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03 Chapter - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential CHAPTER 3 THE REPORTING ENTITY AND CONSOLIDATION OF LESS-THAN-WHOLLY-OWNED SUBSIDIARIES WITH NO DIFFERENTIAL ANSWERS TO QUESTIONS Q3-1 The basic idea underlying the preparation of consolidated financial statements is the notion that the consolidated financial statements present the financial position and the results of operations of a parent and its subsidiaries as if the related companies actually were a single company. Q3-2 Without consolidated statements it is often very difficult for an investor to gain an understanding of the total resources controlled by a company. A consolidated balance sheet provides a much better picture of both the total assets under the control of the parent company and the financing used in providing those resources. Similarly, the consolidated income statement provides a better picture of the total revenue generated and the costs incurred in generating the revenue. Estimates of future profit potential and the ability to meet anticipated funds flows often can be more easily assessed by analyzing the consolidated statements. Q3-3 Parent company shareholders are likely to find consolidated statements more useful. Noncontrolling shareholders may gain some understanding of the basic strength of the overall economic entity by examining the consolidated statements; however, they have no control over the parent company or other subsidiaries and therefore must rely on the assets and earning power of the subsidiary in which they hold ownership. The separate statements of the subsidiary are more likely to provide useful information to the noncontrolling shareholders. Q3-4 A parent company has the ability to exercise control over one or more other entities. Under existing standards, a company is considered to be a parent company when it has direct or indirect control over a majority of the common stock of another company. The FASB has proposed adoption of a broader definition of control that would not be based exclusively on stock ownership. Q3-5 Creditors of the parent company have primary claim to the assets held directly by the parent. Short-term creditors of the parent are likely to look only at those assets. Because the parent has control of the subsidiaries, the assets held by the subsidiaries are potentially available to satisfy parent company debts. Long-term creditors of the parent generally must rely on the soundness and operating efficiency of the overall entity, which normally is best seen by examining the consolidated statements. On the other hand, creditors of a subsidiary typically have a priority claim to the assets of that subsidiary and generally cannot lay claim to the assets of the other companies. Consolidated statements therefore are not particularly useful to them. Q3-6 When one company holds a majority of the voting shares of another company, the investor should have the power to elect a majority of the board of directors of that company and control its actions. Unless the investor holds controlling interest, there is always a chance that another party may acquire a sufficient number of shares to gain control of the company, or that the other shareholders may join together to take control. Q3-7 The primary criterion for consolidation is the ability to directly or indirectly exercise control. Control normally has been based on ownership of a majority of the voting common stock of another company. The Financial Accounting Standards Board is currently working on a broader definition of control. At present, consolidation should occur whenever majority 3-1 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential ownership is held unless other circumstances indicate that control is temporary or does not rest with the parent. Q3-8 Consolidation is not appropriate when control is temporary or when the parent cannot exercise control. For example, if the parent has agreed to sell a subsidiary or plans to reduce its ownership below 50 percent shortly after year-end, the subsidiary should not be consolidated. Control generally cannot be exercised when a subsidiary is under the control of the courts in bankruptcy or reorganization. While most foreign subsidiaries should be consolidated, subsidiaries in countries with unstable governments or those in which there are stringent barriers to funds transfers generally should not be consolidated. Q3-9 Strict adherence to consolidation standards based on majority ownership of voting common stock has made it possible for companies to use many different forms of control over other entities without being forced to include them in their consolidated financial statements. For example, contractual arrangements often have been used to provide control over variable interest entities even though another party may hold a majority (or all) of the equity ownership. Q3-10 Special-purpose entities generally have been created by companies to acquire certain types of financial assets from the companies and hold them to maturity. The special-purpose entity typically purchases the financial assets from the company with money received from issuing some form of collateralized obligation. If the company had borrowed the money directly, its debt ratio would be substantially increased. Q3-11 A variable interest entity normally is not involved in general business activity such as producing products and selling them to customers. They often are used to acquire financial assets from other companies or to borrow money and channel it other companies. A very large portion of the assets held by variable interest entities typically is financed by debt and a small portion financed by equity holders. Contractual agreements often give effective control of the activities of the special-purpose entity to someone other than the equity holders. Q3-12 FIN 46R provides a number of guidelines to be used in determining when a company is a primary beneficiary of a variable interest entity. Generally, the primary beneficiary will absorb a majority of the entitys expected losses or receive a majority of the entitys expected residual returns. Q3-13 Indirect control occurs when the parent controls one or more subsidiaries that, in turn, hold controlling interest in another company. Company A would indirectly control Company Z if Company A held 80 percent ownership of Company M and that company held 70 percent of the ownership of Company Z. Q3-14 It is possible for a company to exercise control over another company without holding a majority of the voting common stock. Contractual agreements, for example, may provide a company with complete control of both the operating and financing decisions of another company. In other cases, ownership of a substantial portion of a company's shares and a broad based ownership of the other shares may give effective control to a company even though it does not have majority ownership. There is no prohibition to consolidation with less than majority ownership; however, few companies have elected to consolidate with less than majority control. Q3-15 Unless intercompany receivables and payables are eliminated, there is an overstatement of the true balances. The result is a distortion of the current asset ratio and other ratios such as those that relate current assets to noncurrent assets or current liabilities to noncurrent liabilities or to stockholders' equity balances. 3-2 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential Q3-16 The consolidated statements are prepared from the viewpoint of the parent company shareholders and only the amounts assignable to parent company shareholders are included in the consolidated stockholders' equity balances. Subsidiary shares held by the parent are not owned by an outside party and therefore cannot be reported as shares outstanding. Those held by the noncontrolling shareholders are included in the balance assigned to noncontrolling shareholders in the consolidated balance sheet rather than being shown as stock outstanding. Q3-17 While it is not considered appropriate to consolidate if the fiscal periods of the parent and subsidiary differ by more than 3 months, a difference in time periods cannot be used as a means of avoiding consolidation. The fiscal period of one of the companies must be adjusted to fall within an acceptable time period and consolidated statement prepared. Q3-18 The noncontrolling interest, or minority interest, represents the claim on the net assets of the subsidiary assigned to the shares not controlled by the parent company. Q3-19 The procedures used in preparing consolidated and combined financial statements may be virtually identical. In general, consolidated statements are prepared when a parent company either directly