Exercises: Unit 16

SHORT ANSWER QUESTIONS, EXERCISES AND PROBLEMS

Questions

➢  For what reasons do corporations purchase the stock of other corporations?

➢  Explain how marketable securities should be classified in the balance sheet.

➢  Describe the valuation bases used for marketable equity securities.

➢  Under what circumstances is the equity method used to account for stock investments?

➢  Explain briefly the accounting for stock dividends and stock splits from the investor's point of view.

➢  Of what significance is par value to the investing corporation?

➢  What is the purpose of preparing consolidated financial statements?

➢  Under what circumstances must consolidated financial statements be prepared?

➢  Why is it necessary to make elimination entries on the consolidated statement work sheet? Are these elimination entries also posted to the accounts of the parent and subsidiary? Why or why not?

➢  Why might a corporation pay an amount in excess of the book value for a subsidiary's stock? Why might it pay an amount less than the book value of the subsidiary's stock?

➢  The item Minority interest often appears as one amount in the consolidated balance sheet. What does this item represent?

➢  How do a subsidiary's earnings, losses, and dividends affect the investment account of the parent when the equity method of accounting is used?

➢  Why are consolidated financial statements of limited usefulness to the creditors and minority stockholders of a subsidiary?

Exercises

Exercise A On 2010 July 1, Tam Company purchased 200 shares of Del Company capital stock as a temporary investment (trading securities) at $ 676.80 per share plus a commission of $ 720. On July 15, a 10 per cent stock dividend was received. Tam received a cash dividend of $ 3.60 per share on 2010 August 12. On November 1, Tam sold all of the shares for $ 835.20 per share, less a commission of $ 720. Prepare entries to record all of these transactions in Tam Company's accounts.

Exercise B Key Company purchased 200 shares of Franklin Company stock at a total cost of $ 7,560 on 2010 July 1. At the end of the accounting year (2010 December 31), the market value for these shares was $ 6,840. By 2011 December 31, the market value had risen to $ 7,920. This stock is the only marketable equity security that Key Company owns. The company classifies the securities as trading securities. Give the entries necessary at the date of purchase and at 2010 December 31, and 2011.

Exericse C Corbit Company has marketable equity securities that have a fair market value at year-end that is $ 13,440 below their cost. Give the required entry if:

  1. The securities are current assets classified as trading securities.
  2. The securities are noncurrent assets classified as available-for-sale securities, and the loss is considered to be temporary.
  3. The securities are noncurrent assets classified as available-for-sale securities, and the loss is considered to be permanent.


State where each of the accounts debited in (a), (b), and (c) would be reported in the financial statements.

Exercise D Ruiz Company owns 75 per cent of Sim Company's outstanding common stock and uses the equity method of accounting. Sim Company reported net income of $ 702,000 for 2010. On 2010 December 31, Sim Company paid a cash dividend of $ 189,000. In 2011, Sim Company incurred a net loss of $ 125,000. Prepare entries to reflect these events on Ruiz Company's books.

Exercise E On 2010 February 1, Larkin Company acquired 100 per cent of the outstanding voting common stock of TRD Company for $ 8,400,000 cash. The stockholders' equity of the TRD Company consisted of common stock, $ 6,720,000, and retained earnings, $ 1,680,000. Prepare (a) the entry to record the investment in TRD Company and (b) the elimination entry on the work sheet used to prepare a consolidated balance sheet as of the date of acquisition.

Exercise F Given the facts in the previous exercise, how much would be recorded as goodwill in each of the following instances? The same amount was paid, but the parent company acquired a—

  1. 90 per cent interest.
  2. 70 per cent interest.
  3. 55 per cent interest.


Exercise G Heidi Corporation acquired, for cash, 80 per cent of the outstanding voting common stock of Sumpter Company. After the close of business on the date of acquisition, Sumpter Company's stockholders' equity consisted of common stock, $ 5,880,000, and retained earnings, $ 2,184,000. The cost of the investment exceeded the book value by $ 302,400 and was attributable to above-average earnings prospects. Prepare (a) the entry to record the investment in Sumpter Company and (b) the elimination entry on the work sheet used to prepare consolidated financial statements as of the date of acquisition.

Exercise H On 2009 January 1, Company J acquired 85 per cent of the outstanding voting common stock of Company K. On that date, Company K's stockholders' equity consisted of:

Stockholders' equity:
  Paid-in capital:
   Common stock, $90 par; 30,000 shares authorized, issued, and outstanding $2,700,000
  Retained earnings 675,000
   Total stockholders' equity $3,375,000
Compute the difference between cost and book value in each of the following cases:

  1. Company J pays $ 2,868,750 cash for its interest in Company K.
  2. Company J pays $ 3,375,000 cash for its interest in Company K.
  3. Company J pays $ 2,610,000 cash for its interest in Company K.


