Test bank with answers for advanced accounting 3e by jeter chapter 04

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Chapter 4
Consolidated Financial Statements after Acquisition
1.

An investor adjusts the investment account for the amortization of any difference between cost and
book value under the
a. cost method.
b. complete equity method.
c. partial equity method.
d. complete and partial equity methods.

2.

Under the partial equity method, the entry to eliminate subsidiary income and dividends includes a
debit to
a. Dividend Income.
b. Dividends Declared - S Company.
c. Equity in Subsidiary Income.

d. Retained Earnings - S Company.

3.

On the consolidated statement of cash flows, the parent‟s acquisition of additional shares of the
subsidiary‟s stock directly from the subsidiary is reported as
a. an investing activity.
b. a financing activity.
c. an operating activity.
d. none of these.

4.

Under the cost method, the workpaper entry to establish reciprocity
a. debits Retained Earnings - S Company.
b. credits Retained Earnings - S Company.
c. debits Retained Earnings - P Company.
d. credits Retained Earnings - P Company.

5.

Under the cost method, the investment account is reduced when
a. there is a liquidating dividend.
b. the subsidiary declares a cash dividend.
c. the subsidiary incurs a net loss.
d. none of these.

6.

The parent company records its share of a subsidiary‟s income by

a. crediting Investment in S Company under the partial equity method.
b. crediting Equity in Subsidiary Income under both the cost and partial equity methods.
c. debiting Equity in Subsidiary Income under the cost method.
d. none of these.

7.

In years subsequent to the year of acquisition, an entry to establish reciprocity is made under the
a. complete equity method.
b. cost method.
c. partial equity method.
d. complete and partial equity methods.




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4-2

8.

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
A parent company received dividends in excess of the parent company‟s share of the subsidiary‟s
earnings subsequent to the date of the investment. How will the parent company‟s investment
account be affected by those dividends under each of the following accounting methods?

a.
b.
c.
d.

Cost Method
No effect
Decrease
No effect
Decrease

Partial Equity Method
No effect
No effect
Decrease
Decrease

9.

P Company purchased 80% of the outstanding common stock of S Company on May 1, 2011, for a
cash payment of $1,272,000. S Company‟s December 31, 2010 balance sheet reported common
stock of $800,000 and retained earnings of $540,000. During the calendar year 2011, S Company
earned $840,000 evenly throughout the year and declared a dividend of $300,000 on November 1.

What is the amount needed to establish reciprocity under the cost method in the preparation of a
consolidated workpaper on December 31, 2011?
a. $208,000
b. $260,000
c. $248,000
d. $432,000

10.

P Company purchased 90% of the outstanding common stock of S Company on January 1, 1997. S
Company‟s stockholders‟ equity at various dates was:
1/1/97
1/1/11
12/31/11
Common stock
$400,000
$400,000
$400,000
Retained earnings
120,000
380,000
460,000
Total
$520,000
$780,000
$860,000
The workpaper entry to establish reciprocity under the cost method in the preparation of a
consolidated statements workpaper on December 31, 2011 should include a credit to P Company‟s
retained earnings of
a. $80,000.

b. $234,000.
c. $260,000.
d. $306,000.

11.

12.

Consolidated net income for a parent company and its partially owned subsidiary is best defined as
the parent company‟s
a. recorded net income.
b. recorded net income plus the subsidiary‟s recorded net income.
c. recorded net income plus the its share of the subsidiary‟s recorded net income.
d. income from independent operations plus subsidiary‟s income resulting from transactions with
outside parties.
In the preparation of a consolidated statements workpaper, dividend income recognized by a parent
company for dividends distributed by its subsidiary is
a. included with parent company income from other sources to constitute consolidated net income.
b. assigned as a component of the noncontrolling interest.
c. allocated proportionately to consolidated net income and the noncontrolling interest.
d. eliminated.




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Chapter 4 Consolidated Financial Statements after Acquisition

4-3

13.

In the preparation of a consolidated statement of cash flows using the indirect method of presenting
cash flows from operating activities, the amount of the noncontrolling interest in consolidated
income is
a. combined with the controlling interest in consolidated net income.
b. deducted from the controlling interest in consolidated net income.
c. reported as a significant noncash investing and financing activity in the notes.
d. reported as a component of cash flows from financing activities.

14.

On October 1, 2011, Parr Company acquired for cash all of the voting common stock of Stein
Company. The purchase price of Stein‟s stock equaled the book value and fair value of Stein‟s net
assets. The separate net income for each company, excluding Parr‟s share of income from Stein was
as follows:
Parr
Stein

Twelve months ended 12/31/11
$4,500,000
$2,700,000
Three months ended 12/31/11
495,000
450,000
During September, Stein paid $150,000 in dividends to its stockholders. For the year ended
December 31, 2011, Parr issued parent company only financial statements. These statements are not
considered those of the primary reporting entity. Under the partial equity method, what is the
amount of net income reported in Parr‟s income statement?
a. $7,200,000.
b. $4,650,000.
c. $4,950,000.
d. $1,800,000.

