Solution manual advanced financial accounting, 8th edition by baker chap003

CHAPTER 3 THE REPORTING ENTITY AND CONSOLIDATED FINANCIAL STATEMENTSANSWERS TO QUESTIONS Q3-1 The basic idea underlying the preparation of consolidated financial statements is the notion

CHAPTER 3 THE REPORTING ENTITY AND CONSOLIDATED FINANCIAL STATEMENTS

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 theresults of operations of a parent and its subsidiaries as if the related companies actuallywere 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 sheetprovides a much better picture of both the total assets under the control of the parentcompany and the financing used in providing those resources Similarly, the consolidatedincome statement provides a better picture of the total revenue generated and the costsincurred in generating the revenue Estimates of future profit potential and the ability to meetanticipated funds flows often can be more easily assessed by analyzing the consolidatedstatements

Q3-3 Parent company shareholders are likely to find consolidated statements more useful.

Noncontrolling shareholders may gain some understanding of the basic strength of theoverall economic entity by examining the consolidated statements; however, they have nocontrol over the parent company or other subsidiaries and therefore must rely on the assetsand 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 noncontrollingshareholders

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 hasdirect or indirect control over a majority of the common stock of another company The FASBhas 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 theparent has control of the subsidiaries, the assets held by the subsidiaries are potentiallyavailable to satisfy parent company debts Long-term creditors of the parent generally mustrely on the soundness and operating efficiency of the overall entity, which normally is bestseen by examining the consolidated statements On the other hand, creditors of a subsidiarytypically 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 particularlyuseful 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 companyand control its actions Unless the investor holds controlling interest, there is always achance that another party may acquire a sufficient number of shares to gain control of thecompany, 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 commonstock of another company The Financial Accounting Standards Board is currently working on

a broader definition of control At present, consolidation should occur whenever majorityownership is held unless other circumstances indicate that control is temporary or does notrest 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 toreduce its ownership below 50 percent shortly after year-end, the subsidiary should not beconsolidated Control generally cannot be exercised when a subsidiary is under the control

of the courts in bankruptcy or reorganization While most foreign subsidiaries should beconsolidated, subsidiaries in countries with unstable governments or those in which there arestringent 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 controlover other entities without being forced to include them in their consolidated financialstatements For example, contractual arrangements often have been used to provide controlover variable interest entities even though another party may hold a majority (or all) of theequity 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 specialpurpose entity typically purchases the financial assets from the company with moneyreceived from issuing some form of collateralized obligation If the company had borrowedthe money directly, its debt ratio would be substantially increased

Q3-11 A variable purpose entity normally is not involved in general business activity such as

producing products and selling them to customers They often are used to acquire financialassets from other companies or to borrow money and channel it other companies A verylarge portion of the assets held by variable purpose entities typically is financed by debt and

a small portion financed by equity holders Contractual agreements often give effectivecontrol of the activities of the special purpose entity to someone other than the equityholders

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 willabsorb a majority of the entity’s expected losses or receive a majority of the entity’sexpected 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 controlCompany 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, mayprovide a company with complete control of both the operating and financing decisions ofanother company In other cases, ownership of a substantial portion of a company's sharesand a broad based ownership of the other shares may give effective control to a companyeven though it does not have majority ownership There is no prohibition to consolidationwith less than majority ownership; however, few companies have elected to consolidate withless than majority control

Q3-15 Unless intercorporate receivables and payables are eliminated, there is an

overstatement of the true balances The result is a distortion of the current asset ratio andother ratios such as those that relate current assets to noncurrent assets or current liabilities

to noncurrent liabilities or to stockholders' equity balances

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 arenot 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 tononcontrolling shareholders in the consolidated balance sheet rather than being shown asstock 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 beadjusted 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 parentcompany either directly or indirectly controls one or more subsidiaries Combined financialstatements are prepared for a group of companies or business entities when there is noparent-subsidiary relationship For example, an individual who controls several companiesmay gain a clearer picture of the financial position and operating results of the overalloperations 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 financialstatements 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 ofthe 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 bothcontrolling and noncontrolling shareholders, each with an equity interest in the consolidatedentity The assets and liabilities of the subsidiary are included in the consolidatedstatements at 100 percent of their fair value at the date of acquisition and consolidated netincome includes the earnings to both controlling and noncontrolling shareholders A majordifference occurs in presenting retained earnings in the consolidated balance sheet Onlyundistributed earnings related to the controlling interest are included in the retained earningsbalance