Exercise I The 2010 January 1, stockholders' equity section of Saye Company's balance sheet follows:

Stockholders' equity:
  Paid-in capital:
   Common stock, $144 par; authorized, 200,000 shares; issued, and outstanding, 150,000 shares $21,600,000
   Paid-in capital in excess of par value 3,600,000
    Total paid-in capital $25,200,000
  Retained earnings 2,160,000
   Total stockholders' equity $27,360,000
Ninety per cent of Saye Company's outstanding voting common stock was acquired by Tim Company on 2011 January 1, for $ 24,048,000. Compute (a) the book value of the investment, (b) the difference between cost and book value, and (c) the minority interest.

Exercise J Company S purchased 90 per cent of Company T's outstanding voting common stock on 2010 January 2. The investment is accounted for under the equity method. Company S paid $ 2,790,000 for its proportionate equity of $ 2,430,000. The difference was due to undervalued land owned by Company T. Company T earned $ 324,000 during 2010 and paid cash dividends of $ 108,000.

  1. Compute the balance in the investment account on 2010 December 31.
  2. Compute the amount of the minority interest on (1) 2010 January 2, and (2) 2010 December 31.


Problems

Problem A Paris Company acquired on 2010 July 15, 400 shares of Rome Company $ 720 par value capital stock at $ 698.40 per share plus a broker's commission of $ 1,728. On 2010 August 1, Paris Company received a cash dividend of $ 8.64 per share. On 2010 November 3, it sold 200 of these shares at $ 756 per share less a broker's commission of $ 1,152. On 2010 December 1, Rome Company issued shares comprising a 100 per cent stock dividend declared on its capital stock on November 18.

On 2010 December 31, the end of Paris Company's calendar-year accounting period, the market quotation for Rome Company's common stock was $ 331.20 per share. The decline was considered to be temporary.

  1. Prepare journal entries to record all of these data assuming the securities are considered temporary investments classified as trading securities. Where should the accounts in the last entry appear in the financial statements?
  2. Assume Rome Company has become a major customer so the shares are held for long-term affiliation purposes. Indicate how the investment should be shown in the balance sheet.


Problem B On 2010 October 17, Strong Company purchased the following common stocks (all trading securities) at the indicated per share prices that included commissions:

600 shares of X Company common stock @ $216 $129,600
1,000 shares of Y Company common stock @ $144 144,000
1,600 shares of Z Company common stock @ $72 115,200
$388,800
On 2010 December 31, the market prices per share of the above common stocks were X, $ 223.20; Y, $ 136.80; and Z, $ 54.

Summarized, the cash dividends per share received in 2011 were X, $ 14.40; Y, $ 7.20; and Z, $ 5.40.

On 2011 December 31, the per share market prices were X, $ 252.80; Y, $ 115.20; and Z, $ 72.

All of these changes in market prices are considered temporary.

Prepare journal entries for all of these transactions, including calendar year-end adjusting entries, assuming the shares of common stock acquired are considered trading securities.

If the securities acquired are considered available-for-sale securities, how would the entries differ?

For both parts a and b, give the descriptions (titles) and the dollar amounts of the items that would appear in the income statements for 2010 and 2011.

Problem C On 2010 January 1, Long Company acquired 80 per cent of the outstanding voting common stock of Fall Company for $ 4,032,000 cash. Long Company uses the equity method. During 2010, Fall reported $ 672,000 of net income and paid $ 288,000 in dividends. The stockholders' equity section of the 2009 December 31, balance sheet for Fall follows:

Stockholders' equity:
  Paid-in capital:
   Common stock - $42 par $4,200,000
  Retained earnings 840,000
   Total stockholders' equity $5,040,000
  1. Prepare the general journal entries to record the investment and the effect of Fall's income and dividends on Long Company's accounts.
  2. Prepare the elimination entry that would be made on the work sheet for a consolidated balance sheet as of the date of acquisition.


Problem D Pearson Company acquired 75 per cent of the outstanding voting common stock of Frost Company for $ 1,444,800 cash on 2010 January 1. The investment is accounted for under the equity method. During 2010, 2011, and 2012, Frost Company reported the following:

  Net income

(loss)
Dividends

Paid
2010 $357,840 $290,640
2011 (45,360) -0-
2012 108,360 72,240
  1. Prepare general journal entries to record the investment and the effect of the subsidiary's income, losses, and dividends on Pearson Company's accounts.
  2. Compute the balance in the investment account on 2012 December 31.


