a.
25%
b.
$110
c.
$138
71. The Seagram Company owns 25 percent of the shares of DuPont, and accounts for its investment using the
equity method. During the year DuPont earned income of $1,500 million and declared dividends. Seagram’s
share of the dividends were $150.0 million.
Required:
a.
What amount of income did Seagram report from its investment in DuPont?
b.
What amount of cash flow from operations did Seagram report for the year from its investment in
DuPont?
a.
$375.0 million = .25 ´ $1,500 million
b.
$150.0 million
72. Assume that P uses the equity method of accounting for its investment in S. Solve for the unknown in each
of the following independent cases:
CASE A
CASE B
CASE C
P’s ownership of S
40%
25%
40%
Investment in S—beginning of year
$100
$100
$130
Investment in S—end of year
$120
$150
$120
S’s income (loss)
A
300
C
S’s dividends paid
80
B
0
A.
$130
B.
$100
C.
$(25)
73. State the purpose of consolidated financial statements. Define which subsidiaries must be included in
consolidated financial statements.
74. The CRUISES Corporation has been using the equity method for its 100-percent owned subsidiary,
Camellia Company, which has both assets and liabilities on its balance sheet and both revenues and expenses on
its income statement. Camellia has positive cash flow from operations. CRUISES now consolidates the
accounts of the Camellia Company, which it has owned 100 percent since organizing it. Camellia has no
investments of its own and regularly declares dividends greater than zero, but less than net income.
Required:
Answer the following questions with one of these: larger, smaller, unchanged, or insufficient (information given
to answer question).
a.
What would be the effect on net income of CRUISES Corporation?
b.
What would be the effect on revenues, including investment income, of CRUISES Corporation?
c.
What would be the effect on investments of CRUISES Corporation?
d.
What would be the effect on assets of CRUISES Corporation?
e.
What would be the effect on liabilities of CRUISES Corporation?
f.
What would be the effect on the debt/equity ratio (= Liabilities/Total Equities)?
a.
Unchanged
d.
Larger
b.
Larger
e.
Larger
c.
Smaller
f.
Larger
75. The adjusted, preclosing trial balances of Parent Company and Sub Company on December 31, Year 2,
appear below.
Parent
Company
Sub Company
$ 4,000
$ 1,000
Accounts Receivable
Merchandise Inventory
10,000
10,000
Investment in Sub Company
9,000
—
Land
l,000
2,000
Buildings and Equipment, net
5,000
Accounts Payable
$17,500
$12,500
Bonds Payable
5,000
4,000
Common Stock
2,500
1,000
Additional Paid-in Capital
1,000
2,500
Retained Earnings, January 1
10,500
2,000
Sales
35,000
25,000
Equity in Earnings of Sub Company
5,000
—
Cost of Goods Sold
25,000
17,500
Selling and Administrative Expenses
5,000
2,500
Dividends Declared
2,500
_______
1,500
Totals
$76,500
$76,500
$47,000
$47,000
Parent Company owns 100 percent of the common stock of Sub Company. It acquired the shares on January 2,
Year 1, for an amount equal to the book value of Sub Company’s underlying net assets. On December 31, Year
2, Sub Company owes Parent Company $1,100 arising from short-term working capital loans.
Required:
Prepare in journal entry form the elimination entries required on December 31, Year 2, to prepare a
consolidated financial statement for Parent Company and Sub Company. Note that neither a formal work sheet
nor formal financial statements are required.
Common Stock
1,000
Additional Paid-in Capital
2,500
Retained Earnings
2,000
Equity in Earnings of Sub Company
5,000
Dividends Declared
1,500
Investment in Sub Company
9,000
To eliminate the investment account.
Accounts Payable
1,100
Accounts Receivable
l,100
To eliminate intercompany loan.
76. Pioneer Co. owns 100% of Scout Co. Pioneer has owned Scout since Scout was incorporated. At December
31, $15,000 of Scout’s accounts receivable represent amounts payable by Pioneer. $10,000 of Pioneer’s accounts
receivable represent amounts payable by Scout. During the current year, Scout sold $10,000 in merchandise to
Pioneer (at cost its cost of $10,000). Pioneer has sold all the merchandise purchased from Scout.
