Fundamentals of advanced accounting 8th edition hoyle solutions manual 1

Fundamentals of Advanced Accounting 8th Edition Hoyle

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Chapter 6

VARIABLE INTEREST ENTITIES, INTRA-ENTITY DEBT, CONSOLIDATED CASH FLOWS, AND OTHER ISSUES

Chapter Outline

I. Variable interest entities (VIEs)

A. VIEs typically take the form of a trust, partnership, joint venture, or corporation. In most cases a sponsoring firm creates these entities to engage in a limited and well-defined set of business activities. For example, a business may create a VIE to finance the acquisition of a large asset. The VIE purchases the asset using debt and equity financing, and then leases the asset back to the sponsoring firm. If their activities are strictly limited and the asset is pledged as collateral, VIEs are often viewed by lenders as less risky than their sponsoring firms. As a result, such arrangements can allow financing at lower interest rates than would otherwise be available to the sponsor.

B. Control of VIEs, by design, sometimes does not rest with its equity holders. Instead, control is exercised through contractual arrangements with the sponsoring firm who becomes the "primary beneficiary" of the entity. These contracts can take the form of leases, participation rights, guarantees, or other residual interests. Through contracting, the primary beneficiary bears a majority of the risks and receives a majority of the rewards of the entity, often without owning any voting shares.

C. An entity whose control rests with a primary beneficiary is addressed by FASB ASC subtopic 810-10 Variable Interest Entities. The following characteristics indicate a controlling financial interest in a variable interest entity.

1. The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity’s economic performance.

2. The obligation to absorb the expected losses of the entity if they occur,or

3. The right to receive the expected residual returns of the entity if they occur

The primary beneficiary bears the risks and receives the rewards of a variable interest entity and is considered to have a controlling financial interest.

D. If a reporting entity has a controlling financial interest in a variable interest entity, it should include the assets, liabilities, and results of the activities of the variable interest entity its consolidated financial statements.

E. In reporting periods subsequent to when a primary beneficiary gains control over a VIE, consolidation procedures are similar to that for a voting interest entity. A notable exception in consolidation procedures occurs in accounting for the allocation of consolidated net income across the controlling and noncontrolling interests. Because variable, rather than voting, interests determine profit allocation, the underlying agreements between the

primary beneficiary, the VIE, and other related parties must be carefully reviewed to determine net income distribution.

II. Intra-entity debt transactions

A. No special difficulty is created when one member of a business combination loans money to another. The resulting receivable/payable accounts as well as the interest income expense balances are identical and can be directly offset in the consolidation process.

B. The acquisition of an affiliate's debt instrument from an outside party does require special handling so that consolidated financial statements can be produced.

1. Because the acquisition price will usually differ from the carrying amount of the liability, a gain or loss has been created by an effective retirement which is not recorded within the individual records of either company.

2. Because of the amortization of any associated discounts and/or premiums, the interest income reported by the buyer will not equal the interest expense of the debtor.

C. In the year of acquisition, the consolidation process eliminates intra-entity accounts (the liability, the receivable, interest income, and interest expense) while the gain or loss (which produced all of the discrepancies because of the initial difference) is recognized.

1. Although several alternatives exist, this textbook assigns all income effects resulting from the retirement to the parent company, the party ultimately responsible for the decision to reacquire the debt.

2. Any noncontrolling interest is, therefore, not affected by the adjustments utilized to consolidate intra-entity debt.

D. After the year of effective retirement, all intra-entity accounts must be eliminated again in each subsequent consolidation. However, when the parent uses the equity method, the parent’s Investment in Subsidiary account is adjusted in consolidation rather than a gain or loss account. If the parent employs an accounting method other than the equity method, then the parent’s Retained Earnings are adjusted for the prior years’ income net effects of the effective gain/loss on retirement.

1. The change in retained earnings is needed because a gain or loss was created in a prior year by the effective retirement of the debt, but only interest income and interest expense were recognized by the two parties.

2. The adjustment to retained earnings at any point in time is the original gain or loss adjusted for the subsequent amortization of discounts or premiums.

III. Subsidiary preferred stock

A. Subsidiary preferred shares not owned by the parent are a part of noncontrolling interest.

B. The fair value of any subsidiary preferred shares not acquired by the parent is added to the consideration transferred along with the fair value of the noncontrolling interest in common shares to compute the acquisition-date fair value of the subsidiary.

