Consolidation Subsequent To Acquisition Date: Solutions Manual, Chapter 5

Chapter 5
Consolidation Subsequent to
Acquisition Date
Copyright  2019 McGraw-Hill Education. All rights reserved.

Solutions Manual, Chapter 5 1
A brief description of the major points covered in each case and problem.
CASES
Case 5-1In this case, students must discuss how to value employees and patentable products
and how these assets should be amortized or checked for impairment on an annual basis.
Case 5-2
In this case, adapted from a CPA exam, students are asked to determine appropriate
accounting policies relating to a restructuring of a real estate company. A special purpose
balance sheet needs to be prepared that reports all assets and liabilities at fair value.
Case 5-3
In this case, adapted from a CPA exam, students are asked to provide advice in managing a
new company providing warranties for new homes. Students must also recommend appropriate
accounting policies relating to revenue recognition, warranty obligations and a business
combination involving some unique factors in allocating the acquisition cost.
Case 5-4
In this real-life case, students are asked to provide advice in resolving a salary dispute for a
hockey team. The owner of the hockey team states that he cannot afford the demands from the
union. However, consolidated statements are not being prepared for the combined operations of
the hockey team and Stadium, which is a subsidiary of the hockey team.
Case 5-5
In this case, adapted from a CPA exam, management appears to be manipulating income to
minimize the payment required under a share-redemption agreement. Students are required to
apply special accounting policies when analyzing controversial accounting issues including the
valuation of inventory, capitalization policies, goodwill, and related party transactions.
Case 5-6
In this case, adapted from a CPA exam, management appears to be manipulating income to
maximize its bonus. Students must recommend appropriate accounting policies relating to
revenue recognition, research and development costs and identifiable assets in a business

2 Modern Advanced Accounting in Canada, Ninth Edition
combination.
PROBLEMS
Problem 5-1 (20 min.)

This problem involves a calculation of goodwill impairment loss and a comparison of the
calculation of goodwill at the date of acquisition compared to goodwill after an impairment loss.

This problem requires the preparation of journal entries under the cost method and equity
method, calculation of various amounts for the consolidated financial statements for the third
year after acquisition and calculation of the equity method balance in the investment account.

This problem requires the calculation of various consolidated amounts for the income statement
and balance sheet for the fifth year after acquisition and an indication of the impact of goodwill
impairment on key financial statement items.

The consolidated balance sheet as well as the balance sheet of a parent and its less than
100%- owned subsidiary are presented. Students are required to answer four questions about
the parent and its subsidiary.

Selected information from the financial statements of a parent and its 85%-owned subsidiary for
a two-year period is given and the student is required to calculate the amounts for various items
that would appear in the consolidated statements during this period.

This problem uses the 2017 financial statements of Empire Company Limited, a Canadian
company. It deals with different methods of consolidation, the significance of non-controlling
interests, goodwill impairment losses and the impact of consolidation method on certain ratios.

Problem 5-7 (30 min)
Consolidated financial statements and a calculation of consolidated retained earnings are
required for a parent and its 80%-owned subsidiary for the third year after acquisition. Non-
controlling interest is measured using the trading price of the subsidiary at the date of
acquisition.

This problem involves the calculation of goodwill and equipment for the consolidated statements
and a series of questions comparing the cost and equity methods and the affects, if any, of
these methods on the preparation of consolidated financial statements.

A relatively straightforward question requiring the preparation of consolidated financial
statements one year after acquisition date.

This problem requires the preparation of consolidated financial statements four years after a
parent acquired 80% control in a subsidiary. Part of the acquisition cost is allocated to
unrecognised trademarks. Students must also assess the impact on two ratios of not allocating
any of the acquisition cost to the trademarks.
Problem 5-11(50 min.)

This problem requires the preparation of consolidated financial statements two and one-half
years after a parent acquired 80% control in a subsidiary. Also required are calculations of
goodwill, goodwill impairment and non-controlling interest under the identifiable net assets
method. The parent uses the equity method for internal reporting.

Consolidated financial statements of a 75%-owned subsidiary, four years after acquisition is
required after impairment tests for goodwill and software have been performed. Also required
are calculations of goodwill impairment loss and non-controlling interest under the identifiable
net assets method and an explanation of how the use of the identifiable net assets method
would affect the debt to equity ratio.

The preparation of consolidated financial statements is required four and one-half years after
the acquisition of an80%-owned subsidiary. Also required are calculations of goodwill, goodwill
impairment and non-controlling interest under the identifiable net assets method.

Consolidated financial statements of a parent and its 80%-owned subsidiary four years after
acquisition are required.

This question requires the preparation of consolidated financial statements three years after
acquisition. The parent uses the equity method for internal reporting. Also required are
calculations of the investment account had the parent used the cost method and calculation and
interpretation of 3 key ratios under the three different reporting methods.
SOLUTIONS TO REVIEW QUESTIONS

1. There are two steps involved in testing the goodwill for impairment:
i) Compare the recoverable amount of each cash-generating unit with its carrying amount
(including goodwill). If the recoverable amount is the larger amount, there is no impairment
of goodwill. If the recoverable amount is the smaller amount the next step (ii) is performed.
ii) If the recoverable amount is less than the carrying amount, an impairment loss should be
recognized and should be allocated to reduce the carrying amount of the assets of the unit
(group of units) in the following order:
a) first, to reduce the carrying amount of any goodwill allocated to the cash-generating
unit; and
b) then, to the other assets of the unit pro rata based on the carrying amount of each
asset in the unit. However, an entity shall not reduce the carrying amount of an
individual asset below the higher of its recoverable amount and zero. The amount of
the impairment loss that could not be allocated to an individual asset because of this
limitation shall be allocated pro rata to the other assets of the unit (group of units).
2. The process for testing for impairment is essentially the same in that the assets are written

