solution manual advanced financial accounting 8th edition baker chap004

Instead, they are entered in the consolidation workpaper so that when the amounts included in the eliminating entries are added to, or deducted from, the balances reported by the individ

CHAPTER 4 CONSOLIDATION OF WHOLLY OWNED SUBSIDIARIES

ANSWERS TO QUESTIONS

Q4-1 An adjusting entry is recorded on the company's books and causes the balances

reported by the company to change Eliminating entries, on the other hand, are not recorded on the books of the companies Instead, they are entered in the consolidation workpaper so that when the amounts included in the eliminating entries are added to, or deducted from, the balances reported by the individual companies, the appropriate balances for the consolidated entity are reported

Q4-2 The differential represents the difference between the acquisition-date fair value

of the acquiree and its book value

Q4-3 A company must acquire a subsidiary at a price equal to the subsidiary’s fair value, and that subsidiary must have a total acquisition-date fair value less than its book value

Q4-4 Each of the stockholders' equity accounts of the subsidiary is eliminated in the

consolidation process Thus, none of the balances is included in the stockholders' equity accounts of the consolidated entity That portion of the stockholders' equity claim assigned to the noncontrolling shareholders is reported indirectly in the balance assigned to the noncontrolling shareholders

Q4-5 Current consolidation standards require recognition of the fair value of the

subsidiary's individual assets and liabilities at the date of acquisition At least some portion of the book value would not be included if the fair value of a particular asset or liability was less than book value

Q4-6 One hundred percent of the fair value of the subsidiary’s assets and liabilities at the date of acquisition should be included The type of asset or liability will determine whether a change in its value will be recognized following the date of acquisition

Q4-7 Using a clearing account can reduce the chance of error in preparing

consolidated statements The number of accounts requiring adjustment for the difference between book value and fair value at the date of acquisition may be very large Rather

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Q4-9 The investment account in the financial statements of the parent company shows

its investment in the subsidiary as a single total and therefore does not provide information on the individual assets and liabilities held by the subsidiary, nor their relative values The existence of a large differential indicates the parent paid well over book value to acquire ownership of the subsidiary When the differential is assigned to identifiable assets or liabilities of the subsidiary, both the consolidated balance sheet and consolidated income statement are likely to provide information not available in the financial statements of the individual companies The consolidated statements are likely

to provide a better picture of the assets actually being used and the resulting income statement charges that should be reported

Q4-10 Additional entries are needed to eliminate all income statement and retained

earnings statement effects of intercorporate ownership and any transfers of goods and services between related companies

Q4-11 Separate parts of the consolidation workpaper are used to develop the

consolidated income statement, retained earnings statement, and balance sheet All eliminating entries needed to complete the entire workpaper normally are entered before any of the three statements are prepared The income statement portion of the workpaper is completed first so that net income can be carried forward to the retained earnings statement portion of the workpaper When the retained earnings portion is completed, the ending balances are carried forward and entered in the consolidated balance sheet portion of the workpaper

Q4-12 None of the dividends declared by the subsidiary are included in the

consolidated retained earnings statement Those which are paid to the parent have not gone outside the consolidated entity and therefore must be eliminated in preparing the consolidated statements Those paid to noncontrolling shareholders are treated as a reduction in the net assets assigned to noncontrolling interest and also must be eliminated

Q4-13 Consolidated net income is equal to the parent’s income from its own operations, excluding any investment income from consolidated subsidiaries, plus the income of each of the consolidated subsidiaries, adjusted for any differential write-off

Q4-14 Consolidated net income includes 100 percent of the revenues and expenses of

the individual consolidating companies arising from transactions with unaffiliated companies

Q4-15 Consolidated retained earnings is defined in current accounting practice as that

portion of the undistributed earnings of the consolidated entity accruing to the parent company shareholders

Q4-16 Consolidated retained earnings at the end of the period is equal to the beginning

consolidated retained earnings balance plus consolidated net income attributable to the controlling interest, less consolidated dividends

