Solution manual advanced accounting 10e by beams ch10

Chapter 10
SUBSIDIARY PREFERRED STOCK, CONSOLIDATED EARNINGS PER SHARE,
AND CONSOLIDATED INCOME TAXATION
Answers to Questions
1

Flora’s investment income
Arom’s net income
Less: Preferred income ($500,000 × 10%)
Income to common stockholders
Flora’s percentage owned
Investment income
Flora’s investment account balance (equal to book value):
Arom’s stockholders’ equity
Less: Preferred equity (no arrearages or call premiums)
Common equity
Flora’s percentage ownership
Investment account balance

$

$

300,000
(50,000)
250,000
60%
150,000

$2,500,000
(500,000)

2,000,000
60%
$1,200,000

2

The payment of two years preferred dividend requirements would not have affected Flora’s investment
income. Since the preferred stock is cumulative, the preferred dividend requirements are deducted from
net income each year regardless of whether preferred dividends are declared.

3

The preferred stock of a subsidiary does not appear in a consolidated balance sheet. If there is a
noncontrolling interest in the preferred stock, it is reported as a noncontrolling interest in the
consolidated balance sheet. In part a, the investment in preferred is eliminated against the preferred
equity and there is no noncontrolling interest in preferred. When 50 percent of the stock is held by the
parent (part b), the investment in preferred is eliminated against 50 percent of the preferred equity and
the other 50 percent is reported as a noncontrolling interest. In part c, all of the preferred stock is
reported as a noncontrolling interest.

4

Assuming that the parent does not hold any of the subsidiary’s preferred stock, the computation of
noncontrolling interest share for an 80 percent owned subsidiary is 100 percent of the income allocated
to preferred plus 20 percent of the income allocated to common.

5

There is no difference between the controlling share of consolidated and parent company EPS.

6

An investor company’s EPS computations must reflect the potential dilution of an equity investee’s
common stock equivalents and other potentially dilutive securities if the effect is material.

7

Procedures applied in computing a parent company’s EPS computations are the same as those for a
corporation without equity investments except when the subsidiary has outstanding common stock
equivalents or other potentially dilutive securities.

8

Subsidiary EPS computations are only needed when computing diluted EPS, never for basic EPS, and
then it is only needed when the subsidiary has potentially dilutive securities convertible into subsidiary
common stock.

9

If a subsidiary has dilutive securities convertible into subsidiary common stock, the parent’s diluted
earnings are adjusted by replacing the parent’s equity in subsidiary realized income with its equity in
subsidiary diluted EPS. Alternatively, when subsidiary securities are convertible into the parent’s
common stock, the parent’s diluted earnings and common shares are adjusted as if the dilutive securities
had been issued by the parent company.

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10-1


10-2

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

10

The replacement computation does not involve unrealized profits from downstream sales because these
items relate solely to parent company operations and do not affect the noncontrolling interest. In the
case of unrealized profits from upstream sales, however, unrealized profits are deducted in the
replacement computation which involves subtracting the parent’s equity in subsidiary realized income
and adding back the parent’s equity in subsidiary primary or fully diluted EPS (also based on subsidiary
realized income).

11

Consolidated tax returns are not required for a consolidated entity, but a consolidated entity that
qualifies as an “affiliated group” may elect to file consolidated tax returns. Once consolidated returns are
elected, it may be difficult to obtain IRS permission to file separate returns.

12

Yes. Consolidated entities that meet the requirements of an affiliated group can and often do elect to file
separate income tax returns.

13

The primary advantages of filing consolidated tax returns are (1) losses of affiliates are offset against
gains of other members of the affiliated group, (2) intercompany profits between group members are
eliminated from taxable income until realized, and (3) intercorporate dividends are fully excluded from
taxable income. (But note that 3 is not a unique advantage of filing a consolidated return.)

14

Dividends received by a member of an affiliated group from other group members are excluded from
federal income taxation regardless of whether the affiliated group elects to file consolidated tax returns.

15

Temporary differences result because investors that are not members of an affiliated group record
income from equity investments as it is earned, but pay taxes only when dividends are actually received.

16

In providing for income taxes on undistributed earnings of equity investees, the parent
company/investor debits income tax expense and credits deferred income taxes as part of the
determination of all income taxes for the period. The investment and investment income accounts are
not affected.

17

Unrealized and constructive gains and losses give rise to temporary differences unless the consolidated
entity is a member of an affiliated group and elects to file consolidated tax returns.

SOLUTIONS TO EXERCISES
Solution E10-1
1

2
3
4

[AICPA adapted]

a
Moss income to preferred
$
2,000
$10,000 × 20% owned
Moss income to common
40,000
$50,000 × 80% owned
Income from Moss
$
42,000
b
$180,000 × 20% taxable × 30% tax rate
d
All dividend income is excluded from a consolidated group.
d
Intercompany profit is deferred in the consolidated tax return until
realized through sale to an outside entity.

