Solution manual advanced accounting 9e by hoyle chapter 07

Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

CHAPTER 7
CONSOLIDATED FINANCIAL STATEMENTS - OWNERSHIP
PATTERNS AND INCOME TAXES
Chapter Outline
I.

Indirect subsidiary control
A. Control of subsidiary companies within a business combination is often of an indirect
nature; one subsidiary possesses the stock of another rather than the parent having
direct ownership.
1. These ownership patterns may be developed specifically to enhance control or for
organizational purposes.
2. Such ownership patterns may also result from the parent company's acquisition of a
company that already possesses subsidiaries.
B. One of the most common corporate structures is the father-son-grandson configuration
where each subsidiary in turn owns one or more subsidiaries.
C. The consolidation process is altered somewhat when indirect control is present.
1. The worksheet entries are effectively doubled by each corporate ownership layer but
the concepts underlying the consolidation process are not changed.
2. Calculation of the accrual-based income of a subsidiary recognizing the consolidated
relationships is an important step in an indirect ownership structure.
a. The determination of accrual-based income figures is needed for equity income
accruals as well as for the computation of noncontrolling interest balances.
b. Any company within the business combination that is in both a parent and a
subsidiary position must recognize the equity income accruing from its subsidiary
before computing its own income.

II. Indirect subsidiary control-connecting affiliation
A. A connecting affiliation exists whenever two or more companies within a business

combination hold an equity interest in another member of that organization.
B. Despite this variation in the standard ownership pattern, the consolidation process is
essentially the same for a connecting affiliation as for a father-son-grandson
organization.
C. Once again, any company in both a parent and a subsidiary position must recognize an
appropriate equity accrual in computing its own income.
III. Mutual ownership
A. A mutual affiliation exists whenever a subsidiary owns shares of its parent company.
B. Parent shares being held by a subsidiary are accounted for by the treasury stock
approach.
1. The cost paid to acquire the parent's stock is reclassified within the consolidation
process to a treasury stock account and no income is accrued.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
7-1


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

2. The treasury stock approach is popular in practice because of its simplicity and is now
required by SFAS 160.
IV. Income tax accounting for a business combination—consolidated tax returns
A. A consolidated tax return can be prepared for all companies comprising an affiliated
group. Any other companies within the business combination file separate tax returns.
B. A domestic corporation may be included in an affiliated group if the parent company
(either directly or indirectly) owns at least 80 percent of the voting stock of the subsidiary
as well as 80 percent of each class of its nonvoting stock.

C. The filing of a consolidated tax return provides several potential advantages to the
members of an affiliated group.
1. Intercompany profits are not taxed until realized.
2. Intercompany dividends are not taxed (although these distributions are nontaxable for
all members of an affiliated group whether a consolidated return or a separate return is
filed).
3. Losses of one affiliate can be used to reduce the taxable income earned by other
members of the group.
D. Income tax expense—effect on noncontrolling interest valuation
1. If a consolidated tax return is filed, an allocation of the total expense must be made to
each of the component companies to arrive at the realized income figures that serve
as a basis for noncontrolling interest computations.
2. Income tax expense is frequently assigned to each subsidiary based on the amounts
that would have been paid on separate returns.
V. Income tax accounting for a business combination—separate tax returns
A. Members of a business combination that are foreign companies or that do not meet the 80
percent ownership rule (as described above) must file separate income tax returns.
B. Companies in an affiliated group can elect to file separate tax returns. Deferred income
taxes are often recognized when separate returns are filed due to temporary differences
stemming from unrealized gains and losses as well as intercompany dividends.
VI. Temporary tax differences can stem from the creation of a business combination
A. The tax basis of a subsidiary's assets and liabilities may differ from their consolidated
values (which is based on the fair market value on the date the combination is created).
B. If additional taxes will result in future years (for example, it the tax basis of an asset is
lower than its consolidated value so that future depreciation expense for tax purposes will
be less), a deferred tax liability is created by a combination.
C. The deferred tax liability is then written off (creating a reduction in tax expense) in future
years so that the net expense recognized (a lower number) matches the combination's
book income (a lower number due to the extra depreciation of the consolidated value).
Vll. Operating loss carryforwards

A. Net operating losses recognized by a company can be used to reduce taxable income
from the previous two years (a carryback) or for the future 20 years (a carryforward).

McGraw-Hill/Irwin
7- 2

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

B. If one company in a newly created combination has a tax carryforward, the future tax
benefits are recognized as a deferred income tax asset.
C. However, a valuation allowance must also be recorded to reduce the deferred tax asset to
the amount that is more likely than not to be realized.

Learning Objectives
Having completed Chapter 7, "Ownership Patterns and Income Taxes—Consolidated Financial
Statements," students should be able to fulfill each of the following learning objectives:
1. Differentiate between a father-son-grandson ownership configuration and a connecting
affiliation.
2. Calculate realized income figures for all companies in a business combination when either a
father-son-grandson or connecting affiliation is in existence.
3. Prepare a consolidation worksheet for both a father-son-grandson ownership pattern and a
connecting affiliation.
4. Eliminate a subsidiary's ownership interest in its parent using the treasury stock approach.
5. Explain the rationale underlying the treasury stock approach to a mutual ownership.
6. List the criteria for being a member of an affiliated group for income tax filing purposes.
7. Discuss the advantages to a business combination of filing a consolidated tax return.