CONDENSED BALANCE SHEETS
As of December 31
Assets
Pioneer
Scout
Accounts receivable
$ 60,000
$ 40,000
Investment in Scout (equity)
130,000
–
Other assets
1,000,000
200,000
Total assets
$1,190,000
$240,000
Liabilities and Equity
Accounts payable
$ 50,000
$ 20,000
Other liabilities
640,000
90,000
Common stock
100,000
150,000
Retained earnings
400,000
(20,000)
Total liabilities and equity
$1,190,000
$240,000
CONDENSED INCOME STATEMENT
for Current Year
Pioneer
Scout
Sales
$300,000
$ 90,000
Equity in earnings of Scout
(10,000)
—
Total revenues
$290,000
$ 90,000
Cost of goods sold
$160,000
60,000
Depreciation
50,000
20,000
Other expenses
20,000
20,000
Tax expense
20,000
—
Total expenses
$250,000
$100,000
Net income
$ 40,000
$(10,000)
Required:
Prepare the appropriate elimination entries necessary to prepare a consolidated balance sheet and income
statement.
a.
Common Stock—Scout
150,000
Retained Earnings—Scout (1/1)
10,000
Equity in Earnings of Scout
10,000
Investment in Scout
130,000
b.
Accounts Payable
25,000
Accounts Receivable
25,000
c.
Sales
10,000
Cost of Goods Sold
10,000
77. On January 1, Year 1, Photo Co. purchased for $180,000, 90% of Snake Co. at a time when Snake had a
book value of $200,000. There were no intercompany transactions during year 4.
CONDENSED BALANCE SHEETS
As of December 31, Year 4
Assets
Photo
Snake
Accounts receivable
$ 50,000
$ 40,000
Investment in Snake (equity)
270,000
–
Other assets
1,680,000
710,000
Total assets
$2,000,000
$750,000
Liabilities and Equity
Accounts payable
$ 40,000
$ 50,000
Other liabilities
1,360,000
400,000
Common stock
200,000
200,000
Retained earnings
400,000
100,000
Total liabilities and equity
$2,000,000
$750,000
CONDENSED INCOME STATEMENT
for Current Year
Photo
Snake
Sales
$800,000
$200,000
Equity in earnings of Snake
18,000
–
Total revenues
$818,000
$200,000
Cost of goods sold
500,000
$120,000
Depreciation
100,000
30,000
Other expenses
78,000
20,000
Tax expense
40,000
10,000
Total expenses
$718,000
$180,000
Net income
$100,000
$ 20,000
Required:
Prepare the appropriate elimination and reclassification entries necessary to prepare a consolidated balance
sheet and income statement.
a.
Common Stock-Snake
180,000
Retained Earnings—Snake (1/1)
72,000
Equity in Earnings of Snake
18,000
Investment in Snake
270,000
b.
Common Stock-Snake
20,000
Retained Earnings—Snake (1/1)
8,000
Minority Equity in Earnings
2,000
Minority Interest in Net Assets of Snake
30,000
78. Given the following separate company balance sheets and income statements, answer the following
questions.
CONDENSED BALANCE SHEETS
As of December 31, Year 4
Assets
Plant
Scone
Accounts receivable
$ 50,000
$ 40,000
Investment in Scone (equity)
300,000
–
Other assets
1,680,000
710,000
Total assets
$2,030,000
$750,000
Liabilities and Equity
Accounts payable
$ 70,000
$ 50,000
Other liabilities
1,360,000
400,000
Common stock
200,000
200,000
Retained earnings
400,000
100,000
Total liabilities and equity
$2,030,000
$750,000
CONDENSED INCOME STATEMENT
for the year ended December 31, Year 4
Plant
Scone
Sales
$800,000
$200,000
Equity in earnings of Scone
20,000
–
Total revenues
$820,000
$200,000
Cost of goods sold
$500,000
$120,000
Depreciation
100,000
30,000
Other expenses
80,000
20,000
Tax expense
40,000
10,000
Total expenses
$720,000
$180,000
Net income
$100,000
$ 20,000
Additional information:
Plant acquired its investment in the stock of Scone on the date of Scone’s incorporation.