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Chapter 10

10-3

Solution E10-2
1

2

3

4

[Preferred stock]

Cost/fair value differential
Total stockholders’ equity January 1, 2010
Less: Preferred equity (10,000 shares × $115)
Common equity

$8,000,000
1,150,000
$6,850,000

Cost

$8,100,000

Implied total fair ($8,100,000 / 90%)
Book value of investment
Excess fair over book value – Goodwill

$9,000,000
6,850,000
$2,150,000

Income from Star for 2010
Star’s net income
Less: Preferred dividends for 2010
Income to common
Income from Star ($1,100,000 × 90%)

$1,200,000
100,000
$1,100,000
$ 990,000

Investment in Star at December 31, 2010
Investment cost January 1, 2010
Add: Income from Star
Less: Dividends ($600,000 - $200,000 preferred) × 90%
Investment in Star

$8,100,000
990,000
(360,000)
$8,730,000

Noncontrolling interest for 2010
Beginning stockholders’ equity
Add: Net income
Less: Dividends
Stockholders’ equity December 31, 2010

$8,000,000
1,200,000

(600,000)
$8,600,000

Preferred equity ($105 × 10,000)
Common noncontroling interest ($8,600,000 + $2,150,000
(Goodwill)-$1,050,000) × 10%
Noncontrolling interest December 31, 2010
Solution E10-3
1

2

$1,050,000
970,000
$2,020,000

[Preferred stock]

Fair value — book value differential
Cost of 80% interest

$1,536,000

Implied total fair value ($1,536,000 / 80%)
Less: Book value ($2,500,000 total equity $630,000 preferred equity)
Excess fair value over book value - Goodwill

$1,920,000
(1,870,000)
$

50,000

Loss from Sommerfeld — 2009
Sommerfeld’s net loss
Add: Income to preferred stockholders
Loss to common stockholders
Percent owned
Loss on investment in Sommerfeld

$

$

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100,000
72,000
172,000
80%
137,600


10-4

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-3 (continued)
3

Income from Sommerfeld — 2010

Net income
Less: Income to preferred stockholders
Income to common stockholders
Percent owned
Income from investment in Sommerfeld

4

Total stockholders’ equity at December 31, 2010
($2,500,000 - $100,000 loss in 2009 + $500,000 income
in 2010 - $344,000 dividends in 2010)
Less: Preferred equity
Common equity
Percent owned
Underlying equity
Add: 80% of Unamortized excess
Investment in Sommerfeld at December 31, 2010

$2,556,000
(630,000)
1,926,000
80%
1,540,800
40,000
$1,580,800

Check: Cost of investment
Loss — 2009
Income — 2010
Dividends 2010 ($344,000 - $144,000) × 80%

Investment in Sommerfeld at December 31, 2010

$1,536,000
(137,600)
342,400
(160,000)
$1,580,800

[Preferred stock]

Investment cost (fair value equals book value)
Total stockholders’ equity of Sandalwood
Less: Preferred equity 10,000 shares × ($100 + $5 + $12)
Common equity
Percent owned
Investment cost (fair value and book value)

2

3

$

500,000
(72,000)
428,000
80%
342,400

Parnell’s investment in Sommerfeld account

Solution E10-4
1

$

$4,000,000
1,170,000
2,830,000
80%
$2,264,000

Consolidated net income and noncontrolling interest share
Penzance separate income
Add: Income from Sandalwood ($500,000 - $120,000) × 80%
Consolidated net income

$3,000,000
304,000
$3,304,000

Noncontrolling interest share ($380,000 common income ×
20%) + $120,000 preferred income

$

196,000

Underlying book value
Total stockholders’ equity

Less: Preferred equity (10,000 shares × $105 call price)
Common equity
Percent owned
Underlying book value December 31, 2010

$4,200,000
1,050,000
3,150,000
80%
$2,520,000

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Chapter 10

10-5

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10-6

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-5
Preliminary computations
Total equity of Shoshone at December 31, 2009
Less: Preferred equity (10,000 shares × $115)
Common equity December 31, 2009

1

$3,500,000
(1,150,000)
$2,350,000

Entries to record preferred stock investment
600,000
Investment in Shoshone — preferred
Cash
600,000
To record purchase of 50% of Shoshone’s preferred stock.
Additional paid-in capital
25,000
25,000
Investment in Shoshone — preferred
To adjust investment in preferred account to underlying equity:
$600,000 cost - ($1,150,000 underlying equity × 50%) = $25,000.