8. Allocate the income tax expense computed on a consolidated tax return to the various
members of a business combination according to their separate taxable incomes.
9. Compute taxable income for an affiliated group based on information presented in a
consolidated set of financial statements.
10. Compute the deferred income tax expense to be recognized when separate tax returns are
filed by any of the members of a business combination.
11. Determine the deferred tax liability that is created when the tax bases of a subsidiary's assets
and liabilities are below consolidated values.
12. Explain the impact that a net operating loss of an acquired affiliate has on consolidated
figures.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
7- 3


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

Answers to Questions
1. A father-son-grandson relationship is a specific type of ownership configuration often
encountered in business combinations. The parent possesses the stock of one or more
companies. At least one of these subsidiaries holds a majority of the voting stock of its own
subsidiary. Each subsidiary controls other subsidiaries with the chain of ownership going on
indefinitely. The parent actually holds control over all of the companies within the business
combination despite having direct ownership in only its own subsidiaries.
2. In a business combination having an indirect ownership pattern, at least one company is in
both a parent and a subsidiary position. To calculate the accrual-based income earned by that
company, a proper recognition of the equity income accruing from its own subsidiary must

initially be made. Structuring the income calculation in this manner is necessary to ensure that
all earnings are properly included by each company.
3. Able—100% of income accrues to the consolidated entity (as parent company).
Baker—70% (percentage of stock owned by Able).
Carter—56% (80% of stock owned by Baker multiplied by the 70% of Baker controlled by
Able).
Dexter—33.6% (60% of stock owned by Carter multiplied by the 80% of Carter controlled by
Baker multiplied by the 70% of Baker owned by Able).
4. When an indirect ownership is present, the quantity of consolidation entries will increase,
perhaps significantly. An additional set of entries is included on the worksheet for each
separate investment. Furthermore, the determination of realized income figures for each
subsidiary must be computed in a precise manner. For any company in both a parent and a
subsidiary position, equity income accruals are recognized prior to the calculation of that
company's realized income. This realized income total is significant because it serves as the
basis for noncontrolling interest calculations as well as the equity accruals to be recognized by
that company's parent.
5. In a connecting affiliation, two (or more) companies within a business combination own shares
in a third member. A mutual ownership, in contrast, exists whenever a subsidiary possesses
an equity interest in its own parent.
6. In accounting for a mutual ownership, SFAS 160 requires the treasury stock approach. The
treasury stock approach presumes that the cost of the parent shares should be reclassified as
treasury stock within the consolidation process. The subsidiary is being viewed, under this
method, as an agent of the parent. Thus, the shares are accounted for as if the parent had
actually made the acquisition.
7. According to present tax laws, an affiliated group can be comprised of all domestic
corporations in which a parent holds 80 percent ownership. More specifically, the parent must
own (directly or indirectly) 80 percent of the voting stock of the corporation as well as at least
80 percent of each class of nonvoting stock.
8. Several basic advantages are available to combinations that file a consolidated tax return.
First, intercompany profits are not taxed until realized. For companies with large amounts of

McGraw-Hill/Irwin
7- 4

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

intercompany transactions, the deferral of unrealized gains causes a delay in the making of
significant tax payments. Second, losses incurred by one company can be used to reduce or
offset taxable income earned by other members of the affiliated group. In addition,
intercompany dividends are not taxable but that exclusion applies to the members of an
affiliated group regardless of whether a consolidated or separate tax return is filed.
Members of a business combination may be forced to file separate tax returns. Foreign
corporations, for example, must always file separately. Domestic companies that do not meet
the 80 percent ownership rule are also required to file in this manner. Furthermore, companies
that are in an affiliated group may still elect to file separately. If all companies within the
combination are profitable and few intercompany transactions are carried out, little advantage
may accrue from preparing a consolidated return. With a separate filing, a subsidiary has
more flexibility as to accounting methods as well as its choice of a fiscal year-end.
9. The allocation of income tax expense among the component companies of a business
combination has a direct bearing on realized income totals and, therefore, noncontrolling
interest calculations. Obviously, the more expense that is assigned to a particular company
the less realized income is attributed to that concern. Income tax expense can be allocated
based on the income totals that would have been reported by various companies if separate
tax returns had been filed or on the portion of taxable income derived from each company.
10. In filing a separate tax return (assuming that the two companies do not qualify as members of
an affiliated group), the parent must include as income the dividends received from the
subsidiary. For financial reporting purposes, however, income is accrued based on the

ownership percentage of the realized income of the subsidiary. Because income is frequently
recognized by the parent prior to being received in the form of dividends (when it is subject to
taxation), deferred income taxes must be recognized.
Either the parent or the subsidiary might also have to record deferred income taxes in
connection with any unrealized intercompany gain. On a separate tax return, such gains are
reported at the time of transfer while for financial reporting purposes they are appropriately
deferred until realized. Once again, a temporary difference is created which necessitates the
recognition of deferred income taxes.
11. If the consolidated value of a subsidiary’s assets exceeds their tax basis, depreciation
expense in the future will be less on the tax return than is shown for external reporting
purposes. The reduced expense creates higher taxable income and, thus, increases taxes.
Therefore, the difference in values dictates an anticipated increase in future tax payments.
This deferred liability is recognized at the time the combination is created. Subsequently, when
actual tax payments do arise, the deferred liability is written off rather than recognizing
expense based solely on the current liability. In this manner, the expense is shown at a lower
figure, one that is matched with reported income (which is also a lower balance because of
the extra depreciation).
Recognition of this deferred liability at date of acquisition also reduces the net amount
attributed to the subsidiary's assets and liabilities in the initial allocation process. Therefore,
the residual asset (goodwill) is increased by the amount of any liability that must be
recognized.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
7- 5