Q3-22* The entity theory is closest to the newly adopted procedures used in current

practice

SOLUTIONS TO CASES

C3-1 Computation of Total Asset Values

The relationship observed should always be true Assets reported by the parent companyinclude 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 intercompanyreceivables and payables between the companies that must be eliminated whenconsolidated statements are prepared In addition, inventory or other assets reported by theindividual companies may be overstated as a result of unrealized profits on intercorporatepurchases and sales The amounts of the assets must be adjusted and the unrealized profitseliminated in the consolidation process In addition, subsidiary assets and liabilities at thetime the subsidiaries were acquired by the parent may have had fair values different fromtheir 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 accountingentity in terms of a specific firm, enterprise, or economic unit that is separate and apartfrom the owner or owners and from other enterprises The accounting entity has notnecessarily been defined in the same way as a legal entity For example, partnershipsand sole proprietorships are accounted for separately from the owners although such adistinction might not exist legally Thus, it was recognized that the transactions of theenterprise should be accounted for and reported on separately from those of theowners

An extension of this approach is to define the accounting entity in terms of an economicunit that controls resources, makes and carries out commitments, and conductseconomic activity In the broadest sense an accounting entity could be established inany situation where there is an input-output relationship Such an accounting entity may

be an individual, a seeking or not-for-profit enterprise, or a subdivision of a seeking or not-for-profit enterprise for which a system of accounts is maintained Thisapproach is oriented toward providing information to the economic entity which it canuse in evaluating its operating results and financial position

profit-An alternative approach is to define the accounting entity in terms of an area ofeconomic 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'sinterest In theory a number of separate legal entities or economic units could beincluded in a single accounting entity Thus, this approach is oriented to the externalusers of financial reports

C3-2 (continued)

(2) The way in which an accounting entity is defined establishes the boundaries of thepossible objects, attributes, or activities that will be included in the accounting recordsand reports Knowledge as to the nature of the entity may aid in determining (1) whatinformation to include in reports of the entity and (2) how to best present informationabout the entity so that relevant features are disclosed and irrelevant features do notcloud the presentation

The applicability of all other generally accepted concepts (or principles or postulates) ofaccounting (for example, continuity, money measurement, and time periods) depends

on the established boundaries and nature of the accounting entity The other accountingconcepts lack significance without reference to an entity The entity must be definedbefore the balance of the accounting model can be applied and the accounting canbegin Thus, the accounting entity concept is so fundamental that it pervades allaccounting

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 andExchange Commission, financial executives, and members of the accountingprofession

(3) Most large corporations issue consolidated financial reports These statementsoften include the financial statements of a number of separate legal entities that areconsidered to constitute a single economic entity for financial reporting purposes

(4) Although the accounting entity often is defined in terms of a business enterprisethat is separate and distinct from other activities of the owner or owners, it also ispossible for an accounting entity to embrace all the activities of an owner or a group ofowners Examples include financial statements for an individual (personal financialstatements) and the financial report of a person's estate

(5) The entire economy of the United States also can be viewed as an accountingentity Consistent with this view, national income accounts are compiled by the U S.Department of Commerce and regularly reported

C3-3 Recognition of Fair Value and Goodwill

MEMO

TO: Mr R U Cleer, Chief Financial Officer

March Corporation

From: , CPA

Re: 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 Ember’s net assets was $810,000 and March’s 65 percentshare of that amount was $526,500 Management determined that the fair value of Ember’sassets was $960,000, and March’s 65 percent share of the difference between fair value andbook value was $97,500 The remaining amount of the purchase price was allocated togoodwill, computed as follows:

Under FASB Statement No 141R, 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, asevidenced 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 Emberare valued at their $960,000 total fair value, resulting in a $150,000 increase over their bookvalue Goodwill is calculated as the difference between the $1,090,000 total fair value ofEmber 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 inMarch’s consolidated balance sheet prepared immediately after the acquisition of Ember

and the amounts that would have been reported had FASB Statement No 141R been in

Amortization of the fair value increment in March’s 2008 consolidated income statement was