Problem E Cord Company acquired 100 per cent of the outstanding voting common stock of Thorpe Company on 2010 January 2, for $ 2,700,000. At the end of business on the date of acquisition, the balance sheets for the two companies were as follows:

  Cord

Company
Thorpe

Company
Assets
Cash $ 315,000 $ 180,000
Accounts receivable, net 234,000 144,000
Notes receivable 360,000 90,000
Merchandise inventory 495,000 234,000
Investment in Thorpe Company 2,700,000
Equipment, net 648,000 450,000
Building, net 1,890,000 990,000
Land 765,000 405,000
Total assets $7,407,000 $2,493,000
Liabilities and stockholders' equity
Accounts payable $ 117,000 $ 135,000
Notes payable 90,000 108,000
Common stock - $45 par value 5,400,000 1,800,000
Retained earnings 1,800,000 450,000
Total liabilities and stockholders' equity $7,407,000 $2,493,000
The excess of cost over book value is attributable to the above-average earnings prospects of Thorpe Company. On the date of acquisition, Thorpe Company borrowed $ 72,000 from Cord Company by giving a note.

  1. Prepare a work sheet for a consolidated balance sheet as of the date of acquisition.
  2. Prepare a consolidated balance sheet for 2010 January 2.


Problem F Refer to the previous problem, Cord Company uses the equity method. Assume the following are from the adjusted trial balances of Cord Company and Thorpe Company on 2010 December 31:

  Cord

Company
Thorpe

Company
Debit balance accounts
Cash $ 351,000 $ 315,000
Accounts receivable, net 378,000 180,000
Notes receivable 315,000 45,000
Merchandise inventory, December 31 495,000 287,100
Investment in Thorpe Company 2,790,000
Equipment, net 615,000 427,500
Building, net 1,814,400 950,400
Land 765,000 405,000
Cost of goods sold 1,800,000 630,000
Expense (excluding depreciation and taxes) 720,000 270,900
Depreciation expense 108,000 62,100
Income tax expense 585,000 189,000
Dividends 540,000 108,000
Total of the accounts with debit balances $11,277,000 $3,870,000
Credit balance accounts
Accounts payable $ 135,000 $ 180,000
Notes payable 144,000 90,000
Common stock - $45 par value 5,400,000 1,800,000
Retained earnings – January 1 1,800,000 450,000
Revenue from sales 3,600,000 1,350,000
Income from Thorpe Company 198,000
Total of the accounts with credit balances $11,277,000 $3,870,000
There is no intercompany debt at the end of the year.

Prepare a work sheet for consolidated financial statements on 2010 December 31.

Problem G Using the work sheet from Problem F, prepare the following items:

  1. Consolidated income statement for the year ended 2010 December 31.
  2. Consolidated statement of retained earnings for the year ended 2010 December 31.
  3. Consolidated balance sheet for 2010 December 31.


Alternate problems

Alternate problems A On 2010 September 1, Ramsey Company purchased the following relatively long-term investments classified as available-for-sale securities:

  • Two thousand shares of Lacey Company capital stock at $ 439.20 plus broker's commission of $ 5,760.
  • One thousand shares of Membrow Company capital stock at $ 705.60 plus broker's commission of $ 5,040.


Cash dividends of $ 18.00 per share on the Lacey capital stock and $ 14.40 per share on the Membrow capital stock were received on December 7 and December 10, respectively.

On 2010 December 31, per share market values are Lacey, $ 460.80; and Membrow, $ 655.20.

  1. Prepare journal entries to record these transactions.
  2. Prepare the necessary adjusting entry(ies) at 2010 December 31, to adjust the carrying values assuming that market price changes are believed to be temporary. Where would the accounts appear in the financial statements?


Alternate problem B Kress, Inc., purchased on 2010 July 2, 240 shares of Baker Company $ 180 par value common stock as a temporary investment at $ 288 per share, plus a broker's commission of $ 432.

On 2010 July 15, a cash dividend of $ 7.20 per share was received. On 2010 September 1, Baker Company split its $ 180 par value common shares two for one.

On 2010 November 2, Kress sold 200 shares of Baker common stock at $ 180, less a broker's commission of $ 288.

  1. Prepare journal entries to record all of the above transactions.
  2. How would you recommend that the remaining shares be classified in the 2010 December 31, balance sheet if still held at that date?
  3. Assume the remaining shares were considered current assets classified as trading securities at the end of 2010, at which time their market value was $ 128 per share. Prepare any necessary adjusting entries for the end of 2010.


