assets to Mumby Corporation: Investment in Mumby Corporation Common Stock Allowance for Uncollectible Accounts Receivable Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Cash Accounts Receivable Inventory Land Buildings Equipment

498,000 7,000 35,000 60,000 40,000 75,000 50,000 35,000 160,000 240,000

b. Journal entry recorded by Mumby Corporation for receipt of assets from Lester Company: Cash Accounts Receivable Inventory Land Buildings Equipment Allowance for Uncollectible Accounts Receivable Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Common Stock Additional Paid-In Capital

40,000 75,000 50,000 35,000 160,000 240,000 7,000 35,000 60,000 120,000 378,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-8 Acquisition of Net Assets Sun Corporation will record the following journal entries: (1)

(2)

Assets Goodwill Liabilities Cash

71,000 9,000

Merger Expense Cash

4,000

20,000 60,000 4,000

E1-9 Reporting Goodwill a. Goodwill: $120,000 = $310,000 - $190,000 Investment: $310,000 b. Goodwill: $6,000 = $196,000 - $190,000 Investment: $196,000 c. Goodwill: $0; no goodwill is recorded when the purchase price is below the fair value of the net identifiable assets. Investment: $190,000; recorded at the fair value of the net identifiable assets. E1-10 Stock Acquisition Journal entry to record the purchase of Tippy Inc., shares: Investment in Tippy Inc., Common Stock Common Stock Additional Paid-In Capital

986,000 425,000 561,000

$986,000 = $58 x 17,000 shares $425,000 = $25 x 17,000 shares $561,000 = ($58 - $25) x 17,000 shares

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-11 Balances Reported Following Combination a. Stock Outstanding: $200,000 + ($10 x 8,000 shares)

$280,000

b. Cash and Receivables: $150,000 + $40,000

190,000

185,000

Land: $100,000 + $85,000

d. Buildings and Equipment (net): $300,000 + $230,000

530,000

e. Goodwill: ($50 x 8,000) - $355,000

45,000

Additional Paid-In Capital: $20,000 + [($50 - $10) x 8,000]

340,000

g. Retained Earnings

330,000

E1-12 Goodwill Recognition Journal entry to record acquisition of Spur Corporation net assets: Cash and Receivables Inventory Land Plant and Equipment Patent Goodwill Accounts Payable Cash

40,000 150,000 30,000 350,000 130,000 55,000 85,000 670,000

Computation of goodwill Fair value of consideration given Fair value of assets acquired Fair value of liabilities assumed Fair value of net assets acquired Goodwill

$670,000 $700,000 (85,000) 615,000 $ 55,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-13 Acquisition Using Debentures Journal entry to record acquisition of Sorden Company net assets: Cash and Receivables Inventory Land Plant and Equipment Discount on Bonds Payable Goodwill Accounts Payable Bonds Payable

50,000 200,000 100,000 300,000 17,000 8,000 50,000 625,000

Computation of goodwill Fair value of consideration given Fair value of assets acquired Fair value of liabilities assumed Fair value of net assets acquired Goodwill

$608,000 $650,000 (50,000) 600,000 $ 8,000

E1-14 Bargain Purchase Journal entry to record acquisition of Sorden Company net assets: Cash and Receivables Inventory Land Plant and Equipment Discount on Bonds Payable Accounts Payable Bonds Payable Gain on Bargain Purchase of Subsidiary

50,000 200,000 100,000 300,000 16,000 50,000 580,000 36,000

Computation of Bargain Purchase Gain Fair value of consideration given Fair value of assets acquired Fair value of liabilities assumed Fair value of net assets acquired Bargain Purchase Gain

$564,000 $650,000 (50,000) 600,000 $ 36,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-15 Impairment of Goodwill a. Goodwill of $80,000 will be reported. The fair value of the reporting unit ($340,000) is greater than the carrying amount of the investment ($290,000) and the goodwill does not need to be tested for impairment. As a result, no loss will be recorded. b. Goodwill of $35,000 will be reported (fair value of reporting unit of $280,000 - fair value of net assets of $245,000). An impairment loss of $45,000 ($80,000 - $35,000) will be recognized. c. Goodwill of $15,000 will be reported (fair value of reporting unit of $260,000 - fair value of net assets of $245,000). An impairment loss of $65,000 ($80,000 - $15,000) will be recognized. E1-16 Assignment of Goodwill a. No impairment loss will be recognized. The fair value of the reporting unit ($530,000) is greater than the carrying value of the investment ($500,000) and goodwill does not need to be tested for impairment. b. An impairment of goodwill of $15,000 will be recognized. The implied value of goodwill is $45,000 ($485,000 - $440,000), which represents a $15,000 decrease from the original $60,000. c. An impairment of goodwill of $50,000 will be recognized. The implied value of goodwill is $10,000 ($450,000 - $440,000), which represents a $50,000 decrease from the original $60,000. E1-17 Goodwill Assigned to Reporting Units Goodwill of $158,000 ($60,000 + $48,000 + $0 + $50,000) should be reported, computed as follows: Reporting Unit A: Goodwill of $60,000 should be reported. The implied value of goodwill is $90,000 ($690,000 - $600,000) and the carrying amount of goodwill is $60,000. Reporting Unit B: Goodwill of $48,000 should be reported. The fair value of the reporting unit ($335,000) is greater than the carrying value of the investment ($330,000). Reporting Unit C: No goodwill should be reported. The fair value of the net assets ($400,000) exceeds the fair value of the reporting unit ($370,000). Reporting Unit D: Goodwill of $50,000 should be reported. The fair value of the reporting unit ($585,000) is greater than the carrying value of the investment ($520,000).

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-18 Goodwill Measurement a. Goodwill of $150,000 will be reported. The fair value of the reporting unit ($580,000) is greater than the carrying value of the investment ($550,000) and goodwill does not need to be tested for impairment. No loss will be recorded. b. Goodwill of $50,000 will be reported. The implied value of goodwill is $50,000 (fair value of reporting unit of $540,000 - fair value of net assets of $490,000). Thus, an impairment of goodwill of $100,000 ($150,000 - $50,000) must be recognized. c. Goodwill of $10,000 will be reported. The implied value of goodwill is $10,000 (fair value of reporting unit of $500,000 - fair value of net assets of $490,000). Thus, an impairment loss of $140,000 ($150,000 - $10,000) must be recognized. d. No goodwill will be reported. The fair value of the net assets ($490,000) exceeds the fair value of the reporting unit ($460,000). Thus, the implied value of goodwill is $0 and an impairment loss of $150,000 ($150,000 - $0) must be recognized. E1-19 Computation of Fair Value Amount paid Book value of assets Book value of liabilities Book value of net assets Adjustment for research and development costs Adjusted book value Fair value of patent rights Goodwill recorded Fair value increment of buildings and equipment Book value of buildings and equipment Fair value of buildings and equipment

$517,000 $624,000 (356,000) $268,000 (40,000) $228,000 120,000 93,000

(441,000) $ 76,000 341,000 $417,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-20 Computation of Shares Issued and Goodwill a. 15,600 shares were issued, computed as follows: Par value of shares outstanding following merger Paid-in capital following merger Total par value and paid-in capital Par value of shares outstanding before merger Paid-in capital before merger

$327,600 650,800 $978,400 $218,400 370,000 (588,400) $390,000 ÷ $25 15,600

Increase in par value and paid-in capital Divide by price per share Number of shares issued b. The par value is $7, computed as follows: Increase in par value of shares outstanding ($327,600 - $218,400) Divide by number of shares issued Par value

$109,200 ÷ 15,600 $ 7.00

c. Goodwill of $34,000 was recorded, computed as follows: Increase in par value and paid-in capital Fair value of net assets ($476,000 - $120,000) Goodwill

$390,000 (356,000) $ 34,000

E1-21 Combined Balance Sheet Adam Corporation and Best Company Combined Balance Sheet January 1, 20X2 Cash and Receivables Inventory Buildings and Equipment Less: Accumulated Depreciation Goodwill

$ 240,000 460,000 840,000 (250,000) 75,000 $1,365,000

Accounts Payable Notes Payable Common Stock Additional Paid-In Capital Retained Earnings

$ 125,000 235,000 244,000 556,000 205,000 $1,365,000

Computation of goodwill Fair value of compensation given Fair value of net identifiable assets ($490,000 - $85,000) Goodwill

$480,000 (405,000) $ 75,000

Computation of APIC Fair value of compensation given ($60 x 8,000 shares) Less par value of shares issued ($8 x 8,000) Plus existing APIC from Adam’s books

$480,000 (64,000) 140,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

Additional Paid-In Capital

$ 556,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

E1-22 Recording a Business Combination Merger Expense Deferred Stock Issue Costs Cash

54,000 29,000

Cash Accounts Receivable Inventory Land Buildings and Equipment Goodwill (1) Accounts Payable Bonds Payable Bond Premium Common Stock Additional Paid-In Capital (2) Deferred Stock Issue Costs

70,000 110,000 200,000 100,000 350,000 30,000

83,000

195,000 100,000 5,000 320,000 211,000 29,000

Computation of goodwill Fair value of consideration given (40,000 x $14) Fair value of assets acquired Fair value of liabilities assumed Fair value of net assets acquired Goodwill

$560,000 $830,000 (300,000) (530,000) $ 30,000

Computation of additional paid-in capital Number of shares issued Issue price in excess of par value ($14 - $8) Total Less: Deferred stock issue costs Increase in additional paid-in capital

40,000 x $6 $240,000 (29,000) $211,000

E1-23 Reporting Income 20X2:

Net income Earnings per share

= =

$6,028,000 [$2,500,000 + $3,528,000] $5.48 [$6,028,000 / (1,000,000 + 100,000*)]

20X1:

Net income Earnings per share

= =

$4,460,000 [previously reported] $4.46 [$4,460,000 / 1,000,000]

