ACC 401 Week 5 Quiz 4 Chapters 6 – 7 and Mid-Term Exam Chapters 1 – 4 – Strayer

ACC 401 Advanced Accounting Week 5 Quiz – Mid-Term Exam (Chapters 1 Through 4) – Strayer (All Possible Questions With Answers)

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Chapter 1 Through 4, 6 and 7 (Quiz 6 – 7 – Mid-Term Exam 1 – 4)

Chapter 1

Introduction to Business Combinations and the Conceptual Framework

Multiple Choice
1. Stock given as consideration for a business combination is valued at
a. fair market value
b. par value
c. historical cost
d. None of the above

2. Which of the following situations best describes a business combination to be accounted for as a statutory merger?
a. Both companies in a combination continue to operate as separate, but related, legal entities.
b. Only one of the combining companies survives and the other loses its separate identity.
c. Two companies combine to form a new third company, and the original two companies are dissolved.
d. One company transfers assets to another company it has created.

3. A firm can use which method of financing for an acquisition structured as either an asset or stock acquisition?
a. Cash
b. Issuing Debt
c. Issuing Stock
d. All of the above

4. The objectives of FASB 141R (Business Combinations) and FASB 160 (NonControlling Interests in Consolidated Financial Statements) are as follows:
a. to improve the relevance, comparibility, and transparency of financial information related to business combinations.
b. to eliminate the amortization of Goodwill.
c. to facilitate the convergence project of the FASB and the International Accounting Standards Board.
d. a and b only

5. A business combination in which the boards of directors of the potential combining companies negotiate mutually agreeable terms is a(n)
a. agreeable combination.
b. friendly combination.
c. hostile combination.
d. unfriendly combination.

6. A merger between a supplier and a customer is a(n)
a. friendly combination.
b. horizontal combination.
c. unfriendly combination.
d. vertical combination.

7. When a business acquisition is financed using debt, the interest payments are tax deductible and create
a. operating synergy.
b. international synergy.
c. financial synergy.
d. diversification synergy.

8. The defense tactic that involves purchasing shares held by the would-be acquiring company at a price substantially in excess of their fair value is called
a. poison pill.
b. pac-man defense.
c. greenmail.
d. white knight.

9. The third period of business combinations started after World War II and is called
a. horizontal integration.
b. merger mania.
c. operating integration.
d. vertical integration.

10. A statutory ______________ results when one company acquires all the net assets of another company and the acquired company ceases to exist as a separate legal entity.
a. acquisition.
b. combination.
c. consolidation.
d. merger.

11. When a new corporation is formed to acquire two or more other corporations and the acquired corporations cease to exist as separate legal entities, the result is a statutory
a. acquisition.
b. combination.
c. consolidation.
d. merger.

12. The excess of the amount offered in an acquisition over the prior stock price of the acquired firm is the
a. bonus.
b. goodwill.
c. implied offering price.
d. takeover premium.

13. The difference between normal earnings and expected future earnings is
a. average earnings.
b. excess earnings.
c. ordinary earnings.
d. target earnings.

14. The first step in estimating goodwill in the excess earnings approach is to
a. determine normal earnings.
b. identify a normal rate of return for similar firms.
c. compute excess earnings.
d. estimate expected future earnings.

15. A potential offering price for a company is computed by adding the estimated goodwill to the
a. book value of the company’s net assets.
b. book value of the company’s net identifiable assets.
c. fair value of the company’s net assets.
d. fair value of the company’s net identifiable assets.

16. Estimated goodwill is determined by computing the present value of the
a. average earnings.
b. excess earnings.
c. expected future earnings.
d. normal earnings.

17. Which of the following statements would not be a valid or logical reason for entering into a business combination?
a. to increase market share.
b. to avoid becoming a takeover target.
c. to reduce risk by acquiring established product lines.
d. the operating costs of the combined entity would be more than the sum of the separate entities.

18. The parent company concept of consolidation represents the view that the primary purpose of consolidated financial statements is:
a. to provide information relevant to the controlling stockholders.
b. to represent the view that the affiliated companies are a separate, identifiable economic entity.
c. to emphasis control of the whole by a single management.
d. to include only a portion of the subsidiary’s assets, liabilities, revenues, expenses, gains, and losses.

19. Which of the following statements is correct?
a. Total elimination is consistent with the parent company concept.
b. Partial elimination is consistent with the economic unit concept.
c. Past accounting standards required the total elimination of unrealized intercompany profit in assets acquired from affiliated companies.
d. none of these.

20. Under the parent company concept, consolidated net income __________ the consolidated net income under the economic unit concept.
a. is the same as
b. is higher than
c. is lower than
d. can be higher or lower than

21. Under the economic unit concept, noncontrolling interest in net assets is treated as
a. a liability.
b. an asset.
c. stockholders’ equity.
d. an expense.

22. The parent company concept adjusts subsidiary net asset values for the
a. differences between cost and fair value.
b. differences between cost and book value.
c. total fair value implied by the price paid by the parent.
d. total cost implied by the price paid by the parent.

23. According to the economic unit concept, the primary purpose of consolidated financial statements is to provide information that is relevant to
a. majority stockholders.
b. minority stockholders.
c. creditors.
d. both majority and minority stockholders.

24. Which of the following statements is correct?
a. The economic unit concept suggests partial elimination of unrealized intercompany profits.
b. The parent company concept suggests partial elimination of unrealized intercompany profits.
c. The economic unit concept suggests no elimination of unrealized intercompany profits.
d. The parent company concept suggests total elimination of unrealized intercompany profits.

25. When following the parent company concept in the preparation of consolidated financial statements, noncontrolling interest in combined income is considered a(n)
a. prorated share of the combined income.
b. addition to combined income to arrive at consolidated net income.
c. expense deducted from combined income to arrive at consolidated net income.
d. deduction from current assets in the balance sheet.

26. When following the economic unit concept in the preparation of consolidated financial statements, the basis for valuing the noncontrolling interest in net assets is the
a. book values of subsidiary assets and liabilities.
b. fair values of subsidiary assets and liabilities.
c. general price level adjusted values of subsidiary assets and liabilities.
d. fair values of parent company assets and liabilities.

27. The view that consolidated financial statements represent those of a single economic entity with several classes of stockholder interest is consistent with the
a. parent company concept.
b. current practice concept.
c. historical cost company concept.
d. economic unit concept.

28. The view that the noncontrolling interest in income reflects the noncontrolling stockholders’ allocated share of consolidated income is consistent with the
a. economic unit concept.
b. parent company concept.
c. current practice concept.
d. historical cost company concept.

29. The view that only the parent company’s share of the unrealized intercompany profit recognized by the selling affiliate that remains in assets should be eliminated in the preparation of consolidated financial statements is consistent with the
a. economic unit concept.
b. current practice concept.
c. parent company concept.
d. historical cost company concept.

Problems

1-1 Perkins Company is considering the acquisition of Barkley, Inc. To assess the amount it might be willing to pay, Perkins makes the following computations and assumptions.
A. Barkley, Inc. has identifiable assets with a total fair value of $6,000,000 and liabilities of $3,700,000. The assets include office equipment with a fair value approximating book value, buildings with a fair value 25% higher than book value, and land with a fair value 50% higher than book value. The remaining lives of the assets are deemed to be approximately equal to those used by Barkley, Inc.
B. Barkley, Inc.’s pretax incomes for the years 2009 through 2011 were $470,000, $570,000, and $370,000, respectively. Perkins believes that an average of these earnings represents a fair estimate of annual earnings for the indefinite future. However, it may need to consider adjustments for the following items included in pretax earnings:

Depreciation on Buildings (each year) 380,000
Depreciation on Equipment (each year) 30,000
Extraordinary Loss (year 2011) 130,000
Salary Expense (each year) 170,000

C. The normal rate of return on net assets for the industry is 15%.

Required:
A. Assume that Perkins feels that it must earn a 20% return on its investment, and that goodwill is determined by capitalizing excess earnings. Based on these assumptions, calculate a reasonable offering price for Barkley, Inc. Indicate how much of the price consists of goodwill.
B. Assume that Perkins feels that it must earn a 15% return on its investment, but that average excess earnings are to be capitalized for five years only. Based on these assumptions, calculate a reasonable offering price for Barkley, Inc. Indicate how much of the price consists of goodwill.

1-2 Pierce Company is trying to decide whether to acquire Hager Inc. The following balance sheet for Hager Inc. provides information about book values. Estimated market values are also listed, based upon Pierce Company’s appraisals.

Hager Inc. Hager Inc.
Book Values Market Values

Current Assets $ 450,000 $ 450,000
Property, Plant & Equipment (net) 1,140,000 1,300,000
Total Assets $1,590,000 $1,750,000

Total Liabilities $700,000 $700,000
Common Stock, $10 par value 280,000
Retained Earnings 610,000
Total Liabilities and Equities $1,590,000

Pierce Company expects that Hager will earn approximately $290,000 per year in net income over the next five years. This income is higher than the 14% annual return on tangible assets considered to be the industry “norm.”

Required:
A. Compute an estimation of goodwill based on the information above that Pierce might be willing to pay (include in its purchase price), under each of the following additional assumptions:
(1) Pierce is willing to pay for excess earnings for an expected life of 4 years (undiscounted).
(2) Pierce is willing to pay for excess earnings for an expected life of 4 years, which should be capitalized at the industry normal rate of return.
(3) Excess earnings are expected to last indefinitely, but Pierce demands a higher rate of return of 20% because of the risk involved.
B. Determine the amount of goodwill to be recorded on the books if Pierce pays $1,300,000 cash and assumes Hager’s liabilities.

1-3 Pope Company acquired an 80% interest in the common stock of Simon Company for $1,540,000 on July 1, 2011. Simon Company’s stockholders’ equity on that date consisted of:

Common stock $800,000
Other contributed capital 400,000
Retained earnings 330,000

Required:
Compute the total noncontrolling interest to be reported in the consolidated balance sheet assuming the:
(1) parent company concept.
(2) economic unit concept.

1-4 The following balances were taken from the records of S Company:

Common stock (1/1/11 and 12/31/11) $720,000
Retained earnings 1/1/11 $160,000
Net income for 2011 180,000
Dividends declared in 2011 (40,000)
Retained earnings, 12/31/11 300,000
Total stockholders’ equity on 12/31/11 $1,020,000

P Company purchased 75% of S Company’s common stock on January 1, 2011 for $900,000. The difference between implied value and book value is attributable to assets with a remaining useful life on January 1, 2011 of ten years.

Required:

A. Compute the difference between cost/(implied) and book value applying:
1. Parent company theory.
2. Economic unit theory.

B. Assuming the economic unit theory:
1. Compute noncontrolling interest in consolidated income for 2011.
2. Compute noncontrolling interest in net assets on December 31, 2011.

Short Answer

1. Estimating the value of goodwill to be included in an offering price can be done under several alternative methods. The excess earnings approach is frequently used. Identify the steps used in this approach to estimate goodwill.

2. The two alternative views of consolidated financial statements are the parent company concept and the economic entity concept. Briefly explain the differences between the concepts.

Short Answer Questions in Textbook

1. Distinguish between internal and external expansion of a firm.

2. List four advantages of a business combination as compared to internal expansion.

3. What is the primary legal constraint on business combinations? Why does such a constraint exist?

4. Business combinations may be classified into three types based upon the relationships among the combining entities (e.g., combinations with suppliers, customers, competitors, etc.). Identify and define these types.

5. Distinguish among a statutory merger, a statutory consolidation, and a stock acquisition.

6. Define a tender offer and describe its use.

7. When stock is exchanged for stock in a business combination, how is the stock exchange ratio generally expressed?

8. Define some defensive measures used by target firms to avoid a takeover. Are these measures beneficial for shareholders?

9. Explain the potential advantages of a stock acquisition over an asset acquisition.

10. Explain the difference between an accretive and a dilutive acquisition.

11. Describe the difference between the economic entity concept and the parent company concept approaches to the reporting of subsidiary assets and liabilities in the consolidated financial statements on the date of the acquisition.

12. Contrast the consolidated effects of the parent company concept and the economic entity con-cept in terms of:
(a)The treatment of noncontrolling interests.
(b)The elimination of intercompany profits.
(c)The valuation of subsidiary net assets in the consolidated financial statements.
(d)The definition of consolidated net income.

13. Under the economic entity concept, the net as-sets of the subsidiary are included in the consolidated financial statements at the total fair value that is implied by the price paid by the parent company for its controlling interest. What practical or conceptual problems do you see in this approach to valuation?

14. Is the economic entity or the parent concept more consistent with the principles addressed in the FASB’s conceptual framework? Explain your answer.

15. How does the FASB’s conceptual framework influence the development of new standards?

16. What is the difference between net income, or earnings, and comprehensive income?

Business Ethics Questions from the Textbook

From 1999 to 2001, Tyco’s revenue grew approximately24% and it acquired over 700 companies. It was widely rumored that Tyco executives aggressively managed the performance of the companies that they acquired by suggesting that before the acquisition, they should accelerate the payment of liabilities, delay recording the collections of revenue, and increase the estimated amounts in reserve accounts.

1. What effect does each of the three items have on the reported net income of the acquired company before the acquisition and on the reported net income of the combined company in the first year of the acquisition and future years?

2. What effect does each of the three items have on the cash from operations of the acquired company before the acquisition and on the cash from operations of the combined company in the first year of the acquisition and future years?

3. If you are the manager of the acquired company, how do you respond to these suggestions?

4. Assume that all three items can be managed within the rules provided by GAAP but would be regarded by many as pushing the limits of GAAP.Is there an ethical issue? Describe your position as: (A) an accountant for the target company and (B) as an accountant for Tyco.

Chapter 2

Accounting for Business Combinations

Multiple Choice

1. SFAS 141R requires that all business combinations be accounted for using
a. the pooling of interests method.
b. the acquisition method.
c. either the acquisition or the pooling of interests methods.
d. neither the acquisition nor the pooling of interests methods.

2. Under the acquisition method, if the fair values of identifiable net assets exceed the value implied by the purchase Pratt of the acquired company, the excess should be
a. accounted for as goodwill.
b. allocated to reduce current and long-lived assets.
c. allocated to reduce current assets and classify any remainder as an extraordinary gain.
d. allocated to reduce any previously recorded goodwill and classify any remainder as an ordinary gain.