$9,750 ($97,500/10) Under FASB Statement No 141R, the annual write-off would have

been $15,000 ($150,000/10)

Primary citations:

FASB 141

FASB 141R

C3-4 Joint Venture Investment

a ARB No 51 and FASB Interpretation No 46R (FIN 46R) are the primary authoritative

pronouncements dealing with the types of ownership issues arising in this situation Undernormal circumstances, the company holding majority ownership in another entity is expected

to consolidate that entity in preparing its financial statements Thus, unless othercircumstances dictate, Dell should have planned to consolidate DFS as a result of its 70

percent equity ownership While FIN 46R is a highly complex document and greater detail of

the ownership agreement may be needed to decide this matter, the interpretation appears topermit equity holders to avoid consolidating an entity if the equity holders (1) do not have theability to make decisions about the entity’s activities, (2) are not obligated to absorb theexpected 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].

It does appear that Dell and CIT Group do, in fact, have the ability to make operating andother decisions about DFS, they must absorb losses in the manner set forth in theagreement, 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 toconsolidation

Dell might argue that it need not consolidate DFS because the joint venture agreementapparently did allocate losses initially to CIT However, these losses were to be recoveredfrom future income Thus, both Dell and CIT were to be affected by the profits and losses ofDFS Given the importance of DFS to Dell and representation on the board of directors byCIT, DFS would not be expected to sustain continued losses

In light of the joint venture arrangement and Dell’s ownership interest, consolidation by Dellseems appropriate and there seems to be little support for Dell not consolidating DFS

b Dell fully consolidated DFS in its latest financial statements in which the joint venture isreported Dell indicated that it is the primary beneficiary of DFS Under the revised jointventure agreement, both profits and losses of DFS are shared 70 percent to Dell and 30percent to CIT Thus, with a 70 percent ownership interest and an allocation of losses inaddition to profits, the requirement to consolidate DFS is quite clear Note (from Dell’s SECForm 10-K) that Dell has an option to purchase CIT’s interest in DFS Thus, DFS maybecome wholly owned by Dell

c Yes, Dell does employ off-balance sheet financing It sells customer financing receivables

to qualifying special purpose entities In accordance with current standards, qualifying SPEsare not consolidated

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 thedate of acquisition Then, the excess of the fair value of the consideration given by Sharp toacquire its ownership interest in Moore, plus the fair value of the noncontrolling interest, overthe sum of the amounts assigned to the identifiable assets acquired less liabilities assumedshould be recognized as goodwill

b Consolidated financial statements should be prepared in order to present the financialposition and operating results for an economic entity in a manner more meaningful than ifseparate 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 whenone 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 OnJanuary 1, 2006, Viacom divided its operations by spinning off to Viacom shareholdersownership of CBS Corporation Following the division Viacom continues to own MTV,Nickelodeon, Nick at Nite, Comedy Central, CMT, Country Music Television, ParamountPictures, Paramount Home Entertainment, SKG, BET, Dreamworks, and other relatedcompanies Summer Redstone holds controlling interest in both Viacom and CBS andserves as Executive Chairman of both companies

b Some of the well-known product lines of ConAgra include Healthy Choice, Pam, PeterPan, Slim Jim, Swill Miss, Orville Redenbacher’s, Hunt’s, Reddi-Wip, VanCamp, Libby’s,LaChoy, Egg Beaters, Wesson, Banquet, Blue Bonnet, Chef Boyardee, Parkay, andRosarita

c Yum! Brands, Inc., is the world’s largest quick service restaurant company Well knownbrands include Taco Bell, A&W, KFC, and Pizza Hut Yum was originally spun off fromPepsico in 1997 Prior to its current name, Yum’s name was TRICON Global Restaurants,Inc