* 100,000 = 200,000 shares x ½ year

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

SOLUTIONS TO PROBLEMS P1-24 Assets and Accounts Payable Transferred to Subsidiary a. Journal entry recorded by Tab Corporation for its transfer of assets and accounts payable to Collon Company: Investment in Collon Company Common Stock Accounts Payable Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Cash Inventory Land Buildings Equipment

320,000 45,000 40,000 10,000 25,000 70,000 60,000 170,000 90,000

b. Journal entry recorded by Collon Company for receipt of assets and accounts payable from Tab Corporation: Cash Inventory Land Buildings Equipment Accounts Payable Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Common Stock Additional Paid-In Capital

25,000 70,000 60,000 170,000 90,000 45,000 40,000 10,000 180,000 140,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-25 Creation of New Subsidiary a. Journal entry recorded by Eagle Corporation for transfer of assets and accounts payable to Sand Corporation: Investment in Sand Corporation Common Stock Allowance for Uncollectible Accounts Receivable Accumulated Depreciation Accounts Payable Cash Accounts Receivable Inventory Land Buildings and Equipment

400,000 5,000 40,000 10,000 30,000 45,000 60,000 20,000 300,000

b. Journal entry recorded by Sand Corporation for receipt of assets and accounts payable from Eagle Corporation: Cash Accounts Receivable Inventory Land Buildings and Equipment Allowance for Uncollectible Accounts Receivable Accumulated Depreciation Accounts Payable Common Stock Additional Paid-In Capital

30,000 45,000 60,000 20,000 300,000 5,000 40,000 10,000 50,000 350,000

P1-26 Incomplete Data on Creation of Subsidiary a. The book value of assets transferred was $152,000 ($3,000 + $16,000 + $27,000 + $9,000 + $70,000 + $60,000 - $21,000 - $12,000). b. Thumb Company would report its investment in New Company equal to the book value of net assets transferred of $138,000 ($152,000 - $14,000). c. 8,000 shares ($40,000/$5). d. Total assets declined by $14,000 (book value of assets transferred of $152,000 - investment in New Company of $138,000). e. No effect. The shares outstanding reported by Thumb Company are not affected by the creation of New Company.

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-27 Acquisition in Multiple Steps Deal Corporation will record the following entries: (1)

(2)

(3)

Investment in Mead Company Stock Common Stock - $10 Par Value Additional Paid-In Capital

85,000

Merger Expense Additional Paid-In Capital Cash

3,500 2,000

Investment in Mead Company Stock Gain on Increase in Value of Mead Company Stock

6,000

Calculation of Gain: Fair value on date of full acquisition Fair value of consideration given Prior investment amount Gain on Increase in Value

40,000 45,000

5,500 6,000

$100,000 (85,000) (9,000) $ 6,000

P1-28 Journal Entries to Record a Business Combination Journal entries to record acquisition of TKK net assets: (1) Merger Expense Cash Record payment of legal fees.

14,000

(2) Deferred Stock Issue Costs Cash Record costs of issuing stock.

28,000

(3) Cash and Receivables Inventory Buildings and Equipment Goodwill Accounts Payable Notes Payable Common Stock Additional Paid-In Capital Deferred Stock Issue Costs Record purchase of TKK Corporation.

28,000 122,000 470,000 12,000

14,000

28,000

41,000 63,000 96,000 404,000 28,000

Computation of goodwill Fair value of consideration given (24,000 x $22) Fair value of net assets acquired ($620,000 - $104,000) Goodwill

$528,000 (516,000) $ 12,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

Computation of additional paid-in capital Number of shares issued Issue price in excess of par value ($22 - $4) Total Less: Deferred stock issue costs Increase in additional paid-in capital

24,000 x $18 $432,000 (28,000) $404,000

P1-29 Recording Business Combinations Merger Expense Deferred Stock Issue Costs Cash

38,000 22,000

Cash and Equivalents Accounts Receivable Inventory Land Buildings Equipment Goodwill Accounts Payable Short-Term Notes Payable Bonds Payable Common Stock $2 Par Additional Paid-In Capital Deferred Stock Issue Costs

41,000 73,000 144,000 200,000 1,500,000 300,000 127,000

60,000

35,000 50,000 500,000 900,000 878,000 22,000

Computation of goodwill Fair value of consideration given (450,000 x $4) Fair value of net assets acquired ($41,000 + $73,000 + $144,000 + $200,000 + $1,500,000 + $300,000 - $35,000 - $50,000 - $500,000) Goodwill

$1,800,000

(1,673,000) $ 127,000

Computation of additional paid-in capital Number of shares issued Issue price in excess of par value ($4 - $2) Total Less: Deferred stock issue costs Increase in additional paid-in capital

450,000 x $2 $900,000 (22,000) $878,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-30 Business Combination with Goodwill a. Journal entry to record acquisition of Zink Company net assets: Cash Accounts Receivable Inventory Patents Buildings and Equipment Goodwill Accounts Payable Notes Payable Cash

20,000 35,000 50,000 60,000 150,000 38,000 55,000 120,000 178,000

b. Balance sheet immediately following acquisition: Anchor Corporation and Zink Company Combined Balance Sheet February 1, 20X3 Cash Accounts Receivable Inventory Patents Buildings and Equipment Less: Accumulated Depreciation Goodwill

$ 82,000 175,000 220,000 140,000 530,000

Accounts Payable Notes Payable Common Stock Additional Paid-In Capital Retained Earnings

$140,000 270,000 200,000 160,000 225,000

(190,000) 38,000 $995,000

$995,000

c. Journal entry to record acquisition of Zink Company stock: Investment in Zink Company Common Stock Cash

178,000 178,000

Computation of goodwill Fair value of consideration given Fair value of net assets acquired ($20,000 + $35,000 + $50,000 + $60,000 + $150,000 - $55,000 -$120,000) Goodwill

$178,000 (140,000) $ 38,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-31 Bargain Purchase Journal entries to record acquisition of Lark Corporation net assets: Merger Expense Cash Cash and Receivables Inventory Buildings and Equipment (net) Patent Accounts Payable Cash Gain on Bargain Purchase of Lark Corporation

5,000 5,000 50,000 150,000 300,000 200,000 30,000 625,000 45,000

Computation of gain Fair value of consideration given Fair value of net assets acquired ($700,000 - $30,000) Gain on bargain purchase

$625,000 (670,000) $ 45,000

P1-32 Computation of Account Balances a.

Liabilities reported by the Aspro Division at year-end: Fair value of reporting unit at year-end Acquisition price of reporting unit ($7.60 x 100,000) Fair value of net assets at acquisition ($810,000 - $190,000) Goodwill at acquisition Impairment in current year Goodwill at year-end Fair value of net assets at year-end Fair value of assets at year-end Fair value of net assets at year-end Fair value of liabilities at year-end

b. Required fair value of reporting unit: Fair value of assets at year-end Fair value of liabilities at year-end (given) Fair value of net assets at year-end Original goodwill balance Required fair value of reporting unit to avoid recognition of impairment of goodwill

$930,000 $760,000 (620,000) $140,000 (30,000) (110,000) $820,000 $950,000 (820,000) $130,000

$ 950,000 (70,000) $ 880,000 140,000 $1,020,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-33 Goodwill Assigned to Multiple Reporting Units a. Goodwill to be reported by Rover Company: A $70,000 90,000 70,000

Carrying value of goodwill Implied goodwill at year-end Goodwill to be reported at year-end

Reporting Unit B $80,000 50,000 50,000

Total goodwill to be reported at year-end: Reporting unit A Reporting unit B Reporting unit C Total goodwill to be reported Computation of implied goodwill Reporting unit A Fair value of reporting unit Fair value of identifiable assets Fair value of accounts payable Fair value of net assets Implied goodwill at year-end

C $40,000 75,000 40,000 $ 70,000 50,000 40,000 $160,000

$400,000 $350,000 (40,000) (310,000) $ 90,000

Reporting unit B Fair value of reporting unit Fair value of identifiable assets Fair value of accounts payable Fair value of net assets Implied goodwill at year-end

$450,000 (60,000)

Reporting unit C Fair value of reporting unit Fair value of identifiable assets Fair value of accounts payable Fair value of net assets Implied goodwill at year-end

$200,000 (10,000)

$440,000 (390,000) $ 50,000 $265,000 (190,000) $ 75,000

b. Goodwill impairment of $30,000 ($80,000 - $50,000) must be reported in the current period for reporting unit B.

1-30

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-34 Journal Entries Journal entries to record acquisition of Light Steel net assets: (1) Merger Expense Cash Record finder's fee and transfer costs.

19,000

(2) Deferred Stock Issue Costs Cash Record audit fees and stock registration fees.

9,000

(3) Cash Accounts Receivable Inventory Land Buildings and Equipment Bond Discount Goodwill Accounts Payable Bonds Payable Common Stock Additional Paid-In Capital Deferred Stock Issue Costs Record merger with Light Steel Company.

