Solution manual advanced accounting 11th by beams chapter10

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

Par’s investment income
Sam’s net income
Less: Preferred income ($500,000  10%)
Income to common stockholders
Par’s percentage owned
Investment income
Par’s investment account balance (equal to book value):
Sam’s stockholders’ equity
Less: Preferred equity (no arrearages or call premiums)
Common equity
Par’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 Par’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 EPS 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.
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10-1

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

10-2

10

The replacement computation does not involve unrealized profits from downstream sales because these
items relate solely to parent 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 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/investor debits
income tax expense and credits deferred tax liability 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
Sob income to preferred
$
4,000
$20,000  20% owned
80,000
Sob income to common
$100,000  80% owned
Income from Sob
$
84,000
a
($180,000- $30,000)  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](in thousands)

Cost/fair value differential
Total stockholders’ equity January 1, 2012
Less: Preferred equity (20,000 shares  $115)
Common equity

$16,000
2,300
$13,700

Cost

$16,200

Implied total fair ($16,200 / 90%)
Book value of investment
Excess fair over book value – Goodwill

$18,000

13,700
$ 4,300

Income from Sir for 2012
Sir’s net income
Less: Preferred dividends for 2012
Income to common
Income from Sir ($2,200  90%)

$2,400
200
$2,200
$1,980

Investment in Sir at December 31, 2012
Investment cost January 1, 2012
Add: Income from Sir
Less: Dividends ($1,200 - $400 preferred)  90%
Investment in Sir

$16,200
1,980
(720)
$17,460

Noncontrolling interest for 2012
Beginning stockholders’ equity
Add: Net income
Less: Dividends
Stockholders’ equity December 31, 2012

$16,000
2,400
(1,200)
$17,200

Preferred equity ($105  10,000)
Common noncontroling interest ($17,200,000 + $4,300,000
(Goodwill)-$2,100,000)  10%
Noncontrolling interest December 31, 2012
Solution E10-3
1

2

$2,100
1,940
$4,040

[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 Sol — 2011
Sol’s net loss
Add: Income to preferred stockholders
Loss to common stockholders
Percent owned
Loss on investment in Sol

$

$

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


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

10-4

Solution E10-3 (continued)
3

Income from Sol — 2012
Net income
Less: Income to preferred stockholders
Income to common stockholders
Percent owned
Income from investment in Sol

4

Total stockholders’ equity at December 31, 2012
($2,500,000 - $100,000 loss in 2011 + $500,000 income
in 2012 - $344,000 dividends in 2012)
Less: Preferred equity
Common equity
Percent owned
Underlying equity
Add: 80% of Goodwill
Investment in Sol at December 31, 2012

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

Check: Cost of investment
Loss — 2011
Income — 2012
Dividends 2012 ($344,000 - $144,000)  80%
Investment in Sol at December 31, 2012

$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 San
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

Par’s investment in Sol 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
Pen separate income
Add: Income from San ($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, 2012

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

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Chapter 10

10-5

Solution E10-5
Preliminary computations
Total equity of Son at December 31, 2011
Less: Preferred equity (10,000 shares  $115)
Common equity December 31, 2011

1

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

Entries to record preferred stock investment
600,000
Investment in Son — preferred
Cash
To record purchase of 50% of Son’s preferred stock.

600,000

25,000
Additional paid-in capital
25,000
Investment in Son — 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

Pam’s income from Son preferred — 2012
$1,000,000 par  15%  50% owned

$

75,000

Pam’s income from Son common — 2012
Equity in Son’s common income ($400,000 income $150,000 preferred dividends)  80% owned
Income from Son common

$
$

200,000
200,000

Noncontrolling interest at December 31, 2012
Total equity at December 31 ($3,500,000 + $400,000
income - $300,000 dividends)
Less: Preferred equity

Common equity
Plus goodwill
Common equity plus excess fair value

$3,600,000
(1,000,000)
$2,600,000
150,000
$2,750,000

Noncontrol. Int. — preferred ($1,000,000  50%) $500,000
Noncontrol. interest — common ($2,750,000  20%) 550,000
Total noncontrolling interest December 31