Alternate problem C Prime Company acquired 90 per cent of the outstanding voting common stock of Orr Company 2010 January 1, for $ 7,560,000 cash. Prime Company uses the equity method. During 2010 Orr reported $ 1,512,000 of net income and paid $ 504,000 in cash dividends. The stockholders' equity section of the 2009 December 31, balance sheet for Orr follows:

Stockholders' equity:
  Paid-in capital:
   Common stock, $21.00 par $6,720,000
  Retained earnings 1,680,000
   Total stockholders' equity $8,400,000
  1. Prepare general journal entries to record the investment and the effect of Orr's earnings and dividends on Prime Company's accounts.
  2. Prepare the elimination entry that would be made on the work sheet for a consolidated balance sheet as of the date of acquisition.


Alternate problem D Codd Company acquired 70 per cent of the outstanding voting common stock of Snow Company for $ 8,568,000 on 2010 January 1. The investment is accounted for under the equity method. During the years 2010-2012, Snow Company reported the following:

  Net Income Dividends
  (loss) Paid
2007 $1,454,880 $871,920
2008 372,960 223,440
2009 (23,520) 55,860
  1. Prepare general journal entries to record the investment and the effect of the subsidiary's income, losses, and dividends on Codd Company's accounts.
  2. Compute the investment account balance on 2011 December 31.


Alternate problem E Maple Company acquired all of the outstanding voting common stock of Dodd Company on 2010 January 2, for $ 4,320,000. On the date of acquisition, the balance sheets for the two companies were as follows:

  Maple

Company
Dodd

Company
Assets
Cash $ 900,000 $270,000
Accounts receivable, net 432,000 360,000
Notes receivable 180,000 108,000
Merchandise inventory 1,368,000 864,000
Investment in Dodd Company 4,320,000
Equipment, net 1,224,000 738,000
Building, net 3,330,000 1,656,000
Land 1,404,000 450,000
Total assets $13,158,000 $4,446,000
Liabilities and stockholders' equity    
Accounts payable $792,000 $360,000
Notes payable 216,000 252,000
Common stock - $120 par value 9,540,000 3,564,000
Retained earnings 2,610,000 270,000
Total liabilities and stockholders' equity $12,158,000 $4,446,000
The management of Maple Company thinks that the Dodd Company's land is undervalued by $ 162,000. The remainder of the excess of cost over book value is due to superior earnings potential.

On the date of acquisition, Dodd Company borrowed $ 180,000 from Maple Company by giving a note.

  1. Prepare a work sheet for a consolidated balance sheet as of the date of acquisition.
  2. Prepare a consolidated balance sheet for 2010 January 2.


Alternate problem F Refer back to the previous problem. Maple Company uses the equity method. Assume the following amounts are taken from the adjusted trial balances of Maple Company and Dodd Company on 2010 December 31:

  Maple

Company
Dodd

Company
Debit balance accounts    
Cash $ 864,000 $ 364,295
Accounts receivable, net 553,536 414,000
Notes receivable 342,000 90,000
Merchandise inventory, December 31 1,530,000 1,008,000
Investment in Dodd Company 4,519,356
Equipment, net 1,147,500 691,860
Building, net 3,136,500 1,573,200
Land 1,404,000 450,000
Cost of goods sold 8,064,000 2,160,000
Expense (excluding depreciation and taxes) 2,160,000 810,000
Depreciation expense 243,000 128,940
Income tax expense 569,664 123,504
Dividends 477,000 178,200
Total of the accounts with debit balances $25,037,556 $7,992,000
Credit balance accounts    
Accounts payable $ 720,000 $ 378,000
Notes payable 270,000 180,000
Common stock - $90 par value 9,540,000 3,564,000
Retained earnings 2,610,000 270,000
Revenue from sales 11,520,000 3,600,000
Income from Dodd Company 377,556
Total of the accounts with credit balances $25,037,556 $7,992,000
There is no intercompany debt at the end of the year.

Prepare a work sheet for consolidated financial statements on 2010 December 31.

Alternate problem G Using the work sheet from the previous problem, prepare the following items:

  1. Consolidated income statement for the year ended 2010 December 31.
  2. Consolidated statement of retained earnings for the year ended 2010 December 31.
  3. Consolidated balance sheet for 2010 December 31.