or indirectly controls one or more subsidiaries. Combined financial statements are prepared for a group of companies or business entities when there is no parent-subsidiary relationship. For example, an individual who controls several companies may gain a clearer picture of the financial position and operating results of the overall operations under his or her control by preparing combined financial statements. Q3-20 Under the proprietary theory the parent company includes only a proportionate share of the assets and liabilities and income statement items of a subsidiary in its financial statements. Thus, if a subsidiary is 60 percent owned, the parent will include only 60 percent of the cash and accounts receivable of the subsidiary in its consolidated balance sheet. Under current practice the full amount of the balance sheet and income statement items of the subsidiary are included in the consolidated statements. Q3-21 Under both current practice and the entity theory the consolidated statements are viewed as those of a single economic entity with a shareholder group that includes both controlling and noncontrolling shareholders, each with an equity interest in the consolidated entity. The assets and liabilities of the subsidiary are included in the consolidated statements at 100 percent of their fair value at the date of acquisition and consolidated net income includes the earnings to both controlling and noncontrolling shareholders. A major difference occurs in presenting retained earnings in the consolidated balance sheet. Only undistributed earnings related to the controlling interest are included in the retained earnings balance. Q3-22 The entity theory is closest to the newly adopted procedures used in current practice. 3-3 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential SOLUTIONS TO CASES C3-1 Computation of Total Asset Values The relationship observed should always be true. Assets reported by the parent company include its investment in the net assets of the subsidiaries. These totals must be eliminated in the consolidation process to avoid double counting. There also may be intercompany receivables and payables between the companies that must be eliminated when consolidated statements are prepared. In addition, inventory or other assets reported by the individual companies may be overstated as a result of unrealized profits on intercorporate purchases and sales. The amounts of the assets must be adjusted and the unrealized profits eliminated in the consolidation process. In addition, subsidiary assets and liabilities at the time the subsidiaries were acquired by the parent may have had fair values different from their book values, and the amounts reported in the consolidated financial statements would be based on those fair values. C3-2 Accounting Entity [AICPA Adapted] a. (1) The conventional or traditional approach has been used to define the accounting entity in terms of a specific firm, enterprise, or economic unit that is separate and apart from the owner or owners and from other enterprises. The accounting entity has not necessarily been defined in the same way as a legal entity. For example, partnerships and sole proprietorships are accounted for separately from the owners although such a distinction might not exist legally. Thus, it was recognized that the transactions of the enterprise should be accounted for and reported on separately from those of the owners. An extension of this approach is to define the accounting entity in terms of an economic unit that controls resources, makes and carries out commitments, and conducts economic activity. In the broadest sense an accounting entity could be established in any situation where there is an input-output relationship. Such an accounting entity may be an individual, a profit-seeking or not-for-profit enterprise, or a subdivision of a profit-seeking or not-forprofit enterprise for which a system of accounts is maintained. This approach is oriented toward providing information to the economic entity which it can use in evaluating its operating results and financial position. An alternative approach is to define the accounting entity in terms of an area of economic interest to a particular individual, group, or institution. The boundaries of such an economic entity would be identified by determining (a) the interested individual, group, or institution and (b) the nature of that individual's, group's, or institution's interest. In theory a number of separate legal entities or economic units could be included in a single accounting entity. Thus, this approach is oriented to the external users of financial reports. (2) The way in which an accounting entity is defined establishes the boundaries of the possible objects, attributes, or activities that will be included in the accounting records and reports. Knowledge as to the nature of the entity may aid in determining (1) what information to include in reports of the entity and (2) how to best present information about the entity so that relevant features are disclosed and irrelevant features do not cloud the presentation. The applicability of all other generally accepted concepts (or principles or postulates) of accounting (for example, continuity, money measurement, and time periods) depends on the established boundaries and nature of the accounting entity. The other accounting concepts lack significance without reference to an entity. The entity must be defined before 3-4 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential the balance of the accounting model can be applied and the accounting can begin. Thus, the accounting entity concept is so fundamental that it pervades all accounting. b. (1) Units created by or under law, such as corporations, partnerships, and, occasionally, sole proprietorships, probably are the most common types of accounting entities. (2) Product lines or other segments of an enterprise, such as a division, department, profit center, branch, or cost center, can be treated as accounting entities. For example, financial reporting by segment was supported by investors, the Securities and Exchange Commission, financial executives, and members of the accounting profession. (3) Most large corporations issue consolidated financial reports. These statements often include the financial statements of a number of separate legal entities that are considered to constitute a single economic entity for financial reporting purposes. (4) Although the accounting entity often is defined in terms of a business enterprise that is separate and distinct from other activities of the owner or owners, it also is possible for an accounting entity to embrace all the activities of an owner or a group of owners. Examples include financial statements for an individual (personal financial statements) and the financial report of a person's estate. (5) The entire economy of the United States also can be viewed as an accounting entity. Consistent with this view, national income accounts are compiled by the U. S. Department of Commerce and regularly reported. 3-5 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential C3-3 Recognition of Fair Value and Goodwill MEMO TO: From: Re: Mr. R. U. Cleer, Chief Financial Officer March Corporation , CPA Analysis of changes resulting from FASB 141R March Corporation purchased 65 percent of the stock of Ember Corporation for $708,500 at a time when the book value of Embers net assets was $810,000 and Marchs 65 percent share of that amount was $526,500. Management determined that the fair value of Embers assets was $960,000, and Marchs 65 percent share of the difference between fair value and book value was $97,500. The remaining amount of the purchase price was allocated to goodwill, computed as follows: Purchase price Book value of 65 percent share of net assets Differential Fair value increment Goodwill $708,500 (526,500) $182,000 (97,500) $ 84,500 The reporting standards in effect at January 2, 2008, required March to include in its consolidated balance sheet 100 percent of the book value of Embers net assets. The consolidated balance sheet also included the amount paid by March in excess of its share of book value, assigned to depreciable assets and goodwill. The noncontrolling interest was reported in the consolidated balance sheet at $283,500 ($810,000 x .35) and did not include any amounts related to the differential. Under FASB Statement No. 141R (ASC 805) , the amounts included in the consolidated balance sheet are based on the $1,090,000 total fair value of Ember at the date of combination, as evidenced by the fair value of the consideration given in the exchange by March Corporation ($708,500) and the fair value of the noncontrolling interest ($381,500). The assets of Ember are valued at their $960,000 