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

12. A net operating loss carryforward allows the company to reduce taxable income for up to 20
years into the future. Thus, a benefit may possibly be derived from the carryforward but that
benefit is based on Wilson (the subsidiary) being able to generate taxable income to be
decreased by the carryforward. To reflect the potential tax reduction, a deferred income tax
asset is recorded for the total amount of anticipated benefit. However, because of the
uncertainty, unless the receipt of this benefit is more likely than not to be received, a valuation
allowance must also be recorded as a contra account to the asset. The valuation allowance
may be for the entire amount or just for a portion of the asset.
13. At the date of acquisition, the valuation allowance was $150,000. As a contra asset account,
recognition of this amount reduced the net assets attributed to the subsidiary and, hence,
increased the recording of goodwill (assuming that the price did not indicate a bargain
purchase). If the valuation allowance is subsequently reduced to $110,000, the net assets
have increased by $40,000. This change is reflected by a decrease in income tax expense.

McGraw-Hill/Irwin
7- 6

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

Answers to Problems
1. D
2. B
3. D
4. C
5. C

6. C
7. A Damson's accrual-based income:
Operational income .................................................................
Defer unrealized gain ...............................................................
Damson's accrual-based income .......................................

$200,000
(40,000)
$160,000

Crimson's accrual-based income:
Operational income .................................................................
Investment Income (90% of Damson’s realized income) .......
Crimson's accrual-based income ......................................

$200,000
144,000
$344,000

Bassett's accrual-based income:
Operational income .................................................................
Investment income (80% of Crimson's realized income) ......
Bassett's accrual-based income ........................................

$300,000
275,200
$575,200

8. C Icede's accrual-based income:
Operational income .................................................................

Defer unrealized gain ...............................................................
Icede's accrual-based income ...........................................
Outside ownership ..................................................................
Noncontrolling interest ......................................................

$220,000
(60,000)
$160,000
20%
$32,000

Healthstone's accrual-based income:
Operational income .................................................................
Defer unrealized gain ...............................................................
Investment income (80% of Icede's accrual-based income) .
Healthstone's accrual-based income ................................
Outside ownership ..................................................................
Noncontrolling interest ......................................................

$300,000
(30,000)
128,000
$398,000
20%
$79,600

Total noncontrolling interest = $111,600 ($32,000 + $79,600)
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
7- 7


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

9. D Juvyn's Operational Income .........................................................
Dividend Income ...........................................................................
Juvyn's Income ..............................................................................
Outside Ownership .......................................................................
Noncontrolling Interest .................................................................

$50,000
14,000
$64,000
10%
$6,400

10. A Equity Income (60% of $200,000) .................................................
Dividend Income (60% of $40,000) ...............................................
Tax Difference ..........................................................................
Dividend Deduction upon Eventual Distribution (80%) ..............
Temporary Portion of Tax Difference .....................................
Tax Rate .........................................................................................
Deferred Income Tax Liability .................................................

$120,000
24,000
$96,000
(76,800)

$19,200
30%
$5,760

11. C Unrealized Gain:
Total Gain ...................................................................................
Portion Still Held .......................................................................
Unrealized Gain ........................................................................
Tax Rate .........................................................................................
Deferred Tax Asset ....................................................................

$30,000
20%
$6,000
25%
$1,500

12. A Recognition of this gain is not required on a consolidated tax return.
13. C Because fair value of the subsidiary's assets exceeds the tax basis by
$100,000 a deferred tax liability of $30,000 (30%) must be recorded. Goodwill
is then computed as follows:
Consideration transferred ......................................
Fair Value ...............................................................
Deferred Tax Liability ...............................................
Goodwill ....................................................................

$420,000
$400,000
(30,000)

370,000
$50,000

14. (35 Minutes) (Series of reporting and consolidation questions pertaining to a
father-son-grandson combination. Includes unrealized inventory gains)
a. Consideration transferred (by Tree) .............................
Noncontrolling interest fair value .................................
Limb’s business fair value .............................................
Book value
...............................................................
Trade name .....................................................................
Life .................................................................................
Annual amortization ......................................................