2

3

4

5

Excess of fair value over book value from common stock investment
Cost of 80% investment in common stock
$2,000,000

Implied total fair value ($2,000,000 / 80%)
Book value
Excess fair value over book value

$2,500,000
(2,350,000)
$ 150,000

Pimlico’s income from Shoshone preferred — 2010
$1,000,000 par × 15% × 50% owned

$

75,000

$

200,000
(12,000)
188,000

Pimlico’s income from Shoshone common — 2010
Equity in Shoshone’s common income ($400,000 income $150,000 preferred dividends) × 80% owned
Amortization of excess ($150,000/10 years) × 80% owned
Income from Shoshone common

$

Noncontrolling interest at December 31, 2010
Total equity at December 31 ($3,500,000 + $400,000

income - $300,000 dividends)
Less: Preferred equity
Common equity
Plus 20% of unamortized differential (20% × $135,000)
Common equity plus excess fair value

$3,600,000
(1,000,000)
$2,600,000
27,000
$2,627,000

Noncontrol. Int. — preferred ($1,000,000 × 50%) $500,000
Noncontrol. interest — common ($2,627,000 × 20%) 525,400
Total noncontrolling interest December 31

$1,025,400

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Chapter 10

10-7

Solution E10-6
1

2

[Preferred stock]

Fair value — book value differentials
Cost of preferred stock
Book value of preferred 60,000 shares × ($100 par +
$5 call premium + $10 dividend arrearage)
Excess book value of preferred stock over cost

$ 6,500,000

Cost of common stock

$35,000,000

Implied total fair value ($35,000,000 / 70%)
Book value of common ($60,000,000 total equity $11,500,000 preferred equity)
Excess fair value over book value of common

$50,000,000

(6,900,000)
(400,000)

$

48,500,000
$ 1,500,000

The $400,000 negative differential should be treated as an increase in
the preferred investment and other paid-in capital accounts on Perry’s

books. Perry will record its investment in Sketch preferred as follows:
Investment in Sketch preferred
6,500,000
Cash
To record purchase of 60% of Sketch’s preferred stock.

6,500,000

Investment in Sketch preferred
400,000
Other paid-in capital
400,000
To adjust other paid-in capital for the constructive retirement of
60% of Sketch’s preferred shares.
Solution E10-7
1
2
3

[EPS]

d
c
d

Solution E10-8
[EPS]
1
a
Solaid’s diluted earnings for consolidated EPS purposes

Polar’s equity in Solaid’s income $176,000/.8
$
2

3

4

c
Solaid’s outstanding shares
Add: Incremental shares 10,000 shares - ($100,000
assumed proceeds/$20 average market price)
Solaid’s common shares and common share equivalents

220,000

50,000 shares
5,000 shares
55,000 shares

b
Polar’s net income
Less: Equity in Solaid’s income
Add: Equity in Solaid’s diluted earnings (40,000 shares ×
Solaid’s $4 diluted EPS)
Polar’s diluted earnings

$

$

316,000
(176,000)

d
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160,000
300,000


10-8

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Polar’s diluted earnings $300,000/300,000 Polar outstanding common
shares = $1

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Chapter 10

10-9

Solution E10-9

[EPS]

Sheridan’s basic and diluted EPS

Basic
Income to common (equal to Sheridan’s net income) = a $18,000
Common shares and common share equivalents:
Outstanding shares
Additional shares using treasury stock method:
1,000 - (1,000 × $9)/$15
Common shares and common share equivalents = b
Sheridan’s EPS = a/b

Diluted
$18,000

5,000

5,000

5,000
$
3.60

400
5,400
$
3.33

$20,000

$20,000

Putman’s basic and diluted EPS

Income to common (equal to Putman’s net income)

Replacement of Putman’s equity in Sheridan’s realized
income with Putman’s equity in Sheridan’s diluted
earnings: Equity in Sheridan’s income to common
($18,000 × 80%)
Equity in Sheridan’s diluted earnings
(4,000 shares × $3.33)
Putman’s basic and diluted earnings = a
$20,000
Outstanding common shares = b
8,000
Putman’s EPS = a/b
$
2.50
Solution E10-10

(14,400)
13,320
$18,920
8,000
$
2.37

[EPS]
Basic

a

b

Stanley’s earnings per share
Net income
Stanley’s common shares outstanding
Incremental shares from warrants
Diluted: 5,000 — ($120,000 assumed
proceeds/$30 average price)
Common shares and equivalents
Earnings per share
Prince’s basic and diluted EPS
Prince’s income to common ($80,467 - $12,000
to preferred)
Replacement computation:
Equity in Stanley’s income
Equity in Stanley’s EPS
16,000 shares × $1.26