3. In a period in which an impairment loss occurs, SFAS No. 142 requires each of the following note disclosures except
a. a description of the facts and circumstances leading to the impairment.
b. the amount of goodwill by reporting segment.
c. the method of determining the fair value of the reporting unit.
d. the amounts of any adjustments made to impairment estimates from earlier periods, if significant.

4. Once a reporting unit is determined to have a fair value below its carrying value, the goodwill impairment loss is computed by comparing the
a. fair value of the reporting unit and the fair value of the identifiable net assets.
b. carrying value of the goodwill to its implied fair value.
c. fair value of the reporting unit to its carrying amount (goodwill included).
d. carrying value of the reporting unit to the fair value of the identifiable net assets.

5. SFAS 141R requires that the acquirer disclose each of the following for each material business combination except the
a. name and a description of the acquiree.
b. percentage of voting equity instruments acquired.
c. fair value of the consideration transferred.
d. Each of the above is a required disclosure

6. In a leveraged buyout, the portion of the net assets of the new corporation provided by the management group is recorded at
a. appraisal value.
b. book value.
c. fair value.
d. lower of cost or market.

7. When the acquisition price of an acquired firm is less than the fair value of the identifiable net assets, all of the following are recorded at fair value except
a. Assumed liabilities.
b. Current assets.
c. Long-lived assets.
d. Each of the above is recorded at fair value.

8. Under SFAS 141R,
a. both direct and indirect costs are to be capitalized.
b. both direct and indirect costs are to be expensed.
c. direct costs are to be capitalized and indirect costs are to be expensed.
d. indirect costs are to be capitalized and direct costs are to be expensed.

9. A business combination is accounted for properly as an acquisition. Which of the following expenses related to effecting the business combination should enter into the determination of net income of the combined corporation for the period in which the expenses are incurred?

Security Overhead allocated
issue costs to the merger
a. Yes Yes
b. Yes No
c. No Yes
d. No No

10. In a business combination, which of the following costs are assigned to the valuation of the security?

Professional or Security
consulting fees issue costs
a. Yes Yes
b. Yes No
c. No Yes
d. No No

11. Par Company and Sub Company were combined in an acquisition transaction. Par was able to acquire Sub at a bargain Pratt. The sum of the fair values of identifiable assets acquired less the fair value of liabilities assumed exceeded the cost to Par. After eliminating previously recorded goodwill, there was still some “negative goodwill.” Proper accounting treatment by Par is to report the amount as
a. paid-in capital.
b. a deferred credit, which is amortized.
c. an ordinary gain.
d. an extraordinary gain.

12. With an acquisition, direct and indirect expenses are
a. expensed in the period incurred.
b. capitalized and amortized over a discretionary period.
c. considered a part of the total cost of the acquired company.
d. charged to retained earnings when incurred.

13. In a business combination accounted for as an acquisition, how should the excess of fair value of net assets acquired over the consideration paid be treated?
a. Amortized as a credit to income over a period not to exceed forty years.
b. Amortized as a charge to expense over a period not to exceed forty years.
c. Amortized directly to retained earnings over a period not to exceed forty years.
d. Recorded as an ordinary gain.

14. P Corporation issued 10,000 shares of common stock with a fair value of $25 per share for all the outstanding common stock of S Company in a business combination properly accounted for as an acquisition. The fair value of S Company’s net assets on that date was $220,000. P Company also agreed to issue an additional 2,000 shares of common stock with a fair value of $50,000 to the former stockholders of S Company as an earnings contingency. Assuming that the contingency is expected to be met, the $50,000 fair value of the additional shares to be issued should be treated as a(n)
a. decrease in noncurrent liabilities of S Company that were assumed by P Company.
b. decrease in consolidated retained earnings.
c. increase in consolidated goodwill.
d. decrease in consolidated other contributed capital.

15. On February 5, Pryor Corporation paid $1,600,000 for all the issued and outstanding common stock of Shaw, Inc., in a transaction properly accounted for as an acquisition. The book values and fair values of Shaw’s assets and liabilities on February 5 were as follows

Book Value Fair Value
Cash $ 160,000 $ 160,000
Receivables (net) 180,000 180,000
Inventory 315,000 300,000
Plant and equipment (net) 820,000 920,000
Liabilities (350,000) (350,000)
Net assets $1,125,000 $1,210,000

What is the amount of goodwill resulting from the business combination?
a. $-0-.
b. $475,000.
c. $85,000.
d. $390,000.

16. P Company purchased the net assets of S Company for $225,000. On the date of P’s purchase, S Company had no investments in marketable securities and $30,000 (book and fair value) of liabilities. The fair values of S Company’s assets, when acquired, were

Current assets $ 120,000
Noncurrent assets 180,000
Total $300,000

How should the $45,000 difference between the fair value of the net assets acquired ($270,000) and the consideration paid ($225,000) be accounted for by P Company?
a. The noncurrent assets should be recorded at $ 135,000.
b. The $45,000 difference should be credited to retained earnings.
c. The current assets should be recorded at $102,000, and the noncurrent assets should be recorded at $153,000.
d. An ordinary gain of $45,000 should be recorded.
17. If the value implied by the purchase price of an acquired company exceeds the fair values of identifiable net assets, the excess should be
a. allocated to reduce any previously recorded goodwill and classify any remainder as an ordinary gain.
b. allocated to reduce current and long-lived assets.
c. allocated to reduce long-lived assets.
d. accounted for as goodwill.

18. P Co. issued 5,000 shares of its common stock, valued at $200,000, to the former shareholders of S Company two years after S Company was acquired in an all-stock transaction. The additional shares were issued because P Company agreed to issue additional shares of common stock if the average post combination earnings over the next two years exceeded $500,000. P Company will treat the issuance of the additional shares as a (decrease in)
a. consolidated retained earnings.
b. consolidated goodwill.
c. consolidated paid-in capital.
d. non-current liabilities of S Company assumed by P Company.

19. In a business combination in which the total fair value of the identifiable assets acquired over liabilities assumed is greater than the consideration paid, the excess fair value is:
a. classified as an extraordinary gain.
b. allocated first to eliminate any previously recorded goodwill, and any remaining excess over the consideration paid is classified as an ordinary gain.
c. allocated first to reduce proportionately non-current assets then to non-monetary current assets, and any remaining excess over cost is classified as a deferred credit.
d. allocated first to reduce proportionately non-current, depreciable assets to zero, and any remaining excess over cost is classified as a deferred credit.

20. The first step in determining goodwill impairment involves comparing the
a. implied value of a reporting unit to its carrying amount (goodwill excluded).
b. fair value of a reporting unit to its carrying amount (goodwill excluded).
c. implied value of a reporting unit to its carrying amount (goodwill included).
d. fair value of a reporting unit to its carrying amount (goodwill included).

21. If an impairment loss is recorded on previously recognized goodwill due to the transitional goodwill impairment test, the loss should be treated as a(n):
a. loss from a change in accounting principles.
b. extraordinary loss
c. loss from continuing operations.
d. loss from discontinuing operations.

22. P Company acquires all of the voting stock of S Company for $930,000 cash. The book values of S Company’s assets are $800,000, but the fair values are $840,000 because land has a fair value above its book value. Goodwill from the combination is computed as:
a. $130,000.
b. $90,000.
c. $40,000.
d. $0.

23. Under SFAS 141R, what value of the assets and liabilities are reflected in the financial statements on the acquisition date of a business combination?
a. Carrying value
b. Fair value
c. Book value
d. Average value

Use the following information to answer questions 24 & 25.

Pratt Company issued 24,000 shares of its $20 par value common stock for the net assets of Sele Company in business combination under which Sele Company will be merged into Pratt Company. On the date of the combination, Pratt Company common stock had a fair value of $30 per share. Balance sheets for Pratt Company and Sele Company immediately prior to the combination were as follows:

Pratt Sele

Current Assets $1,314,000 $192,000
Plant and Equipment (net) 1,725,000 408,000
Total $3,039,000 $600,000

Liabilities $ 900,000 $150,000
Common Stock, $20 par value 1,650,000 240,000
Other Contributed Capital 218,000 60,000
Retained Earnings 271,000 150,000
Total $3,039,000 $600,000

24. If the business combination is treated as an acquisition and Sele Company’s net assets have a fair value of $686,400, Pratt Company’s balance sheet immediately after the combination will include goodwill of
a. $30,600.
b. $38,400.
c. $33,600.
d. $56,400.

25. If the business combination is treated as an acquisition and the fair value of Sele Company’s current assets is $270,000, its plant and equipment is $726,000, and its liabilities are $168,000, Pratt Company’s financial statements immediately after the combination will include
a. Negative goodwill of $108,000.
b. Plant and equipment of $2,133,000.
c. Plant and equipment of $2,343,000.
d. An ordinary gain of $108,000.

26. On May 1, 2011, the Phil Company paid $1,200,000 for 80% of the outstanding common stock of Sage Corporation in a transaction properly accounted for as an acquisition. The recorded assets and liabilities of Sage Corporation on May 1, 2011, follow:

Cash $100,000
Inventory 200,000
Property & equipment (Net of accumulated depreciation) 800,000
Liabilities (160,000)

On May 1, 2011, it was determined that the inventory of Sage had a fair value of $220,000 and the property and equipment (net) has a fair value of $1,200,000. What is the amount of goodwill resulting from the business combination?
a. $0.
b. $112,000.
c. $140,000.
d. $28,000.

Use the following information to answer questions 27 & 28.

Posch Company issued 12,000 shares of its $20 par value common stock for the net assets of Sato Company in a business combination under which Sato Company will be merged into Posch Company. On the date of the combination, Posch Company common stock had a fair value of $30 per share. Balance sheets for Posch Company and Sato Company immediately prior to the combination were as follows:

Posch Sato

Current Assets $ 657,000 $ 96,000
Plant and Equipment (net) 863,000 204,000
Total $1,520,000 $300,000

Liabilities $ 450,000 $ 75,000
Common Stock, $20 par value 825,000 120,000
Other Contributed Capital 109,000 30,000
Retained Earnings 136,000 75,000
Total $1,520,000 $300,000

27. If the business combination is treated as an acquisition and Sato Company’s net assets have a fair value of $343,200, Posch Company’s balance sheet immediately after the combination will include goodwill of
a. $15,300.
b. $19,200.
c. $16,800.
d. $28,200.

28. If the business combination is treated as an acquisition and the fair value of Sato Company’s current assets is $135,000, its plant and equipment is $363,000, and its liabilities are $84,000, Posch Company’s financial statements immediately after the combination will include
a. Negative goodwill of $54,000.
b. Plant and equipment of $1,226,000.
c. Plant and equipment of $1,172,000.
d. An extraordinary gain of $54,000.

29. Following its acquisition of the net assets of Sandy Company, Potter Company assigned goodwill of $60,000 to one of the reporting divisions. Information for this division follows:

Carrying Amount Fair Value
Cash $ 20,000 $20,000
Inventory 35,000 40,000
Equipment 125,000 160,000
Goodwill 60,000
Accounts Payable 30,000 30,000

Based on the preceding information, what amount of goodwill will be reported for this division if its fair value is determined to be $200,000?
a. $0
b. $60,000
c. $30,000
d. $10,000

30. The fair value of net identifiable assets exclusive of goodwill of a reporting unit of X Company is $300,000. On X Company’s books, the carrying value of this reporting unit’s net assets is $350,000, including $60,000 goodwill. If the fair value of the reporting unit is $335,000, what amount of goodwill impairment will be recognized for this unit?
a. $0
b. $10,000
c. $25,000
d. $35,000

31. The fair value of net identifiable assets of a reporting unit exclusive of goodwill of Y Company is $270,000. The carrying value of the reporting unit’s net assets on Y Company’s books is $320,000, including $50,000 goodwill. If the reported goodwill impairment for the unit is $10,000, what would be the fair value of the reporting unit?
a. $320,000
b. $310,000
c. $270,000
d. $290,000

32. Potter Corporation acquired Sims Company through an exchange of common shares. All of Sims’ assets and liabilities were immediately transferred to Potter. Potter Company’s common stock was trading at $20 per share at the time of exchange. The following selected information is also available:
Potter Company
Before Acquisition After Acquisition
Par value of shares outstanding $200,000 $250,000
Additional Paid in Capital 350,000 550,000

What number of shares was issued at the time of the exchange?
a. 5,000
b. 17,500
c. 12,500
d. 10,000

Problems

2-1 Balance sheet information for Seitz Corporation at January 1, 2011, is summarized as follows:
Current assets $ 920,000 Liabilities $ 1,200,000
Plant assets 1,800,000 Capital stock $10 par 800,000
Retained earnings 720,000
$2,720,000 $ 2,720,000

Seitz’s assets and liabilities are fairly valued except for plant assets that are undervalued by $200,000. On January 2, 2011, Pell Corporation issues 80,000 shares of its $10 par value common stock for all of Seitz’s net assets and Seitz is dissolved. Market quotations for the two stocks on this date are:

Pell common: $28
Seitz common: $19

Pell pays the following fees and costs in connection with the combination:

Finder’s fee $10,000
Costs of registering and issuing stock 5,000
Legal and accounting fees 6,000

Required:
A. Calculate Pell’s investment cost of Seitz Corporation.

B. Calculate any goodwill from the business combination.

2-2 Peterson Corporation purchased the net assets of Scarberry Corporation on January 2, 2011 for $560,000 and also paid $20,000 in direct acquisition costs. Scarberry’s balance sheet on January
1, 2011 was as follows:

Accounts receivable-net $ 180,000 Current liabilities $ 70,000
Inventory 360,000 Long term debt 160,000
Land 40,000 Common stock ($1 par) 20,000
Building-net 60,000 Paid-in capital 430,000
Equipment-net 80,000 Retained earnings 40,000
Total assets $ 720,000 Total liab. & equity $ 720,000

Fair values agree with book values except for inventory, land, and equipment, which have fair values of $400,000, $50,000 and $70,000, respectively. Scarberry has patent rights valued at $20,000.

Required:
A. Prepare Peterson’s general journal entry for the cash purchase of Scarberry’s net assets.

B. Assume Peterson Corporation purchased the net assets of Scarberry Corporation for $500,000 rather than $560,000, prepare the general journal entry.

