Solution manual advanced accounting 4e jeter ch03

3 An individual affiliate’s legal existence provides a measure of protection of the parent’s assets from attachment by creditors of the subsidiary.. The purpose of consolidated financial

CHAPTER 3

Note: The letter A or B indicated for a question, exercise, or problem means that the question, exercise,

or problem relates to a chapter appendix

ANSWERS TO QUESTIONS

1 (1) Stock acquisition is greatly simplified by avoiding the lengthy negotiations required in an

exchange of stock for stock in a complete takeover

(2) Effective control can be accomplished with more than 50% but less than all of the voting stock

of a subsidiary; thus the necessary investment is smaller

(3) An individual affiliate’s legal existence provides a measure of protection of the parent’s assets from attachment by creditors of the subsidiary

2 The purpose of consolidated financial statements is to present, primarily for the benefit of the shareholders and creditors of the parent company, the results of operations and the financial position

of a parent company and its subsidiaries essentially as if the group were a single company with one

or more branches or divisions The presumption is that these consolidated statements are more meaningful than separate statements and necessary for fair presentation Emphasis then is on substance rather than legal form, and the legal aspects of the separate entities are therefore ignored

in light of economic aspects

3 Each legal entity must prepare financial statements for use by those who look to the legal entity for analysis Creditors of the subsidiary will use the separate statements in assessing the degree of protection related to their claims Noncontrolling shareholders, too, use these individual statements

in determining risk and the amounts available for dividends Regulatory agencies are concerned with the net resources and results of operations of the individual legal entities

4 (1) Control should exist in fact, through ownership of more than 50% of the voting stock of the subsidiary

(2) The intent of control should be permanent If there are current plans to dispose of a subsidiary, then the entity should not be consolidated

(3) Majority owners must have control Such would not be the case if the subsidiary were in bankruptcy or legal reorganization, or if the subsidiary were in a foreign country where political forces were such that control by majority owners was significantly curtailed

5 Consolidated workpapers are used as a tool to facilitate the preparation of consolidated financial statements Adjusting and eliminating entries are entered on the workpaper so that the resulting consolidated data reflect the operations and financial position of two or more companies under common control

6 Noncontrolling interest represents the equity in a partially owned subsidiary by those shareholders who are not members in the affiliation and should be accounted and presented in equity, separately from the parents’ shareholders equity Alternative views have included: presenting the noncontrolling interest as a liability from the perspective of the controlling shareholders; presenting the noncontrolling interest between liabilities and shareholders’ equity to acknowledge its hybrid status; presenting it as a contra-asset so that total assets reflect only the parent’s share; and

presenting it as a component of owners’ equity (the choice approved by FASB in its most recent exposure drafts)

7 The fair, or current, value of one or more specific subsidiary assets may exceed its recorded value,

or specific liabilities may be overvalued In either case, an acquiring company might be willing to pay more than book value Also, goodwill might exist in the form of above normal earnings Finally, the parent may be willing to pay a premium for the right to acquire control and the related economic advantages gained

8 The determination of the percentage interest acquired, as well as the total equity acquired, is based

on shares outstanding; thus, treasury shares must be excluded The treasury stock account should be eliminated by offsetting it against subsidiary stockholder equity accounts The accounts affected as well as the amounts involved will depend upon whether the cost or par method is used to account for the treasury stock

9 None The full amount of all intercompany receivables and payables is eliminated without regard to the percentage of control held by the parent

10A The decision in SFAS No 109 and SFAS No 141R [topics 740 and 805] is primarily a display

issue and would only affect the calculation of consolidated net income if there were changes in expected future tax rates that resulted in an adjustment to the balance of deferred tax assets or

deferred tax liabilities Prior to SFAS No 109 and SFAS No 141R, purchased assets and liabilities

were displayed at their net of tax amounts and related figures for amortization and depreciation

were based on the net of tax amounts With the adoption of SFAS No 109 and SFAS No 141R,

assets and liabilities are displayed at fair values and the tax consequences for differences between their assigned values and their tax bases are displayed separately as deferred tax assets or deferred tax liabilities Although the amounts shown for depreciation, amortization and income tax expense

are different under SFAS No 109 and SFAS No 141R, absent a change in expected future tax rates,

the amount of consolidated net income will be the same

ANSWERS TO BUSINESS ETHICS CASE

Part 1

Even though the suggested changes by the CFO lie within GAAP, the proposed changes will unfairly increase the EPS of the company, misleading the common investors and other users It is evident that the CFO is doing it for his or her personal gain rather than for the transparency of financial reporting Thus, manipulating the reserve in this case comes under the heading of unethical behavior Taking a stand in such a situation is a difficult and challenging test for an employee who reports to the CFO

