Solution manual advanced financial accounting, 8th edition by baker chap010

On the other hand, all the cashgenerated by the subsidiary is included in the consolidated cash flow statement and all uses of cash must also be included, including that distributed to n

CHAPTER 10 ADDITIONAL CONSOLIDATION REPORTING ISSUES

ANSWERS TO QUESTIONS

Q10-1 The balance sheet, income statement, and statement of changes in retained

earnings are an integrated set and generally need to be completed as a unit Oncecompleted, these statements can then be used in preparing a consolidated cash flowstatement Because both the beginning and ending consolidated balance sheet totals areneeded in determining cash flows for the period, the cash flow statement cannot be easilyincorporated into the existing three-part workpaper format

Q10-2 Consolidated retained earnings do not include the earnings assigned to

noncontrolling shareholders As a result, dividends paid to noncontrolling shareholders arenot included in the consolidated retained earnings statement On the other hand, all the cashgenerated by the subsidiary is included in the consolidated cash flow statement and all uses

of cash must also be included, including that distributed to noncontrolling shareholders in theform of dividends

Q10-3 The indirect method focuses on reconciling between net income and cash flows from

operations and does not attempt to report payments to suppliers or other specific uses ofcash It does report the change in inventory and accounts payable which are included indetermining payments to suppliers While adjusting net income for changes in inventory andaccounts payable leads to a correct reporting of cash flows from operations, it does notpermit explicit reporting of payments to suppliers

Q10-4 Changes in inventory balances are used in computing the amount reported as

payments to suppliers and do not need to be separately reported

Q10-5 Sales must be included in the consolidated cash flows workpaper when the direct

method is used They are excluded from the workpaper when the indirect method is used

Q10-6 (a) When the indirect method is used the changes in inventory are reported as a

reconciling item in the statement of cash flows (b) When the direct method is used, changes

in inventory are included in the computation of payments to suppliers and not separatelydisclosed

Q10-7 Only sales subsequent to the date of acquisition are included The acquired

Q10-9 The revenues and expenses of the subsidiary for the full year are included in the

consolidated income statement when the acquisition occurs at the beginning of the year When a mid-year acquisition occurs, the revenues and expenses of the acquired company prior to the date of acquisition were not transactions of the consolidated entity The

eliminating entries at the end of the year must be expanded to eliminate those amounts In addition, the eliminating entry used to assign income to the noncontrolling interest and eliminate dividends paid to the noncontrolling shareholders will be modified to include only the income earned and dividends declared for that portion of the year in which ownership was held by the parent

Q10-10 An accurate measure of the overall profit contribution from each segment of

business operations is often considered desirable in evaluating past operations and in planning future strategy In some cases the tax impact of operating a particular division is very different from one or more other divisions, and that difference should be recognized in evaluating the segment Even when such differences do not exist, better knowledge of the approximate after tax return from a particular subsidiary can be very helpful in assessing future investment and operating strategies

Q10-11 When a consolidated tax return is filed, all intercorporate transfers are eliminated in

computing taxable income and there should be no need to adjust recorded tax expense inpreparing consolidated financial statements for the period When the companies do not file aconsolidated return, tax payments and expense accruals recorded by the individualcompanies presumably will include gains and losses on intercompany transfers If anunrealized gain or loss is eliminated in consolidation, the amount reported as tax expensealso should be adjusted to reflect only the tax expense on those items included in theconsolidated income statement

Q10-12 Assuming an unrealized profit has been reported, an additional elimination entry is

needed to reduce tax expense and establish a deferred tax asset in the amount of theexcess payment If a loss is eliminated, additional tax expense and taxes payable must beestablished in the elimination process

Q10-13 When one of the companies in the consolidated entity has recorded tax expense on

unrealized profit in a preceding period, its retained earnings balance at the start of the periodwill be overstated by the amount of unrealized profit less the tax expense recorded thereon

In the period in which the item is sold and the profit is considered realized, the eliminatingentries must include a debit to beginning retained earnings for the amount of the netoverstatement and a debit to tax expense for the proper amount of expense to berecognized

Q10-14 When taxes are not considered, income assigned to noncontrolling shareholders is

reduced by a proportionate share of the unrealized profit When taxes are considered, thereduction is based on a proportionate share of the after tax balance of unrealized profits

Q10-15 Perhaps the most important reason is that the earnings per share data reported by

the separate companies may include unrealized profits that must be eliminated in computingthe consolidated totals Even without unrealized profits, simple addition could not be usedwhen the companies do not have an equal number of shares outstanding or when the parentdoes not hold all the common or preferred shares of the subsidiary

assigned to noncontrolling common shareholders are deducted from consolidated revenueand expenses in computing consolidated net income and earnings per share Subsidiarypreferred dividends paid to the parent or other affiliates must be eliminated and are notdeducted in computing consolidated earnings per share.