McGraw-Hill/Irwin
7- 8

$252,000
108,000
360,000
(300,000)
$60,000
30 years
$2,000

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

14. (continued)
Consideration transferred for Leaf (by Limb) ..............
Noncontrolling interest fair value .................................
Leaf’s business fair value .............................................
Book value
...............................................................
Trade name .....................................................................
Life .................................................................................
Annual amortization ......................................................
a. Investment in Limb
Limb's reported income-2009
Amortization expense
Accrual-based income
Limb’s percentage ownership
Equity accrual-2009
Dividends received 2009
Limb's reported income-2010
Amortization expense
Income from Leaf
Accrual-based income
Limb’s percentage ownership
Equity accrual-2010
Dividends received 2010
Investment in Limb 12-31-10

$252,000
$40,000
(2,000)
$38,000

70%
$26,600
(7,000)
$60,000
(2,000)
6,300
$64,300
70%
$45,010
(14,000)
$302,610

b. Leaf—2010 income (revenues minus expenses)
Amortization
Accrual-based income
Limb's ownership percentage
Equity Income accrual
Income recognized ($2,000 dividends × 70%)
Retained earnings increase (Limb), 1/1/11

$10,000
(1,000)
$9,000
70%
$6,300
(1,400)
$4,900

Limb—2009 operating income
Limb—2010 operating income

Amortization (2 years at $2,000 per year)
Equity income from ownership of Leaf (above)
Total income for previous periods
Tree's ownership percentage
Equity Income accrual
Income recognized ($10,000 [2009] + $20,000 [2010]
dividends × 70% ownership)
Retained earnings Increase (Tree), 1/1/11
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

$91,000
39,000
$130,000
(100,000)
$30,000
30 years
$1,000

$40,000
60,000
(4,000)
6,300
102,300
70%
71,610
(21,000)
$50,610

© The McGraw-Hill Companies, Inc., 2009

7- 9


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

14. (continued)
c. Consolidated sales (total for the companies)
Consolidated expenses (total for the companies)
Total amortization expense (see a.)
Consolidated net income for 2011
d. Noncontrolling interest in income of Leaf
Revenues less expenses
Excess amortization
Accrual-based income
Noncontrolling interest percentage
Noncontrolling interest in income of Leaf

$1,260,000
(1,025,000)
(3,000)
$232,000

$30,000
(1,000)
$29,000
30%
$8,700

Noncontrolling interest in income of Limb:
Revenues less expenses

$65,000
Excess amortization
(2,000)
Equity in Leaf income [(30,000-1,000) × 70%] 20,300
Realized income of Limb—2011
$83,300
Outside ownership
30%
NCI share of consolidated income

$24,990
$33,690

e. 2010 Realized income of Limb (prior to accounting
for unrealized gains) (see a)
2009 Transfer-gain recognized in 2010
2010 Transfer-gain to be recognized in 2011
2010 Realized income Limb

$64,300
10,000
(16,000)
$58,300

2011 Realized Income of Limb (prior to accounting
for unrealized gains) (see d.)
2010 Transfer-gain recognized in 2011
2011 Transfer-gain to be recognized in 2012
2011 Realized income—Limb

$83,300
16,000
(25,000)
$74,300

f. In b., an adjustment of $50,610 was made to the beginning 2011 retained
earnings. Question e. takes this same question and alters it by including
unrealized gains. The $10,000 gain does not affect the answer because the 2010
and 2011 effects cancel each other.
Thus, only the $16,000 gain must be taken into consideration on January 1,
2011. Limb’s realized income in 2010 is reduced by $16,000 because of the
deferred gain. The parent's equity accrual would be reduced by $11,200 or 70%
of that figure. The adjustment as of January 1, 2011 is $39,410 ($50,610 –
$11,200).
McGraw-Hill/Irwin
7- 10

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
7- 11

Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

15. (15 minutes) (Income and noncontrolling interest with mutual ownership.)
a. Consideration transferred by Uncle .............................
Noncontrolling interest fair value .................................
Nephew’s business fair value .......................................
Book value .....................................................................
Intangible Assets ...........................................................
Life .................................................................................
Amortization expense (annual) .....................................
Income reported by Nephew—2011 ..............................
Amortization expense (above) ......................................
Accrual-based income....................................................
Uncle's ownership percentage .....................................
Income of subsidiary recognized by Uncle .................

$500,000
125,000
$625,000
600,000
$25,000
10 years
$2,500
$50,000
(2,500)
47,500
80%
$38,000

b. To the outside owners, the $6,000 intercompany dividends ($20,000 × 30%) paid

by Uncle are viewed as income because the book value of Nephew is
increasing. Thus, the noncontrolling interest's share of income is $10,700 or
20% of [$47,500 income ($50,000 operational income less $2,500 excess
amortization) plus the $6,000 in dividends].
16. (35 Minutes) (Consolidated income for a father-son-grandson combination.)
a. Mesa's operating income
Butte's operating income
Valley's operating income
Amortization expense–Mesa's investment in Butte
Amortization expense–Butte's investment in Valley
Consolidated net income
b. Valley's operating income
Amortization expense (on Butte's investment)
Valley's accrual-based income
Outside ownership
Noncontrolling interest in Valley's income
Butte's operating income
Amortization expense (on Mesa's investment)
Equity accrual from ownership of Valley
($132,000 × 55%)
Butte's accrual-based income
Outside ownership
Noncontrolling interest in Butte's income
Total noncontrolling interest in income of subsidiaries
McGraw-Hill/Irwin
7- 12

$250,000
98,000
140,000

(22,500)
(8,000)
$457,500
$140,000
(8,000)
$132,000
45%
$59,400
$ 98,000
(22,500)
72,600
$148,100
20%
$29,620
$89,020