down to recoverable amount when they are less than the carrying amount. Recoverable
amount is defined as the higher of fair value less costs of disposal and value in use.
When the intangible assets must be tested for impairment is not the same for the different
types of intangible assets. Goodwill impairment tests must be conducted at least once a year
unless there has been no impairment during the year and more often than once a year when
there is an indication that the cash-generating unit may be impaired. For intangible assets
with a definite useful live, the recoverable amount is only compared to carrying amount if
there is an indication that the asset may be impaired. Intangible assets with indefinite useful
lives must be checked for impairment on an annual basis and whenever there is an
indication that the intangible asset may be impaired.
3. The asset “Investment in subsidiary” on the balance sheet of the parent company is
removed and replaced with the individual assets and liabilities from the balance sheet of the
subsidiary (which are remeasured by the undepleted acquisition differential), and by the non-
controlling interest in the net assets of the subsidiary (in cases of less than 100%
ownership). The item of income “Investment income” on the income statement of the parent
company is removed and replaced with the income and expenses from the income
statement of the subsidiary (adjusted for the changes to the acquisition differential), and by
the non-controlling interest in the net income of the subsidiary (in cases of less than 100%
ownership). As well, any intercompany transactions such as payables and receivables would
be eliminated upon consolidation, whereas under the equity method they remain.
4. Under the equity method:

Cash 7,500
Investment in subsidiary 7,500
Under the cost method:
Cash 7,500
Dividend revenue 7,500
5. IFRS does not specify any method for internal record keeping purposes because the parent
is required to prepare consolidated statements for external financial reporting purposes, and
these statements are not affected by the method used by the parent to record the
investment. However, if the parent wants to issue separate entity financial statements in

accordance with GAAP, IAS 27 requires that the investment in subsidiary on the separate
entity financial statements shall be reported at cost or in accordance with IAS 39 Financial
Instruments: Recognition and Measurement (or IFRS 9 Financial Instruments: Classification
and Measurement if it is adopted early).
6. The dividends that appear in the retained earnings column in the consolidated statement of
changes in equity are those of the parent company only. The subsidiary’s dividends that
were paid outside the entity to the non-controlling shareholders would appear on a
statement of changes in non-controlling interest (if such a statement was prepared). The
subsidiary’s dividends that were paid to the parent do not appear on any consolidated
statement because no cash left the combined economic entity.
7. This statement is partially true. If the parent continues to control the subsidiary and if the
subsidiary continues to hold the land, this part of the acquisition differential will be used to
remeasure the land on all subsequent consolidated balance sheets. If the land is sold by the
subsidiary, the acquisition differential will in part be used to determine the loss or gain for
consolidated purposes and will no longer appear on the consolidated balance sheet. If
consolidation of this subsidiary ceases (due to loss of control), the acquisition differential
would become redundant since the acquisition differential only appears within the
consolidated financial statements.
8. What this statement means is that in addition to recording the investor’s share of net income
earned by the investee since acquisition, entries must also be made for changes to the
acquisition differential, and for the holdback and realization of any unrealized profits
regardless of whether the profit was recorded by the investee or the investor. The
calculations for these entries are identical to those that would be made when consolidating.
9. The undepleted acquisition differential was:

Investment account 120,000
Shareholders’ equity 125,000
75% 93,750
Parent’s share of undepleted acquisition differential (i.e., 75%) 26,250
Implied value of undepleted acquisition differential (26,250 / 75%) 35,000

(If equity method journal entries had been made to holdback unrealized profits, we would
not get this result.)
10. The elimination of intercompany receivables and payables has no effect on consolidated
shareholders’ equity or non-controlling interest.
11. Any fair value excess arising from the acquisition must be amortized, written down or
derecognized on consolidation in the same way that a cost of an individual asset purchased
directly by an entity is amortized, written down or derecognized. The matching principle
states that the cost of an asset should be expensed in the same period as the benefits
received from using the asset. The benefits are received over the useful life of an asset.
Consequently, assets such as property, plant and equipment should be amortized over their
useful lives and assets such as inventory should be derecognized and expensed in the year
they are sold.
12. The balance sheet accounts of the parent that have different balances are:
Investment in subsidiary, and
Retained earnings.
In addition, the following two income statement accounts differ in amount and their
description:
Dividend income (using the cost method)
Investment income (or equity earnings) (using the equity method)
13. This adjusts the parent's retained earnings under the cost method to what they would be
using the equity method. Under the equity method, the retained earnings of the parent
contain the parent's share of the subsidiary's net income since acquisition. Under the cost
method, the parent's retained earnings contain the parent's share of the subsidiary's
dividends since acquisition. Net income less dividends equals the change in retained
earnings. When we add the parent's share of the increase in the retained earnings of the
subsidiary to the retained earnings of the parent, the resultant amount now contains the
parent's share of the subsidiary's net income earned since acquisition.

14. The subsidiary’s revenue and expenses included in the consolidated income statement are
only those that have occurred since acquisition. Also, the non-controlling interest is based
on the subsidiary’s income earned subsequent to the date of acquisition.
*15. The recoverable amount for a cash-generating unit is typically determined by first preparing
estimates of future cash flows of the cash-generating unit and then calculating the present
value of these future cash flows. The discount rate should reflect current market
assessments of the time value of money and the risks specific to the cash-generating unit.
*16.The initialentry adjusts the parent's investment account and retained earnings at the
beginning of the year to equity method balances. The investment account now reflects the
equity method balance at the beginning of the current year.
17.Under the cost method, the parent has recorded only its share of dividends received from the
subsidiary. It has not recorded its share of the subsidiary’s change in retained earnings or its
share of the changes to the acquisition differential. Therefore, an entry or entries must be
made on the consolidation to record the parent’s share of the subsidiary’s change in
retained earnings and its share of the changes to the acquisition differential. Since the
starting point for consolidation is the separate entity records of the parent and subsidiary, a
cumulative entry is required each year on consolidation to adjust the parent company’s
retained earnings to what it would be under the equity method. When the equity method is
used, the parent’s retained earnings already reflect its share of the subsidiary’s retained
earnings and its share of the changes to the acquisition differential.
SOLUTIONS TO CASES
Case 5-1
a) None of the acquisition cost should be allocated to BIO’s skilled workersas long as the
workers are not under contract. The skilled workers are not capable of being separated
or divided from the acquired enterprise and cannot be sold, transferred, licensed, rented,
or exchanged. Therefore, the value of the skilled workers would be included as a part of
goodwill. [IAS 38.12]