total fair value, resulting in a $150,000 increase over their book value. Goodwill is calculated as the difference between the $1,090,000 total fair value of Ember and the $960,000 fair value of its assets. The noncontrolling interest is valued initially at its fair value at the date of combination. The following comparison shows the amounts related to Ember that were reported in Marchs consolidated balance sheet prepared immediately after the acquisition of Ember and the amounts that would have been reported had FASB Statement No. 141R (ASC 805) been in effect: Prior Standards $810,000 97,500 84,500 $992,000 Book value of Embers net assets Fair value increment Goodwill Total Noncontrolling interest $283,500 3-6 FASB 141R $ 810,000 150,000 130,000 $1,090,000 $381,500 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential Amortization of the fair value increment in Marchs 2008 consolidated income statement was $9,750 ($97,500/10). Under FASB Statement No. 141R (ASC 850) , the annual write-off would have been $15,000 ($150,000/10). Primary citations: FASB 141R (ASC 805) C3-4 Joint Venture Investment a. ARB No. 51 (ASC 810) and FASB Interpretation No. 46R (FIN 46R) (ASC 810) are the primary authoritative pronouncements dealing with the types of ownership issues arising in this situation. Under normal circumstances, the company holding majority ownership in another entity is expected to consolidate that entity in preparing its financial statements. Thus, unless other circumstances dictate, Dell should have planned to consolidate DFS as a result of its 70 percent equity ownership. While FIN 46R (ASC 810) is a highly complex document and greater detail of the ownership agreement may be needed to decide this matter, the interpretation appears to permit equity holders to avoid consolidating an entity if the equity holders (1) do not have the ability to make decisions about the entitys activities, (2) are not obligated to absorb the expected losses of the entity if they occur, or (3) do not have the right to receive the expected residual returns of the entity if they occur [FIN 46R, Par. 5b; ASC 810-10-15-14]. It does appear that Dell and CIT Group do, in fact, have the ability to make operating and other decisions about DFS, they must absorb losses in the manner set forth in the agreement, and they must share residual returns in the manner set forth in the agreement. Control appears to reside with the equity holders and should not provide a barrier to consolidation. Dell might argue that it need not consolidate DFS because the joint venture agreement apparently did allocate losses initially to CIT. However, these losses were to be recovered from future income. Thus, both Dell and CIT were to be affected by the profits and losses of DFS. Given the importance of DFS to Dell and representation on the board of directors by CIT, DFS would not be expected to sustain continued losses. In light of the joint venture arrangement and Dells ownership interest, consolidation by Dell seems appropriate and there seems to be little support for Dell not consolidating DFS. b. Yes, Dell does employ off-balance sheet financing. It sells customer financing receivables to qualifying special-purpose entities. In accordance with current standards, qualifying SPEs are not consolidated. 3-7 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential C3-5 Need for Consolidation [AICPA Adapted] a. All identifiable assets acquired and liabilities assumed in a business combination, whether or not shown in the financial statements of Moore, should be valued at their fair values at the date of acquisition. Then, the excess of the fair value of the consideration given by Sharp to acquire its ownership interest in Moore, plus the fair value of the noncontrolling interest, over the sum of the amounts assigned to the identifiable assets acquired less liabilities assumed should be recognized as goodwill. b. Consolidated financial statements should be prepared in order to present the financial position and operating results for an economic entity in a manner more meaningful than if separate statements are prepared. c. The usual first necessary condition for consolidation is a controlling financial interest. Under current accounting standards, a controlling financial interest is assumed to exist when one company, directly or indirectly, owns over fifty percent of the outstanding voting shares of another company. C3-6 What Company is That? Information for answering this case can be obtained from the SEC's EDGAR database (www.sec.gov) and from the home pages for Viacom ( www.viacom.com), ConAgra (www.conagra.com), and Yum! Brands (www.yum.com). a.. Viacom is well known for ownership of companies in the entertainment industry. On January 1, 2006, Viacom divided its operations by spinning off to Viacom shareholders ownership of CBS Corporation. Following the division Viacom continues to own MTV, Nickelodeon, Nick at Nite, Comedy Central, Country Music Television, Paramount Pictures, Paramount Home Entertainment, SKG, BET, Dreamworks, and other related companies. Summer Redstone holds controlling interest in both Viacom and CBS and serves as Executive Chairman of both companies. b. Some of the well-known product lines of ConAgra include Healthy Choice, Pam, Peter Pan, Slim Jim, Swiss Miss, Orville Redenbachers, Hunts, Reddi-Wip, VanCamp, Libbys, LaChoy, Egg Beaters, Wesson, Banquet, Blue Bonnet, Chef Boyardee, Parkay, and Rosarita. c. Yum! Brands, Inc., is the worlds largest quick service restaurant company. Well known brands include Taco Bell, A&W, KFC, and Pizza Hut. Yum was originally spun off from Pepsico in 1997. Prior to its current name, Yums name was TRICON Global Restaurants, Inc. 3-8 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential C3-7 Subsidiaries and Core Businesses Most of the information needed to answer this case can be obtained from articles available in libraries, on the Internet, or through various online databases. Some of the information is available in filings with the SEC (www.sec.gov). a. General Electric was never able to turn Kidder, Peabody into a profitable subsidiary. In fact, Kidder became such a drain on the resources of General Electric, that GE decided to get rid of Kidder. Unfortunately, GE was unable to sell the company as a whole and ultimately broke the company into pieces and sold the pieces that it could. GE suffered large losses from its venture into the brokerage business. b. Sears, Roebuck and Co. has been a major retailer for many decades. For a while, Sears attempted to provide virtually all consumer needs so that customers could purchase financial and related services at Sears in addition to goods. It owned more than 200 other companies. During that time, Sears sold insurance (Allstate Insurance Group, consisting of many subsidiaries), real estate (Coldwell Banker Real Estate Group, consisting of many subsidiaries), brokerage and investment advisor services (Dean Witter), credit cards (Sears and Discover Card), and various other related services through many different subsidiaries. During the midnineties, Sears sold or spun off most of its subsidiaries that were unrelated to its core business, including Allstate, Coldwell Banker, Dean Witter, and Discover. On March 24, 2005, Sears Holding Corporation was established and became the parent company for Sears, Roebuck and Co. and K Mart Holding Corporation. From an accounting perspective, Kmart acquired Sears, even though Kmart had just emerged from bankruptcy proceedings. Following the merger the company now has approximately 2,350 full-line and off-mall stores and 1,100 specialty retail stores in the United States, and approximately 370 full-line and specialty retail stores in Canada. c. PepsiCo entered the restaurant business in 1977 with the purchase of Pizza Hut. By 1986, PepsiCo also owned Taco Bell and KFC (Kentucky Fried Chicken). In 1997, these subsidiaries were spun off to a new company, TRICON Global Restaurants, with TRICON's stock distributed to PepsiCo's shareholders. TRICON Global Restaurants changed its name to YUM! Brands, Inc., in 2002. Although PepsiCo exited the restaurant business, it continued in the snack-food business with its Frito-Lay subsidiary, the world's largest maker of salty snacks. PepsiCo bought Quaker Oats Company in 2001an acquisition that brought Gatorade under the PepsiCo name. d. When consolidated financial statements are presented, financial statement users are provided with information about the company's overall operations. Assessments can be made about how the company as a whole has fared as a result of all its operations. However, comparisons with other companies may be difficult because the operations of other companies may not be similar. If a company operates in a number