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

16. (Continued)
Mesa’s operating income
Mesa’s share of Butte’s operating income (80% × $98,000)
Mesa’s share of Valley’s operating income (80% × 55% × $140,000)
Mesa’s share of Butte’s excess amortization (80% × $22,500)
Mesa’s share of Valley’s excess amortization (80% × 55% × $8,000)
Controlling interest in consolidated net income
Noncontrolling interest in consolidated net income

Consolidated net income

$250,000
78,400
61,600
(18,000)
(3,520)
$368,480
89,020
$457,500

17. (30 Minutes) (Consolidated income figures for a connecting affiliation)
UNREALIZED GAINS:
Cleveland ($12,000 remaining inventory × 25% markup) =
$3,000
Wisconsin ($40,000 remaining inventory × 30% markup) = $12,000
NONCONTROLLING INTERESTS:
CLEVELAND:
Operational income (sales minus cost of goods sold and
expenses) .................................................................
$60,000
Defer unrealized gain (above) .......................................
(3,000)
Realized income—Cleveland ...................................
$57,000
Outside ownership ........................................................
20%
Noncontrolling interest in Cleveland's income ......
$11,400
WISCONSIN:

Operational income (sales minus cost of goods sold and
expenses) .................................................................
$110,000
Defer unrealized gain (above) .......................................
(12,000)
Investment income (60% of Cleveland's realized income of
$57,000) ....................................................................
34,200
Realized income—Wisconsin ..................................
$132,200
Outside ownership ........................................................
10%
Noncontrolling interest in Wisconsin's income .....
$13,220
TOTAL NONCONTROLLING INTERESTS: $24,620 ($11,400 + $13,220)
CONSOLIDATION TOTALS


Sales = $1,590,000 (add the three book values and eliminate intercompany
transfers of $40,000 and $100,000)



Cost of Goods Sold = $1,015,000 (add the three book values, eliminate
intercompany transfers of $40,000 and $100,000, and defer [add] unrealized
gains of $3,000 and $12,000)

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
7- 13


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

17. (continued)


Expenses = $200,000 (add the three book values)



Dividend Income = -0- (eliminated for consolidation purposes)



Consolidated net income = $375,000 (consolidated revenues less
consolidated cost of goods sold and expenses)



Noncontrolling Interests in subsidiaries' income = $24,620 (computed above)



Controlling interest in consolidated net income = $350,380 (consolidated net
income less noncontrolling interest share)

18. (15 Minutes) (Consolidated income and equity accounts--mutual ownership.)

a. CONSOLIDATED TOTALS
 Sales = $1,800,000 (add the two book values)
 Cost of goods sold = $1,020,000 (add the two book values)
 Expenses = $352,000 (add the two book values and include the amortization
expense of $12,000)
 Dividend income = -0- (eliminated for consolidation purposes)
 Consolidated net income = $428,000 (consolidated revenues less
consolidated cost of goods sold and expenses)
 Noncontrolling interest in Wonderland's income = $11,400 (10 percent of the
reported balance less $12,000 excess amortization). Dividend income is
included because it increases the book value of the subsidiary and,
therefore, the noncontrolling interest.)
b.
 Common Stock = $880,000 (the parent company balance only)
 Treasury Stock = $111,000 (cost paid by subsidiary for the shares of the
parent company)
19.

(25 Minutes) (Tax expense with separate tax returns for a combination.)

a. CONSOLIDATED TOTALS
 Sales = $790,000 (add the two book values and eliminate the $110,000
intercompany transfer)
 Cost of Goods Sold = $340,000 (add the book values, eliminate intercompany
transfers of $110,000, recognize [subtract] $30,000 deferred gain from 2010,
and defer [add] $40,000 intercompany gain deferred into 2011)
 Operating expenses = $234,000 (add the two book values)
 Dividend Income = -0- (eliminated for consolidation purposes)
 Consolidated net income = $216,000 (Revenues less expenses)
 Noncontrolling interest in Down's Income = $18,000 (20 percent of reported

Income of $100,000 plus $30,000 gain deferred from 2010 less $40,000 gain
deferred into 2011)
McGraw-Hill/Irwin
7- 14

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

 Controlling interest in consolidated net income = $198,000
19. (continued)
b. On separate returns, the unrealized gains are reported as taxable income.
Because Up owns 80 percent of Down's stock, the dividends are tax- free and no
deferred tax liability is necessary on the undistributed income.
DUE TO GOVERNMENT: (separate returns)
UP:
Income (without dividend income) ...............................
Tax rate .........................................................................
Currently payable to government ............................

$126,000
30%
$37,800

DOWN:
Reported income ...........................................................
Tax rate .........................................................................
Currently payable to government ............................

$100,000
30%
$30,000

Total Income Tax Payable: Current = $67,800 ($37,800 + $30,000)
CURRENT EXPENSE:
Consolidated net income (part a.) ...........................
Eliminate noncontrolling interest ...........................
Income to be taxed .............................................
Tax rate ..................................................................
Income tax expense .................................................

