Ch04_Test Bank Jeter Advanced Accounting 3rd Edition

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.

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Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd

Edition

4-2

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, 2011?

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.




Chapter 4 Consolidated Financial Statements after Acquisition

4-3

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





Edition

4-4

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





4-5

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.





Edition

4-6

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





4-7

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.





Edition

4-8

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





4-9

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.





Edition

4-10

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?





4-11

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)





Edition

4-12

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.





4-13

ANSWER KEY

Multiple Choice

1. b 8. d 15. a 22. b 29. c

2. c 9. a 16. d 23. c 30. b

3. d 10. b 17. c 24. c

4. d 11. d 18. c 25. d

5. a 12. d 19. d 26. d

6. d 13. a 20. d 27. b

7. b 14. c 21. a 28. a

Problems

4-1 A. Dividend Income (80,000 × .80) 64,000

Dividends Declared – Stahl 64,000

Common Stock – Stahl 925,000*

Retained Earnings, 1/1 – Stahl 300,000

Difference Between Implied and Book Value 75,000**

Investment in Stahl Company 1,040,000

Noncontrolling Interest in Equity 260,000

*[(1,040,000 – 60,000)/.8] – 300,000

**60,000/.8 = 75,000

Land 75,000

Difference Between Implied and Book Value 75,000

B. Noncontrolling Interest:

In 1/1/11 retained earnings 300,000 × .20 $60,000

In 2011 net income 220,000 × .20 44,000

In dividends declared 80,000 × .20 (16,000)

In common stock of Stahl 925,000 × .20 185,000

In difference between implied and book value 75,000 x .20 15,000

Total noncontrolling interest $288,000

4-2 A. Dividend Income (8,000 × .90) 7,200

Dividends Declared – Shipley 7,200

Common Stock - Shipley 90,000

Other Contributed Capital – Shipley 40,000

Retained Earnings 1/1 – Shipley 50,000

Difference between Implied# and Book Value

(290,000/.9 – 300,000*) 22,222

Subsidiary Income Purchased

(160,000 × 9/12) 120,000

Investment in Shipley Company 290,000

Noncontrolling Interest in Equity (.10 x $322,222) 32,222





Edition

4-14

*BV=[90,000 + 40,000 + 50,000 + (160,000 × 9/12)] = $300,000

#Implied Value = Purchase Price/90% = $322,222

Land 22,222


B. Controlling interest in Consolidated Net Income

Packer‟s reported net income $260,000

– dividend income from Shipley 7,200

Packer‟s income from independent operations 252,800

+ Packer‟s share of Shipley‟s net income in 2011

since acquisition (.90 × 40,000) 36,000

Controlling Interest in Consolidated Net Income $288,800

4-3 A. Investment in Stanley Company 600,000

Cash 600,000

Investment in Stanley Company

(.80 × 320,000) 256,000

Equity in Subsidiary Income 256,000

Cash (.80 × 120,000) 96,000

Investment in Stanley Company 96,000

B. Equity in Subsidiary Income 216,000

Dividends Declared – Stanley 96,000


Common Stock – Stanley 220,000

Other Contributed Capital – Stanley 90,000

Retained Earnings 1/1 – Stanley 320,000




Goodwill 120,000


4-4 A. Cash 48,000

Dividend Income (.8 × $60,000) 48,000

B. To Establish Reciprocity

Investment in Selby Company 164,000

1/1 Retained Earnings - Pratt Company 164,000

$295,000 – $210,000 + $60,000 = $145,000 Retained Earnings on 1/1/11

$145,000 + $60,000 (deficit on date of acquisition) = $205,000 increase in retained earnings

from date of acquisition to 1/1/11

Pratt Company‟s share of increase = (.8 × $205,000) = $164,000





4-15

Eliminating Entries

Dividend Income 48,000

Dividends Declared – Selby Company 48,000

Common Stock – Selby 540,000

Other Contributed Capital – Selby 325,000

1/1 Retained Earnings – Selby 145,000

Difference Between Implied and Book Value45,000*

Investment in Selby Company 844,000


Implied Value = $680,000/.80 = $850,000. Diff = $850,000 – $805,000BV.