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 isavailable in filings with the SEC (www.sec.gov)

a General Electric was never able to turn Kidder, Peabody into a profitable subsidiary Infact, Kidder became such a drain on the resources of General Electric, that GE decided toget rid of Kidder Unfortunately, GE was unable to sell the company as a whole andultimately broke the company into pieces and sold the pieces that it could GE suffered largelosses from its venture into the brokerage business

b Sears, Roebuck and Co has been a major retailer for many decades For a while, Searsattempted to provide virtually all consumer needs so that customers could purchase financialand 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 manysubsidiaries), real estate (Coldwell Banker Real Estate Group, consisting of manysubsidiaries), brokerage and investment advisor services (Dean Witter), credit cards (Searsand Discover Card), and various other related services through many different subsidiaries.During the mid-nineties, Sears sold or spun off most of its subsidiaries that were unrelated toits core business, including Allstate, Coldwell Banker, Dean Witter, and Discover On March

24, 2005, Sears Holding Corporation was established and became the parent company forSears, 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 storesand 1,100 specialty retail stores in the United States, and approximately 370 full-line andspecialty 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, thesesubsidiaries were spun off to a new company, TRICON Global Restaurants, with TRICON'sstock 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 saltysnacks

d When consolidated financial statements are presented, financial statement users areprovided with information about the company's overall operations Assessments can bemade 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 ofother companies may not be similar If a company operates in a number of differentindustries, consolidated financial statements may not permit detailed comparisons with othercompanies unless the other companies operate in all of the same industries, with about thesame 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 areincluded in the financial statements Similarly, standard measures used in comparingfinancial institutions might be distorted when financial statement information includes datarelating to manufacturing or merchandising operations A partial solution to the problemresults from providing disaggregated (segment or line-of-business) information along withthe consolidated financial statements, as required by the FASB

C3-8 International Consolidation Issues

The following answers are based on information from the Financial Accounting StandardsBoard website at www.fasb.org, the International Accounting Standards Board website atwww.iasb.org, and from the PricewaterhouseCoopers publication entitled Similarities and Differences ─ A Comparison of IFRS and US GAAP, available at

www.pwc.com/extweb/pwcpublications.nsf/docid/74d6c09e0a4ee610802569a1003354c8.PWC updates the site regularly, and more current information may be available

a Parent companies must prepare consolidated financial statements that include allsubsidiaries However, if the parent itself is wholly owned by another entity, the companymay be exempt from this requirement For the company to be exempt, the owners of theminority interest must have been informed and they must indicate that they do not object toomitting the consolidated statements Additionally, the parent’s securities must not bepublicly traded and the parent must not be in the process of issuing such securities Further,the immediate or ultimate parent must still publish consolidated financial statements thatcomply with IFRS

b According to IFRS, if any excess of fair value over the purchase price arises, theacquiring company must reassess the acquired identifiable assets, liabilities and contingentliabilities to determine that they have been properly identified and valued The acquiringcompany must also reassess the cost of the combination If there is still a differential afterreassessment, this amount is recognized immediately in the income statement This

treatment is consistent with the FASB’s current standard on business combinations (FASB Statement No 141R).

c 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 goodwilland for the subsequent evaluation of goodwill for potential impairment However, theaggregation of CGUs for goodwill allocation and evaluation must not be larger than asegment

Similar to U.S GAAP, the impairment review must be done annually, but the evaluation datedoes not have to coincide with the end of the reporting year However, if the annualimpairment test has already been performed prior to the allocation of goodwill acquiredduring the fiscal year, a subsequent impairment test is required before the balance sheetdate

While U.S GAAP requires a two-step impairment test, IFRS requires a one-step test Therecoverable amount, which is the greater of the net fair market value of the CGU and thevalue of the unit in use, is compared to the book value of the CGU to determine if animpairment loss exists A loss exists when the carrying value exceeds the recoverableamount This loss is recognized in operating results The impairment loss applies to all ofthe 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 ismade on a pro rata basis to the other assets in the CGU

C3-9 Off-Balance Sheet Financing and VIEs

a Off-balance sheet financing refers to techniques that allow companies to borrow whilekeeping the debt, and related assets, from being reported in the company’s 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 ascollateral