19,000

9,000 60,000 100,000 115,000 70,000 350,000 20,000 95,000 10,000 200,000 120,000 471,000 9,000

Computation of goodwill Fair value of consideration given (12,000 x $50) Fair value of net assets acquired ($695,000 - $10,000 - $180,000) Goodwill

$600,000 (505,000) $ 95,000

Computation of additional paid-in capital Number of shares issued Issue price in excess of par value ($50 - $10) Total Less: Deferred stock issue costs Increase in additional paid-in capital

1-31

12,000 x $40 $480,000 (9,000) $471,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-35 Purchase at More than Book Value a. Journal entry to record acquisition of Stafford Industries net assets: Cash Accounts Receivable Inventory Land Buildings and Equipment Bond Discount Goodwill Accounts Payable Bonds Payable Common Stock Additional Paid-In Capital

30,000 60,000 160,000 30,000 350,000 5,000 125,000 10,000 150,000 80,000 520,000

b. Balance sheet immediately following acquisition: Ramrod Manufacturing and Stafford Industries Combined Balance Sheet January 1, 20X2 Cash Accounts Receivable Inventory Land Buildings and Equipment Less: Accumulated Depreciation Goodwill

$ 100,000 160,000 360,000 80,000 950,000

Accounts Payable Bonds Payable Less: Discount Common Stock Additional Paid-In Capital (250,000) Retained Earnings 125,000 $1,525,000

$ $450,000 (5,000)

1-32

445,000 280,000 560,000 180,000 $1,525,000

Computation of goodwill Fair value of consideration given (4,000 x $150) Fair value of net assets acquired ($630,000 - $10,000 - $145,000) Goodwill

60,000

$600,000 (475,000) $125,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-36 Business Combination Journal entry to record acquisition of Toot-Toot Tuba net assets: Cash Accounts Receivable Inventory Plant and Equipment Other Assets Goodwill Allowance for Uncollectibles Accounts Payable Notes Payable Mortgage Payable Bonds Payable Capital Stock ($10 par) Premium on Capital Stock

300 17,000 35,000 500,000 25,800 86,500 1,400 8,200 10,000 50,000 100,000 90,000 405,000

Computation of fair value of net assets acquired Cash Accounts Receivable Allowance for Uncollectible Accounts Inventory Plant and Equipment Other Assets Accounts Payable Notes Payable Mortgage Payable Bonds Payable Fair value of net assets acquired

$300 17,000 (1,400) 35,000 500,000 25,800 (8,200) (10,000) (50,000) (100,000) $408,500

Computation of goodwill Fair value of consideration given (9,000 x $55) Fair value of net assets acquired Goodwill

1-33

$495,000 (408,500) $86,500

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-37 Combined Balance Sheet a. Balance sheet: Bilge Pumpworks and Seaworthy Rope Company Combined Balance Sheet January 1, 20X3 Cash and Receivables Inventory Land Plant and Equipment Less: Accumulated Depreciation Goodwill

$110,000 Current Liabilities 142,000 Capital Stock 115,000 Capital in Excess 540,000 of Par Value Retained Earnings (150,000) 13,000 $770,000

100,000 214,000 216,000 240,000

770,000

222,000

328,000 240,000 790,000

Computation of goodwill Fair value of consideration given (700 x $300) Fair value of net assets acquired ($217,000 – $20,000) Goodwill b.

$210,000 (197,000) $13,000

(1) Stockholders' equity with 1,100 shares issued: Capital Stock [$200,000 + ($20 x 1,100 shares)] Capital in Excess of Par Value [$20,000 + ($300 - $20) x 1,100 shares] Retained Earnings

(2) Stockholders' equity with 1,800 shares issued: Capital Stock [$200,000 + ($20 x 1,800 shares)] Capital in Excess of Par Value [$20,000 + ($300 - $20) x 1,800 shares] Retained Earnings

$ 236,000 524,000 240,000 $1,000,000

(3) Stockholders' equity with 3,000 shares issued: Capital Stock [$200,000 + ($20 x 3,000 shares)] Capital in Excess of Par Value [$20,000 + ($300 - $20) x 3,000 shares] Retained Earnings

1-34

$ 260,000 860,000 240,000 $1,360,000

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-38 Incomplete Data Problem a. 5,200 = ($126,000 - $100,000)/$5 b. $208,000 = ($126,000 + $247,000) - ($100,000 + $65,000) c. $46,000 = $96,000 - $50,000 d. $130,000 = ($50,000 + $88,000 + $96,000 + $430,000 - $46,000 $220,000 - $6,000) - ($40,000 + $60,000 + $50,000 + $300,000 $32,000 - $150,000 - $6,000) e. $78,000 = $208,000 - $130,000 f. $97,000 (as reported by End Corporation) g. $13,000 = ($430,000 - $300,000)/10 years P1-39 Incomplete Data Following Purchase a. 14,000 = $70,000/$5 b. $8.00 = ($70,000 + $42,000)/14,000 c. 7,000 = ($117,000 - $96,000)/$3 d. $24,000 = $65,000 + $15,000 - $56,000 e. $364,000 = ($117,000 + $553,000 + $24,000) – ($96,000 + $234,000) f. $110,000 = $320,000 - $210,000 g. $306,000 = ($15,000 + $30,000 + $110,000 + $293,000) ($22,000 + $120,000) h. $58,000 = $364,000 - $306,000

1-35

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-40 Comprehensive Business Combination Problem a. Journal entries on the books of Bigtime Industries to record the combination: Merger Expense Cash

135,000

Deferred Stock Issue Costs Cash

42,000

135,000 42,000

Cash Accounts Receivable Inventory Long-Term Investments Land Rolling Stock Plant and Equipment Patents Special Licenses Discount on Equipment Trust Notes Discount on Debentures Goodwill Current Payables Mortgages Payable Premium on Mortgages Payable Equipment Trust Notes Debentures Payable Common Stock Additional Paid-In Capital — Common Deferred Stock Issue Costs

28,000 251,500 395,000 175,000 100,000 63,000 2,500,000 500,000 100,000 5,000 50,000 109,700 137,200 500,000 20,000 100,000 1,000,000 180,000 2,298,000 42,000

Computation of goodwill Value of stock issued ($14 x 180,000) Fair value of assets acquired Fair value of liabilities assumed Fair value of net identifiable assets Goodwill

$2,520,000 $4,112,500 (1,702,200) (2,410,300) $ 109,700

1-36

Chapter 01 - Intercorporate Acquisitions and Investments in Other Entities

P1-40 (continued) b. Journal entries on the books of HCC to record the combination: Investment in Bigtime Industries Stock Allowance for Bad Debts Accumulated Depreciation Current Payables Mortgages Payable Equipment Trust Notes Debentures Payable Discount on Debentures Payable Cash Accounts Receivable Inventory Long-Term Investments Land Rolling Stock Plant and Equipment Patents Special Licenses Gain on Sale of Assets and Liabilities Record sale of assets and liabilities.

2,520,000 6,500 614,000 137,200 500,000 100,000 1,000,000 40,000 28,000 258,000 381,000 150,000 55,000 130,000 2,425,000 125,000 95,800 1,189,900

Common Stock Additional Paid-In Capital — Common Stock Treasury Stock Record retirement of Treasury Stock:* $7,500 = $5 x 1,500 shares $4,500 = $12,000 - $7,500

7,500 4,500

Common Stock Additional Paid-In Capital — Common Additional Paid-In Capital — Retirement of Preferred Retained Earnings Investment in Bigtime Industries Stock Record retirement of HCC stock and distribution of Integrated Industries stock: $592,500 = $600,000 - $7,500 $495,500 = $500,000 - $4,500 1,410,000 = $220,100 + $1,189,900

592,500 495,500

*Alternative approaches exist.

1-37

12,000

22,000 1,410,000 2,520,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

CHAPTER 2 REPORTING INTERCORPORATE INVESTMENTS AND CONSOLIDATION OF WHOLLY OWNED SUBSIDIARIES WITH NO DIFFERENTIAL ANSWERS TO QUESTIONS Q2-1 (a) An investment in the voting common stock of another company is reported on an equity-method basis when the investor is able to significantly influence the operating and financial policies of the investee. (b) The cost method normally is used for investments in common stock when the investor does not have significant influence and for investments in preferred stock and other securities. The cost method may also be used by the parent company for bookkeeping purposes when the investor owns a controlling interest because the investment account is eliminated in the consolidation process. Q2-2A Significant influence occurs when the investor has the ability to influence the operating and financial policies of the investee. Representation on the board of directors of the investee is perhaps the strongest evidence, but other evidence such as routine participation in management decisions or entering into formal agreements that give the investor some degree of influence over the investee also may be used. Q2-3A Equity-method reporting should not be used when (a) the investee has initiated litigation or complaints challenging the investor's ability to exercise significant influence, (b) the investor signs an agreement surrendering important shareholder rights, (c) majority ownership is concentrated in a small group that operates the company without regard to the investor's desires, (d) the investor is not able to acquire the information from the investee, or (e) the investor tries and fails to gain representation on the board of directors. Q2-4 The balances will be the same at the date of acquisition and in the periods that follow whenever the cumulative dividends paid by the investee equal or exceed the investee's cumulative earnings since the date of acquisition. The latter case assumes there are no other adjustments needed under the equity method for amortization of differential or other factors. Q2-5 When a company has used the cost method and purchases additional shares which cause it to gain significant influence, a retroactive adjustment is recorded to move from a cost basis to an equity-method basis in the preceding periods. Dividend income is replaced by income from the investee and dividends received are treated as an adjustment to the investment account. Q2-6 An investor considers a dividend to be a liquidating dividend when the cumulative dividends received from the investee exceed a proportionate share of the cumulative earnings of the investee from the date ownership was acquired. For example, an investor would consider a dividend to be liquidating if it purchases shares of another company in early December and receives a dividend at year-end substantially in excess of its portion of the investee's net income for December.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