$26,400
20,000

Diluted
$26,400
20,000
1,000

20,000
1.32

21,000
1.26

$

$

$68,467

$68,467
(21,120)
20,160

a
b

Earnings
Prince’s common shares outstanding

$68,467
10,000

$67,507
10,000

a/b

Earnings per share

$

$

6.85

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6.75


10-10

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-11

[EPS]
Diluted

1
a

Scony’s earnings per share
Scony’s earnings:
Income to Scony common (equals net income)
Scony’s outstanding shares
Incremental shares from warrants
Diluted: 10,000 — ($240,000 assumed
proceeds/$40 average price)

b

Common and equivalent shares

a/b

Scony’s earnings per share

a

Consolidated earnings per share
Poway’s income to common (equals net
income)
Replacement:
80% of Scony’s income
Equity in diluted earnings
40,000 shares × $11.67
diluted EPS
Poway’s earnings

b

Poway’s outstanding shares

a/b

Consolidated earnings per share

2

Solution E10-12

[Tax]

1

c

b

2

Solution E10-13
1

3

c

4

$630,000
50,000
4,000
54,000
$

11.67

Basic

Diluted

$1,480,000

$1,480,000
(504,000)

$1,480,000

466,800
$1,442,800

1,000,000

1,000,000

$

1.48

$

1.44

b

[Tax]

c
Assigned value of equipment
Related deferred tax liability

($6,000,000 - $4,000,000 tax basis) × 34% tax rate

$6,000,000
$

680,000

2

c
Income tax expense = $500,000 investment income × 20% taxable × 34% tax
rate

3

c
Income taxes currently payable:
$30,000 dividends × 20% taxable × 34% tax rate = $2,040
Income tax expense:
$60,000 income from Springer × 20% taxable × 34% tax rate = $4,080
Deferred tax liability:
$30,000 undistributed earnings × 20% taxable × 34% tax rate = $2,040

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Chapter 10

10-11

Solution E10-13 (continued)
4

d
Income taxes currently payable:
$17,500 dividends × 20% taxable × 34% tax rate = $1,190
Deferred income taxes:
$17,500 share of undistributed earnings × 20%
taxable × 34% tax rate = $1,190

5

a
No income tax is assessed on dividends received from a 100% owned
domestic subsidiary

Solution E10-14
1

2

3

[Tax]

Separate company tax returns
Pruit’s income taxes currently payable:
Pretax accounting income $300,000 × 34% tax rate =
Solo’s income taxes currently payable:
Pretax accounting income $100,000 × 34% tax rate =

Income taxes currently payable
Less: Increase in deferred tax asset ($200,000 × 34%)
Consolidated income tax expense
Consolidated tax return
Combined pretax accounting income
Less: Unrealized gain on downstream sale of land
Taxable income
Tax rate
Consolidated income tax expense
Separate tax returns
Pruit’s income taxes currently payable:
Pretax accounting income $300,000 × 34% tax rate =
Solo’s income taxes currently payable:
Pretax accounting income $100,000 × 34% tax rate =
Income taxes currently payable
Consolidated tax return
Combined pretax accounting income
Less: Unrealized gain on downstream sale of land
Taxable income
Tax rate
Income taxes currently payable

$102,000
34,000
136,000
(68,000)
$ 68,000
$400,000
(200,000)
200,000

34%
$ 68,000

$102,000
34,000
136,000
$400,000
(200,000)
200,000
34%
$ 68,000

Note: No tax is paid on intercompany profits when consolidated returns
are filed.

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10-12

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-15

[Tax]

Preliminary computations — Because there is only one tax rate, a schedule
approach to this solution is not necessary.
Sales
Gain on equipment

Cost of sales
Other expenses(includes $50,000 patent
amortization)
Pretax operating income
Income taxes payable on operating income
at 34% income tax rate
Income taxes payable on dividends ($400,000
paid × 70% interest × 20% taxable × 34%)
Income taxes currently payable
Increase in deferred tax asset*
Income tax expense
Separate incomes
Add: Income from Sutter ($528,000 × 70%
owned - $160,000 unrealized gain)
Net income
*

Paxton
Sutter
$8,000,000 $4,000,000
200,000
(5,000,000) (2,000,000)
(1,850,000) (1,200,000)
1,350,000
800,000
(459,000)

(272,000)

(19,040)

(478,040)
48,307
(429,733)
920,267

(272,000)
(272,000)
528,000

209,600
$1,129,867

$

528,000

Deferred tax asset ($160,000 unrealized gain × 34%) - ($128,000 future dividends
× 70% owned × 20% taxable × 34% enacted tax rate) = $48,307