15.

A parent company uses the partial equity method to account for an investment in common stock of
its subsidiary. A portion of the dividends received this year were in excess of the parent company‟s
share of the subsidiary‟s earnings subsequent to the date of the investment. The amount of dividend
income that should be reported in the parent company‟s separate income statement should be
a. zero.
b. the total amount of dividends received this year.
c. the portion of the dividends received this year that were in excess of the parent‟s share of
subsidiary‟s earnings subsequent to the date of investment.
d. the portion of the dividends received this year that were NOT in excess of the parent‟s share of
subsidiary‟s earnings subsequent to the date of investment.

16.

Masters, Inc. owns 40% of Fields Corporation. During the year, Fields had net earnings of $200,000
and paid dividends of $50,000. Masters used the cost method of accounting. What effect would this
have on the investment account, net earnings, and retained earnings, respectively?
a. understate, overstate, overstate.
b. overstate, understate, understate
c. overstate, overstate, overstate
d. understate, understate, understate




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4-4

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

Use the following information in answering questions 17 and 18.
17.

Prior Industries acquired a 70 percent interest in Stevenson Company by purchasing 14,000 of its
20,000 outstanding shares of common stock at book value of $210,000 on January 1, 2010.
Stevenson reported net income in 2010 of $90,000 and in 2011 of $120,000 earned evenly
throughout the respective years. Prior received $24,000 dividends from Stevenson in 2010 and
$36,000 in 2011. Prior uses the equity method to record its investment.
Prior should record investment income from Stevenson during 2011 of:
a. $36,000
b. $120,000
c. $84,000
d. $48,000

18.

The balance of Prior‟s Investment in Stevenson account at December 31, 2011 is:
a. $210,000
b. $285,000
c. $297,000
d. $315,000

19.

Parkview Company acquired a 90% interest in Sutherland Company on December 31, 2010, for
$320,000. During 2011 Sutherland had a net income of $22,000 and paid a cash dividend of $7,000.
Applying the cost method would give a debit balance in the Investment in Stock of Sutherland
Company account at the end of 2011 of:
a. $335,000
b. $333,500
c. $313,700
d. $320,000

20.

Hall, Inc., owns 40% of the outstanding stock of Gloom Company. During 2011, Hall received a
$4,000 cash dividend from Gloom. What effect did this dividend have on Hall‟s 2011 financial
statements?
a. Increased total assets.
b. Decreased total assets.
c. Increased income.
d. Decreased investment account.

21.

P Company purchased 80% of the outstanding common stock of S Company on May 1, 2011, for a
cash payment of $318,000. S Company‟s December 31, 2010 balance sheet reported common stock
of $200,000 and retained earnings of $180,000. During the calendar year 2011, S Company earned
$210,000 evenly throughout the year and declared a dividend of $75,000 on November 1. What is
the amount needed to establish reciprocity under the cost method in the preparation of a
consolidated workpaper on December 31, 2011?
a. $52,000
b. $65,000
c. $62,000
d. $108,000




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Chapter 4 Consolidated Financial Statements after Acquisition
22.

4-5

P Company purchased 90% of the outstanding common stock of S Company on January 1, 1997. S
Company‟s stockholders‟ equity at various dates was:
1/1/97
1/1/11
12/31/11
Common stock
$200,000
$200,000
$200,000
Retained earnings
60,000
190,000
230,000
Total
$260,000

$390,000
$430,000
The workpaper entry to establish reciprocity under the cost method in the preparation of a
consolidated statements workpaper on December 31, 2011 should include a credit to P Company‟s
retained earnings of
a. $40,000.
b. $117,000.
c. $130,000.
d. $153,000.

Use the following information in answering questions 23 and 24.
23.

Prior Industries acquired an 80 percent interest in Sanderson Company by purchasing 24,000 of its
30,000 outstanding shares of common stock at book value of $105,000 on January 1, 2010.
Sanderson reported net income in 2010 of $45,000 and in 2011 of $60,000 earned evenly
throughout the respective years. Prior received $12,000 dividends from Sanderson in 2010 and
$18,000 in 2011. Prior uses the equity method to record its investment.
Prior should record investment income from Sanderson during 2011 of:
a. $18,000.
b. $60,000.
c. $48,000.
d. $33,600.

24.

The balance of Prior‟s Investment in Sanderson account at December 31, 2011 is:
a. $105,000.
b. $138,600.
c. $159,000.

d. $165,000.

25.

Pendleton Company acquired a 70% interest in Sunflower Company on December 31, 2010, for
$380,000. During 2011 Sunflower had a net income of $30,000 and paid a cash dividend of
$10,000. Applying the cost method would give a debit balance in the Investment in Stock of
Sunflower Company account at the end of 2011 of:
a. $400,000.
b. $394,000.
c. $373,000.
d. $380,000.