Land 45,000


4-5 Equity in Subsidiary Income 270,000

Dividends Declared - S Company 90,000

Investment in S Company 180,000

Common Stock – S 400,000

Other Contributed Capital – S 100,000

1/1 Retained Earnings – S 450,000


Investment in S Company 900,000


Land 50,000


4-6

A. 2010

Investment in Sax Company 675,000

Cash 675,000

Cash 28,000

Dividend Income (.8 × $35,000) 28,000

2011

Cash (.8 × $75,000) 60,000

Investment in Sax Company (.8 × $5,000) 4,000


B. 2010


Cash 675,000





Edition

4-16

Cash 28,000



Equity in Subsidiary Income (.8 × $45,000) 36,000

Equity in Subsidiary Income ($75,000*/20) 3,750


* $675,000/.8 – $750,000 = $93,750 write-up of PPE; Parent‟s share = 80%, or $75,000

2011

Cash 60,000



Equity in Subsidiary Income (.8 × $60,000) 48,000



4-7 Workpaper entries 12/31/11

Investment in Silk Company 396,000

Retained Earnings 1/1 - Pell company 396,000

To establish reciprocity (.90 × ($640,000 – $200,000))


Dividends Declared - Silk Company 36,000

Common Stock - Silk Company# 1,800,000

Retained Earnings 1/1/11 - Silk Company 640,000

Difference between Implied and Book Values 66,667

Investment in Silk Company ($1,860,000 + $396,000) 2,256,000

Noncontrolling Interest in Equity ($206,667 + $44,000##) 250,667

#$2,000,000– $200,000

##NCI share of change in R/E = .10($640,000 - $200,000)

Goodwill* 66,667

Difference between Implied and Book Values 66,667

*See computation of difference between implied and book values on following page.





4-17

Computation and Allocation of Difference between Implied and Book Value

Parent Non- Entire

Share Controlling Value

Share

Purchase price and implied value $1,860,000 206,667 2,066,667

Equity at book value 1,800,000* 200,000 2,000,000**

Difference between Implied value and bv 60,000 6,667 66,667

Allocated to undervalued land (60,000) (6,667) (66,667)

Balance -0- -0- -0-

* $1,860,000 – $60,000

** $1,800,000/.9

4-8 A. Investment in Small 525,000

Cash 525,000

Investment in Small ($222,000)(.85) 188,700


Cash ($75,000)(.85) 63,750

Investment in Small 63,750

B. Equity in Subsidiary Income 188,700

Dividends Declared - Small 63,750


Common Stock - Small 150,000

Other Contributed Capital - Small 60,000

Retained Earnings 1/1 - Small 210,000

Difference between Implied and Book Value 197,647



Land 197,647

Difference between Implied and Book Value 197,647

Computation and Allocation of Difference between Implied and Book Value

Parent Non- Entire

Share controlling value

share

Purchase price and implied value $ 525,000 92,647 617,647

Book Value of Equity Acquired 357,000 63,000 420,000

Difference between Implied and Book Value 168,000 29,647 197,647

Adjust Land Upward (168,000) (29,647) (197,647)

Balance -0- -0- -0-





Edition

4-18

4-9 Solution: A. Picture Company 2011 equity-method income: Proportionate share of reported income ($30,000 x .40) $ 12,000 Amortization of differential assigned to: Buildings and equipment [($35,000 x .40) / 5 years] (2,800) Goodwill ($8,000: not impaired) -0- Investment Income $ 9,200

Assignment of differential Purchase price $150,000

Proportionate share of book value of

net assets ($320,000 x .40) (128,000)

Proportionate share of fair value increase in buildings

and equipment ($35,000 x .40) (14,000) Goodwill $ 8,000 B. Dividend income, 2011 ($9,000 x .40) $ 3,600 C. Cost-method account balance (unchanged): $150,000 Equity-method account balance: Balance, January 1, 2011 $150,000 Investment income 9,200 Dividends received (3,600) Balance, December 31, 2011 $155,600

Short Answers

1. The three levels of influence (control) over an investee are (1) no significant influence, (2)

significant influence, and (3) effective control. When an investor has no significant influence over

an investee, the investment is accounted for at fair value with year-end adjustment for market

changes (the cost method). If the investor has significant influence over the investee, the investment

is accounted for under the equity method. In the equity method, the investor adjusts the investment

account for changes in the investee's net assets.