2-3 Pyle Company acquired the assets (except cash) and assumed the liabilities of Sand Company on January 1, 2011, paying $2,600,000 cash. Immediately prior to the acquisition, Sand Company’s balance sheet was as follows:

BOOK VALUE FAIR VALUE
Accounts receivable (net) $ 240,000 $ 220,000
Inventory 290,000 320,000
Land 960,000 1,508,000
Buildings (net) 1,020,000 1,392,000
Total $2,510,000 $3,440,000

Accounts payable $ 270,000 $ 270,000
Note payable 600,000 600,000
Common stock, $5 par 420,000
Other contributed capital 640,000
Retained earnings 580,000
Total $2,510,000

Pyle Company agreed to pay Sand Company’s former stockholders $200,000 cash in 2012 if post- combination earnings of the combined company reached $1,000,000 during 2011.

Required:
A. Prepare the journal entry necessary for Pyle Company to record the acquisition on January 1, 2011. It is expected that the earnings target is likely to be met.

B. Prepare the journal entry necessary for Pyle Company in 2012 assuming the earnings contingency was not met.

2-4 Condensed balance sheets for Payne Company and Sigle Company on January 1, 2011 are as follows:

Payne Sigle
Current Assets $ 440,000 $200,000
Plant and Equipment (net) 1,080,000 340,000
Total Assets $1,520,000 $540,000

Total Liabilities $ 230,000 $ 80,000
Common Stock, $10 par value 840,000 240,000
Other Contributed Capital 300,000 130,000
Retained Earnings 150,000 90,000
Total Equities $1,520,000 $540,000

On January 1, 2011 the stockholders of Payne and Sigle agreed to a consolidation whereby a new corporation, Lawson Company, would be formed to consolidate Payne and Sigle. Lawson Company issued 70,000 shares of its $20 par value common stock for the net assets of Payne and Sigle. On the date of consolidation, the fair values of Payne’s and Sigle’s current assets and liabilities were equal to their book values. The fair value of plant and equipment for each company was: Payne, $1,270,000; Sigle, $360,000.
An investment banking house estimated that the fair value of Lawson Company’s common stock was $35 per share. Payne will incur $45,000 of direct acquisition costs and $15,000 in stock issue costs.

Required:
Prepare the journal entries to record the consolidation on the books of Lawson Company assuming that the consolidation is accounted for as an acquisition.

2-5 The stockholders’ equities of P Corporation and S Corporation were as follows on January 1, 2011:

P Corp. S Corp.
Common Stock, $1 par $1,000,000 $ 600,000
Other Contributed Capital 2,800,000 1,100,000
Retained Earnings 600,000 340,000
Total Stockholders’ Equity $4,400,000 $2,040,000

On January 2, 2011 P Corp. issued 100,000 of its shares with a market value of $14 per share in exchange for all of S’s shares, and S Corp. was dissolved. P Corp. paid $10,000 to register and issue the new common shares.

Required:
Prepare the stockholders’ equity section of P Corp. balance sheet after the business combination on January 2, 2011.

2-6 The managers of Petty Company own 10,000 of its 100,000 outstanding common shares. Swann Company is formed by the managers of Petty Company to take over Petty Company in a leveraged buyout. The managers contribute their shares in Petty Company and Swann Company then borrows $675,000 to purchase the remaining 90,000 shares of Petty Company for $600,000; the remaining $75,000 is used for working capital. Petty Company is then merged into Swann Company effective January 1, 2011. Data relevant to Petty Company immediately prior to the leveraged buyout follow:

Book Value Fair Value
Current Assets $ 90,000 $ 90,000
Plant Assets 255,000 525,000
Liabilities (45,000) (45,000)
Stockholders’ Equity $300,000 $570,000

Required:
A. Prepare journal entries on Swann Company’s books to reflect the effects of the leveraged buyout.
B. Determine the balance of each of the following immediately after the merger:
1. Current Assets
2. Plant Assets
3. Note Payable
4. Common Stock

2-7 On January 1, 2010, Presley Company acquired the net assets of Sill Company for $1,580,000 cash. The fair value of Sill’s identifiable net assets was $1,310,000 on his date. Presley Company decided to measure goodwill impairment using the present value of future cash flows to estimate the fair value of the reporting unit (Sill). The information for these subsequent years is as follows:

Carrying value of Fair Value
Present value Sill’s Identifiable Sill’s Identifiable
Year of Future Cash Flows Net Assets* Net Assets
2011 $1,400,000 $1,160,000 $1,190,000
2012 $1,400,000 $1,120,000 $1,210,000
* Identifiable net assets do not include goodwill.
Required:
A: For each year determine the amount of goodwill impairment, if any.
B: Prepare the journal entries needed each year to record the goodwill impairment (if any) on Presley’s books.

2-8 The following balance sheets were reported on January 1, 2011, for Piper Company and Sieler Company:

Piper Sieler
Cash $ 150,000 $ 30,000
Inventory 450,000 150,000
Equipment (net) 1,320,000 570,000
Total $1,920,000 $750,000

Total liabilities $ 450,000 $150,000
Common stock, $20 par value 600,000 300,000
Other contributed capital 375,000 105,000
Retained earnings 495,000 195,000
Total $1,920,000 $750,000

Required:
Appraisals reveal that the inventory has a fair value $180,000, and the equipment has a current value of $615,000. The book value and fair value of liabilities are the same. Assuming that Piper Company wishes to acquire Sieler for cash in an asset acquisition, determine the following cutoff amounts:
A. The purchase price above which Piper would record goodwill.
B. The purchase price at which Piper would record a $50,000 gain.
C. The purchase price below which Piper would obtain a “bargain.”
D. The purchase price at which Piper would record $75,000 of goodwill.

Short Answer

1. SFAS No. 142 requires that goodwill impairment be tested annually for each reporting unit. Discuss the necessary steps of the goodwill impairment test.

2. Briefly describe the different treatment under SFAS 141 vs. SFAS 141R for the following issues:
a. Business definition
b. Acquisitions costs
c. In-process R&D
d. Contingent consideration

Short Answer Questions from the Textbook

1. When contingent consideration in an acquisition is based on security prices, how should this contingency be reflected on the acquisition date? If the estimate changes during the measurement period, how is this handled? If the estimate changes after the end of the measurement period, how is this adjustment handled? Why?

2. What are pro forma financial statements? What is their purpose?

3. How would a company determine whether goodwill has been impaired?

4. AOL announced that because of an accounting change (FASB Statements Nos. 141R [ASC 805] and142 [ASC 350]), earnings would be increasing 2002, Veritas Software Corporation’s CFO resigned after claiming to have an MBA from Stanford University. On the other hand, Bausch & Lomb Inc.’s board re-fused the CEO’s offer to resign following a questionable claim to have an MBA. Suppose you have been retained by the board of a company where the CEO has ‘overstated’ credentials. This company has a code of ethics and conduct which over the next 25 years by $5.9 billion a year. What change(s) required by FASB (in SFAS Nos. 141Rand 142) resulted in an increase in AOL’s in-come? Would you expect this increase in earnings to have a positive impact on AOL’s stock price? Why or why not?

Business Ethics Question from Textbook
There have been several recent cases of a CEO or CFO resigning or being ousted for misrepresenting academic credentials. For instance, during February 2006,the CEO of RadioShack resigned by ‘mutual agreement’ for inflating his educational background. During states that the employee should always do “the right thing.”(a) What is the board of directors’ responsibility in such matters?(b) What arguments would you make to ask the CEO to resign? What damage might be caused if the decision is made to retain the current CEO?

Chapter 3

Consolidated Financial Statements—Date of Acquisition

Multiple Choice

1. A majority-owned subsidiary that is in legal reorganization should normally be accounted for using
a. consolidated financial statements.
b. the equity method.
c. the market value method.
d. the cost method.

2. Under the acquisition method, indirect costs relating to acquisitions should be
a. included in the investment cost.
b. expensed as incurred.
c. deducted from other contributed capital.
d. none of these.

3. Eliminating entries are made to cancel the effects of intercompany transactions and are made on the
a. books of the parent company.
b. books of the subsidiary company.
c. workpaper only.
d. books of both the parent company and the subsidiary.

4. One reason a parent company may pay an amount less than the book value of the subsidiary’s stock acquired is
a. an undervaluation of the subsidiary’s assets.
b. the existence of unrecorded goodwill.
c. an overvaluation of the subsidiary’s liabilities.
d. none of these.

5. In a business combination accounted for as an acquisition, registration costs related to common stock issued by the parent company are
a. expensed as incurred.
b. deducted from other contributed capital.
c. included in the investment cost.
d. deducted from the investment cost.

6. On the consolidated balance sheet, consolidated stockholders’ equity is
a. equal to the sum of the parent and subsidiary stockholders’ equity.
b. greater than the parent’s stockholders’ equity.
c. less than the parent’s stockholders’ equity.
d. equal to the parent’s stockholders’ equity.

7. Majority-owned subsidiaries should be excluded from the consolidated statements when
a. control does not rest with the majority owner.
b. the subsidiary operates under governmentally imposed uncertainty.
c. a foreign subsidiary is domiciled in a country with foreign exchange restrictions or controls.
d. any of these circumstances exist.

8. Under the economic entity concept, consolidated financial statements are intended primarily for the benefit of the
a. stockholders of the parent company.
b. creditors of the parent company.
c. minority stockholders.
d. all of the above.

9. Reasons a parent company may pay more than book value for the subsidiary company’s stock include all of the following except
a. the fair value of one of the subsidiary’s assets may exceed its recorded value because of appreciation.
b. the existence of unrecorded goodwill.
c. liabilities may be overvalued.
d. stockholders’ equity may be undervalued.

10. What is the method of presentation required by SFAS 160 of “non-controlling interest” on a consolidated balance sheet?
a. As a deduction from goodwill from consolidation.
b. As a separate item within the long-term liabilities section.
c. As a part of stockholders’ equity.
d. As a separate item between liabilities and stockholders’ equity.

11. Which of the following is a limitation of consolidated financial statements?
a. Consolidated statements provide no benefit for the stockholders and creditors of the parent company.
b. Consolidated statements of highly diversified companies cannot be compared with industry standards.
c. Consolidated statements are beneficial only when the consolidated companies operate within the same industry.
d. Consolidated statements are beneficial only when the consolidated companies operate in different industries.

12. Pine Corp. owns 60% of Sage Corp.’s outstanding common stock. On May 1, 2011, Pine advanced Sage $90,000 in cash, which was still outstanding at December 31, 2011. What portion of this advance should be eliminated in the preparation of the December 31, 2011 consolidated balance sheet?
a. $90,000.
b. $54,000.
c. $36,000.
d. $-0-.

Use the following information for questions 13-15.

On January 1, 2011, Polk Company and Sigler Company had condensed balance sheets as follows:
Polk Sigler
Current assets $ 280,000 $ 80,000
Noncurrent assets _360,000 __160,000
Total assets $ 640,000 $240,000

Current liabilities $ 120,000 $ 40,000
Long-term debt 200,000 -0-
Stockholders’ equity __320,000 200,000
Total liabilities & stockholders’ equity $ 640,000 $240,000
On January 2, 2011 Polk borrowed $240,000 and used the proceeds to purchase 90% of the outstanding common stock of Sigler. This debt is payable in 10 equal annual principal payments, plus interest, starting December 30, 2011. Any difference between book value and the value implied by the purchase price relates to land.

On Polk’s January 2, 2011 consolidated balance sheet,

13. Noncurrent assets should be
a. $520,000.
b. $536,000.
c. $544,000.
d. $586,667.

14. Current liabilities should be
a. $200,000.
b. $184,000.
c. $160,000.
d. $120,000.

15. Noncurrent liabilities should be
a. $440,000.
b. $416,000.
c. $240,000.
d. $216,000.

16. A newly acquired subsidiary has pre-existing goodwill on its books. The parent company’s consolidated balance sheet will:
a. treat the goodwill the same as other intangible assets of the acquired company.
b. will always show the pre-existing goodwill of the subsidiary at its book value.
c. not show any value for the subsidiary’s pre-existing goodwill.
d. do an impairment test to see if any of it has been impaired.

17. The Difference between Implied and Book Value account is:
a. an account necessary for the preparation of consolidated working papers.
b. used in allocating the amounts paid for recorded balance sheet accounts that are different than
their fair values.
c. the excess implied value assigned to goodwill.
d. the unamortized excess that cannot be assigned to any related balance sheet accounts

18. The main evidence of control for purposes of consolidated financial statements involves
a. possessing majority ownership
b. having decision-making ability that is not shared with others.
c. being the sole shareholder
d. having the parent company and the subsidiary participating in the same industry.

19. In which of the following cases would consolidation be inappropriate?
a. The subsidiary is in bankruptcy.
b. Subsidiary’s operations are dissimilar from those of the parent.
c. The parent owns 90 percent of the subsidiary’s common stock, but all of the subsidiary’s nonvoting preferred stock is held by a single investor.
d. Subsidiary is foreign.

20. Princeton Company acquired 75 percent of the common stock of Sheffield Corporation on December 31, 2011. On the date of acquisition, Princeton held land with a book value of $150,000 and a fair value of $300,000; Sheffield held land with a book value of $100,000 and fair value of $500,000. What amount would land be reported in the consolidated balance sheet prepared immediately after the combination?
a. $650,000
b. $500,000
c. $550,000
d. $375,000

Use the following information to answer questions 21 – 23.

On January 1, 2011, Pena Company and Shelby Company had condensed balanced sheets as follows:

Pena Shelby

Current assets $ 210,000 $ 60,000
Noncurrent assets 270,000 120,000
Total assets $480,000 $180,000

Current liabilities $ 90,000 $ 30,000
Long-term debt 150,000 -0-
Stock holders’ equity 240,000 150,000
Total liabilities & stockholders’ equity $ 480,000 $ 180,000

On January 2, 2011 Pena borrowed $180,000 and used the proceeds to purchase 90% of the outstanding common stock of Shelby. This debt is payable in 10 equal annual principal payments, plus interest, starting December 30, 2011. Any difference between book value and the value implied by the purchase price relates to land.