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4-6

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

Use the following information to answer questions 26 and 27
On January 1, 2011, Rotor Corporation acquired 30 percent of Stator Company's stock for $150,000. On
the acquisition date, Stator reported net assets of $450,000 valued at historical cost and $500,000 stated at
fair value. The difference was due to the increased value of buildings with a remaining life of 10 years.
During 2011 Stator reported net income of $25,000 and paid dividends of $10,000. Rotor uses the equity
method.
26.

What will be the balance in the Investment account as of Dec 31, 2011?
a. $150,000
b. $157,500
c. $154,500
d. $153,000

27.

What amount of investment income will be reported by Rotor for the year 2011?
a. $7,500
b. $6,000
c. $4,500
d. $25,000

28.

On January 1, 2011, Potter Company purchased 25 % of Smith Company‟s common stock; no
goodwill resulted from the acquisition. Potter Company appropriately carries the investment using the
equity method of accounting and the balance in Potter‟s investment account was $190,000 on

December 31, 2011. Smith reported net income of $120,000 for the year ended December 31, 2011
and paid dividends on its common stock totaling $48,000 during 2011. How much did Potter pay for
its 25% interest in Smith?
a. $172,000
b. $202,000
c. $208,000
d. $232,000

Use the following information to answer questions 29 and 30.
29.

On January 1, 2011, Paterson Company purchased 40% of Stratton Company‟s 30,000 shares of
voting common stock for a cash payment of $1,800,000 when 40% of the net book value of Stratton
Company was $1,740,000. The payment in excess of the net book value was attributed to depreciable
assets with a remaining useful life of six years. As a result of this transaction Paterson has the ability
to exercise significant influence over Stratton Company‟s operating and financial policies. Stratton‟s
net income for the ended December 31, 2011 was $600,000. During 2011, Stratton paid $325,000 in
dividends to its shareholders. The income reported by Paterson for its investment in Stratton should
be:
a. $120,000
b. $130,000
c. $230,000
d. $240,000

30.

What is the ending balance in Paterson‟s investment account as of December 31, 2011?
a. $1,800,000
b. $1,900,000
c. $1,910,000

d. $2,030,000




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Chapter 4 Consolidated Financial Statements after Acquisition

4-7

Problems
4-1

On January 1, 2011, Price Company purchased an 80% interest in the common stock of Stahl
Company for $1,040,000, which was $60,000 greater than the book value of equity acquired. The
difference between implied and book value relates to the subsidiary‟s land.
The following information is from the consolidated retained earnings section of the consolidated
statements workpaper for the year ended December 31, 2011:

1/01/11 retained earnings
Net income
Dividends declared
12/31/11 retained earnings

STAHL
COMPANY
$300,000
220,000
(80,000)
$440,000

CONSOLIDATED
BALANCES
$1,400,000
680,000
(140,000)
$1,940,000

Stahl‟s stockholders‟ equity includes only common stock and retained earnings.
Required:
A. Prepare the workpaper eliminating entries for a consolidated statements workpaper on
December 31, 2011. Price uses the cost method.
B. Compute the total noncontrolling interest to be reported on the consolidated balance sheet on
December 31, 2011.

4-2

On October 1, 2011, Packer Company purchased 90% of the common stock of Shipley Company

for $290,000. Additional information for both companies for 2011 follows:

Common stock
Other contributed capital
Retained Earnings, 1/1
Net Income
Dividends declared (10/31)

PACKER
$300,000
120,000
240,000
260,000
40,000

SHIPLEY
$90,000
40,000
50,000
160,000
8,000

Any difference between implied and book value relates to Shipley‟s land. Packer uses the cost
method to record its investment in Shipley. Shipley Company‟s income was earned evenly
throughout the year.
Required:
A. Prepare the workpaper entries that would be made on a consolidated statements workpaper on
December 31, 2011. Use the full year reporting alternative.
B. Calculate the controlling interest in consolidated net income for 2011.

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4-8
4-3

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
On January 1, 2011, Pierce Company purchased 80% of the common stock of Stanley Company for
$600,000. At that time, Stanley‟s stockholders‟ equity consisted of the following:
Common stock
Other contributed capital
Retained earnings

$220,000
90,000
320,000

During 2011, Stanley distributed a dividend in the amount of $120,000 and at year-end reported a
$320,000 net income. Any difference between implied and book value relates to subsidiary
goodwill. Pierce Company uses the equity method to record its investment. No impairment of
goodwill is observed in the first year.
Required:
A. Prepare on Pierce Company‟s books journal entries to record the investment related activities
for 2011.
B. Prepare the workpaper eliminating entries for a workpaper on December 31, 2011.