b) Part of the acquisition cost should be allocated to patentable technology because this
technology has a value in the marketplace and it could be separated or divided from the
acquired enterprise and sold, transferred, licensed, rented, or exchanged. An appraiser
could be hired to estimate a value for the patentable technology. The technology would
be amortized over its expected useful life, which is likely to be short because of rapid
changes in technology. The technology would be checked for impairment whenever
events or changes in circumstances indicate that its carrying amount may not be
recoverable. [IAS 38. 12 & 97]
c) Goodwill is the difference between the acquisition cost and the fair value of identifiable
net assets. The goodwill can only be determined once all the identifiable assets including
the patentable technology and identifiable liabilities have been measured at fair value.
According to IAS 36, goodwill of a cash-generating unit should be tested for impairment
on an annual basis, unless all the following criteria have been met:
(a) The assets and liabilities that make up the cash-generating unit have not changed
significantly since the most recent determination of recoverable amount.
(b) The most recent determination of recoverable amount resulted in an amount that
exceeded the carrying amount of the cash-generating unit by a substantial margin.
(c) Based on an analysis of events that have occurred and circumstances that have
changed since the most recent determination of recoverable amount, the
likelihood that today’s recoverable amount would be less than the current carrying
amount of the reporting unit is remote.
A two-step impairment test should be used to identify potential goodwill impairment and
measure the amount of a goodwill impairment loss to be recognized, if any:
(a) The recoverable amount of the cash-generating unit should be compared with its
carrying amount, including goodwill, to identify a potential impairment. When the
recoverable amount of a cash-generating unit exceeds its carrying amount,
goodwill of the reporting unit is considered not to be impaired and the second step
of the impairment test is unnecessary.
(b) When the recoverable amount is less than the carrying amount, an impairment
loss should be recognized and should be allocated to reduce the carrying amount
of the assets of the unit (group of units) in the following order:
(i) first, to reduce the carrying amount of any goodwill allocated to the cash-
generating unit; and
(ii) then, to the other assets of the unit pro rata based on the carrying amount of each
asset in the unit. However, an entity shall not reduce the carrying amount of an
individual asset below the higher of its recoverable amount and zero. The amount
of the impairment loss that could not be allocated to an individual asset because
of this limitation shall be allocated pro rata to the other assets of the unit (group of
units). [IAS 36]
Case 5-2
Memo to: Board of Directors of GIL
From: CPA
Subject: Financial Accounting & Reporting Policies
As requested, I have prepared a report recommending appropriate accounting and reporting

policies related to GIL’s November 30, Year 3 financial statements.
Users and Needs
In determining appropriate accounting policies for GIL, I considered the users of GIL’s financial
statements and their information needs. There are many users, with varied and often conflicting
information needs. Accordingly, I have had to make assumptions when ranking the users to
determine the most appropriate policies.
The users of GIL’s financial statements are as follows:
 The bank will be concerned about liquidity and its security. Cash flow and current value
information would be useful for this purpose.
 Sam and Ida Growth will be concerned that the valuation of GIL’s net assets are
calculated so that the redemption value of their preferred shares is fair. They will also
want information to evaluate the performance of GIL’s management since they still have
voting control.
 The common shareholders, the Growth children and Mario Thibeault, will be interested
in evaluating management’s performance and the performance of GIL’s investments.
Current value information is necessary for this purpose.
 The senior management of GIL will want to maximize income since it receives a bonus
based on net income.
 CRA requires historical cost information on realized gains and losses to assess income
taxes.
In my view, the most important users are Sam and Ida Growth, the preferred shareholders
because they have the most at stake in the company and could redeem their shares at any time
for fair value of GIL at November 30, Year 3. Thus, accounting policies have been chosen to
meet Sam and Ida’s objective of receiving a fair redemption value for their preferred shares and
of evaluating management. The valuation of the redemption creates a conflict. The common
shareholders will want the redemption value of the preferred shares to be as low as possible
while Sam and Ida will want the value to be high to maximize their cash flows when they
redeem their shares.
To satisfy the information needs of Sam and Ida for a one-time revaluation of the net assets of
GIL at November 30, Year 3, a special purpose balance sheet should be prepared. The balance
sheet will report all assets and liabilities at fair value. This will determine the redemption value
of, and the value assigned to, the preferred shares. The old common shares will be cancelled.
The new common shares will be valued at $400, the cash received on issuance of these new
shares.
The special purpose balance sheet will not comply with generally accepted accounting policies
(GAAP) because GAAP only allows for a comprehensive revaluation of net assets when there
has been a change in control. Since Sam and Ida controlled GIL both before and after the
reorganization, there has not been a change in control.
To satisfy the information needs of the other users for Year 3 and subsequent years, general
purpose financial statements should be prepared in accordance with ASPE. The net assets of
GIL will be retained at their carrying value. Accordingly, the value assigned to the preferred
shares will be equal to the carrying value of the common shareholders’ equity prior to the
reorganization. As noted above, the new common shares will be valued at $400, the cash
received on issuance of these new shares.
In the ensuing discussion, I will indicate the accounting and reporting requirements for both the