$198,000
+18,000
$216,000
30%
$64,800

The $3,000 difference between the liability and the expense is an increase in the
Deferred Income Tax Asset account. It is created by the tax effect (30%) on the
net unrealized gain for the period ($10,000 or $40,000 – $30,000).
20. (45 Minutes) (Series of questions requires computation of income tax expense
and the related payable balance)
a. $260,000 ($650,000 × 40%)
The affiliated group would be taxed on its operating income of $650,000 (the
net unrealized gain is deferred on a consolidated return). The intercompany
income and dividends are not relevant since a consolidated return is filed.
b. $260,000 ($650,000 × 40%)
The affiliated group would be taxed on its operating income of $650,000 (the

net unrealized gain is deferred on a consolidated return). The intercompany
income and dividends are not relevant because a consolidated return is filed.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
7- 15


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

The percentage ownership does not affect the figures on a consolidated
return.

McGraw-Hill/Irwin
7- 16

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

20. (continued)
c. $296,000 ($96,000 + $200,000)
Rogers would pay $96,000 or 40% of its $240,000 operating income. Clarke
would pay $200,000 or 40% of its $500,000 operating income. The unrealized
gain is not deferred when separate returns are filed. Intercompany dividends are
not taxable because the parties qualify as an affiliated group even though

separate returns are being filed. Answer (c.) differs from (a.) and (b.) because
tax on the $90,000 unrealized gain (40% or $36,000) is paid immediately.
d. $268,064
Rogers would record income tax expense of $96,000 or 40% of its $240,000
operating income.
Clarke must record its expense based on the revenue recognized during the
period. Thus, the tax expense is based on operating income of $410,000 (the net
unrealized gain is not being recognized in this period) plus equity income
accruing from Rogers of $100,800 (70% of that company's after-tax income).
Clarke will record an income tax expense of $164,000 in connection with the
operating income ($410,000 × 40%). The expense recognized in connection with
the equity accrual is affected by the dividends-received deduction:
Equity income of subsidiary ..........................................
Dividends-received deduction (when received) (80%) .
Income subject to taxation ............................................
Tax rate .........................................................................
Income tax expense—equity income (Clarke) .............
Income tax expense—operating income (Clarke)
(above) ......................................................................
Income tax expense—operating income (Rogers)
(above) ......................................................................
Income tax expense .......................................................

$100,800
80,640
$20,160
40%
$8,064
164,000

$172,064
96,000
$268,064

e. $204,480
Clarke will pay $200,000 in connection with its operating income ($500,000 ×
40%) because the unrealized gain cannot be deferred. Clarke also receives
$56,000 in dividends from Rogers ($80,000 × 70%). Tax payment on these
dividends is $4,480 ($56,000 × 20% × 40%). The difference between the payment
by Clarke ($204,480) and the company's expense in (d.) ($172,064) is created by
the premature payment of the tax (a deferred tax asset) on the unrealized gain
($90,000) less the deferred tax liability on the parent's equity accrual ($100,800)
in excess of dividends received ($56,000).

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
7- 17


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

21. (20 Minutes) (Comparison of income tax expense and payable on separate and
consolidated tax returns.)
a. Consolidated Return—2010
Piranto income 2010 (sales less expenses) ......................................
Slinton income 2010 (sales less expenses) ......................................
2009 gain realized in 2010 ...................................................................
2010 deferred gain ...............................................................................

Taxable income .............................................................................
Tax rate ..............................................................................................
Income tax payable—current ........................................................

$300,000
100,000
120,000
(150,000)
$370,000
40%
$148,000

Because no temporary differences exist in this problem, the income tax expense
would also be $148,000. The unrealized gain is not taxed until realized. Dividend
income is not important because a consolidated return is being filed.
b. Separate Returns—2010
On its separate tax return, Piranto will report taxable income of $300,000—the
unrealized gains cannot be deferred. The dividends would not be taxable
because Slinton still meets the criteria to be a member of an affiliated group. A
consolidated return is not a requirement for these dividends to be excluded.
Thus, income taxes payable by Piranto would be $120,000 ($300,000 × 40%).
To determine the income tax expense for Piranto, the two temporary differences
must be taken into account:
Taxable income ..............................................................
Gain taxed in 2009 although realized
in 2010 .......................................................................
Gain taxed in 2010 although not yet realized ...............
2010 realized income subject to taxation .....................
Tax rate ...........................................................................
Income tax expense .......................................................

$300,000
120,000
(150,000)
$270,000
40%
$108,000

The $12,000 difference between the expense and the payable is the tax effect on
the net unrealized gain ($30,000 × 40%).
Slinton will have an expense and payable of $40,000 ($100,000 × 40%).

McGraw-Hill/Irwin
7- 18

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

22. (45 Minutes) (Comparison of income tax expense and payable on separate and
consolidated tax returns. Includes question on mutual ownership and the
conventional approach.)
a. Total income tax expense is $156,877. Because of the level of ownership,
separate returns must be filed. Unrealized gains are taxed immediately as are
intercompany dividends.
Because the unrealized gains are deferred on the consolidated financial
statements, Boxwood's expense would be $34,400 or 40% of $86,000 in realized
income ($100,000 + $18,000 – $32,000).