When an investor has effective control over the investee, consolidated financial statements are

prepared. The investor's investment account is eliminated in the consolidated process.





4-19

2.

The two methods of accounting for interim acquisitions are the full-year reporting alternative and

the partial-year reporting alternative. The full-year method includes the subsidiary's revenues and

expenses in the consolidated income statement for the entire year and then makes a deduction at the

bottom of the income statement for the preacquisition earnings.

The partial-year method includes in the consolidated income statement only the subsidiary's revenue

and expense amounts for the period after acquisition. The full-year method is preferred.

Short Answer Questions in Textbook Solutions

1 Nonconsolidated subsidiaries are expected to be relatively rare. In those situations where a subsidiary

is not consolidated, the investment in the subsidiary should be reported in the consolidated statement

of financial position at cost, along with other long-term investments.

2. A liquidating dividend is a return of investment rather than a return on investment. Consequently, the

amount of a liquidating dividend should be credited to the investment account rather than to dividend

income when the cost method is used, whereas regular dividends are recorded as dividend income

under the cost method. If the equity method is used, all dividends are credited to the investment

account.

3. When the parent company uses the cost method, the work paper elimination of intercompany

dividends is made by a debit to Dividend Income and a credit to Dividends Declared. This

elimination prevents the double counting of income since the subsidiary's individual revenue and

expense items are combined with the parent company's in the determination of consolidated net

income. When the parent company uses the equity method, the work paper elimination for

intercompany dividends is made by a debit to the investment account and a credit to Dividends

Declared.

4. When the parent company uses the cost method, dividends received are recorded as dividend income.

When the parent company uses the partial equity method, the parent company recognizes equity

income on its books equal to its ownership percentage times the investee company‟s reported net

income. When the parent company uses the complete equity method, the parent recognizes income

similar to the partial equity method, but adjusts the equity income for additional charges or credits

when the purchase price differs from the fair value of the investee company‟s net assets, and for

intercompany profits (addressed in chapters 6 and 7).

5. Consolidated net income consists of the parent company's net income from independent operations

plus (minus) any income (loss) earned (incurred) by its subsidiaries during the period, adjusted for

any intercompany transactions during the period and for any excess depreciation or amortization

implied by a purchase price in excess of book values.

Consolidated retained earnings consist of the parent company's retained earnings from its

independent operations plus (minus) the parent company's share of the increase (decrease) in its

subsidiaries' retained earnings from the date of acquisition.





Edition

4-20

6. Investment in S Company 356,144

1/1 Retained Earnings, P Company

80% ($461,430 - $16,250)] 356,144

This adjustment recognizes that P Company's share of S Company's undistributed profits from the

date of acquisition to the beginning of the current year is properly a part of beginning-of-year

consolidated retained earnings. It also enhances the elimination of the investment account. This entry

is only needed if the parent company uses the cost method. If the equity method is used, the parent‟s

retained earnings already reflect the undistributed earnings of the subsidiary.

7. The noncontrolling interest column accumulates the noncontrolling stockholders' share of subsidiary

income, less their share of excess depreciation or amortization implied by fair value adjustments

(addressed in detail in chapter 5), dividends (as a reduction), and the beginning noncontrolling

interest in equity carried forward from the previous period.

8. The method used to record the investment on the books of the parent company (cost method, partial

equity method, or complete equity method) has no effect on the consolidated financial statements.

Only the workpaper elimination procedures are affected.