Q2-7 Liquidating dividends decrease the investment account in both cases. All dividends are treated as a reduction of the investment account when equity-method reporting is used. When the cost method is used and dividends are received in excess of a proportionate share of investee earnings since acquisition, they are treated as a reduction of the investment account as well. Q2-8 A dividend is treated as a reduction of the investment account under equity-method reporting. Unless it is a liquidating dividend, it is treated as dividend income under the cost method. Q2-9 Dividends received by the investor are recorded as dividend income under both the cost and fair value methods. The change in the fair value of the shares held by the investor is recorded as an unrealized gain or loss under the fair value method. The fair value method differs from the equity method in two respects. Under the equity method the investor’s share of the earnings of the investee are included as investment income and dividends received from the investee are treated as a reduction of the investment account. Q2-10A When the modified equity method is used, a proportionate share of subsidiary net income and dividends is recorded on the parent's books and an appropriate amount of any differential is amortized each period. In some situations, companies also choose not to make adjustments for intercompany profits and the amortization of the differential. Under the fully adjusted equity method, the parent's books also are adjusted for unrealized profits and any other items that are needed to bring the investor's net income into agreement with the income to the controlling interest that would be reported if consolidation were used. Q2-11 A one-line consolidation implies that under equity-method reporting the investor's net income and stockholders' equity will be the same as if the investee were consolidated. Income from the investee is included in a single line in the investor's income statement and the investment is reported as a single line in the investor's balance sheet. Q2-12A The term modified equity method generally is used when the investor records its portion of the reported net income and dividends of the investee and amortizes an appropriate portion of any differential. Unlike the fully adjusted equity method, no adjustment for unrealized profit on intercompany transfers normally is made on the investor's books. (In some situations, companies also choose not to amortize the differential.) When an investee is consolidated for financial reporting purposes, the investor may not feel it is necessary to record fully adjusted equity method entries on its books since income from the investee and the balance in the investment account must be eliminated in preparing the consolidated statements. Q2-13A The investor reports a proportionate share of an investee's extraordinary item as an extraordinary item in its own income statement. Q2-14 An adjusting entry is recorded on the company's books and causes the balances reported by the parent or subsidiary company to change. Consolidation entries, on the other hand, are not recorded on the books of the companies. Instead, they are entered in the consolidation worksheet so that when the amounts included in the consolidation entries are applied, the appropriate balances for the consolidated entity are reported.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

Q2-15 Each of the stockholders' equity accounts of the subsidiary is eliminated in the consolidation process. Thus, none of the balances is included in the stockholders' equity accounts of the consolidated entity. That portion of the stockholders' equity claim assigned to the noncontrolling shareholders is reported indirectly in the balance assigned to the noncontrolling shareholders. Q2-16 Additional entries are needed to eliminate all income statement and retained earnings statement effects of intercorporate ownership and any transfers of goods and services between related companies. Q2-17 Separate parts of the consolidation worksheet are used to develop the consolidated income statement, retained earnings statement, and balance sheet. All consolidation entries needed to complete the entire worksheet normally are entered before any of the three statements are prepared. The income statement portion of the worksheet is completed first so that net income can be carried forward to the retained earnings statement portion of the worksheet. When the retained earnings portion is completed, the ending balances are carried forward and entered in the consolidated balance sheet portion of the worksheet. Q2-18 None of the dividends declared by the subsidiary are included in the consolidated retained earnings statement. Those which are paid to the parent have not gone outside the consolidated entity and therefore must be eliminated in preparing the consolidated statements. Q2-19 Consolidated net income includes 100 percent of the revenues and expenses of the individual consolidating companies arising from transactions with unaffiliated companies. Q2-20 Consolidated retained earnings is that portion of the undistributed earnings of the consolidated entity accruing to the parent company shareholders. Q2-21 Consolidated retained earnings at the end of the period is equal to the beginning consolidated retained earnings balance plus consolidated net income attributable to the controlling interest, less consolidated dividends. Under the fully adjusted equity method, consolidated retained earnings should equal the parent company’s retained earnings. Q2-22 The retained earnings statement shows the increase or decrease in retained earnings during the period. Thus, income for the period is added to the beginning balance and dividends are deducted in deriving the ending balance in retained earnings. Because the consolidation worksheet includes the retained earnings statement, the beginning retained earnings balance must be entered in the worksheet.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

SOLUTIONS TO CASES C2-1A Choice of Accounting Method a. The equity method is to be used when an investor has significant influence over an investee. Significant influence normally is assumed when more than 20 percent ownership is held. Factors to be considered in determining whether to apply equity-method reporting include the following: 1. Is the investee under the control of the courts or other parties as a result of filing for reorganization or entering into liquidation procedures? 2. Does the investor have representation on the board of directors, or has it attempted to gain representation and been unable to do so? 3. Has the investee initiated litigation or complaints challenging the investor's ability to exercise significant influence? 4. Has the investor signed an agreement surrendering its ability to exercise significant influence? 5. Is majority ownership concentrated in a small group that operates the company without regard of the wishes of the investor? 6. Is the investor able to acquire the information needed to use equity-method reporting? b. When subsidiary net income is greater than dividends paid, equity-method reporting is likely to show a larger reported contribution to the earnings of Slanted Building Supplies. If 20X4 earnings are negative or less than dividends distributed in 20X4, the cost basis is likely to result in a larger contribution to Slanted's reported earnings. c. As the investor uses more of its resources to acquire ownership of the investee, and as the investor has a greater share of the investee's profits and losses, the success of the investee's operations may have more of an impact on the overall financial well-being of the investor. In many cases, the investor will want to participate in key decisions of the investee once the investor's ownership share reaches a certain level. Also, use of the equity method eliminates the possibility of the investor manipulating its own income by influencing investee dividend distributions, as might occur under the cost method.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

C2-2 Intercorporate Ownership MEMO To:

Chief Accountant Most Company

From: Re:

, CPA Equity Method Reporting for Investment in Adams Company

The equity method should be used in reporting investments in which the reporting company has a significant influence over the operating and financing decisions of another company. In this case, Most Company holds 15 percent of the voting common stock of Adams Company and Port Company holds an additional 10 percent. During the course of the year, both Most and Port are likely to use the cost method in recording their respective investments in Adams. However, when consolidated statements are prepared for Most, the combined ownership must be used in determining whether significant influence exists. Both direct and indirect ownership must be taken into consideration. [ASC 323-10-15-6 through 15-8] A total of 15 percent of the voting common stock of Adams is held directly by Most Company and an additional 10 percent is controlled indirectly though Most’s ownership of Port Company. Equity-method reporting for the investment in Adams Company therefore appears to be required. If the cost method has been used by Most and Port in recording their investments during the year, at the time consolidated statements are prepared, adjustments must be made to (a) increase the balance in the investment account for a proportionate share of the investee’s reported net income (25 percent) and reduce the balance in the investment account for a proportionate share of the dividend paid by the investee, (b) include a proportionate share of the investee’s net income in the consolidated income statement, and (c) delete any dividend income recorded by Most and Port. Primary citation ASC 323-10-15-6 through 15-8

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

C2-3A Application of the Equity Method MEMO To:

Controller Forth Company

From: Re:

, CPA Equity Method Reporting for Investment in Brown Company

This memo is prepared in response to your request regarding use of the cost or equity methods in accounting for Forth’s investment in Brown Company. Forth Company held 85 percent of the common stock of Brown Company prior to January 1, 20X2, and was required to fully consolidate Brown Company in its financial statements prepared prior to that date [ASC 810]. Forth now holds only 15 percent of the common stock of Brown. The cost method is normally used in accounting for ownership when less than 20 percent of the stock is directly or indirectly held by the investor. Equity-method reporting should be used when the investor has “significant influence over operating and financing policies of the investee.” While 20 percent ownership is regarded as the level at which the investor is presumed to have significant influence, other factors must be considered as well. [ASC 323-10-15-6 through 15-8] Although Forth currently holds only 15 percent of Brown’s common stock, the other factors associated with its ownership indicate that Forth does exercise significant influence over Brown. Forth has two members on Brown’s board of directors, it purchases a substantial portion of Brown’s output, and Forth appears to be the largest single shareholder by virtue of its sale of 10,000 shares to each of 7 other investors. These factors provide strong evidence that Forth has significant influence over Brown and points to the need to use equity-method reporting for its investment in Brown. Your office should monitor the activities of the standard setting bodies with respect to consolidation standards [www.fasb.org]. Active consideration is being given to situations in which control may be exercised even though the investor does not hold majority ownership. It is conceivable that your situation might be one in which consolidation could be required. Primary citations APB 18, par. 17; ASC 323-10-15-6 through 15-8 ASC 810

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

C2-4 Need for Consolidation Process After the financial statements of each of the individual companies are prepared in accordance with generally accepted accounting principles, consolidated financial statements must be prepared for the economic entity as a whole. The individual companies generally record transactions with other subsidiaries on the same basis as transactions with unrelated enterprises. In preparing consolidated financial statements, the effects of all transactions with related companies must be removed, just as all transactions within a single company must be removed in preparing financial statements for that individual company. It therefore is necessary to prepare a consolidation worksheet and to enter a number of special journal entries in the worksheet to remove the effects of the intercorporate transactions. The parent company also reports an investment in each of the subsidiary companies and investment income or loss in its financial statements. Each of these accounts must be eliminated as well as the stockholders' equity accounts of the subsidiaries. The latter must be eliminated so that only the parent’s equity remains. This is because only the parent's ownership is held by parties outside the consolidated entity.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

C2-5 Account Presentation MEMO To:

Chief Accountant Prime Company

From: Re:

, Accounting Staff Combining Broadly Diversified Balance Sheet Accounts

Many manufacturing and merchandising enterprises excluded finance, insurance, real estate, leasing, and perhaps other types of subsidiaries from consolidation prior to 1987 on the basis of “nonhomogeneous” operations. Companies generally argued that the accounts of these companies were dissimilar in nature and combining them in the consolidated financial statements would mislead investors. ASC 810 specifically eliminated the exception for nonhomogeneous operations. ASC 810-10-65-1 affirms the requirement for consolidating entities in which a controlling financial interest is held. Prime Company controls companies in very different industries and combining the accounts of its subsidiaries may lead to confusion by some investors; however, it may be equally confusing to provide detailed listings of assets and liabilities by industry or other breakdowns in the consolidated balance sheet. The actual number of assets and liabilities presented in the consolidated balance sheet must be carefully considered, but is the decision of Prime’s management. It is important to recognize that the notes to the consolidated financial statements are regarded as an integral part of the financial statements and Prime Company is required to include in its notes to the financial statements certain information on its reportable segments [ASC 280-10]. Because of the diversity of its ownership, Prime may wish to provide more than the minimum disclosures specified in the guidance. Segment information appears to be used quite broadly by investors and permits the company to provide sufficient detail to assist the financial statement user in gaining a better understanding of the various operating divisions of the company. You have requested information on those situations in which it may not be appropriate to combine similar appearing accounts of two or more subsidiaries. The following is a partial listing of such situations: (a) the accounts of a subsidiary should not be included along with other subsidiaries if control of the assets and liabilities does not rest with Prime Company, as when a subsidiary is in receivership; (b) while the assets and liability accounts of the subsidiary should be combined with the parent, the equity account balances should not; (c) negative account balances in cash or accounts receivable should be reclassified as liabilities rather than being added to the positive balances of other affiliates if there is no right of offset in the underlying bank accounts, and (d) assets pledged for a specific purpose and not available for other use by the consolidated entity generally should be separately reported. Primary citations: ASC 810 ASC 280-10 ASC 810-10-65-1 Secondary sources: ASC 810