special purpose balance sheet and the general-purpose financial statements.
Special Purpose Balance Sheet
The special purpose balance sheet will show the fair value of Sam and Ida preferred shares at
the date of the reorganization. This value will be used as the base for future dividend
distribution. This balance sheet will not be updated on an annual basis.
Fair value is defined in IFRS 13 Fair Value Measurement as the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between market participants
at the measurement date (i.e., an exit price). It would reflect the highest and best use for the
asset. [IFRS 13]
The various properties should be valued at appraised value regardless of whether the appraised
value is higher or lower than carrying value. The non-interest-bearing note receivable should be
discounted at current market rates to reflect the true value. Assuming an interest rate of 10%
(based on current five-year mortgage interest rates), the present value of the receivable is
$1,895,000 ($500,000 x 3.79).
GIL’s outstanding debt bears varying interest rates. These liabilities should also be discounted
at current market rates to reflect their true value.
In revaluing the assets and liabilities of GIL, we must consider the tax effects of the revaluation.
Selling costs should be deducted in determining the fair value of these assets and liabilities.
Then, future income taxes should be set up to reflect the tax that would be payable or
receivable if these assets and liabilities were sold or paid off at their fair value.
There would be no benefit in capitalizing the real estate taxes and interest on the debt incurred
to finance the raw land purchases since the land is being revalued to its fair value. If these costs
were capitalized, the land would be reported at a value in excess of its fair value.
A professional appraiser should appraise the apartment building that is planned to be converted
to a condominium. The appraised value should reflect the likelihood of conversion and the
potential profits from the conversion.

GIL should record the benefits of the low lease payments ($100,000 versus $220,000 per year)
as an asset at the time of reorganization because the new shareholders will benefit from the
leasing decision made by the previous owners. Using a discount rate of 10% for 14 years, the
remaining term of the lease, the reduced payments have a value of $884,400 ($120,000 x 7.37).
The investment in the joint venture should be valued at fair value by valuing the net assets
owned by the joint venture at fair value and multiplying by GIL’s 50% interest.
The likely amount of contingent consideration to be received from the sale of the office building
should be included in the redemption value of the shares since the decision to sell the building
was made by Sam and Ida.
General Purpose Financial Statements
The general-purpose financial statements will be prepared in accordance with ASPE and will be
prepared on an annual basis. Unless otherwise noted below, the assets and liabilities of GIL will
not be revalued to fair value on the date of the reorganization.
The non-interest-bearing note receivable should be valued at $1,895,000, as calculated above,

on the date of the sale of the building. The difference between the face value and the present
value of the note, $605,000, represents deferred interest revenue. It should be reported as a
deferred credit on the balance sheet and amortized into income over the five-year term of the
receivable. The $605,000 of interest revenue will reduce the amount of gross profit recognized
on the sale. Only $500,000 of the note receivable should be reported as a current asset. The
remainder should be reported as a long-term asset. [Section 3856.07]
The real estate taxes and interest on debt incurred to finance the raw land purchase should be
added to the cost of the land. These are costs of getting the land ready for sale or ready for use.
These costs will be recovered through future sales. [Section 3061.11]
The increase in value of the building due to conversion to condominium status will not be
reflected in the financial statement on conversion. The gain will be reported when the building is
sold. [Section 1000.43]
GIL should report a gain as a result of the sale to the joint venture partner of one-half of its
interest in the land on which the shopping center is being built as this portion was deemed to be
sold to an arm’s length party. [Section 1000.43]
GIL has an accounting policy choice to report its investment in the joint venture using the cost
method, equity method or proportionate consolidation. The equity method or proportionate
consolidation both reflect GIL’s share of the income in the joint venture as the income is earned
by the joint venture. The cost method is easier to account for but doesn’t reflect income until it is
received as a dividend from the joint venture. The details of the joint venture arrangement
should be disclosed including its significant commitment to the construction company. [Section
3056]
The sales agreement for the office building contains a contingent fee clause. Any additional
sums received are really a part of the selling price of the building. These additional amounts
should be added to the selling price once they are measurable. Since new leases have already
been signed, no uncertainty exists regarding at least a portion of the contingent consideration.
[Section 3856.07]
GIL is currently using the same depreciation rates and methods for tax purposes and
accounting purposes. However, the rates used for tax purposes do not necessarily reflect the
true economic lives of the assets. GIL should review all its depreciation rates and ensure that
they properly represent the actual usage of the assets over time. [Section 3061.16 to .20]
An entity that issues preferred shares in a tax planning arrangement should present the shares
at par, stated or assigned value as a separate line item in the equity section of the balance
sheet, with a suitable description indicating that they are redeemable at the option of the holder.
When redemption is demanded, the issuer shall reclassify the shares as liabilities and measure
them at the redemption amount. Any adjustment shall be recognized in retained earnings.
Extensive note disclosure will be required of the share exchange and the conditions of the
preferred share issue. [Section 3856.23]
(CPA Canada adapted)
Case 5-3
REPORT ON MANAGEMENT ASSISTANCE AT TOTAL PROTECTION LIMITED

We have been engaged to provide you with recommendations that will assist you in managing
Total Protection Limited (TPL or the Company) profitably on a long-term basis. The key
decisions that TPL will be making concern pricing, cost control, and cash management and
investment. Our report offers advice intended to assist the Company with these decisions, as
they are the determinants of future profitability.