On Pena’s January 2, 2011 consolidated balance sheet,

21. Noncurrent assets should be
a. $390,000.
b. $402,000.
c. $408,000.
d. $440,000.

22. Current liabilities should be
a. $150,000.
b. $138,000.
c. $120,000.
d. $90,000.

23. Noncurrent liabilities should be
a. $330,000.
b. $312,000.
c. $180,000.
d. $162,000.

24. On January 1, 2011, Primer Corporation acquired 80 percent of Sutter Corporation’s voting common stock.
Sutters’s buildings and equipment had a book value of $300,000 and a fair value of $350,000 at the time of
acquisition. At what amount will Sutter’s buildings and equipment will be reported in the consolidated
statements ?
a. $350,000
b. $340,000
c. $280,000
d. $300,000

Problems

3-1 On December 31, 2011, Page Company purchased 80% of the outstanding common stock of Snead Company for cash. At the time of acquisition, Snead Company’s balance sheet was as follows:

Current assets $ 1,680,000
Plant and equipment 1,580,000
Land 280,000
Total assets $3,540,000

Liabilities $ 1,320,000
Common stock, $10 par value 1,440,000
Other contributed capital 700,000
Retained earnings 240,000
Total $3,700,000
Treasury stock at cost, 5,000 shares 160,000
Total equities $3,540,000

Required:

Prepare the elimination entry(s) required for the preparation of a consolidated balance sheet workpaper on December 31, 2011, assuming the purchase price of the stock was $1,670,000. Any difference between the value implied by the purchase price of the investment and the book value of net assets acquired relates to subsidiary land.

3-2 P Company purchased 80% of the outstanding common stock of S Company on January 2, 2011, for $380,000. Balance sheets for P Company and S Company immediately after the stock acquisition were as follows:

P Company S Company
Current assets $ 166,000 $ 96,000
Investment in S Company 380,000 -0-
Plant and equipment (net) 560,000 224,000
Land 40,000 120,000
$1,146,000 $440,000

Current liabilities $ 120,000 $ 44,000
Long-term notes payable -0- 36,000
Common stock 480,000 160,000
Other contributed capital 244,000 64,000
Retained earnings 302,000 136,000
$1,146,000 $440,000

S Company owed P Company $16,000 on open account on the date of acquisition.

Required:

Prepare a consolidated balance sheet for P and S Companies on the date of acquisition. Any difference between the value implied by the purchase price of the investment and the book value of net assets acquired relates to subsidiary land. The book values of S Company’s other assets and liabilities are equal to their fair values.

3-3 P Company acquired 54,000 shares of the common stock of S Company on January 1, 2011, for $950,000 cash. The stockholders’ equity section of S Company’s balance sheet on that date was as follows:

Common stock, $10 par value $600,000
Other contributed capital 80,000
Retained earnings 320,000
Total $1,000,000

On the date of acquisition, S Company owed P Company $10,000 on open account.

Required:
Present, in general journal form, the elimination entries for the preparation of a consolidated balance sheet workpaper on January 1, 2011. The difference between the value implied by the purchase price of the investment and the book value of the net assets acquired relates to subsidiary land.

3-4 On January 2, 2011, Potter Company acquired 90% of the outstanding common stock of Smiley Company for $480,000 cash. Just before the acquisition, the balance sheets of the two companies were as follows:

Potter Smiley
Cash $ 650,000 $ 160,000
Accounts Receivable (net) 360,000 60,000
Inventory 290,000 140,000
Plant and Equipment (net) 970,000 240,000
Land 150,000 80,000
Total Assets $2,420,000 $680,000

Accounts Payable $ 260,000 $ 120,000
Mortgage Payable 180,000 100,000
Common Stock, $2 par value 1,000,000 170,000
Other Contributed Capital 520,000 50,000
Retained Earnings 460,000 240,000
Total Equities $2,420,000 $680,000

The fair values of Smiley’s assets and liabilities are equal to their book values with the exception of land.

Required:

A. Prepare the journal entry necessary to record the purchase of Smiley’s common stock.
B. Prepare a consolidated balance sheet at the date of acquisition.

3-5 P Corporation paid $420,000 for 70% of S Corporation’s $10 par common stock on December 31, 2011, when S Corporation’s stockholders’ equity was made up of $300,000 of Common Stock, $90,000 of Other Contributed Capital and $60,000 of Retained Earnings. S’s identifiable assets and liabilities reflected their fair values on December 31, 2011, except for S’s inventory which was undervalued by $60,000 and their land which was undervalued by $25,000. Balance sheets for P and S immediately after the business combination are presented in the partially completed work-paper below.

Eliminations
P S Debit Credit
Noncontrolling Interest Consolidated Balances
ASSETS
Cash $40,000 $30,000
Accounts
receivable-net 30,000 45,000
Inventories 185,000 165,000
Land 45,000 120,000
Plant assets-
net 480,000 240,000
Investment in
S Corp. 420,000
Difference between implied and book value
Goodwill
Total Assets $1,200,000 $600,000
EQUITIES
Current
liabilities $170,000 $150,000
Capital stock 600,000 300,000
Additional paid-in capital 150,000 90,000
Retained earnings 280,000 60,000
Noncontrolling interest
Total Equities $1,200,000 $600,000

Required:
Complete the consolidated balance sheet workpaper for P Corporation and Subsidiary.

3-6 Prepare in general journal form the workpaper entries to eliminate Porter Company’s investment in Sewell Company in the preparation of a consolidated balance sheet at the date of acquisition for each of the following independent cases:

Sewell Company Equity Balances
Cash Percent of Stock Owned Investment Cost Common Stock Other Contributed Capital Retained Earnings
a. 90 $675,000 $450,000 $180,000 $75,000
b. 80 318,000 620,000 140,000 20,000

Any difference between book value of net assets acquired and the value implied by the purchase price relates to subsidiary property, plant, and equipment except for case (b). In case (b) assume that all book values and fair values are the same.

3-7 On December 31, 2011, Pryor Company purchased a controlling interest in Shelby Company for $1,060,000. The consolidated balance sheet on December 31, 2011 reported noncontrolling interest in Shelby Company of $265,000.

On the date of acquisition, the stockholders’ equity section of Shelby Company’s balance sheet was as follows:

Common stock $520,000
Other contributed capital 380,000
Retained earnings 280,000
Total 1,180,000

Required:

A. Compute the noncontrolling interest percentage on December 31, 2011.
B. Prepare the investment elimination entry made to prepare a consolidated balance sheet workpaper. Any difference between book value and the value implied by the purchase price relates to subsidiary land.

3-8 On January 1, 2011, Primer Company issued 1,500 of its $20 par value common shares with a fair value of $50 per share in exchange for 2,000 outstanding common shares of Swartz Company in a purchase transaction. Registration costs amounted to $1,700 paid in cash. Just prior to the acquisition, the balance sheets of the two companies were as follows:

Primer Swartz

Cash $ 73,000 $13,000
Accounts Receivable (net) 95,000 19,000
Inventory 58,000 25,000
Plant and Equipment (net) 95,000 43,000
Land 26,000 20,000
Total Assets $ 347,000 $ 120,000

Accounts Payable $ 66,000 16,000
Notes Payable 82,000 21,000
Common Stock, $20 par value 100,000 40,000
Other Contributed Capital 60,000 24,000
Retained Earnings 39,000 19,000
Total Liabilities and Equities $ 347,000 $ 120,000

Any differences between the book value of equity and the value implied by the purchase price relates to Land.

Required:
A. Prepare the journal entry on Primer’s books to record the exchange of stock.
B. Prepare a Computation and Allocation Schedule for the Difference between book value and value implied by the purchase price.
C. Calculate the consolidated balance for each of the following accounts as of December 31, 2011:
1. Cash
2. Land
3. Common Stock
4. Other Contributed Capital

Short Answer

1. There are several reasons why a company would acquire a subsidiary’s voting common stock rather than its net assets. Identify at least two advantages to acquiring a controlling interest in the voting stock of another company rather than its assets.

2. A useful first step in the consolidating process is to prepare a Computation and Allocation of Difference (CAD) Schedule. Identify the steps involved in preparing the CAD schedule.

Short Answer Questions from the Textbook

1. What are the advantages of acquiring the majority of the voting stock of another company rather than acquiring all its voting stock?

2. What is the justification for preparing consolidated financial statements when, in fact, it is ap-parent that the consolidated group is not a legal entity?

3. Why is it often necessary to prepare separate financial statements for each legal entity in a consolidated group even though consolidated statements provide a better economic picture of the combined activities?

4. What aspects of control must exist before a subsidiary is consolidated?

5. Why are consolidated work papers used in pre-paring consolidated financial statements?

6. Define noncontrolling (minority) interest. List three methods that might be used for reporting the noncontrolling interest in a consolidated balance sheet, and state which is preferred under the SFAS No. 160[topic 810].

7. Give several reasons why a parent company would be willing to pay more than book value for subsidiary stock acquired.

8. What effect do subsidiary treasury stock holdings have at the time the subsidiary is acquired? How should the treasury stock be treated on consolidated work papers?

9. What effect does a noncontrolling interest have on the amount of intercompany receivables and payables eliminated on a consolidated balance sheet?

10 A.SFAS No. 109and SFAS No. 141R[ASC 740 and805] require that a deferred tax asset or liability be recognized for likely differences between the reported values and tax bases of assets and liabilities recognized in business combinations (for example, in exchanges that are nontaxable to the selling shareholders). Does this decision change the amount of consolidated net income reported in years subsequent to the business combination? Explain.

Business Ethics Question from the Textbook

Part I. You are working on the valuation of accounts receivable, and bad debt reserves for the current year’s annual report. The CFO stops by and asks you to reduce the reserve by enough to increase the current year’s EPS by 2 cents a share. The company’s policy has always been to use the previous year’s actual bad debt percentage adjusted for a specific economic index. The CFO’s suggested change would still be within acceptable GAAP. However, later, you learn that with the increased EPS, the CFO would qualify for a significant bonus. What do you do and why?

Part II. Consider the following: Accounting firm KPMG created tax shelters called BLIPS, FLIP, OPIS, and SOS that were based largely in the Cayman Islands and allowed wealthy clients (there were 186) to create $5 billion in losses, which were then deducted from their income for IRS tax purposes. BLIPS (Bond Linked Issue Premium Structures) had clients borrow from an offshore bank for purposes of purchasing currency. The client would then sell the currency back to the lender for a loss. However, the IRS contends the losses were phony and that there was never any risk to the client in the deals. The IRS has indicted eight former KPMG partners and an outside lawyer alleging that the transactions were shams, illegal methods for avoiding taxes. KPMG has agreed to pay a$456 million fine, no longer to do tax shelters, and to cooperate with the government in its prosecution of the nine individuals involved in the tax shelter scheme. Many argue that the courts have not always held that such tax avoidance schemes show criminal intent because the tax laws permit individuals to minimize taxes. However, the IRS argues that these shelters evidence intent because of the lack of risk.

Question
In this case, the IRS contends that the losses generated by the tax shelters were phony and that the clients never incurred any risk. Do tax avoidance schemes indicate criminal intent if the tax laws permit individuals to minimize taxes? Justify your answer.

Chapter 4

Consolidated Financial Statements after Acquisition

1. An investor adjusts the investment account for the amortization of any difference between cost and book value under the
a. cost method.
b. complete equity method.
c. partial equity method.
d. complete and partial equity methods.

2. Under the partial equity method, the entry to eliminate subsidiary income and dividends includes a debit to
a. Dividend Income.
b. Dividends Declared – S Company.
c. Equity in Subsidiary Income.
d. Retained Earnings – S Company.

3. On the consolidated statement of cash flows, the parent’s acquisition of additional shares of the subsidiary’s stock directly from the subsidiary is reported as
a. an investing activity.
b. a financing activity.
c. an operating activity.
d. none of these.

4. Under the cost method, the workpaper entry to establish reciprocity
a. debits Retained Earnings – S Company.
b. credits Retained Earnings – S Company.
c. debits Retained Earnings – P Company.
d. credits Retained Earnings – P Company.

5. Under the cost method, the investment account is reduced when
a. there is a liquidating dividend.
b. the subsidiary declares a cash dividend.
c. the subsidiary incurs a net loss.
d. none of these.

6. The parent company records its share of a subsidiary’s income by
a. crediting Investment in S Company under the partial equity method.
b. crediting Equity in Subsidiary Income under both the cost and partial equity methods.
c. debiting Equity in Subsidiary Income under the cost method.
d. none of these.

7. In years subsequent to the year of acquisition, an entry to establish reciprocity is made under the
a. complete equity method.
b. cost method.
c. partial equity method.
d. complete and partial equity methods.

8. A parent company received dividends in excess of the parent company’s share of the subsidiary’s earnings subsequent to the date of the investment. How will the parent company’s investment account be affected by those dividends under each of the following accounting methods?

Cost Method Partial Equity Method
a. No effect No effect
b. Decrease No effect
c. No effect Decrease
d. Decrease Decrease

9. P Company purchased 80% of the outstanding common stock of S Company on May 1, 2011, for a cash payment of $1,272,000. S Company’s December 31, 2010 balance sheet reported common stock of $800,000 and retained earnings of $540,000. During the calendar year 2011, S Company earned $840,000 evenly throughout the year and declared a dividend of $300,000 on November 1. What is the amount needed to establish reciprocity under the cost method in the preparation of a consolidated workpaper on December 31, 2012?
a. $208,000
b. $260,000
c. $248,000
d. $432,000

10. P Company purchased 90% of the outstanding common stock of S Company on January 1, 1997. S Company’s stockholders’ equity at various dates was:
1/1/97 1/1/11 12/31/11
Common stock $400,000 $400,000 $400,000
Retained earnings 120,000 380,000 460,000
Total $520,000 $780,000 $860,000

The workpaper entry to establish reciprocity under the cost method in the preparation of a consolidated statements workpaper on December 31, 2011 should include a credit to P Company’s retained earnings of
a. $80,000.
b. $234,000.
c. $260,000.
d. $306,000.

11. Consolidated net income for a parent company and its partially owned subsidiary is best defined as the parent company’s
a. recorded net income.
b. recorded net income plus the subsidiary’s recorded net income.
c. recorded net income plus the its share of the subsidiary’s recorded net income.
d. income from independent operations plus subsidiary’s income resulting from transactions with outside parties.