Paxton Corporation and Subsidiary
Consolidated Income Statement
for the year 2009
Consolidated sales
$12,000,000
Less: Cost of sales
(7,000,000)
Less: Other expenses ($3,000,000 + $50,000 - $40,000)
(3,010,000)
Income before income taxes and noncontrolling interest share 1,990,000
Income tax expense**

(701,733)
Total consolidated income
1,288,267
Noncontrolling interest share
(158,400)
Controlling share of onsolidated net income
$ 1,129,867
** Taxes currently payable of $478,040 for Paxton + $272,000 for Sutter - $48,307
increase in deferred tax asset = $701,733

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Chapter 10

10-13

Solution E10-16
1

[Tax]

One-line consolidation entries
Separate tax returns are filed
Income from Sullivan
40,000
Investment in Sullivan
40,000
To eliminate unrealized profit on downstream sale of merchandise.
Computation: $50,000 gross profit × 80% unrealized.

Note: that the tax effect of the unrealized profit is $13,600, but
that amount is a deferred tax asset to be included in the
computation of Peddicord’s income tax expense. The deferred tax
asset may be reduced by a valuation allowance following FIN 48.
Consolidated income tax returns are filed
Income from Sullivan
40,000
Investment in Sullivan
40,000
To eliminate unrealized profit on downstream sale of merchandise.
Computation: $50,000 gross profit × 80% unrealized.
Note: since no tax is paid on the inventory profit, no income tax
adjustment is necessary.

2

Consolidation working paper entries
Separate Income Tax
Consolidated Income
Returns Filed
Tax Returns Filed
Sales
100,000
100,000
Cost of goods sold
100,000
100,000
To eliminate reciprocal sales and purchases.
Cost of goods sold
40,000

40,000
Inventory
40,000
To eliminate unrealized profits in ending inventory.

40,000

Note: No adjustments for tax effects are needed because consolidated
income tax is equal to combined separate company income taxes under
FASB Statement No. 109.
Solution E10-17
1

[Tax]

One-line consolidation entry
Income from Sweeney
80,000
Investment in Sweeney
80,000
To eliminate unrealized profit on upstream sale. Computation:
$100,000 unrealized profit × 80% owned.

2

Consolidation working paper entries
Gain on sale of equipment
100,000
Equipment
100,000

To eliminate unrealized gain and reduce equipment to its cost
basis.

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10-14

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution E10-17 (continued)
3

Noncontrollig interest share
Net income of Sweeney (includes the tax effect of the gain) $800,000
Less: Unrealized profit
(100,000)
Realized income of Sweeney
700,000
Noncontrolling interest percentage
20%
Noncontrolling interest share
$140,000

1Solution E10-18
Possible Estimated
Outcome

Individual
Probability

of Occurring (%)

Cumulative Probability
of Occurring (%)

$500,000

10

10

400,000

25

35

300,000

25

60

200,000

20

80

100,000

10

90

0

10

100

Because $300,000 is the largest amount of benefit that is greater than 50
percent likely of being realized, Pax would recognize a tax benefit of
$300,000. in the financial statements (Deferred tax asset of $500,000 less a
valuation allowance of $200,000).
Solution E10-19
Possible Estimated
Outcome

Individual
Probability
of Occurring (%)

Cumulative Probability
of Occurring (%)

$150,000

50

50

125,000

20

70

100,000

10

80

50,000

10

90

0

10

100

Because $125,000 is the largest amount of benefit that is greater than 50
percent likely of being realized, Pony would recognize a tax benefit of
$125,000. in the financial statements (Deferred tax asset of $150,000 less a
valuation allowance of $25,000).

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Chapter 10

10-15

SOLUTIONS TO PROBLEMS
Solution P10-1
1

2

3

4

5

[Preferred stock] (amounts in thousands)

Undervaluation of the building from Parrella’s investment in Stanley
Cost of 180,000 shares of common stock

$3,600

Implied total fair value ($3,600 / 90%)
Less: Book value
Stockholders equity

$4,150
1,150
Less: Preferred equity (10,000 × $115)*
Common equity
Excess fair value = Goodwill
* Preferred equity at liq. Pref. (!0,000 × $105)
+ Div. in arrears ($100,000)

$4,000

Income from Stanley
Stanley’s reported income
Less: Preferred dividend for 2009
Stanley’s adjusted income to common
90% of Stanley’s adjusted income
Noncontrolling interest share for 2009
Income allocable to preferred
Stanley’s adjusted income
Noncontrol. common interest share (10%)
Noncontrolling interest share