IV. Consolidated statement of cash flows

A. Statement is produced from consolidated balance sheet and income statement and not from the separate cash flow statements of the component companies.

B. Consolidated net income is the starting point for the cash flow from operating section including both the parent and noncontrolling interest share.

C. Intra-entity cash transfers are omitted from this statement because they do not occur with an outside unrelated party.

D. Dividends paid by the subsidiary to the noncontrolling interest are reported as a financing activity.

V. Consolidated earnings per share

A. This computation normally follows the pattern described in intermediate accounting textbooks. For basic EPS, consolidated net income is divided by the weighted-average number of parent shares outstanding. If convertibles (such as bonds or warrants) exist for the parent shares, their weight must be included in computing diluted EPS but only if earnings per share is reduced.

1. The subsidiary's diluted earnings per share are computed first to arrive at (1) an earnings figure and (2) a shares figure.

2. The portion of the shares figure belonging to the parent is computed. That percentage of the subsidiary's diluted earnings is then added to the parent's net income in order to complete the earnings per share computation.

VI. Subsidiary stock transactions

A. If the subsidiary issues new shares of stock or reacquires its own shares as treasury stock, a change is created in the book value underlying the parent's investment account. The increase or decrease should be reflected by the parent as an adjustment to this balance.

B. The book value of the subsidiary that corresponds to the parent's ownership is measured before and after the transaction with any alteration recorded directly to the investment account. The parent's additional paid-in capital (or retained earnings) account is normally adjusted although the recognition of a gain or loss is an alternate accounting treatment.

C. Treasury stock acquired by the subsidiary may also necessitate a similar adjustment to the parent's investment account. In addition, any subsidiary treasury stock is eliminated within the consolidation process.

Answer to Discussion Question: Who Lost this $300,000?

This case is designed to give life to a theoretical accounting issue: If a subsidiary's debt is retired, should the resulting gain or loss be assigned to the parent or to the subsidiary? The case illustrates that there is no clear-cut solution. This lack of an absolute answer makes financial accounting both intriguing and frustrating.

The assignment decision is only necessary in the presence of a noncontrolling interest. Regardless of the ownership level all intra-entity balances are eliminated on the worksheet with a gain or loss recognized. Not until the consolidated net income is allocated across the controlling interest and the noncontrolling interest does the assignment decision have an impact.

We assume that financial and operating decisions are made in the best interest of the business entity as a whole. This debt would not have been retired unless corporate officials believed that Penston/Swansan would benefit from the decision. Thus, an argument can be made against any assignment to either separate party.

Students should choose and justify one method. Discussion often centers on the following:

 Parent company officials made the actual choice that created the book loss. Therefore, assigning the $300,000 to the subsidiary directs the impact of their decision to the wrong party. In effect, the subsidiary had nothing to do with this transaction (as indicated in the case) so that its share of consolidated net income should not be affected by the $300,000 loss.

 The debt was that of the subsidiary. Because the subsidiary's debt is being retired, all of the $300,000 should be attributed to that party. Financial records measure the results of transactions and the retirement simply culminates an earlier transaction made by the subsidiary. The parent is doing no more than acting as an agent for the subsidiary (as indicated in the case). If the subsidiary had acquired its own debt, for example, no question as to the assignment would have existed. Thus, changing that assignment simply because the parent agreed to be the acquirer is not justified.

 Both parties were involved in the transaction so that some allocation of the loss is required. If, at the time of repurchase, a discount existed within the subsidiary's accounts, this figure would have been amortized to interest expense (if the debt had not been retired). Thus, the $300,000 loss was accepted now in place of the later amortization. This reasoning then assigns this portion of the loss to the subsidiary. Because the parent agreed to pay more than face value, that remaining portion is assigned to the buyer.

Answers to Questions

1. A variable interest entity (VIE) is a business structure that is designed to accomplish a specific purpose. A VIE can take the form of a trust, partnership, joint venture, or corporation although typically it has neither independent management nor employees. The entity is frequently sponsored by another firm to achieve favorable financing rates.

2. Variable interests are contractual, ownership, or other pecuniary interests in an entity that change with changes in the entity's net asset value. Variable interests will absorb portions of a variable interest entity's expected losses if they occur or receive portions of the entity's expected residual returns if they occur. Variable interests typically are accompanied by contractual arrangements that provide decision making power to the owner of the variable interests. Examples of variable interests include debt guarantees, lease residual value guarantees, participation rights, and other financial interests.