4-4

Pratt Company purchased 80% of the outstanding common stock of Selby Company on January 2,
2004, for $680,000. The composition of Selby Company‟s stockholders‟ equity on January 2, 2004,
and December 31, 2011, was:
1/2/04
12/31/11
Common stock
$540,000
$540,000
Other contributed capital
325,000
325,000
Retained earnings (deficit)
(60,000)
295,000
Total stockholders‟ equity
$805,000
$1,160,000
During 2011, Selby Company earned $210,000 net income and declared a $60,000 dividend. Any
difference between implied and book value relates to land. Pratt Company uses the cost method to

record its investment in Selby Company.
Required:
A. Prepare any journal entries that Pratt Company would make on its books during 2011 to record
the effects of its investment in Selby Company.
B. Prepare, in general journal form, all workpaper entries needed for the preparation of a
consolidated statements workpaper on December 31, 2011.

4-5

P Company purchased 90% of the common stock of S Company on January 2, 2011 for $900,000.
On that date, S Company‟s stockholders‟ equity was as follows:
Common stock, $20 par value
Other contributed capital
Retained earnings

$400,000
100,000
450,000




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Chapter 4 Consolidated Financial Statements after Acquisition

4-9

During 2011, S Company earned $200,000 and declared a $100,000 dividend. P Company uses the
partial equity method to record its investment in S Company. The difference between implied and
book value relates to land.
Required:
Prepared, in general journal form, all eliminating entries for the preparation of a consolidated
statements workpaper on December 31, 2011.

4-6

Pair Company acquired 80% of the outstanding common stock of Sax Company on January 2, 2010
for $675,000. At that time, Sax‟s total stockholders‟ equity amounted to $1,000,000. Sax Company
reported net income and dividends for the last two years as follows:

Reported net income
Dividends distributed

2010
$45,000
35,000

2011

$60,000
75,000

Required:
Prepare journal entries for Pair Company for 2010 and 2011 assuming Pair uses:
A. The cost method to record its investment
B. The complete equity method to record its investment. The difference between implied value and
the book value of equity acquired was attributed solely to a building, with a 20-year expected
life.

4-7

Pell Company purchased 90% of the stock of Silk Company on January 1, 2007, for $1,860,000, an
amount equal to $60,000 in excess of the book value of equity acquired. All book values were equal
to fair values at the time of purchase (i.e., any excess payment relates to subsidiary goodwill). On
the date of purchase, Silk Company‟s retained earnings balance was $200,000. The remainder of the
stockholders‟ equity consists of no-par common stock. During 2011, Silk Company declared
dividends in the amount of $40,000, and reported net income of $160,000. The retained earnings
balance of Silk Company on December 31, 2010 was $640,000. Pell Company uses the cost method
to record its investment. No impairment of goodwill was recognized between the date of
acquisition and December 31, 2011.
Required:
Prepare in general journal form the workpaper entries that would be made in the preparation of a
consolidated statements workpaper on December 31, 2011.

4-8

On January 1, 2011, Pitt Company purchased 85% of the outstanding common stock of Small
Company for $525,000. On that date, Small Company‟s stockholders‟ equity consisted of common
stock, $150,000; other contributed capital, $60,000; and retained earnings, $210,000. Pitt Company

paid more than the book value of net assets acquired because the recorded cost of Small Company‟s
land was significantly less than its fair value.
During 2011 Small Company earned $222,000 and declared and paid a $75,000 dividend. Pitt
Company used the partial equity method to record its investment in Small Company.




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4-10 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

Required:
A. Prepare the investment related entries on Pitt Company‟s books for 2011.
B. Prepare the workpaper eliminating entries for a workpaper on December 31, 2011.
4-9
Picture Company purchased 40% of Stuffy Corporation on January 1, 2011 for $150,000. Stuffy
Corporation‟s balance sheet at the time of acquisition was as follows:

Cash
Accounts Receivable
Inventory
Land
Buildings & Equipment
Less: Acc. Depreciation

$30,000
120,000
80,000
150,000
300,000
(120,000)

Current Liabilities
Bonds Payable
Common Stock
Additional Paid in Capital
Retained Earnings

Total Assets

$560,000

Total Liabilities and Equities

$40,000
200,000
200,000
40,000

80,000

$560,000

During 2011, Stuffy Corporation reported net income of $30,000 and paid dividends of $9,000. The
fair values of Stuffy‟s assets and liabilities were equal to their book values at the date of acquisition,
with the exception of Building and Equipment, which had a fair value of $35,000 above book value.
All buildings and equipment had a remaining useful life of five years at the time of the acquisition.
The amount attributed to goodwill as a result of the acquisition in not impaired.
Required:
A. What amount of investment income will Picture record during 2011 under the equity method of
accounting?
B. What amount of income will Picture record during 2011 under the cost method of accounting?
C. What will be the balance in the investment account on December 31, 2011 under the cost and
equity method of accounting?




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Chapter 4 Consolidated Financial Statements after Acquisition

4-11

Short Answer
1.

There are three levels of influence or control by an investor over an investee, which determine the
appropriate accounting treatment. Identify and briefly describe the three levels and their accounting
treatment.

2.

Two methods are available to account for interim acquisitions of a subsidiary‟s stock at the end of
the first year. Describe the two methods of accounting for interim acquisitions.