$1,050,000

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

10-6

Solution E10-6
1

2

[Preferred stock] (in thousands)

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

Cost of common stock

$35,000

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

$50,000

(6,900)
$ (400)

48,500
$ 1,500

The $400,000 negative differential should be treated as an increase in
the preferred investment and other paid-in capital accounts on Pay’s
books. Pay will record its investment in Set preferred as follows:
Investment in Set preferred

6,500
Cash
To record purchase of 60% of Set’s preferred stock.

6,500

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

[EPS]

d
c
d

Solution E10-8
[EPS]
1
a
Sod’s diluted earnings for consolidated EPS purposes
Pal’s equity in Sod’s income $176,000/.8
2

3

4

c
Sod’s outstanding shares
Add: Incremental shares 10,000 shares - ($100,000
assumed proceeds/$20 average market price)
Sod’s common shares and common share equivalents
b
Pal’s net income
Less: Equity in Sod’s income
Add: Equity in Sod’s diluted earnings (40,000 shares 
Sod’s $4 diluted EPS)
Pal’s diluted earnings

$

220,000

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

$

$

316,000

(176,000)
160,000
300,000

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

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Chapter 10

10-7

Solution E10-9

[EPS]

San’s basic and diluted EPS
Income to common (equal to San’s net income) = a
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
San’s EPS = a/b

Basic
$18,000

Diluted
$18,000

5,000

5,000

5,000
$
3.60

400
5,400
$
3.33

Put’s basic and diluted EPS
Income to common (equal to Put’s net income)
Replacement of Put’s equity in San’s realized
income with Put’s equity in San’s diluted
earnings: Equity in San’s income to common
($18,000  80%)
Equity in San’s diluted earnings
(4,000 shares  $3.33)
Put’s basic and diluted earnings = a
Outstanding common shares = b
Put’s EPS = a/b

Solution E10-10

$20,000

$20,000

(14,400)
13,320
$20,000
$18,920
8,000
8,000
$
2.50 $
2.37

[EPS]
Basic

a

b

Sal’s earnings per share
Net income
Sal’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
Pin’s basic and diluted EPS
Pin’s income to common ($80,467 - $12,000
to preferred)
Replacement computation:
Equity in Sal’s realized income
Equity in Sal’s diluted 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
Pin’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


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

10-8

Solution E10-11

[EPS]
Diluted

1
a

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

b

Common and equivalent shares

a/b

Soy’s earnings per share

a

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

b

Pow’s outstanding shares

a/b

Consolidated earnings per share

2

Solution E10-12

[Tax]

1

c

b

2

Solution E10-13
1

3

c

$630,000
50,000

4,000
54,000
$

4

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 Sap  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

10-9

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 in an affiliated group.

Solution E10-14
1

2

3

[Tax]

Separate company tax returns
Pit’s income taxes currently payable:
Pretax accounting income $300,000  34% tax rate =
Sol’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

34,000

136,000
(68,000)
$ 68,000

Consolidated tax return
Combined pretax accounting income
Less: Unrealized gain on downstream sale of land
Taxable income
Tax rate
Consolidated income tax expense

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

Separate tax
Pit’s income
Pretax
Sol’s income
Pretax
Income taxes

returns
taxes currently payable:
accounting income $300,000  34% tax rate =
taxes currently payable:
accounting income $100,000  34% tax rate =
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

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

10-10

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 Sum ($528,000  70%
owned - $160,000 unrealized gain)
Net income
*

Sum
Pan
$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)
(272,000)
48,307 ___________
(429,733)
(272,000)
920,267
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

Pan Corporation and Subsidiary
Consolidated Income Statement
for the year 2011
Consolidated sales