Q4-17 The retained earnings statement shows the increase or decrease in retained

earnings during the period Thus, income for the period is added to the beginning balance and dividends are deducted in deriving the ending balance in retained earnings Because the consolidation workpaper includes the retained earnings statement, the beginning retained earnings balance must be entered in the workpaper

Q4-18 An additional eliminating entry normally must be entered in the workpaper to

expense an appropriate portion of the amount assigned to buildings and equipment Normally, depreciation expense is debited and accumulated depreciation is credited

Q4-19 The differential is simply a clearing account used in the consolidation process If

the differential arises because the fair value of land held by the subsidiary is greater than book value, the amount assigned to the differential will remain constant so long as the subsidiary continues to hold the land When the differential arises because the fair value

of depreciable or amortizable assets is greater than book value, the amount debited to the differential account each period will decrease as the parent amortizes an appropriate portion of the differential against investment income

Q4-20 Push-down accounting occurs when the assets and liabilities of the subsidiary

are revalued on the subsidiary's books as a result of the purchase of shares by the parent company The basis of accountability that the parent company would use in accounting for its investment in the various assets and liabilities is used to revalue the subsidiary's assets and liabilities; thereby pushing down the parent's basis of accountability onto the books of the subsidiary

Q4-21 Push-down accounting is considered appropriate when a subsidiary is

substantially wholly owned by the parent

Q4-22 When the assets and liabilities of the subsidiary are revalued at the date of

acquisition there will no longer be a differential The parent's portion of the revised carrying value of the net assets on the books of the subsidiary will agree with the balance in the investment account reported by the parent

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SOLUTIONS TO CASES

C4-1 Need for Consolidation Process

After the financial statements of each of the individual companies are prepared in accordance with generally accepted accounting principles, consolidated financial statements must be prepared for the economic entity as a whole The individual companies generally record transactions with other subsidiaries on the same basis as transactions with unrelated enterprises In preparing consolidated financial statements, the effects of all transactions with related companies must be removed, just as all transactions within a single company must be removed in preparing financial statements for that individual company It therefore is necessary to prepare a consolidation workpaper and to enter a number of special journal entries in the workpaper to remove the effects of the intercorporate transactions The parent company also reports an investment in each of the subsidiary companies and investment income or loss in its financial statements Each of these accounts must be eliminated as well as the stockholders' equity accounts of the subsidiaries The latter must be eliminated because only the parent's ownership is held by parties outside the consolidated entity

C4-2 Account Presentation

MEMO

To: Chief Accountant

Prime Company

From: , Accounting Staff

Re: Combining Broadly Diversified Balance Sheet Accounts

Many manufacturing and merchandising enterprises excluded finance, insurance, real estate, leasing, and perhaps other types of subsidiaries from consolidation prior to 1987

on the basis of ―nonhomogeneous‖ operations Companies generally argued that the accounts of these companies were dissimilar in nature and combining them in the

consolidated financial statements would mislead investors FASB 94 specifically eliminated the exception for nonhomogeneous operations [FASB 94, Par 9] FASB 160

affirms the requirement for consolidating entities in which a controlling financial interest

is held

Prime Company controls companies in very different industries and combining the accounts of its subsidiaries may lead to confusion by some investors; however, it may be equally confusing to provide detailed listings of assets and liabilities by industry or other breakdowns in the consolidated balance sheet The actual number of assets and liabilities presented in the consolidated balance sheet must be carefully considered, but

is the decision of Prime’s management

It is important to recognize that the notes to the consolidated financial statements are regarded as an integral part of the financial statements and Prime Company is required

to include in its notes to the financial statements certain information on its reportable

segments [FASB 131] Because of the diversity of its ownership, Prime may wish to provide more than the minimum disclosures specified in FASB 131 Segment

information appears to be used quite broadly by investors and permits the company to provide sufficient detail to assist the financial statement user in gaining a better understanding of the various operating divisions of the company

You have requested information on those situations in which it may not be appropriate to combine similar appearing accounts of two or more subsidiaries The following is a partial listing of such situations: (a) the accounts of a subsidiary should not be included along with other subsidiaries if control of the assets and liabilities does not rest with Prime Company, as when a subsidiary is in receivership; (b) while the assets and liability