12. In the preparation of a consolidated statements workpaper, dividend income recognized by a parent company for dividends distributed by its subsidiary is
a. included with parent company income from other sources to constitute consolidated net income.
b. assigned as a component of the noncontrolling interest.
c. allocated proportionately to consolidated net income and the noncontrolling interest.
d. eliminated.

13. In the preparation of a consolidated statement of cash flows using the indirect method of presenting cash flows from operating activities, the amount of the noncontrolling interest in consolidated income is
a. combined with the controlling interest in consolidated net income.
b. deducted from the controlling interest in consolidated net income.
c. reported as a significant noncash investing and financing activity in the notes.
d. reported as a component of cash flows from financing activities.

14. On October 1, 2011, Parr Company acquired for cash all of the voting common stock of Stein Company. The purchase price of Stein’s stock equaled the book value and fair value of Stein’s net assets. The separate net income for each company, excluding Parr’s share of income from Stein was as follows:
Parr Stein
Twelve months ended 12/31/11 $4,500,000 $2,700,000
Three months ended 12/31/11 495,000 450,000

During September, Stein paid $150,000 in dividends to its stockholders. For the year ended December 31, 2011, Parr issued parent company only financial statements. These statements are not considered those of the primary reporting entity. Under the partial equity method, what is the amount of net income reported in Parr’s income statement?
a. $7,200,000.
b. $4,650,000.
c. $4,950,000.
d. $1,800,000.

15. A parent company uses the partial equity method to account for an investment in common stock of its subsidiary. A portion of the dividends received this year were in excess of the parent company’s share of the subsidiary’s earnings subsequent to the date of the investment. The amount of dividend income that should be reported in the parent company’s separate income statement should be
a. zero.
b. the total amount of dividends received this year.
c. the portion of the dividends received this year that were in excess of the parent’s share of subsidiary’s earnings subsequent to the date of investment.
d. the portion of the dividends received this year that were NOT in excess of the parent’s share of subsidiary’s earnings subsequent to the date of investment.

16. Masters, Inc. owns 40% of Fields Corporation. During the year, Fields had net earnings of $200,000 and paid dividends of $50,000. Masters used the cost method of accounting. What effect would this have on the investment account, net earnings, and retained earnings, respectively?
a. understate, overstate, overstate.
b. overstate, understate, understate
c. overstate, overstate, overstate
d. understate, understate, understate

Use the following information in answering questions 17 and 18.

17. Prior Industries acquired a 70 percent interest in Stevenson Company by purchasing 14,000 of its 20,000 outstanding shares of common stock at book value of $210,000 on January 1, 2010. Stevenson reported net income in 2010 of $90,000 and in 2011 of $120,000 earned evenly throughout the respective years. Prior received $24,000 dividends from Stevenson in 2010 and $36,000 in 2011. Prior uses the equity method to record its investment.

Prior should record investment income from Stevenson during 2011 of:
a. $36,000
b. $120,000
c. $84,000
d. $48,000

18. The balance of Prior’s Investment in Stevenson account at December 31, 2011 is:
a. $210,000
b. $285,000
c. $297,000
d. $315,000

19. Parkview Company acquired a 90% interest in Sutherland Company on December 31, 2010, for $320,000. During 2011 Sutherland had a net income of $22,000 and paid a cash dividend of $7,000. Applying the cost method would give a debit balance in the Investment in Stock of Sutherland Company account at the end of 2011 of:
a. $335,000
b. $333,500
c. $313,700
d. $320,000

20. Hall, Inc., owns 40% of the outstanding stock of Gloom Company. During 2011, Hall received a $4,000 cash dividend from Gloom. What effect did this dividend have on Hall’s 2011 financial statements?
a. Increased total assets.
b. Decreased total assets.
c. Increased income.
d. Decreased investment account.

21. P Company purchased 80% of the outstanding common stock of S Company on May 1, 2011, for a cash payment of $318,000. S Company’s December 31, 2010 balance sheet reported common stock of $200,000 and retained earnings of $180,000. During the calendar year 2011, S Company earned $210,000 evenly throughout the year and declared a dividend of $75,000 on November 1. What is the amount needed to establish reciprocity under the cost method in the preparation of a consolidated workpaper on December 31, 2011?
a. $52,000
b. $65,000
c. $62,000
d. $108,000

22. P Company purchased 90% of the outstanding common stock of S Company on January 1, 1997. S Company’s stockholders’ equity at various dates was:
1/1/97 1/1/11 12/31/11
Common stock $200,000 $200,000 $200,000
Retained earnings 60,000 190,000 230,000
Total $260,000 $390,000 $430,000

The workpaper entry to establish reciprocity under the cost method in the preparation of a consolidated statements workpaper on December 31, 2011 should include a credit to P Company’s retained earnings of
a. $40,000.
b. $117,000.
c. $130,000.
d. $153,000.

Use the following information in answering questions 23 and 24.

23. Prior Industries acquired an 80 percent interest in Sanderson Company by purchasing 24,000 of its 30,000 outstanding shares of common stock at book value of $105,000 on January 1, 2010. Sanderson reported net income in 2010 of $45,000 and in 2011 of $60,000 earned evenly throughout the respective years. Prior received $12,000 dividends from Sanderson in 2010 and $18,000 in 2011. Prior uses the equity method to record its investment.

Prior should record investment income from Sanderson during 2011 of:
a. $18,000.
b. $60,000.
c. $48,000.
d. $33,600.

24. The balance of Prior’s Investment in Sanderson account at December 31, 2011 is:
a. $105,000.
b. $138,600.
c. $159,000.
d. $165,000.

25. Pendleton Company acquired a 70% interest in Sunflower Company on December 31, 2010, for $380,000. During 2011 Sunflower had a net income of $30,000 and paid a cash dividend of $10,000. Applying the cost method would give a debit balance in the Investment in Stock of Sunflower Company account at the end of 2011 of:
a. $400,000.
b. $394,000.
c. $373,000.
d. $380,000.

Use the following information to answer questions 26 and 27

On January 1, 2011, Rotor Corporation acquired 30 percent of Stator Company’s stock for $150,000. On the acquisition date, Stator reported net assets of $450,000 valued at historical cost and $500,000 stated at fair value. The difference was due to the increased value of buildings with a remaining life of 10 years. During 2011 Stator reported net income of $25,000 and paid dividends of $10,000. Rotor uses the equity method.

26. What will be the balance in the Investment account as of Dec 31, 2011?
a. $150,000
b. $157,500
c. $154,500
d. $153,000

27. What amount of investment income will be reported by Rotor for the year 2011?
a. $7,500
b. $6,000
c. $4,500
d. $25,000

28. On January 1, 2011, Potter Company purchased 25 % of Smith Company’s common stock; no goodwill resulted from the acquisition. Potter Company appropriately carries the investment using the equity method of accounting and the balance in Potter’s investment account was $190,000 on December 31, 2011. Smith reported net income of $120,000 for the year ended December 31, 2011 and paid dividends on its common stock totaling $48,000 during 2011. How much did Potter pay for its 25% interest in Smith?
a. $172,000
b. $202,000
c. $208,000
d. $232,000

Use the following information to answer questions 29 and 30.

29. On January 1, 2011, Paterson Company purchased 40% of Stratton Company’s 30,000 shares of voting common stock for a cash payment of $1,800,000 when 40% of the net book value of Stratton Company was $1,740,000. The payment in excess of the net book value was attributed to depreciable assets with a remaining useful life of six years. As a result of this transaction Paterson has the ability to exercise significant influence over Stratton Company’s operating and financial policies. Stratton’s net income for the ended December 31, 2011 was $600,000. During 2011, Stratton paid $325,000 in dividends to its shareholders. The income reported by Paterson for its investment in Stratton should be:
a. $120,000
b. $130,000
c. $230,000
d. $240,000

30. What is the ending balance in Paterson’s investment account as of December 31, 2011?
a. $1,800,000
b. $1,900,000
c. $1,910,000
d. $2,030,000

Problems

4-1 On January 1, 2011, Price Company purchased an 80% interest in the common stock of Stahl Company for $1,040,000, which was $60,000 greater than the book value of equity acquired. The difference between implied and book value relates to the subsidiary’s land.

The following information is from the consolidated retained earnings section of the consolidated statements workpaper for the year ended December 31, 2011:

STAHL CONSOLIDATED
COMPANY BALANCES
1/01/11 retained earnings $300,000 $1,400,000
Net income 220,000 680,000
Dividends declared (80,000) (140,000)
12/31/11 retained earnings $440,000 $1,940,000

Stahl’s stockholders’ equity includes only common stock and retained earnings.

Required:

A. Prepare the workpaper eliminating entries for a consolidated statements workpaper on December 31, 2011. Price uses the cost method.

B. Compute the total noncontrolling interest to be reported on the consolidated balance sheet on December 31, 2011.

4-2 On October 1, 2011, Packer Company purchased 90% of the common stock of Shipley Company for $290,000. Additional information for both companies for 2011 follows:

PACKER SHIPLEY
Common stock $300,000 $90,000
Other contributed capital 120,000 40,000
Retained Earnings, 1/1 240,000 50,000
Net Income 260,000 160,000
Dividends declared (10/31) 40,000 8,000

Any difference between implied and book value relates to Shipley’s land. Packer uses the cost method to record its investment in Shipley. Shipley Company’s income was earned evenly throughout the year.

Required:

A. Prepare the workpaper entries that would be made on a consolidated statements workpaper on December 31, 2011. Use the full year reporting alternative.

B. Calculate the controlling interest in consolidated net income for 2011.

4-3 On January 1, 2011, Pierce Company purchased 80% of the common stock of Stanley Company for $600,000. At that time, Stanley’s stockholders’ equity consisted of the following:

Common stock $220,000
Other contributed capital 90,000
Retained earnings 320,000

During 2011, Stanley distributed a dividend in the amount of $120,000 and at year-end reported a $320,000 net income. Any difference between implied and book value relates to subsidiary goodwill. Pierce Company uses the equity method to record its investment. No impairment of goodwill is observed in the first year.

Required:

A. Prepare on Pierce Company’s books journal entries to record the investment related activities for 2011.

B. Prepare the workpaper eliminating entries for a workpaper on December 31, 2011.

4-4 Pratt Company purchased 80% of the outstanding common stock of Selby Company on January 2, 2004, for $680,000. The composition of Selby Company’s stockholders’ equity on January 2, 2004, and December 31, 2011, was:
1/2/04 12/31/11
Common stock $540,000 $540,000
Other contributed capital 325,000 325,000
Retained earnings (deficit) (60,000) 295,000
Total stockholders’ equity $805,000 $1,160,000

During 2011, Selby Company earned $210,000 net income and declared a $60,000 dividend. Any difference between implied and book value relates to land. Pratt Company uses the cost method to record its investment in Selby Company.

Required:

A. Prepare any journal entries that Pratt Company would make on its books during 2011 to record the effects of its investment in Selby Company.

B. Prepare, in general journal form, all workpaper entries needed for the preparation of a consolidated statements workpaper on December 31, 2011.

4-5 P Company purchased 90% of the common stock of S Company on January 2, 2011 for $900,000. On that date, S Company’s stockholders’ equity was as follows:

Common stock, $20 par value $400,000
Other contributed capital 100,000
Retained earnings 450,000

During 2011, S Company earned $200,000 and declared a $100,000 dividend. P Company uses the partial equity method to record its investment in S Company. The difference between implied and book value relates to land.

Required:

Prepared, in general journal form, all eliminating entries for the preparation of a consolidated statements workpaper on December 31, 2011.

4-6 Pair Company acquired 80% of the outstanding common stock of Sax Company on January 2, 2010 for $675,000. At that time, Sax’s total stockholders’ equity amounted to $1,000,000. Sax Company reported net income and dividends for the last two years as follows:

2010 2011
Reported net income $45,000 $60,000
Dividends distributed 35,000 75,000

Required:

Prepare journal entries for Pair Company for 2010 and 2011 assuming Pair uses:
A. The cost method to record its investment
B. The complete equity method to record its investment. The difference between implied value and the book value of equity acquired was attributed solely to a building, with a 20-year expected life.

4-7 Pell Company purchased 90% of the stock of Silk Company on January 1, 2007, for $1,860,000, an amount equal to $60,000 in excess of the book value of equity acquired. All book values were equal to fair values at the time of purchase (i.e., any excess payment relates to subsidiary goodwill). On the date of purchase, Silk Company’s retained earnings balance was $200,000. The remainder of the stockholders’ equity consists of no-par common stock. During 2011, Silk Company declared dividends in the amount of $40,000, and reported net income of $160,000. The retained earnings balance of Silk Company on December 31, 2010 was $640,000. Pell Company uses the cost method to record its investment. No impairment of goodwill was recognized between the date of acquisition and December 31, 2011.

Required:

Prepare in general journal form the workpaper entries that would be made in the preparation of a consolidated statements workpaper on December 31, 2011.

4-8 On January 1, 2011, Pitt Company purchased 85% of the outstanding common stock of Small Company for $525,000. On that date, Small Company’s stockholders’ equity consisted of common stock, $150,000; other contributed capital, $60,000; and retained earnings, $210,000. Pitt Company paid more than the book value of net assets acquired because the recorded cost of Small Company’s land was significantly less than its fair value.

During 2011 Small Company earned $222,000 and declared and paid a $75,000 dividend. Pitt Company used the partial equity method to record its investment in Small Company.

Required:

A. Prepare the investment related entries on Pitt Company’s books for 2011.

B. Prepare the workpaper eliminating entries for a workpaper on December 31, 2011.

4-9

Picture Company purchased 40% of Stuffy Corporation on January 1, 2011 for $150,000. Stuffy Corporation’s balance sheet at the time of acquisition was as follows:

Cash $30,000 Current Liabilities $40,000
Accounts Receivable 120,000 Bonds Payable 200,000
Inventory 80,000 Common Stock 200,000
Land 150,000 Additional Paid in Capital 40,000
Buildings & Equipment 300,000 Retained Earnings 80,000
Less: Acc. Depreciation (120,000)

Total Assets $560,000
Total Liabilities and Equities $560,000

During 2011, Stuffy Corporation reported net income of $30,000 and paid dividends of $9,000. The fair values of Stuffy’s assets and liabilities were equal to their book values at the date of acquisition, with the exception of Building and Equipment, which had a fair value of $35,000 above book value. All buildings and equipment had a remaining useful life of five years at the time of the acquisition. The amount attributed to goodwill as a result of the acquisition in not impaired.