$
(
$

500
100)
400
$

360

$

100

$
$

40
140

$400

Noncontrolling interest December 31, 2009
Total stockholders’ equity ($4,150,000
+ $500,000 net income $400,000 dividends)
$4,250
Less: Preferred equity (No div. in
1,050 × 100%
arrears)
Common equity – book value
$3,200
Plus Unamortized fair value at 12/31
1,000
Common equity at fair value
$4,200 × 10%
Noncontrolling interest December 31
Investment in Stanley December 31, 2009
Investment cost

Add: Income from Stanley
Less: Dividends ($400,000 - $100,000 preferred dividends
in arrears - $100,000 current preferred dividends) × 90%
Investment in Stanley December 31
Check:
Equity of common ($3,200,000 × 90%)
Undepreciated excess ($1,000,000 × 90%)
Investment in Stanley December 31

3,000
$1,000

$1,050

420
$1,470
$3,600
360
(180)
$3,780
$2,880
900
$3,780

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10-16

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-2

[Preferred stock]

Preliminary computations
Stockholders’ equity July 1, 2009
$900,000 - ($46,000 income × 1/2 year)
Less: Preferred equity July 1, 2009
Par value with call premium
Dividend arrearage — 2008 ($200,000 × 9%)
Dividend arrearage — 2009 ($200,000 × 9% ×
1/2 year)
Common equity July 1, 2009

$877,000
$210,000
18,000
9,000

237,000
$640,000

Cost of 90% interest in Starky’s common stock

$630,000

Implied total fair value ($630,000 / 90%)
Book value of common equity
Goodwill

$700,000
(640,000)
$ 60,000

Cost of 80% interest in Starky’s preferred stock
Book value acquired ($237,000 × 80%)
Book value over cost of preferred

$175,000
(189,600)
$(14,600)

1

2

Investment account balances at December 31, 2009
Common
Investment cost
$630,000
Adjust preferred to book value and recognize
a constructive retirement
Income to preferred ($18,000 × 1/2 year × 80%)
12,600
Income to common ($28,000 × 1/2 year × 90%)
Investment balances December 31
$642,600

Preferred

$175,000
14,600
7,200
$196,800

Consolidated balance sheet working paper entries
9% preferred stock, $100 par
200,000
46,000
Retained earnings — Starky
196,800
Investment in Starky — preferred
49,200
Noncontrolling interest — preferred
To eliminate reciprocal preferred equity and investment balances
and enter noncontrolling interest. The preferred stockholders’
claim on Starky’s retained earnings consists of $18 per share
preferred dividends in arrears plus a $5 per share call premium.
Computations: Investment in Starky preferred = $123 × 1,600
shares. Noncontrolling interest — preferred = $123 × 400 shares.
Capital stock, $10 par — Starky
Paid-in capital in excess of par — Starky
Retained earnings — Starky
Goodwill
Investment in Starky — common
Noncontrolling interest — common

500,000
40,000
114,000

60,000
642,600
71,400

To eliminate reciprocal common equity and investment amounts and
enter goodwill and noncontrolling interest in common.
NOTE: Noncontrolling interest includes 10% of Goodwill.
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Chapter 10

10-17

© 2009 Pearson Education, Inc. publishing as Prentice Hall


10-18

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-3 [Preferred stock]
Preliminary computations
Cost of 70% interest in Sal January 1, 2008
Implied total fair value of Sal ($490,000 / 70%)
Book value acquired of common equity
Excess of fair value over book value

$490,000
$700,000

700,000
$
0

Cost of 20% interest in Sal April 1, 2009

$152,000

Implied total fair value of Sal ($152,000 / 20%)
Book value of Sal($850,000 + $22,500 - $12,500 - $100,000)
Excess of fair value over book value

$760,000
760,000
$
0

Pat’s investment income from Sal for 2009
Sal’s net income
$
Less: Preferred income ($100,000 × 10%)
Income to common
$
Income from Sal($80,000 × 70% × 1 year)+($80,000 × 20% × 3/4 year) $

© 2009 Pearson Education, Inc. publishing as Prentice Hall

90,000
10,000
80,000

68,000


Chapter 10

10-19

Solution P10-3 (continued)
Pat Corporation and Subsidiary
Consolidation Working Papers
for the year ended December 31, 2009
(in thousands)
Pat
Income Statement
Sales
$1,233
Income from Sal
68
Cost of sales
610 *
Other expenses
390 *
Preacquisition income
Noncontrolling int. share
Controlling share of NI
$ 301
Retained Earnings
Retained earnings — Pat

$

Retained earnings — Sal
Net income
Dividends

Retained earnings
December 31
Balance Sheet
Cash
Other current assets
Plant assets
Investment in Sal**

Current liabilities
$10 preferred stock
Common stock
Other paid-in capital
Retained earnings