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C4-2 (continued)

balances of other affiliates, and (d) assets pledged for a specific purpose and not available for other use by the consolidated entity generally should be separately reported

C4-3 Consolidating an Unprofitable Subsidiary

MEMO

TO: Chief Accountant

Amazing Chemical Corporation FROM: , Accounting Staff

Re: Consolidation of Unprofitable Boatyard

This memo is intended to provide recommendations on the presentation of the boatyard

in Amazing Chemical’s consolidated financial statements Amazing Chemical Corporation currently has full ownership of the boatyard and should fully consolidate the boatyard in its financial statements Consolidated statements should be prepared when

a company directly or indirectly has a controlling financial interest in one or more other

companies [ARB 51, Par 1] This requirement has been reaffirmed by FASB 160 Prior to the issuance of FASB 94, Amazing Chemical may have justified excluding the

boatyard from consolidation based on the differences in operating characteristics

between the subsidiary and the parent company; however, FASB 94 specifically deleted the nonhomogeneity exclusion [FASB 94, Par 9] Thus, Amazing Chemical appears to

be following generally accepted accounting procedures in fully consolidating the boatyard in its financial statements and should continue to do so

The operations of the boatyard appear to be distinct from the other operations of the parent company and its losses appear to be sufficient to establish it as a reportable

segment [FASB 131, Par 10 and 18] While the operating losses of the boatyard may

not be evident in analyzing the consolidated income statement, a review of the notes to the consolidated statements should provide adequate disclosure of its operations as a reportable segment The financial statements for the current period should contain these disclosures and if prior period statements have not included the boatyard as a reportable segment it may be necessary to restate those statements

Failure of the president of Amazing Chemical to receive approval by the board of directors for the purchase of the boatyard and his subsequent actions to keep information about its operations from the board members appears to be a serious breach

of ethics These actions by the president should immediately be brought to the attention

of the board of directors for appropriate action by the board

Primary citations:

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C4-4 Assigning an Acquisition Differential

It may be difficult to determine the amount of the differential to be assigned to the manufacturing facilities of Ball Corporation The equipment is relatively old and may be

in varying states of repair or operating condition Some units may be technologically obsolete or of little value because production needs have changed The $600,000 estimated fair value of net assets therefore may be difficult to document and even more difficult to assign to specific assets and liabilities

Inventories should be compared to sales to determine if Ball has excess balances on hand Factors such as the degree of salability, physical condition, and expected sales prices should be examined as well in determining the portion of the differential to be assigned to inventory The LIFO inventory balances are likely to be below fair value while the FIFO balances may be relatively close to fair value The amount of differential assigned to inventory will be significantly affected by the rate of change in inventory costs since the LIFO inventory method was adopted and the relative magnitude of inventory on hand under each method

No mention is made of patents or other intangible assets developed by Ball Corporation While Ball Corporation could not record as assets its expenditures on research and development, the buyer should recognize all tangible and intangible assets at fair value before goodwill is computed Goodwill normally is measured as the excess of the sum of the consideration given in the acquisition and the fair value of the noncontrolling interest over the fair value of the identifiable net assets of the acquired company Timber must evaluate the fair value of Ball as a whole and consider the fair value of the equity interest

in Ball that it is not acquiring

C4-5 Negative Retained Earnings

Net assets of the subsidiary increase when positive earnings results occur and decrease when negative results occur A negative retained earnings balance indicates that the other stockholders' equity balances of the subsidiary exceed the reported net assets of the subsidiary

a The negative retained earnings balance of the subsidiary is eliminated in the consolidation process and does not affect the dollar amounts reported in the consolidated stockholders' equity accounts

b The consolidation process does not change in any substantive manner Rather than debiting retained earnings in the entry to eliminate the stockholders' equity balances of the subsidiary in the consolidation workpaper, the account must be credited

c Goodwill is recorded whenever the fair value of the acquired company as a whole, as evidenced by the fair value of the consideration given in the acquisition and the fair value

of the noncontrolling interest, exceeds the fair value of the net identifiable assets acquired In this case it is not known whether the fair value is above or below book value Sloan Company recorded losses in prior periods and may have written down all assets that had decreased in value On the other hand, management may have been reluctant to recognize such losses in order to avoid reducing earnings even further In the extreme, it may even have sold all assets that had appreciated in value Many factors, including the future earning power of the company, will affect the purchase price and it is therefore difficult to determine whether goodwill will be recorded in a situation such as this