Required:

A. What amount of investment income will Picture record during 2011 under the equity method of accounting?

B. What amount of income will Picture record during 2011 under the cost method of accounting?

C. What will be the balance in the investment account on December 31, 2011 under the cost and equity method of accounting?

Short Answer

1. There are three levels of influence or control by an investor over an investee, which determine the appropriate accounting treatment. Identify and briefly describe the three levels and their accounting treatment.

2. Two methods are available to account for interim acquisitions of a subsidiary’s stock at the end of the first year. Describe the two methods of accounting for interim acquisitions.

Short Answer Questions from the Textbook

1. How should nonconsolidated subsidiaries be re-ported in consolidated financial statements?

2. How are liquidating dividends treated on the books of an investor, assuming the investor uses the cost method? Assuming the investor uses the equity method?

3. How are dividends declared and paid by a subsidiary during the year eliminated in the consolidated work papers under each method of ac-counting for investments?

4. How is the income reported by the subsidiary reflected on the books of the investor under each of the methods of accounting for investments?

5. Define: Consolidated net income; consolidated retained earnings.

6. At the date of an 80% acquisition, a subsidiary had common stock of $100,000 and retained earnings of $16,250. Seven years later, at December 31, 2010, the subsidiary’s retained earnings had increased to $461,430. What adjustment will be made on the consolidated work paper at December 31, 2011, to recognize the parent’s share of the cumulative undistributed profits (losses)of its subsidiary? Under which method(s) is this adjustment needed? Why?

7. On a consolidated work paper for a parent and its partially owned subsidiary, the noncontrolling interest column accumulates the non controlling interests’ share of several account balances. What are these accounts?

8. If a parent company elects to use the partial equity method rather than the cost method to record its investments in subsidiaries, what effect will this choice have on the consolidated financial statements? If the parent company elects the complete equity method?

9. Describe two methods for treating the preacquisition revenue and expense items of a subsidiary purchased during a fiscal period.

10. A principal limitation of consolidated financial statements is their lack of separate financial in-formation about the assets, liabilities, revenues, and expenses of the individual companies included in the consolidation. Identify some problems that the reader of consolidated financial statements would encounter as a result of this limitation.

11. In the preparation of a consolidated statement of cash flows, what adjustments are necessary because of the existence of a noncontrolling interest? (AICPA adapted)

12. What do potential voting rights refer to, and how do they affect the application of the equity method for investments under IFRS? Under U.S.GAAP? What is the term generally used for equity method investments under IFRS?

13B. Is the recognition of a deferred tax asset or deferred tax liability when allocating the difference between book value and the value implied by the purchase price affected by whether or not the affiliates file a consolidated income tax re-turn?

14B. What assumptions must be made about the realization of undistributed subsidiary income when the affiliates file separate income tax returns? Why? (Appendix)

15B. The FASB elected to require that deferred tax effects relating to unrealized intercompany profits be calculated based on the income tax paid by the selling affiliate rather than on the future tax benefit to the purchasing affiliate. Describe circumstances where the amounts calculated under these approaches would be different. (Appendix)

16B. Identify two types of temporary differences that may arise in the consolidated financial statements when the affiliates file separate income tax returns.

Business Ethics Question from the Textbook
On April 5, 2006, the New York State Attorney sued a New York online advertising firm for surreptitiously installing spyware advertising programs on consumers’ computers. The Attorney General claimed that con-sumers believed they were downloading free games or ‘browser’ enhancements. The company claimed that the spyware was identified as ‘advertising-supported’ and that the software is easy to remove and doesn’t collect personal data. Is there an ethical issue for the company? Comment on and justify your position.

Chapter 6

Elimination of Unrealized Profit on Intercompany Sales of Inventory

Multiple Choice

1. Sales from one subsidiary to another are called
a. downstream sales.
b. upstream sales.
c. intersubsidiary sales.
d. horizontal sales.

2. Noncontrolling interest in consolidated income is never affected by
a. upstream sales.
b. downstream sales.
c. horizontal sales.
d. Noncontrolling interest is affected by all sales.

3. Failure to eliminate intercompany sales would result in an overstatement of consolidated
a. net income.
b. gross profit.
c. cost of sales.
d. all of these.

4. Pratt Company owns 80% of Storey Company’s common stock. During 2011, Storey sold $400,000 of merchandise to Pratt. At December 31, 2011, one-fourth of the merchandise remained in Pratt’s inventory. In 2011, gross profit percentages were 25% for Pratt and 30% for Storey. The amount of unrealized intercompany profit that should be eliminated in the consolidated statements is
a. $80,000.
b. $24,000.
c. $30,000.
d. $25,000.

5. The noncontrolling interest’s share of the selling affiliate’s profit on intercompany sales is considered to be realized under
a. partial elimination.
b. total elimination.
c. 100% elimination.
d. both total and 100% elimination.

6. The workpaper entry in the year of sale to eliminate unrealized intercompany profit in ending inventory includes a
a. credit to Ending Inventory (Cost of Sales).
b. credit to Sales.
c. debit to Ending Inventory (Cost of Sales).
d. debit to Inventory – Balance Sheet.

7. Perez Company acquired an 80% interest in Seaman Company in 2010. In 2011 and 2012, Sutton reported net income of $400,000 and $480,000, respectively. During 2011, Seaman sold $80,000 of merchandise to Perez for a $20,000 profit. Perez sold the merchandise to outsiders during 2012 for $140,000. For consolidation purposes, what is the noncontrolling interest’s share of Seaman’s 2011 and 2012 net income?
a. $90,000 and $96,000.
b. $100,000 and $76,000.
c. $84,000 and $92,000.
d. $76,000 and $100,000.

8. A 90% owned subsidiary sold merchandise at a profit to its parent company near the end of 2010. Under the partial equity method, the workpaper entry in 2011 to recognize the intercompany profit in beginning inventory realized during 2011 includes a debit to
a. Retained Earnings – P.
b. Noncontrolling interest.
c. Cost of Sales.
d. both Retained Earnings – P and Noncontrolling Interest.

9. The noncontrolling interest in consolidated income when the selling affiliate is an 80% owned subsidiary is calculated by multiplying the noncontrolling minority ownership percentage by the subsidiary’s reported net income
a. plus unrealized profit in ending inventory less unrealized profit in beginning inventory.
b. plus realized profit in ending inventory less realized profit in beginning inventory.
c. less unrealized profit in ending inventory plus realized profit in beginning inventory.
d. less realized profit in ending inventory plus realized profit in beginning inventory.

10. In determining controlling interest in consolidated income in the consolidated financial statements, unrealized intercompany profit on inventory acquired by a parent from its subsidiary should:
a. not be eliminated.
b. be eliminated in full.
c. be eliminated to the extent of the parent company’s controlling interest in the subsidiary.
d. be eliminated to the extent of the noncontrolling interest in the subsidiary.

11. P Company sold merchandise costing $240,000 to S Company (90% owned) for $300,000. At the end of the current year, one-third of the merchandise remains in S Company’s inventory. Applying the lower-of- cost-or-market rule, S Company wrote this inventory down to $92,000. What amount of intercompany profit should be eliminated on the consolidated statements workpaper?
a. $20,000.
b. $18,000.
c. $12,000.
d. $10,800.

12. The material sale of inventory items by a parent company to an affiliated company:
a. enters the consolidated revenue computation only if the transfer was the result of arm’s length bargaining.
b. affects consolidated net income under a periodic inventory system but not under a perpetual inventory system.
c. does not result in consolidated income until the merchandise is sold to outside parties.
d. does not require a working paper adjustment if the merchandise was transferred at cost.

13. A parent company regularly sells merchandise to its 80%-owned subsidiary. Which of the following statements describes the computation of noncontrolling interest income?
a. the subsidiary’s net income times 20%.
b. (the subsidiary’s net income x 20%) + unrealized profits in the beginning inventory – unrealized profits in the ending inventory.
c. (the subsidiary’s net income + unrealized profits in the beginning inventory – unrealized profits in the ending inventory) × 20%.
d. (the subsidiary’s net income + unrealized profits in the ending inventory – unrealized profits in the beginning inventory) × 20%.

14. P Corporation acquired a 60% interest in S Corporation on January 1, 2011, at book value equal to fair value. During 2011, P sold merchandise that cost $135,000 to S for $189,000. One-third of this merchandise remained in S’s inventory at December 31, 2011. S reported net income of $120,000 for 2011. P’s income from S for 2011 is:
a. $36,000.
b. $50,400.
c. $54,000.
d. $61,200.

Use the following information for Questions 15 & 16:

P Company regularly sells merchandise to its 80%-owned subsidiary, S Corporation. In 2010, P sold merchandise that cost $240,000 to S for $300,000. Half of this merchandise remained in S’s December 31, 2010 inventory. During 2011, P sold merchandise that cost $375,000 to S for $468,000. Forty percent of this merchandise inventory remained in S’s December 31, 2011 inventory. Selected income statement information for the two affiliates for the year 2011 is as follows:

P _ S _
Sales Revenue $2,250,000 $1,125,000
Cost of Goods Sold 1,800,000 937,500
Gross profit $450,000 $187,500

15. Consolidated sales revenue for P and Subsidiary for 2011 are:
a. $2,907,000.
b. $3,000,000.
c. $3,205,500.
d. $3,375,000.

16. Consolidated cost of goods sold for P Company and Subsidiary for 2011 are:
a. $2,260,500.
b. $2,268,000.
c. $2,276,700.
d. $2,737,500.

Use the following information for Questions 17 & 18:

P Company owns an 80% interest in S Company. During 2011, S sells merchandise to P for $200,000 at a profit of $40,000. On December 31, 2011, 50% of this merchandise is included in P’s inventory. Income statements for P and S are summarized below:

P __ S __
Sales $1,200,000 $600,000
Cost of Sales (600,000) (400,000)
Operating Expenses (300,000) ( 80,000)
Net Income (2011) $300,000 $120,000

17. Controlling interest in consolidated net income for 2011 is:
a. $300,000.
b. $380,000.
c. $396,000.
d. $420,000.

18. Noncontrolling interest in income for 2011 is:
a. $4,000.
b. $19,200.
c. $20,000.
d. $24,000.

19. The amount of intercompany profit eliminated is the same under total elimination and partial elimination in the case of
1. upstream sales where the selling affiliate is a less than wholly owned subsidiary.
2. all downstream sales.
3. horizontal sales where the selling affiliate is a wholly owned subsidiary.
a. 1.
b. 2.
c. 3.
d. both 2 and 3.

20. Paige, Inc. owns 80% of Sigler, Inc. During 2011, Paige sold goods with a 40% gross profit to Sigler. Sigler sold all of these goods in 2011. For 2011 consolidated financial statements, how should the summation of Paige and Sigler income statement items be adjusted?
a. Sales and cost of goods sold should be reduced by the intercompany sales.
b. Sales and cost of goods sold should be reduced by 80% of the intercompany sales.
c. Net income should be reduced by 80% of the gross profit on intercompany sales.
d. No adjustment is necessary.

21. P Corporation acquired a 60% interest in S Corporation on January 1, 2011, at book value equal to fair value. During 2011, P sold merchandise that cost $225,000 to S for $315,000. One-third of this merchandise remained in S’s inventory at December 31, 2011. S reported net income of $200,000 for 2011. P’s income from S for 2011 is:
a. $60,000.
b. $90,000.
c. $120,000.
d. $102,000.

Use the following information for Questions 22 & 23:

P Company regularly sells merchandise to its 80%-owned subsidiary, S Corporation. In 2010, P sold merchandise that cost $192,000 to S for $240,000. Half of this merchandise remained in S’s December 31, 2010 inventory. During 2011, P sold merchandise that cost $300,000 to S for $375,000. Forty percent of this merchandise inventory remained in S’s December 31, 2011 inventory. Selected income statement information for the two affiliates for the year 2011 is as follows:

P _ S _
Sales Revenue $1,800,000 $900,000
Cost of Goods Sold 1,440,000 750,000
Gross profit $ 360,000 $150,000

22. Consolidated sales revenue for P and Subsidiary for 2011 are:
a. $2,325,000.
b. $2,400,000.
c. $2,565,000.
d. $2,700,000.

23. Consolidated cost of goods sold for P Company and Subsidiary for 2011 are:
a. $1,809,000.
b. $1,815,000.
c. $1,821,000.
d. $2,190,000.

Use the following information for Questions 24 & 25:

P Company owns an 80% interest in S Company. During 2011, S sells merchandise to P for $150,000 at a profit of $30,000. On December 31, 2011, 50% of this merchandise is included in P’s inventory. Income statements for P and S are summarized below:

P __ S __
Sales $900,000 $450,000
Cost of Sales (450,000) (300,000)
Operating Expenses (225,000) ( 60,000)
Net Income (2011) $225,000 $ 90,000

24. Controlling interest in consolidated net income for 2011 is:
a. $225,000.
b. $285,000.
c. $297,000.
d. $315,000.

25. Noncontrolling interest in income for 2011 is:
a. $3,000.
b. $14,400.
c. $15,000.
d. $18,000.

Problems

6-1 On January 1, 2011, Palmer Company purchased a 90% interest in Sauder Company for $2,800,000. At that time, Sauder had $1,840,000 of common stock and $360,000 of retained earnings. The difference between implied and book value was allocated to the following assets of Sauder Company:

Inventory $ 80,000
Plant and equipment (net) 240,000
Goodwill 591,111

The plant and equipment had a 10-year remaining useful life on January 1, 2011.

During 2011, Palmer sold merchandise to Sauder at a 20% markup above cost. At December 31, 2011, Sauder still had $180,000 of merchandise in its inventory that it had purchased from Palmer. In 2011, Palmer reported net income from independent operations of $1,600,000, while Sauder reported net income of $600,000.

Required:
A. Prepare the workpaper entry to allocate, amortize, and depreciate the difference between implied and book value for 2011.