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

C2-6 Consolidating an Unprofitable Subsidiary MEMO TO:

Chief Accountant Amazing Chemical Corporation

FROM: Re:

, Accounting Staff Consolidation of Unprofitable Boatyard

This memo is intended to provide recommendations on the presentation of the boatyard in Amazing Chemical’s consolidated financial statements. Amazing Chemical Corporation currently has full ownership of the boatyard and should fully consolidate the boatyard in its financial statements. Consolidated statements should be prepared when a company directly or indirectly has a controlling financial interest in one or more other companies. [ASC 810-10-10-1 and ASC 810-10-65-1]. Amazing Chemical appears to be following generally accepted accounting procedures in fully consolidating the boatyard in its financial statements and should continue to do so. The operations of the boatyard appear to be distinct from the other operations of the parent company and its losses appear to be sufficient to establish it as a reportable segment [ASC 280-10-50]. While the operating losses of the boatyard may not be evident in analyzing the consolidated income statement, a review of the notes to the consolidated statements should provide adequate disclosure of its operations as a reportable segment. The financial statements for the current period should contain these disclosures and if prior period statements have not included the boatyard as a reportable segment it may be necessary to restate those statements. Failure of the president of Amazing Chemical to receive approval by the board of directors for the purchase of the boatyard and his subsequent actions to keep information about its operations from the board members appears to be a serious breach of ethics. These actions by the president should immediately be brought to the attention of the board of directors for appropriate action by the board. Primary citations: ASC 810-10-10-1 ASC 810 ASC 280-10-50 ASC 810-10-65-1

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

SOLUTIONS TO EXERCISES E2-1 Multiple-Choice Questions on Use of Cost and Equity Methods [AICPA Adapted] 1. a – Cash dividends received will never cause an increase in the investment account under either method. (b) Incorrect. A cash dividend is recorded as dividend income and does not affect the investment account under the cost method. Under the equity method, dividends reduce the investment account. (c) Incorrect. A cash dividend is recorded as dividend income and does not affect the investment account under the cost method. (d) Incorrect. Under the equity method, dividends reduce the investment account. 2. a – Because the ownership in Amal Corporation is less than 20%, the cost method should be applied. Accordingly, the $1,500 dividend received from Amal is recorded as dividend revenue. (b) Incorrect. Stock dividends are not recorded as income. (c) Incorrect. The cash dividend received from B&K is not recorded as dividend revenue because it is accounted for under the equity method. (d) Incorrect. The stock dividend and cash dividend from B&K are not recorded as dividend revenue. 3. a – Under the equity method, net income increases the investment account while dividends decrease it. Because net income was greater than the dividends declared, this results in a net increase in the investment account. Under the cost method, the investment would not be altered, and thus would be lower than it would be under the equity method. (b) Incorrect. This would only be true if the dividends were less than the net income. (c) Incorrect. It doesn’t matter when the dividends are paid; as soon as they are declared they act as a reduction to the investment under the equity method. (d) Incorrect. It doesn’t matter when the dividends are paid; as soon as they are declared they act as a reduction to the investment under the equity method. 4. b – Under the equity method the company records a share of the affiliate net income as income for the company. This increases the net income of the company which increases earnings per share. (a) Incorrect. An increase in income affects long-term assets, not current assets or current liabilities, so it would have no effect on the current ratio. (c) Incorrect. The assets would be higher so asset turnover would decrease. No other turnover ratios would be affected. (d) Incorrect. The affiliate company’s profitability would not decrease the book value per share of the company, it would increase it since retained earnings would increase with the recognition of income from the subsidiary.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

5. d – Since these are liquidating dividends they would decrease the investment account under the cost method and decrease the investment account under the equity method. (a) Incorrect. Dividends usually decrease the investment account under the equity method so there would be an effect. (b) Incorrect. Dividends usually decrease the investment account under the equity method so there would be an effect. (c) Incorrect. Since these are liquidating dividends they would decrease the investment account under the cost method so there would be an effect. 6. d – The amount of dividends not in excess would be considered dividend income. (a) Incorrect. There would be at least some dividend income recorded. (b) Incorrect. Since these are liquidating dividends a portion of the dividends will go to reduce the investment account thus not all of the dividends received will be income. (c) Incorrect. The portion of dividends received in excess of the share of earnings would cause a reduction in the investment account. E2-2 Multiple-Choice Questions on Intercorporate Investments 1. b – Equity method reporting is used when an investor gains significant influence over the operating and financing decisions of the investee. Typically, this is satisfied by maintaining 20% or more of the voting stock, but can also be obtained by other contractual obligations or circumstances. (a) Incorrect. Voting shares can be obtained without gaining significant influence (i.e. less than 20%) and thus the equity method is not typically used. (c) Incorrect. Purchasing goods and services would not constitute significant influence over the company, and thus does not result in the equity method being applied. (d) Incorrect. This would result in a write-down of the investment, and does not correlate to the use of the equity method. 2. c – Under the equity method, net income from the investee causes an increase to the investment, while dividends declared by the investee causes a reduction. (a) Incorrect. This simply represents the historical cost of the investment. It must be adjusted for the income and dividends declared by the investee. (b) Incorrect. Dividends declared by the investee cause a reduction to the investment, not an increase. (d) Incorrect. Net income reported by the investee causes an increase to the investment, not a decrease.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

E2-3 Multiple-Choice Questions on Applying Equity Method [AICPA Adapted] 1. d – $250,000 + ($100,000 x 0.30) – ($10,000 x 0.30) = $277,000 2. c – 20X9 investment income: $650,000 * 30% = $195,000, 20X8 adjustment: ($600,000 * 10%) – ($200,000 * 10%) = $40,000. 3. d – Because income is greater than the amount of dividends declared, the equity method would have resulted in a higher balance in the investment account, net earnings, and retained earnings than under the cost method. (a) Incorrect. Because the investor’s portion of income ($40,000) is greater than the portion of dividends ($4,000), using the cost method would only result in an earnings increase of $4,000 from dividend revenue rather than $40,000. Thus, both net earnings and retained earnings would be understated. (b) Incorrect. The cost method does not record any increase to the investment account, thus its balance would be understated when compared to the equity method. (c) Incorrect. The cost method causes an understatement to the investment account, net earnings and retained earnings. 4. d – Under the equity method, dividends by the investee are recorded with a credit to the investment account, not to dividend revenue. By wrongly classifying this entry, the investment is overstated, and retained earnings are also overstated. (a) Incorrect. Because the dividend entry was recorded incorrectly, the financial position will not be correctly stated. (b) Incorrect. Because the dividends were recorded as dividend revenue, retained earnings would be overstated. (c) Incorrect. Currently, the investment is overstated because the dividends declared should have resulted in a reduction to the investment account.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

E2-4 Cost versus Equity Reporting a. Winston Corporation net income – cost method: 20X2 20X3 20X4 a

$100,000 $ 60,000 $250,000

+ + +

.40($30,000) .40($60,000) .40($20,000

$25,000)

$112,000 84,000 268,000

Dividends paid from undistributed earnings of prior years ($70,000 + $40,000 - $30,000 - $60,000 = $20,000) and $25,000 earnings of current period.

b. Winston Corporation net income – equity method: 20X2 $100,000 + .40($70,000) 20X3 $ 60,000 + .40($40,000) 20X4 $250,000 + .40($25,000)

$128,000 76,000 260,000

E2-5 Acquisition Price Balance at date of acquisition: a. Cost method

$54,000 + $2,800 = $56,800

b. Equity method

$54,000 - $2,000 = $52,000

Year Net Income 20X1 $ 8,000 20X2 12,000 20X3 20,000 Change in account balance

Dividends $15,000 10,000 10,000

Change in Investment Account Cost Method Equity Method $(2,800) $(2,800) 800 ______ 4,000 $(2,800) $ 2,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

E2-6 Investment Income a. (1) Ravine Corporation net income under Cost Method: 20X6 20X7 20X8 20X9 a

$140,000 $ 80,000 $220,000 $160,000

+ + + +

0.30($20,000) 0.30($40,000) a 0.30($20,000 + $10,000) 0.30($20,000)

= = = =

$146,000 $ 92,000 $229,000 $166,000

Dividends paid from undistributed earnings of prior years ($30,000 + $50,000 - $20,000 - $40,000= $20,000) and $10,000 earnings of current period.