(3) A company may create a new VIE and transfer assets to the new entity in exchange forcash

c VIEs may serve a genuine business purpose, such as risk sharing among investors andisolation of project risk from company risk

d VIEs may be structured to avoid consolidation To the extent that standards forconsolidation are rule-based, it is possible to structure a VIE so that it is not consolidatedeven if the underlying economic substance of the entity would indicate that it should beconsolidated By artificially removing debt, assets, and expenses from the financial reports ofthe sponsoring company, the financial position of a company and the results of its operationscan be distorted The FASB has been working to ensure that rule-based consolidationstandards result in financial statements that reflect the underlying economic substance

C3-10 Alternative Accounting Methods

a Amerada Hess’s (www.hess.com) interests in oil and gas exploration and productionventures are proportionately consolidated (pro rata consolidation), a frequently foundindustry practice in oil and gas exploration and production Investments in affiliatedcompanies, 20 to 50 percent owned, are reported using the equity method A 50 percentinterest in a trading partnership over which the company exercises control is consolidated

b Although EnCana Corporation (www.encana.com) reports investments in companies overwhich it has significant influence using the equity method Investments in jointly controlledcompanies and ventures are accounted for using proportionate consolidation EnCana is aCanadian company Proportionate consolidation is found more frequently outside of theUnited States Although not considered generally accepted in the United States,proportionate (pro rata) consolidation is nevertheless sometimes found in the oil and gasexploration 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 proportionateconsolidated citing joint control as the reason

C3-11 Consolidation Differences among Major Corporations

a Union Pacific is rather unusual for a large company It has only two subsidiaries:

Union Pacific Railroad Company

Southern Pacific Rail Corporation

b Exxon Mobil does not consolidate majority owned subsidiaries if the minority

shareholders have the right to participate in significant management decisions Exxon Mobil does consolidate 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 Corporation’s voting interests.” The company uses the 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

E3-4 Multiple-Choice Questions on Consolidation Overview

d $200,000 (as reported by Guild Corporation)

E3-6 Balance Sheet Consolidation with Intercompany Transfer

a $645,000 = $510,000 + $135,000

b $845,000 = $510,000 + $350,000 - $15,000

c $655,000 = ($320,000 + $135,000) + $215,000 - $15,000

d $190,000 (as reported by Potter Company)

E3-7 Intercompany Transfers

a Consolidated current assets will be overstated by $37,000 if no eliminations are made.Inventory will be overstated by $25,000 and accounts receivable will be overstated by

$12,000

b Net working capital will be overstated by $25,000 due to unrealized intercompanyinventory profits The overstatement of accounts payable and accounts receivable willoffset

c Net income of the period following will be understated by $25,000 as a result ofoverstating cost of goods sold by that amount

E3-8 Subsidiary Acquired for Cash

Fineline Pencil Company and SubsidiaryConsolidated Balance SheetJanuary 2, 20X3

E3-9 Subsidiary Acquired with Bonds

Byte Computer Corporation and Subsidiary

Consolidated Balance SheetJanuary 2, 20X3

E3-10 Subsidiary Acquired by Issuing Preferred Stock

Byte Computer Corporation and Subsidiary

Consolidated Balance SheetJanuary 2, 20X3

E3-11 Reporting for a Variable Interest Entity

Gamble CompanyConsolidated Balance Sheet

Less: Accumulated Depreciation (10,100,000) 360,500,000

E3-12 Consolidation of a Variable Interest Entity

Teal CorporationConsolidated Balance Sheet

E3-13 Computation of Subsidiary Net Income

Messer Company reported net income of $60,000 ($18,000 / 30) for 20X9

E3-14 Incomplete Consolidation

a Belchfire apparently owns 100 percent of the stock of Premium Body Shop since thebalance in the investment account reported by Belchfire is equal to the net book value ofPremium Body Shop

$1,120,000

Accounts receivable were reduced by

$10,000, presumably as a reduction

of receivables and payables

There is no indication of intercorporateownership

Common stock of Premium must beeliminated

Retained earnings of Premium also must

be eliminated in preparingconsolidated statements

E3-15 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 ofthe noncontrolling interest and the stockholders' equity section of the subsidiary iseliminated when the consolidated balance sheet is prepared:

c Sanderson is mainly interested in assuring a steady supply of electronic switches It cancontrol the operations of Kline with 70 percent ownership and can use the money thatwould be needed to purchase the remaining shares of Kline to finance additionaloperations or purchase other investments