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C4-6 Balance Sheet Reporting Issues

a Under the first two alternatives, the cars and associated debt would appear on Crumple's consolidated balance sheet In the first case the debt is recorded directly by Crumple In the second case, the leasing subsidiary should be fully consolidated Although in economic substance there may be little difference between creating a leasing subsidiary and creating a trust to accomplish the same goals, consolidation of a trust generally has not been required under generally accepted accounting procedures

However, the recent issuance of FASB 160 changes the definition of a subsidiary to

include trusts Although the FASB is still grappling with specifically what entities to include in consolidation, it now seems unlikely that a trust in which another company has

a controlling financial interest can escape being included in the consolidated financial statements If Crumple has the capability to name the directors of the trust and to administer its activities, the activities of the trust may be carried out to benefit Crumple in virtually the same manner as an operating corporate affiliate The situation presented provides an opportunity to think about the concept of control and the use of nontraditional organization structures in carrying out the business activities of a company

b Crumple apparently has not considered selling additional common or preferred shares The sale of additional shares or use of convertible securities would be one set of options to consider If Crumple is willing to lease the automobiles, other leasing companies or automobile manufacturers may be interested in participating If the availability of rental cars is considered important in the economic development of the states into which Crumple intends to expand, the company may be able to negotiate low cost loans or partially forgivable loans in acquiring the facilities and automobiles needed for expansion

c Some individuals may focus on the fact that Crumple will not get any residual amounts if the trust is dissolved However, through management charges and selection

of lease rates, Crumple is likely to be able to leave as large or small a balance in the trust as it wishes Students may wish to look at the financial statements of one or more leasing companies in arriving at their recommendation(s)

From a financial reporting perspective, all three alternatives now should be reported in essentially the same manner in the consolidated financial statements Thus, the financial reporting aspects of the three alternatives have become irrelevant However, even when different alternatives lead to different reporting treatments, the choice of an alternative should be based on economic considerations rather than on the financial reporting effects Even though the three financing alternatives Crumple is considering are reported

in the same manner, they each may have different legal, tax, and economic aspects that should be considered by Crumple’s management

C4-7 Subsidiary Ownership: AMR Corporation and International Lease

a (1) Airline service

(2) American Airlines, Inc

(3) Fort Worth, Texas

b (1) International Lease Finance Corporation leases aircraft to airlines

(2) AIG Capital Corporation and National Union Fire Insurance Company of Pittsburgh, Pennsylvania are the direct owners of International Lease

(3) Los Angeles, California

(4) California

(5) International Lease’s common stock is not publicly traded because the company

is an indirect wholly owned subsidiary of American International Group

(6) American International Group, Inc., is the parent of the consolidated group American International is a holding company with businesses that include insurance, and related products, financial services, and asset management

E4-3 Basic Elimination Entry

Common Stock – Broadway Corporation 200,000

Investment in Broadway Common Stock 600,000

E4-4 Eliminating Entries with Differential

Book value of Brown's liabilities (28,000)

a consolidation workpaper is prepared

Book value of Thorne's liabilities (280,000)

E4-6 Acquisition with Differential

a Goodwill is $60,000, computed as follows:

Book value of Conger's net assets:

Fair value increment:

Buildings ($400,000 - $220,000) 180,000 200,000

b Eliminating entries needed:

E(1) Common Stock – Conger Corporation 80,000

b Blank Corporation and Faith Corporation

Consolidated Balance Sheet Workpaper

December 31, 20X2 Blank Faith Eliminations Consol- Item Corp Corp Debit _ Credit Idated