$12,000,000
(7,000,000)
Less: Cost of sales
Less: Other expenses ($3,000,000 + $50,000 - $40,000)
(3,010,000)
Income before income taxes and noncontrolling interest share 1,990,000
(701,733)
Income tax expense**
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 Pan + $272,000 for Sum - $48,307 increase
in deferred tax asset = $701,733

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Chapter 10

10-11

Solution E10-16
1

[Tax]

One-line consolidation entries
Separate tax returns are filed
40,000
Income from Sun
Investment in Sun
40,000
To eliminate unrealized profit on downstream sale of merchandise.
Computation: $50,000 gross profit  80% unrealized.
Note: that the
that amount is
computation of
may be reduced

tax effect of the unrealized profit is $13,600, but
a deferred tax asset to be included in the
Ped’s income tax expense. The deferred tax asset
by a valuation allowance.

Consolidated income tax returns are filed
40,000
Income from Sun
Investment in Sun
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
Consolidated Income
Separate Income Tax
Tax Returns Filed
Returns Filed
Sales
100,000
100,000
Cost of goods sold
100,000
100,000
To eliminate reciprocal sales and cost of goods sold.
40,000
40,000
Cost of goods sold
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
GAAP.
Solution E10-17
1

[Tax]

One-line consolidation entry

80,000
Income from Son
Investment in Son
80,000
To eliminate unrealized profit on upstream sale. Computation:
$100,000 unrealized profit  80% owned.

2

Consolidation working paper entries
100,000
Gain on sale of equipment
Equipment
100,000
To eliminate unrealized gain and reduce equipment to its cost
basis.

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

10-12

Solution E10-17 (continued)
3

Noncontrollig interest share

Net income of Son (includes the tax effect of the gain)
Less: Unrealized profit
Realized income of Son
Noncontrolling interest percentage
Noncontrolling interest share

$800,000
(100,000)
700,000
20%
$140,000

Solution E10-18

Field Code Changed

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
$150,000

Individual
Probability
of Occurring (%)

Cumulative Probability
of Occurring (%)

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, Pun 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

10-13

SOLUTIONS TO PROBLEMS
Solution P10-1
1

2

3

4

5

[Preferred stock] (amounts in thousands)

Goodwill from Par’s investment in Sun
Cost of 360,000 shares of common stock

$7,200

Implied total fair value ($7,200 / 90%)
Less: Book value
$8,300
Stockholders equity
2,300
Less: Preferred equity (20,000  $115)*
Common equity
Excess fair value = Goodwill
* Preferred equity at liq. Pref. (20,000  $105)
+ Div. in arrears ($200,000)

$8,000

Income from Sun
Sun’s reported income
Less: Preferred dividend for 2011
Sun’s adjusted income to common
90% of Sun’s adjusted income
Noncontrolling interest share for 2011
Income allocable to preferred
Sun’s adjusted income
Noncontrol. common interest share (10%)
Noncontrolling interest share

$1,000
( 200)
$ 800
$

720

$

200

$
$

80
280

$800

Noncontrolling interest December 31, 2011
Total stockholders’ equity ($8,300
+ $1,000 net income $8,500
$800 dividends)
Less: Preferred equity (No div. in
2,100  100%
arrears)
Common equity – book value
$6,400
Plus Unamortized goodwill at 12/31
2,000
Common equity at fair value
$8,400  10%
Noncontrolling interest December 31
Investment in Sun December 31, 2011
Investment cost
Add: Income from Sun
Less: Dividends ($800 - $200 preferred dividends
in arrears - $200 current preferred dividends)  90%
Investment in Sun December 31
Check:
Equity of common ($6,400  90%)
Undepreciated excess ($2,000  90%)
Investment in Sun December 31

6,000
$2,000

$2,100

840
$2,940
$7,200
720
(360)
$7,560
$5,760
1,800
$7,560

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

10-14

Solution P10-2

[Preferred stock]

Preliminary computations
Stockholders’ equity July 1, 2011
$900,000 - ($46,000 income  1/2 year)
Less: Preferred equity July 1, 2011
Par value with call premium