Short Answer Questions from the Textbook
1. How should nonconsolidated subsidiaries be re-ported in consolidated financial statements?
2. How are liquidating dividends treated on the books of an investor, assuming the investor uses the cost
method? Assuming the investor uses the equity method?
3. How are dividends declared and paid by a subsidiary during the year eliminated in the consolidated
work papers under each method of ac-counting for investments?
4. How is the income reported by the subsidiary reflected on the books of the investor under each of the
methods of accounting for investments?
5. Define: Consolidated net income; consolidated retained earnings.
6. At the date of an 80% acquisition, a subsidiary had common stock of $100,000 and retained earnings of
$16,250. Seven years later, at December 31, 2010, the subsidiary‟s retained earnings had increased to
$461,430. What adjustment will be made on the consolidated work paper at December 31, 2011, to

recognize the parent‟s share of the cumulative undistributed profits (losses)of its subsidiary? Under
which method(s) is this adjustment needed? Why?
7. On a consolidated work paper for a parent and its partially owned subsidiary, the noncontrolling interest
column accumulates the non controlling interests‟ share of several account balances. What are these
accounts?
8. If a parent company elects to use the partial equity method rather than the cost method to record its
investments in subsidiaries, what effect will this choice have on the consolidated financial statements?
If the parent company elects the complete equity method?
9. Describe two methods for treating the preacquisition revenue and expense items of a subsidiary
purchased during a fiscal period.
10. A principal limitation of consolidated financial statements is their lack of separate financial information about the assets, liabilities, revenues, and expenses of the individual companies included in
the consolidation. Identify some problems that the reader of consolidated financial statements would
encounter as a result of this limitation.
11. In the preparation of a consolidated statement of cash flows, what adjustments are necessary because of
the existence of a noncontrolling interest? (AICPA adapted)




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4-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
12. What do potential voting rights refer to, and how do they affect the application of the equity method for
investments under IFRS? Under U.S.GAAP? What is the term generally used for equity method
investments under IFRS?
13B.

Is the recognition of a deferred tax asset or deferred tax liability when allocating the difference
between book value and the value implied by the purchase price affected by whether or not the
affiliates file a consolidated income tax re-turn?

14B.

What assumptions must be made about the realization of undistributed subsidiary income when the
affiliates file separate income tax returns? Why? (Appendix)

15B.

The FASB elected to require that deferred tax effects relating to unrealized intercompany profits be
calculated based on the income tax paid by the selling affiliate rather than on the future tax benefit
to the purchasing affiliate. Describe circumstances where the amounts calculated under these
approaches would be different. (Appendix)

16B.

Identify two types of temporary differences that may arise in the consolidated financial statements
when the affiliates file separate income tax returns.

Business Ethics Question from the Textbook

On April 5, 2006, the New York State Attorney sued a New York online advertising firm for surreptitiously
installing spyware advertising programs on consumers‟ computers. The Attorney General claimed that consumers believed they were downloading free games or „browser‟ enhancements. The company claimed that
the spyware was identified as „advertising-supported‟ and that the software is easy to remove and doesn‟t
collect personal data. Is there an ethical issue for the company? Comment on and justify your position.




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Chapter 4 Consolidated Financial Statements after Acquisition
ANSWER KEY
Multiple Choice
1.
2.
3.
4.
5.
6.

7.

b
c
d
d
a
d
b

8.
9.
10.
11.
12.
13.
14.

d
a
b
d
d
a
c

15.
16.
17.
18.

19.
20.
21.

a
d
c
c
d
d
a

22.
23.
24.
25.
26.
27.
28.

b
c
c
d
d
b
a

29.
30.

Problems
4-1

A. Dividend Income (80,000 × .80)
Dividends Declared – Stahl
Common Stock – Stahl
Retained Earnings, 1/1 – Stahl
Difference Between Implied and Book Value
Investment in Stahl Company
Noncontrolling Interest in Equity

64,000
64,000
925,000*
300,000
75,000**
1,040,000
260,000

*[(1,040,000 – 60,000)/.8] – 300,000
**60,000/.8 = 75,000
Land
Difference Between Implied and Book Value

75,000
75,000

B. Noncontrolling Interest:
In 1/1/11 retained earnings 300,000 × .20

In 2011 net income 220,000 × .20
In dividends declared 80,000 × .20
In common stock of Stahl 925,000 × .20
In difference between implied and book value 75,000 x .20
Total noncontrolling interest
4-2

A. Dividend Income (8,000 × .90)
Dividends Declared – Shipley

$60,000
44,000
(16,000)
185,000
15,000
$288,000

7,200

Common Stock - Shipley
90,000
Other Contributed Capital – Shipley
40,000
Retained Earnings 1/1 – Shipley
50,000
Difference between Implied# and Book Value
(290,000/.9 – 300,000*)
22,222
Subsidiary Income Purchased
(160,000 × 9/12)

