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Chapter 1 BUSINESS COMBINATIONS Answers to Questions 1

A business combination is a union of business entities in which two or more previously separate and independent companies are brought under the control of a single management team. Three situations establish the control necessary for a business combination, namely, when one or more corporations become subsidiaries, when one company transfers its net assets to another, and when each combining company transfers its net assets to a newly formed corporation.

The dissolution of all but one of the separate legal entities is not necessary for a business combination. An example of one form of business combination in which the separate legal entities are not dissolved is when one corporation becomes a subsidiary of another. In the case of a parent-subsidiary relationship, each combining company continues to exist as a separate legal entity even though both companies are under the control of a single management team.

A business combination occurs when two or more previously separate and independent companies are brought under the control of a single management team. Merger and consolidation in a generic sense are frequently used as synonyms for the term business combination. In a technical sense, however, a merger is a type of business combination in which all but one of the combining entities are dissolved and a consolidation is a type of business combination in which a new corporation is formed to take over the assets of two or more previously separate companies and all of the combining companies are dissolved.

Goodwill arises in a business combination accounted for under the acquisition method when the cost of the investment (fair value of the consideration transferred) exceeds the fair value of identifiable net assets acquired. Under GAAP, goodwill is not amortized for financial reporting purposes and will have no effect on net income, unless the goodwill is deemed to be impaired. If goodwill is impaired, a loss will be recognized.

A bargain purchase occurs when the acquisition price is less than the fair value of the identifiable net assets acquired. The acquirer records the gain from a bargain purchase as an ordinary gain during the period of the acquisition. The gain equals the difference between the investment cost and the fair value of the identifiable net assets acquired.

1-1

1-2

Business Combinations

SOLUTIONS TO EXERCISES Solution E1-1 1 2 3 4

b c c c

Solution E1-2 [AICPA adapted] 1

a Plant and equipment should be recorded at the $220,000 fair value.

c Investment cost Less: Fair value of net assets Cash Inventory Property and equipment — net Liabilities Goodwill

$1,600,000 $

160,000 380,000 1,120,000 (360,000) $

1,300,000 300,000

Solution E1-3 Stockholders’ equity — Pop Corporation on January 3 Capital stock, $10 par, 600,000 shares outstanding

$ 6,000,000

Other paid-in capital [$400,000 + $3,000,000 – $10,000]

3,390,000

Retained earnings [$1,200,000 - $20,000] Total stockholders’ equity

1,180,000 $10,570,000

Entry to record combination Investment in Son Capital stock, $10 par Other paid-in capital

6,000,000 3,000,000 3,000,000

Investment expense Other paid-in capital Cash Check: Net assets per books (book value) Goodwill and write-up of assets Less: Expense of direct costs

20,000 10,000 30,000 $ 7,600,000 3,000,000 (20,000)

Less: Issuance of stock (10,000) $10,570,000 .

Chapter 1

1-3

Solution E1-4 Journal entries on Pam’s books to record the acquisition Investment in Sun 10,200,000 Common stock, $10 par 4,800,000 Additional paid-in capital 5,400,000 To record issuance of 480,000 shares of $10 par common stock with a fair value of $10,200,000 for the common stock of Sun in a business combination. Additional paid-in capital 60,000 Investment expenses 180,000 Other assets (or Cash) 240,000 To record costs of registering and issuing securities as a reduction of paidin capital, and record direct and indirect costs of combination as expenses. Current assets 4,400,000 Plant assets 8,800,000 Liabilities 1,200,000 Investment in Sun 10,200,000 Gain from bargain purchase 1,800,000 To record allocation of the $10,200,000 cost of Sun Company to identifiable assets and liabilities according to their fair values, and the gain from the bargain purchase,computed as follows: Cost $10,200,000 Fair value of net assets acquired 12,000,000 Bargain purchase amount $ 1,800,000

1-4

Business Combinations

Solution E1-5 Journal entries on the books of Pop Corporation to record merger with Son Corporation Investment in Son 1,060,000 Common stock, $10 par 360,000 Additional paid-in capital 300,000 Cash 400,000 To record issuance of 36,000 common shares and payment of cash in the acquisition of Son Corporation in a merger. Investment expenses 140,000 Additional paid-in capital 60,000 Cash 200,000 To record costs of registering and issuing securities and additional direct costs of combination. Cash 80,000 Inventories 200,000 Other current assets 40,000 560,000 Plant assets — net Goodwill 320,000 Current liabilities 60,000 Other liabilities 80,000 Investment in Son 1,060,000 To record allocation of cost to assets received and liabilities assumed on the basis of their fair values and to goodwill computed as follows: Cost of investment Fair value of net assets acquired Goodwill Solution E1-6* Net assets (+A) Common stock (+SE) Additional paid-in capital (+SE) Retained earnings (+SE) Expenses (E, -SE) Cash (-A)

$1,060,000 740,000 $ 320,000 2,200 1,200 800 200 60 60

Solution E1-7* Net assets (+A) Capital stock (+SE) Retained earnings (+SE) Investment in Sun Corporation (-A)

2,100 1,470 600 30

Chapter 1

1-5

SOLUTIONS TO PROBLEMS Solution P1-1 (in thousands) Preliminary computations Fair Value: Cost of investment in Son at January 2 (240,000 shares  $40) Book value of net assets ($8,000 - $960) Excess fair value over book value Excess assigned to: Current assets Remainder to goodwill Excess fair value over book value

$9,600 (7,040) $2,560 $

640 1,920 $2,560

Note: $400,000 direct costs of combination are expensed. The excess fair value of Pop’s buildings is not considered.

Pop Corporation Balance Sheet at January 2, 2016 (in thousands) Assets Current assets ($2,080 + $960 + $640 excess - $640 direct costs)

$ 3,040

Land ($800 + $1,600)

2,400

Buildings — net ($4,800 + $1,600)

6,400

Equipment — net ($3,520 + $3,840)

7,360

Goodwill Total assets

1,920 $21,120

Liabilities and Stockholders’ Equity Current liabilities ($800 + $960)

$ 1,760

Capital stock, $10 par ($8,000 + $2,400 new issue)

10,400

Additional paid-in capital [$800 + ($30  240 shares) — $240 costs of issuing and registering securities]

7,760

Retained earnings (subtract $400 expensed direct cost) Total liabilities and stockholders’ equity

1,200 $ 21,120

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Business Combinations

Solution P1-2 Preliminary computations Fair Value: Cost of acquiring Son Fair value of assets acquired and liabilities assumed Goodwill from acquisition of Son

$1,650,000 1,340,000 $ 310,000

Pop Corporation Balance Sheet at January 2, 2016 Assets Current assets Cash [$300,000 + $60,000 - $280,000 expenses paid]

80,000 540,000

Accounts receivable — net [$460,000 + $80,000 fair value] Inventories [$1,040,000 + $240,000 fair value]

1,280,000

Plant assets Land [$800,000 + $300,000 fair value]

1,100,000

Buildings — net [$2,000,000 + $600,000 fair value]

2,600,000

Equipment — net [$1,000,000 + $500,000 fair value]

1,500,000

Goodwill Total assets

310,000 $7,410,000

Liabilities and Stockholders’ Equity Liabilities Accounts payable [$600,000 + $80,000] Note payable [$1,200,000 + $360,000 fair value]

680,000 1,560,000

Stockholders’ equity Capital stock, $10 par [$1,600,000 + (66,000 shares  $10)]

2,260,000

Other paid-in capital [$1,200,000 - $80,000 + ($1,650,000 - $660,000)]

2,110,000

Retained earnings (subtract $200,000 expensed direct costs) Total liabilities and stockholders’ equity

800,000 $7,410,000

Chapter 1

1-7

Solution P1-3 Pam issues 25,000 shares of stock for Sun’s outstanding shares 1a

Investment in Sun 1,500,000 Capital stock, $10 par 250,000 Additional paid-in capital 1,250,000 To record issuance of 25,000, $10 par shares with a market price of $60 per share in a business combination with Sun. Investment expenses 60,000 Additional paid-in capital 40,000 Cash 100,000 To record costs of combination in a business combination with Sun. Cash 20,000 Inventories 120,000 Other current assets 200,000 Land 200,000 700,000 Plant and equipment — net Goodwill 360,000 Liabilities 100,000 Investment in Sun 1,500,000 To assign investment cost to identifiable assets and liabilities according to their fair values and the remainder to goodwill. Goodwill is computed: $1,500,000 cost - $1,140,000 fair value of net assets acquired.

Pam Corporation Balance Sheet January 2, 2016 (after business combination) Assets Cash [$240,000 + $20,000 - $100,000] Inventories [$100,000 + $120,000] Other current assets [$200,000 + $200,000] Land [$160,000 + $200,000] Plant and equipment — net [$1,300,000 + $700,000] Goodwill Total assets Liabilities and Stockholders’ Equity Liabilities [$400,000 + $100,000] Capital stock, $10 par [$1,000,000 + $250,000] Additional paid-in capital [$400,000 + $1,250,000 $40,000] Retained earnings (subtract $60,000 direct costs) Total liabilities and stockholders’ equity

160,000 220,000 400,000 360,000 2,000,000 360,000 $3,500,000 $

500,000 1,250,000 1,610,000

140,000 $3,500,000

1-8

Business Combinations

Solution P1-3 (continued) Pam issues 15,000 shares of stock for Sun’s outstanding shares 2a

900,000 Investment in Sun (15,000 shares  $60) Capital stock, $10 par 150,000 Additional paid-in capital 750,000 To record issuance of 15,000, $10 par common shares with a market price of $60 per share. Investment expense 60,000 Additional paid-in capital 40,000 Cash 100,000 To record costs of combination in the acquisition of Sun. Cash 20,000 Inventories 120,000 Other current assets 200,000 Land 200,000 700,000 Plant and equipment — net Liabilities 100,000 Investment in Sun 900,000 Gain on bargain purchase 240,000 To record Sun’s net assets at fair values and the gain on the bargain purchase.

Fair value of net assets acquired Investment cost (Fair value of consideration) Gain on Bargain Purchase 2b

$1,140,000 900,000 $ 240,000

Pam Corporation Balance Sheet January 2, 2016 (after business combination) Assets Cash [$240,000 + $20,000 - $100,000] Inventories [$100,000 + $120,000] Other current assets [$200,000 + $200,000] Land [$160,000 + $200,000] Plant and equipment — net [$1,300,000 + $700,000] Total assets Liabilities and stockholders’ equity Liabilities [$400,000 + $100,000] Capital stock, $10 par [$1,000,000 + $150,000] Additional paid-in capital [$400,000 + $750,000 $40,000] Retained earnings (subtract $60,000 direct costs and add $240,000 Gain from bargain purchase) Total liabilities and stockholders’ equity

160,000 220,000 400,000 360,000 2,000,000 $3,140,000 $

500,000 1,150,000 1,110,000 380,000

$3,140,000

Chapter 1

1-9

Solution P1-4 1

Schedule to allocate investment cost to assets and liabilities Investment cost (fair value), January 1 Fair value acquired from Diego ($300,000  100%) Excess fair value over cost (bargain purchase gain)

$250,000 300,000 $ 50,000

Allocation: Allocation 40,000 30,000 100,000 50,000 100,000 75,000 (50,000) (45,000) (50,000) $ 250,000

Cash Receivables — net Inventories Land Buildings — net Equipment — net Accounts payable Other liabilities Gain on bargain purchase Totals

Pablo Corporation Balance Sheet at January 1, 2017 (after combination) Liabilities

Assets Cash Receivables — net Inventories Land Buildings — net Equipment — net

90,000 80,000 230,000 100,000 250,000 175,000

Total assets $ 925,000

Accounts payable Note payable (5 years) Other liabilities Liabilities

130,000 200,000 145,000 475,000

Stockholders’ Equity Capital stock, $10 par Other paid-in capital Retained earnings* Stockholders’ equity Total equities

200,000 100,000 150,000 450,000 925,000

* Retained earnings reflects the $50,000 gain on the bargain purchase.