Pricing
There appears to be no rationale for pricing other than charging what the market will bear. It is
important to set prices for each builder that will more than offset the costs of warranty repairs
and price guarantees if long-term profitability is to be achieved. The attached accounting
policies report discusses the problems with estimating warranty costs, so the discussion is not
repeated here.
I have done an analysis of warranty revenues and costs by builder (see Appendix I). No undue
reliance should be placed on the data, given the condition of the Company's records. However,
some problems seem apparent:
1. The prices being charged for the warranties and repair costs incurred vary widely among
the builders.
2. Warranty revenues charged by Kings Road and Safe-Way Builders are low in
comparison to those of the other builders and are unlikely to cover future warranty costs.
3. Repair costs bear no relationship to the price of the warranties. Not surprisingly,
warranties for houses built by the companies using lower cost materials are experiencing
higher repair cost claims. These builders are also charging only the minimum amount for
the upfront fees.
4. Safe-Way has the highest repair cost per warranty sold of the shareholder participants
and is, therefore, probably the least qualified to do the warranty repairs.
5. Kings Road has the smallest margin between cost and revenues and given the length of
the warranty, its costs will soon exceed its revenues.
6. Repair costs based on experience to date are highest for the builders that are not
shareholders in the Company, and they may be using the warranties to increase their
own profits.
All these problems suggest that a major overhaul of the pricing structure is to allow flexibility for
homes of different quality. Although the current commission structure helps maximize the price
that is received for the warranties sold, it does not motivate the builders to minimize the repair
costs incurred as a result of using lower quality materials.
The minimum premiums for Kings Road, Safe-Way Builders, and the other builders will all have
to be increased substantially to cover repair costs adequately and ensure fairness to all
shareholder participants in the Company. At present, the better-quality builders are subsidizing
the lower-quality builders. Perhaps a large deductible should be imposed on each repair claim
to reduce the amount of this differential, or some other variation of pricing structure should be
considered that relates price to cost history.
Larkview, Towne and Granite have sold warranties at reasonably high prices and have relatively
low repair costs, perhaps because of the higher-quality construction they undertake. Little
change in their pricing structure is needed at this time for these builders.
Cost control of warranty work
Safe-Way Builders are currently performing all the repair work on warranties. There is a problem
in having any shareholder solely responsible for the repair work. The motivation for any builder
will be to maximize the price of the repair work to increase its own profits. TPL should therefore
institute certain controls to ensure that all repair work performed is in fact required and that it is
performed at the best price to TPL.
Standards should be developed for hourly rates and the number of hours required for the
various types of repairs.
An approval process for repairs should be introduced whereby another shareholder must
approve the warranty work of a given builder. A system of reporting should also be
implemented, requiring TPL to report the various repair claims it undertakes to each of the
shareholders and to include an analysis of the variances from standard,
Hiring independent staff and increasing the segregation of duties in the Company may help
improve controls over warranty claims and will reduce the need for involvement by the
shareholders in the future.
Cash management and investment
As warranty costs are usually incurred in the future while the warranty revenue (initial fee) is
received currently, TPL will always have excess cash balances that must be invested.
Investments in low risk government/corporate bonds and other investments typically used for
trusts would be the most appropriate. A cash budget should be completed, and the terms to
maturity of such investments should coincide with the requirements identified in the cash

budgets. A large portion of the investments should be highly liquid because the future cash
flows cannot be estimated with a high degree of certainty.
Real estate investments can be illiquid and risky in cyclical markets and should be avoided. The
acquisition of the local construction company was probably not a good idea because you are
likely going to need the cash for warranty work soon. You should seriously consider divesting of
this investment unless you need the construction company to carry out the warranty work.
Dividends should not be declared and management fees should not be charged by the
participants until the Company has more experience with warranty repair claims.
REPORT ON ACCOUNTING POLICIES
There are several users of the financial statements of TPL, each with different interests:
1. The shareholders/builders will use the financial statements to assess the profitability of
the Company and to determine what cash, if any, should be distributed.
2. Safe-Way will calculate its royalties based on the revenue-recognition policies adopted by
the Company.
3. Customers may use the statements to determine the liquidity and viability of the Company
before purchasing a warranty.
4. Other builders may rely on the statements before participating in the warranty programs.
Their reputations are at stake.
5. The government may use the statements as part of its review of the Company's operations
from time to time.
Accordingly, policies for accruals of future warranty costs will be of great importance to all the
users and will affect the long-term viability of TPL. Given the number of users and high levels of
assurance each requires, statements should be prepared in accordance with ASPE, with the
appropriate disclosures.
The most significant accounting policies that must be developed are for warranty liabilities and
expenses, revenue recognition and business combinations.
Matching the revenues and expenses is the critical issue because the largest portion of cash
from warranty sales is received up front and expenditures will be made on warranty repairs
unevenly over the following ten years.

To the extent that cash reserves are in place to meet future contingencies, interest will be
earned on those funds. Policies should be re-evaluated from year to year according to repair
experience and potential increases in reserves from investment income.
Warranty liabilities and expenses
Future warranty costs are difficult to estimate because few warranties of 10 years have been
offered in the marketplace. Accordingly, data on repair history for warranties longer than one
year are not available in the industry. Further complicating estimations is the fact that new
builders do not use materials and construction techniques of identical quality, and there are no
controls over the builders participating in the plan.
The market-decline provision due to faulty construction is unique in this industry, so no

comparable information is available to determine the extent of the risk arising from this
coverage.
Despite the problems with warranty cost estimation, an attempt must be made to quantify the
estimated future liability by reviewing the repair history of each builder participating in the plan
and the nature of the repairs incurred to date. Otherwise, revenue cannot be recognized until
the end of the warranty period.
Historical repair data from each builder should be reviewed to properly estimate the current
portion of the warranty liability at the balance-sheet date. This is particularly important
considering the Company's liquidity objective. [Section 1000.45]
Revenue recognition
Revenue can be recognized in several ways:
1. Recognize all revenues from warranties sold, including discounted maintenance

payments (at the time the contract is signed).
This method is appropriate if the total warranty costs can be estimated and if the collection of all
maintenance fees is assured. The method provides information to the shareholders and other
users on the expected profitability from yearly sales. It is unlikely that the estimations required
by this method can be made with sufficient certainty.
2. Defer all revenues until the end of the warranty period (year ten).

This method is the most conservative and implicitly recognizes that warranty cost estimation is
impossible and that income should, therefore, not be recognized until the critical event takes
place - that is, the expiration of the warranty period. Thus, revenues could be recognized only to
the extent that costs were incurred.
This method is of limited usefulness to the shareholders because profitability is not assessed
(although regulators would likely be most satisfied with this treatment because of its
conservative nature).
3. Recognize the initial warranty fee and annual maintenance fees on a cash basis.
A percentage of total warranty costs is expensed in the same proportion as the income
recognized. The problems with estimating total warranty costs have been discussed previously.
Using the cash basis of revenue recognition avoids the problem of estimating the collection of
future maintenance fees.
This method provides the shareholders with information on cash flows and estimated future
liabilities that are required to determine dividend payments.
4. Recognize revenues on a percentage-of-completion basis, based on estimated warranty

expenditures throughout the ten-year warranty period.
This is similar to the previous method except that warranty costs drive revenue recognition.
Warranty-cost estimation is still very subjective and is not an appropriate basis on which to
recognize revenue.
5. Amortize the initial payment received for the warranties equally over the ten-year life and
recognize maintenance fees as received.
This method assumes that the initial fee represents the present value of future cash flows.
Again, warranty expenses must still be estimated and are unlikely to be incurred equally
throughout the life of the warranty, resulting in a mismatch of revenues and expenses in most
years.
I recommend recognizing revenues and expenses on a cash basis because this method
recognizes the reality of warranties for homes (i.e., that most claims will occur in the first two
years). If there is a problem with construction, it is much more likely to become apparent in the
first year than in later years. The cash method recognizes more revenues and expenses in the

first year, and the maintenance payments should cover repairs that may be made in subsequent
periods. [Section 3400]
Business combinations
By purchasing 100% of the shares of Gainery Construction Ltd. (Gainery), TPL has obtained
control over Gainery. Under ASPE, TPL can report its investment in Gainery on a consolidated
basis or by using the cost method or equity method. The cost method is the simplest but only
reports income as dividends are received. Given that Gainery probably needs its cash for
operating purposes, it may be more meaningful to use the equity method or consolidation
method. Both methods will report the same amount of income. As indicated in Appendix II, the
amount paid by TPL for Gainery appears to be less than the fair value of the identifiable net
assets. You will need to verify that these fair values are realistic. If they are realistic, then TPL
could report a gain on purchase in the amount of $380,868 on the consolidated income
statement for Year 1. However, when the homes under construction and undeveloped land are
sold, the acquisition differential for these assets will have to be expensed. This will reduce the
gains reported on the consolidated income statement. The acquisition differential pertaining to
the equipment should be amortized over the life of the equipment. This will reduce depreciation
expense reported on the consolidated income statement.[Section 1582]
Other accounting issues
Commission expense should be recognized on the same basis as the revenue-recognition

policy selected. To the extent that cash commission payments differ from the expense recorded,
prepaid commissions will be recorded on the balance sheet. [Section 1000.45]
The repairs and rent charged by Safe-Way to TPL and the royalties received by Safe-Way from
the Company are related party transactions. Details of these transactions must be fully
disclosed in the financial statements. [Section 3840.51]
APPENDIX I
Warranty Revenues and Repair Costs*
Larkview Towne Granite Kings Safe-Way Others Total
Number of warranties 50 85 190 250 175 465 1,215
Warranty revenue $120,000 $165,000 $395,000 $90,000 $160,000 $705,000

$1,635,000
Per warranty 2,400 1,941 2,079 360 914 1,516 1,346
Repair costs 6,000 9,000 21,000 42,000 39,000 107,000 224,000
Per warranty 120 106 111 168 223 230 184
* Readers should be cautioned that these figures have not been independently verified.
APPENDIX II
Determination and Allocation of Acquisition cost
Present value of amounts paid to Mr. Gainery (Note 1) $1,891,632
Less: amount attributable to consulting services provided by Mr. Gainery (Note 2) (22,500)
Amount paid for acquisition of shares of Gainery 1,869,132
Fair value of identifiable net assets (4,720,000 – 2,470,000) 2,250,000
Gain on purchase $ 380,868
Notes:
1. Assuming an incremental borrowing rate of 8%, $1,000,000 on closing plus annuity of
$500,000 per year for 2 years.
2. Assuming that consulting services are worth $50 per hour: $50 x (300 + 150)
Case 5-4
(a)
It appears that Mr. Slim is trying to hide profits of the hockey operations by funnelling the profits
of the Stadium through a separate company and not disclosing the results of the Stadium’s
operations as part of the salary negotiations. Furthermore, the price for the use of the Stadium
may be inflated to transfer profits from the Club to the Stadium.
Since the Club owns 90% of the Stadium, it controls the Stadium and it would normally prepare
consolidated financial statements to present the financial situation for the combined economic
entity. Furthermore, since the Stadium is used primarily by the Oilers, it would be appropriate to

incorporate the Club’s share of the Stadium’s income when considering the Club’s ability to pay
increased salaries to the players.
The consolidated income statement for the Club would appear as follows:
Revenues
Tickets $6,000,000
Concessions 2,400,000
Parking 200,000
Total revenues 8,600,000
Expenses
Cost of concessions 800,000
Player salaries 1,200,000
Staff salaries 2,400,000
Depreciation of stadium 1,000,000
Advertising 400,000
Total expenses 5,800,000
Net income $2,800,000
Attributable to:
Shareholders of the Club $2,440,000
Non-controlling interest (10% x 3,600,000) 360,000
$2,800,000
The consolidated net income attributable to the shareholders of the Club of $2,440,000 presents
a much different situation than the net loss of $800,000 presented by the Club on its separate
entity income statement. The consolidated financial statement is the more relevant figure as it
presents the overall picture of the hockey operations.
To determine what a fair salary increase is for the players, the following additional information is
required:
 What did the owner pay for the Club and what is a fair return on this investment?
 What was the cost of the Stadium and over what period is the Stadium being amortized?
 Who owns the other 10% of the Stadium and what is the relationship to Mr. Slim?

 How much of the staff salaries are paid to Mr. Slim and parties related to Mr. Slim?
If Mr. Slim were not willing to provide answers to these questions, it would be very difficult to
determine a fair salary. It would create a lack of trust in his leadership and could have negative
impacts on the players’ willingness to perform at a high level for the team.
(b)
Since Mr. Slim owns the Stadium, GAAP would not require that consolidated financial
statements be prepared for the Club and the Stadium since the Club does not control the
Stadium. Since the Club has no financial interest in the Stadium, one could argue that the
employees and players of the Club should not expect to share in any of the profits earned by the
Stadium. However, employees and players of the Club would expect that a fair price be paid for
use of the Stadium. If the Stadium were owned by a non-related party, a fair price would likely
be negotiated between the Club and the Stadium.
Since the Club and Stadium are both owned by Mr. Slim, these two companies are related. Any
transactions between the two companies can be used to manipulate the profits of the individual
companies. To ensure that a fair salary is paid by the owners, I would want to determine
whether the price paid for the use of the Stadium is fair. To make this determination, I would like
to see the financial statements for the Stadium and get answers to questions presented in (a)
above.
Case 5-5
MEMO TO PARTNER
Memo to: Partner

From: CPA
Subject: Share-redemption price, Gerry's Fabrics Ltd.
My initial assessment of the Preferred Share Agreement (the Agreement), suggests that the
policies listed lean towards recognizing revenue as early as possible while also delaying
recognition of expenses as long as possible. Therefore, in reviewing the policies used in Year
45 we must ensure that they conform to the policies specified in the Agreement or are

consistent with the intent of the Agreement (Clause 1). Further, parties to the Agreement had
reason to assume that policies in effect in Year 41 (when the Agreement was signed) but not
specifically referred to in the Agreement would remain the same. When there is no specific
policy in the agreement to deal with the dispute, ASPE will be used to resolve the issue.
One point to note is that the figure for income before tax of $895,420 is unaudited and was
prepared by the vice-president of finance of GFL. The validity of this figure will need to be
established before a share-redemption price is calculated.
It appears from a review of the disputed items that GFL has been trying to minimize its
revenues and maximize its expenses. This bias is understandable since it is in GFL's best
interests to minimize the amount it must pay the shareholder. The preferred shareholder had
to notify GFL by January 1, Year 45 of his intention to redeem his shares. After this date, GFL
entered into transactions and changed certain policies; these actions tend to confirm a bias on
GFL's part since they lower the redemption price.
The above factors will need to be taken into consideration when determining the share-
redemption price.
ANALYSIS OF TRANSACTIONS
J. Ltd.
Since goodwill was recorded in Year 44, the company has chosen to use consolidated financial
statements to report its interest in J Ltd. Goodwill should not be amortized but should be
checked for impairment on an annual basis. By reversing the amortization of goodwill, income
will increase. If there is an impairment of goodwill, then income will decrease. Only the
impairment for Year 45 should be reported in Year 45. Impairment tests will have to be
performed at the end of Year 44 and end of Year 45 to determine the amount of impairment for
Year 45. The overall impact for Year 45 will result in an increase/decrease in income if the
previously recorded goodwill amortization is greater/lesser than goodwill impairment. [Section
3064.70]
Allocating the difference between acquisition cost and carrying amount to goodwill may not
conform to the Agreement if other assets should have been debited instead. Identifiable assets
and liabilities acquired should have been recorded at their fair values at the time of acquisition.
[Section 1582.19]
By choosing to debit goodwill instead of debiting the appropriate asset, GFL may or may not
achieve a low-income figure for Year 45. It depends on whether the identifiable asset would be
amortized in Year 45 and how this compares to any goodwill impairment. For the ensuing
discussion, I will assume that there was no goodwill impairment for Year 45. If GFL had debited
an asset such as inventory in Year 44, the fair value excess on the inventory would have been
expensed in Year 44 and there would be no expense in Year 45. Conversely, if GFL had
debited a larger amount to an asset that was must be amortized or was sold in Year 45, some
or all ofthe fair value excess would be expensed in Year 45 and income would decrease.
Overall, the value of each asset and liability will have to be examined to determine whether the
correct amount was recorded initially. Then, the appropriate changes to the acquisition
differential for Year 45 will need to be recorded. If adjustments are needed the share-
redemption price will be affected.
Even though the Agreement does not refer to intangible assets, Clause C can be used for
guidance on the any acquisition differential assigned to intangible assets. Clause C refers,
however, to the physical life of an asset, and an intangible asset by definition, does not have a
physical life. Although the Agreement specifies that physical life be used regardless of the
useful life of the asset, perhaps in this instance the use of useful life can be justified.
If the allocation of the acquisition differential results in higher amounts being assigned to
liabilities and this pushes GFL's debt-to-equity ratio beyond the 1: 1 ratio required under
Clause E, then any amortization of the fair value excess/deficiency on the debt above the ratio
should be added back to income for calculating the share-redemption price.
Volume discounts
One could argue that since Clause A2 prohibits the setting up of an allowance for returns, no
allowance should be set up for volume discounts. Or, it could be argued that a discount is like
an adjustment and, therefore, should be recorded in the year to which it relates, in accordance
with Clause F. Accordingly, if the volume to which the discount applies was to be reached after
year-end, it can be argued that it should not be accrued. On the other hand, if the volume to
which the discount applies is reached before year-end, then the discount should be accrued.
More information is needed to determine how to account for the discount, but the intent of the
agreement to delay expenses suggests that the discount should not be accrued.
Standard costing
Standard costing variances are not specifically mentioned in the Agreement, but expensing all
variances seems inconsistent with its intent. The variance allocation likely does not result in
inventory being costed with its full share of all designated overhead expenditures as required in
Clause B1. Since the current policy was introduced in Year 4, it is possible that income reflects
the actual costs of the inventory, but only if opening and closing inventories were constant.
Inventory, and hence cost of goods sold, should be adjusted to reflect the actual production
costs; no adjustment may be necessary if Year 44 variances offset Year 45 variances.
Incentives
Compensation is to be in accordance with levels used in Year 41 adjusted by the Consumer