Beyond the numbers—Critical thinking

Business decision case A You are the CPA engaged to audit the records of Quigley Company. You find that your client has a portfolio of marketable equity securities that has a total market value of $ 300,000 less than the total cost of the portfolio. You ask the vice president for finance if the client expects to sell these securities in the coming year. He answers that he does not know. The securities will be sold if additional cash is needed to finance operations. When you ask for a cash forecast, you are told that a forecast has been prepared that covers the next year. It indicates no need to sell the marketable securities.

Write a brief statement in which you explain how you would classify the client's portfolio of marketable securities in the balance sheet. Does it really make any difference whether the securities are classified as trading securities or available-for-sale securities? Explain.

Business decision case B On 2010 January 2, Brown Company acquired 60 per cent of the voting common stock of Cobb Company for $ 720,000 cash. The excess of cost over book value was due to above-average earnings prospects. Brown has hired you to help it prepare consolidated financial statements and has already collected the following information for both companies as of 2010 January 2:

  Brown

Company
Cobb

Company
Assets
Cash $ 72,000 $ 54,000
Accounts receivable, net 108,000 126,000
Merchandise inventory 288,000 216,000
Investment in Cobb Company 720,000
Plant and equipment, net 936,000 738,000
Total assets $2,124,000 $1,134,000
Liabilities and stockholders' equity    
Accounts payable $ 144,000 $ 54,000
Common stock 1,440,000 720,000
Retained earnings 540,000 360,000
Total liabilities and stockholders' equity $2,124,000 $1,134,000
  1. Brown believes that consolidated financial statements can be prepared simply by adding together the amounts in the two individual columns. Is this correct? If not, why not?
  2. Prepare a consolidated balance sheet for the date of acquisition without preparing a consolidated statement work sheet.


Business decision case C International Flavors & Fragrances, Inc., is the leading creator and manufacturer of flavors and fragrances used by others to impart or improve flavor or fragrance in a wide variety of consumer products.

Use the following excerpt from International Flavors & Fragrances Inc.'s 2000 annual report to calculate the dividend yield on common stock and the payout ratios. Then comment on the results.

2000 1999 1998
Earnings per share $1.22 $1.53 $1.90
Dividends per share ($) 1.29 1.52 1.48
Stock price per common share ($) 20.31 37.63 44.19
Group project D In teams of two or three students, select three companies you believe may be profitable short-term investments. Determine the current market prices for those companies' stocks from today's newspaper and the market prices six months ago. Calculate the gain or loss that your team would have recorded if it had purchased 500 shares of each company's stock six months ago and sold all of the shares today. Write a short memo to your instructor describing why you selected those companies and why you believe the market prices of their stocks increased or decreased. Also, be prepared to describe your analysis to the class.

Group project E With one or two other students, go to the library and locate Statement of Financial Standards No. 94, "Consolidation of All Majority-Owned Subsidiaries", published by the Financial Accounting Standard Board. In a report to your instructor answer questions such as: What does the standard require? Why did the FASB act on this topic? Why are "nonhomogeneous" subsidiaries included in the consolidated group? Why did one of the Board members dissent from the statement? Describe some of the important background on this topic as given in the statement.

Group project F In a small group of students, locate the annual reports of three companies with investments in other companies. Compare the accounting and reporting for the investments by the three companies. For instance, by reading the notes to the financial statements, try to determine whether they account for the investments using the cost or equity methods. Is there goodwill on the balance sheets? What else can you determine about the investments? Write a report to your instructor summarizing your findings.

Using the Internet—A view of the real world

Visit the following website for General Electric Company:

http://www.ge.com

Pursue choices on the screen until you locate the consolidated statement of financial position. You will probably go down some "false paths" to get to this financial statement, but you can get there. This experience is all part of learning to use the Internet. Check to see if there is a minority interest listed on the consolidated statement of financial position. Check out the notes to the financial statements for further information. Browse around the site for any other interesting information concerning the company. Write a memo to your instructor summarizing your findings.

  1. [1]FASB, Statement of Financial Accounting Standards No. 115, "Accounting for Certain Marketable Securities" (Stamford, Conn., 1993). Copyright © by the Financial Accounting Standards Board, Stamford, Connecticut 06856, U.S.A. Quoted (or excerpted) with permission. Copies of the complete document are available from the FASB.
  2. FASB, Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (Norwalk, Conn., 2007). Copyright © by theFinancial Accounting Standards Board, Norwalk, Connecticut 06856, U.S.A.
  3. [2]FASB, Statement of Financial Accounting Standards No. 94, "Consolidation of All Majority-Owned Subsidiaries" (Stamford, Conn., 1987), p. 5. Copyright © by the Financial Accounting Standards Board, High Ridge Park, Stamford, Connecticut 06905, U.S.A.


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