120,000
Investment in Shipley Company
Noncontrolling Interest in Equity (.10 x $322,222)



7,200

290,000
32,222

c
b

4-13


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4-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
*BV=[90,000 + 40,000 + 50,000 + (160,000 × 9/12)] = $300,000
#Implied Value = Purchase Price/90% = $322,222
Land
Difference Between Implied and Book Value
B. Controlling interest in Consolidated Net Income
Packer‟s reported net income
– dividend income from Shipley
Packer‟s income from independent operations
+ Packer‟s share of Shipley‟s net income in 2011
since acquisition (.90 × 40,000)
Controlling Interest in Consolidated Net Income
4-3

A. Investment in Stanley Company
Cash
Investment in Stanley Company
(.80 × 320,000)
Equity in Subsidiary Income

22,222
22,222

$260,000
7,200
252,800
36,000
$288,800

600,000

600,000

256,000
256,000

Cash (.80 × 120,000)
Investment in Stanley Company

96,000

B. Equity in Subsidiary Income
Dividends Declared – Stanley
Investment in Stanley Company

216,000

Common Stock – Stanley
Other Contributed Capital – Stanley
Retained Earnings 1/1 – Stanley
Difference Between Implied and Book Value
Investment in Stanley Company
Noncontrolling Interest in Equity

96,000

96,000
120,000
220,000
90,000
320,000

120,000
600,000
150,000

Goodwill
120,000
Difference Between Implied and Book Value

4-4

A. Cash
Dividend Income (.8 × $60,000)
B. To Establish Reciprocity
Investment in Selby Company
1/1 Retained Earnings - Pratt Company

120,000

48,000
48,000

164,000
164,000

$295,000 – $210,000 + $60,000 = $145,000 Retained Earnings on 1/1/11
$145,000 + $60,000 (deficit on date of acquisition) = $205,000 increase in retained earnings
from date of acquisition to 1/1/11
Pratt Company‟s share of increase = (.8 × $205,000) = $164,000

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Chapter 4 Consolidated Financial Statements after Acquisition
Eliminating Entries
Dividend Income
Dividends Declared – Selby Company

48,000
48,000

Common Stock – Selby
540,000
Other Contributed Capital – Selby
325,000
1/1 Retained Earnings – Selby
145,000
Difference Between Implied and Book Value45,000*

Investment in Selby Company
Noncontrolling Interest in Equity

844,000
211,000

Implied Value = $680,000/.80 = $850,000. Diff = $850,000 – $805,000BV.
Land
45,000
Difference Between Implied and Book Value

4-5

Equity in Subsidiary Income
Dividends Declared - S Company
Investment in S Company

270,000

Common Stock – S
Other Contributed Capital – S
1/1 Retained Earnings – S
Difference Between Implied and Book Value
Investment in S Company
Noncontrolling Interest in Equity

400,000
100,000
450,000
50,000

45,000

90,000
180,000

900,000
100,000

Land
50,000
Difference Between Implied and Book Value

50,000

4-6
A. 2010
Investment in Sax Company
Cash
Cash
Dividend Income (.8 × $35,000)

675,000
675,000
28,000
28,000

2011
Cash (.8 × $75,000)
60,000

Investment in Sax Company (.8 × $5,000)
Dividend Income
B. 2010
Investment in Sax Company
Cash

4,000
56,000

675,000
675,000



4-15


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4-16 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
Cash

28,000
Investment in Sax Company

28,000

Investment in Sax Company
36,000
Equity in Subsidiary Income (.8 × $45,000)
Equity in Subsidiary Income ($75,000*/20)
Investment in Sax Company

36,000

3,750
3,750

* $675,000/.8 – $750,000 = $93,750 write-up of PPE; Parent‟s share = 80%, or $75,000
2011
Cash
Investment in Sax Company

60,000
60,000

Investment in Sax Company
48,000
Equity in Subsidiary Income (.8 × $60,000)

Equity in Subsidiary Income
Investment in Sax Company

4-7

48,000

3,750

Workpaper entries 12/31/11
Investment in Silk Company
Retained Earnings 1/1 - Pell company
To establish reciprocity (.90 × ($640,000 – $200,000))
Dividend Income
Dividends Declared - Silk Company

3,750

396,000
396,000

36,000
36,000

Common Stock - Silk Company#
1,800,000
Retained Earnings 1/1/11 - Silk Company
640,000
Difference between Implied and Book Values
66,667

Investment in Silk Company ($1,860,000 + $396,000)
Noncontrolling Interest in Equity ($206,667 + $44,000##)
#$2,000,000– $200,000
##NCI share of change in R/E = .10($640,000 - $200,000)
Goodwill*
Difference between Implied and Book Values

2,256,000
250,667

66,667
66,667

*See computation of difference between implied and book values on following page.