9. The two methods for treating the preacquisition revenue and expense items of a subsidiary purchased

during a fiscal year are (1) including the revenue and expense items of the subsidiary for the entire

period with a deduction at the bottom of the consolidated income statement for the net income earned

prior to acquisition (this is the preferred method), and (2) including in the consolidated income

statement only the subsidiary's revenue earned and expenses incurred subsequent to the date of

purchase.

10. (a) Readers of consolidated financial statements will be unable to evaluate the financial

position and results of operations (neither of which is shown separately from the parent's)

of the subsidiaries.

(b) Because consolidated assets are not generally available to meet the claims of the creditors of a

subsidiary, creditors will have to look to the financial statements of the debtor (subsidiary)

corporation. Similarly, the creditors of the parent company are most interested in only the assets of

the parent company, although large creditors are likely to gain control over or have indirect access

to the assets of subsidiaries in the case of parent company default.

(c) Because consolidated financial statements are a composite, it is impossible to distinguish a

financially weak subsidiary from financially strong ones.

(d) Ratio analyses based on consolidated data are not reliable guides, especially when the related group

produces a conglomerate of unrelated product lines and services.

(e) Consolidated financial statements often do not disclose data about subsidiaries that are not

consolidated.

(f) A reader of consolidated financial statements cannot assume that a certain amount of unrestricted

consolidated retained earnings will be available for dividends. Data on the ability of the individual

subsidiaries to pay dividends are frequently unavailable.





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11. A consolidated statement of cash flows contains two adjustments that result from the existence of a

noncontrolling interest: (1) an adjustment for the noncontrolling interest in net income or loss of the

subsidiary in the determination of net cash flow from operating activities, and (2) subsidiary dividend

payments to the noncontrolling stockholders must be included with parent company dividends paid in

determining cash paid as dividends because the entire amount of the noncontrolling interest in net

income (loss) is added back (deducted) in determining net cash flows from operating activities.

12. Potential voting rights refer to the rights associated with potentially dilutive securities such as

convertible bonds or stocks, or stock options, rights, or warrants that are currently exercisable. These

are considered under international standards in determining the applicability of the equity method for

investments where the investor may be considered to have significant influence. They are generally not

considered under U.S. GAAP. International standards (IFRS) refer to investments that are accounted

for under the equity method as “investments in associates.”

13B. No. The recognition and display of a deferred tax asset or deferred tax liability relating to the

assignment of the difference between implied value and book value is necessary without regard to

whether the affiliates file consolidated income tax returns or separate income tax returns.

14B An assumption must be made as to whether the undistributed income will be realized in a future

dividend distribution or as a result of the sale of the subsidiary. This is necessary because the

calculation of the tax consequences differs depending on the assumption made. Dividend

distributions are subject to a dividends received exclusion, whereas gains or losses on disposal are

not. In addition, gains or losses on disposal may be taxed at different tax rates than dividend

distributions. Although capital gains are currently taxed at the same rates as ordinary income, the

rates have been different in the past and may be again in the future.

15B The amounts calculated under these two approaches would be different (1) if the affiliates had

different marginal tax rates, (2) if the affiliates were in different tax jurisdictions, or (3) when

expected future tax rates differ from the tax rate used in determining the tax paid or accrued by the

selling affiliate.

16B When the affiliates file separate returns, two types of temporary differences may arise:

1. Deferred income tax consequences that arise in the consolidated financial statements because of

undistributed subsidiary income, and

2. Deferred income tax consequences that arise in the consolidated financial statements because of

the elimination of unrealized intercompany profit.

ANSWERS TO BUSINESS ETHICS CASE

Surreptitiously installing spyware on computers can be an unethical practice (the word surreptitious implies

that the customer is unaware of the activity). The programs run in the background and can significantly slow down the computer’s operating performance. Sometimes these programs are used to pass on the consumer browsing history and may leak personal information to the advertising firm.




Documents

Ch04_Test Bank Jeter Advanced Accounting 3rd Edition