Consolidated accounts receivable is $80,000.
Consolidated sales total $900,000.
No purchases from Scone remain in Plant’s ending inventory.
Required:
a.
What percentage of Scone does Plant appear to own?
b.
What is beginning retained earnings of Plant?
c.
How much was Plant’s initial investment in Scone?
d.
What is the amount of intercompany accounts receivable?
e.
What is consolidated cost of goods sold?
a.
100%
b.
$300,000
c.
$200,000
d.
$ 10,000
e.
$520,000
79. Given the following consolidated balance sheet and additional information, prepare a separate company
balance sheet and income statement for P.
–
P owns 100% of S.
–
S sold $20,000 of inventory to P.
–
P sold all of the inventory it purchased from S.
–
$10,000 of S’s accounts receivable are payable by P.
As of December 31, Year 4
Accounts receivable
$ 50,000
Other assets
1,680,000
Total assets
$1,730,000
Accounts payable
$ 80,000
Other liabilities
1,200,000
Common stock
50,000
Retained earnings
400,000
Total liabilities and equity
$1,730,000
for the year ended December 31, Year 4
Sales
$780,000
Total revenues
$780,000
Cost of goods sold
$490,000
Depreciation
120,000
Other expenses
15,000
Tax expense
55,000
Total expenses
$680,000
CONDENSED BALANCE SHEETS
As of December 31, Year 4
Assets
P
S
Accounts receivable
(a)
$ 40,000
Investment in S (equity)
(b)
–
Other assets
(c)
400,000
Total assets
(d)
$440,000
Liabilities and Equity
Accounts payable
(e)
$ 40,000
Other liabilities
(f)
200,000
Common stock
(g)
100,000
Retained earnings
(h)
100,000
Total liabilities and equity
(i)
$440,000
CONDENSED INCOME
STATEMENT
for the year ended December 31,
Year 4
P
S
Sales
(j)
$200,000
Equity in earnings of S
(k)
–
Total revenues
(l)
$200,000
Cost of goods sold
(m)
110,000
Depreciation
(n)
20,000
Other expenses
(o)
5,000
Tax expense
(p)
15,000
Total expenses
(q)
$150,000
Net income
(r)
$ 50,000
CONDENSED BALANCE SHEETS
As of December 31, Year 4
Assets
P
S
Accounts receivable
$ 20,000
$ 40,000
Investment in S (equity)
200,000
–
Other assets
1,280,000
400,000
Total assets
$1,500,000
$440,000
Liabilities and Equity
Accounts payable
$ 50,000
$ 40,000
Other liabilities
1,000,000
200,000
Common stock
50,000
100,000
Retained earnings
400,000
100,000
Total liabilities and equity
$1,500,000
$440,000
CONDENSED INCOME STATEMENT
for the year ended December 31, Year 4
P
S
Sales
$600,000
$200,000
Equity in earnings of S
50,000
–
Total revenues
$650,000
$200,000
Cost of goods sold
400,000
110,000
Depreciation
100,000
20,000
Other expenses
10,000
5,000
Tax expense
40,000
15,000
Total expenses
$550,000
$150,000
Net income
$100,000
$ 50,000
80. What role does management intent play in the accounting treatment of marketable equity securities?
81. Why would a firm choose to acquire less than 50 percent of an organization yet not desire to exercise
significant influence within the organization?
82. Kofe Company manufactures and sells coffee products. The cost of coffee products depends primarily on
the cost of coffee commodities. On January 1, Year 5, Kofe Company had excess inventories of commodities it
had acquired at a cost of $50,000. The company can use those commodities later to produce coffee products, or
it can sell the commodities now to others. To hedge against possible declines in the price of the coffee
commodity, Kofe Company sold commodity futures, obligating the company to deliver the commodities at the
end of February for a price to be received then of $60,000.