of different industries, consolidated financial statements may not permit detailed comparisons with other companies unless the other companies operate in all of the same industries, with about the same relative mix. Thus, standard measures used in manufacturing and merchandising, such as gross margin percentage, inventory and receivables turnover, and the debt-to-asset ratio, may be useless or even misleading when significant financial-services operations are included in the financial statements. Similarly, standard measures used in comparing financial institutions might be distorted when financial statement information includes data relating to manufacturing or merchandising operations. A partial solution to the problem results from providing disaggregated (segment or line-of-business) information along with the consolidated financial statements, as required by the FASB. 3-9 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential C3-8 International Consolidation Issues The following answers are based on information from the Financial Accounting Standards Board website at www.fasb.org, the International Accounting Standards Board website at www.iasb.org, and from the PricewaterhouseCoopers publication entitled IFRS and US GAAP: similarities and differences September 2010, available online at http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaapsimilarities-and-differences-september-2010.jhtml . Note that the original URL listed in the book refers to the 2009 update. However, it still forwards to the new URL. a. Consolidation under IFRS is required when an entity is able to govern the policies of another entity in order to obtain benefits. To determine if consolidation is necessary, IFRS focuses on the concept of control. Factors of control, such as voting rights and contractual rights, are given by international standards. If control is not apparent, a general assessment of the relationship is required, including an evaluation of the allocation of risks and benefits. (See pages 154, 157) b. Under IFRS, Goodwill is reviewed annually (or more frequently) for impairment. Goodwill is initially allocated at the organizational level where cash flows can be clearly identified. These cash generating units (CGUs) may be combined for purposes of allocating goodwill and for the subsequent evaluation of goodwill for potential impairment. However, the aggregation of CGUs for goodwill allocation and evaluation must not be larger than a segment. Similar to U.S. GAAP, the impairment review must be done annually, but the evaluation date does not have to coincide with the end of the reporting year. However, if the annual impairment test has already been performed prior to the allocation of goodwill acquired during the fiscal year, a subsequent impairment test is required before the balance sheet date. While U.S. GAAP requires a two-step impairment test, IFRS requires a one-step test. The recoverable amount, which is the greater of the net fair market value of the CGU and the value of the unit in use, is compared to the book value of the CGU to determine if an impairment loss exists. A loss exists when the carrying value exceeds the recoverable amount. This loss is recognized in operating results. The impairment loss applies to all of the assets of the unit and must be allocated to assets in the unit. Impairment is allocated first to goodwill. If the impairment loss exceeds the book value of goodwill, then allocation is made on a pro rata basis to the other assets in the CGU. (See page 174) c. Under IFRS, entities have the option of measuring noncontrolling interests at either their proportion of the fair value or at full fair value. When using the full fair value option, the full value of goodwill will be recorded on both the controlling and noncontrolling interest. (See page 175) 3-10 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential C3-9 Off-Balance Sheet Financing and VIEs a. Off-balance sheet financing refers to techniques that allow companies to borrow while keeping the debt, and related assets, from being reported in the companys balance sheet. b. (1) Funds to acquire new assets for a company may be borrowed by a third party such as a VIE, with the acquired assets then leased to the company. (2) A company may sell assets such as accounts receivable instead of using them as collateral. (3) A company may create a new VIE and transfer assets to the new entity in exchange for cash. c. VIEs may serve a genuine business purpose, such as risk sharing among investors and isolation of project risk from company risk. d. VIEs may be structured to avoid consolidation. To the extent that standards for consolidation are rule-based, it is possible to structure a VIE so that it is not consolidated even if the underlying economic substance of the entity would indicate that it should be consolidated. By artificially removing debt, assets, and expenses from the financial reports of the sponsoring company, the financial position of a company and the results of its operations can be distorted. The FASB has been working to ensure that rule-based consolidation standards result in financial statements that reflect the underlying economic substance. C3-10 Alternative Accounting Methods a. Amerada Hesss (www.hess.com) interests in oil and gas exploration and production ventures are proportionately consolidated (pro rata consolidation), a frequently found industry practice in oil and gas exploration and production. Investments in affiliated companies, 20 to 50 percent owned, are reported using the equity method. A 50 percent interest in a trading partnership over which the company exercises control is consolidated. b. EnCana Corporation (www.encana.com) reports investments in companies over which it has significant influence using the equity method. Investments in jointly controlled companies and ventures are accounted for using proportionate consolidation. EnCana is a Canadian company. Proportionate consolidation is found more frequently outside of the United States. Although not considered generally accepted in the United States, proportionate (pro rata) consolidation is nevertheless sometimes found in the oil and gas exploration and transmission industries. c. If a joint venture is not incorporated, its treatment is less clear than for corporations. Generally, the equity method should be used, but companies sometimes use proportionate consolidated citing joint control as the reason. 3-11 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential C3-11 Consolidation Differences among Major Corporations a. 1Union Pacific is rather unusual for a large company. It has only two subsidiaries: Union Pacific Railroad Company Southern Pacific Rail Corporation b.1 ExxonMobil does not consolidate majority owned subsidiaries if the minority shareholders have the right to participate in significant management decisions. ExxonMobil does 1consolidate some variable interest entities even though it has less than majority ownership according to its Form 10-K because of guarantees or other arrangements that create majority economic interests in those affiliates that are greater than the Corporations voting interests. The company uses 1the equity method, cost method, and fair value method to account for investments in the common stock of companies in which it holds less than majority ownership. 3-12 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential SOLUTIONS TO EXERCISES E3-1 Multiple-Choice Questions on Consolidation Overview [AICPA Adapted] 1. d 2. c 3. b 4. a 5. b E3-2 Multiple-Choice Questions on Variable Interest Entities 1. c 2. d 3. a 4. b E3-3 Multiple-Choice Questions on Consolidated Balances [AICPA Adapted] 1. a 2. b 3. b 4. c 5. a E3-4 Multiple-Choice Questions on Consolidation Overview [AICPA Adapted] 1. d 2. The wording of this question is somewhat confusing. Since Aaron owns 80% of Belle, it has to consolidate Belle. There is no choice about whether or not to consolidate. A more clear wording of the question would say to compare Aarons parent company earnings (Y) to the consolidated earnings (X). The question also assumes both companies have positive earnings. a (if Aaron accounts for the investment under the cost method) b (if Aaron accounts for the investment under the equity method) 3-13 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential 3. b 4. d E3-5 Balance Sheet Consolidation a. $470,000 = $470,000 - $44,000 + $44,000 b. $616,000 = ($470,000 - $44,000) + $190,000 c. $405,000 = $270,000 + $135,000 d. $211,000 Acquisition price percent purchased Total fair value of Bristol Corporation's NA NCI in NA of Bristol Corporation $ $ 44,000 80% 55,000 $ Guild Corporation's Stockholders Equity Total Consolidated Stockholder's Equity 11,000 200,000 $ 211,000 E3-6 Balance Sheet