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Business Combinations

Solution P1-5 1

Journal entries to record the acquisition of Huang Corporation

Investment in Huang 350,000 Common stock, $10 par 100,000 Other paid-in capital 200,000 Cash 50,000 To record acquisition of Huang for 10,000 shares of common stock and $50,000 cash Investment expense 30,000 Other paid-in capital 10,000 Cash 40,000 To record payment of costs to register and issue the shares of stock ($10,000) and for accounting and legal fees ($30,000). Cash 50,000 Receivables—net 50,000 Inventories 100,000 Land 100,000 Buildings—net 100,000 Equipments—net 100,000 Accounts payable 50,000 Other liabilities 75,000 Investment in Huang 350,000 Gain on bargain purchase 25,000 To record the net assets of Saw at fair value and the gain on the bargain purchase. Gain on Bargain Purchase Calculation Acquisition price $ 350,000 Fair value of net assets acquired 375,000 Gain on bargain purchase $ 25,000

Balance Sheet:

Assets

Cash Receivable—net Inventories Land Buildings—net Equipment—net

Ling Corporation Balance Sheet at January 1, 2017 Liabilities 960,000 800,000 1,600,000 1,100,000 2,100,000 1,600,000

Total assets

8,160,000

Accounts payable Other liabilities Liabilities

850,000 1,075,000 1,925,000

Stockholders’ equity Common stock, $10 par Other paid-in capital Retained earnings* Stockholders’ equity Total equities

3,100,000 1,390,000 1,745,000 6,235,000 8,160,000

Chapter 1

1-11

Solution P1-5 (continued) 2

Journal entries to record the acquisition of Huang Corporation:

Investment in Huang 400,000 Common Stock, $10 par 100,000 Other paid-in capital 200,000 Cash 100,000 To record acquisition of Huang for 10,000 shares of common stock and $50,000 cash. Investment expense 30,000 Other paid-in capital 10,000 Cash 40,000 To record payment of costs to register and issue the shares of stock ($10,000) and for accounting and legal fees ($30,000). Cash 50,000 Receivables—net 50,000 Inventories 100,000 Land 100,000 Buildings—net 100,000 Equipments—net 100,000 Goodwill 25,000 Accounts payable 50,000 Other liabilities 75,000 Investment in Huang 400,000 To record the net assets of Saw at fair value and the goodwill. Goodwill calculation Acquisition price $400,000 Fair value of net assets acquired 375,000 Goodwill $ 25,000

Balance Sheet: Ling Corporation Balance Sheet at January 1, 2017 Liabilities

Assets Cash Receivable—net Inventories Land Buildings—net Equipment—net Goodwill

Total assets

910,000 800,000 1,600,000 1,100,000 2,100,000 1,600,000 25,000

8,135,000

Accounts Payable Other Liabilities Liabilities

850,000 1,075,000 1,925,000

Stockholders’ Equity Common Stock, $10 par Other paid-in capital Retained Earnings* Stockholders’ equity Total equities

3,100,000 1,390,000 1,720,000 6,210,000 8,135,000

1-12

Business Combinations

Solution P1-6* Pooled Balance Sheets Pop

800,000 shares

Son

1,000,000 shares

Current assets

15,000

4,000

19,000

Plant assets - net

40,000

6,000

46,000

Total assets

55,000

10,000

65,000

Liabilities

10,000

3,000

13,000

Common stock

30,000

4,000

38,000

40,000

APIC

3,000

2,000

1,000

Retained earnings

12,000

1,000

13,000

12,000

Total equities

55,000

10,000

65,000

Solution P1-7* 1. Net assets (+A) Capital stock (+SE) Additional paid-in capital (+SE) Retained earnings (+SE)

2. Net assets (+A) Additional paid-in capital (-SE) Capital stock (+SE) Retained earnings (+SE)

800 350 150 300

800 200 770 230

Chapter 1

1-13

Solution P1-8* a. Net assets (+A) Treasury stock (-SE) Common stock (+SE) Additional paid-in capital (+SE) Retained earnings (+SE)

11,500 500

Investment expenses (E, -SE) Cash(-A)

10,000 1,000 1,000 300 300

b. Pop Corporation Son Corporation Merger Pop’s Books Current Assets $6,500 $4,500 $10,700 Plant & Equipment--net 10,000 10,000 20,000 Investment in Pop ______ ___500 ______ Total Assets $16,500 $15,000 $30,700 Liabilities $1,500 $3,000 $4,500 Common Stock 10,000 8,000 20,000 Add. Paid-in Capital 2,000 3,000 3,000 Retained Earnings 3,000 1,000 3,700 Treasury Stock ______ ______ (500) Total Equities $16,500 $15,000 $30,700 *Current assets and retained earnings are reduced $300 for investment expenses. Solution PR 1-1 (ASC 350-20-50)GAAP requires the following information for each balance sheet presented: The change in the carrying amount of goodwill during the period. a. The gross amount and accumulated impairment losses at the beginning of the period b. Additional goodwill recognized during the period, except goodwill included in a disposal group that, on acquisition, meets the criteria to be classified as held for sale c. Adjustments resulting from the subsequent recognition of deferred tax assets during the period d. Goodwill included in a disposal group classified as held for sale e. Impairment losses recognized during the period in accordance with this Subtopic f.

Net exchange differences arising during the period

Any other changes in the carrying amounts during the period

h. The gross amount and accumulated impairment losses at the end of the period.

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Business Combinations

Solution PR 1-2 (ASC 805-20-30-12) Yes, there are fair value exceptions. The codification lists those exceptions and provides separate guidance in accounting for these items. Here are the listed exceptions: a. Income taxes b.

Employee benefits

Indemnification assets

Reacquired rights

Share-based payment awards

Assets held for sale

Certain assets and liabilities arising from contingencies.

Chapter 2 STOCK INVESTMENTS — INVESTOR ACCOUNTING AND REPORTING Answers to Questions 1

Only the investor’s accounts are affected when outstanding stock is acquired from existing stockholders. The investor records the investment at its cost. Since the investee company is not a party to the transaction, its accounts are not affected. Both investor and investee accounts are affected when unissued stock is acquired directly from the investee. The investor records the investment at its cost and the investee adjusts its asset and owners’ equity accounts to reflect the issuance of previously unissued stock.

Goodwill arising from an equity investment of 20 percent or more is not recorded separately from the investment account. Under the equity method, the investment is presented on one line of the balance sheet in accordance with the one-line consolidation concept.

Dividends received from earnings accumulated before an investment is acquired are treated as decreases in the investment account balance under the fair value/cost method. Such dividends are considered a return of a part of the original investment.

The equity method of accounting for investments increases the investment account for the investor’s share of the investee’s income and decreases it for the investor’s share of the investee’s losses and for dividends received from the investee. In addition, the investment and investment income accounts are adjusted for amortization of any investment cost-book value differentials related to the interest acquired. Adjustments to the investment and investment income accounts are also needed for unrealized profits and losses from transactions between the investor and investee companies. A fair value adjustment is optional under SFAS No. 159.

The equity method is referred to as a one-line consolidation because the investment account is reported on one line of the investor’s balance sheet and investment income is reported on one line of the investor’s income statement (except when the investee has discontinued operations). In addition, the investment income is computed such that the parent company’s income and stockholders’ equity are equal to the consolidated net income and consolidated stockholders’ equity that would result if the statements of the investor and investee were consolidated.

If the equity method is applied correctly, the income of the parent company will generally equal the controlling interest share of consolidated net income.

The difference in the equity method and consolidation lies in the detail reported, but not in the amount of income reported. The equity method reports investment income on one line of the income statement whereas the details of revenues and expenses are reported in a consolidated income statement.

The investment account balance of the investor will equal underlying book value of the investee if (a) the equity method is correctly applied, (b) the investment was acquired at book value which was equal to fair value, the pooling method was used, or the cost-book value differentials have all been amortized, and (c) there have been no intercompany transactions between the affiliated companies that have created investment account-book value differences.

The investment account balance must be converted from the cost to the equity method when acquisitions increase the interest held to 20 percent or more. The amount of the adjustment is the difference between the investment income reported under the cost method in prior years and the income that would have been reported if the equity method of accounting had been used. Changes from the cost to the equity method of accounting for equity investments are changes in the reporting entity that require restatement of prior years’ financial statements when the effect is material. .

2-1

2-2

Stock Investments — Investor Accounting and Reporting

The one-line consolidation is adjusted when the investee’s income includes gains or losses from discontinued operations. In this case, the investor’s share of the investee’s ordinary income is reported as investment income under a one-line consolidation, but the investor’s share of gains and losses from discontinued operations is combined with similar items of the investor.

The remaining 15 percent interest in the investee is accounted for under the fair value/cost method, and the investment account balance immediately after the sale becomes the new cost basis.

Yes. When an investee has preferred stock in its capital structure, the investor has to allocate the investee’s income to preferred and common stockholders. Then, the investor takes up its share of the investee’s income allocated to common stockholders in applying the equity method. The allocation is not necessary when the investee has only common stock outstanding.

Goodwill impairment losses are calculated by business reporting units. For each reporting unit, the company must first determine the fair values of the net assets. The fair value of the reporting unit is the amount at which it could be purchased in a current market transaction. This may be based on market prices, discounted cash flow analyses, or similar current transactions. This is done in the same manner as is done to originally record a combination. The first step requires a comparison of the carrying value and fair value of all the net assets at the business reporting level. If the fair value exceeds the carrying value, goodwill is not impaired and no further tests are needed. If the carrying value exceeds the fair value, then we proceed to step two. In step two, we calculate the implied value of goodwill. Any excess measured fair value over the net identifiable assets is the implied fair value of goodwill. The company then compares the goodwill’s implied fair value estimate to the carrying value of goodwill to determine if there has been an impairment during the period.

Yes. Impairment losses for subsidiaries are computed as outlined in the solution to question 13. Companies compare fair values to book values for equity method investments as a whole. Firms may recognize impairments for equity method investments as a whole, but perform no separate goodwill impairment tests.

SOLUTIONS TO EXERCISES Solution E2-1 Klaus AG recorded investment in Max AG using fair value/cost method because no significant influence was obtained. Journal entries on Klaus AG's book March 2 Investment in Max AG (+A) Cash (-A) To record purchase of Max AG’s outstanding shares

10,000 10,000

April 1 Cash (+A) 25,000 Dividend income (R, +SE) 25,000 To record dividends received from Max AG ($500,000  500 / 10,000) Note: under the fair value/cost method, there is no need to recognize a portion of Max AG earnings.

Chapter 2

2-3

Solution E2-2 Interest acquired (5,000 shares / 20,000 shares)

25%

Cost of 25% interest in Atah PLC Book value acquired ($100,000,000  25%) Excess fair value over book value

$29,000,000 $25,000,000 $4,000,000

Excess allocated to: Overvalued Inventories ($4,000,000  25%) Undervalued equipment ($24,000,000  25%) Undervalued notes payable ($8,000,000  25%) Goodwill for remainder Excess fair value over book value

($1,000,000) $6,000,000 ($2,000,000) $1,000,000 $4,000,000

Goodwill from Henry PLC investment in Atah PLC was $1,000,000 Solution E2-3 1

Cost of 30% common interest in William Ltd Book value (and fair value) acquired: Common stock, $10 par Additional paid-in capital Retained earnings Common stockholders’ equity Percent acquired Goodwill

$3,500,000 $3,000,000 $5,000,000 $3,000,000 $9,000,000 30%

$2,700,000 $800,000

William Ltd’s net income Less: preferred income ($1,000,000  10%) Income to common

$1,000,000 $100,000 $900,000

Income from William Ltd ($900,000  30%)

$270,000

Solution E2-4 Income from Sun for 2016 Share of Sun’s income ($100,000  1/2 year  30%)

$ 15,000

Stock Investments — Investor Accounting and Reporting

2-4

Solution E2-5 1

Income from Son Share of Son’s reported income ($200,000  30%) Less: Excess allocated to inventory Less: Depreciation of excess allocated to building ($50,000/4 years) Income from Son

60,000 (25,000) (12,500)

22,500

500,000 22,500 (15,000) 507,500

Investment account balance at December 31 Cost of investment in Son Add: Income from Son Less: Dividends ($50,000 x 30%) Investment in Son December 31

Alternative solution Underlying equity in Son at January 1 ($375,000/.3) Income less dividends Underlying equity December 31 Interest owned Book value of interest owned December 31 Add: Unamortized excess Investment in Son December 31

$1,250,000 150,000 1,400,000 30% 420,000 87,500 $ 507,500

Solution E2-6 Journal entry on Pam’s books Investment in Sun ($1,200,000 x 40%) Loss from discontinued operations Income from Sun To recognize income from 40% investment in Sun.