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Chapter 4 Consolidated Financial Statements after Acquisition

4-17

Computation and Allocation of Difference between Implied and Book Value
Parent
Share
Purchase price and implied value
Equity at book value
Difference between Implied value and bv
Allocated to undervalued land
Balance
* $1,860,000 – $60,000
** $1,800,000/.9

4-8

A. Investment in Small
Cash

$1,860,000
1,800,000*
60,000
(60,000)
-0-

NonEntire
Controlling
Value

Share
206,667
2,066,667
200,000
2,000,000**
6,667
66,667
(6,667)
(66,667)
-0-0-

525,000
525,000

Investment in Small ($222,000)(.85)
Equity in Subsidiary Income
Cash ($75,000)(.85)
Investment in Small
B. Equity in Subsidiary Income
Dividends Declared - Small
Investment in Small

188,700
188,700
63,750
63,750
188,700
63,750
124,950

Common Stock - Small
Other Contributed Capital - Small
Retained Earnings 1/1 - Small
Difference between Implied and Book Value
Investment in Small
Noncontrolling Interest in Equity

150,000
60,000
210,000
197,647

Land
Difference between Implied and Book Value

197,647

525,000
92,647

197,647

Computation and Allocation of Difference between Implied and Book Value
Parent
NonShare
controlling
share
Purchase price and implied value
$ 525,000
92,647

Book Value of Equity Acquired
357,000
63,000
Difference between Implied and Book Value
168,000
29,647
Adjust Land Upward
(168,000)
(29,647)
Balance
-0-0-



Entire
value
617,647
420,000
197,647
(197,647)
-0-


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4-18 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

4-9
Solution:
A. Picture Company 2011 equity-method income:
Proportionate share of reported income ($30,000 x .40)
Amortization of differential assigned to:
Buildings and equipment [($35,000 x .40) / 5 years]
Goodwill ($8,000: not impaired)
Investment Income

$ 12,000
(2,800)
-0$ 9,200

Assignment of differential
Purchase price
Proportionate share of book value of
net assets ($320,000 x .40)
Proportionate share of fair value increase in buildings
and equipment ($35,000 x .40)
Goodwill

$150,000

(128,000)
(14,000)
$ 8,000

B.

Dividend income, 2011 ($9,000 x .40)

$ 3,600

C.

Cost-method account balance (unchanged):

$150,000

Equity-method account balance:
Balance, January 1, 2011
Investment income
Dividends received
Balance, December 31, 2011

$150,000
9,200
(3,600)
$155,600

Short Answers
1.
The three levels of influence (control) over an investee are (1) no significant influence, (2)

significant influence, and (3) effective control. When an investor has no significant influence over
an investee, the investment is accounted for at fair value with year-end adjustment for market
changes (the cost method). If the investor has significant influence over the investee, the investment
is accounted for under the equity method. In the equity method, the investor adjusts the investment
account for changes in the investee's net assets.
When an investor has effective control over the investee, consolidated financial statements are
prepared. The investor's investment account is eliminated in the consolidated process.




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Chapter 4 Consolidated Financial Statements after Acquisition

4-19

2.
The two methods of accounting for interim acquisitions are the full-year reporting alternative and

the partial-year reporting alternative. The full-year method includes the subsidiary's revenues and
expenses in the consolidated income statement for the entire year and then makes a deduction at the
bottom of the income statement for the preacquisition earnings.
The partial-year method includes in the consolidated income statement only the subsidiary's revenue
and expense amounts for the period after acquisition. The full-year method is preferred.

Short Answer Questions in Textbook Solutions

1

Nonconsolidated subsidiaries are expected to be relatively rare. In those situations where a subsidiary
is not consolidated, the investment in the subsidiary should be reported in the consolidated statement
of financial position at cost, along with other long-term investments.

2.

A liquidating dividend is a return of investment rather than a return on investment. Consequently, the
amount of a liquidating dividend should be credited to the investment account rather than to dividend
income when the cost method is used, whereas regular dividends are recorded as dividend income
under the cost method. If the equity method is used, all dividends are credited to the investment
account.

3.

When the parent company uses the cost method, the work paper elimination of intercompany
dividends is made by a debit to Dividend Income and a credit to Dividends Declared. This
elimination prevents the double counting of income since the subsidiary's individual revenue and
expense items are combined with the parent company's in the determination of consolidated net
income. When the parent company uses the equity method, the work paper elimination for
intercompany dividends is made by a debit to the investment account and a credit to Dividends

Declared.

4.

When the parent company uses the cost method, dividends received are recorded as dividend income.
When the parent company uses the partial equity method, the parent company recognizes equity
income on its books equal to its ownership percentage times the investee company‟s reported net
income. When the parent company uses the complete equity method, the parent recognizes income
similar to the partial equity method, but adjusts the equity income for additional charges or credits
when the purchase price differs from the fair value of the investee company‟s net assets, and for
intercompany profits (addressed in chapters 6 and 7).

5.