3. The following characteristics are indicative of an enterprise qualifying as a primary beneficiary with a controlling financial interest in a VIE.

 The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity’s economic performance.

 The obligation to absorb the expected losses of the entity if they occur, or

 The right to receive the expected residual returns of the entity if they occur

4. Because the bonds were purchased from an outside party, the acquisition price is likely to differ from the carrying amount of the debt in the subsidiary's records. This difference creates accounting challenges in handling the intra-entity transaction. From a consolidated perspective, the debt is retired; a gain or loss is reported with no further interest being recorded. In reality, each company continues to maintain these bonds on their individual financial records. Also, because discounts and/or premiums are likely to be present, these account balances as well as the interest income/expense will change from period to period because of amortization. For reporting purposes, all individual accounts must be eliminated with the gain or loss being reported so that the events are shown from the vantage point of the consolidated entity.

5. If the bonds are acquired directly from the affiliate company, all reciprocal accounts will be equal in amount. The debt and the receivable will be in agreement so that no gain or loss is created. Interest income and interest expense should also reflect identical amounts. Therefore, the consolidation process for this type of intra-entity debt requires no more than the offsetting of the various reciprocal balances.

6. The gain or loss to be reported is the difference between the price paid and the carrying amount of the debt on the date of acquisition. For consolidation purposes, this gain or loss should be recognized immediately on the date of acquisition.

7. Because the bonds are still legally outstanding, they will continue to be found on both sets of financial records. Thus, each account (Bonds Payable, Investment in Bonds, Interest Expense, and Interest Income) must be eliminated within the consolidation process. Any gain or loss on the effective retirement as well as later effects on interest caused by amortization are also included to arrive at an adjustment to the beginning retained earnings (or the Investment account if the equity method is used) of the parent company.

8. The original gain is never recognized within the financial records of either company. Thus, within the consolidation process for the year of acquisition, the gain is directly recorded whereas (for each subsequent year) it is entered as an adjustment to beginning retained earnings (or the Investment account if the equity method is used). In addition, because the carrying amount of the debt and the investment are not in agreement, the interest expense and interest income balances being recorded by the two companies will differ each year because of the amortization process. This amortization effectively reduces the difference between the individual retained earnings balances and the total that is appropriate for the consolidated entity. Consequently, a smaller change is needed each period to arrive at the balance to be reported. For this reason, the annual adjustment to beginning retained earnings (or the Investment account if the equity method is used) gradually decreases over the life of the bond.

9. No set rule exists for assigning the income effects from intra-entity debt transactions although several different theories exist and include: (1) assignment of the entire amount to the debtor, (2) assignment of the entire amount to the buyer, and (3) allocation of the gain or loss between the two parties in some manner. This textbook attributes the entire income effect (the $45,000 gain in this case) to the parent company. Assignment to the parent is justified because that party is ultimately responsible for the decision to retire the debt from the public market. The answer to the discussion question included in this chapter analyzes this question in more detail.

10 Subsidiary outstanding preferred shares are part of the noncontrolling interest and are included in the consolidated financial statements at acquisition-date fair value and subsequently adjusted for their share of subsidiary income and dividends.

11 The consolidated cash flow statement is developed from consolidated balance sheet and income statement figures. Thus, the cash flows generated by operating, investing, and financing activities are identified only after the consolidation of these other statements.

12. The noncontrolling interest share of the subsidiary’s net income is a component of consolidated net income. Consolidated net income then is adjusted for noncash and other

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items to arrive at consolidated cash flows from operations. Any dividends paid by the subsidiary to these outside owners are listed as a financing activity because an actual cash outflow occurs

13 An alternative to the normal diluted earnings per share calculation is required whenever the subsidiary has dilutive convertible securities such as bonds or warrants. In this case, the potential impact of the conversion of subsidiary shares must be factored into the overall diluted earnings per share computation.

14 Basic Earnings per Share. The existence of subsidiary convertible securities does not affect basic EPS. The parent’s basic earnings per share is computed by dividing the parent’s share of consolidated net income by the weighted average number of parent shares outstanding.