Lake's income subject to taxation includes its $300,000 in operating income
plus $30,960 in income accruing from its investment in Boxwood (60% of the
after-tax Income of $51,600 [$86,000 – $34,400]). Income tax expense for Lake is
computed as follows:
Operating income ..........................................................
Equity income ................................................................
Taxable portion ..............................................................
Income eventually subject to taxation .........................
Tax rate............................................................................
Income tax expense Lake (rounded) .............................
Income tax expense Boxwood (above) .........................
Total income tax expense .............................................

$300,000
$30,960
20%

6,192
$306,192
40%
$122,477
34,400
$156,877

b. Boxwood will pay $40,000 ($100,000 × 40%) because separate returns are filed.
Lake, however, will pay its taxes based on dividends received rather than on the
equity accrual. A deferred income tax liability would be established for the
difference. Lake's payment for the current year is computed as follows:
Operating income ...........................................................
Dividend income (60% × $10,000) .................................

Taxable portion ..............................................................
Income currently taxable ...............................................
Tax rate .........................................................................
Income tax payable—Lake ............................................
Income tax payable—Boxwood (above) ......................
Total Income tax payable current .................................

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

$300,000
$6,000
20%

1,200
$301,200
40%
$120,480
40,000
$160,480

© The McGraw-Hill Companies, Inc., 2009
7- 19


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

22. (continued)
The $3,603 difference between the expense in a. and the payable in b. is created
by the following two effects:

Deferred income tax liability on equity income accrual not yet taxed
($30,960 – $6,000 = $24,960 × 20% × 40%)...................................
Deferred income tax asset on net unrealized gain
($32,000 – $18,000 = $14,000 × 40%)............................................
Net decrease in expense ...................................................................

$1,997
5,600
$3,603

c. Because a consolidated tax return is filed, unrealized gains are deferred in the
same manner as for external reporting purposes. Dividend income is not
taxable.
Lake's operating income ...............................................
Boxwood's operating income .......................................
Prior year unrealized gain .............................................
Current year unrealized gain ........................................
Income subject to taxation (and currently taxable) ......
Tax rate ...........................................................................
Income tax expense .......................................................

$300,000
$100,000
18,000
(32,000)

86,000
$386,000
40%
$154,400

23. (30 Minutes) (Computation of income tax expense and income tax payable on
consolidated and separate tax returns.)
a. Operating Income ..........................................................
Tax rate . .........................................................................
Taxes to be paid ............................................................

$450,000
40%
$180,000

The affiliated group would be taxed on its operating income of $450,000 (the
$50,000 unrealized gain is deferred). Intercompany income and dividends are
not relevant because a consolidated return is filed.
b. Total taxes to be paid are $200,000. Robertson would have to pay $80,000 or
40% of its $200,000 operating income. Garrison would pay $120,000 or 40% of its
$300,000 operating income. The unrealized gain is not deferred because
separate returns are being filed. Intercompany dividends are not taxable
because the parties still qualify as an affiliated group even though separate
returns are being filed.
c. Robertson must report an income tax expense of $80,000 or 40% of its $200,000
operating income.

McGraw-Hill/Irwin
7- 20

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual

Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
7- 21


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

23. (continued)
Garrison records its expense based on the revenue recognized during the
period. Thus, the expense is computed on an operating income of $250,000 (the
net unrealized gain is not recognized in this period) along with equity income
from Robertson of $84,000 (70% of that company's $120,000 after-tax income).
Garrison will record an income tax expense of $100,000 in connection with the
operating income ($250,000 × 40%) and $6,720 resulting from its equity income
($84,000 × 20% × 40%). Total expense to be reported amounts to $186,720 for
Garrison and Robertson ($80,000 + $100,000 + $6,720).
d. Garrison will pay $120,000 in connection with its operating income ($300,000 ×
40%) and $2,400 because of the dividends received from Robertson. Garrison
will receive $30,000 in dividends based on its 60% ownership. Of this total, only
$6,000 (20%) is taxable. Thus, at a 40% rate, the tax on the dividends would
amount to $2,400 ($6,000 × 40%). The total income taxes payable by Garrison is
$122,400 ($120,000 + $2,400).

24. (10 Minutes) (Impact on goodwill of assets with a different tax vs. book value.)
The assets and liabilities of Kew (the subsidiary) will be consolidated at their
individual fair values (netting to $500,000). However, both the buildings and

equipment have a tax basis that is lower than fair value. Thus, for tax purposes,
future depreciation expense will be lower on the tax return so that taxable
income will exceed book income. The higher taxable income (anticipated in the
future) creates a deferred tax liability at the time the combination is created.

Buildings ........................................
Equipment ......................................
Total temporary difference ......
Tax rate .....................................
Deferred tax liability .................

Tax
Basis
$140,000
150,000

Fair
Value
$180,000
200,000

Temporary
Difference
$40,000
50,000
$90,000
30%
$27,000

Consequently, Kew's accounts will be consolidated as follows: (parentheses

indicate a credit balance)
Accounts receivable ......................................................
Inventory ........................................................................
Land ..............................................................................
Buildings ........................................................................
Equipment .......................................................................
McGraw-Hill/Irwin
7- 22

$110,000
130,000
100,000
180,000
200,000

© The McGraw-Hill Companies, Inc., 2009
Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

24. (continued)
Liabilities .........................................................................
Deferred tax liability ......................................................
Assigned to specific accounts .....................................
Purchase price ...............................................................
Excess assigned to goodwill ........................................

