978-0078025877 Chapter 2 Solution Manual Part 1

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential

CHAPTER 2

Q2-1 (a) An investment in the voting common stock of another company is reported on an

equity-method basis when the investor is able to significantly influence the operating and

Q2-2A Significant influence occurs when the investor has the ability to influence the operating

and financial policies of the investee. Representation on the board of directors of the investee is

Q2-3A Equity-method reporting should not be used when (a) the investee has initiated

litigation or complaints challenging the investor’s ability to exercise significant influence, (b) the

Q2-4 The balances will be the same at the date of acquisition and in the periods that follow

Q2-5 When a company has used the cost method and purchases additional shares which

cause it to gain significant influence, a retroactive adjustment is recorded to move from a cost

Q2-6 An investor considers a dividend to be a liquidating dividend when the cumulative

dividends received from the investee exceed a proportionate share of the cumulative earnings

Q2-7 Liquidating dividends decrease the investment account in both cases. All dividends are

as well.

Q2-8 A dividend is treated as a reduction of the investment account under equity-method

method.

Q2-9 Dividends received by the investor are recorded as dividend income under both the cost

and fair value methods. The change in the fair value of the shares held by the investor is

Q2–10A When the modified equity method is used, a proportionate share of subsidiary net

income and dividends is recorded on the parent‘s books and an appropriate amount of any

Q2–11 A one-line consolidation implies that under equity-method reporting the investor’s net

Q2–12A The term modified equity method generally is used when the investor records its

portion of the reported net income and dividends of the investee and amortizes an appropriate

Q2–13A The investor reports a proportionate share of an investee‘s extraordinary item as an

Q2–14 An adjusting entry is recorded on the company’s books and causes the balances

reported by the parent or subsidiary company to change. Consolidation entries, on the other

Q2–15 Each of the stockholders’ equity accounts of the subsidiary is eliminated in the

consolidation process. Thus, none of the balances is included in the stockholders’ equity

Q2–16 Additional entries are needed to eliminate all income statement and retained earnings

Q2–17 Separate parts of the consolidation worksheet are used to develop the consolidated

income statement, retained earnings statement, and balance sheet. All consolidation entries

Q2–18 None of the dividends declared by the subsidiary are included in the consolidated

Q2–19 Consolidated net income includes 100 percent of the revenues and expenses of the

Q2–20 Consolidated retained earnings is that portion of the undistributed earnings of the

Q2–21 Consolidated retained earnings at the end of the period is equal to the beginning

Q2–22 The retained earnings statement shows the increase or decrease in retained earnings

during the period. Thus, income for the period is added to the beginning balance and dividends

for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted

on a website in whole or part.

C2-1A Choice of Accounting Method

a. The equity method is to be used when an investor has significant influence over an investee.

1. Is the investee under the control of the courts or other parties as a result of filing for

2. Does the investor have representation on the board of directors, or has it attempted to

3. Has the investee initiated litigation or complaints challenging the investor’s ability to

4. Has the investor signed an agreement surrendering its ability to exercise significant

5. Is majority ownership concentrated in a small group that operates the company without

6. Is the investor able to acquire the information needed to use equity-method reporting?

b. When subsidiary net income is greater than dividends paid, equity-method reporting is likely

to show a larger reported contribution to the earnings of Slanted Building Supplies. If 20X4

earnings are negative or less than dividends distributed in 20X4, the cost basis is likely to result

C2-2 Intercorporate Ownership

MEMO

To: Chief Accountant

Most Company

From: , CPA

Re: Equity Method Reporting for Investment in Adams Company

ASC 323-10–15-6 through 15-8

C2-3A Application of the Equity Method

MEMO

To: Controller

Forth Company

From: , CPA

Re: Equity Method Reporting for Investment in Brown Company

considered as well. [ASC 323-10–15-6 through 15-8]

Although Forth currently holds only 15 percent of Brown’s common stock, the other factors

associated with its ownership indicate that Forth does exercise significant influence over Brown.

Forth has two members on Brown’s board of directors, it purchases a substantial portion of

Brown’s output, and Forth appears to be the largest single shareholder by virtue of its sale of

C2-4 Need for Consolidation Process

After the financial statements of each of the individual companies are prepared in accordance

with generally accepted accounting principles, consolidated financial statements must be

prepared for the economic entity as a whole. The individual companies generally record

C2-5 Account Presentation

MEMO

To: Chief Accountant

Prime Company

From: , Accounting Staff

Re: Combining Broadly Diversified Balance Sheet Accounts

consolidated balance sheet. The actual number of assets and liabilities presented in the

consolidated balance sheet must be carefully considered, but is the decision of Prime’s

management.

It is important to recognize that the notes to the consolidated financial statements are regarded

as an integral part of the financial statements and Prime Company is required to include in its

be combined with the parent, the equity account balances should not; (c) negative account

balances in cash or accounts receivable should be reclassified as liabilities rather than being

added to the positive balances of other affiliates if there is no right of offset in the underlying

bank accounts, and (d) assets pledged for a specific purpose and not available for other use by

the consolidated entity generally should be separately reported.

ASC 280-10

ASC 810-10–65-1

C2-6 Consolidating an Unprofitable Subsidiary

MEMO

TO: Chief Accountant

Amazing Chemical Corporation

FROM: , Accounting Staff

280–10–50]. While the operating losses of the boatyard may not be evident in analyzing the

consolidated income statement, a review of the notes to the consolidated statements should

provide adequate disclosure of its operations as a reportable segment. The financial statements

ASC 810-10–10-1

ASC 810

ASC 280-10–50

ASC 810-10–65-1

for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted

on a website in whole or part.

E2-1 Multiple-Choice Questions on Use of Cost and Equity Methods

1. a – Cash dividends received will never cause an increase in the investment account under

either method.

2. a – Because the ownership in Amal Corporation is less than 20%, the cost method should be

applied. Accordingly, the $1,500 dividend received from Amal is recorded as dividend

revenue.

3. a – Under the equity method, net income increases the investment account while dividends

decrease it. Because net income was greater than the dividends declared, this results in

a net increase in the investment account. Under the cost method, the investment would

4. b – Under the equity method the company records a share of the affiliate net income as

income for the company. This increases the net income of the company which increases

earnings per share.