Required:
a.
Is this hedge a cash-flow hedge or a fair-value hedge? Explain your answer.
b.
How are gains/losses recognized?
a.
This is a cash-flow hedge. It is hedging the exposure to variability in expected future cash flows
attributable to a particular risk.
b.
Gains/losses are reported as a component of other comprehensive income and reclassified into earnings
in the same period during which the hedged transaction affects earnings. Any gains or losses associated
with hedge ineffectiveness would be recognized in income immediately in the period in which they
occur.
83. Parent Computer Corporation acquired significant influence over Child Computer Company on January 2
by purchasing 20 percent of its outstanding stock for $100 million. Parent attributes the entire excess of cost
over book value acquired to a patent, which it amortizes over 10 years. Child Computer had earnings of $100
million and declared dividends of $30 million during the year. The accounts receivable of Parent Computer
Corporation at December 31 included $600,000 due from Child Computer. Parent Computer Corporation
accounts for its investment in Child Computer using the equity method. Parent Computer Corporation considers
reducing its ownership from 20 percent to 19.5 percent so that it no longer has to use the equity method.
Comment on the ethical implications of this possibility.
Ethical issues confront Parent Computer Corporation’s management when they make financial reporting
84. Describe the accounting and reporting of investments in common stock.
OVERVIEW OF THE ACCOUNTING FOR AND REPORTING OF INVESTMENTS
IN COMMON STOCK
The accounting for investments in common stock depends on (1) the expected holding period,
and (2) the purpose of the investment, as determined by both the percentage held and management intent.
EXPECTED HOLDING PERIOD
as a noncurrent asset on the balance sheet. For our purpose, the word investment is reserved for holdings with a
long-term purpose.
PURPOSE OF AN INVESTMENT IN COMMON STOCK
The purpose of an investment in common stock and the percentage of common stock held combine to determine
the accounting for that investment.
85. Describe the accounting for minority, active investments.
MINORITY, ACTIVE INVESTMENTS
When an investor owns less than a majority of the voting stock of another corporation, the accountant must
judge when the investor can exert significant influence. For the sake of uniformity, U.S. GAAP and IFRS
presume that significant influence exists at 20% ownership (that is, when the investor owns 20% or more of the
voting stock of the investee). Significant influence can exist at lower ownership levels, provided management
has a contractual or other basis to demonstrate that influence.
U.S. GAAP and IFRS require firms to account for minority, active investments, generally those where the
investor owns between 20% and 50%, using the equity method. Under the equity method, the investor
recognizes as revenue (expense) each period its share of the net income (loss) of the investee. The investor
recognizes dividends received from the investee as a return (reduction) of investment, not as income.
appear in earnings until P realizes the fair value increase. Because P, by assumption, exerts significant influence
over S, it can affect S’s dividend policy, which in turn affects P’s net income. For example, if P would like to
increase its income for a particular period, it can pressure S to raise S’s dividend for the period or pay a special
dividend. When P can so easily manage its own net income (via influencing the dividend policy of S),
measuring its investment in S at fair value and reporting unrealized gains and losses in other comprehensive
income will not reasonably reflect P’s net income from investing in S. The rationale for the equity method is
that it better measures an investor’s income from investing activities when, because of its ownership interest, it
can exert significant influence over the operations and dividend policy of the investee.
P does not reclassify this excess out of its Investment in Stock of S account to Buildings and Equipment and to
Goodwill. However, P must amortize (or depreciate) any amount attributed to assets with limited lives. Thus, P
must depreciate the premium attributed to buildings and equipment over their remaining useful lives. U.S.
GAAP and IFRS do not permit the investor to amortize the excess purchase price attributed to goodwill and
other assets with indefinite lives. Instead, the investor must test the investment account annually for possible
impairment. Impairment occurs when the balance sheet carrying value exceeds the fair value of the investment.