Diluted Earnings per Share. The subsidiary's diluted earnings per share is computed by including both convertible items. The portion of the parent's controlled shares to the total shares used in this calculation is then determined. Only this percentage (of the income figure used in the subsidiary's computation) is added to the parent's income in arriving at the parent company’s diluted earnings per share.

15. Several reasons could exist for a subsidiary to issue new shares of stock to outside parties. First, additional financing is brought into the company by any such sale. Also, stock issuance may be used to entice new individuals to join the organization. Additional management personnel, as an example, might be attracted to the company in this manner. The company could also be forced to sell shares because of government regulation. Many countries require some degree of local ownership as a prerequisite for operating within that country.

16 Because the new stock was issued at a price above the subsidiary’s assigned consolidation value, the overall valuation for Metcalf's stock has been increased. Consequently, the Washburn's investment is increased to reflect this change. To measure the effect, the value of Washburn's investment is calculated both before and after the new issue Because the increment is the result of a stock transaction, an increase is made to additional paid-in capital. Although the subsidiary's shares (both new and old) are eliminated in the consolidation process, the increase in the parent's APIC (or gain or loss) carries into the consolidated figures. Also, the noncontrolling interest percentage of the subsidiary increases

17 A stock dividend does not alter the assigned consolidated subsidiary value and, thus, creates no effect on Washburn's investment account or on the consolidated figures. Hence, no entry is recorded by the parent company in connection with the subsidiary's stock dividend.

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12.B Mattoon’s share of consolidated net income.......... $465,000

common

14.B 30% of $147,000 subsidiary net income; the intra-entity debt effects are

solely to the parent company. 30% x $147,000 = $44,100

15.A For 2018, the adjustment to beginning retained earnings should recognize the gain on the retirement of the debt, the elimination of the 2017 interest expense, and the elimination of the 2017 interest income.

fair value of prior to new share issue

fair value after issuing new

20.A Because the parent acquired 80 percent of the new shares, its proportional ownership remains the same. Because the amount the parent pays will necessarily equal 80 percent of the increase in the subsidiary's book value, no separate adjustment by the parent is required.

23. (10 minutes) (Qualification of Primary Beneficiary of a VIE)

Consolidation of a variable interest entity is required if a firm has a variable interest that gives the firm

 The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity’s economic performance.

 The obligation to absorb a majority of the entity's expected losses if they occur and/or the right to receive a majority of the entity's expected residual returns if they occur

Because (1) HCO Media’s losses are limited by contract, and (2) Hillsborough has the right to receive the residual benefits of the sales generated on the HCO Media internet site above $500,000, Hillsborough should consolidate HCO Media.

24. (30 minutes) (VIE Qualifications for Consolidation)

a. The purpose of consolidated financial statements is to present the financial position and results of operations of a group of businesses as if they were a single entity. They are designed to provide information useful for making business and economic decisions—especially assessing amounts, timing, and uncertainty of prospective cash flows. Consolidated statements also provide more complete information about the resources, obligations, risks, and opportunities of an enterprise than separate statements.

b. An entity qualifies as a VIE and is subject to consolidation if either of the following conditions exist.

24. (continued)

 The total equity at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties. In most cases, if equity at risk is less than 10% of total assets, the risk is deemed insufficient.

 The equity investors in the VIE lack any one of the following three characteristics of a controlling financial interest.

1. The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity’s economic performance.

2. The obligation to absorb the expected losses of the entity if they occur (e.g., another firm may guarantee a return to the equity investors)

3. The right to receive the expected residual returns of the entity (e.g., the investors' return may be capped by the entity's governing documents or other arrangements with variable interest holders).

Consolidation of a variable interest entity is required if a firm has a variable interest that gives the firm

 The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity’s economic performance.

 The obligation to absorb a majority of the entity's expected losses if they occur and/or the right to receive a majority of the entity's expected residual returns if they occur

c. Risks of the construction project that has TecPC has effectively shifted to the owners of the VIE:

At the end of the 1st five-year lease term, if the parent opts to sell the facility, and the proceeds are insufficient to repay the VIE investors, TecPC may be required to pay up to 85% of the project's cost. Thus, a potential 15% risk.

Risks that remain with TecPC

 Guarantees of return to VIE investors at market rate, if facility does not perform as expected TecPC is still obligated to pay market rates.

 If lease is not renewed, TecPC must either purchase the facility or sell it on behalf of the VIE with a guarantee of Investors' (debt and equity) balances representing a risk of decline in market value of asset

 Debt guarantees

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24. (continued)

d. TecPC possesses the following characteristics of a primary beneficiary:

 Direct decision-making ability (end of five-year lease term).

 Absorb a majority of the entity's expected losses if they occur (via debt guarantees and guaranteed lease payments and residual value).

 Receive a majority of the entity's expected residual returns if they occur (via use of the facility and potential increase in its market value).

25. (10 minutes) (Consolidation of variable interest entity.)

a.

PanTech recognizes the $20,000 excess net asset fair value as a bargain purchase and records all of SoftPlus’ assets and liabilities at their individual fair values.

When the fair value of a VIE (that is a business) is greater than assessed asset values, all identifiable assets and liabilities are reported at fair values (unless a previously held interest) and the difference is treated as goodwill.

26. (40 minutes) (Acquisition-date consolidation worksheet for a parent and a variable interest entity)

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27. (35 minutes) (Consolidation of a primary beneficiary and variable interest entity one year after control is obtained)

28. (25 Minutes) (Consolidation entry for three consecutive years to report effects of intra-entity bond acquisition. Straight-line method used. Parent uses equity method)

a.

ENTRY B (2016)

eliminate accounts stemming from intra-entity bonds [balances computed above] and to recognize gain on the effective retirement of this debt.)

b. In 2017, because straight-line amortization is used, the interest accounts remain unchanged at $38,000 and $34,000. However, the premium associated with the bond payable as well as the discount on the investment are affected by the $2,000 per year amortization. In addition, the gain now has to be removed from the Investment in Hamilton account. Concurrently, the two interest balances recorded by the individual companies in 2017 are removed from the Investment in Hamilton because they occurred after the intra-entity retirement. Gain of $32,000 plus $34,000 expense removal less $38,000 income elimination yields a $28,000 credit to the investment account.

CONSOLIDATION ENTRY *B (2017)

(To remove intra-entity bond accounts that remain on the individual records of both companies. Both debt and bond investment balances have been adjusted for amortizations. Entry to Investment in Hamilton brings the totals reported by the individual companies [interest income and expense] to the balance of the original gain.)

c. As with part b, new premium and discount balances must be determined and then removed. The adjustment made to the Investment in Hamilton takes into account that another year of interest expense ($34,000) and income ($38,000) have been incorporated into the investment account through application of the equity method.

28.(continued)

CONSOLIDATION ENTRY *B (2018)

(To remove intra-entity bond accounts that remain on the individual records of both companies. Both debt and bond investment balances have been adjusted for amortizations. Credit to Investment in Hamilton brings the totals reported by the individual companies to the balance of the original gain.)

29. (12 Minutes) (Determine consolidated income statement accounts after acquisition of intra-entity bonds.)

 Interest Expense To Be Eliminated = $84,000 × 11% = $9,240

 Interest Income To Be Eliminated = $108,000 × 8% = $8,640

 Loss To Be Recognized = $108,000 – $84,000 = $24,000

CONSOLIDATED TOTALS

 Revenues and Interest Income = $1,051,360 (add the two book values and eliminate interest income on intra-entity bond)

 Operating and Interest Expense = $751,760 (add the two book values and eliminate interest expense on intra-entity bond)

 Other Gains and Losses = $152,000 (add the two book values)

 Loss on Retirement of Debt = $24,000 (computed above)

 Net Income = $427,600 (consolidated revenues, interest income, and gains less consolidated operating and interest expense and losses)

30. (30 Minutes) (Consolidation entry for two years to report effects of intraentity bond acquisition. Effective rate method applied.)

30. (continued)

30.

(continued)

Adjustment Needed to Investment in Zack for Bond Retirement Loss:

(To eliminate intra-entity bond holdings and adjust the Investment in Zack for the unrecognized loss on retirement. Amounts computed above.)

Many of the above amounts can also be determined using amortization tables as shown below.

31. (35 Minutes) (Consolidation procedures and balances related to intra-entity bonds. Both straight-line and effective interest rate methods are used.)

SCHEDULE 1 Carrying Amount of Bonds Payable

Although not required in the problem, the consolidation entry as of 12/31/18 is as follows. The reduction in retained earnings represents the loss only; no intraentity interest was recognized in the previous year because the purchase was made on December 31.

*B (2018)

31. (continued)

c. Loss on Retirement of Bond Because Bloom uses the straight-line method of amortization, the loss on retirement must be computed again.

The reduction in retained earnings represents the loss only; no intra-entity interest was recognized in the previous year because the purchase was made on December 31.

32.(8 Minutes) (Determine goodwill for an acquisition in which subsidiary has both common stock and preferred stock)

33. (30 Minutes) (Consolidation entries with subsidiary cumulative preferred stock.)

a. The preferred shares are entitled to the specified cumulative dividend. Thus, the noncontrolling interest's share of the subsidiary's income equals $160,000 or 8 percent of the preferred stock's par value.

33. c. (continued)

computation above].)

34. (30 Minutes) (Prepare consolidation entries for an acquisition where subsidiary has outstanding preferred stock)

(To eliminate subsidiary stockholders’ equity, record excess acquisition-date fair values, and record outside ownership of subsidiary's preferred stock at acquisition-date fair value)

offset intra-entity preferred stock dividends recognized as income by parent—$1,000,000 par value × 8% dividend rate.)

eliminate intra-entity dividends [60% of $320,000] on common stock. Because the $320,000 in dividends remaining after Entry I1 equals exactly 8 percent of the common stock par value, the participation factor does not affect the distribution.)

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35.(15 Minutes) (The effect that various events have on a consolidated statement of cash flows.)

 Sale of building. The $44,000 in cash received from the sale is listed as a cash inflow within the company's investing activities. If the company is using the direct method in presenting cash flows from operating activities, the $12,000 gain is not presented. However, if the indirect method is used, the gain (a positive) must be eliminated from net income by a subtraction.

 Intra-entity inventory transfers. Because these transactions do not occur with any parties outside of the business combination, they are not reflected in the consolidated statement of cash flows.

 Dividend paid by the subsidiary. The $27,000 payment to the parent is eliminated in consolidated statements and is not a cash outflow from the consolidated entity. The remaining $3,000 payment to the noncontrolling interest is reported as a cash outflow from a financing activity.

 Amortization of intangible asset. This $16,000 noncash expense appears in the consolidated income statement. If the combined companies are using the direct method to present cash flows from operating activities, this expense not presented. If the indirect method is used, the expense must be removed by adding it back to consolidated net income.

 Decrease in accounts payable. Cash payments have reduced this liability balance during the period. If the direct method is used to present cash flows from operating activities, the change is added to cost of goods sold as one step in deriving the cash paid during the period for inventory (an outflow). If the indirect method is applied, the decrease is subtracted from net income in arriving at the net cash generated from operating activities during the period.

36.(20 Minutes) (Determine cash flows from operations for a consolidated entity.)

DIRECT

(add book values, eliminate intra-entity transfers, and add decrease in accounts receivable)

= $206,200 + 9,800 = $216,000 or computation below:

subtract intra-entity

37. (30 Minutes) (Compute basic and diluted earnings per share for a parent and its 100 percent owned subsidiary, both with convertible bonds.)

38. (15 Minutes) (Compute diluted EPS. Subsidiary has stock warrants outstanding)

39. (15 Minutes) (Compute diluted EPS. Subsidiary has convertible bonds.)

40. (35 Minutes) (Compute basic and diluted earnings per share for parent company. Subsidiary has stock warrants and convertible bonds.)

*Foreman’s convertible bonds are antidilutive and thus excluded from the diluted EPS calculations.

Burks’ diluted EPS:

a. Prior to the issuance of the new shares, Albuquerque owns an 80% interest in Marmon (16,000 shares out of 20,000 shares). The adjusted acquisition-date fair value is $840,000 ($600,000 + $150,000 + $90,000). After the stock issue, the adjusted acquisition-date fair value of the subsidiary will increase by $235,000 (the price of the stock) to $1,075,000. Albuquerque' ownership, however, will only be 64% (16,000 ÷ 25,000). The investment’s equity method balance before stock issue is $672,000 (600,000 + [$90,000 × 80%]). The book value underlying Albuquerque' investment is now $688,000 (64% of $1,075,000) so that a $16,000 increase is recorded by the parent.

40. (continued)

41. (8 Minutes) (Effect of subsidiary stock issuance to public at a price above reported value per share)

42. (20 Minutes) (Effects of two different stock issuances by subsidiary.)