E4-8 Balance Sheet Workpaper with Differential

b Blank Corporation and Faith Corporation

Consolidated Balance Sheet Workpaper

December 31, 20X2 Blank Faith Eliminations Consol- Item Corp Corp Debit Credit idated

Investment in Premium Builders Stock 167,000 Eliminate investment balance

Consolidated Balance Sheet Workpaper

January 1, 20X5 Gold

Enter- Premium Eliminations Consol- Item prises Builders Debit Credit idated Cash and Receivables 80,000 30,000 (1) 2,000 108,000

Consolidated Balance Sheet January 1, 20X5 Cash and Receivables $ 108,000 Current Liabilities $ 210,000

Equipment (net) 522,000 Retained Earnings 127,000 327,000

Total Liabilities &

Total Assets $1,137,000 Stockholders' Equity $1,137,000

E4-10 Computation of Consolidated Balances

d Goodwill: Fair value of consideration given $ 576,000

Book value of net assets

Balance assigned to goodwill $ 46,000

e Investment in Astor Corporation: Nothing would be reported; the balance in the investment account is eliminated

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E4-11 Multiple-Choice Questions on Balance Sheet Consolidation

1 d $215,000 = $130,000 + $85,000

2 b $23,000 = $198,000 – ($405,000 - $265,000 + $15,000 + $20,000)

3 c $1,109,000 = Total Assets of Top Corp $ 844,000

Less: Investment in Sun Corp (198,000) Book value of assets of Top Corp $ 646,000 Book value of assets of Sun Corp 405,000

Payment in excess of book value ($198,000 - $140,000) 58,000

4 c $701,500 = ($61,500 + $95,000 + $280,000) + ($28,000 + $37,000

+ $200,000)

5 d $257,500 = The amount reported by Top Corporation

6 a $407,500 = The amount reported by Top Corporation

E4-12 Consolidation Entries for Wholly Owned Subsidiary

a Journal entries recorded by Trim Corporation:

(1) Investment in Round Corporation Stock 400,000

(3) Investment in Round Corporation Stock 80,000

Record equity-method income

E(2) Common Stock — Round Corporation 120,000

Investment in Round Corporation Stock 400,000 Eliminate beginning investment balance

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E4-13 Basic Consolidation Entries for Fully Owned Subsidiary

a Journal entries recorded by Purple Company:

(3) Investment in Amber Corporation Stock 50,000

Record equity-method income

E(2) Common Stock — Amber Corporation 300,000

Investment in Amber Corporation Stock 500,000 Eliminate beginning investment balance

E4-14 Wholly Owned Subsidiary with Differential

a Journal entries recorded by Winston Corporation:

(3) Investment in Canton Corporation Stock 30,000

Record equity-method income

Investment in Canton Corporation Stock 4,000 Amortize differential assigned to equipment:

E(2) Common Stock — Canton Corporation 60,000

E(2) Common Stock — Shaw Corporation 100,000

Investment in Shaw Corporation Stock 150,000 Eliminate beginning investment balance

E4-15 (continued)

b Blake Corporation and Shaw Corporation

Consolidation Workpaper December 31, 20X3 Blake Shaw Eliminations Consol- Item Corp Corp Debit Credit idated

Dividends Declared (40,000) (10,000) (1) 10,000 (40,000) Ret Earnings, Dec 31,

E(2) Common Stock — Shaw Corporation 100,000

Investment in Shaw Corporation Stock 170,000 Eliminate beginning investment balance

E4-16 (continued)

b Blake Corporation and Shaw Corporation

Consolidation Workpaper December 31, 20X4 Blake Shaw Eliminations Consol- Item Corp Corp Debit Credit idated

Dividends Declared (50,000) (15,000) (1) 15,000 (50,000) Ret Earnings, Dec 31,

Eliminate income from subsidiary

Assign beginning differential

Amortize differential

E4-17 (continued)

b Kennelly Corporation and Short Company

Consolidation Workpaper December 31, 20X5 Kennelly Short Eliminations Consol- Item Corp Co Debit Credit idated

Dividends Declared (40,000) (10,000) (1) 10,000 (40,000) Ret Earnings, Dec 31,