B. Calculate controlling interest in consolidated net income for 2011.

6-2 Percy Company owns 80% of the common stock of Smyth Company. Percy sells merchandise to Smyth at 20% above cost. During 2011 and 2012, intercompany sales amounted to $1,080,000 and $1,200,000 respectively. At the end of 2011, Smyth had one-fifth of the goods purchased that year from Percy in its ending inventory. Smyth’s 2012 ending inventory contained one-fourth of that year’s purchases from Percy. There were no intercompany sales prior to 2011.

Percy reported net income from its own operations of $720,000 in 2011 and $760,000 in 2012. Smyth reported net income of $400,000 in 2011 and $460,000 in 2012. Neither company declared dividends in either year.

Required:

A. Prepare in general journal form all entries necessary on the consolidated statements workpapers to eliminate the effects of the intercompany sales for both 2011 and 2012.

B. Calculate controlling interest in consolidated net income for 2012.

6-3 Payton Company owns 90% of the common stock of Sanders Company. Sanders Company sells merchandise to Payton Company at 25% above cost. During 2010 and 2011 such sales amounted to $800,000 and $1,020,000, respectively. At the end of each year, Payton Company had in its inventory one-fourth of the amount of goods purchased from Sanders Company during that year. Payton Company reported income of $1,500,000 from its independent operations in 2010 and $1,720,000 in 2011. Sanders Company reported net income of $600,000 in each year and did not declare any dividends in either year. There were no intercompany sales prior to 2010.

Required:
A. Prepare, in general journal form, all entries necessary on the 2011 consolidated statements workpaper to eliminate the effects of intercompany sales.

B. Calculate the amount of noncontrolling interest to be deducted from consolidated income in the consolidated income statement in 2011.

C. Calculate controlling interest in consolidated net income for 2011.

6-4 Powers Company owns an 80% interest in Smiley Company and a 90% interest in Toro Company. During 2010 and 2011, intercompany sales of merchandise were made by all three companies. Total sales amounted to $2,400,000 in 2010, and $2,700,000 in 2011. The companies sold their merchandise at the following percentages above cost.
Powers 15%
Smiley 20%
Toro 25%

The amount of merchandise remaining in the 2011 beginning and ending inventories of the companies from these intercompany sales is shown below.

Merchandise Remaining in Beginning Inventory
Powers Smiley Toro Total
Sold by
Powers $225,000 $189,000 $414,000
Smiley $180,000 216,000 396,000
Toro 180,000 135,000 315,000

Merchandise Remaining in Ending Inventory
Powers Smiley Toro Total
Sold by
Powers $207,000 $138,000 $345,000
Smiley $144,000 198,000 342,000
Toro 195,000 150,000 345,000

Reported net incomes (from independent operations including sales to affiliates) of Powers, Smiley, and Toro for 2011 were $3,600,000, $1,500,000, and $2,400,000, respectively.

Required:
A. Calculate the amount noncontrolling interest to be deducted from consolidated income in the consolidated income statement for 2011.

B. Calculate the controlling interest in consolidated net income for 2011.

6-5 The following balances were taken from the records of S Company:
Common stock $2,500,000
Retained earnings, 1/1/11 $1,450,000
Net income for 2011 3,000,000
Dividends declared in 2011 (1,550,000)
Retained earnings, 12/31/11 2,900,000
Total stockholders’ equity, 12/31/11 $5,400,000

P Company owns 80% of the common stock of S Company. During 2011, P Company purchased merchandise from S Company for $4,000,000. S Company sells merchandise to P Company at cost plus 25% of cost. On December 31, 2011, merchandise purchased from S Company for $1,250,000 remains in the inventory of P Company. On January 1, 2011, P Company’s inventory contained merchandise purchased from S Company for $525,000. The affiliated companies file a consolidated income tax return. There was no difference between the implied value and the book value of net assets acquired.

Required:
A. Prepare all workpaper entries necessitated by the intercompany sales of merchandise.

B. Compute noncontrolling interest in consolidated income for 2011.

C. Compute noncontrolling interest in consolidated net assets on December 31, 2011.

6-6
P Corporation acquired 80% of S Corporation on January 1, 2011 for $240,000 cash when S’s stockholders’ equity consisted of $100,000 of Common Stock and $30,000 of Retained Earnings. The difference between the price paid by P and the underlying equity acquired in S was allocated solely to a patent amortized over 10 years.
P sold merchandise to S during the year in the amount of $30,000. $10,000 worth of inventory is still on hand at the end of the year with an unrealized profit of $4,000. The separate company statements for P and S appear in the first two columns of the partially completed consolidated workpaper.

Required:
Complete the consolidated workpaper for P and S for the year 2011.

P Corporation and Subsidiary
Consolidated Statements Workpaper
P S Eliminations Noncontrolling Consolidated
Corp. Corp. Dr. Cr. Interest Balances
Income Statement
Sales 200,000 150,000
Dividend Income 16,000
Cost of Sales (92,000) (47,000)
Other Expenses (23,000) (40,000)
Noncontrolling Interest in Income
Net Income 101,000 63,000
Retained Earnings Statement
Retained Earnings 1/1 110,000 30,000
Add: Net Income 101,000 63,000
Less: Dividends ( 30,000) (20,000)
Retained Earnings 12/31 181,000 73,000
Balance Sheet
Cash 20,000 19,000
Accounts Receivable-net 120,000 55,000
Inventories 140,000 80,000
Patent
Land 270,000 420,000
Equipment and Buildings-net 600,000 430,000
Investment in S Corporation 240,000
Total Assets 695,000 1,004,000
Equities
Accounts Payable 909,000 831,000
Common Stock 300,000 100,000
Retained Earnings 181,000 73,000
1/1 Noncontrolling Interest in Net Assets
12/31 Noncontrolling Interest in Net Assets
Total Equities 1,390,000 1,004,000
at December 31, 2011

6-7 On January 1, 2011, Porter Company purchased an 80% interest in the capital stock of Shilo Company for $3,400,000. At that time, Shilo Company had common stock of $2,200,000 and retained earnings of $620,000. Porter Company uses the cost method to record its investment in Shilo Company. Differences between the fair value and the book value of the identifiable assets of Shilo Company were as follows:

Fair Value in Excess of Book Value

Equipment $400,000
Land 200,000
Inventory 80,000

The book values of all other assets and liabilities of Shilo Company were equal to their fair values on January 1, 2011. The equipment had a remaining life of five years on January 1, 2011; the inventory was sold in 2011.

Shilo Company’s net income and dividends declared in 2011 were as follows:

Year 2011 Net Income of $400,000; Dividends Declared of $100,000

Required:

Prepare a consolidated statements workpaper for the year ended December 31, 2012 using the partially completed worksheet.

PORTER COMPANY AND SUBSIDIARY
Consolidated Statements Workpaper
For the Year Ended December 31, 2012
Porter Shilo Eliminations Noncontrolling Consolidated
Company Company Dr. Cr. Interest Balances
Income Statement
Sales 4,400,000 1,800,000
Dividend Income 192,000
Total Revenue 4,592,000 1,800,000
Cost of Goods Sold 3,600,000 800,000
Depreciation Expense 160,000 120,000
Other Expenses 240,000 200,000
Total Cost & Expenses 4,000,000 1,120,000
Net/Consolidated Income 592,000 680,000
Noncontrolling Interest in Income
Net Income to Retained Earnings 592,000 680,000
Retained Earnings Statement
1/1 Retained Earnings
Porter Company 2,000,000
Shilo Company 920,000
Net Income from above 592,000 680,000
Dividends Declared
Porter Company (360,000)
Shilo Company (240,000)
12/31 Retained Earnings to
Balance Sheet 2,232,000 1,360,000
Porter Shilo Eliminations Noncontrolling Consolidated
Company Company Dr. Cr. Interest Balances
Balance Sheet
Cash 280,000 260,000
Accounts Receivable 1,040,000 760,000
Inventory 960,000 700,000
Investment in Shilo Company 3,400,000
Difference between Implied and Book Value
Land 1,280,000
Plant and Equipment 1,440,000 1,120,000
Total Assets 7,120,000 4,120,000
Accounts Payable 528,000 440,000
Notes Payable 360,000 120,000
Common Stock:
Porter Company 4,000,000
Shilo Company 2,200,000
Retained Earnings from above 2,232,000 1,360,000
1/1 Noncontrolling Interest in Net Assets
12/31 Noncontrolling Interest in Net Assets
Total Liabilities & Equity 7,120,000 4,120,000
6-8 Pool Company owns a 90% interest in Slater Company. The consolidated income statement drafted by the controller of Pool Company appeared as follows:

Pool Company and Subsidiary
Consolidated Income Statement
for Year Ended December 31, 2011

Sales $13,800,000
Cost of Sales $9,000,000
Operating Expenses 1,800,000 10,800,000
Consolidated Income 3,000,000
Less Noncontrolling Interest in Consolidated Income 190,000
Controlling Interest in Consolidated Net Income $2,810,000

During your audit you discover that intercompany sales transactions were not reflected in the controller’s draft of the consolidated income statement. Information relating to intercompany sales and unrealized intercompany profit is as follows:

Selling Unsold at
Cost Price Year-End
2010 Sales—Slater to Pool $1,500,000 $1,800,000 1/4
2011 Sales—Pool to Slater 900,000 1,350,000 2/5

Required:
Prepare a corrected consolidated income statement for Pool Company and Slocum Company for the year ended December 31, 2011.

Short Answer

1. Past and proposed GAAP agree that unrealized intercompany profit should not be included in consolidated net income or assets. Briefly explain the preferred approach of eliminating intercompany profit.

2. Determination of the noncontrolling interest in consolidated net income differs depending on whether intercompany sales are downstream or upstream. Explain the difference in calculating noncontrolling interest for downstream and upstream sales.

Short Answer Questions from the Textbook

1. Does the elimination of the effects of intercompany sales of merchandise always affect the amount of reported consolidated net income? Explain.

2. Why is the gross profit on intercompany sales, rather than profit after deducting selling and administrative expenses, ordinarily eliminated from consolidated inventory balances?

3. P Company sells inventory costing $100,000 to its subsidiary, S Company, for $150,000. At the end of the current year, one-half of the goods re-mains in S Company’s inventory. Applying the lower of cost or market rule, S Company writes down this inventory to $60,000. What amount of intercompany profit should be eliminated on the consolidated statements workpaper?

4. Are the adjustments to the noncontrolling interest for the effects of intercompany profit eliminations illustrated in this text necessary for fair presentation in accordance with generally accepted accounting principles? Explain.

5. Why are adjustments made to the calculation of the noncontrolling interest for the effects of intercompany profit in upstream but not in down-stream sales?

6. What procedure is used in the consolidated statements workpaper to adjust the noncontrolling interest in consolidated net assets at the be-ginning of the year for the effects of intercompany profits?

7. What is the essential procedural difference between workpaper eliminating entries for unrealized intercompany profit made when the selling affiliate is a less than wholly owned subsidiary and those made when the selling affiliate is the parent company or a wholly owned subsidiary?

8. Define the controlling interest in consolidated net income using the t-account or analytical approach.

9. Why is it important to distinguish between up-stream and downstream sales in the analysis of intercompany profit eliminations?

Chapter 7

Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

Multiple Choice

1. In the year a subsidiary sells land to its parent company at a gain, a workpaper entry is made debiting
1. Retained Earnings – P Company.
2. Retained Earnings – S Company.
3. Gain on Sale of Land.
a. 1
b. 2
c. 3
d. both 1 and 2.

2. In years subsequent to the year a 90% owned subsidiary sells equipment to its parent company at a gain, the noncontrolling interest in consolidated income is computed by multiplying the noncontrolling interest percentage by the subsidiary’s reported net income
a. minus the net amount of unrealized gain on the intercompany sale.
b. plus the net amount of unrealized gain on the intercompany sale.
c. minus intercompany gain considered realized in the current period.
d. plus intercompany gain considered realized in the current period.

3. Company S sells equipment to its parent company (P) at a gain. In years subsequent to the year of the intercompany sale, a workpaper entry is made under the cost method debiting
a. Retained Earnings – P.
b. Noncontrolling interest.
c. Equipment.
d. all of these.

4. Pinick Corp. owns 90% of the outstanding common stock of Shell Company. On December 31, 2011, Shell sold equipment to Pinick for an amount greater than the equipment’s book value but less than its original cost. The equipment should be reported on the December 31, 2011 consolidated balance sheet at
a. Pinick’s original cost less 90% of Shell’s recorded gain.
b. Pinick’s original cost less Shell’s recorded gain.
c. Shell’s original cost.
d. Pinick’s original cost.

5. Pratt Company owns 100% of Sage Corporation. On January 1, 2011 Pratt sold equipment to Sage at a gain. Pratt had owned the equipment for four years and used a ten-year straight-line rate with no residual value. Sage is using an eight-year straight-line rate with no residual value. In the consolidated income statement, Sage’s recorded depreciation expense on the equipment for 2011 will be reduced by
a. 10% of the gain on sale.
b. 12 1/2% of the gain on sale.
c. 80% of the gain on sale.
d. 100% of the gain on sale.

6. Pratt Corporation owns 100% of Stone Company’s common stock. On January 1, 2011, Pratt sold equipment with a book value of $210,000 to Stone for $300,000. Stone is depreciating the equipment over a ten-year life by the straight-line method. The net adjustments to compute 2011 and 2012 consolidated income would be an increase (decrease) of
2011 2012
a. ($90,000) $0
b. ($90,000) $9,000
c. ($81,000) $0
d. ($81,000) $9,000

7. In the year an 80% owned subsidiary sells equipment to its parent company at a gain, the noncontrolling interest in consolidated income is calculated by multiplying the noncontrolling interest percentage by the subsidiary’s reported net income
a. plus the intercompany gain considered realized in the current period.
b. plus the net amount of unrealized gain on the intercompany sale.
c. minus the net amount of unrealized gain on the intercompany sale.
d. minus the intercompany gain considered realized in the current period.

8. The amount of the adjustment to the noncontrolling interest in consolidated net assets is equal to the noncontrolling interest’s percentage of the
a. unrealized intercompany gain at the beginning of the period.
b. unrealized intercompany gain at the end of the period.
c. realized intercompany gain at the beginning of the period.
d. realized intercompany gain at the end of the period.