(2) Ravine Corporation net income under Equity Method: 20X6 20X7 20X8 20X9

$140,000 $ 80,000 $220,000 $160,000

+ + + +

0.30($30,000) 0.30($50,000) 0.30($10,000) 0.30($40,000)

= = = =

$149,000 $ 95,000 $223,000 $172,000

b. Journal entries recorded by Ravine Corporation in 20X8: (1) Cost method: Cash Dividend Income Investment in Valley Stock

12,000 9,000 3,000

(2) Equity method: Cash Investment in Valley Stock

12,000

Investment in Valley Stock Income from Valley

3,000

12,000 3,000

E2-7 Investment Value The following amounts would be reported as the carrying value of Port’s investment in Sund: 20X2 20X3 20X4

$184,500 = $193,500 = $195,000 =

$180,000 $184,500 $193,500

+ ($40,000 x 0.30) + ($30,000 x 0.30) + ($5,000 x 0.30)

($25,000 x 0.30)

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

E2-8A Income Reporting Journal entry recorded by Grandview Company: Investment in Spinet Corporation Stock Income from Spinet Corporation Extraordinary Gain (from Spinet Corporation)

36,000 24,000 12,000

E2-9 Fair Value Method a. Cost method: Operating income reported by Mock Dividend income from Small ($15,000 x 0.20) Net income reported by Mock

$90,000 3,000 $93,000

b. Equity method: Operating income reported by Mock Income from investee ($40,000 x 0.20) Net income reported by Mock

$90,000 8,000 $98,000

c. Fair value method: Operating income reported by Mock Unrealized gain on increase in value of Small stock Dividend income from Small ($15,000 x 0.20) Net income reported by Mock

$90,000 16,000 3,000 $ 109,000

E2-10 Fair Value Recognition a. Journal entries under the equity method: (1) Investment in Lomm Company Stock Cash Record purchase of Lomm Company stock.

140,000 140,000

(2) Cash Investment in Lomm Company Stock Record dividends from Lomm Company: $20,000 x 0.35

7,000

(3) Investment in Lomm Company Stock Income from Lomm Company Record equity-method income: $80,000 x 0.35

28,000

7,000

28,000

Journal entries under fair value method: (1) Investment in Lomm Company Stock Cash Record purchase of Lomm Company stock.

140,000 140,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

(2) Cash Dividend Income Record dividends from Lomm Company: $20,000 x 0.35

7,000 7,000

(3) Investment in Lomm Company Stock 34,000 Unrealized Gain on Increase in Value of Lomm Stock Record increase in value of Lomm stock: $174,000 - $140,000

34,000

E2-11A Investee with Preferred Stock Outstanding Journal entries recorded by Reden Corporation: (1) Investment in Montgomery Co. Stock Cash Record purchase of Montgomery Co. stock.

288,000 288,000

(2) Cash 6,750 Investment in Montgomery Co. Stock 6,750 Record dividend from Montgomery Co.: [$40,000 - ($250,000 x .10)] x 0.45 (3) Investment in Montgomery Co. Stock 31,500 Income from Montgomery Co. 31,500 Record equity-method income: [$95,000 - ($250,000 x .10)] x 0.45

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

E2-12A Other Comprehensive Income Reported by Investee Journal entries recorded by Callas Corp. during 20X9: (1) Investment in Thinbill Co. Stock Cash Record purchase of Thinbill Company

380,000 380,000

(2) Cash Investment in Thinbill Co. Stock Record dividend from Thinbill: $9,000 x 0.40

3,600 3,600

(3) Investment in Thinbill Co. Stock 18,000 Income from Thinbill Co. Record equity-method income: $18,000 = $45,000 x 0.40

18,000

(4) Investment in Thinbill Co. Stock 8,000 Unrealized Gain on Investments of Investee (OCI) Record share of OCI reported by Thinbill: $8,000 = $20,000 x 0.40

8,000

Closing entries recorded at December 31, 20X9: (5) Income from Thinbill Co. Retained Earnings

18,000

(6) Unrealized Gain on Investments of Investee (OCI) Accumulated Other Comprehensive Income from Investee-Unrealized Gain on Investments

8,000

18,000

8,000

E2-13A Other Comprehensive Income Reported by Investee Investment account balance reported by Baldwin Corp. Add decrease in account recorded in 20X8: Equity-method loss ($20,000 x .25) Dividend received ($10,000 x .25) Deduct increase in account recorded in 20X9: Equity-method income ($68,000 x .25) Dividend received ($16,000 x .25) Other comprehensive income reported by Gwin Company ($12,000 x .25) Purchase price

$67,000 $ (5,000) (2,500)

7,500

$17,000 (4,000) 3,000

(16,000) $58,500

E2-14 Basic Consolidation Entry Common Stock – Broadway Corporation Additional Paid-In Capital Retained Earnings Investment in Broadway Common Stock

200,000 300,000 100,000 600,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

E2-15 Balance Sheet Worksheet a. Equity Method Entries on Blank's Books: Investment in Faith 150,000 Cash 150,000 Record the initial investment in Faith 12/31/X2 Goodwill = 0

Identifiable excess = 0

$150,000 Initial investment in Faith

Book value = CS + RE = 150,000

Book Value Calculations: Total Book Value Ending book value

150,000

Common Stock

60,000

Retained Earnings 90,000

Basic Consolidation Entry Common stock

60,000

Retained earnings

90,000

Investment in Faith

150,000

Optional accumulated depreciation consolidation entry Accumulated depreciation Buildings & equipment

30,000 30,000

(Since the buildings and equipment are reported net of accumulated depreciation on the balance sheet, this entry will not affect the worksheet. However, if sufficient information had been given, this entry would have made a difference in the worksheet balances for Buildings and Equipment and Accumulated Depreciation. Additionally, this entry would impact any footnote disclosure of the details of Buildings and Equipment.) Copyright © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website in whole or part.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

E2-15 (continued) b.

Consolidation Entries Blank

Faith

Consolidated

Cash

65,000

18,000

83,000

Accounts Receivable

87,000

37,000

124,000

Inventory

110,000

60,000

170,000

Buildings & Equipment (net)

220,000

150,000

Investment in Faith

150,000

Total Assets

632,000

265,000

Accounts Payable

92,000

35,000

127,000

Bonds Payable

150,000

80,000

230,000

Common Stock

100,000

60,000

100,000

Retained Earnings

290,000

90,000

290,000

Total Liabilities & Equity

632,000

265,000

150,000

Balance Sheet

30,000

370,000

150,000

180,000

747,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

E2-16 Consolidation Entries for Wholly Owned Subsidiary a. Equity Method Entries on Trim Corp.'s Books: Investment in Round Corp.

400,000

Cash

400,000

Record the initial investment in Round Corp.

Investment in Round Corp.

80,000

Income from Round Corp.

80,000

Record Trim Corp.'s 100% share of Round Corp.'s 20X2 income

Cash

25,000

Investment in Round Corp.

25,000

Record Trim Corp.'s 100% share of Round Corp.'s 20X2 dividend

b. Book Value Calculations: Total Book Value Beginning book value

400,000

Common Stock 120,000

Retained Earnings 280,000

+ Net Income

80,000

- Dividends

(25,000)

Ending book value

455,000

120,000

335,000

1/1/X2

12/31/X2

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 400,000

$400,000 Initial investment in Round Corp.

Book value = CS + RE = 455,000

$455,000 Net investment in Round Corp.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

E2-16 (continued) Basic Consolidation Entry Common stock

120,000

Retained earnings

280,000

Income from Round Corp.

80,000

Dividends declared

25,000

Investment in Round Corp.

455,000

E2-17 Basic Consolidation Entries for Fully Owned Subsidiary a. Equity Method Entries on Purple Co.'s Books: Investment in Amber Corp.

500,000

Cash

500,000

Record the initial investment in Amber Corp.

Investment in Amber Corp.

50,000

Income from Amber Corp.

50,000

Record Purple Co.'s 100% share of Amber Corp.'s 20X7 income

Cash

20,000

Investment in Amber Corp.

20,000

Record Purple Co.'s 100% share of Amber Corp.'s 20X7 dividend

b. Book Value Calculations: Total Book Value Original book value

500,000

Common Stock 300,000

Retained Earnings 200,000

+ Net Income

50,000

- Dividends

(20,000)

Ending book value

530,000

300,000

230,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

1/1/X7

12/31/X7

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 500,000

$500,000 Initial investment in Amber Corp.

Identifiable excess = 0

Book value = CS + RE = 530,000

$530,000 Net investment in Amber Corp.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

E2-17 (continued)

Basic Consolidation Entry Common stock

300,000

Retained earnings

200,000

Income from Amber Corp.

50,000

Dividends declared

20,000

Investment in Amber Corp.

530,000

Investment in

Income from

Amber Corp.

Acquisition Price

500,000

Net Income

50,000 20,000

Ending Balance

Net Income

50,000

Ending Balance

Dividends

530,000 530,000

50,000

Basic

50,000 0

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

SOLUTIONS TO PROBLEMS P2-18 Retroactive Recognition Journal entries recorded by Idle Corporation: (1) Investment in Fast Track Enterprises Stock Cash Record purchase of Fast Track stock.

34,000

(2) Investment in Fast Track Enterprises Stock Retained Earnings Record pick-up of difference between cost and equity income: 20X2 .10($40,000 - $20,000) 20X3 .10($60,000 / 2) .15[($60,000 / 2) - $20,000] 20X4 .15($40,000 - $10,000) Amount of increase

11,000

34,000

11,000 $ 2,000 $3,000 1,500

4,500 4,500 $11,000

(3) Cash 5,000 Investment in Fast Track Enterprises Stock Record dividend from Fast Track Enterprises: $20,000 x .25

5,000

(4) Investment in Fast Track Enterprises Stock Income from Fast Track Enterprises Record equity-method income: $50,000 x .25

12,500

P2-19 Fair Value Method 20X6

20X7

20X8

Dividend income

$ 3,000

$ 6,000

$ 4,000

Balance in investment account

$70,000

a. Cost method:

b. Equity method: Investment income: $40,000 x .20 $35,000 x .20 $60,000 x .20 Balance in investment account: Balance at January 1 Investment income Dividends received Balance at December 31

$ 8,000 $ 7,000 $12,000 $70,000 8,000 (3,000) $75,000

$75,000 7,000 (6,000) $76,000

$76,000 12,000 (4,000) $84,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

c. Fair value method: 20X6

20X7

20X8

Investment income: Dividends received Gain (loss) on fair value Total income reported

$ 3,000 19,000 $22,000

$ 6,000 (3,000) $ 3,000

$ 4,000 11,000 $15,000

Balance in investment account

$89,000

$86,000

$97,000

P2-20 Fair Value Journal Entries Journal entries under fair value method for 20X8: (1) Investment in Brown Company Stock Cash Record purchase of Brown Company stock.