42. (continued)

b. Albuquerque's adjusted acquisition-date fair value is $840,000 (see above) prior to the issuance of the new shares. The 4,000 additional shares increase subsidiary's total value by $132,000 (the price of the stock) to $972,000. Albuquerque' ownership decreases to 2/3 (16,000 shares out of a total of 24,000) for a fair value equivalency of $648,000. Reducing the $672,000 (see a.) to $648,000 requires a $24,000 decrease to the parent’s APIC.

43.(55 Minutes) (Prepare consolidation entries following a subsidiary stock issue to outside parties.)

Initially, Aronsen owns 18,000 shares (or 90%) of Siedel's outstanding shares (the total number of shares can be determined by dividing the subsidiary's common stock account by the $10 per share par value). After issuing 4,000 additional shares, the parent must prepare an adjustment to reflect the change in its share of the subsidiary’s unamortized acquisition-date fair value. Because that entry has not been recorded, it is included on the consolidation worksheet as Entry C1 (labeled in this manner as a correction). Other consolidation procedures follow as described in previous chapters.

43. (continued)

Consolidation worksheet entries:

(To convert 1/1/18 balance to full accrual [$100,000 less two year’s amortization expense $5,000 × 2] × 90%)

(To record adjustment for subsidiary stock transaction; computation shown above.)

(To eliminate subsidiary stockholders' equity accounts against Investment account and to recognize noncontrolling interest. Stockholders’equity balances have been adjusted for increase in book value during 2016–2018 and the issuance by the subsidiary of 4,000 shares of stock on 1/1/18.)

(To recognize acquisition price allocated to land and copyrights. Copyrights balance has been reduced for 2016–2018 amortization to arrive at 1/1/18 balance. NCI now reflects 25% of the unamortized 1/1/18 balance.)

(To eliminate intra-entity dividends recorded by parent as income [75% × $20,000].)

(To recognize current year amortization.)

44. (50 Minutes) (Prepare consolidation worksheet for business combination. Intraentity bond acquisition is made during the current year.)

Acquisition-date fair-value allocation and amortization:

As indicated in the problem, the parent is applying the partial equity method. Hence an Entry *C must be recorded on the worksheet to convert the recorded figures (amortization is needed for the three years prior to 2018) to equity balances: Amortization expense ($5,000 × 3 years) = ............ $15,000 (Entry *C)

Deferred gross profit in ending inventory (downstream):

Amortization during 2018 changed the carrying amount of the bond payable from $282,000 to $288,000 (found in the balance sheet) and the investment from $145,500 to $147,000. This amortization also affects interest income and expense accounts.

Entry A reflects remaining values after three years of amortizations.

6-6-35

44.(continued) Pavin and Stabler Consolidation Worksheet Year Ending December 31, 2018

45.(45 Minutes) (Prepare consolidation entries after intra-entity bond acquisition.)

(To eliminate intra-entity gain created by previous intra-entity transfer. Investment is adjusted here because transfer was downstream and equity method has been applied by parent. Thus, retained earnings have already been corrected.)

(To remove intra-entity inventory gross profit from prior year recognize the profit in the current

Amount is computed as shown below.)

(To eliminate effect created by bond acquisition and recognize the related retirement gain [$21,386 – $18,732]. Amounts are calculated below.)

45. (continued)

c. The balances in the individual records as of December 31, 2019 pertaining to the Intra-entity bonds are as follows:

The adjustment to recognize the original gain by the parent can be computed as follows:

(To remove accounts pertaining to intra-entity bonds. "Investment in Herman" is adjusted here rather than retained earnings because equity method is used and the gain is attributed to the parent.)

or distribution without the prior written consent of McGraw-Hill Education.

46. (50 Minutes) (Prepare consolidation entries for intra-entity preferred stock and bonds. Determine specified account balances. Preferred stock is a debt instrument.)

(To eliminate subsidiary stockholders’ equity, record excess acquisition-date fair values, and record outside ownership of subsidiary's preferred and common stock at acquisition-date fair values.)

47.(35 Minutes) (Prepare statement of cash flows for a business combination.)

(Note: before working this problem, students may wish to review the statement of cash flows in an intermediate accounting textbook.)

The above statement uses the indirect method for computing cash flows from operations.

47. (continued)

48.(40 Minutes) (Compute basic and diluted earnings per share. Subsidiary has stock warrants outstanding and convertible debt.)