Consolidation with Intercompany Transfer a. $631,500 = $510,000 + $121,500 b. $845,000 = $510,000 + $350,000 - $15,000 c. $641,500 = ($320,000 + $121,500) + $215,000 - $15,000 d. $203,500 Acquisition price percent purchased Total fair value of Stately Corporation's NA NCI in NA of Stately Corporation $ $ 121,500 90% 135,000 $ Potter Company's Stockholders Equity Total Consolidated Stockholder's Equity 13,500 190,000 $ 203,500 3-14 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential E3-7 Subsidiary Acquired for Cash Equity Method Entries on Fineline Pencil's Books: Investment in Smudge Eraser 72,000 Cash 72,000 Record the initial investment in Smudge Eraser Book Value Calculations: NCI 20% Original book value + Fineline Pencil 80% 18,000 Retained = Common Stock 72,000 50,000 1/1/X3 Goodwill = 0 Identifiable excess = 0 80% Book value = 72,000 $72,000 Initial investment in Smudge Eraser Basic Elimination Entry Common stock Retained earnings Investment in Smudge Eraser NCI in NA of Smudge Eraser Acquisition Price Investment in Smudge Eraser 72,000 72,000 0 50,000 40,000 72,000 18,000 Basic Entry 3-15 + Earnings 40,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential E3-7 (continued) Elimination Entries Fineline Pencil Smudge Eraser Cash 128,000 50,000 Other Assets 400,000 120,000 Investment in Smudge Eraser 72,000 Total Liabilities 100,000 80,000 Common Assets 600,000 170,000 Current Stock 300,000 50,000 50,000 Retained Earnings 200,000 40,000 40,000 DR CR Consolidated Balance Sheet 178,000 520,000 72,000 72,000 0 698,000 180,000 NCI in NA of Smudge Eraser Total Liabilities & Equity 0 300,000 200,000 18,000 600,000 170,000 90,000 18,000 18,000 698,000 Fineline Pencil Company and Subsidiary Consolidated Balance Sheet January 2, 20X3 Cash ($128,000 + $50,000) Other Assets ($400,000 + $120,000) Total Assets $178,000 520,000 $698,000 Current Liabilities ($100,000 + $80,000) Common Stock Retained Earnings Noncontrolling Interest in Net Assets of Smudge Eraser Total Liabilities and Stockholders' Equity $180,000 300,000 200,000 18,000 $698,000 E3-8 Subsidiary Acquired with Bonds Equity Method Entries on Byte Computer's Books: Investment in Nofail Software 67,500 Cash 67,500 Record the initial investment in Nofail Software Book Value Calculations: NCI 25% Original book value 22,500 + Byte Computer 75% Retained = 67,500 Common Stock 50,000 3-16 + Earnings 40,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential 1/1/X3 Goodwill = 0 Identifiable excess = 0 75% Book value = 67,500 $67,500 Initial investment in Nofail Software Basic Elimination Entry Common stock Retained earnings Investment in Nofail Software NCI in NA of Nofail Software Acquisition Price Investment in Nofail Software 67,500 67,500 0 50,000 40,000 67,500 22,500 Basic Entry 3-17 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential E3-8 (continued) Byte Computer Nofail Software Cash 200,000 50,000 Other Assets 400,000 Elimination Entries 120,000 DR CR Consolidated Balance Sheet Investment in Nofail Software 250,000 520,000 67,500 67,500 Total Assets 667,500 170,000 Current Liabilities 100,000 67,500 770,000 80,000 Bonds Payable 0 0 180,000 50,000 50,000 Bond Premium 17,500 Common Stock 300,000 50,000 50,000 300,000 17,500 Retained Earnings 200,000 40,000 40,000 200,000 NCI in NA of Nofail Software Total Liabilities & Equity 22,500 667,500 170,000 90,000 22,500 22,500 770,000 Byte Computer Corporation and Subsidiary Consolidated Balance Sheet January 2, 20X3 Cash ($200,000 + $50,000) Other Assets ($400,000 + $120,000) Total Assets $250,000 520,000 $770,000 Current Liabilities Bonds Payable Bond Premium Common Stock Retained Earnings Noncontrolling Interest in Net Assets of Smudge Eraser Total Liabilities and Stockholders' Equity E3-9 Subsidiary Acquired by Issuing Preferred Stock Equity Method Entries on Byte Computer's Books: Investment in Nofail Software 81,000 Preferred Stock Additional Paid-In Capital Record the initial investment in Nofail Software 3-18 60,000 21,000 $50,000 17,500 $180,000 67,500 300,000 200,000 22,500 $770,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential Book Value Calculations: NCI 10% Original book value + Byte Computer 90% 9,000 Retained = Common Stock 81,000 50,000 1/1/X3 Goodwill = 0 Identifiable excess = 0 90% Book value = 81,000 $81,000 Initial investment in Nofail Software Basic Elimination Entry Common stock Retained earnings Investment in Nofail Software NCI in NA of Nofail Software Acquisition Price Investment in Nofail Software 81,000 81,000 0 50,000 40,000 81,000 9,000 Basic Entry 3-19 + Earnings 40,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential E3-9 (continued) Elimination Entries Byte Computer Nofail Software Cash 200,000 50,000 250,000 Other Assets 400,000 120,000 520,000 DR CR Consolidated Balance Sheet Investment in Nofail Software 81,000 81,000 Total Assets 681,000 170,000 Current Liabilities 100,000 0 0 81,000 770,000 80,000 180,000 Preferred Stock 60,000 60,000 Additional Paid-In Capital 21,000 21,000 Common Stock 300,000 50,000 50,000 300,000 Retained Earnings 200,000 40,000 40,000 200,000 NCI in NA of Nofail Software Total Liabilities & Equity 9,000 681,000 170,000 90,000 9,000 9,000 770,000 Byte Computer Corporation and Subsidiary Consolidated Balance Sheet January 2, 20X3 Cash ($200,000 + $50,000) Other Assets ($400,000 + $120,000) Total Assets $250,000 520,000 $770,000 Current Liabilities ($100,000 + $80,000) Preferred Stock ($6 x 10,000) Additional Paid-In Capital ($2.10 x 10,000) Common Stock Retained Earnings Noncontrolling Interest in Net Assets of Nofail Total Liabilities and Stockholders' Equity $180,000 60,000 21,000 300,000 200,000 9,000 $770,000 3-20 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential E3-10 Reporting for a Variable Interest Entity Gamble Company Consolidated Balance Sheet Cash Buildings and Equipment Less: Accumulated Depreciation Total Assets $370,600,000(b) (10,100,000) Accounts Payable Bonds Payable Bank Notes Payable Noncontrolling Interest Common Stock Retained Earnings Total Liabilities and Equities (a) $18,600,000 (b) $370,600,000 $ 18,600,000(a) 360,500,000 $379,100,000 $ $103,000,000 105,200,000 5,000,000 20,300,000 140,000,000 5,600,000 208,200,000 $379,100,000 = $3,000,000 + $5,600,000 + ($140,000,000 $130,000,000) = $240,600,000 + $130,000,000 E3-11 Consolidation of a Variable Interest Entity Teal Corporation Consolidated Balance Sheet Total Assets $682,500(a) Total Liabilities Noncontrolling Interest Common Stock Retained Earnings Total Liabilities and Equities $550,000(b) 22,500(c) (a) $682,500 (b) $550,000 (c) $22,500 = = = $15,000 95,000 $500,000 + $190,000 - $7,500 $470,000 + $80,000 ($500,000 - $470,000) x 0.75 E3-12 Computation of Subsidiary Net Income Messer Company reported net income of $60,000 ($18,000 / 0.30) for 20X9. 3-21 110,000 $682,500 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential E3-13 Incomplete Consolidation a. b. Belchfire apparently owns 100 percent of the stock of Premium Body Shop since the balance in the investment account reported by Belchfire is equal to the net book value of Premium Body Shop. Accounts Payable $ 60,000 Accounts receivable were reduced by $10,000, presumably as a reduction of receivables and payables. Bonds Payable 600,000 There is no indication of intercorporate ownership. Common Stock 200,000 Common stock of Premium must be eliminated. Retained Earnings 260,000 Retained earnings of Premium also must be eliminated in preparing consolidated statements. $1,120,000 E3-14 Noncontrolling Interest a. The total noncontrolling interest reported in the consolidated balance sheet at January 1, 20X7, is $126,000 ($420,000 x .30). b. The stockholders' equity section of the consolidated balance sheet includes the claim of the noncontrolling interest and the stockholders' equity section of the subsidiary is eliminated when the consolidated balance sheet is prepared: Controlling Interest: Common Stock Additional Paid-In Capital Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders Equity $ 400,000 222,000 358,000 $ 980,000 126,000 $1,106,000 c. Sanderson is mainly interested in assuring a steady supply of electronic switches. It can control the operations of Kline with 70 percent ownership and can use the money that would be needed to purchase the remaining shares of Kline to finance additional operations or purchase other investments. 