Dividend arrearage — 2010 ($200,000  9%)
Dividend arrearage — 2011 ($200,000  9% 
1/2 year)
Common equity July 1, 2011

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

237,000
$640,000

Cost of 90% interest in Set’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 Set’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, 2011
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 — Set
196,800
Investment in Set — preferred
49,200
Noncontrolling interest — preferred
To eliminate reciprocal preferred equity and investment balances
and enter noncontrolling interest. The preferred stockholders’
claim on Set’s retained earnings consists of $18 per share
preferred dividends in arrears plus a $5 per share call premium.
Computations: Investment in Set preferred = $123  1,600 shares.
Noncontrolling interest — preferred = $123  400 shares.
Capital stock, $10 par — Set
Paid-in capital in excess of par — Set
Retained earnings — Set
Goodwill
Investment in Set — 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

10-15

Solution P10-3 [Preferred stock](in thousands)
Preliminary computations
Cost of 70% interest in Sal January 1, 2010
Implied total fair value of Sal ($490 / 70%)
Book value acquired of common equity
Excess of fair value over book value

$490
$700
700
$ 0

Cost of 20% interest in Sal April 1, 2011

$152

Implied total fair value of Sal ($152 / 20%)
Book value of Sal($850 + $22.5 - $12.5 - $100)
Excess of fair value over book value

$760
760

$ 0

Pat’s investment income from Sal for 2011
Sal’s net income
Less: Preferred income ($100  10%)
Income to common
Income from Sal($80  70%  1 year)+($80  20%  3/4 year)

$ 90
10
$ 80
$ 68

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

10-16

Solution P10-3 (continued)
Pat Corporation and Subsidiary
Consolidation Working Papers
for the year ended December 31, 2011
(in thousands)
Pat
Income Statement
Sales

Income from Sal
Cost of sales
Other expenses
Preacquisition income
Noncontrolling int. share
Controlling share of NI

$1,233
68
610*
390*

Adjustments and
Eliminations

Sal
$

700

$1,933
a

301

$

501

68

400*
210*
b
d

$

$

90

$

200

Consolidated
Statements

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

4
18

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

$

301
200*

301

90
50*

a
d

b

34
14
2

602

$

240

$

$

191
200
900
711

$

50
300
600

$

$2,002

$

950

$

$

60
100
500
50
240
950

a 34
b 677

1,200
602
$2,002

602

241
500
1,500

$

$2,241
$
c 100
b 500
b 50

260

1,200
602

Noncontrolling interest — common

b

Noncontrolling interest — preferred
Noncontrolling interest December 31

c 100

*

200*

$

200

501

b 200

d

75
4

179
$2,241

Deduct

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

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Chapter 10

10-17

Solution P10-4 [Preferred stock]
Preliminary computations
Fair value — book value differential
Investment cost
Implied total fair value of Sam ($240,000 / 80%)
Less: Book value acquired

Sam’s stockholders’ equity January 1, 2010
Less: Preferred equity
Sam’s common equity
Excess fair value over book value = Goodwill
Income from Sam for 2011
Equity in Sam’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 2010
Add: Constructive gain on bonds ($9,000  80%)
Less: Piecemeal recognition of gain
($9,000/3 years  1/2 year  80%)
Income from Sam
Investment in Sam December 31, 2011
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
Sam’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)
Sam’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

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

10-18

Solution P10-4 (continued)
Par Corporation and Subsidiary
Consolidation Working Papers
for the year ended December 31, 2011
Par
Income Statement
Sales
Gain on land
Interest income
Gain on bonds
Income from Sam
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

Sam 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
Retained earnings

— Par

Retained earnings — Sam
Controlling share of NI

158,000
100,000*

Dividends
Retained earnings
December 31

— Sam
Investment — Sam
Investment

190,000

$

90,000

$

$

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

bonds

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

stock

282,000

$1,014,000

$

550,000

$

$

15,000
100,000
45,000
200,000
100,000

24,000
100,000
700,000
190,000

$1,014,000
Noncontrolling interest

— common

158,000
f
i

b

d
h

Goodwill

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

50,000

60,000
20,000*

$

Balance Sheet
Cash
Accounts receivable
Inventories
Other current assets
Land
Plant and equipment

h

12,000

8,000
75,000

8,000
12,000

j
c

5,000
16,000

e

92,500

$

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

90,000
$

100,000*

550,000

(beginning)