Q10-17 A subsidiary's contribution to consolidated earnings per share may be different from

its contribution to consolidated net income if the subsidiary has convertible bonds orpreferred stock outstanding that are treated as if they had been converted, or if the treasurystock method is used to include the dilutive effects of subsidiary stock rights or stock optionsoutstanding

Q10-18 The net of tax interest savings from the assumed conversion of the bond into

common stock is included in the numerator and the additional shares are added to thedenominator of the earnings per share computation for the subsidiary In doing so, earningsper share of the subsidiary will be reduced Moreover, the additional shares added to thedenominator will potentially alter the ownership ratio held by the parent; thus, the amount ofsubsidiary income included in the consolidated earnings per share computation is likely to bereduced

Q10-19 Those rights, warrants, and options treated as stock outstanding in the denominator

of the earnings per share computation of the subsidiary will reduce the amount of subsidiaryincome included in the consolidated earnings per share computation to the extent that theownership ratio held by the parent is reduced The actual shares will not be reported as such,because they are assumed to be either eliminated or assigned to the noncontrolling interest

Q10-20 In the earnings per share computation, the amount of income assigned to

noncontrolling interest may change as it is assumed that convertible securities are converted

or rights, warrants, and options are exercised Both the amount of subsidiary incomeincluded in the numerator and the proportion of parent company ownership may vary, therebychanging the amount of subsidiary income included in the consolidated earnings per sharecomputation

SOLUTIONS TO CASES

C10-1 The Effect of Security Type on Earnings per Share

a Until the securities are converted, the interest expense on bonds and the preferreddividends must both be deducted in determining income available to common shareholderswhen basic earnings per share is computed Because interest expense is deductible for taxpurposes and preferred dividends are not, the increase in earnings available to commonshareholders will be less with conversion of the debentures The decrease in earnings pershare will be greater with conversion of the convertible debentures since the two securitiesconvert into an equal number of common shares

b Interest expense is deducted in computing net income and preferred dividends are not.Thus, conversion of the bonds will increase net income and conversion of the preferred stockwill have no effect on the reported net income of Stage Corporation If Stage Corporation is aparent company, consolidated net income will increase by the full amount of the interestsaving (net of tax) if the bonds are converted In the event Stage Corporation is a subsidiary

of another company, consolidated net income again will increase if the bonds are converted,but the amount of the increase depends on the percentage ownership of Stage by the parent.Conversion of the preferred stock will increase consolidated net income because it increasesStage’s income available to common shareholders, of which the parent is one The increasewill be greater than the effect of the bond conversion because the preferred dividends have

no tax effect, but the amount of the increase will depend on the parent’s percentageownership

c If the preferred shares are those of a parent company, they will be excluded entirely if (1)all the shares are owned by its subsidiaries, or (2) the preferred shares are noncumulativeand have had no dividends declared during the period If the shares are those of asubsidiary, the preferred shares will have an effect on basic earnings per share unless (1) theparent or other affiliates own all the common and preferred shares outstanding, or (2) thepreferred shares are noncumulative and have had no dividends declared during the period

d Interest expense will be deducted in computing Stage's net income The preferreddividends will then be deducted from net income in computing Stage's income available tocommon shareholders Assuming both securities are dilutive, interest expense (net of tax)will be added back to Stage's net income, no preferred dividends will be deducted, and theincreased number of shares from the conversion of both securities will be added to thedenominator in computing Stage’s diluted earnings per share These earnings per shareamounts will then be used by Prop Company in determining the income from the subsidiary

to be included in its consolidated earnings per share computations

C10-2 Evaluating Consolidated Statements

MEMO

Cowl Corporation

From: , Accounting Staff

Re: Disclosure of Transfer of Cash from Subsidiary to Parent

The following comments are provided in response to your concern with respect to thetransfer of cash from Plum Corporation to the parent company Intercompany borrowingsoften offer an opportunity for one company to borrow money from an affiliate at ratesfavorable to both parties As a result, transfers of cash between affiliates are very common.These transactions are eliminated in preparing the consolidated statements and the financialstatement reader will be unaware of them unless supplemental disclosures are made