3-22 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential E3-15 Computation of Consolidated Net Income a. Ambrose should report income from its subsidiary of $15,000 ($20,000 x .75) rather than dividend income of $9,000. b. A total of $5,000 ($20,000 x .25) should be assigned to the noncontrolling interest in the 20X4 consolidated income statement. c. Consolidated net income of $70,0000 should be reported for 20X4, computed as follows: Reported net income of Ambrose Less: Dividend income from Kroop Operating income of Ambrose Net income of Kroop Consolidated net income $59,000 (9,000) $50,000 20,000 $70,000 d. Income of $79,000 would be attained by adding the income reported by Ambrose ($59,000) to the income reported by Kroop ($20,000). However, the dividend income from Kroop recorded by Ambrose must be excluded from consolidated net income. E3-16 Computation of Subsidiary Balances a. Light's net income for 20X2 was $32,000 ($8,000 / 0.25). b. Common Stock Outstanding (1) Additional Paid-In Capital (given) Retained Earnings ($70,000 + $32,000) Total Stockholders' Equity $120,000 40,000 102,000 $262,000 (1) Computation of common stock outstanding: Total stockholders' equity ($65,500 / 0.25) Additional paid-in capital Retained earnings Common stock outstanding 3-23 $262,000 (40,000) (102,000) $120,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential E3-17 Subsidiary Acquired at Net Book Value Equity Method Entries on Banner Corp.'s Books: Investment in Dwyer Co. 36,000 Cash Record the initial investment in Dwyer Co. 136,000 Book Value Calculations: NCI 20% Original book value 34,000 + Banner Corp. 80% Retained = 136,000 Common Stock 90,000 1/1/X8 Goodwill = 0 Identifiable excess = 0 $136,000 Initial investment in Dwyer Co. 80% Book value = 136,000 Basic Elimination Entry Common stock Retained earnings Investment in Dwyer Co. NCI in NA of Dwyer Co. Acquisition Price Investment in Dwyer Co. 136,000 136,000 0 90,000 80,000 136,000 34,000 Basic Entry 3-24 + Earnings 80,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential E3-17 (continued) Banner Corp. Dwyer Co. Elimination Entries DR CR Consolidated Balance Sheet Cash 74,000 20,000 94,000 Accounts Receivable 120,000 70,000 190,000 Inventory 180,000 90,000 270,000 Fixed Assets (net) 350,000 240,000 Investment in Dwyer Co. 136,000 Total Assets 860,000 420,000 65,000 30,000 Notes Payable 350,000 220,000 Common Stock 150,000 90,000 90,000 150,000 Retained Earnings 295,000 80,000 80,000 295,000 Accounts Payable 590,000 136,000 0 0 136,000 1,144,000 95,000 570,000 NCI in NA of Dwyer Co. 34,000 Total Liabilities & Equity 860,000 420,000 170,000 34,000 34,000 1,144,000 Banner Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X8 Cash ($74,000 + $20,000) Accounts Receivable ($120,000 + $70,000) Inventory ($180,000 + $90,000) Fixed Assets (net) ($350,000 + $240,000) Total Assets $ 94,000 190,000 270,000 590,000 $1,144,000 Accounts Payable ($65,000 + $30,000) Notes Payable ($350,000 + $220,000) Common Stock Retained Earnings Noncontrolling Interest in Net Assets of Dwyer Co. Total Liabilities and Stockholders' Equity $ 95,000 570,000 150,000 295,000 34,000 $1,144,000 E3-18 Applying Alternative Accounting Theories a. Proprietary theory: Total revenue [$400,000 + ($200,000 x .75)] Total expenses [$280,000 + ($160,000 x .75)] Consolidated net income [$120,000 + ($40,000 x .75)] b. $550,000 400,000 150,000 Parent company theory: Total revenue ($400,000 + $200,000) Total expenses ($280,000 + $160,000) $600,000 440,000 3-25 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential Consolidated net income [$120,000 + ($40,000 x .75)] c. Entity theory: Total revenue ($400,000 + $200,000) Total expenses ($280,000 + $160,000) Consolidated net income ($120,000 + $40,000) d. 150,000 $600,000 440,000 160,000 Current accounting practice: Total revenue ($400,000 + $200,000) Total expenses ($280,000 + $160,000) Consolidated net income ($120,000 + $40,000) $600,000 440,000 160,000 E3-19 Measurement of Goodwill a. $240,000 = computed in the same manner as under the parent company approach. b. $400,000 = $240,000 / 0.60 c. $400,000 = computed in the same manner as under the entity theory. E3-20 Valuation of Assets under Alternative Accounting Theories a. Entity theory: Book Value Fair Value Increase ($240,000 x 1.00) ($50,000 x 1.00) $240,000 50,000 $290,000 b. Parent company theory: Book Value Fair Value Increase ($240,000 x 1.00) ($50,000 x 0.75) $240,000 37,500 $277,500 c. Proprietary theory: Book Value Fair Value Increase ($240,000 x 0.75) ($50,000 x 0.75) $180,000 37,500 $217,500 d. Current accounting practice: Book Value Fair Value Increase ($240,000 x 1.00) ($50,000 x 1.00) $240,000 50,000 $290,000 E3-21 Reported Income under Alternative Accounting Theories a. Entity theory: 3-26 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential Total revenue ($410,000 + $200,000) Total expenses ($320,000 + $150,000) Consolidated net income [$90,000 + ($50,000 x 1.00)] $610,000 470,000 140,000 b. Parent company theory: Total revenue ($410,000 + $200,000) Total expenses ($320,000 + $150,000) Consolidated net income [$90,000 + ($50,000 x 0.80)] $610,000 470,000 130,000 c. Proprietary theory: Total revenue [$410,000 + ($200,000 x 0.80)] Total expenses [$320,000 + ($150,000 x 0.80)] Consolidated net income [$90,000 + ($50,000 x 0.80)] $570,000 440,000 130,000 d. Current accounting practice: Total revenue ($410,000 + $200,000) Total expenses ($320,000 + $150,000) Consolidated net income [$90,000 + (50,000 x 1.00)] $610,000 470,000 140,000 E3-22 Acquisition of Majority Ownership a. Net identifiable assets: $720,000 = $520,000 + $200,000 b. Noncontrolling interest: $50,000 = $200,000 x 0.25 SOLUTIONS TO PROBLEMS P3-23 Multiple-Choice Questions on Consolidated and Combined Financial Statements [AICPA Adapted] 1. d 2. c 3. b 4. c P3-24 Determining Net Income of Parent Company Consolidated net income Income of subsidiary ($15,200 / 0.40) Income from Tally's operations $164,300 (38,000) $126,300 P3-25 Reported Balances 3-27 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential a. The investment balance reported by Roof will be $192,000. b. Total assets will increase by $310,000. c. Total liabilities will increase by $95,000. d. The amount of goodwill for the entity as a whole will be $25,000 [($192,000 + $48,000) - ($310,000 - $95,000)]. e. Noncontrolling interest will be reported at $48,000 ($240,000 x 0.20). P3-26 Acquisition Price a. $57,000 = ($120,000 - $25,000) x 0.60 b. $81,000 = ($120,000 - $25,000) + $40,000 - $54,000 c. $48,800 = ($120,000 - $25,000) + $27,000 - $73,200 P3-27 Consolidation of a Variable Interest Entity Stern Corporation Consolidated Balance Sheet January 1, 20X4 Cash Accounts Receivable Less: Allowance for Uncollectibles Other Assets Total Assets $12,200,000 (b) (610,000) (c) Accounts Payable Notes Payable Bonds Payable Stockholders Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders Equity Total Liabilities and Stockholders Equity (a) $ 8,150,000 (b) $12,200,000 (c) $ 610,000 = = = $ 8,150,000 (a) 11,590,000 5,400,000 $25,140,000 $ 700,000 6,150,000 $ 6,850,000 40,000 950,000 7,500,000 9,800,000 $ $7,960,000 + $190,000 $4,200,000 + $8,000,000 $210,000 + $400,000 3-28 6,890,000 $25,140,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-28 Reporting for Variable Interest Entities Purified Oil Company Consolidated Balance Sheet Cash Drilling Supplies Accounts Receivable Equipment (net) Land Total Assets $ 640,000 420,000 640,000 8,500,000 5,100,000 $15,300,000 Accounts Payable Bank Loans Payable Stockholders Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders Equity Total Liabilities and Stockholders Equity $ 590,000 11,800,000 $ 560,000 2,150,000 $2,710,000 200,000 2,910,000 $15,300,000 P3-29 Consolidated Income Statement Data a. Sales: ($300,000 + $200,000 - $50,000) $450,000 b. Investment income from LoCal Bakeries: $ c. Cost of goods sold: ($200,000 + $130,000 - $35,000) $295,000 d. Depreciation expense: ($40,000 + $30,000) $ 70,000 -0- P3-30 Parent Company and Consolidated Amounts a. Common stock of Tempro Company on December 31, 20X5 Retained earnings of Tempro Company January 1, 20X5 Sales for 20X5 Less: Expenses Dividends paid Retained earnings of Tempro Company on December 31, 20X5 Net book value on December 31, 20X5 Proportion of stock acquired by Quoton Purchase price $ 90,000 $130,000 195,000 (160,000) (15,000) 150,000 $240,000 x 0.80 $192,000 3-29 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential b. Net book value on December 31, 20X5 Proportion of stock held by noncontrolling interest Balance assigned to noncontrolling interest $240,000 x 0.20 $ 48,000 c. Consolidated net income is $143,000. None of the 20X5 net income of Tempro Company was earned after the date of purchase and, therefore, none can be included in consolidated net income. d. Consolidate net income would be $178,000 [$143,000 + ($195,000 - $160,000)]. P3-31 Parent Company and Consolidated Balances a. Balance in investment account, December 31, 20X7 Cumulative earnings since acquisition Cumulative dividends since acquisition Total Proportion of stock held by True Corporation Total Amount Debited to Investment Account