85,000

(2) Cash Dividend Income Record dividends from Brown Company: $10,000 x .40

4,000

85,000

4,000

(3) Investment in Brown Company Stock 12,000 Unrealized Gain on Increase in Value of Brown Company Stock Record increase in value of Brown stock: $97,000 - $85,000

12,000

Journal entries under fair value method for 20X9: (1) Cash Dividend Income Record dividends from Brown Company: $15,000 x .40

6,000

(2) Unrealized Loss on Decrease in Value of Brown Company Stock 5,000 Investment in Brown Company Stock Record decrease in value of Brown stock: $97,000 - $92,000

6,000

5,000

P2-21A Other Comprehensive Income Reported by Investee a. Equity-method income reported by Dewey Corporation in 20X5: Amounts reported by Jimm Co. for 20X5: Operating income Dividend income Gain on investment in trading securities Net income Ownership held by Dewey Investment income reported by Dewey

$70,000 7,000 18,000 $95,000 x .30 $28,500

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

b. Computation of other comprehensive income reported by Jimm Co.: Amount added to investment account in 20X5 Investment income reported by Dewey in 20X5 Increase due to other comprehensive income reported by Jimm Co. Proportion of ownership held by Dewey Other comprehensive income reported by Jimm Co.

$ 37,800 (28,500) $ 9,300 ÷ 0.30 $ 31,000

c. Computation of market value of securities held by Jimm Co. Amount paid by Jimm Co. to purchase securities Increase in market value reported as other comprehensive income in 20X5 Market value of available-for-sale securities at December 31, 20X5

$130,000 31,000 $161,000

P2-22A Equity-Method Income Statement a. Diversified Products Corporation Income Statement Year Ended December 31, 20X8 Net Sales Cost of Goods Sold Gross Profit Other Expenses Gain on Sale of Truck Income from Continuing Operations Discontinued Operations: Operating Loss from Discontinued Division Gain on Sale of Division Income before Extraordinary Item Extraordinary Item: Loss on Volcanic Activity Net Income

$400,000 (320,000) $ 80,000 $(25,000) 10,000 $(15,000) 44,000

(15,000) $ 65,000 29,000 $ 94,000 (5,000) $ 89,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

Diversified Products Corporation Retained Earnings Statement Year Ended December 31, 20X8 Retained Earnings, January 1, 20X8 20X8 Net Income

$260,000 89,000 $349,000 (10,000) $339,000

Dividends Declared, 20X8 Retained Earnings, December 31, 20X8 b. Wealthy Manufacturing Company Income Statement Year Ended December 31, 20X8 Net Sales Cost of Goods Sold Gross Profit Other Expenses Income from Continuing Operations of Diversified Products Corporation Income from Continuing Operations Discontinued Operations: Share of Operating Loss Reported by Diversified Products on Discontinued Division Share of Gain on Sale of Division Reported by Diversified Products Income before Extraordinary Item Extraordinary Item: Share of Loss on Volcanic Activity Reported by Diversified Products Net Income

$850,000 (670,000) $180,000 $(90,000) 26,000

(64,000) $116,000

$ (6,000) 17,600

11,600 $127,600 (2,000) $125,600

Wealthy Manufacturing Company Retained Earnings Statement Year Ended December 31, 20X8 Retained Earnings, January 1, 20X8 20X8 Net Income Dividends Declared, 20X8 Retained Earnings, December 31, 20X8

$420,000 125,600 $545,600 (30,000) $515,600

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-23 Consolidated Worksheet at End of the First Year of Ownership (Equity Method) a. Equity Method Entries on Peanut Co.'s Books: Investment in Snoopy Co.

300,000

Cash

300,000

Record the initial investment in Snoopy Co. Investment in Snoopy Co.

75,000

Income from Snoopy Co.

75,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X8 income Cash

20,000

Investment in Snoopy Co.

20,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X8 dividend b. Book Value Calculations: Total Book Value Beginning book value 300,000

Common Stock 200,000

Retained Earnings 100,000

+ Net Income

75,000

- Dividends

(20,000)

Ending book value

355,000

200,000

155,000

1/1/X8

12/31/X8

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 300,000

$300,000 Initial investment in Snoopy Co.

Identifiable excess = 0

Book value = CS + RE = 355,000

$355,000 Net investment in Snoopy Co.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-23 (continued) Basic Consolidation Entry Common stock

200,000

Retained earnings

100,000

Income from Snoopy Co.

75,000

Dividends declared

20,000

Investment in Snoopy Co.

355,000

Optional accumulated depreciation consolidation entry Accumulated depreciation

10,000

Buildings & equipment

10,000

The amount of this entry is found by looking at the depreciation expense ($10,000) for the year and the accumulated depreciation at the end of the year ($20,000). The difference must be what was in accumulated depreciation at the date of the acquisition. Note that this assumes there were no sales or other disposals of Buildings and equipment during the year.

Investment in

Income from

Snoopy Co.

Acquisition Price

300,000

Net Income

75,000 20,000

Ending Balance

355,000 355,000 0

75,000

Net Income

75,000

Ending Balance

Dividends

Basic

75,000 0

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-23 (continued) Consolidation Entries

Peanut Co.

Snoopy Co.

Sales

800,000

250,000

1,050,000

Less: COGS

(200,000)

(125,000)

(325,000)

Less: Depreciation Expense

(50,000)

(10,000)

(60,000)

Less: Other Expenses

(225,000)

(40,000)

(265,000)

Income from Snoopy Co.

75,000

Net Income

400,000

75,000

Beginning Balance

225,000

100,000

Net Income

400,000

75,000

Less: Dividends Declared

(100,000)

(20,000)

Ending Balance

525,000

155,000

Cash

130,000

80,000

210,000

Accounts Receivable

165,000

65,000

230,000

Inventory

200,000

75,000

Investment in Snoopy Co.

355,000

Land

200,000

100,000

Buildings & Equipment

700,000

200,000

Less: Accumulated Depreciation

(450,000)

(20,000)

10,000

Total Assets

1,300,000

500,000

10,000

Accounts Payable

75,000

60,000

Bonds Payable

200,000

85,000

Common Stock

500,000

200,000

Retained Earnings

525,000

155,000

175,000

20,000

525,000

1,300,000

500,000

375,000

20,000

1,445,000

Consolidated

Income Statement

75,000

0 0

400,000

Statement of Retained Earnings

175,000

225,000 0

400,000

20,000

(100,000)

20,000

525,000

Balance Sheet

Total Liabilities & Equity

275,000 355,000

0 300,000

10,000

890,000 (460,000)

365,000

1,445,000

135,000 285,000 500,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-24 Consolidated Worksheet at End of the Second Year of Ownership (Equity Method) a. Equity Method Entries on Peanut Co.'s Books: Investment in Snoopy Co.

80,000

Income from Snoopy Co.

80,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X9 income Cash

30,000

Investment in Snoopy Co.

30,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X9 dividend

b. 1/1/X9

12/31/X9

Goodwill = 0

Identifiable excess = 0

$355,000 Net investment in Snoopy Co.

Book value = CS + RE = 355,000

Identifiable excess = 0

Book value = CS + RE = 405,000

$405,000 Net investment in Snoopy Co.

Book Value Calculations: Total Book Value Beg. book value

355,000

Common Stock 200,000

Retained Earnings 155,000

+ Net Income

80,000

- Dividends

(30,000)

Ending book value

405,000

200,000

205,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-24 (continued) Basic Consolidation Entry Common stock

200,000

Retained earnings

155,000

Income from Snoopy Co.

80,000

Dividends declared

30,000

Investment in Snoopy Co.

405,000

Optional accumulated depreciation consolidation entry Accumulated depreciation

10,000

Buildings & equipment

10,000

Note that this entry is carried forward from the previous year (see solution to P2-23) again assuming that no sales or other disposals of Buildings and equipment took place during the year. Investment in

Income from

Snoopy Co.

Beginning Balance

355,000

Net Income

80,000

Ending Balance

405,000

30,000 405,000 0

80,000

Net Income

80,000

Ending Balance

Dividends Basic

80,000 0

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-24 (continued) Consolidation Entries

Peanut Co.

Snoopy Co.

Sales

850,000

300,000

1,150,000

Less: COGS

(270,000)

(150,000)

(420,000)

Less: Depreciation Expense

(50,000)

(10,000)

(60,000)

Less: Other Expenses

(230,000)

(60,000)

(290,000)

Income from Snoopy Co.

80,000

Net Income

380,000

80,000

Beginning Balance

525,000

155,000

Net Income

380,000

80,000

Less: Dividends Declared

(225,000)

(30,000)

Ending Balance

680,000

205,000

Cash

230,000

75,000

305,000

Accounts Receivable

190,000

80,000

270,000

Inventory

180,000

100,000

Investment in Snoopy Co.

405,000

Land

200,000

100,000

Buildings & Equipment

700,000

200,000

Less: Accumulated Depreciation

(500,000)

(30,000)

10,000

Total Assets

1,405,000

525,000

10,000

Accounts Payable

75,000

35,000

Bonds Payable

150,000

85,000

Common Stock

500,000

200,000

Retained Earnings

680,000

205,000

235,000

30,000

680,000

1,405,000

525,000

435,000

30,000

1,525,000

Consolidated

Income Statement

80,000

0 0

380,000

Statement of Retained Earnings

235,000

525,000 0

380,000

30,000

(225,000)

30,000

680,000

Balance Sheet

Total Liabilities & Equity

280,000 405,000

0 300,000

10,000

890,000 (520,000)

415,000

1,525,000

110,000 235,000 500,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-25 Consolidated Worksheet at End of the First Year of Ownership (Equity Method) a. Equity Method Entries on Paper Co.'s Books: Investment in Scissor Co.

370,000

Cash

370,000

Record the initial investment in Scissor Co. Investment in Scissor Co.