Part 2

The tax laws permit individuals to minimize taxes by means that are within the law like using tax deductions, changing one's tax status through incorporation, or setting up a charitable trust or foundation In the given case the losses reported were phony and the whole scheme was fabricated

to illegally benefit certain individuals; hence there appears to be a criminal intent in the scheme

ANSWERS TO EXERCISES

Exercise 3-1

Other Contributed Capital - Saltez 92,000

Other Contributed Capital – Saltez 75,000

Property, Plant, and Equipment 21,778

($232,000/0.9-[$190,000+$75,000-$29,000])

Other Contributed Capital – Saltez 40,000

Gain on Purchase of Business – Prancer ** 13,800

Noncontrolling Interest (.2) ($198,750) + $3,450* 43,200

** The ordinary gain to Prancer is $159,000 – (.80)($216,000) = $13,800

* Noncontrolling interest reflects the noncontrolling share of implied value (.20 x $198,750, or

$39,750), plus the NCI portion of the bargain (.20 x $17,250)

NOTE: We know this is a bargain acquisition in part c because the investment cost of $159,000 implies

a total value of $198,750 Since this value is less than the book value of equity of $216,000

[$180,000+$40,000-$4,000], the difference is a bargain of $17,250 This bargain is allocated between the parent (this portion is reflected as a gain) and the NCI

Other Contributed Capital – Save 175,000

Exercise 3-3

Consolidated Balance Sheet January 2, 2011 Assets

Total Liabilities and Stockholders’ Equity $1,075,333

* [$192,000/0.9 – ($70,000 + $20,000 + $95,000)] = $28,333

Exercise 3-4

Part A Investment in Swartz Company ($60 1,500) 90,000

Other Contributed Capital ($40 1,500) 60,000

Part B Computation and Allocation of Difference

Share Controlling Value

Share Purchase price and implied value $90,000 0 90,000

Difference between implied and book value 7,000 0 7,000

Exercise 3-4 (continued)

Consolidated Balance Sheet January 1, 2010

* Cost of investment less fair value acquired equals goodwill or ($90,000 – $83,000 = $7,000)

Recall that the book value of net assets equals the fair value of net assets in this problem

Part A Long-term receivable from subsidiary $500,000

Current assets: interest receivable from subsidiary $50,000

*(.40 ($52,000 + $25,000 + $71,000 + $20,000))

**228,000 – [($52,000 + $25,000 + $71,000 + $20,000) x 60%]

Exercise 3-11A

Other Contributed Capital (($70 – $5) 10,000) 650,000

Because the combination is consummated as a stock acquisition, the entry on the books of the acquirer

is no different than in the absence of deferred taxes However, in the elimination entries, a deferred tax liability will be recognized and the amount of goodwill will be altered accordingly

P S Eliminations Noncontrolling Consolidated

Problem 3-1 (continued)

Computation and Allocation of Difference (Case 2)

Share Controlling Value

Share Purchase price and implied value 190,000 21,111 211,111* Less: Book value of equity acquired 198,000 22,000 220,000

Difference between implied and book value (8,000) (889) (8,889)

Decrease long-term assets to fair value 8,000 889 8,889

Balance - 0 - - 0 - - 0 –

* $190,000/.90

Problem 3-2

Part A $100,000 Soho Total Par/$10 Par per share = 10,000 shares of Soho issued

8,000 shares acquired/10,000 total shares = 80%

Implied Value of Soho (100%) = $120,000/80% = $150,000

Implied Value of Noncontrolling share = $150,000 x 20% = $30,000

Computation and Allocation of Difference Schedule

Parent Non- Entire Share Controlling Value

Share Purchase price and implied value 120,000 30,000 150,000* Less: Book value of equity acquired:

Difference between implied and book value 8,000 2,000 10,000

Balance - 0 - - 0 - - 0 -

*$120,000/.80

Problem 3-2 (continued) PERRY COMPANY AND SUBSIDIARY SOHO

January 1, 2011

Perry Company

Soho Company

Eliminations Noncontrolling

Interest

Consolidated Balance Debit Credit

Accounts Receivable 53,000 31,000 84,000 Inventory 42,000 25,000 67,000 Investment in Soho 120,000 (1) 120,000