Noncontrolling interest — preferred (beginning)
Noncontrolling interest December 31

d

2,000

h

65,000

g 100,000
i

11,500

174,500

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Chapter 10

10-19
$1,243,500

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10-20

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

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

$ 60
6
$ 66

$ 60
NA
$ 60

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

50
10

60
$1.10

50
NA
50
$1.20

$150

$150

Pal’s EPS
Pal’s net income (equal to income to common
stockholders)
Add: Net-of-tax interest on convertible bonds
of Sir
Replacement of Pal’s equity in Sir’s
income with Pal’s equity in Sir’s diluted
EPS (35,000 shares  $1.10) and convertible
to Pal securities (35,000 shares  $1.20)
Pal’s earnings = a
Pal’s outstanding common shares
Add: Shares from assumed conversion of bonds
Common shares and common share equivalents = b
Pal’s EPS = a/b
a

6
(42)

38.5
$146.5
100
100
$1.47

(42)a
42a
$156
100
10
110
$1.42

When subsidiary securities are convertible into parent 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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Chapter 10

10-21

Solution P10-6 [EPS]
Diluted

Basic

a

b

a
b
a

She’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
Pen’s earnings per share
Income to common
Replacement calculation
Equity in She’s income to common
($45,000  80%)
Equity in She’s EPS
8,000  $4.50 basic EPS
8,000  $3.93 diluted EPS
Earnings

Common shares
EPS a/b

$ 45,000
$ 45,000

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

10-22

Solution P10-7 [EPS]
1

a

b

Common and common equivalent shares

2

a

b

$

Consolidated earnings per share
Net income to Pro
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 Pro
Add: Income to preferred
Earnings
Common stock of Pro
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

Basic
Sit’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

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]

Pin’s net income
Replacement calculation:
Pin’s equity in Sum’s realized
income ($500,000 - $60,000)  80%
Pin’s equity in Sum’s diluted EPS
(40,000 shares  $7.44)
Consolidated diluted earnings = a
Pin’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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Chapter 10

10-23

Solution P10-9 [EPS](in thousands)

a

b

a
b

Sim’s earnings per share
Income to common
Less: Unrealized profit — upstream sale
Add: Income to preferred
Earnings
Common shares outstanding
Add: Shares from conversion of preferred
Add: Incremental shares from warrants
10,000 - ($150,000/$20)
Common and common equivalent shares
EPS a/b

Basic

Diluted

$200
(20)

$200
(20)
100
$280
50
30

$180
50

Consolidated (and Pit’s) earnings per share
Pit’s income to common
Replacement calculation
Equity in Sim’s realized income
($200,000 - $20,000)  80%
Equity in Sim’s diluted EPS 40,000  $3.39
Earnings
Outstanding common shares
EPS a/b

50
$3.60

2.5
82.5
$3.3939

$450

$450

$450
100
$4.50

(144)
135.6
$441.6
100
$4.42

Solution P10-10 [Tax]
Par Corporation
Income Statement
for the current year
(in thousands)
(a)
Assuming Separate
Tax Returns
Sales
$2,400
Gain on sale of land
100
98
Income from Sama
Cost of sales
(1,200)

(700)
Operating expenses
Income before income taxes
698
(170)
Income tax expenseb
Net income
$ 528

(b)
Assuming Consolidated
Tax Return
$2,400
100
98
(1,200)
(700)
698
(170)
$ 528

Supporting computations
a

b

Income from Sam
Equity in Sam’s income
($300 - $102 income taxes)  100%
Less: Unrealized profit

Income from Sam
Income tax expense
Income tax currently payable:
Par’s $600 taxable income  34%
Consolidated taxable income of
$800  34%  $500/$800
Deferred income taxes:
Deferred tax asset ($100  34%)
Income tax expense

$ 198
(100)
$ 98

$198
(100)
$ 98

$204
$170
(34)
$ 170

____
$170

Note: There is no tax on undistributed income because Par and Sam are an
affiliated group.