93,000

Income from Scissor Co.

93,000

Record Paper Co.'s 100% share of Scissor Co.'s 20X8 income Cash

25,000

Investment in Scissor Co.

25,000

Record Paper Co.'s 100% share of Scissor Co.'s 20X8 dividend b. Book Value Calculations: Total Book Value Beginning book value

370,000

Common Stock 250,000

Retained Earnings 120,000

+ Net Income

93,000

- Dividends

(25,000)

Ending book value

438,000

250,000

188,000

1/1/X8

12/31/X8

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 370,000

$370,000 Initial investment in Scissor Co.

Identifiable excess = 0

Book value = CS + RE = 438,000

$438,000 Net investment in Scissor Co.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-25 (continued) Basic Consolidation Entry Common stock

250,000

Retained earnings

120,000

Income from Scissor Co.

93,000

Dividends declared

25,000

Investment in Scissor Co.

438,000

Optional accumulated depreciation consolidation entry Accumulated depreciation

24,000

Buildings & equipment

24,000

The amount of this entry is found by looking at the depreciation expense ($12,000) for the year and the accumulated depreciation at the end of the year ($36,000). The difference must be what was in accumulated depreciation at the date of the acquisition. Note that this assumes there were no sales or other disposals of Buildings and equipment during the year.

Investment in

Income from

Scissor Co.

Acquisition Price

370,000

Net Income

93,000

Ending Balance

438,000

25,000 438,000 0

93,000

Net Income

93,000

Ending Balance

Dividends Basic

93,000 0

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-25 (continued) Consolidation Entries

Paper Co.

Scissor Co.

Sales

800,000

310,000

1,110,000

Less: COGS

(250,000)

(155,000)

(405,000)

Less: Depreciation Expense

(65,000)

(12,000)

(77,000)

Less: Other Expenses

(280,000)

(50,000)

(330,000)

Income from Scissor Co.

93,000

Net Income

298,000

93,000

Beginning Balance

280,000

120,000

Net Income

298,000

93,000

Less: Dividends Declared

(80,000)

(25,000)

Ending Balance

498,000

188,000

Cash

122,000

46,000

168,000

Accounts Receivable

140,000

60,000

200,000

Inventory

190,000

120,000

Investment in Scissor Co.

438,000

Land

250,000

125,000

Buildings & Equipment

875,000

250,000

Less: Accumulated Depreciation

(565,000)

(36,000)

24,000

Total Assets

1,450,000

565,000

24,000

Accounts Payable

77,000

27,000

Bonds Payable

250,000

100,000

Common Stock

625,000

250,000

Retained Earnings

498,000

188,000

213,000

25,000

498,000

1,450,000

565,000

463,000

25,000

1,577,000

Consolidated

Income Statement

93,000

0 0

298,000

Statement of Retained Earnings

213,000

280,000 0

298,000

25,000

(80,000)

25,000

498,000

Balance Sheet

Total Liabilities & Equity

310,000 438,000

0 375,000

24,000

1,101,000 (577,000)

462,000

1,577,000

104,000 350,000 625,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-26 Consolidated Worksheet at End of the Second Year of Ownership (Equity Method) a. Equity Method Entries on Paper Co.'s Books: Investment in Scissor Co.

107,000

Income from Scissor Co.

107,000

Record Paper Co.'s 100% share of Scissor Co.'s 20X9 income

Cash

30,000

Investment in Scissor Co.

30,000

Record Paper Co.'s 100% share of Scissor Co.'s 20X9 dividend b. Book Value Calculations: Total Book Value

Common Stock 250,000

Retained Earnings

Beg. book value

438,000

+ Net Income

107,000

- Dividends

(30,000)

Ending book value

515,000

250,000

188,000

265,000

1/1/X9

12/31/X9

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 438,000

$438,000 Net investment in Scissor Co.

Identifiable excess = 0

Book value = CS + RE = 515,000

$515,000 Net investment in Scissor Co.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-26 (continued) Basic Consolidation Entry Common stock

250,000

Retained earnings

188,000

Income from Scissor Co.

107,000

Dividends declared

30,000

Investment in Scissor Co.

515,000

Optional accumulated depreciation consolidation entry Accumulated depreciation

24,000

Buildings & equipment

24,000

Note that this entry is carried forward from the previous year (see solution to P2-25) again assuming that no sales or other disposals of Buildings and equipment took place during the year.

Investment in

Income from

Scissor Co.

Beginning Balance

438,000

Net Income

107,000

Ending Balance

515,000

30,000 515,000 0

107,000

Net Income

107,000

Ending Balance

Dividends Basic

107,000 0

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-26 (continued) Consolidation Entries

Paper Co.

Scissor Co.

Sales

880,000

355,000

1,235,000

Less: COGS

(278,000)

(178,000)

(456,000)

Less: Depreciation Expense

(65,000)

(12,000)

(77,000)

Less: Other Expenses

(312,000)

(58,000)

(370,000)

Income from Scissor Co.

107,000

Net Income

332,000

107,000

Beginning Balance

498,000

188,000

Net Income

332,000

107,000

Less: Dividends Declared

(90,000)

(30,000)

Ending Balance

740,000

265,000

Cash

232,000

116,000

348,000

Accounts Receivable

165,000

97,000

262,000

Inventory

193,000

115,000

Investment in Scissor Co.

515,000

Land

250,000

125,000

Buildings & Equipment

875,000

250,000

Less: Accumulated Depreciation

(630,000)

(48,000)

24,000

Total Assets

1,600,000

655,000

24,000

Accounts Payable

85,000

40,000

Bonds Payable

150,000

100,000

Common Stock

625,000

250,000

Retained Earnings

740,000

265,000

295,000

30,000

740,000

1,600,000

655,000

545,000

30,000

1,740,000

Consolidated

Income Statement

107,000

0 0

332,000

Statement of Retained Earnings

295,000

498,000 0

332,000

30,000

(90,000)

30,000

740,000

Balance Sheet

Total Liabilities & Equity

308,000 515,000

0 375,000

24,000

1,101,000 (654,000)

539,000

1,740,000

125,000 250,000 625,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-27B Consolidated Worksheet at End of the First Year of Ownership (Cost Method) a. Cost Method Entries on Peanut Co.'s Books: Investment in Snoopy Co.

300,000

Cash

300,000

Record the initial investment in Snoopy Co.

Cash

20,000

Dividend Income

20,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X8 dividend b. Book Value Calculations: Total Book Value Original book value

300,000

Common Stock 200,000

Retained Earnings 100,000

1/1/X8

12/31/X8

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 300,000

$300,000 Initial investment in Snoopy Co.

Identifiable excess = 0

Book value = CS + RE = 300,000

$300,000 Net investment in Snoopy Co.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-27B (continued) Investment consolidation entry Common stock

200,000

Retained earnings

100,000

Investment in Snoopy Co.

300,000

Dividend consolidation entry Dividend income

20,000

Dividends declared

20,000

Optional accumulated depreciation consolidation entry Accumulated depreciation

10,000

Buildings & equipment

10,000

Investment in Snoopy Co. Acquisition Price Ending Balance

Dividend Income

300,000 300,000 300,000 0

Basic

20,000

Dividends

20,000

Ending Balance

20,000 0

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-27B (continued) Consolidation Entries

Peanut Co.

Snoopy Co.

Sales

800,000

250,000

1,050,000

Less: COGS

(200,000)

(125,000)

(325,000)

Less: Depreciation Expense

(50,000)

(10,000)

(60,000)

Less: Other Expenses

(225,000)

(40,000)

(265,000)

Consolidated

Income Statement

Dividend Income

20,000

Net Income

345,000

75,000

20,000

Beginning Balance

225,000

100,000

Net Income

345,000

75,000

20,000

Less: Dividends Declared

(100,000)

(20,000)

Ending Balance

470,000

155,000

Cash

130,000

80,000

210,000

Accounts Receivable

165,000

65,000

230,000

Inventory

200,000

75,000

Investment in Snoopy Co.

300,000

Land

200,000

100,000

Buildings & Equipment

700,000

200,000

Less: Accumulated Depreciation

(450,000)

(20,000)

10,000

Total Assets

1,245,000

500,000

10,000

Accounts Payable

75,000

60,000

Bonds Payable

200,000

85,000

Common Stock

500,000

200,000

Retained Earnings

470,000

155,000

120,000

20,000

525,000

1,245,000

500,000

320,000

20,000

1,445,000

400,000

Statement of Retained Earnings

120,000

225,000 0

400,000

20,000

(100,000)

20,000

525,000

Balance Sheet

Total Liabilities & Equity

275,000 300,000

0 300,000

10,000

890,000 (460,000)

310,000

1,445,000

135,000 285,000 500,000

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-28B Consolidated Worksheet at End of the Second Year of Ownership (Cost Method) a. Cost Method Entries on Peanut Co.'s Books: Cash

30,000

Dividend Income

30,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X9 dividend b. Book Value Calculations: Total Book Value Original book value

300,000

Common Stock

200,000

Retained Earnings 100,000

1/1/X9

12/31/X9

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 300,000

$300,000 Net investment in Snoopy Co.

Identifiable excess = 0

Book value = CS + RE = 300,000

$300,000 Net investment in Snoopy Co.

Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

P2-28 (continued) Investment consolidation entry Common stock

200,000

Retained earnings

100,000

Investment in Snoopy Co.

300,000

Dividend consolidation entry Dividend income

30,000

Dividends declared

30,000

Optional accumulated depreciation consolidation entry Accumulated depreciation

10,000

Buildings & equipment

10,000

Note that this entry is carried forward from the previous year (see solution to P2-27B) again assuming that no sales or other disposals of Buildings and equipment took place during the year.

Investment in Snoopy Co. Acquisition Price Ending Balance

Dividend Income

300,000 300,000 300,000 0

Basic

20,000

Dividends

20,000

Ending Balance

20,000 0