In general, the FASB does not require separate disclosure of transactions betweenconsolidated entities when they are eliminated in the preparation of consolidated or

combined financial statements [FASB 57, Par 2]

Nevertheless, the fact that Cowl Company is unable to generate sufficient cash from itsseparate operations to pay its bills appears to be of sufficient importance that disclosurewould be appropriate in both the Management Discussion and Analysis (MD&A) section ofCowl’s annual report and in the notes to the financial statements The SEC establishes thedisclosure requirements for MD&A and requires discussion of currently known trends,demands, commitments, events, or uncertainties that are reasonably expected to havematerial effects on the registrant’s financial condition or results of operations, or that wouldcause reported financial information not to be necessarily indicative of future operating

results or financial condition [SEC Regulation S-K, Item 303]

The SEC also requires discussion of both short- and long-term liquidity and capitalresources [SEC Financial Reporting Release 36]

C10-2 (continued)

FASB Statement No 95, “Statement of Cash Flows,” does not specify those situations in

which a discussion of operating cash flows must be included in the notes to the financialstatements However, if the negative cash flow from Cowl Company’s operations significantlyaffects the operating cash flows of the consolidated entity, one or more notes to the financialstatements should be used to provide information to the financial statement readers Onepossible form for doing so would be to include supplemental cash flow information if the

operations of the parent are identified as a separate reportable segment [FASB 131, Par.

C10-3 Income Tax Expense

a When prior-period intercompany profits are realized through resale to a nonaffiliate in thecurrent period, tax expense reported by the consolidated entity will be greater than actual taxpayments made by the separate companies

b Two reporting procedures are usually discussed in dealing with income tax allocation forconsolidated entities One procedure is to report the additional amount paid as a deferred taxasset or as prepaid income tax in the consolidated balance sheet An alternate approach is tonet the overpayment for unrealized profits against deferred income taxes payable

c Whenever separate tax returns are filed and unrealized profits are recorded onintercompany transfers of land, buildings and equipment, or other assets, income taxexpense reported in the consolidated income statement in the period of the intercompanytransfer will be less than tax payments made A similar effect occurs when one affiliatepurchases the bonds of another affiliate and a constructive loss on bond retirement isreported in the consolidated income statement

d When unrealized profits from a prior period are realized in the current period, income taxexpense recognized in the current period will be greater than the actual tax payment made.Also, when unrealized losses are recorded on intercompany transfers, tax expense reported

in the consolidated income statement in the period of the transfer will be greater than theactual tax payment A constructive gain on bond retirement on a purchase of an affiliate'sbonds will also result in an excess of consolidated tax expense over tax payments

C10-4 Consolidated Cash Flows

a The factors contributing to the increase in net income over the prior period are key in thiscase One possible explanation is that operating earnings of the combined companiesactually declined and the increase in net income resulted from a substantial gain on sale of adivision or other assets in the current period Another possibility would be a decrease innoncash charges deducted in computing income Cash generated by operations often is wellabove operating earnings as a result of charges such as amortization of intangible assets ordepreciation A decrease in these charges will increase net income but not change cashflows

Changes in the net amounts invested in receivables, inventories, and other current assetsare included in the computation of cash flows from operations Increases in these balancescan substantially reduce the reported cash flows from operations without affecting netincome

b Both sales and the balance in accounts receivable should increase when less stringentcriteria are used in extending credit Similarly, both should decrease when credit terms aretightened If the companies have relaxed credit standards during the current period, netincome may be greater as a result of increased sales; however, cash flows are likely toincrease to a lesser degree as accounts receivable increase

c An inventory write-down under lower of cost or market and other noncash charges will notreduce cash flows from operations The amount expensed would be added back toconsolidated net income in arriving at cash generated by operating activities

d Assuming an allowance account is used, this particular write-off will not appear in eitherthe income statement or computation of cash flows from operations There is no charge inthe income statement and no change in the net receivable balance as a result of a simplewrite-off of an account receivable

e There are no significant differences between the preparation of a statement of cash flowsfor a consolidated entity and a single corporate entity However, for the consolidated entity,dividend payments to the subsidiary’s noncontrolling interest must be included in thefinancing section because they use cash even though they are not viewed as dividends ofthe consolidated entity