Difference between Implied

and Book Value (1) 10,000 (2) 10,000

Plant Assets 160,000 110,500 (2) 10,000 280,500 Accumulated Depreciation (52,000) (19,500) (71,500) Total 362,000 166,000 418,000

Current Liabilities 18,500 26,000 44,500 Mortgage Note Payable 40,000 40,000 Common Stock:

Perry Company 120,000 120,000 Soho Company 100,000 (1) 100,000

Other Contributed Capital

Perry Company 135,000 135,000 Soho Company 16,500 (1) 16,500

Retained Earnings:

Perry Company 48,500 48,500 Soho Company 23,500 (1) 23,500

Noncontrolling Interest (1) 30,000 30,000 30,000 Total 362,000 166,000 160,000 160,000 418,000

(1) To eliminate investment account and create noncontrolling interest account

(2) To allocate the difference between implied and book value to plant assets

Problem 3-3 P COMPANY AND SUBSIDIARY

Consolidated Balance Sheet Workpaper

August 1, 2011

P Company

S Company

Eliminations Noncontrolling

Interest

Consolidated Balance

Dr Cr

Cash 165,500 106,000 (b) 35,000 306,500 Receivables 366,000 126,000 (a) 800 (3) 800 457,000

(4) 35,000 Inventory 261,000 108,000 369,000 Investment in Bonds 306,000 (2) 40,000 266,000 Investment in S Company Stock 586,500 (1) 586,500

Difference between Implied and

Accounts Payable 174,000 58,000 232,000 Accrued Expenses 32,400 26,000 (3) 800 57,600 Bonds Payable, 8% 200,000 (2) 40,000 160,000 Common Stock:

Advances from P Company (4) 35,000 (b) 35,000

Total Liabilities and Equity 811,933 811,933 2,767,167

(a) To establish reciprocity for interest receivable and payable and to recognize interest earned

(b) To establish reciprocity for intercompany advances

(1) To eliminate Investment in S Company and create noncontrolling interest account

(2) To eliminate intercompany bondholdings

(3) To eliminate intercompany interest receivable and payable

(4) To eliminate intercompany advances

(5) To allocate the difference between implied value and book value to plant and equipment

Problem 3-3 (continued)

Computation and Allocation of Difference

Share Controlling Value

Share Purchase price and implied value 586,500 65,167 651,667*

Less: Book value of equity acquired ($676,000 x 9) 608,400 67,600 676,000

Difference between implied and book value (21,900) (2,433) (24,333)

Balance - 0 - - 0 - - 0 -

* $586,500/.90

Consolidated Balance Sheet Workpaper

January 2, 2011 Phillips

Company

Sanchez Company

Thomas Company

Eliminations Noncontrolling Consolidated

Balance

Dr Cr Interest Cash 7,000 43,700 20,000 70,700 Account Receivable 28,000 24,000 20,000 72,000 Note Receivable 10,000 (1) 10,000

Interest Receivable 300 (2) 300

Inventory 120,000 96,000 43,000 259,000 Investment in Sanchez Company 225,000 (3) 225,000

Investment in Thomas Company 168,000 (4) 168,000

Equipment 60,000 40,000 30,000 130,000 Land 180,000 80,000 70,000 (3) 7,250 * * 369,217

(4) 31,967 * **

Total Assets 788,000 294,000 183,000 900,917

Accounts Payable 28,000 20,000 18,000 66,000 Note Payable 10,000 (1) 10,000

Accrued Interest Payable (2) 300 (a) 300

Common Stock:

Phillips Company 300,000 300,000 Sanchez Company 120,000 (3) 120,000

Thomas Company 75,000 (4) 75,000

Other Contributed Capital:

Phillips Company 300,000 300,000 Sanchez Company 90,000 (3) 90,000

Thomas Company 40,000 (4) 40,000

Retained Earnings

Phillips Company 160,000 160,000 Sanchez Company 64,000 (3) 64,000

Thomas Company 40,000 (a) 300

(4) 39,700 * Noncontrolling Interest (3)(4)74,917 * *** 74,917 74,917 Total Liabilities and Equity 788,000 294,000 183,000 478,517 478,517 900,917

* ($40,000 – $300); ** [$225,000/.80 – ($120,000 + $90,000 + $64,000)]; *** [$168,000/.90 – ($75,000 + $40,000 + $40,000 – $300)];

**** ($225,000/.80 x 20) + ($168,000/.90 x 10)