Adjustments and
Eliminations

Sal
$

700

$1,933
a

68

400 *
210 *
b
d
$

1,010 *
600 *
4*
18*
$ 301

4
18

90

501

$
$

301ü
200 *

200

501

b 200

90ü
50*

301
a
d
b

34
14
2

200 *

$

602

$

240

$

602

$

191
200
900
711

$

50
300
600

$

241
500
1,500

$2,002

$

950

$2,241

$

$

60
100
500
50
240ü
950

$

200

a 34
b 677

1,200
602ü
$2,002

$

c 100
b 500
b 50

260
1,200
602

Noncontrolling interest — common

b

Noncontrolling interest — preferred
Noncontrolling interest December 31

c 100

*

Consolidated
Statements

d

75
4

179
$2,241

Deduct

** Common equity of Sal = $790 x 90% = $711

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10-20

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-4 [Preferred stock]
Preliminary computations
Fair value — book value differential
Investment cost
Implied total fair value of Sak ($240,000 / 80%)
Less: Book value acquired
Sak’s stockholders’ equity January 1, 2008
Less: Preferred equity
Sak’s common equity
Excess fair value over book value = Goodwill
Income from Sak for 2009
Equity in Sak’s income ($60,000 - $10,000 pf) × 80%
Add: Intercompany profits beginning inventory
($50,000 × 40% × 3/5)
Less: Intercompany profits ending inventory
($60,000 × 40% × 4/6)
Add: Realization of 80% of $10,000 profit deferred on
land from 2005
Add: Constructive gain on bonds ($9,000 × 80%)
Less: Piecemeal recognition of gain
($9,000/3 years × 1/2 year × 80%)
Income from Sak
Investment in Sak December 31, 2009
Underlying book value ($390,000 - $100,000) × 80%
Add: 80% of Goodwill
Less: Unrealized inventory profit
Add: Constructive gain less 1/2 year piecemeal
recognition ($9,000 - $1,500) × 80%
Investment in Sak December 31

Noncontrolling interest share — common
Sak’s reported income less income to preferred
($60,000 - $10,000)
Recognition of previously deferred gain on land
Constructive gain on bonds less 1/2 year piecemeal
recognition of gain ($9,000 - $1,500)
Sak’s realized income to common
Noncontrolling interest percentage
Noncontrolling interest share — common

$240,000
$300,000
$325,000
100,000
225,000
$ 75,000
$ 40,000
12,000
(16,000)
8,000
7,200
(1,200)
$ 50,000
$232,000
60,000
(16,000)
6,000
$282,000

$ 50,000

10,000
7,500
67,500
20%
$ 13,500

© 2009 Pearson Education, Inc. publishing as Prentice Hall


Chapter 10

10-21

Solution P10-4 (continued)
Pari Corporation and Subsidiary
Consolidation Working Papers
for the year ended December 31, 2009
Pari
Income Statement
Sales
Gain on land
Interest income
Gain on bonds
Income from Sak
Cost of sales

$

900,000
10,000

6,500

$

50,000
600,000*

Operating expenses
Interest expense
Consolidated net income
Noncontrolling share
Preferred

300,000

140,000*

208,500*

Noncontrol. Share — common
Controlling share of NI

Adjustments and
Eliminations

Sak 80%
a
e

6,500

f
c

50,000
16,000

90,000*
10,000*

i
i
$

158,000

$

132,000

60,000

$

60,000

$

50,000

Consolidated
Statements

d

10,000

$1,140,000
20,000

e

9,000

9,000

a
b

60,000
12,000

e

5,000

684,000*
298,500*
5,000*
181,500

10,000
13,500

10,000*
13,500*
$

158,000

$

132,000

Retained Earnings

—
earnings —

Retained earnings

Pari

Retained
Sak
Controlling share of NI
Dividends
Retained earnings
December 31

—
Investment —

190,000

$

90,000

$

$

15,000
20,000
60,000
5,000
30,000
420,000

Sak bonds

5,500
26,000
80,000
100,000
160,000
268,000
92,500

Sak stock

282,000

$1,014,000

$

550,000

$

$

15,000
100,000
45,000
200,000
100,000
90,000ü

24,000
100,000
700,000
190,000ü

$1,014,000

—
interest —

Noncontrolling interest

158,000
f
i

b
d
h

Goodwill
Accounts payable
10% bonds payable
Other liabilities
Capital stock
10% preferred stock
Retained earnings

50,000

60,000ü
20,000*

$

Balance Sheet
Cash
Accounts receivable
Inventories

Other current assets
Land
Plant and equipment
Investment

158,000ü
100,000*

h

$

12,000
8,000
75,000

8,000
12,000

j
c

5,000
16,000

e

92,500

100,000*

$

190,000

$

20,500
41,000
124,000
105,000
190,000
688,000

f 42,000
h 260,000
75,000
$1,243,500

j
5,000
e 100,000

$

34,000
145,000
700,000

h 200,000
g 100,000

190,000

550,000

common (beginning)