SOLUTIONS TO EXERCISES

E10-1 Analysis of Cash Flows

a The consolidated cash balance at January 1, 20X2, was $83,000, computed as follows:

Decrease in cash balance during 20X2:

Cash outflow for investment activities (80,000)

Cash outflow for financing activities (230,000)

b Dividends of $48,000 were reported:

Dividends paid to noncontrolling interest of

c Consolidated net income was $207,000, computed as follows:

Adjustments to reconcile consolidated net income

E10-2 Statement of Cash Flows

a The noncontrolling interest received dividends of $6,000 ($15,000 x 40)

b A total of $320,000 will be reported as cash provided by operations, computed as follows:

Dividends paid to Becon Corporation shareholders (25,000)

Dividends paid to noncontrolling interests (6,000)

e The cash balance increased by $78,000 ($320,000 - $161,000 - $81,000) in 20X4

E10-3 Computation of Operating Cash Flows

Cash received from customers was $293,000 ($310,000 - $17,000) Cash payments tosuppliers was $193,000 ($180,000 - $8,000 + $21,000), resulting in cash flows fromoperations of $100,000 ($293,000 - $193,000)

E10-4 Consolidated Operating Cash Flows

a Cash received from customers was $482,000 ($300,000 + $200,000 - $28,000 +

$10,000)

b Cash payments to suppliers was $288,000 ($160,000 + $95,000 + $35,000 - $15,000 +17,000 - $4,000)

c Cash flows from operating activities was $194,000 ($482,000 - $288,000)

E10-5 Preparation of Statement of Cash Flows

Consolidated Enterprises Inc and SubsidiaryConsolidated Statement of Cash FlowsFor the Year Ended December 31, 20X3Cash Flows from Operating Activities:

Noncash Expenses, Revenue, and Gains

Included in Income:

Cash Flows from Investing Activities:

Cash Flows from Financing Activities:

E10-6 Direct Method Cash Flow Statement

Consolidated Enterprises Inc and SubsidiaryConsolidated Statement of Cash FlowsFor the Year Ended December 31, 20X3

Cash Flows from Operating Activities:

Cash Flows from Investing Activities:

Cash Flows from Financing Activities:

Net Cash Provided by Financing Activities 19,000

Adjustments to reconcile net income to net cash

provided by operating activities:

E10-7 Analysis of Consolidated Cash Flow Statement

Proportion of stock held by noncontrolling interest ÷ 40

b When bonds are sold at a premium the annual cash payment is greater than reported interest expense The amount of premium amortized must therefore be deducted from net income in determining the cash flow from operations

c An increase in accounts receivable means that cash collections have been less than sales for the period The amount of the increase must be deducted from operating income to determine the amount of cash actually made available from current period operations

d Dividends paid to noncontrolling shareholders are reported as a cash outflow in the cash flow statement because they represent funds that have been distributed during the period and are no longer available to the consolidated entity On the other hand, these same dividends are omitted from the retained earnings

statement Only the income to the parent company shareholders is included in the consolidated retained earnings statement and only dividends to the parent

company shareholders are deducted in deriving the ending consolidated retained earnings balance

e The loss occurred on a sale to a nonaffiliate All profits and losses on sales to affiliates are eliminated in the period of intercorporate sale and are considered realized as the equipment is depreciated by the purchasing affiliate

E10-8 Midyear Acquisition

a The retained earnings balance reported for the consolidated entity as of January 1, 20X1, would be $400,000

Portion of year ownership was held by Yarn x 4/12

Income to noncontrolling interest ($20,000 x 05) (1,000)

E10-9 Purchase of Shares at Midyear

a Journal entries recorded by Highbeam in 20X2:

Record purchase of Copper Company Stock

Record dividends from Copper Company

Record equity-method income

b Eliminating Entries:

Eliminate income from subsidiary

Assign income to noncontrolling interest:

$3,000 = $30,000 x 10 $1,500 = $15,000 x 10

E10-10 Tax Deferral on Gains and Losses

Eliminating entries, December 31, 20X7:

Eliminate tax expense on unrealized intercompany profit on inventory transfer

Eliminate upstream gain on sale of land

Eliminate tax expense on unrealized intercompany profit on land transfer

E10-11 Unrealized Profits in Prior Year

Eliminating entries, December 31, 20X8:

Eliminate beginning inventory profit

Eliminate unrealized gain on sale of land

E10-12 Allocation of Income Tax Expense

a Allocation of tax expense incurred in 20X5:

Winter Ray Guard Block Item Corporation Corporation Company

Unrealized profits in 20X5

Income tax assigned:

($130,000 / $200,000) x $80,000 $ 52,000

b Computation of consolidated net income and income to controlling interest:

Realized income before tax:

Income to noncontrolling interests:

Ray Guard Corporation ($30,000 - $12,000) x 20 $ 3,600

Block Company ($40,000 - $16,000) x 10 2,400 (6,000)

E10-13 Effect of Preferred Stock on Earnings per Share

Because both companies paid preferred dividends in 20X1 and neither issue is convertible,only one basic consolidated earnings per share number will be reported for 20X1:

Consolidated earnings per share for 20X1

E10-14 Effect of Convertible Bonds on Earnings per Share

Basic earnings per share:

Contribution to consolidated EPS from Evans Company

Consolidated earnings per share for 20X2

Diluted earnings per share:

Contribution to consolidated EPS from Evans Company:

$30,000 + $12,000 (a) x 6,000 shares

Consolidated earnings per share for 20X2

(a) $12,000 = ($200,000 x 10) x (1 - 40)

E10-15 Effect of Convertible Preferred Stock on Earnings per Share

Basic earnings per share:

Contribution to consolidated EPS from Standard Company:

$45,000 - $12,000 x 8,000 shares

Consolidated earnings per share for 20X1

Diluted earnings per share:

Contribution to consolidated EPS from Standard Company:

$45,000 x 8,000 shares

Consolidated earnings per share for 20X1

SOLUTIONS TO PROBLEMS

P10-16 Direct Method Computation of Cash Flows

Car Corporation and SubsidiaryOperating Cash FlowsFor the Year Ended December 31, 20X1

Cash Flows from Operating Activities:

Computation of payments received from customers

Sales to outside parties by Bus Company ($240,000 - $100,000) 140,000

Decrease in Bus Company’s accounts receivable 2,000

Computation of payments to suppliers

Cost of goods sold by Car Corporation excluding sale of

inventory purchased from Bus Company ($235,000 - $40,000) $195,000 Cost of goods sold on sales by Bus Company

Cost of goods sold on intercompany sales

P10-17 Preparing a Statement of Cash Flows

Consolidated Cash Flow WorkpaperYear Ended December 31, 20X3

Cash Flows from Investing Activities:

Cash Flows from Financing Activities:

P10-17 (continued)

b Consolidated statement of cash flows for 20X3

Metal Corporation and SubsidiaryConsolidated Statement of Cash FlowsYear Ended December 31, 20X3Cash Flows from Operating Activities

Noncash Expenses, Revenue, Losses, and Gains

Cash Flows from Investing Activities:

Cash Flows from Financing Activities:

Dividends Paid to Parent Company Shareholders (30,000)

Dividends Paid to Noncontrolling Shareholders ( 5,000)

P10-18 Preparing a Statement of Cash Flows – Direct Method

Consolidated Cash Flow WorkpaperYear Ended December 31, 20X3

490,000 490,000

P10-18 (continued)

Cash Flows from Operating Activities:

Cash Flows from Investing Activities:

Cash Flows from Financing Activities:

Dividends Paid:

Increase in Cash (a) 32,000

490,000 490,000

b Consolidated statement of cash flows for 20X3

Metal Corporation and SubsidiaryConsolidated Statement of Cash FlowsYear Ended December 31, 20X3Cash Flows from Operating Activities:

Cash Paid for Interest on Notes Payable 16,000 (378,000)

Cash Flows from Investing Activities:

Purchase of Buildings and Equipment (35,000)

Cash Flows from Financing Activities:

Dividends Paid to Parent Company Shareholders (30,000)

Dividends Paid to Noncontrolling Shareholders ( 5,000)

Adjustments to reconcile net income to net cash

provided by operating activities: