SM Hoyle AdvAcc11e Ch07
SM Hoyle AdvAcc11e Ch07
SM Hoyle AdvAcc11e Ch07
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.
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 combinationconsolidated 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 expenseeffect 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.
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).
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 TaxesConsolidated 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.
Answers to Questions
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
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 subsidiarys 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.
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.
Answers to Problems
1. D
2. B
3. D
4. C
5. C
6. C
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:
14. (continued)
14. (continued)
Thus, only the $16,000 gain must be taken into consideration on January 1,
2011. Limbs 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).
15. (15 minutes) (Income and noncontrolling interest with mutual ownership.)
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. (Continued)
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 incomeCleveland ................................... $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 incomeWisconsin .................................. $132,200
Outside ownership ........................................................ 10%
Noncontrolling interest in Wisconsin's income ..... $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)
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)
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)
DOWN:
Reported income ........................................................... $100,000
Tax rate ......................................................................... 30%
Currently payable to government ............................ $30,000
CURRENT EXPENSE:
Consolidated net income (part a.) ........................... $198,000
Eliminate noncontrolling interest ........................... +18,000
Income to be taxed ............................................. $216,000
Tax rate .................................................................. 30%
Income tax expense ................................................. $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)
20. (continued)
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:
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).
21. (20 Minutes) (Comparison of income tax expense and payable on separate and
consolidated tax returns.)
a. Consolidated Return2010
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 Returns2010
On its separate tax return, Piranto will report taxable income of $300,000the
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:
The $12,000 difference between the expense and the payable is the tax effect on
the net unrealized gain ($30,000 40%).
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.)
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:
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%)................................... $1,997
Deferred income tax asset on net unrealized gain
($32,000 $18,000 = $14,000 40%)............................................ 5,600
Net decrease in expense ................................................................... $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.
23. (30 Minutes) (Computation of income tax expense and income tax payable on
consolidated and separate tax returns.)
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.
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.
24. (continued)
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 20092010. 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.)
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) ............................ 40,000
(To eliminate effects of intercompany dividend payments.)
25. (continued)
Entry D2
Investment in Wilson Company .............................. 67,200
Dividends Paid (70%) (Wilson) ........................... 67,200
(To eliminate effects of intercompany dividend payments.)
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 ............................................ 200,000
(To eliminate intercompany inventory sales for the current year.)
Entry G
Cost of Goods Sold .................................................. 18,000
Inventory...............................................................
18,000
(To defer unrealized gain in ending inventory.)
25. (continued)
HOUSE CORPORATION AND CONSOLIDATED SUBSIDIARIES
Consolidation Worksheet
December 31, 2011
Cost of goods sold 551,000 300,000 140,000 (G) 18,000 (*G) 12,000 797,000
(TI) 200,000
Operating expenses 219,000 270,000 90,000 (E) 2,000 581,000
Income of Wilson Company (91,000) (I2) 91,000 -0-
Income of Cuddy Company (28,000) (28,000) (I1) 56,000 -0-
Net Income (249,000) (158,000) (70,000)
Consolidated net income (322,000)
Noncontrolling interest in
Wilson net income (45,000) 45,000
Noncontrolling interest in
Cuddy net income (14,000) 14,000
To House Corporation (263,000)
Retained earnings, 1/1/11:
House Corporation (820,000) (*C) 11,200 (808,800)
Wilson Company (590,000) (*G) 12,000 -0-
(S2)578,000
Cuddy Company (150,000) (S1)150,000 -0-
Net Income (249,000) (158,000) (70,000) (263,000)
Dividends paid
House Corporation 100,000 100,000
Wilson Company 96,000 (D2) 67,200 28,800 -0-
Cuddy Company 50,000 (D1) 40,000 10,000 -0-
Retained earnings, 12/31/11 (969,000) (652,000) (170,000) (971,800)
25. (continued)
26. (20 Minutes) (Consolidation entries for a mutual holding business combination)
CONSOLIDATION ENTRIES
Entry *C
Investment in Lowly ................................................. 117,000
Retained Earnings, 1/1/10 (Mighty) .................... 117,000
(To record $180,000 income accruing to parent during the previous years as
measured by increase in book value [$200,000 60%] and amortization
expense of $3,000 [$5,000 60%] for the previous year.)
Entry S1
Common Stock (Lowly) ........................................... 300,000
Retained Earnings, 1/1/10 (Lowly) ........................... 500,000
Investment in Lowly (60%) ................................. 480,000
Noncontrolling Interest in Lowly 1/1/10 (40%) .. 320,000
(To eliminate subsidiary stockholders' equity accounts against investment
account and to recognize noncontrolling interest ownership.)
Entry S2
Treasury Stock ......................................................... 240,000
Investment in Mighty .......................................... 240,000
(To reclassify cost of parent shares as treasury stock.)
Entry A
Trademarks ............................................................... 95,000
Investment in Lowly ............................................ 57,000
Noncontrolling Interest in Lowly 1/1/10 (40%) .. 38,000
(To recognize unamortized portion of acquisition-date excess fair value.)
Entry E
Amortization Expense .............................................. 5,000
Trademarks .......................................................... 5,000
(To record trademarks amortization expense for 2010.)
CONSOLIDATION ENTRIES
Entry *G
Retained Earnings, 1/1/10 (Stookey) ....................... 7,680
Cost of Goods Sold ............................................ 7,680
(To give effect to unrealized gain from 2009. Amount is calculated based on
normal 48% markup [found from Income Statement] multiplied by $16,000
retained inventory [20% of $80,000])
Entry *C1
Investment in Stookey ............................................. 85,856
Retained Earnings, 1/1/10 (Yarrow) ................... 85,856
(To recognize equity income accruing from Yarrow's investment in Stookey
during 2009. Because the initial value method is applied and no dividends
paid, no income has been recognized in connection with the 2009 ownership
of Stookey. Reported income of $120,000 [2009] less unrealized gain of
$7,680 deferred above indicates income of $112,320. Based on 80%
ownership, an $89,856 accrual is needed, which is reduced by the $4,000
amortization (80% $5,000) for that year.
27. (continued)
Entry *C2
Investment in Yarrow ............................................... 217,670
Retained Earnings, 1/1/10 (Travers) ................... 217,670
(To recognize equity income accruing from Travers' investment in Yarrow
during 2009. Because the initial method is applied and no dividends paid,
income has not been recognized in connection with the 2009 ownership of
Yarrow. Income of $245,856 is calculated based on reported income of
$160,000 [2009] plus the $85,856 accrual recognized in Entry *C1. Ownership
of 90% dictates a $221,270 accrual that is then reduced to $217,670 by the
$3,600 [90% $4,000] amortization applicable to 2009.)
Entry S1
Common Stock (Stookey) ........................................ 200,000
Retained Earnings, 1/1/10 (Stookey, as adjusted
by Entry *G) ......................................................... 292,320
Investment in Stookey (80%) ......................... 393,856
Noncontrolling Interest in Stookey (20%) .... 98,464
(To eliminate stockholders' equity accounts of subsidiary [Stookey] against
corresponding balance in investment account and to recognize
noncontrolling interest ownership.)
Entry S2
Common Stock (Yarrow) ......................................... 300,000
Retained Earnings, 1/1/10 (Yarrow, as adjusted
by Entry *C1) ....................................................... 685,856
Investment in Yarrow (90%) .......................... 887,270
Noncontrolling Interest in Yarrow (10%) ...... 98,586
(To eliminate stockholders equity accounts of subsidiary Yarrow against
corresponding balance in investment account and to recognize
noncontrolling interest ownership.)
Entry A1
Customer List ............................................................ 45,000
Investment in Stookey ........................................ 36,000
Noncontrolling Interest in Stookey (20%) ......... 9,000
27. (continued)
Entry A2
Copyright ................................................................... 56,000
Investment in Yarrow . ......................................... 50,400
Noncontrolling interest in Yarrow ...................... 5,600
(To recognize January 1, 2010 unamortized portion of acquisition price
assigned to copyright.)
Entry E
Operating Expenses ................................................. 9,000
Customer List ....................................................... 5,000
Copyright .............................................................. 4,000
(To recognize amortization expense for 2010$5,000 in connection with
Travers' investment and $3,000 in connection with Yarrow's investment.)
Entry Tl
Sales .......................................................................... 100,000
Cost of Goods Sold ............................................ 100,000
(To eliminate intercompany inventory transfers made during 2010.)
Entry G
Cost of Goods Sold .................................................. 9,600
Inventory (current assets) .................................. 9,600
(To defer unrealized gain on ending inventory$20,000 48% markup.)
27. (continued)
(2) Stookey's unrealized gains are recognized in one time period for financial
reporting purposes and in a different time period for tax purposes. A
temporary difference is created. The net effect is an increase in taxable
income by $1,920 over reported income:
27. d. (continued)
Because a single rate is used, income tax expense can also be computed by
taking consolidated net income (prior to noncontrolling interest reduction) of
$609,080 (part a.) and multiplying by the 45% tax rate to obtain $274,086.
28. (40 Minutes) (Series of questions about a business combination and its income
tax reporting)
f. $20,000. For both receivables and liabilities, the consolidated total is $20,000
less than the sum of the two companies.
28. (continued)
28. k. (continued)
29. (45 Minutes) Develop worksheet entries that were used to consolidate the
financial statements of a father-son-grandson combination.
Entry *G
Retained Earnings, 1/1/11 (Delta) ............................ 15,000
Cost of Goods Sold ............................................ 15,000
(To recognize gain that was unrealized in 2010 [amount provided].)
Entry *C1
Retained Earnings, 1/1/11 (Delta) ............................ 7,000
Investment in Omega Company ......................... 7,000
(To recognize amortization expense from Deltas acquisition for 2010.)
29. (continued)
Entry *C2
Retained Earnings, 1/1/11 (Alpha) ........................... 27,600
Investment in Delta Company ............................ 27,600
To recognize accrual adjustments for excess amortization
and inventory deferral as follows:
Excess amortization from Delta acquisition
(80% $6,250 2 years) ........................................ $10,000
Deltas share of excess amortization from Omega acquisition
(80% [70% $10,000] 1 year) .......................... 5,600
Inventory profit deferral at 1/1/11 (80% $15,000) .. (12,000)
*C2 adjustment .......................................................... $27,600
Entry S1
Common Stock (Omega) .......................................... 100,000
Retained Earnings, 1/1/11 (Omega) ......................... 100,000
Investment in Omega (70%) ................................ 140,000
Noncontrolling Interest in Omega (30%) ........... 60,000
(To eliminate stockholders' equity accounts of Omega against parent's
Investment account and to recognize outside ownership.)
Entry S2
Common Stock (Delta) ............................................. 120,000
Retained Earnings, 1/1/11 (Delta, as adjusted) ....... 378,000
Investment in Delta (80%) ................................... 398,400
Noncontrolling Interest in Delta (20%) ............... 99,600
(To eliminate stockholders' equity accounts of Delta [as adjusted as Entry *G
and Entry *C1] against corresponding balance in Investment account and to
recognize outside ownership.)
Entry A
Copyrights ................................................................ 222,500
Investment in Delta ............................................. 90,000
Investment in Omega .......................................... 77,000
Noncontrolling interest in Delta .......................... 22,500
Noncontrolling interest in Omega ...................... 33,000
(To recognize January 1, 2011 unamortized copyrights, 2 years amortization
recorded on first investment but only one year for second.)
Entry I1
Income of Subsidiary ............................................... 144,000
Investment in Delta ............................................. 144,000
(To eliminate intercompany income accrual found on Alpha's records.)
29. (continued)
Entry I2
Income of Subsidiary ............................................... 49,000
Investment in Omega .......................................... 49,000
(To eliminate intercompany income accrual found on Delta's records.)
Entry D1
Investment in Delta .................................................. 32,000
Dividends Paid (Delta) ........................................ 32,000
(To eliminate intercompany dividend payments, 80% of Delta's payment.)
Entry D2
Investment in Omega ............................................... 35,000
Dividends Paid (Omega) ..................................... 35,000
(To eliminate intercompany dividend payments, 70% of Omega's payment.)
Entry E
Operating Expenses ................................................. 16,250
Copyrights ........................................................... 16,250
(Current year amortization, $6,250 on first acquisition and $10,000 on
second.)
Entry Tl
Sales ......................................................................... 200,000
Cost of Goods Sold ............................................ 200,000
(To eliminate intercompany inventory transfer.)
Entry G
Cost of Goods Sold .................................................. 22,000
Inventory............................................................... 22,000
(To defer ending unrealized gain on intercompany transfers.)
29. (continued)
Ownership percentages
Summit-->Treeline 90%
Treeline-->Basecamp 70%
Comparison
Consolidated net income (operating incomes less
amortizations) $755,000
Noncontrolling interest in consolidated net income
(30% $150,000 plus 10% $365,000) $81,500
Controlling interest in consolidated net income $673,500