The investor applies the impairment test to its investment in the investee, not to the investee’s individual assets
and liabilities.
On the balance sheet, an investment accounted for with the equity method appears among noncurrent assets.
The amount shown generally equals the acquisition cost of the shares, plus P’s share of S’s undistributed
86. Discuss the accounting for majority, active investments.
MAJORITY, ACTIVE INVESTMENTS
When one firm, P, owns more than 50% of the voting stock of another company, S, P can control the activities
of S in terms of both broad policy making and day-to-day operations. Common usage refers to the majority
investor as the parent and to the majority-owned company as the subsidiary. U.S. GAAP and IFRS require the
parent to combine the financial statements of majority-owned companies with those of the parent in
consolidated financial statements.
REASONS FOR LEGALLY SEPARATE CORPORATIONS
Business firms have several reasons for preferring to operate as a group of legally separate corporations, rather
than as a single entity. From the standpoint of the parent company, the more important reasons for maintaining
legally separate subsidiary companies include the following:
A firm may enter a new line of business, or expand an existing line, by acquiring a controlling interest in
another company’s voting stock. This approach may be faster, less expensive, and less risky than constructing a
new plant or starting a new line of business.
assets separately. In addition, a sale of shares transfers all known and, perhaps, unknown liabilities to a buyer.
PURPOSE OF CONSOLIDATED STATEMENTS
For various reasons, then, a single economic entity may exist in the form of a parent and
several legally separate subsidiaries, often referred to as an affiliated group. A consolidation
of the financial statements of the parent and each of its subsidiaries presents the results of operations, financial
position, and cash flows of an affiliated group of companies under the control of a parent as if the group of
companies composed a single entity. The parent and each subsidiary are legally separate entities that operate as
one centrally controlled economic entity. Consolidated financial statements generally provide more useful
information to the shareholders of the parent corporation than do separate financial statements for the parent and
each subsidiary.
87. Describe U.S. GAAP and IFRS requirements in accounting for the business combination.
THE PURCHASE TRANSACTION
In a business combination, one corporation either
1. Acquires the assets and assumes the liabilities of another corporation, or
2. Acquires all, or a majority, of another corporation’s common shares and thereby acquires
a controlling interest in the net assets of the other corporation.
In both cases, U.S. GAAP and IFRS require firms to account for the business combination
using the acquisition, or purchase, method. The acquisition method views a business
combination as conceptually identical to the purchase of any single asset (for example, inventory or a machine).
Application of the acquisition method involves two steps:
88. Why do accountants sometimes refer to the equity method as a one-line consolidation?
89. What is a noncontrolling interest in a consolidated subsidiary?
90. Describe what a consolidated income statement shows.
91. Describe the limitations of consolidated statements.
92. Describe the U.S. GAAP requirement in accounting for joint venture investments.,
JOINT VENTURE INVESTMENTS
93. Variable interest entities have what characteristics?
VARIABLE INTEREST ENTITIES
The usual criterion for preparing consolidated financial statements is voting control in the
form of majority ownership of common stock. However, for some entities common stock
ownership does not indicate control because the common stock of the entity lacks one or
more of the economic characteristics associated with equity. U. S. GAAP refers to such entities as a variable
interest entity (VIE). A variable interest entity is an entity that meets one or both of the following criteria:
94. What are qualifying special purpose entities?
QUALIFYING SPECIAL PURPOSE ENTITIES
Both U.S. GAAP and IFRS address the accounting for sales of financial assets in exchange for cash when the
seller or transferor has continuing involvement. In some cases, the transferee (the entity that receives the
transferred financial assets) has some of the characteristics of a VIE. However, U.S. GAAP specifically
The accounting for investments in equity securities subsequent to acquisition depends on the ownership
percentage: The fair value method generally applies when the investor owns less than 20%. The equity method
generally applies when the investor owns at least 20% but not more than 50% of the common stock of another
company (the investee). The equity method applies also when the investor can exercise significant influence
over the investee even though it owns less than 20%. Firms have the option to use the fair value method instead