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

10-24

Solution P10-11 [Tax]
Preliminary computations
Investment cost

$577,500

Implied total fair value of Sir($577,500 / 70%)
Less: Book value of Sir
Excess fair value over book value = Goodwill

$825,000
800,000
$ 25,000

1

Income tax expense (separate tax returns required)
Pan
Tax on operating income
($500,000  34%)
($200,000  34%)
Tax on dividends received

($50,000  70%)  20% taxable  34% tax rate
Income taxes currently payable
Deferred tax on undistributed income
($49,000*  70%)  20% taxable  34% tax rate
Deferred tax asset on unrealized inventory
profit ($50,000  34%)

________

Income tax expense

$174,712

*

2

Sir

$170,000
$ 68,000
2,380
172,380

68,000

2,332
(17,000)
$ 51,000

Undistributed income (Sir’s operating income of $200,000 - $51,000 tax $50,000 unrealized profit - $50,000 dividends paid) = $49,000

Income from Sir
Equity in Sir’s net income ($200,000 - $51,000 tax)  70%
Unrealized inventory profit ($50,000  70%)
Income from Sir

3

$104,300
(35,000)
$ 69,300

Pan Corporation and Subsidiary
Consolidated Income Statement
for the year ended December 31, 2011
Sales ($5,000,000 - $120,000)
Cost of sales ($2,550,000 + $50,000 - $120,000)
Gross profit
Operating expenses
Income before income taxes and noncontrolling interest
Less: Income taxes ($174,712 + $51,000)
Total consolidated income
Less: Noncontrolling interest share ($149,000
net income - $50,000 unrealized)  30%

$4,880,000
2,480,000
2,400,000
1,750,000

650,000
225,712
424,288

Controlling share of NI

$

394,588

$

325,288
69,300
394,588

Check:
Pan’s separate income ($500,000 - $174,712)
Income from Sir
Pan’s and Controlling share of NI

29,700

$

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Chapter 10

10-25

Solution P10-12 [Tax]
Pub Corporation and Subsidiary
Partial Consolidation Working Papers
for the year ended December 31, 2011
Pub
Income Statement
$500,000
Sales
Dividends received
from Sew
28,000
Cost of sales
250,000*
Operating expenses
78,000*
Income tax expense
58,222*
Noncont. Share**
Control. Share - NI $141,778

70%
Sew
$300,000

120,000*
80,000*

34,000*

Adjustments and
Eliminations

Noncont.
Interest

a 90,000
c 28,000
b 10,000

Consolidated
Statements
$

710,000

$

290,000*
158,000*
92,222*
19,800*
149,978

a 90,000

$19,800
$ 66,000

Note: The offsetting credits to entries b and c are to inventory and dividend
accounts, respectively.
*
**

Deduct
Noncontrolling interest share = $66,000  30%

Supporting computations
Pub
Income taxes currently payable
Taxes on operating income
($172,000  34%)
($100,000  34%)
Tax on dividends received
($40,000  70%)  20% taxable  34% tax rate
Tax on undistributed income
($26,000  70%)  20% taxable  34% tax rate
Less: Deferred tax on inventory profit
$10,000  34% tax rate
Income tax expense
Consolidated net income check
Sew’s net income of $66,000  70%
Less: Unrealized inventory profit
Income from Sew — equity basis
Less: Sew’s income — cost basis
Cost — equity method difference
Add: Pub’s reported net income
Controlling share of NI

Sew

$58,480
$ 34,000
1,904
60,384

34,000

1,238
(3,400)
$58,222

$ 34,000
$ 46,200
(10,000)
36,200
(28,000)
8,200
141,778
$149,978

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