Consolidated net income consists of the parent company's net income from independent operations
plus (minus) any income (loss) earned (incurred) by its subsidiaries during the period, adjusted for
any intercompany transactions during the period and for any excess depreciation or amortization
implied by a purchase price in excess of book values.
Consolidated retained earnings consist of the parent company's retained earnings from its
independent operations plus (minus) the parent company's share of the increase (decrease) in its
subsidiaries' retained earnings from the date of acquisition.




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4-20 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

6.

Investment in S Company
1/1 Retained Earnings, P Company
80% ($461,430 - $16,250)]

356,144
356,144

This adjustment recognizes that P Company's share of S Company's undistributed profits from the
date of acquisition to the beginning of the current year is properly a part of beginning-of-year
consolidated retained earnings. It also enhances the elimination of the investment account. This entry
is only needed if the parent company uses the cost method. If the equity method is used, the parent‟s
retained earnings already reflect the undistributed earnings of the subsidiary.
7.

The noncontrolling interest column accumulates the noncontrolling stockholders' share of subsidiary
income, less their share of excess depreciation or amortization implied by fair value adjustments
(addressed in detail in chapter 5), dividends (as a reduction), and the beginning noncontrolling
interest in equity carried forward from the previous period.

8.

The method used to record the investment on the books of the parent company (cost method, partial
equity method, or complete equity method) has no effect on the consolidated financial statements.
Only the workpaper elimination procedures are affected.

9.

The two methods for treating the preacquisition revenue and expense items of a subsidiary purchased
during a fiscal year are (1) including the revenue and expense items of the subsidiary for the entire
period with a deduction at the bottom of the consolidated income statement for the net income earned
prior to acquisition (this is the preferred method), and (2) including in the consolidated income
statement only the subsidiary's revenue earned and expenses incurred subsequent to the date of
purchase.

10. (a) Readers of consolidated financial statements will be unable to evaluate the financial
position and results of operations (neither of which is shown separately from the parent's)
of the subsidiaries.
(b) Because consolidated assets are not generally available to meet the claims of the creditors of a
subsidiary, creditors will have to look to the financial statements of the debtor (subsidiary)
corporation. Similarly, the creditors of the parent company are most interested in only the assets of
the parent company, although large creditors are likely to gain control over or have indirect access
to the assets of subsidiaries in the case of parent company default.
(c) Because consolidated financial statements are a composite, it is impossible to distinguish a
financially weak subsidiary from financially strong ones.
(d) Ratio analyses based on consolidated data are not reliable guides, especially when the related group
produces a conglomerate of unrelated product lines and services.

(e) Consolidated financial statements often do not disclose data about subsidiaries that are not

consolidated.
(f) A reader of consolidated financial statements cannot assume that a certain amount of unrestricted
consolidated retained earnings will be available for dividends. Data on the ability of the individual
subsidiaries to pay dividends are frequently unavailable.




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Chapter 4 Consolidated Financial Statements after Acquisition

4-21

11. A consolidated statement of cash flows contains two adjustments that result from the existence of a
noncontrolling interest: (1) an adjustment for the noncontrolling interest in net income or loss of the
subsidiary in the determination of net cash flow from operating activities, and (2) subsidiary dividend
payments to the noncontrolling stockholders must be included with parent company dividends paid in
determining cash paid as dividends because the entire amount of the noncontrolling interest in net

income (loss) is added back (deducted) in determining net cash flows from operating activities.
12. Potential voting rights refer to the rights associated with potentially dilutive securities such as
convertible bonds or stocks, or stock options, rights, or warrants that are currently exercisable. These
are considered under international standards in determining the applicability of the equity method for
investments where the investor may be considered to have significant influence. They are generally not
considered under U.S. GAAP. International standards (IFRS) refer to investments that are accounted
for under the equity method as “investments in associates.”
13B.

No. The recognition and display of a deferred tax asset or deferred tax liability relating to the
assignment of the difference between implied value and book value is necessary without regard to
whether the affiliates file consolidated income tax returns or separate income tax returns.

14B

An assumption must be made as to whether the undistributed income will be realized in a future
dividend distribution or as a result of the sale of the subsidiary. This is necessary because the
calculation of the tax consequences differs depending on the assumption made. Dividend
distributions are subject to a dividends received exclusion, whereas gains or losses on disposal are
not. In addition, gains or losses on disposal may be taxed at different tax rates than dividend
distributions. Although capital gains are currently taxed at the same rates as ordinary income, the
rates have been different in the past and may be again in the future.

15B

The amounts calculated under these two approaches would be different (1) if the affiliates had
different marginal tax rates, (2) if the affiliates were in different tax jurisdictions, or (3) when
expected future tax rates differ from the tax rate used in determining the tax paid or accrued by the
selling affiliate.

16B

When the affiliates file separate returns, two types of temporary differences may arise:
1. Deferred income tax consequences that arise in the consolidated financial statements because of
undistributed subsidiary income, and
2. Deferred income tax consequences that arise in the consolidated financial statements because of
the elimination of unrealized intercompany profit.

ANSWERS TO BUSINESS ETHICS CASE
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