480,000 80,000 560,000

Chapter 2

2-5

Solution E2-7 1

a Dividends received from Son ($120,000  15%) Share of income since acquisition of interest 2016 ($20,000  15%) 2017 ($80,000  15%) Excess dividends received over share of income Investment in Son January 3, 2016 Less: Excess dividends received over share of income Investment in Son December 31, 2017

b Cost of 10,000 of 40,000 shares outstanding Book value of 25% interest acquired ($4,000,000 stockholders’ equity at December 31, 2016 + $1,400,000 from additional stock issuance)  25% Excess fair value over book value(goodwill)

d The investment in Son balance remains at the original cost.

c Income from continuing operations Percent owned Income from Son Products

18,000

(3,000) (12,000) 3,000

$ $

50,000 (3,000) 47,000

$1,400,000 1,350,000 $ 50,000

$ $

200,000 40% 80,000

Stock Investments — Investor Accounting and Reporting

2-6

Solution E2-8 Preliminary computations Cost of 40% interest January 1, 2016 Book value acquired ($4,000,000  40%) Excess fair value over book value Excess allocated to Inventories $100,000  40% Equipment $200,000  40% Goodwill for the remainder Excess fair value over book value Pam’s underlying equity in Sun ($5,500,000  40%) Add: Goodwill Investment balance December 31, 2019 Alternative computation Pam’s share of the change in Sun’s stockholders’ equity ($1,500,000  40%) Less: Excess allocated to inventories ($40,000  100%) Less: Excess allocated to equipment ($80,000/4 years  4 years) Increase in investment account Original investment Investment balance December 31, 2019

$2,400,000 (1,600,000) $ 800,000 $

40,000 80,000 680,000 800,000

$2,200,000 680,000 $2,880,000

600,000 (40,000) (80,000) 480,000 2,400,000 $2,880,000

Solution E2-9 1

Income from Son Share of income to common ($400,000 - $30,000 preferred dividends)  30% Investment in Son December 31, 2017 NOTE: The $50,000 direct costs of acquiring the investment must be expensed when incurred. They are not a part of the cost of the investment. Investment cost Add: Income from Son Less: Dividends from Son ($200,000 dividends - $30,000 dividends to preferred)  30% Investment in Son December 31, 2017

111,000

$1,200,000 111,000 (51,000) $1,260,000

Chapter 2

2-7

Solution E2-10 1

Income from Sun ($200,000 – $150,000)  25% Investment income October 1 to December 31 Investment balance December 31 Investment cost October 1 Add: Income from Sun Less: Dividends Investment in Sun at December 31

12,500

300,000 12,500 --312,500

December 31 $ 600,000 400,000 $200,000

Sales Expenses Net Income

October 1 $450,000 300,000 $150,000

Solution E2-11 Preliminary computations Goodwill from first 10% interest: Cost of investment Book value acquired ($210,000  10%) Excess fair value over book value Goodwill from second 10% interest: Cost of investment Book value acquired ($250,000  10%) Excess fair value over book value 1.

Correcting entry as of January 2, 2017 to convert investment to the equity method Accumulated gain/loss on stock available for Sale Valuation allowance to record Son at fair value To remove the valuation allowance entered on December 31, 2016 under the fair value method for an available for sale security. Investment in Son Retained earnings To adjust investment account to an equity basis computed as follows: Share of Son’s income for 2016 Less: Share of dividends for 2016

$ $ $ $

25,000 (21,000) 4,000 50,000 (25,000) 25,000

25,000 25,000

4,000 4,000 $ $

10,000 (6,000) 4,000

Income from Son on original 10% investment

5,000

Income from Son on second 10% investment 2017 Income from Son

5,000 10,000

Income from Son for 2017

Stock Investments — Investor Accounting and Reporting

2-8

Solution E2-12 Preliminary computations Stockholders’ equity of Sun on December 31, 2016 Sale of 12,000 previously unissued shares on January 1, 2017 Stockholders’ equity after issuance on January 1, 2017 Cost of 12,000 shares to Pam Book value of 12,000 shares acquired $630,000  12,000/36,000 shares Excess fair value over book value

$380,000 250,000 $630,000 $250,000 210,000 $ 40,000

Excess is allocated as follows Buildings $60,000  12,000/36,000 shares Goodwill Excess fair value over book value

$ 20,000 20,000 $ 40,000

Journal entries on Pam’s books during 2017 January 1 Investment in Sun Cash To record acquisition of a 1/3 interest in Sun. During 2017 Cash Investment in Sun To record dividends received from Sun ($90,000  1/3).

250,000 250,000

30,000

December 31 Investment in Sun 38,000 Income from Sun To record investment income from Sun computed as follows: Share of Sun’s income ($120,000  1/3) Depreciation on building ($20,000/10 years) Income from Sun

30,000

38,000 $ 40,000 (2,000) $ 38,000

Chapter 2

2-9

Solution E2-13 1

Journal entries on Pop’s books for 2017 Cash

120,000

Investment in Son (30%) To record dividends received from Son ($400,000  30%).

120,000

Investment in Son (30%) 240,000 Discontinued operations loss (from Son) 24,000 Income from Son To record investment income from Son computed as follows: Share of income from continuing operations $680,000  30% Add: Excess fair value over cost realized in 2017 $200,000  30% Income from Son before discontinued operations 2

264,000

204,000

60,000 $

264,000

780,000 240,000 (120,000) $900,000

Investment in Son balance December 31, 2017 Investment cost Add: Income from Son after discontinued operations Less: Dividends received from Son Investment in Son December 31 Check: Investment balance is equal to underlying book value ($2,800,000 + $600,000 - $400,000)  30% = $900,000

Pop Corporation Income Statement for the year ended December 31, 2017 Sales Expenses Operating income Income from Son (before discontinued operations) Income from continuing operations Discontinued operations loss (net of tax effect) Net income

$4,000,000 2,800,000 1,200,000 264,000 1,464,000 24,000 $1,440,000

Stock Investments — Investor Accounting and Reporting

2-10

Solution E2-14 1

Income from Sun for 2017 Equity in income ($108,000 - $8,000 preferred)  40%

40,000

290,000 40,000 (16,000) 314,000

Investment in Sun December 31, 2017 Cost of investment in Sun Add: Income from Sun Less: Dividends ($40,000* x 40%) Investment in Sun December 31 * $48,000 total dividends less $8,000 preferred dividend

Solution E2-15 Since the total fair value of Son has declined by $60,000 while the fair value of the net identifiable assets is unchanged, the $60,000 decline is the impairment in goodwill for the period. The $60,000 impairment loss is deducted in calculating Pop’s income from continuing operations. Solution E2-16 Goodwill impairments are calculated at the business reporting unit level. Increases and decreases in fair values across business units are not offsetting. Pam must report an impairment loss of $5,000 in calculating 2017 income from continuing operations.

Chapter 2

2-11

SOLUTIONS TO PROBLEMS Solution P2-1 1

Schedule for allocating the investment cost over the book values/fair values interest acquired: RAJ LTD AND ITS 40%-OWNED EQUITY INVESTEE, AKASH LTD (IN THOUSANDS) Investment in Akash Ltd Book value of the interest acquired (40%  $2,250,000)

$800

Excess of cost over book value acquired

-$100

Fair Value

Book Value

$900



% Interest Acquired

Amount Assigned

Inventory

$ 150

$ 130

40%

Equipment-net

$ 460

$ 500

40%

-$ 16

Notes payable

$ 220

$ 300

40%

$ 32

Total assigned to identifiable net assets

-$124 -$100

Journal entries in Raj Ltd’s book: January 1 Investment in Akash Ltd (+A) 924,000 Common stock (+SE) 700,000 Additional paid-in capital (+SE) 100,000 Gain on bargain purchase (Ga, +SE) 124,000 To record acquisitions of 1 40% equity investment in Akash Ltd. December 1 Cash (+A) Investment in Akash Ltd To record dividends received ($160,000  40%) December 31 Investment in Akash Ltd (+A) Income from Akash Ltd (R, +SE)

64,000 64,000

92,000 92,000

To recognize investment income from Akash Ltd computed as follows: 40% of Akash Ltd’s $400,000 net income $100,000 Excess allocated to inventories ($8,000) Excess allocated to equipment ($16,000 / 4 years) $4,000 Excess allocated to notes payable ($32,000 / 8 years) ($4,000) $92,000

$ 24

Remainder assigned to gain on bargain purchase Total excess of cost over book value acquired 2

Stock Investments — Investor Accounting and Reporting

2-12

Solution P2-1 (continued) 3

Investment in Akash Ltd Balance at December 31, 2014: Initial cost Gains on bargain purchase Dividends received Income from Akash Ltd Ending balance

$800,000 $124,000 ($64,000) $92,000 $952,000

Solution P2-2 1

Preliminary computations: Javier CA’s net assets at January 1 Income for the first quarter ($100,000  3 / 12) Javier CA’s net assets at March 31

$1,200,000 $25,000 $1,225,000

WERO CA AND ITS 40%-OWNED EQUITY INVESTEE, JAVIER CA (IN THOUSANDS) Investment in Javier CA

Book value of the interest acquired (30%  $1,225,000)

$ 367.5

Excess of cost over book value acquired

Undervalued (Overvalued)



% Interest Acquired

82.5

Amount Assigned

Inventory

-$ 100

30%

-$ 30

Equipment-net

$ 300

30%

$ 90

Total assigned to identifiable net assets

450

$ 60

Remainder assigned to goodwill

$ 22.5

Total excess of cost over book value acquired

$ 82.5

Journal entries in Wero CA book: March 31 Investment in Javier CA (+A) Cash (-A) July 1 Cash (+A) Investment in Javier CA (-A) To record dividends received ($50,000  30%)

450,000 450,000 15,000 15,000

December 31 Investment in Javier CA (+A) 45,000 Income from Javier CA (R, +SE) 45,000 To recognize investment income from Javier CA computed as follows: 30% of Javier CA’s $100,000 net income $30,000 Excess allocated to inventories $30,000 Excess allocated to equipment ($90,000/6 years) ($15,000) $45,000 .

Chapter 2

2-13

Solution P2-2 (continued) 3

Investment in Javier CA Balance at December 31, 2014: Initial cost Dividends received Income from Javier CA Ending balance

$450,000 ($15,000) $45,000 $480,000

Solution P2-3 Preliminary computations Cost of investment in Son Book value acquired ($1,000,000  30%) Excess fair value over book value Excess allocated Undervalued inventories ($30,000  30%) Overvalued building (-$60,000  30%) Goodwill for the remainder Excess fair value over book value 1

Income from Son Share of Son’s reported income ($100,000  30%) Less: Excess allocated to inventories sold in 2016 Add: Depreciation of excess allocated to overvalued building $18,000/10 years Income from Son — 2016

$331,000 300,000 $ 31,000 $

9,000 (18,000) 40,000 $ 31,000 $ 30,000 ( 9,000) 1,800 $ 22,800

Investment balance December 31, 2016 Cost of investment Add: Income from Son Less: Share of Son’s dividends ($50,000  30%) Investment in Son balance December 31

$331,000 22,800 (15,000) $338,800

Pop’s share of Son’s net assets Share of stockholders’ equity ($1,000,000 + $100,000 income - $50,000 dividends)  30%

$315,000

Stock Investments — Investor Accounting and Reporting

2-14

Solution P2-4 Preliminary computations Investment cost of 40% interest Book value acquired [$250,000 + ($50,000  1/2 year)]  40% Excess fair value over book value Excess allocated Land $15,000  40% Equipment $25,000  40% Remainder to goodwill Excess fair value over book value July 1, 2016 Investment in Sun Cash To record initial investment for 40% interest in Sun. November 2016 Cash (other receivables) Investment in Sun To record receipt of dividends ($25,000  40%).

$190,000 110,000 $ 80,000 $

6,000 10,000 64,000 $ 80,000 190,000 190,000

10,000 10,000

December 31, 2016 Investment in Sun 10,000 Income from Sun To record share of Sun’s income ($50,000  1/2 year  40%).

10,000

December 31, 2016 Income from Sun Investment in Sun To record depreciation on excess allocated to Undervalued equipment ($10,000/5 years  1/2 year).

1,000

Chapter 2

2-15

Solution P2-5 1

Schedule to allocate fair value — book value differentials Investment cost January 1 Book value acquired ($3,900,000 net assets  30%) Excess fair value over book value

$1,680,000 1,170,000 $ 510,000

Allocation of excess Inventories Land Buildings — net Equipment — net Bonds payable Assigned to identifiable net assets Remainder to goodwill Excess fair value over book value 2

Fair Value — Percent Book Value Acquired $200,000 30% 800,000 30% 500,000 30% (700,000) 30% (100,000) 30%

Income from Son for 2016 Equity in income ($1,200,000  30%) Less: Amortization of differentials Inventories (sold in 2016) Buildings — net ($150,000/10 years) Equipment — net ($210,000/7 years) Bonds payable ($30,000/5 years) Income from Son Investment in Son balance December 31, 2016 Investment cost Add: Income from Son Less: Dividends ($600,000  30%) Investment in Son December 31

Allocation $ 60,000 240,000 150,000 (210,000) (30,000) 210,000 300,000 $ 510,000 $

360,000

(60,000) (15,000) 30,000 6,000 321,000

$1,680,000 321,000 (180,000) $1,821,000

Check: Underlying equity ($4,500,000  30%) Unamortized excess: Land Buildings — net ($150,000 - $15,000) Equipment — net ($210,000 - $30,000) Bonds payable ($30,000 - $6,000) Goodwill Investment in Son account

$1,350,000 240,000 135,000 (180,000) (24,000) 300,000 $1,821,000

Stock Investments — Investor Accounting and Reporting

2-16

Solution P2-6 1

Income from Sun Investment in Sun July 1, 2016 at cost Book value acquired ($130,000  60%) Excess fair value over book value

$96,000 78,000 $18,000

Pam’s share of Sun’s income for 2016 ($20,000  1/2 year  60%) Less: Excess Depreciation ($18,000/10 years  1/2 year) Income from Sun for 2016

$ 6,000 900 $ 5,100

Investment balance December 31, 2016 Investment cost July 1 Add: Income from Sun Less: Dividends ($12,000  60%) Investment in Sun December 31

$96,000 5,100 (7,200) $93,900

Solution P2-7 Pop Corporation Partial Income Statement for the year ended December 31, 2018 Investment income Income from Son (equity basis) Income from continuing operations

$90,000 90,000

Discontinued operations gain Share of Son’s discontinued opertions gain Net income

60,000 $150,000

Chapter 2

2-17

Solution P2-8 Preliminary computations Investment cost of 90% interest in Sun

$1,980,000

Implied total fair value of Sun ($1,980,000 / 90%) Book value($2,525,000 + $125,000) Excess book value over fair value

$2,200,000 (2,650,000) $ (450,000)

Excess allocated Overvalued plant assets Undervalued inventories Excess book value over fair value

$ (500,000) 50,000 $ (450,000)

Investment income for 2016 Share of reported income ($250,000  1/2 year  90%) Add: Depreciation on overvalued plant assets (($500,000 x 90%) / 9 years)  1/2 year Less: 90% of Undervaluation allocated to inventories Income from Sun — 2016 Investment balance at December 31, 2017 Underlying book value of 90% interest in Sun (Sun’s December 31, 2017 equity of $2,700,000  90%) Less: Unamortized overvaluation of plant assets ($50,000 per year  7 1/2 years) Investment balance December 31, 2017 Journal entries to account for investment in 2018 Cash (or Dividends receivable) 135,000 Investment in Sun To record receipt of dividends ($150,000  90%).

112,500

25,000 (45,000) 92,500

$2,430,000 (375,000) $2,055,000

135,000

Investment in Sun 230,000 Income from Sun 230,000 To record income from Sun computed as follows: Pam’s share of Sun’s reported net income ($200,000  90%) plus $50,000 amortization of overvalued plant assets. Check: Investment balance December 31, 2017 of $2,055,000 + $230,000 income from Sun - $135,000 dividends = $2,150,000 balance December 31, 2018 Alternatively, Sun’s underlying equity ($2,000,000 paid-in capital + $750,000 retained earnings)  90% interest - $325,000 unamortized excess allocated to plant assets = $2,150,000 balance December 31, 2018.

Stock Investments — Investor Accounting and Reporting

2-18

Solution P2-9 1

Market price of $24 for Pop’s shares Cost of investment in Son (40,000 shares  $24) The $80,000 direct costs must be expensed. Book value acquired ($2,000,000 net assets  40%) Excess fair value over book value

960,000

800,000 160,000

Allocation of excess Fair Value — Book Value Inventories $ 200,000 Land 400,000 (400,000) Buildings — net 200,000 Equipment — net Assigned to identifiable net assets Remainder assigned to goodwill Total allocated 2

Market price of $16 for Pop’s shares Cost of investment in Son (40,000 shares  $16) Other direct costs are $0 Book value acquired ($2,000,000 net assets  40%) Excess book value over fair value Excess allocated to Fair Value — Percent Book Value Acquired Inventories $200,000 40% Land 400,000 40% (400,000) 40% Buildings — net 200,000 40% Equipment — net Bargain purchase gain

Allocation $ 80,000 160,000 (160,000) 80,000 (320,000) $(160,000)

Percent Acquired 40% 40% 40% 40%

Allocation $ 80,000 160,000 (160,000) 80,000 160,000 0 $ 160,000

640,000 800,000 $ (160,000)

Chapter 2

2-19

Solution P2-10 1

Income from Sun — 2016 Pam’s share of Sun’s income for 2016 $40,000  1/2 year  15%

Investment in Sun balance December 31, 2016 Investment in Sun at cost Add: Income from Sun Less: Dividends from Sun November 1 ($15,000  15%) Investment in Sun balance December 31

$ 48,750 3,000 (2,250) $ 49,500

Income from Sun — 2017 Pam’s share of Sun’s income for 2017: $60,000 income  15% interest  1 year $60,000 income  30% interest  1 year $60,000 income  45% interest  1/4 year Pam’s share of Sun’s income for 2017

9,000 18,000 6,750 $ 33,750

Investment in Sun December 31, 2017 Investment balance December 31, 2016 (from 2) Add: Additional investments ($99,000 + $162,000) Add: Income for 2017 (from 3) Less: Dividends for 2017 ($15,000  45%) + ($15,000  90%) Investment in Sun balance at December 31 Alternative solution Investment cost ($48,750 + $99,000 + $162,000) Add: Share of reported income 2016 — $40,000  1/2 year  15% 2017 — $60,000  1 year  45% 2017 — $60,000  1/4 year  45% Less: Dividends 2016 — $15,000  15% 2017 — $15,000  45% 2017 — $15,000  90% Investment in Sun

3,000

$ 49,500 261,000 33,750 (20,250) $324,000 $309,750

$ 3,000 27,000 6,750 $ 2,250 6,750 13,500

36,750

(22,500) $324,000

Note: Since Pam’s investment in Sun consisted of 9,000 shares (a 45% interest) on January 1, 2017, Pam correctly used the equity method of accounting for the 15% investment interest held during 2016. The alternative of reporting income for 2016 on a fair value/cost basis and applying the equity method retroactively for 2017 is not appropriate in view of the overwhelming evidence of an ability to exercise significant influence by the time 2016 income is recorded.

Stock Investments — Investor Accounting and Reporting

2-20

Solution P2-11 Income from Sun

As reported Correct amounts Overstatement

2016

2017

2018

2019

Total

$ 80,000 40,000a $120,000

$64,000 64,000b $ -0-

$104,000 104,000c $ -0-

$96,000 96,000d $ -0-

$344,000 304,000 $ 40,000

 1/2 year  40%)  40%) c($260,000  40%) d($240,000  40%) a($200,000 b($160,000

Investment in Sun balance December 31, 2019 Investment in Sun per books December 31 Less: Overstatement Correct investment in Sun balance December 31

$800,000 40,000 $760,000

Check Underlying equity in Sun ($1,800,000  40%) Add: Goodwill ($600,000-($1,400,000  40%)) Investment balance

$720,000 40,000 $760,000

Correcting entry (before closing for 2019) Retained earnings 40,000 Investment in Sun 40,000 To record investment and retained earnings accounts for prior error.

Chapter 2

2-21

Solution P2-12 1

Schedule to allocate excess cost over book value Investment cost (14,000 shares  $13) $10,000 direct costs must be expensed. Book value acquired $190,000  70% Excess fair value over book value

$182,000 133,000 $ 49,000

Excess allocated Interest Fair Value — Book Value  Acquired = $ 50,000 $60,000 70% 50,000 30,000 70% 135,000 95,000 70%

Inventories Land Equipment — net Remainder to goodwill Excess fair value over book value 2

Investment income from Son Share of Son’s reported income $60,000  70% Add: Overvalued inventory items Less: Depreciation on undervalued equipment ($28,000/4 years)  3/4 year Investment income from Son

Allocation $ (7,000) 14,000 28,000 14,000 $ 49,000

$ 42,000 7,000 (5,250) $ 43,750

Investment in Son account at December 31, 2016 Investment cost Add: Income from Son Less: Dividends received (14,000 shares  $2) Investment in Son balance December 31 Check Underlying equity at December 31, 2016 ($210,000*  70%) Add: Unamortized excess of cost over book value Land Equipment Goodwill Investment balance

$182,000 43,750 (28,000) $197,750 $147,000 14,000 22,750 14,000 $197,750

* $100,000 (C/S) + $70,000 (R/E) + $80,000 (current earnings) -$40,000 (Dividends) = $210,000 Solution PR 2-1 Yes, since this is a noncontrolling interest, the equity method can be used. (ASC 323-10). Solution PR 2-2 (ASC 320-30-4) The initial basis under the new accounting method should be the amount carried over from the equity method amount at the date of the change.

Chapter 3 AN INTRODUCTION TO CONSOLIDATED FINANCIAL STATEMENTS Answers to Questions 1

A corporation becomes a subsidiary when another corporation either directly or indirectly acquires a controlling financial interest (generally over 50 percent) of its outstanding voting stock.

Amounts assigned to identifiable assets and liabilities in excess of recorded amounts on the books of the subsidiary are not recorded separately by the parent. Instead, the parent records the fair value/purchase price of the interest acquired in an investment account. The assignment to identifiable asset and liability accounts is made through working paper entries when the parent and subsidiary financial statements are consolidated.

The land would be shown in the consolidated balance sheet at $100,000, its fair value, assuming that the purchase price of the subsidiary is greater than the book value of the subsidiary’s net assets. If the parent had acquired an 80 percent interest and the implied fair value of the subsidiary was greater than the book value of the subsidiary’s net assets, the land would still appear in the consolidated balance sheet at $100,000. Under GAAP, the noncontrolling interest is also reported based on fair values at the acquisition date.

Parent company—a corporation that owns a controlling interest in the outstanding voting stock of another corporation (its subsidiary). Subsidiary company—a corporation that is controlled by a parent that owns a controlling interest in its outstanding voting stock, either directly or indirectly. Affiliates—companies that are controlled by a single management team through parent-subsidiary relationships. (Although the term affiliate is a synonym for subsidiary, the parent is included in the total affiliation structure.) In many annual reports, the term includes all investments accounted for by the equity method. Associates—companies that are controlled through parent-subsidiary relationships or whose operations can be significantly influenced through equity investments of 20 percent to 50 percent.

A noncontrolling interest is the equity interest in a subsidiary that is owned by stockholders outside of the affiliation structure. In other words, it is the equity interest in a subsidiary (recorded at fair value) that is not held by the parent or subsidiaries of the parent.

Under GAAP, a subsidiary will not be consolidated if control does not rest with the majority owner, such as in the case of a subsidiary in reorganization or bankruptcy, or when the subsidiary operates under severe foreign exchange restrictions or other governmentally imposed uncertainties.

Consolidated financial statements are intended primarily for the stockholders and creditors of the parent, according to GAAP.

The amount of capital stock that appears in a consolidated balance sheet is the total par or stated value of the outstanding capital stock of the parent.

Goodwill from consolidation may appear in the general ledger of the surviving entity in a merger or a consolidation accounted for as an acquisition. But goodwill from consolidation would not appear in the general ledger of a parent or its subsidiary. Goodwill is entered in consolidation working papers when the reciprocal investment and equity amounts are eliminated. Working paper entries affect consolidated financial statements, but they are not entered in any general ledger.

3-1

3-2

An Introduction to Consolidated Financial Statements

The parent’s investment in subsidiary does not appear in a consolidated balance sheet if the subsidiary is consolidated. It would appear in the parent’s separate balance sheet under the heading “investments” or “other assets.” Investments in unconsolidated subsidiaries are shown in consolidated balance sheets as investments or other assets. They are accounted for under the equity method if the parent can exercise significant influence over the subsidiary; otherwise, they are accounted for by the fair value / cost method.

Parent’s books: Investment in subsidiary Sales Accounts receivable Interest income Dividends receivable Advance to subsidiary

Reciprocal accounts are eliminated in the process of preparing consolidated financial statements in order to show the financial position and results of operations of the total economic entity that is under the control of a single management team. Sales by a parent to a subsidiary are internal transactions from the viewpoint of the economic entity and the same is true of interest income and interest expense and rent income and rent expense arising from intercompany transactions. Similarly, receivables from and payables to affiliates do not represent assets and liabilities of the economic entity for which consolidated financial statements are prepared.

The stockholders’ equity of a parent under the equity method is the same as the consolidated stockholders’ equity of a parent except for noncontrolling interest. Consolidated balance sheets disclose noncontrolling interest for subsidiaries that are not wholly owned.

No. The amounts that appear in the parent’s statement of retained earnings under the equity method and the amounts that appear in the consolidated statement of retained earnings are identical, assuming that the noncontrolling interest is included as a separate component of stockholders’ equity.

Income attributable to noncontrolling interest is not an expense, but rather it is an allocation of the total income to the consolidated entity between controlling and noncontrolling stockholders. From the viewpoint of the controlling interest (the stockholders of the parent), income attributable to noncontrolling interest has the same effect on consolidated net income as an expense. This is because consolidated net income is income to all stockholders. Alternatively, you can view total consolidated net income as being allocated to the controlling and noncontrolling interests.

The computation of noncontrolling interest is comparable to the computation of retained earnings. It is computed:

Reciprocal accounts on subsidiary’s books: Capital stock and retained earnings Purchases Accounts payable Interest expense Dividends payable Advance from parent

Noncontrolling interest beginning of the period Add: Income attributable to noncontrolling interest Deduct: Noncontrolling interest dividends Deduct: Noncontrolling interest of amortization of excess of fair value over book value Add: Noncontrolling interest of amortization of excess of book value over fair value Noncontrolling interest end of the period 17

It is acceptable to consolidate the annual financial statements of a parent and a subsidiary with different fiscal periods, provided that the dates of closing are not more than three months apart. Any significant developments that occur in the intervening three-month period should be disclosed in notes to the financial statements. In the situation described, it is acceptable to consolidate the financial statements of the subsidiary with an October 31 closing date with the financial statements of the parent with a December 31 closing date. .

Chapter 3

3-3

The acquisition of shares from noncontrolling stockholders is not a business combination. It is not possible, by definition, to acquire a controlling interest from noncontrolling stockholders. Increasing a controlling interest is the same as making an additional investment. Acquisition of additional subsidiary stock is recorded by increasing the investment account and reducing the noncontrolling interest account.

SOLUTIONS TO EXERCISES Solution E3-1 1

Implied fair value of Matt Inc. ($1,400,000/70%) Less: book value of Matt Inc. Goodwill

$2,000,000 $1,500,000 $500,000

Noncontrolling interest at January 1 ($2,000,000  30%) Add: noncontrolling interest share ($600,000  30%) Less: Dividends declared ($300,000  30%) Noncontrolling interest at December 31

$600,000

Check: Investment in Matt Inc. at January 1 Add: controlling interest share ($600,000 x 70%) Less: dividends declared ($300,000  70%) Investment in Matt Inc. at December 31 Noncontrolling interest at December 31 ($1,610,000  30%/70%)

$180,000 $90,000 $690,000 $1,400,000 $420,000 $210,000 $1,610,000 $690,000

Solution E3-2 1

Cost of acquiring Patricia NV’s stocks ($45 x 10,000) Implied fair value ( $40,000 + $20,000 + $80,000 + 280,000 -$40,000) Goodwill Journal entries to record push-down value: Inventories (+A) 30 Plant assets (+A) 50 Accounts payable (-L) 10 Goodwill (+A) 70 Retained earnings (-SE) 200 Accounts receivable (-A) Push-down capital (+SE)

$450,000 $380,000 $70,000

10 350

Push-down capital in the balance sheet of Patricia NV is $350,000

3-4

An Introduction to Consolidated Financial Statements

Solution E3-3 1

Sooseck Co Ltd net income Percentage of ownership Income allocated to controlling interest

Controlling share of net income is equal to parent’s net income. Yum Co Ltd separate net income Income from Sooseck Co Ltd Controlling share of net income

$240,000 80% $192,000

$350,000 $192,000 $542,000

Solution E3-4 (in thousands) 1

Implied fair value of Son ($3,600 / 90%) $4,000 Less: Book value of Son (3,600) Excess fair value over book value $ 400 Equipment undervalued 120 Goodwill at January 1, 2016 $ 280 Goodwill at December 31, 2016 = Goodwill from consolidation $ 280 Since goodwill is not amortized

Consolidated net income Pop’s reported net income Less: Correction to income from Son for depreciation on excess allocated to equipment [($120,000/3 years)x 90%] Controlling share of consolidated net income Noncontrolling share of consolidated net income [$400,000 - $40,000 depreciation] x 10% Controlling share of consolidated net income Consolidated net income

$1,960 (36) $1,924 $

36 1,924 $1,960

Chapter 3

3-5

Solution E3-5 (in thousands) 1

$2,400, the dividends of Pam

$1,320, equal to $1,200 dividends payable of Pam plus $120 (30% of $400) dividends payable to noncontrolling interests of Sun.

Solution E3-6 (in thousands) Preliminary computation Cost of Son stock (Fair value) Fair value of Son’s identifiable net assets Goodwill 1

$10,000 8,000 $ 2,000

Journal entry to record push down values Inventories Land Buildings — net Equipment — net Goodwill Retained earnings Note payable Push-down capital

160 400 1,200 640 2,000 1,680 80 6,000 Son Corporation Balance Sheet January 1, 2016 (in thousands)

Assets Cash Accounts receivable Inventories Land Buildings — net Equipment — net Goodwill Total assets Liabilities Accounts payable Note payable Total liabilities Stockholders’ equity Capital stock Push-down capital Total stockholders’ equity Total liabilities and stockholders’ equity

560 640 800 1,600 4,000 2,400 2,000 $12,000 $

800 1,200 2,000

$ 4,000 6,000 10,000 $12,000

3-6

An Introduction to Consolidated Financial Statements

Solution E3-7 1

Pam Corporation and Subsidiary Consolidated Income Statement for the year 2017 (in thousands) Sales ($4,000 + $1,600) Less: Cost of sales ($2,400 + $800) Gross profit Less: Depreciation expense ($200 + $160) Other expenses ($796 + $360) Consolidated net income Less: Noncontrolling interest share ($280  30%) Controlling interest share of cnsolidated net income Pam Corporation and Subsidiary Consolidated Income Statement for the year 2017 (in thousands) Sales ($4,000 + $1,600) Less: Cost of sales ($2,400 + $800) Gross profit Less: Depreciation expense ($200 + $160 - $24) Other expenses ($796 + $360) Consolidated net income Less: Noncontrolling interest share [($280  30%)+ ($24 depreciation x 30%)] Controlling interest share of consolidated net income Supporting computations Depreciation of excess allocated to overvalued equipment: $120/5 years = $24

$5,600 (3,200) 2,400 (360) (1,156) 884 (84) $ 800

$5,600 (3,200) 2,400 (336) (1,156) 908

(91.2) 816.8

Chapter 3

3-7

Solution E3-8 (in thousands) 1

Capital stock The capital stock appearing in the consolidated balance sheet at December 31, 2016 is $3,600, the capital stock of Pop,the parent company.

Goodwill at December 31, 2016 Investment cost at January 2, 2016 (80% interest) Implied total fair value of Son ($1,400 / 80%) Book value of Son(100%) Excess is considered goodwill since no other fair value information is given.

550

$1,600 600 (360) $1,840

Noncontrolling interest at December 31, 2016 Capital stock and retained earnings of Son on January 2 Add: Son’s net income Less: Dividends declared by Son Son’s stockholders’ equity December 31 Noncontrolling interest percentage Noncontrolling interest at book value Add: 20% Goodwill Noncontrolling interest December 31

Consolidated retained earnings at December 31, 2016 Pop’s retained earnings January 2 (equal to beginning consolidated retained earnings Add: Net income of Pop (equal to controlling share of consolidated net income) Less: Dividends declared by Pop Consolidated retained earnings December 31

$1,400 $1,750 (1,200)

$1,200 180 (100) 1,280 20% $ 256 110 $ 366

Dividends payable at December 31, 2016 Dividends payable to stockholders of Pop $ 180 10 Dividends payable to noncontrolling stockholders ($50  20%) Dividends payable to stockholders outside the Consolidated entity $ 190

3-8

An Introduction to Consolidated Financial Statements

Solution E3-9 (in thousands) Pam Corporation and Subsidiary Partial Balance Sheet at December 31, 2016 Stockholders’ equity: Capital stock, $10 par Additional paid-in capital Retained earnings Equity of controlling stockholders Noncontrolling interest Total stockholders’ equity

$1,200 200 260 1,660 164 $1,824

Supporting computations Computation of consolidated retained earnings: Pam’s December 31, 2015 retained earnings Add: Pam’s reported income for 2016 Less: Pam’s dividends Consolidated retained earnings December 31, 2016

$ 140 220 (100) $ 260

Computation of noncontrolling interest at December 31, 2016 Sun’s December 31, 2015 stockholders’ equity Income less dividends for 2016 ($80 - $60) Sun’s December 31, 2016 stockholders’ equity Noncontrolling interest percentage Noncontrolling interest December 31, 2016

$800 20 820 20% $164

Chapter 3

3-9

Solution E3-10 Pop Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2018 (in thousands) Sales Cost of goods sold Gross profit Deduct: Operating expenses Consolidated net income Deduct: Noncontrolling interest share Controlling interest share

$4,200 2,200 2,000 1,110 890 29 $ 861

Supporting computations Investment cost January 1, 2016 (90% interest) Implied total fair value of Son ($1,620 / 90%) Son’s Book value acquired (100%) Excess of fair value over book value Excess allocated to: Inventories (sold in 2016) Equipment (4 years remaining useful life) Goodwill Excess of fair value over book value Operating expenses: Combined operating expenses of Pop and Son Add: Depreciation on excess allocated to equipment ($40/4 years) Consolidated operating expenses

$ 1,620 $ 1,800 (1,400) $ 400 $ $

60 40 300 400

$1,100 10 $1,110

3-10

An Introduction to Consolidated Financial Statements

SOLUTIONS TO PROBLEMS Solution P3-1 1

Schedule to allocate excess of investment fair value over book value: TOBIAS AG AND ITS 90%-OWNED SUBSIDIARY MARK AG (IN THOUSANDS) Fair value (purchase price) of 90% interest acquired

$ 8,100

Implied fair value of sad ($8,100 / 90%)

$ 9,000

Book value of Mark AG net assets

$ 7,200

Excess of fair value over book value acquired

$ 1,800

Fair Value

Book Value

Excess Allocated

Inventories

$2,000

$1,600

Land

$4,000

$3,000

$ 1,000

Buildings-net

$2,500

$2,800

300

Equipment-net

$4,000

$3,900

100

Notes payable

$2,000

$1,800

200

Bonds payable

$2,000

$2,400

400

Patents

100

Total assigned to identifiable net assets Remainder assigned to goodwill Total excess of cost over book value acquired

400

$ 1,500 $

300

$ 1,800

Chapter 3

3-11

Solution P3-1 (continued) 2

Preliminary computations: Fair value (purchase price) of 80% interest acquired Implied fair value of David PLC ($2,080,000 / 80%) David PLC stockholders’ equity on January 1 ($1,000,000 + $1,800,000 + $200,000 - $500,000) Excess allocated to goodwill

$2,080,000 $2,600,000 $2,500,000 $100,000

HARRISON PLC AND SUBSIDIARY CONSOLIDATED BALANCE SHEET WORKPAPERS DECEMBER 31, 2014 (IN THOUSANDS) Adjustments and Eliminations

Consolidated Balance Sheet

Harrison PLC

80 %David PLC

Cash

300

Accounts receivable

400

200

Dividends receivable

160

Equipment-net

$1,000

800

$1,800

Building-net

$2,000

$1,000

$3,000

Land Investment in David PLC

$1,600

$1,400

$3,000

Debits

Credits

Assets c 100

380

500

b 160

$2,320

a 2320

Goodwill

a 100

Total assets

100

$7,780

$3,480

$8,780

Accounts payable

500

c 100

480

Dividends payable

100

200

b 160

140

Notes payable

$1,000

400

Capital stock

$2,000

$1,000

a 1000

$2,000

Retained earnings

$4,180

$1,800

a 1800

$4,180

$7,780

$3,480

Liabilities and Equity

Noncontrolling interest Total liabilities and stockholders' equity

$1,400

a 580

580

$8,780

a. To eliminate reciprocal subsidiary investment and equity balances, establish noncontrolling interest, and enter goodwill b.To eliminate reciprocal dividends receivable and dividends payable accounts. c.To eliminate reciprocal accountss receivable and accountss payable accounts.

3-12

An Introduction to Consolidated Financial Statements

Chapter 3

3-13

Solution P3-2 (in thousands) 1

Schedule to allocate fair value/book value differential Cost of investment in Son Implied fair value of Son ($350 / 70%) Book value of Son Excess fair value over book value Excess allocated: Fair Value Book Value Inventories ($100 $60) Land ($120 $100) ($180 $140) Buildings — net ($60 $80) Equipment — net Other liabilities ($80 $100) Allocated to identifiable net assets Goodwill for the remainder Excess fair value over book value

$ $

350 500 (220) $ 280 Allocation $ 40 20 40 (20) 20 100 180 $280

Pop Corporation and Subsidiary Consolidated Balance Sheet at January 1, 2016 Assets Current assets: Cash ($70 + $40) Receivables — net ($160 + $60) Inventories ($140 + $60 + $40) Property, plant and equipment: Land ($200 + $100 + $20) Buildings — net ($220 + $140 + $40) Equipment — net ($160 + $80 - $20) Goodwill (from consolidation) Total assets Liabilities and Stockholders’ Equity Liabilities: Accounts payable ($180 + $160) Other liabilities ($20 + $100 - $20) Stockholders’ equity: Capital stock Retained earnings Equity of controlling stockholders Noncontrolling interest * Total liabilities and stockholders’ equity

* 30% of implied fair value of $500 = $150.

$110 220 240 $320 400 220

340 100

$1,000 100 1,100 150

570

940 180 $1,690

440

1,250 $1,690

3-14

An Introduction to Consolidated Financial Statements

Solution P3-3 (in thousands) Cost of investment in Sun January 1, 2016 Implied fair value of Sun ($10,800 / 80%) Book value of Sun Excess of fair value over book value

$10,800 $13,500 10,000 $ 3,500

Schedule to Allocate Fair Value — Book Value Differential Fair Value - Book Value $2,000 4,000

Current assets Equipment

Allocation $2,000 4,000

Bargain purchase gain* Excess fair value over book value

(2,500) $3,500

*After recognizing acquired assets and liabilities at fair values, we are left with a negative excess of $2,500. Under GAAP, this difference is recorded as a gain in the consolidated income statement in the year of acquisition. The gain is attributable entirely to the controlling interest, and is recorded on the parent’s books by a debit to the Investment account and a credit to a Gain from bargain Purchase account. An alternative calculation of this amount takes the difference between the fair values of the net assets ($16,000) and their fair value implied by the acquisition price ($13,500), which equals $2,500. Solution P3-4 (in thousands) Noncontrolling interest of $260 (fair value) plus $1,040 (fair value of Pam’s investment) equals total fair value of $1,300. Therefore, Pam’s interest is 80% ($1,040 / $1,300), and noncontrolling interest is 20% ($260 / $1,300). Total fair value Book value of Sun Excess fair value over book value

$1,300 (1,040) $ 260

Excess allocated to Fair Value $840

Plant assets — net Goodwill Total

Book Value $800 $ $

40 220 260

Chapter 3

3-15

Solution P3-5 Pop Corporation and Subsidiary Consolidated Balance Sheet at December 31, 2016 (in thousands) Assets Current assets Plant assets Goodwill

$ 2,720 6,640 1,600 $10,960

Equities Liabilities Capital stock Retained earnings

$ 5,280 2,400 3,280 $10,960

Supporting computations Son’s net income ($3,200 - $2,400 - $400) Less: Excess allocated to inventories that were sold in 2016 Less: Depreciation on excess allocated to plant assets ($320 /4 years) Income from Son

400 (160) (80) 160

Plant assets ($4,000 + $2,400 + $320 - $80)

$6,640

Pop’s retained earnings: Beginning retained earnings Add: Operating income Add: Income from Son Deduct: Dividends Retained earnings December 31, 2016

$2,720 800 160 (400) $3,280

3-16

An Introduction to Consolidated Financial Statements

Solution P3-6 Pam Corporation and Subsidiary Consolidated Balance Sheet Working Papers at December 31, 2016 (in thousands) Pam per books $ 168 200

Cash Receivables — net Inventories Land

Sun per books $ 80 520

1,400 600 2,400 1,836 ______

______

$6,604

$2,000

Accounts payable Dividends payable Capital stock Retained earnings Noncontrolling interest Total equities

$1,640 240 4,000 724 ______ $6,604

200 800 400

Equipment — net Investment in Sun Goodwill Total assets

Adjustments and Eliminations

Consolidated Balance Sheet $ 248 684 1,600 1,400 2,800

a 1,836

320 40 1,200 440 ______ $2,000

400

400 $7,132

b 36 a 1,200 a 440 a

204

$1,960 244 4,000 724 204 $7,132

To eliminate reciprocal investment and equity accounts, record goodwill ($400), and enter noncontrolling interest [($1,640 equity + $400 goodwill)  10%)]. To eliminate reciprocal dividends receivable (included in receivables — net) and dividends payable amounts ($40 dividends  90%).

Chapter 3

3-17

Solution P3-7 (in thousands) Preliminary computations Cost of 80% investment January 3, 2016 Implied total fair value of Son ($1,120 / 80%) Book value of Son Excess fair value over book value on January 3 = Goodwill 1

$1,120 $1,400 (1,000) $ 400

Noncontrolling interest share of income: Son’s net income $200  20% noncontrolling interest

$ 40

Current assets: Combined current assets ($816 + $300) Less: Dividends receivable ($40  80%) Current assets

$1,116 (32) $1,084

Income from Son: None Investment income is eliminated in consolidation.

Capital stock: $2,000 Capital stock of the parent, Pop Corporation.

Investment in Son: None The investment account is eliminated.

Excess of fair value over book value

$400

Controlling share of consolidated net income: Equals Pop’s net income, or: Consolidated sales Less: Consolidated cost of goods sold Less: Consolidated expenses Consolidated net income Less: Noncontrolling interest share Controlling share

$ 2,400 (1,480) (320) $ 600 (40) $ 560

Consolidated retained earnings December 31, 2016: $808 Equals Pop’s beginning retained earnings.

Consolidated retained earnings December 31, 2017 Equal to Pop’s ending retained earnings: Beginning retained earnings Add: Controlling share of consolidated net income Less: Pop’s dividends for 2017 Ending retained earnings

Noncontrolling interest December 31, 2017 Son’s capital stock and retained earnings Add: Net income Less: Dividends Son’s equity December 31, 2017 at fair value Noncontrolling interest percentage Noncontrolling interest December 31, 2017 using book value Add: Noncontrolling interest share of Goodwill Noncontrolling interest December 31, 2017 at fair value

808 560 (240) $1,128 $1,200 200 (100) 1,300 20% $ 260 80 $ 340

3-18

An Introduction to Consolidated Financial Statements

Solution P3-8 [AICPA adapted] Preliminary computations Investment cost: Son (2,000 shares  80%)  $280 Sam (6,000 shares  70%)  $160 Implied total fair values: Son ($448,000 / 80%) Sam ($672,000 / 70%) Book value Son Sam Excess fair value over book value at acquisition Goodwill 1

Son

Sam

448,000 672,000 560,000 960,000 280,000 480,000 $280,000

$480,000

a. Journal entries to account for investments January 1, 2016 — Acquisition of investments Investment in Son (80%) Cash To record acquisition of 1,600 shares of Son common stock at $280 per share. Investment in Sam (70%) Cash To record acquisition of 4,200 shares of Sam common stock at $160 per share.

448,000 448,000 672,000 672,000

b. During 2016 — Dividends from subsidiaries Cash 51,200 Investment in Son (80%) 51,200 To record dividends received from Son ($64,000  80%). Cash 25,200 Investment in Sam (70%) 25,200 To record dividends received from Sam ($36,000  70%). c. December 31, 2016 — Share of income or loss Investment in Son (80%) 115,200 Income from Son 115,200 To record investment income from Son ($144,000  80%). Loss from Sam 33,600 Investment in Sam (70%) 33,600 To record investment loss from Sam ($48,000  70%).

Chapter 3

3-19

Solution P3-8 (continued) 2

Noncontrolling interest December 31, 2016 Common stock Capital in excess of par Retained earnings Equity December 31 Noncontrolling interest percentage Noncontrolling interest December 31 Plus: Goodwill $280,000 x 20% $480,000 x 30% Noncontrolling interest December 31

Son $200,000 160,000 360,000 20% $ 72,000 56,000 $128,000

Sam $240,000 80,000 76,000 396,000 30% $118,800 144,000 $262,800

Consolidated retained earnings December 31, 2016 Consolidated retained earnings is reported at $1,218,400, equal to the retained earnings of Pop Corporation, the parent, at December 31, 2016.

Investment balance December 31, 2016: Investment cost January 1 Add (deduct): Income (loss) Deduct: Dividends received Investment balances December 31

Son $448,000 115,200 (51,200) $512,000

Sam $672,000 (33,600) (25,200) $613,200

Check: Investment balances should be equal to the underlying book value plus share of goodwill Son ($360,000  80%) = $288,000 + ($280,000 x 80%) = $512,000 Sam ($396,000  70%) = $277,200 + ($480,000 x 70%) = $613,200 After consolidation, the Investment balances are $0.

3-20

An Introduction to Consolidated Financial Statements

Solution P3-9 Preliminary computations (in thousands) Cost of 90% investment January 1, 2016 Implied total fair value of Sun ($14,400 / 90%) Book value of Sun Excess fair value over book value on January 1 Allocation to equipment Remainder is Goodwill Additional annual depreciation on equipment ($3,200 / 8 years)

$14,400 $16,000 (10,800) $ 5,200 $ 3,200 $ 2,000 $ 400

Pam Corporation and Subsidiary Consolidated Balance Sheet Working Papers at December 31, 2016 (in thousands) Pan $ 1,200 2,400

Cash Receivables — net Dividends receivable Inventory Land Buildings — net Equipment — net Investment in Sun Goodwill Total assets

Adjustments and Eliminations

360 2,800 2,400 8,000

2,400 2,800 4,000

6,000

3,200

2,800

15,120 _______ $38,280

________ $ 14,800

2,000

b a a

360 8,000 4,000

Accounts payable $ 1,200 Dividends payable 2,000 Capital stock 28,000 Retained earnings 7,080 Noncontrolling interest _______ Total equities $38,280 a

90% Son 800 1,600

Consolidated Balance Sheet $ 2,000 4,000

360 5,200 5,200 12,000 12,000

a 15,120

2,400 400 8,000 4,000 ________ $ 14,800

2,000 $42,400

1,680

$ 3,600 2,040 28,000 7,080 1,680 $42,400

To eliminate reciprocal investment and equity accounts, enter unamortized excess allocated to equipment, record goodwill, and enter noncontrolling interest (at fair value). To eliminate reciprocal dividends receivable and dividends payable amounts.

Chapter 3

3-21

Solution P3-10 1

Purchase price of investment in Sun (in thousands) Underlying book value of investment in Sun: Equity of Sun January 1, 2016 Add: Excess investment fair value over book value: Goodwill at December 31, 2020 Fair value of Sun January 1, 2016

$1,760 480 $2,240

Purchase price of 80% investment at fair value($2,240 x 80%) 2

$1,792

Sun’s stockholders’ equity on December 31, 2020 (in thousands) 20% noncontrolling interest at fair value $496 20% goodwill (96) 20% noncontrolling interest’s equity at book value $400 Total equity = Noncontrolling interest’s equity $400/20% = $2,000

Pam’s investment in Sun account balance at December 31, 2020 (in thousands) Underlying book value in Sun December 31, 2020 $1,600 ($2,000  80%) Add: 80% of Goodwill December 31, 2020 (20% is attributable to the noncontrolling interest) 384 Investment in Sun December 31, 2020 $1,984 Alternative solution: Investment cost January 1, 2016 Add: 80% of Sun’s increase since acquisition ($2,000 - $1,760)  80% Investment in Sun December 31, 2020

$1,792 192 $1,984

Pam’s capital stock and retained earnings December 31, 2020 (in thousands) Capital stock $3,200 Retained earnings $ 240 Amounts are equal to capital stock and retained earnings shown in the consolidated balance sheet.

3-22

An Introduction to Consolidated Financial Statements

Solution P3-11 Preliminary computations (in thousands) Cost of 70% investment in Son Implied fair of Son($2,800 / 70%) Book value of Son (100%) Excess Excess allocated: Inventories Plant assets Goodwill Excess

$2,800 $4,000 3,200 $ 800 $ $

Investment balance at January 1, 2016 Share of Son’s retained earnings increase ($240  70%) Less: Amortization 70% of excess allocated to inventories (sold in 2016) 70% of excess allocated to plant assets ($320 /8 years) Investment balance at December 31, 2016

80 320 400 800

$2,800 168 (56) (28) $2,884

Noncontrolling interest at December 31 30% of Son’s book value at December 31 ($3,440 x 30%) 30% of Goodwill 30% Unamortized excess for plant assets 30% x ($320 - $40 amortization) Noncontrolling at December 31 (fair value)

$1,032 120 84 $1,236

Pop Corporation and Subsidiary Consolidated Balance Sheet Working Papers at December 31, 2016 (in thousands) Cash Accounts receivable — net Accounts receivable — Pop Dividends receivable Inventories Land

Pop $ 240 1,760

70% Son 80 800

Adjustments and Eliminations

28 2,000 400 2,800

1,280 600 1,400

a 280

2,884 _______

_______

a 400

$10,112

$ 4,200

Accounts payable Account payable to Son Dividends payable Long-term debt Capital stock Retained earnings Noncontrolling interest

$ 1,200 40 160 2,400 4,000 2,312

($4,120,000  30%) Equities

_______

$10,112

$ 4,200

Plant assets — net Investment in Son Goodwill Assets

Consolidated Balance Sheet $ 320 2,560

3,280 1,000 4,480 a 2,884 400 $12,040

320 40 400 2,000 1,440

$ 1,520 b c

40 28

172 2,800 4,000 2,312

a 2,000 a 1,440 a 1,236

1,236 $12,040

Chapter 3

3-23

3-24

An Introduction to Consolidated Financial Statements

Solution P3-12 Preliminary computations (in thousands) 80% Investment in Sun at cost January 1, 2016 Implied total fair value of Sun ($6,080 / 80%) Sun book value Excess fair value over book value recorded as goodwill

2016 2017 2018

Sun Dividends $ 320 400 480 $1,200

Sun Net Income $ 640 800 960 $2,400

$ 6,080 $ 7,600 7,200 $ 400

80% of Net Income $ 512 640 768 $1,920

Sun’s dividends for 2017 ($320 / 80%)

400

Sun’s net income for 2017 ($640 / 80%)

800

Goodwill — December 31, 2017

400

Noncontrolling interest share of income — 2018 Sun’s income for 2018 ($384 dividends received/80%)  2 Noncontrolling interest percentage Noncontrolling interest share

960 20% 192

Noncontrolling interest December 31, 2018 Equity of Sun January 1, 2016 Add: Income for 2016, 2017 and 2018 Deduct: Dividends for 2016, 2017 and 2018 Equity book value of Sun December 31, 2018 Goodwill Equity fair value of Sun December 31, 2018 Noncontrolling interest percentage Noncontrolling interest December 31, 2018

$7,200 2,400 (1,200) 8,400 400 $8,800 20% $1,760

Controlling share of consolidated net income for 2018 Pam’s separate income Add: Income from Sun Controlling share of consolidated net income

$2,240 768 $3,008

Pam’s net income Sun’s net income Consolidated net income Less: Noncontrolling interest share ($960 x 20%) Controlling interest share

$2,240 960 $3,200 192 $3,008

Chapter 3

3-25

PR 3-1 ASC 805-10-20 Glossary: “Acquisition Date - The date on which the acquirer obtains control of the acquiree.” PR 3-2 ASC 810-10-50-1A: A parent with one or more less-than-wholly-owned subsidiaries shall disclose all of the following for each reporting period: a.

Separately, on the face of the consolidated financial statements, both

of the following: 1.

The amounts of consolidated net income and consolidated

comprehensive income 2.

The related amounts of each attributable to the parent and

the noncontrolling interest. b.

Either

the

notes

the

face

the

consolidated

income

statement, amounts attributable to the parent for any of the following, if reported in the consolidated financial statements:

Income from continuing operations

Discontinued operations

Either in the consolidated statement of changes in equity, if presented,

or in the notes to consolidated financial statements, a reconciliation at the beginning and the end of the period of the carrying amount of total equity (net assets), equity (net assets) attributable to the parent, and equity (net assets)

attributable

the

noncontrolling

interest.

That

reconciliation

shall separately disclose all of the following: 1.

Net income

Transactions with owners acting in their capacity as owners,

showing separately contributions from and distributions to owners 3. d.

Each component of other comprehensive income.

In notes to the consolidated financial statements, a separate schedule

that shows the effects of any changes in a parent’s ownership interest in a subsidiary on the equity attributable to the parent.

Chapter 4 CONSOLIDATION TECHNIQUES AND PROCEDURES Answers to Questions 1

Under the equity method, a parent amortizes patents from subsidiary investments by adjusting its subsidiary investment and income accounts. Since patents and patent amortization accounts are not recorded on the parent’s books, they are created for consolidated statement purposes through workpaper entries.

Noncontrolling interest share is entered in the consolidation workpapers by preparing a workpaper adjusting entry in which noncontrolling interest share is debited and noncontrolling interest is credited. The noncontrolling interest share (debit) is carried to the consolidated income statement as a deduction, and the credit to noncontrolling interest for noncontrolling interest share is added to the beginning noncontrolling interest. The noncontrolling interest share is calculated based on the subsidiary’s reported net income adjusted to reflect fair value through the amortization of the excess of fair value over book value. This is the approach illustrated throughout this text.

Workpaper procedures for the investment in subsidiary, income from subsidiary, and subsidiary equity accounts are alike in regard to the objectives of consolidation. Regardless of the configuration of the workpaper entries, the final result of adjustments for these items is to eliminate them through workpaper entries. In other words, the investment in subsidiary, income from subsidiary, and the capital stock, additional paid-in capital, retained earnings, and other stockholders’ equity accounts of the subsidiary never appear in consolidated financial statements.

When the parent does not amortize fair value/book value differentials on its separate books, the parent’s income from subsidiary and investment in subsidiary accounts are overstated in the year of acquisition. In subsequent years, the income from the subsidiary, investment in subsidiary, and parent’s beginning retained earnings will be overstated. The error may be corrected in the workpapers with the following entries: Year of acquisition Income from subsidiary Investment in subsidiary Subsequent year Income from subsidiary Retained earnings — parent Investment in subsidiary

XXX XXX XXX XXX XXX

By entering a correcting entry, all other workpaper entries are the same as if the parent provided for amortization on its separate books. If the errors are not corrected through the workpaper entries suggested above, the entry to eliminate the income from subsidiary in the year of acquisition is prepared in the usual manner without further complications because neither the beginning investment nor retained earnings accounts are affected by the omission. In subsequent years the entry to eliminate income from subsidiary and dividends from subsidiary will have to be changed to correct the beginning-of-the-period retained earnings as follows: Income from subsidiary Retained earnings — parent Dividends (subsidiary) Investment in subsidiary

XXX XXX XXX XXX

4-1

4-2

Consolidation Techniques and Procedures

Workpaper adjustments are not normally entered in the general ledger of the parent or any other entity. They are used in the preparation of consolidated financial statements for a conceptual entity for which there are no formal accounting records. An exception occurs when the adjusting entries involve the correction of an error. For example, if a parent does not record a dividend from a subsidiary. Then the workpaper entry is recorded in the parent’s separate books.

Workpapers are tools of the accountant that facilitate the consolidation of parent and subsidiary financial statements. Given the tools available, the accountant should select those that are most convenient in the circumstances. If financial statements are to be consolidated, the financial statement approach is the appropriate tool. The trial balance approach is most convenient when the data are presented in the form of a trial balance. The accountant needs to be familiar with both approaches to perform the work as efficiently as possible.

Workpaper adjustment and elimination entries as illustrated in this text are exactly the same when the trial balance approach is used as when the financial statement approach is used.

The retained earnings of the parent will equal consolidated retained earnings if the equity method of accounting has been correctly applied. In consolidating the financial statements of affiliated companies, the beginning retained earnings of the parent are used as beginning consolidated retained earnings. If the equity method has not been correctly applied, parent beginning retained earnings will not equal beginning consolidated retained earnings. In this case, retained earnings of the parent are adjusted to a correct equity basis in order to establish the correct amount of beginning consolidated retained earnings. Thus, workpaper adjustments to beginning retained earnings of the parent are needed whenever the beginning retained earnings of the parent do not correctly reflect the equity method.

The noncontroling interest that appears in the consolidated balance sheet can be checked by first adjusting the equity of the subsidiary on the consolidated balance sheet date to fair value (i.e., adjusting for any unamortized excess of fair value over book value) and then multiplying by the noncontrolling interest percentage. Consolidated retained earnings at a balance sheet date can be checked by comparing the amount with the parent’s retained earnings on the same date. If consolidated retained earnings and parent retained earnings are not equal, either consolidated retained earnings have been computed incorrectly, or parent retained earnings do not reflect a correct equity method of accounting.

Consolidated assets and liabilities are reported for all equity holders—noncontrolling as well as controlling. Therefore, the change in net cash from operations for a period results from noncontrolling interest share and controlling interest share.

No. It relates to all interests in the consolidated entity. This difference is one of many inconsistencies in the concepts underlying consolidated financial statements. Consider, for example, the error that could result from dividing cash provided by operations by outstanding parent shares to compute cash flow per share.

The method used by a parent company in accounting for its subsidiary can be determined by examining the separate financial statements of the parent company and the subsidiary. If the cost method is used, the parent company will report dividend income from the subsidiary and the investment account will be stated at original cost (fair value). If the equity method is used, the parent company will report investment income from the subsidiary, and the investment account will reflect subsidiary income since acquisition. When the equity method is used but the difference between investment fair value and book value has not been amortized on the parent company’s books, the difference between the investment balance and underlying book value at any statement date will reflect the difference between the investment fair value and underlying book value at the time of acquisition.

When the cost method is used, reciprocity between the investment account balance and the underlying subsidiary equity is established by adjusting the parent company’s investment and retained earnings accounts for the parent’s share of the change in subsidiary retained earnings between the dates the subsidiary was acquired and the beginning of the current year. .

Chapter 4

4-3

SOLUTIONS TO EXERCISES Solution E4-1 1

Fair value (purchase price) of 80% interest acquired Implied fair value of Salim PJSC ($800,000/80%) Book Value of Salim PJSC’s net assets Total of excess of fair value over book value Excess allocated to patent Excess allocated to goodwill

$800,000

Patent at January 1, 2014 Less: amortization for 4 years ($20,000  4/10) Patent at December 31, 2017

$20,000 $8,000 $12,000

$1,000,000 $900,000 $100,000 $20,000 $80,000

Solution E4-2 1

Dividends from subsidiary in the consolidated financial statement are eliminated to return the investment account of parent to its beginning balance and to enter noncontrolling interest account in the consolidated balance sheet. Therefore, the amount of dividends in the consolidated financial statement is solely parent’s dividends. Since Folake PLC didn’t declare any dividends for the year, the amount of dividends that should be reported in the consolidated financial statement is zero.

Unpaid Anele PLC dividend Unpaid dividend to Folake PLC

$200,000 75% $150,000

Annele PLC dividend payable Less: unpaid dividedn to Folake PLC Dividend payable on the consolidated balance sheet

$200,000 $150,000 $50,000

Solution E4-3 1

Fair value (purchase price) of 90% interest acquired Implied fair value of Sanun Ltd ($3,600,000/90%) Book value of Sanun Ltd’s net assets Excess of fair value over book value Allocation to identifiable assets and liabilities Inventory Land Equipment Building Notes receivable Total allocated to identifiable net assets Remainder allocated to goodwill Total excess of fair value over book value

$3,600,000 $4,000,000 $5,000,000 ($1,000,000) ($200,000) ($500,000) $400,000 ($750,000) ($200,000) ($1,250,000) $250,000 ($1,000,000)

4-4

Consolidation Techniques and Procedures

Solution E4-3 (continued) 2

Income from Sanun Ltd for 2014: 90% of Sanun Ltd $1,000,000 net income

$900,000

Excess allocated to inventory (90%  $200,000)

$180,000

Excess allocated to equipment (90%  $400,000/4)

($90,000)

Excess allocated to building (90%  $750,000/5) Excess allocated to notes receivable

$135,000 $45,000

(90%  $200,000/4) $1,170,000 3

Investment in Sanun Ltd at January 1, 2014 Income from Sanun Ltd for 2014 Dividends from Sanun Ltd ($300,000 x 90%) Investment in Sanun Ltd at December 31, 2014

$3,600,000 $1,170,000 ($270,000) $4,500,000

Noncontrolling interest share for 2014: 10% of Sanun Ltd $1,000,000 net income

$100,000

Excess allocated to inventory (10%  $200,000)

$20,000

Excess allocated to equipment (10%  $400,000/4)

($10,000)

Excess allocated to building (10%  $750,000/5) Excess allocated to notes receivable

$15,000 $5,000

(10%  $200,000/4) $130,000 Noncontrolling interest at January 1, 2014

$400,000

($4,000,000  10%) Noncontrolling interest share for 2014 Dividends for noncontrolling interest

$130,000 ($30,000)

($300,000  10%) Noncontrolling interest at December 1, 2014

$500,000

Check: Investment in Sanun Ltd at December 31, 2014

$4,500,000

Noncontrolling interest at December 1, 2014 ($4,500,000  10% / $450,000)

$500,000

Chapter 4

4-5

Solution E4-4 Preliminary computations Investment cost Implied total fair value of Son ($580,000 / 80%) Book value Total excess fair value over book value

$580,000 $725,000 600,000 $125,000

Excess allocated to: Equipment (5-year life) Patents (10-year amortization period) Total excess fair value over book value

$ 50,000 75,000 $125,000

Income from Son Son’s reported net income Less: Depreciation of excess allocated to equipment Less: Amortization of patents Son’s adjusted income Income from Son (80%) 1

2016 $120,000 (10,000) ( 7,500) $102,500 $ 82,000

2017 $150,000 (10,000) ( 7,500) $132,500 $106,000

Consolidated net income for 2016 Pop’s net income = controlling share of consolidated net income under equity method Add: Noncontrolling interest share($102,500 x 20%) Consolidated net income

$340,000 20,500 $360,500

Investment in Son December 31, 2016 Cost January 1 Add: Income from Son — 2016 Less: Dividends from Son — 2016 ($80,000  80%) Investment in Son December 31

$580,000 82,000 ( 64,000) $598,000

Noncontrolling interest share — 2016 ($102,500 adjusted income  20%)

$ 20,500

Noncontrolling interest December 31, 2017 Son’s equity book value at acquisition date Add: Income less dividends for 2016 and 2017 (see note) Son’s equity book value at December 31, 2017 Unamortized excess at December 31, 2017 Son’s equity fair value at December 31, 2017 Noncontrolling interest percentage Noncontrolling interest December 31, 2017

$600,000 100,000 700,000 90,000 $790,000 20% $158,000

Note: Son’s income less dividends: 2016 Net Income 2016 Dividends 2017 Net Income 2017 Dividends Total

$120,000 ( 80,000) 150,000 ( 90,000) $100,000

4-6

Consolidation Techniques and Procedures

Solution E4-5 1 2 3 4 5

c a b c d

Solution E4-6 Mahdi Corporation and Subsidiary Partial Consolidated Cash Flows Statement for the year ended December 31, 2016 Cash Flows from Operating Activities Controlling interest share of consolidated net income Adjustments to reconcile controlling interest share of consolidated net income to net cash provided by operating activities: Noncontrolling interest share Undistributed income of equity investees Loss on sale of land Depreciation on buildings Depreciation on equipment Patents amortization Increase in accounts receivable Increase in inventories Decrease in accounts payable Net cash flows from operating activities

$400,000

$100,000 (10,000) 200,000 100,000 80,000 10,000 (25,000) (40,000) (30,000)

385,000 $785,000

Solution E4-7 Pierre Corporation and Subsidiary Partial Consolidated Cash Flows Statement for the year ended December 31, 2016 Cash Flows from Operating Activities Cash received from customers Dividends received from equity investees Less: Cash paid to suppliers Cash paid to employees Cash paid for other operating items Net cash flows from operating activities

$550,000 15,000 $225,000 90,000 25,000

340,000 $225,000

Chapter 4

4-7

Solution E4-8 1

Cost method Cash 30,000 Dividend income To record receipt of dividends ($40,000  75%). Cost method Investment cost January 1, 2018 Less: Dividends in excess of earnings ($30,000 - $10,000)  75% Investment account balance — cost method

$300,000 (15,000) $285,000

Equity method Investment in Son 45,000 Income from Son To record share of Son’s net income ($60,000  75%). Cash

30,000

30,000 Investment in Son To record receipt of dividends ($40,000  75%).

45,000

30,000

Investment balance under equity method Investment cost Add: Share of income for 2018 and 2019 ($70,000  75%) Less: Share of dividends for 2018 and 2019 ($70,000  75%) Investment in Son balance December 31, 2019

$300,000 52,500 (52,500) $300,000

Consolidated net income Pop’s separate income Add: Investment income Controlling share of consolidated net income

$ 90,000 45,000 $135,000

Controlling share of consolidated net income Add: Noncontrolling interest share ($60,000 x 25%) Consolidated net income

$ 135,000 15,000 $150,000

4-8

Consolidation Techniques and Procedures

Solutions to Problems Solution P4-1 (in thousands of $) Preliminary computations: Purchase price for 80% interest acquired Implied fair value of Theo AB ($10,000,000 / 80%) Book value of Theo AB’s net assets Allocated to goodwill

$10,000,000 $12,500,000 $10,000,000 $2,500,000d

Noncontrolling interest share: 20% of Theo AB net income ($150,000 x 20%)

$300,000b

Beginning noncontrolling interest: 20% of Beginning implied fair value of Theo ($12,500,000 x 20%)

$2,500,000c

Chapter 4

4-9

Solution P4-1 (continued) LIAM AB AND SUBSIDIARY CONSOLIDATION WORKPAPER FOR THE YEAR ENDED DECEMBER 31, 2014 (IN THOUSANDS) Adjustments and Eliminations Consolidated Liam AB Theo AB Debits Credits Statements Income Statement Sales

$ 67,000

Income from Theo AB

$ 30,500

$ 1,200

a. 1,200

Cost of sales

-$ 42,000

-$ 25,000

Expenses

-$ 21,900

-$ 4,000

Noncontrolling interest share Controlling share of net income

$ 97,500

-$ 67,000 -$ 25,900 b. 300

$ 4,300

-$ 300

$ 1,500

$ 4,300

Retained Earnings Statement Retained earnings - Liam AB

$ 11,600

Retained earnings - Theo AB

$ 11,600

Controlling share of net income

$ 4,300

$ 8,000 $ 1,500

c. 8,000

Dividends

-$ 3,000

-$ 500

Retained earnings - December 31

$ 12,900

$ 9,000

$ 12,900

$ 800

$ 600

$ 1,400

$ 1,300

$ 800

$ 4,300 a. 400

-$ 3,000

b. 100

Balance Sheet Cash Accounts receivable-net Dividends receivable

$ 2,100

$ 400

d. 400

Inventories

$ 2,600

$ 400

$ 3,000

Other current assets

$ 1,200

$ 1,800

$ 3,000

Land

$ 3,000

$ 4,200

$ 7,200

Buildings-net

$ 3,200

$ 3,600

$ 6,800

Equipment-net

$ 2,200

$ 2,400

$ 4,600

Investment in Theo AB

$ 10,800

a. 800 c. 10,000

Goodwill

c. 2,500

Total Assets

$ 25,500

$ 13,800

Accounts payable

$ 1,000

$ 400

Dividends payable

$ 2,500

$ 500

Notes payable

$ 4,100

$ 1,900

Capital Stock, $10 par

$ 5,000

$ 2,000

Retained earnings

$ 12,900

$ 9,000

$ 25,500

$ 13,800

$ 2,500 $ 30,600

$ 1,400 d. 400

$ 2,600 $ 6,000

c. 2,000

$ 5,000 $ 12,900

Noncontrolling interest January 1

c. 2,500

Noncontrolling interest December 31

b. 200

Total liabilities and equities

$ 2,700 $ 30,600

4-10

Consolidation Techniques and Procedures

Solution P4-2 Preliminary computations: Purchase price for 90% interest acquired Implied fair value of Kim NV ($9,000,000/90%) Book value of Kim NV’s net assets Excess of fair value over book value Allocated to inventory Allocated to building Remainder to goodwill

$9,000,000 $10,000,000 $9,000,000 $1,000,000 $100,000 ($600,000) $500,000c

Noncontrolling interest share: 10% of Kim NV net income ($500,000  10%) Amortization of overvalued inventory Amortization of undervalued building ($600,000  10%/6)

$50,000 $100,000 ($100,000) $50,000b

Beginning noncontrolling interest: 10% of Beginning implied fair value of Kim NV ($10,000,000  10%)

$1,000,000c