Purchase Amount 110,000 (46,000) $64,000 x 0.75 $259,800 (48,000) $211,800 b. $282,400 ($211,800 / 0.75) is the fair value of net assets on January 1, 20X5 c. $70,600 ($282,400 x 0.25) is the value assigned to the NCI shareholders on January 1, 20X5. d. $86,600 = ($259,800 / 0.75) x 0.25 will be assigned to noncontrolling interest in the consolidated balance sheet prepared at December 31, 20X7. P3-32 Indirect Ownership The following ownership chain exists: Purple 3-30 .70 .40 .10 Orange Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential Yellow .60 The earnings of Blue Company and Orange Corporation are included under cost method Blue reporting due to the 10 percent ownership level of Orange Corporation. Net income of Green Company: Reported operating income Dividend income from Orange ($30,000 x 0.10) Equity-method income from Yellow ($60,000 x 0.40) Green Company net income $ 20,000 3,000 24,000 $ 47,000 Consolidated net income: Operating income of Purple Net income of Green Consolidated net income $ 90,000 47,000 $137,000 Purple company net income (Not Required): Operating income of Purple Purple's share of Green's net income ($47,000 x 0.70) Purples net income $ 90,000 32,900 $122,900 P3-33 Balance Sheet Amounts under Alternative Accounting Theories a. Proprietary theory: Cash and inventory [$300,000 + ($80,000 x 0.75)] Buildings and Equipment (net) [$400,000 + ($180,000 x 0.75)] Goodwill [$210,000 - ($260,000 x 0.75)] b. $380,000 565,000 15,000 Entity theory: Cash and inventory ($300,000 + $80,000) Buildings and Equipment (net) ($400,000 + $180,000) Goodwill [($210,000 / 0.75) - $260,000] d. 535,000 15,000 Parent company theory: Cash and inventory ($300,000 + $80,000) Buildings and Equipment (net) [$400,000 + $120,000 + ($60,000 x 0.75)] Goodwill [$210,000 ($260,000 x 0.75)] c. $360,000 $380,000 580,000 20,000 Current accounting practice: Cash and inventory ($300,000 + $80,000) Buildings and Equipment (net) ($400,000 + $180,000) Goodwill [($210,000 / 0.75) - $260,000] 3-31 $380,000 580,000 20,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-34 Consolidated Worksheet and Balance Sheet on the Acquisition Date (Equity Method) a. Equity Method Entries on Peanut Co.'s Books: Investment in Snoopy Co. 270,000 Cash Record the initial investment in Snoopy Co. 270,000 b. Book Value Calculations: NCI 10% Original book value 30,000 + Peanut Co. 90% 270,000 Retained = Common Stock 200,000 + Earnings 100,000 1/1/X8 Goodwill = 0 Identifiable excess = 0 $270,000 Initial investment in Snoopy Co. 90% Book value = 270,000 Basic Elimination Entry Common stock Retained earnings Investment in Snoopy Co. NCI in NA of Snoopy Co. 200,000 100,000 270,000 30,000 Optional accumulated depreciation elimination entry Accumulated depreciation Building & equipment Acquisition Price Investment in Snoopy Co. 270,000 270,000 0 3-32 Basic Entry 10,000 10,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-34 (continued) Peanut Co. Snoopy Co. Elimination Entries DR CR Consolidated Balance Sheet Cash 55,000 20,000 75,000 Accounts Receivable 50,000 30,000 80,000 Inventory 100,000 60,000 Investment in Snoopy Co. 270,000 Land 225,000 100,000 Buildings & Equipment 700,000 200,000 Less: Accumulated Depreciation (400,000) (10,000) 10,000 Total Assets 1,000,000 400,000 10,000 75,000 25,000 100,000 Bonds Payable 200,000 75,000 275,000 Common Stock 500,000 200,000 200,000 Retained Earnings 225,000 100,000 100,000 Accounts Payable 160,000 270,000 325,000 10,000 NCI in NA of Snoopy Co. Total Liabilities & Equity 0 890,000 (400,000) 280,000 1,130,000 500,000 225,000 30,000 1,000,000 400,000 c. Peanut Co. Consolidated Balance Sheet 1/1/20X8 Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Total Assets 75,000 80,000 160,000 325,000 890,000 (400,000) 1,130,000 Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Snoopy Co. Total Liabilities & Equity 100,000 275,000 500,000 225,000 30,000 1,130,000 3-33 300,000 30,000 30,000 1,130,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-35 Consolidated Worksheet at End of the First Year of Ownership (Equity Method) a. Equity Method Entries on Peanut Co.'s Books: Investment in Snoopy Co. 270,000 Cash Record the initial investment in Snoopy Co. 270,000 Investment in Snoopy Co. 67,500 Income from Snoopy Co. 67,500 Record Peanut Co.'s 90% share of Snoopy Co.'s 20X8 income Cash 18,000 Investment in Snoopy Co. 18,000 Record Peanut Co.'s 90% share of Snoopy Co.'s 20X8 dividend b. Book Value Calculations: Original book value + Net Income - Dividends NCI 10% 30,000 7,500 (2,000) Ending book value 35,500 + Peanut Co. 90% 270,000 67,500 (18,000) Retained = 319,500 Common Stock 200,000 + Earnings 100,000 75,000 (20,000) 200,000 155,000 1/1/X8 12/31/X8 Goodwill = 0 Goodwill = 0 Identifiable excess = 0 90% Book value = 270,000 Excess = 0 $270,000 Initial investment in Snoopy Co. 90% Book value = 319,500 3-34 $319,500 Net investment in Snoopy Co. Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-35 (continued) Basic Elimination Entry Common stock Retained earnings Income from Snoopy Co. NCI in NI of Snoopy Co. Dividends declared Investment in Snoopy Co. NCI in NA of Snoopy Co. 200,000 100,000 67,500 7,500 20,000 319,500 35,500 Optional accumulated depreciation elimination entry Accumulated depreciation Building & equipment Acquisition Price 90% Net Income Ending Balance Investment in Snoopy Co. 270,000 67,500 18,000 319,500 319,500 0 10,000 10,000 Income from Snoopy Co. 67,500 90% Net Income 67,500 Ending Balance 90% Dividends Basic 67,500 0 3-35 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-35 (continued) Elimination Entries Peanut Co. Snoopy Co. 800,000 250,000 1,050,000 (200,000) (125,000) (325,000) (50,000) (10,000) (60,000) (225,000) (40,000) (265,000) DR CR Consolidated Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Snoopy Co. 67,500 Consolidated Net Income 392,500 NCI in Net Income Controlling Interest in Net Income 67,500 67,500 400,000 7,500 75,000 0 (7,500) 392,500 75,000 75,000 0 392,500 Beginning Balance 225,000 100,000 100,000 Net Income 392,500 75,000 75,000 (100,000) (20,000) 517,500 155,000 Cash 158,000 80,000 238,000 Accounts Receivable 165,000 65,000 230,000 Inventory 200,000 75,000 Investment in Snoopy Co. 319,500 Land 200,000 100,000 Buildings & Equipment 700,000 200,000 Less: Accumulated Depreciation (450,000) (20,000) 10,000 Total Assets 1,292,500 500,000 10,000 75,000 60,000 135,000 Bonds Payable 200,000 85,000 285,000 Common Stock 500,000 200,000 200,000 Retained Earnings 517,500 155,000 175,000 Statement of Retained Earnings Less: Dividends Declared Ending Balance 225,000 392,500 20,000 175,000 0 (100,000) 20,000 517,500 Balance Sheet Accounts Payable 275,000 319,500 300,000 10,000 890,000 (460,000) 329,500 1,473,000 500,000 1,292,500 3-36 500,000 375,000 20,000 517,500 35,500 NCI in NA of Snoopy Co. Total Liabilities & Equity 0 35,500 55,500 1,473,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-36 Consolidated Worksheet at End of the Second Year of Ownership (Equity Method) a. Equity Method Entries on Peanut Co.'s Books: Investment in Snoopy Co. 72,000 Income from Snoopy Co. 72,000 Record Peanut Co.'s 90% share of Snoopy Co.'s 20X9 income Cash 27,000 Investment in Snoopy Co. 27,000 Record Peanut Co.'s 90% share of Snoopy Co.'s 20X9 dividend b. Book Value Calculations: Beginning book value + Net Income - Dividends NCI 10% 35,500 8,000 (3,000) Ending book value 40,500 + Peanut Co. 90% 319,500 72,000 (27,000) 364,500 Retained = Common Stock 200,000 + 200,000 1/1/X9 205,000 12/31/X9 Goodwill = 0 Earnings 155,000 80,000 (30,000) Goodwill = 0 Excess = 0 90% Book value = 319,500 Excess = 0 $319,500 Net investment in Snoopy Co. 90% Book value = 364,500 3-37 $364,500 Net investment in Snoopy Co. Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-36 (continued) Basic Elimination Entry Common stock Retained earnings Income from Snoopy Co. NCI in NI of Snoopy Co. Dividends declared Investment in Snoopy Co. NCI in NA of Snoopy Co. 200,000 155,000 72,000 8,000 30,000 364,500 40,500 Optional accumulated depreciation elimination entry Accumulated depreciation Building & equipment Beginning Balance 90% Net Income Ending Balance Investment in Snoopy Co. 319,500 72,000 27,000 364,500 364,500 0 10,000 10,000 Income from Snoopy Co. 72,000 90% Net Income 72,000 Ending Balance 90% Dividends Basic 72,000 0 3-38 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-36 (continued) Elimination Entries Peanut Co. Snoopy Co. 850,000 300,000 1,150,000 (270,000) (150,000) (420,000) (50,000) (10,000) (60,000) (230,000) (60,000) (290,000) DR CR Consolidated Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Snoopy Co. 72,000 Consolidated Net Income 372,000 NCI in Net Income Controlling Interest in Net Income 72,000 72,000 380,000 8,000 80,000 0 (8,000) 372,000 80,000 80,000 0 372,000 Beginning Balance 517,500 155,000 155,000 Net Income 372,000 80,000 80,000 (225,000) (30,000) 664,500 205,000 Cash 255,000 75,000 330,000 Accounts Receivable 190,000 80,000 270,000 Inventory 180,000 100,000 Investment in Snoopy Co. 364,500 Land 200,000 100,000 Buildings & Equipment 700,000 200,000 Less: Accumulated Depreciation (500,000) (30,000) 10,000 Total Assets 1,389,500 525,000 10,000 75,000 35,000 110,000 Bonds Payable 150,000 85,000 235,000 Common Stock 500,000 200,000 200,000 Retained Earnings 664,500 205,000 235,000 Statement of Retained Earnings Less: Dividends Declared Ending Balance 517,500 372,000 30,000 235,000 0 (225,000) 30,000 664,500 Balance Sheet Accounts Payable 280,000 364,500 300,000 10,000 890,000 (520,000) 374,500 1,550,000 500,000 1,389,500 3-39 525,000 435,000 30,000 664,500 40,500 NCI in NA of Snoopy Co. Total Liabilities & Equity 0 40,500 70,500 1,550,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-37 Consolidated Worksheet and Balance Sheet on the Acquisition Date (Equity Method) a. Equity Method Entries on Paper Co.'s Books: Investment in Scissor Co. 296,000 Cash Record the initial investment in Scissor Co. 296,000 b. Book Value Calculations: NCI 20% Original book value 74,000 + Paper Co. 80% Retained = 296,000 Common Stock 250,000 + Earnings 120,000 1/1/X8 Goodwill = 0 Identifiable excess = 0 80% Book value = 296,000 $296,000 Initial investment in Scissor Co. Basic Elimination Entry Common stock Retained earnings Investment in Scissor Co. NCI in NA of Scissor Co. 250,000 120,000 296,000 74,000 Optional accumulated depreciation elimination entry Accumulated depreciation Building & equipment Investment in Scissor Co. Acquisition Price 296,000 296,000 Basic Entry 0 3-40 24,000 24,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-37 (continued) Elimination Entries Paper Co. Scissor Co. 109,000 25,000 134,000 65,000 37,000 102,000 Inventory 125,000 87,000 212,000 Investment in Scissor Co. 296,000 Land 280,000 125,000 Buildings & Equipment 875,000 250,000 Less: Accumulated Depreciation (500,000) (24,000) 24,000 Total Assets 1,250,000 500,000 24,000 95,000 30,000 125,000 Bonds Payable 250,000 100,000 350,000 Common Stock 625,000 250,000 250,000 Retained Earnings 280,000 120,000 120,000 DR CR Consolidated Balance Sheet Cash Accounts Receivable Accounts Payable 296,000 24,000 NCI in NA of Scissor Co. Total Liabilities & Equity 0 405,000 1,101,000 (500,000) 320,000 1,454,000 625,000 280,000 74,000 1,250,000 500,000 c. Paper Co. Consolidated Balance Sheet 1/1/20X8 Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Total Assets 134,000 102,000 212,000 405,000 1,101,00 0 (500,000) 1,454,000 Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Scissor Co. Total Liabilities & Equity 125,000 350,000 625,000 280,000 74,000 1,454,000 3-41 370,000 74,000 74,000 1,454,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-38 Consolidated Worksheet at End of the First Year of Ownership (Equity Method) a. Equity Method Entries on Paper Co.'s Books: Investment in Scissor Co. 296,000 Cash Record the initial investment in Scissor Co. 296,000 Investment in Scissor Co. 74,400 Income from Scissor Co. 74,400 Record Paper Co.'s 80% share of Scissor Co.'s 20X9 income Cash 20,000 Investment in Scissor Co. 20,000 Record Paper Co.'s 80% share of Scissor Co.'s 20X9 dividend b. Book Value Calculations: Original book value + Net Income - Dividends NCI 20% 74,000 18,600 (5,000) Ending book value 87,600 + Paper Co. 80% 296,000 74,400 (20,000) Retained = 350,400 Common Stock 250,000 + Earnings 120,000 93,000 (25,000) 250,000 188,000 1/1/X9 12/31/X9 Goodwill = 0 Goodwill = 0 Identifiable excess = 0 80% Book value = 296,000 Excess = 0 $296,000 Initial investment in Scissor Co. 80% Book value = 350,400 3-42 $350,400 Net investment in Scissor Co. Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-38 (continued) Basic Elimination Entry Common stock Retained earnings Income from Scissor Co. NCI in NI of Scissor Co. Dividends declared Investment in Scissor Co. NCI in NA of Scissor Co. 250,000 120,000 74,400 18,600 25,000 350,400 87,600 Optional accumulated depreciation elimination entry Accumulated depreciation Building & equipment Acquisition Price 80% Net Income Investment in Scissor Co. 296,000 74,400 24,000 Income from Scissor Co. 74,400 Ending Balance 80% Dividends 350,400 350,400 80% Net Income 74,400 20,000 Ending Balance 24,000 Basic 0 74,400 0 3-43 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-38 (continued) Paper Co. Scissor Co. Elimination Entries DR CR Consolidated Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses 800,000 310,000 1,110,000 (250,000) (155,000) (405,000) (65,000) (12,000) (77,000) (280,000) (50,000) (330,000) Income from Scissor Co. 74,400 Consolidated Net Income 279,400 NCI in Net Income Controlling Interest in Net Income 74,400 0 74,400 298,000 18,600 93,000 (18,600) 279,400 93,000 93,000 0 279,400 Beginning Balance 280,000 120,000 120,000 Net Income 279,400 93,000 93,000 Less: Dividends Declared (80,000) (25,000) Ending Balance 479,400 188,000 Cash 191,000 46,000 237,000 Accounts Receivable 140,000 60,000 200,000 Inventory 190,000 120,000 310,000 Investment in Scissor Co. 350,400 Land 250,000 125,000 Buildings & Equipment 875,000 250,000 Less: Accumulated Depreciation (565,000) (36,000) 24,000 Total Assets 1,431,400 565,000 24,000 Statement of Retained Earnings 280,000 279,400 25,000 213,000 0 (80,000) 25,000 479,400 Balance Sheet Accounts Payable 350,400 0 375,000 24,000 1,101,000 (577,000) 374,400 1,646,000 77,000 27,000 104,000 Bonds Payable 250,000 100,000 350,000 Common Stock 625,000 250,000 250,000 Retained Earnings 479,400 188,000 213,000 1,431,400 3-44 565,000 463,000 25,000 479,400 87,600 NCI in NA of Scissor Co. Total Liabilities & Equity 625,000 87,600 112,600 1,646,000 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-39 Consolidated Worksheet at End of the Second Year of Ownership (Equity Method) a. Equity Method Entries on Paper Co.'s Books: Investment in Scissor Co. 85,600 Income from Scissor Co. 85,600 Record Paper Co.'s 80% share of Scissor Co.'s 20X9 income Cash 24,000 Investment in Scissor Co. 24,000 Record Paper Co.'s 80% share of Scissor Co.'s 20X9 dividend b. Book Value Calculations: Beginning book value + Net Income - Dividends Ending book value NCI 20% 87,600 21,400 (6,000) 103,000 + Paper Co. 80% 350,400 85,600 (24,000) 412,000 Retained = Common Stock 250,000 + 250,000 1/1/X9 265,000 12/31/X9 Goodwill = 0 Earnings 188,000 107,000 (30,000) Goodwill = 0 Excess = 0 80% Book value = 350,400 Excess = 0 $350,400 Net investment in Scissor Co. 80% Book value = 412,000 3-45 $412,000 Net investment in Scissor Co. Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-39 (continued) Basic Elimination Entry Common stock Retained earnings Income from Scissor Co. NCI in NI of Scissor Co. Dividends declared Investment in Scissor Co. NCI in NA of Scissor Co. 250,000 188,000 85,600 21,400 30,000 412,000 103,000 Optional accumulated depreciation elimination entry Accumulated depreciation Building & equipment Beginning Balance 80% Net Income Ending Balance Investment in Scissor Co. 350,400 85,600 24,000 412,000 412,000 0 24,000 24,000 Income from Scissor Co. 85,600 80% Net Income 85,600 Ending Balance 80% Dividends Basic 85,600 0 3-46 Chapter 03 - The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential P3-39 (continued) Elimination Entries Paper Co. Scissor Co. 880,000 355,000 1,235,000 (278,000) (178,000) (456,000) (65,000) (12,000) (77,000) (312,000) (58,000) DR CR Consolidated Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Scissor Co. 85,600 Consolidated Net Income 310,600 NCI in Net Income Controlling Interest in Net Income (370,000) 85,600 85,600 332,000 21,400 107,000 0 (21,400) 310,600 107,000 107,000 0 310,600 Beginning Balance 479,400 188,000 188,000 Net Income 310,600 107,000 107,000 Less: Dividends Declared (90,000) (30,000) Ending Balance 700,000 265,000 Cash 295,000 116,000 411,000 Accounts Receivable 165,000 97,000 262,000 Inventory 193,000 115,000 308,000 Investment in Scissor Co. 412,000 Land 250,000 125,000 Buildings & Equipment 875,000 250,000 Less: Accumulated Depreciation (630,000) (48,000) 24,000 Total Assets 1,560,000 655,000 24,000 85,000 40,000 125,000 Bonds Payable 150,000 100,000 250,000 Common Stock 625,000 250,000 250,000 Retained Earnings 700,000 265,000 295,000 Statement of Retained Earnings 479,400 310,600 30,000 295,000 0 (90,000) 30,000 700,000 Balance Sheet Accounts Payable 412,000 24,000 1,101,000 (654,000) 436,000 1,803,000 625,000 1,560,000 3-47 655,000 545,000 30,000 700,000 103,000 NCI in NA of Scissor Co. Total Liabilities & Equity 0 375,000 103,000 133,000 1,803,000 ... View Full Document

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