Solution manual advanced financial accounting, 8th edition by baker chap009

Forthose preferred shares held by the parent company, a proportionate share of subsidiaryincome and net assets assigned to the preferred shares is eliminated against the balance inthe pa

CHAPTER 9 CONSOLIDATION OWNERSHIP ISSUES

ANSWERS TO QUESTIONS

Q9-1 Preferred stock of the subsidiary is eliminated in the consolidation process in a

manner comparable to that used in eliminating the common stock of the subsidiary Forthose preferred shares held by the parent company, a proportionate share of subsidiaryincome and net assets assigned to the preferred shares is eliminated against the balance inthe parent's investment account Subsidiary income and net assets assigned to preferredshares not held by the parent are included as a part of the noncontrolling interest along withthe balances assigned to noncontrolling interest for common stock not held by the parent.The claim of the preferred shareholders normally is computed before the common stock iseliminated so that any priority claim associated with the preferred stock can be properlyrecognized and assigned to the correct shareholder group

Q9-2 All preferred shares held by the parent are eliminated against the balance in the

investment account Those held by unrelated parties are included in the total assigned to thenoncontrolling interest

Q9-3 Preferred dividends normally are deducted in arriving at income available to common

shareholders When preferred dividends are paid by the subsidiary to shareholders otherthan the parent, the income accruing to the common shares held by the parent company isreduced Therefore, they must be deducted to arrive at income available to the parentcompany shareholders No preferred dividends are deducted if the parent company owns allthe shares or if no dividends are declared and the preferred stock is noncumulative

Q9-4 In the event the preferred shares are redeemed, the subsidiary must pay the call

premium and the net assets of the subsidiary will be reduced by the amount of the premium.Because it is more conservative to assume the call premium will be paid, the amount of thepremium normally is added to the claim of the preferred shareholders and deducted from theequity assigned to the common shareholders whenever consolidated statements areprepared

Q9-5 The fair value of the net assets of the subsidiary is computed by deducting the fair

value of the subsidiary's liabilities from the fair value of its assets When the subsidiary haspreferred stock outstanding, the claims of the preferred shareholders, including dividends inarrears and participation rights held by preferred shareholders, must be taken intoconsideration in determining the fair value of net assets available to common shareholders.These items, when deducted from the fair value of the identifiable assets of the acquiredcompany, will reduce the amount of net assets assigned to common stock and potentiallyincrease the amount reported as goodwill

Q9-6 The parent may record the difference between the carrying value and the sale price

of the shares as either a gain on sale of investment or an adjustment to its additional paid-incapital No gain or loss on the sale of subsidiary shares should be reported in theconsolidated statements If the parent records a gain on the sale, it should be eliminated inthe consolidation process and treated as a part of additional paid-in capital of theconsolidated entity

Q9-7 All common shareholders should share equally in the net assets of a company When

a subsidiary sells additional shares to a nonaffiliate at a price in excess of existing bookvalue, the effect will be to increase the net book value of all shareholders Because it is acapital transaction, no gain or loss is recognized on the sale

Q9-8 Each purchase of additional shares should be examined to determine the difference

between the price paid and underlying book value When an amount greater than book value

is paid directly to the subsidiary for the shares, the book value of the shares held by thenoncontrolling interest will increase As a result, the increase in the parent’s claim on the netassets of the subsidiary will be less than the amount paid When consolidated statementsare prepared, additional paid-in capital or retained earnings (if the parent has no additionalpaid-in capital) must be debited for the increase in the balance assigned to thenoncontrolling interest, thereby reducing the amount reported in the consolidated balancesheet

Q9-9 All the shares of the subsidiary are eliminated in preparing the consolidated

statements Thus, treasury shares reported by the subsidiary are eliminated in theconsolidation workpaper The effect of the retirement on the consolidated statementsdepends on the price paid and whether the shares were purchased from the parent or from anonaffiliate

Q9-10 Indirect ownership is a general term used whenever one company owns shares of

another company and that company holds ownership in a third company Indirect controloccurs when a majority of the shares of a particular company are held by one or morecompanies that are, in turn, under the control of another company By exercising its controlover those companies the parent can exercise control of the company indirectly owned

Q9-11 A reciprocal relationship exists if Subsidiary A and Subsidiary B hold ownership in

each other If Subsidiary A records investment income based on the reported net income ofSubsidiary B and Subsidiary B records investment income based on the reported net income

of Subsidiary A, the sum of the reported net income totals for the two companies may besubstantially greater than the sum of the reported operating income totals for the twocompanies Parent company net income will be overstated if the impact of the reciprocalrelationship is ignored when the parent company records investment income on itsownership in the two subsidiaries

Q9-12 Under the treasury stock method the parent company shares that have been

purchased by a subsidiary are reported as treasury stock in the consolidated balance sheet.The carrying value of the shares is the amount paid by the subsidiary when they werepurchased

9-2

Q9-13 Consolidated net income will be reduced by $100,000 Income assigned to the

controlling interest will be reduced by $72,000 ($100,000 x 90 x 80) when the unrealizedprofit of Tiny Corporation is eliminated A total of $10,000 is treated as a reduction to theincome assigned to noncontrolling shareholders of Tiny Corporation ($100,000 x 10) and

$18,000 is a reduction of the income assigned to noncontrolling shareholders of SubsidiaryCompany ($100,000 x 90 x 20)

Q9-14 All three companies should be included in the consolidated financial statements.

Slide Company should be consolidated with Bit Company because Bit holds majorityownership of Slide Bit Company, in turn, should be consolidated with Snapper Corporationbecause Snapper holds majority ownership of Bit

Q9-15 A subsidiary's stock dividend results in the capitalization of some portion of its

retained earnings Such an action will have no effect on the consolidated financialstatements since the entire stockholders' equity section of the subsidiary is eliminated inpreparing the consolidation workpaper

Q9-16 A 15 percent stock dividend is a small stock dividend and must be recorded by

capitalizing retained earnings equal to the market price per share of the stock times thenumber of shares actually issued As a result, retained earnings will decrease and the parvalue of stock outstanding and additional paid-in capital will increase on the subsidiary'sbooks There should be no change in the investment account balance reported by theparent Thus, the only change in the eliminating entries is the relative amount debited toeach of the three individual stockholders' equity accounts of the subsidiary

Q9-17 When the parent or other affiliates own all the shares of all companies included in the

consolidation, the order in which the consolidation is completed may not be particularlycritical On the other hand, when less than 100 percent ownership is held there is a muchgreater chance of error in apportioning unrealized profits or other adjustments betweennoncontrolling ownership and consolidated net income when some other sequence is used

By starting the consolidation with the company furthest away from the parent, thecomputation of income assigned to noncontrolling interest at each level can be most easilyaccomplished

SOLUTIONS TO CASES

C9-1 Effect of Subsidiary Preferred Stock

When a parent company does not own all the shares of a subsidiary, income assigned to thenoncontrolling interest includes (1) a portion of subsidiary preferred dividends and (2) aportion of earnings available to common shareholders

To determine the amount of income to assign to preferred and common shareholders of thesubsidiary, the controller needs to have the following information about the preferred stock:

1 The number of preferred shares outstanding and the number owned by the parent andother affiliates

2 The annual preferred dividend rate per share and whether the dividends are cumulative

C9-2 Consolidated Stockholders’ Equity: Theory vs Practice

a Upon the sale of stock of a subsidiary, Xerox used to recognize a gain or loss in the consolidated income statement equal to the company’s proportionate share of the

corresponding increase or decrease in that subsidiary’s equity Under FASB 160, the sale of

subsidiary shares is viewed as an equity transaction and does not affect income Instead, the difference between the fair value of the consideration received and the change in the amount of the noncontrolling interest is recognized as an adjustment to stockholders’ equity (usually additional paid-in capital)

b Occidental Petroleum has generally treated subsidiary preferred stock as a liability (the amount is small) It should be reported as part of the noncontrolling interest

9-4

C9-3 Sale of Subsidiary Shares

MEMO

Vice President of Finance

Book Corporation

From: , CPA

Re: Recognition of Gain on Sale of Subsidiary Shares

Previous accounting standards did not specifically address the issue of how to treat a sale ofsubsidiary shares when the parent retained controlling ownership However, a commonpractice was to recognize a gain or loss on the sale of shares

The FASB’s recent issuance of FASB 160 makes clear that, from a consolidated

perspective, a parent’s sale of subsidiary shares while maintaining control is an equitytransaction Accordingly, no gain or loss on the sale should be reported in the consolidatedincome statement Instead, equity should be adjusted by the difference between theconsideration received and the change in the parent’s subsidiary interest

In the current situation, Book’s interest in Lance prior to its sale of Lance shares was

$360,000, an amount equal to 90 percent of Lance’s $400,000 book value Immediatelyfollowing the sale of Lance shares, Book’s remaining 60 percent interest in Lance is

$240,000 ($400,000 x 60), a decrease of $120,000 ($360,000 - $240,000) The differencebetween the proceeds received and the change in the book value of Book’s interest in Lance

is as follows:

Proceeds received ($5.60 x 30,000 shares) $168,000

Change in book value of interest ($360,000 - $240,000) 120,000

This $48,000 difference should be reported within equity in the consolidated balance sheet.Although alternatives exist in terms of how to meet the FASB’s reporting requirement, thefollowing entry to record the sale of shares on Book’s books would be consistent with theFASB’s requirement and probably the most efficient approach:

The additional paid-in capital recorded on Book’s books would carry over to the consolidatedbalance sheet and would be included in consolidated equity

If Book elected to record a $48,000 gain on the sale of Lance shares instead of recognizingadditional paid-in capital as shown in the entry, that gain would have to be transferred toadditional paid-in capital in the preparation of consolidated financial statements

9-6

C9-4 Sale of Subsidiary Shares

(a) With a sale of shares to a nonaffiliate, net resources have been brought into theconsolidated entity and the noncontrolling shareholders have an additional claim Theexcess of the proceeds received from the sale over the change in the parent’s interest in thesubsidiary increases the amount of additional paid-in capital reported in the consolidatedbalance sheet A sale of subsidiary shares to a nonaffiliate also changes the amount ofincome assigned to the noncontrolling interest in the consolidated income statement and theamount of net assets assigned to the noncontrolling interest in the consolidated balancesheet

(b) When a parent sells shares of one subsidiary to another subsidiary, net resources to theconsolidated entity do not change Any gain recorded by the parent must be eliminated whenthe investment balance reported by the subsidiary is eliminated in preparing consolidatedfinancial statements A change in the claim of the noncontrolling interest is likely to occur ifthe subsidiary that purchases the shares is not wholly owned As a result, there may besome change in consolidated income and the balance sheet totals assigned tononcontrolling interest

C9-5 Reciprocal Ownership

A great many factors beyond the immediate impact on reported earnings may be important

in deciding on the use of the funds Items such as the following should be considered:

1 Are the excess funds held by Thorson available only temporarily or are they not likely to

be needed in the foreseeable future?

2 Will there be any regulatory or taxation problems associated with one or more of thealternatives?

3 Can shares of the companies be purchased in the desired quantities and at existingmarket prices or are there potential difficulties associated with one or more alternatives?

4 Is it desirable to acquire more shares of either subsidiary since controlling ownershipalready is in the hands of Strong Manufacturing?

5 Have the noncontrolling shareholders of either subsidiary been troublesome or causedthe parent to refrain from actions that it might otherwise have taken?

With the information given, it is difficult to determine which action will have the mostfavorable impact on consolidated net income The earnings of each company, the number ofshares outstanding, and the relative market prices of the shares each will have an effect Ingeneral, reported income is maximized by purchasing the shares with the lowest price-earnings ratio

SOLUTIONS TO EXERCISES

E9-1 Multiple-Choice Questions on Preferred Stock Ownership

1 d $50,000 = $20,000 + $30,000

2 c $29,000 = $20,000 + 30($30,000)

3 b Only the retained earnings of the acquiring company is included

4 a The portion held by the parent is eliminated when the preferred investment is

eliminated, and the portion held by nonaffiliates is eliminated and included with the balance reported as noncontrolling interest in the consolidated balance sheet

E9-2 Multiple-Choice Questions on Multilevel Ownership

Eliminate investment in common stock

Investment in Separate Company

Eliminate subsidiary preferred stock

9-8

E9-4 Reciprocal Ownership [AICPA Adapted]

a None of Simba's dividends is reported in the consolidated statements All of Simba'sdividends are eliminated in the consolidation process

b Only 90 percent of Pride's dividends are included in the consolidated retained earnings statement The dividend payment on the 10 percent owned by Simba is an intercorporate payment to an affiliate and must be eliminated in the consolidation process

E9-5 Subsidiary with Preferred Stock Outstanding

Eliminate investment in common stock

Eliminate subsidiary preferred stock

E9-6 Subsidiary with Preferred Stock Outstanding

a Entries recorded by Clayton Corporation:

Record purchase of Topple stock

Record dividends from Topple:

E9-6 (continued)

b Eliminating entries:

Eliminate income from subsidiary

Eliminate dividend income from subsidiary preferred

Assign income to noncontrolling interest:

$23,100 = [($70,000 - $16,000) x 25] + ($16,000 x 60)

$9,600 = $16,000 x 60 $8,500 = ($50,000 - $16,000) x 25 $5,000 = $13,500 - $8,500

Eliminate beginning investment balance

Eliminate subsidiary preferred stock

9-10

E9-7 Preferred Dividends and Call Premium

a Culbertson Company's contribution to 20X2 consolidated net income is equal to its reported net income of $70,000

b Income assigned to noncontrolling interest:

Common shares {.10[$70,000 - ($100,000 x 12)]} 5,800

c Retained earnings assignable to preferred shareholders:

d Book value of common shares:

Less: Balance assigned to preferred shares (80,000) 300,000

e Total noncontrolling interest:

E9-8 Multilevel Ownership

a Consolidated net income for 20X6 is $190,000 ($90,000 + $40,000

+ $60,000)

b Income of $36,800 is assigned to the noncontrolling interest:

Income from Latent [($60,000 + $16,000) x 30] 22,800 Total income assigned to noncontrolling interest $36,800

c Income of $153,200 is assigned to the controlling interest:

Less: Income assigned to noncontrolling interest (36,800)

d Only the $45,000 of dividends paid by Grasper Corporation to its

shareholders will be reported as dividends declared in Grasper’s

20X6 consolidated retained earnings statement

9-12

E9-9 Eliminating entries for Multilevel Ownership

a Journal entries recorded by Brown Corporation on its investment in Tann Company:

Record purchase of Tann Company stock

Record dividends from Tann Company:

$15,000 x 60

Record equity-method income:

Record dividends from Brown Corporation:

$50,000 x 90

Record equity-method income:

($120,000 + $24,000) x 90

c Eliminating entries:

Eliminate income from Tann Company

Assign income to noncontrolling interest:

$16,000 = $40,000 x 40 $6,000 = $15,000 x 40

E9-9 (continued)

Eliminate investment in Tann Company stock:

$120,000 = $200,000 x 60 $80,000 = $200,000 x 40

Eliminate income from Brown Corporation

$9,400 = $14,400 - $5,000

Eliminate investment in Brown Corporation stock:

$315,000 = $350,000 x 90 $35,000 = $350,000 x 10

9-14

E9-10 Reciprocal Ownership

Less: Income to noncontrolling interest:

E9-11 Consolidated Balance Sheet with Reciprocal Ownership

Talbott Company and Short CompanyConsolidated Balance Sheet Workpaper

December 31, 20X9Talbott Short Eliminations Consol- Item Company Company Debit Credit idated

Investment in Talbott Company

9-16

E9-11 (continued)

Talbott Company and SubsidiaryConsolidated Balance SheetDecember 31, 20X9Current Assets:

Total Equity before Reduction for Treasury Shares $698,000

E9-12 Subsidiary Stock Dividend

a Lake Company:

Lindale Company: No entry required

b Eliminating entries, December 31, 20X3:

c Eliminating entry, January 1, 20X4:

Cash dividend paid in 20X3 (10,000)

9-18

E9-13 Sale of Subsidiary Shares by Parent

a Investment in Acme Concrete, January 1, 20X5:

Dividends paid by Acme in 20X3 and 20X4 (40,000)

$ 60,000 Proportion of stock held by Stable x 80 48,000

b Journal entry recorded by Stable Home Builders for sale of shares:

$102,000 = $408,000 x 4,000 / [($200,000 / $10) x 80]

c Eliminating entries:

E9-14 Purchase of Additional Shares from Nonaffiliate

Modern Products Company net income for 20X8

Proportion of stock held by Weal x .60

Dividend received from Modern Products Company

9-20

E9-14 (continued)

Purchase of additional shares on January 1, 20X9 96,000

Modern Products Company net income for 20X9

Proportion of stock held by Weal x .80

$56,000 Less: Amortization of differential on stock

purchased January 1, 20X9: ($20,000 / 10 years) (2,000)

Dividend received from Modern Products

Eliminate income from subsidiary

Assign income to noncontrolling interest:

$14,000 = $70,000 x 20

E(3) Common Stock — Modern Products Company 150,000