Noncontrolling
preferred (beginning)
Noncontrolling interest December 31

d

2,000

h

65,000

g 100,000
i

11,500

174,500

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10-22

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
$1,243,500

© 2009 Pearson Education, Inc. publishing as Prentice Hall


Chapter 10

10-23

Solution P10-5 [EPS]
Requirement 1 Requirement 2
Diluted
Diluted
Skinner’s EPS
Skinner’s net income (equal to income to common
stockholders)
Add: Net-of-tax interest on convertible bonds
Skinner’s earnings = a

$ 60,000
6,000
$ 66,000

$ 60,000
NA
$ 60,000

Skinner’s outstanding common shares

Add: Shares from assumed conversion of bonds
Common shares and common share equivalents = b
Skinner’s EPS = a/b

50,000
10,000
60,000
$
1.10

50,000
NA
50,000
$
1.20

Palace’s EPS
Palace’s net income (equal to income to common
stockholders)
$150,000
Add: Net-of-tax interest on convertible bonds
of Skinner
Replacement of Palace’s equity in Skinner’s
income with Palace’s equity in Skinner’s diluted (42,000)
38,500
EPS (35,000 shares × $1.10) and convertible
to Palace securities (35,000 shares × $1.20)
Palace’s earnings = a
$146,500
Palace’s outstanding common shares

Add: Shares from assumed conversion of bonds
Common shares and common share equivalents = b
Palace’s EPS = a/b
a

100,000
100,000
1.47

$

$150,000
6,000
(42,000)a
42,000a
$156,000
100,000
10,000
110,000
$
1.42

When subsidiary securities are convertible into parent company common stock, the
replacement calculation is not needed. The replacement is included in this
solution only to show that it has no effect on the calculation.

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10-24

Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation

Solution P10-6 [EPS]
Basic

a

b

a
b
a

Sheridan’s earnings per share
Income to common
Income to preferred assumed converted
Earnings
Common shares and common share equivalents:
Common shares outstanding
Add: Common shares issuable on preferred
Add: Incremental shares issuable on options
2,000 - [($2,000 × $15)/$30]
Common and common equivalent shares
EPS a/b
Pensacola’s earnings per share
Income to common
Replacement calculation
Equity in Sheridan’s income to common
($45,000 × 80%)

Equity in Sheridan’s EPS
8,000 × $4.50 basic EPS
8,000 × $3.93 diluted EPS
Earnings
Common shares
EPS a/b

$ 45,000
$ 45,000

Diluted
$ 45,000
10,000
$ 55,000

10,000

10,000
3,000

1,000
10,000
14,000
$
4.50 $
3.93
$150,000
(36,000)a

$150,000

(36,000)

36,000a
31,440
$150,000
$145,440
20,000
20,000
$
7.50 $
7.27

A replacement calculation is never needed when calculating basic earnings per
share. It is only included here to illustrate the point that the replacement will
have no impact on the earnings per share calculation.

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Chapter 10

10-25

Solution P10-7 [EPS]
1

a

b

Basic
Starch’s earnings per share
Income to common $50,000 - $14,000
$36,000
Add: Income to preferred assumed
converted
Earnings
$36,000
Common shares outstanding
6,000
Common shares from conversion of preferred
Common and common equivalent shares

2
a

b

$

Consolidated earnings per share
Net income to Protein
Replacement calculation for diluted EPS
$36,000 × 80% share of realized income
$5.00 diluted EPS × 4,800 shares
Earnings
Outstanding common shares
EPS a/b
Net income of Protein
Add: Income to preferred

Earnings
Common stock of Protein
Common shares from conversion of
preferred
Common and common share equivalents
EPS a/b

Solution P10-8

$ 36,000
14,000
$ 50,000
6,000
4,000

6,000

EPS a/b

a
b

Diluted

10,000

6.00

$

5.00

$93,800

$ 93,800

$93,800
20,000
$
4.69

(28,800)
24,000
$ 89,000
20,000
$
4.45

$93,800
$93,800
20,000

$ 93,800
14,000
$107,800
20,000

20,000
$
4.69

5,000
25,000
$
4.312

[EPS]

Premble’s net income
Replacement calculation:
Premble’s equity in Smithfield’s realized
income ($500,000 - $60,000) × 80%
Premble’s equity in Smithfield’s diluted EPS
(40,000 shares × $7.44)
Consolidated diluted earnings = a
Premble’s outstanding common shares = b
Consolidated diluted EPS = a/b

$1,262,000
$352,000
297,600

54,400
$1,207,600
100,000
$
12.08

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