9. In January 2008, S Company, an 80% owned subsidiary of P Company, sold equipment to P Company for $1,980,000. S Company’s original cost for this equipment was $2,000,000 and had accumulated depreciation of $200,000. P Company continued to depreciate the equipment over its 9 year remaining life using the straight-line method. This equipment was sold to a third party on January 1, 2011 for $1,440,000. What amount of gain should P Company record on its books in 2011?
a. $60,000.
b. $120,000.
c. $240,000.
d. $360,000.

10. In years subsequent to the upstream intercompany sale of nondepreciable assets, the necessary consolidated workpaper entry under the cost method is to debit the
a. Noncontrolling interest and Retained Earnings (Parent) accounts, and credit the nondepreciable asset.
b. Retained Earnings (Parent) account and credit the nondepreciable asset.
c. Nondepreciable asset, and credit the Noncontrolling interest and Investment in Subsidiary accounts.
d. No entries are necessary.

11. When preparing consolidated financial statement workpapers, unrealized intercompany gains, as a result of equipment or inventory sales by affiliates, are allocated proportionately by percent of ownership between parent and subsidiary only when the selling affiliate is
a. the parent and the subsidiary is less than wholly owned.
b. a wholly owned subsidiary.
c. the subsidiary and the subsidiary is less than wholly owned.
d. the parent of a wholly owned subsidiary.

12. Gain or loss resulting from an intercompany sale of equipment between a parent and a subsidiary is
a. recognized in the consolidated statements in the year of the sale.
b. considered to be realized over the remaining useful life of the equipment as an adjustment to depreciation in the consolidated statements.
c. considered to be unrealized in the consolidated statements until the equipment is sold to a third party.
d. amortized over a period not less than 2 years and not greater than 40 years.

13. In 2011, P Company sells land to its 80% owned subsidiary, S Company, at a gain of $50,000. What is the effect of this sale of land on consolidated net income assuming S Company still owns the land at the end of the year?
a. consolidated net income will be the same as if the sale had not occurred.
b. consolidated net income will be $50,000 less than it would had the sale not occurred.
c. consolidated net income will be $40,000 less than it would had the sale not occurred.
d. consolidated net income will be $50,000 greater than it would had the sale not occurred.

14. Several years ago, P Company bought land from S Company, its 80% owned subsidiary, at a gain of $50,000 to S Company. The land is still owned by P Company. The consolidated working papers for this year will require:
a. no entry because the gain happened prior to this year.
b. a credit to land for $50,000.
c. a debit to P’s retained earnings for $50,000.
d. a debit to Noncontrolling interest for $50,000.

15. On January 1, 2010 S Corporation sold equipment that cost $120,000 and had a book value of $48,000 to P Corporation for $60,000. P Corporation owns 100% of S Corporation and the equipment has a 4-year remaining life. What is the effect of the sale on P Corporation’s Equity from Subsidiary Income account for 2011?
a. no effect
b. increase of $12,000.
c. decrease of $12,000.
d. increase of $3,000.

16. P Corporation acquired an 80% interest in S Corporation two years ago at an implied value equal to the book value of S. On January 2, 2011, S sold equipment with a five-year remaining life to P for a gain of $120,000. S reports net income of $600,000 for 2011 and pays dividends of $200,000. P’s Equity from Subsidiary Income for 2011 is:
a. $480,000.
b. $384,000.
c. $403,200.
d. $576,000

17. P Company purchased land from its 80% owned subsidiary at a cost of $100,000 greater than it subsidiary’s book value. Two years later P sold the land to an outside entity for $50,000 more than it’s cost. In its current year consolidated income statement P and its subsidiary should report a gain on the sale of land of:
a. $50,000.
b. $120,000.
c. $130,000.
d. $150,000.

18. On January 1, 2010, P Corporation sold equipment with a 3-year remaining life and a book value of $40,000 to its 70% owned subsidiary for a price of $46,000. In the consolidated workpapers for the year ended December 31, 2011, an elimination entry for this transaction will include a:
a. debit to Equipment for $6,000.
b. debit to Gain on Sale of Equipment for $6,000.
c. credit to Depreciation Expense for $6,000.
d. debit to Accumulated Depreciation for $4,000.

19. Parks Corporation owns 100% of Starr Company’s common stock. On January 1, 2011, Parks sold equipment with a book value of $350,000 to Starr for $500,000. Starr is depreciating the equipment over a ten-year life by the straight-line method. The net adjustments to compute 2011 and 2012 consolidated income would be an increase (decrease) of
2011 2012
a. ($150,000) $0
b. ($150,000) $15,000
c. ($135,000) $0
d. ($135,000) $15,000

20. In January 2008, S Company, an 80% owned subsidiary of P Company, sold equipment to P Company for $990,000. S Company’s original cost for this equipment was $1,000,000 and had accumulated depreciation of $100,000. P Company continued to depreciate the equipment over its 9 year remaining life using the straight-line method. This equipment was sold to a third party on January 1, 2011 for $720,000. What amount of gain should P Company record on its books in 2011?
a. $30,000.
b. $60,000.
c. $120,000.
d. $180,000.

21. P Corporation acquired an 80% interest in S Corporation two years ago at an implied value equal to the book value of S. On January 2, 2011, S sold equipment with a five-year remaining life to P for a gain of $180,000. S reports net income of $900,000 for 2011 and pays dividends of $300,000. P’s Equity from Subsidiary Income for 2011 is:
a. $720,000.
b. $576,000.
c. $604,800.
d. $864,000

22. P Company purchased land from its 80% owned subsidiary at a cost of $30,000 greater than it subsidiary’s book value. Two years later P sold the land to an outside entity for $15,000 more than it’s cost. In its current year consolidated income statement P and its subsidiary should report a gain on the sale of land of:
a. $15,000.
b. $36,000.
c. $39,000.
d. $45,000.

23. On January 1, 2010, P Corporation sold equipment with a 3-year remaining life and a book value of $100,000 to its 70% owned subsidiary for a price of $115,000. In the consolidated workpapers for the year ended December 31, 2011, an elimination entry for this transaction will include a:
a. debit to Equipment for $15,000.
b. debit to Gain on Sale of Equipment for $15,000.
c. credit to Depreciation Expense for $15,000.
d. debit to Accumulated Depreciation for $10,000.
Problems

7-1 Parker Company, a computer manufacturer, owns 90% of the outstanding stock of Santo Company. On January 1, 2011, Parker sold computers to Santo for $500,000. The computers, which are inventory to Parker, had a cost to Parker of $350,000. Santo Company estimated that the computers had a useful life of six years from the date of purchase.

Santo Company reported net income of $310,000, and Parker Company reported net income of $870,000 from its independent operations (including sales to affiliates) for the year ended December 31, 2011.

Required:
A. Prepare in general journal form the workpaper entries necessary because of the intercompany sales in the consolidated statements workpaper for both 2011 and 2012.

B. Calculate controlling interest in consolidated net income for 2011.

7-2 On January 1, 2008, Penny Company purchased a 90% interest in Stein Company for $800,000, the same as the book value on that date. On January 1, 2011, Stein sold new equipment to Penny for $16,000. The equipment cost $11,000 and had a five year estimated life as of January 1, 2011.

During 2012, Penny sold merchandise to Stein at 20% above cost in the amount (selling price) of $126,000. At the end of the year, Stein had one-third of this merchandise in its ending inventory. At the beginning of 2012, Stein had $48,000 of inventory purchased in 2011 from Penny

Required:
A. Prepare all workpaper entries necessary to eliminate the effects of the intercompany sales on the consolidated financial statements for 2012.

B. Calculate the amount of noncontrolling interest to be deducted from consolidated net income in the consolidated income statement for 2012. Stein Company reported $40,000 of net income in 2012.

7-3 Pringle Company owns 104,000 of the 130,000 shares outstanding of Seely Corporation. Seely Corporation sold equipment to Pringle Company on January 1, 2011 for $740,000. The equipment was originally purchased by Seely Corporation on January 1, 2010 for $1,280,000 and at that time its estimated depreciable life was 8 years. The equipment is estimated to have a remaining useful life of four years on January 1, 2011. Both companies use the straight-line method to depreciate equipment. In 2012 Pringle Company reported net income from its independent operations of $3,270,000, and Seely Corporation reported net income of $820,000 and declared dividends of $60,000. Pringle Company uses the cost method to record the investment in Seely Company.

Required:
A. Prepare, in general journal form, the workpaper entries relating to the intercompany sale of equipment that are necessary in the December 31, 2012 consolidated financial statements workpapers.

B. Calculate the amount of noncontrolling interest to be deducted from consolidated net income in the consolidated income statement for 2012.

C. Calculate controlling interest in consolidated net income for 2012.

7-4 P Company bought 60% of the common stock of S Company on January 1, 2011. On January 1, 2011 there was an intercompany sale of equipment at a gain of $63,000. The equipment had an estimated remaining life of six years. Net incomes of the two companies from their own operations (including sales to affiliates) were as follows:
2011 2012
P Company $280,000 $210,000
S Company 70,000 105,000

A. If S Company sold the equipment to P Company, fill in the following matrix:
2011 2012
Noncontrolling interest in consolidated net income

Controlling Interest in Consolidated net income

B. If P Company sold the equipment to S Company, fill in the following matrix:
2011 2012
Noncontrolling interest in consolidated net income

Controlling interest in consolidated net income

7-5 On January 1, 2011, Pinkel Company purchased equipment from its 80%-owned subsidiary for $2,400,000. On the date of the sale, the carrying value of the equipment on the books of the subsidiary company was $1,800,000. The equipment had a remaining useful life of six years on January 2011. On January 1, 2012, Pinkel Company sold the equipment to an outside party for $2,200,000.

Required:
A. Prepare, in general journal form, the entries necessary in 2011 and 2012 on the books of Pinkel Company to account for the purchase and sale of the equipment.

B. Determine the consolidated gain or loss on the sale of the equipment and prepare, in general journal form, the entry necessary on the December 31, 2012 consolidated statements workpaper to properly reflect this gain or loss.

7-6 P Corporation acquired 80% of the outstanding voting stock of S Corporation when the fair values equaled the book values.

On July 1, 2010, P sold land to S for $300,000. The land originally cost P $200,000. S recently resold the land on October 30, 2011 for $350,000.

On October 1, 2011, S Corporation sold equipment to P Corporation for $80,000. S originally paid $100,000 for this equipment and had accumulated depreciation of $40,000 thus far. The equipment has a five-year remaining life.

Required:
A. Complete the consolidated income statement for P Corporation and subsidiary for the year ended December 31, 2011.

P S Elimination Entries
Dr. Cr. Noncontrolling Interest Consolidated Balances
Sales 1,200,000 600,000
Dividend Income from S 80,000
Gain on Sale of
Equipment 20,000
Gain on Sale of Land 50,000
Cost of Sales (800,000) (300,000)
Depreciation Expense (160,000) (80,000)
Other Expenses (200,000) (160,000)
Noncontrolling Interest
in Income
Net Income 120,000 130,000

7-7 Pike Company owns 90% of the outstanding common stock of Sanka Company. On January 1, 2011, Sanka Company sold equipment to Pike Company for $300,000. Sanka Company had purchased the equipment for $450,000 on January 1, 2006 and has been depreciating it over a 10 year life by the straight-line method. The management of Pike Company estimated that the equipment had a remaining life of 5 years on January 1, 2011. In 2011, Pike Company reported $225,000 and Sanka Company reported $150,000 in net income from their independent operations.

Required:
A. Prepare in general journal form the workpaper entries relating to the intercompany sale of equipment that are necessary in the December 31, 2011 and 2012 consolidated statements workpapers. Pike Company uses the cost method to record its investment in Sanka Company.

B. Calculate equity in subsidiary income for 2011 and noncontrolling interest in net income for 2011.

7-8 On January 1, 2010, Peine Company acquired an 80% interest in the common stock of Stine Company on the open market for $3,000,000, the book value at that date.

On January 1, 2011, Peine Company purchased new equipment for $58,000 from Stine Company. The equipment cost $36,000 and had an estimated life of five years as of January 1, 2011.

During 2012, Peine Company had merchandise sales to Stine Company of $400,000; the merchandise was priced at 25% above Peine Company’s cost. Stine Company still owes Peine Company $70,000 on open account and has 20% of this merchandise in inventory at December 31, 2012. At the beginning of 2012, Stine Company had in inventory $100,000 of merchandise purchased in the previous period from Peine Company.

Required:
A. Prepare all workpaper entries necessary to eliminate the effects of the intercompany sales on the consolidated financial statements for the year ended December 31, 2012.

B. Assume that Stine Company reports net income of $160,000 for the year ended December 31, 2012. Calculate the amount of noncontrolling interest to be deducted from consolidated income in the consolidated income statement for the year ended December 31, 2012.

Short Answer

1. When there have been intercompany sales of depreciable property, workpaper entries are necessary to accomplish several financial reporting objectives. Identify three of these financial reporting objectives for depreciable property.

2. An eliminating entry is needed to adjust the consolidated financial statements when the purchasing affiliate sells a depreciable asset that was acquired from another affiliate. Describe the necessary eliminating entry.

Short Answer Questions from the Textbook

1. From a consolidated point of view, when should profit be recognized on intercompany sales of depreciable assets? Nondepreciable assets?

2. In what circumstances might a consolidated gain be recognized on the sale of assets to a nonaffiliate when the selling affiliate recognizes a loss?

3. What is the essential procedural difference between workpaper eliminating entries for un-realized intercompany profit when the selling affiliate is a less than wholly owned subsidiary and such entries when the selling affiliate is the parent company or a wholly owned subsidiary?

4. Define the controlling interest in consolidated net income using the t-account approach.

5. Why is it important to distinguish between up-stream and downstream sales in the analysis of intercompany profit eliminations?

6. In what period and in what manner should profits relating to the intercompany sale of depreciable property and equipment be recognized in the consolidated financial statements?

7. Define consolidated retained earnings using the analytical approach.

Business Ethics Question from the Textbook
Some people believe that the use of executive stock options is directly related to the increased number of earnings restatements. For each of the following items, discuss the potential ethical issues that might be related to earnings management within the firm.
1. Should stock options be expensed on the Income Statement?
2. Should the CEO or CFO be a past employee of the firm’s audit firm?
3. Should the firm’s audit committee be com-posed entirely of outside members and be solely responsible for hiring the firm’s auditors?