(220,000)
(27,000)

473,000
650,000
$177,000

25. (55 Minutes) (Consolidation worksheet for a father-son-grandson combination.
Includes intercompany inventory transfers.)
The following computations are needed before the consolidation worksheet is
prepared: calculation of the deferred gains in beginning and ending inventory.
Beginning Unrealized Gain (Wilson)
(January 1, 2011 Inventory
Balance)

Ending Unrealized Gain (Wilson)
(December 31, 2011 Inventory
Balance)

Transfer Price (goods remaining) =
Cost + .25 Cost
$60,000 = 1.25 Cost
$48,000 = Cost
$12,000 is Unrealized Gain
Transfer Price (goods remaining) =
Cost + .25 Cost
$90,000 = 1.25 Cost
$72,000 = Cost
$18,000 is Unrealized Gain

CONSOLIDATION ENTRIES
Entry *G
Retained Earnings, 1/1/11 (Wilson) .........................

12,000
Cost of Goods Sold ............................................
12,000
(To recognize income on intercompany inventory transfers made in previous
year but not resold until current year as per above computation.)
Entry *C
Retained Earnings, 1/1/11 (House) ...............................
11,200
Investment in Wilson Company .........................
11,200
(To convert investment account from partial equity method to equity method.
Unrealized gain shown in Entry *G is not properly reflected by parent under
partial equity method [12,000 × 70% = $8,400 income decrease] nor would the
$2,800 in amortization expense for 2009–2010. Thus, a reduction of $11,200 is
required. Because Cuddy is a current year acquisition, no prior conversion to
equity method is required for the investment.)

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009
7- 23


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

25. (continued)
Entry S1
Common Stock (Cuddy) ................................................
150,000

Retained Earnings, 1/1/11 (Cuddy) ...............................
150,000
Investment in Cuddy Company (80%) ......................
240,000
Noncontrolling Interest in Cuddy Common Stock (20%)
60,000
(To eliminate Cuddy's stockholders' equity against the corresponding
investment balance and to recognize noncontrolling interest on common stock.)
Entry S2
Common Stock (Wilson) ...............................................
310,000
Retained Earnings, 1/1/11 (Wilson)
(adjusted by Entry *G) ..............................................
578,000
Investment in Wilson Company (70%) ...............
621,600
Noncontrolling Interest in Wilson (30%) ...........
266,400
(To eliminate Wilson's stockholders' equity against corresponding investment
balance and to recognize noncontrolling interest.)
Entry A
Buildings .........................................................................
54,000
Franchise Contracts ......................................................
32,000
Goodwill ..........................................................................
140,000
Equipment ................................................................
10,000
Investment in Wilson Company ..............................

151,200
Noncontrolling interest in Wilson Company ...........
64,800
(To allocate excess payment made in connection with purchase of Wilson
shown above. Amortization for 2009 and 2010 has been taken into account in
determining the January 1, 2011 value for each account.)
Entry I1
Income of Cuddy Company .....................................
56,000
Investment in Cuddy Company ..........................
56,000
(To eliminate intercompany income accrued by both House and Wilson
during the year.)
Entry I2
Income of Wilson Company ....................................
91,000
Investment in Wilson Company .........................
91,000
(To eliminate intercompany income accrued by House during the year.)
Entry D1
Investment in Cuddy Company ...............................
40,000
Dividends Paid (80%) (Cuddy) ............................
(To eliminate effects of intercompany dividend payments.)
McGraw-Hill/Irwin
7- 24

40,000

© The McGraw-Hill Companies, Inc., 2009

Solutions Manual


Find more slides, ebooks, solution manual and testbank on www.downloadslide.com

25. (continued)
Entry D2
Investment in Wilson Company ..............................
67,200
Dividends Paid (70%) (Wilson) ...........................
(To eliminate effects of intercompany dividend payments.)

67,200

Entry E
Operating Expenses .................................................
2,000
Equipment ...............................................................
5,000
Franchise Contracts ...........................................
4,000
Buildings ..............................................................
3,000
(To record 2011 amortization on excess payment made in connection with
acquisition of Wilson Company.)
Entry TI
Sales and Other Revenues ......................................
200,000
Cost of Goods Sold ............................................
(To eliminate intercompany inventory sales for the current year.)

Entry G
Cost of Goods Sold ..................................................
Inventory...............................................................
18,000
(To defer unrealized gain in ending inventory.)

200,000

18,000

Noncontrolling Interest in Net Income of Cuddy
Reported net income
Outside ownership
Noncontrolling interest in Cuddy income—common

$70,000
20%
$14,000

Noncontrolling Interest in Net Income of Wilson*
Reported operational income
Equity income of Cuddy ($70,000 × 40%)
Excess amortization .....................................................................
Recognition of 2010 gain (Entry *G)
Deferral of 2011 unrealized gain (Entry G)
Realized income
Outside ownership
Noncontrolling interest in net income of Wilson

McGraw-Hill/Irwin

Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

$130,000
28,000
(2,000)
12,000
(18,000)
$150,000
30%
$45,000

© The McGraw-Hill Companies, Inc., 2009
7- 25