Price Index (CPI), under Clause G. It is reasonable to assume that incentives form part of
compensation.
GFL must determine the average compensation per employee at Year 41 and adjust it
according to the CPI. This figure should then be multiplied by the number of employees to
determine how much compensation can be charged for the year.
Changing investment from equity to cost
The cost method recognizes dividends that GFL receives as income whereas the equity
method recognizes GFL's share (based on its percentage ownership) of the investment’s
earnings. The change in policy from equity to cost could be an attempt by GFL to manipulate
net income if dividends were low compared to its proportional share of earnings. This
manipulation could have an even greater effect if GFL can influence the amount of dividends
distributed during GFL's Year 45 fiscal year.
The equity method reflects Clause F better than the cost method since the adjustment under
the equity methodcauses an increase in the carrying amount on GFL's books and is closer to
the change in the value of the investment.
If GFL owned the investment in Year 41, we should determine how it was accounted for then,
since that was what was expected at the time the Agreement was signed. We should also
investigate whether there have been any significant changes in the investment since Year 41
that warrant changing the accounting method used.
New plant costs
Clause D1 states that expenditures should be capitalized as assets unless their useful life is
limited to the current financial period. Accordingly, all costs of constructing the plant should be
capitalized. These construction costs are necessary for the long-term operations of a plant,
and thus their useful life is longer than one year. Further, although it is difficult to state exactly
when construction has been completed, it is hard to justify calling it completed just because
some form of manufacturing began. Both parties are satisfied with capitalizing construction
costs since GFL did capitalize the costs until manufacturing activities began. In this case,
capitalizing costs until economic production levels are attainable is reasonable i.e., until the
plant can produce what it was built to produce.
From a procedural standpoint, we need to assess how much manufacturing occurred in

relation to what the manufacturing capacity will be when the plant is completed. It can be
argued that the proportion related to the area completed should be expensed and the rest
capitalized as construction costs.
On the other side of this issue is revenue recognition. It would make sense to argue that
revenue recognition should be delayed while costs are still being capitalized since there is no
expense to offset revenue. The Agreement, however, recognizes revenue up-front (Clause A –
when production is completed or items are shipped). If revenue is recognized up-front,
perhaps expenses associated with the production should be accrued.
It would be useful to determine which expenditures create future income since we could then
infer that the life of those expenditures was greater than one year. If any expenditure can be
shown to benefit GFL over a period longer than the Year 45 fiscal period, they should be
capitalized and amortized over their useful life, regardless of whether manufacturing activity
has begun. Some amortization should occur in the period related to the space that was used
for production.
Land for development
If the land can legitimately be considered inventory, Clause B of the Agreement should be
followed. Clause B does not mention writing down the asset; it specifies only that all
expenditures needed to make the inventory available for use must be included. If the land was
unjustifiably reclassified as inventory, Clause Dapplies, since there was no change in GFL's
handling of the property. Clause D states that assets should be recorded at cost; like Clause B,
Clause D does not refer to writing down an asset's value.
If a write down can be justified under Clause F (all changes in value should be attributed to
the year to which the error or adjustment relates), then only the decline in value that occurred
in Year 45 should be charged against income of the period. There should be a write down only
if the decline in value is felt to be permanent. However, only the change in value during Year
45 should be charged to income in Year 45.
Deferred payment on capital asset sale
Regular sales are not recognized on a cash basis for purposes of the Agreement but rather
when inventory is shipped (Clause A). The only reason for deferring recognition of the income
from the sale of assets might be the possibility that the purchaser will not pay. However, in
Clause A2 the Agreement specifically states that no allowances should be made for returned
merchandise. If the same line of reasoning is followed, then no allowance for uncollectible
amounts should be set up. Therefore, the full gain on the sale of the asset should be recorded
for the benefit of the preferred shareholder.
It could be counter-argued that selling of property, plant and equipment does not fall under
Clause A, which deals with revenue from the sale of inventory. If so, then the intent of the
Agreement to recognize revenue early and delay expenses becomes applicable. Thus, the
previous recommendation still applies.
The deferral of payment (and hence deferral of revenue recognition) may be a deliberate
attempt on the part of GFL to decrease income. The deal was entered into in March, at which
time GFL would have known that the shareholder was cashing in his preferred shares based
on the financial statements of fiscal Year 45.
New pension benefits
Pension benefits are probably considered part of compensation and hence should be
measured as prescribed in Clause G. If these pension benefits are not considered part of
compensation, then we must determine what basis was used for determining the charges that
were made against income. Actuarial reports may contain some of this information.
If the costs relate to past service, then the expense should be charged to the year that it
relates to (Clause F of the Agreement). However, Clause F could also be interpreted to mean
that since the adjustment in pension was made in Year 45, the increase in expenses should
be charged to Year 45.
DGR transactions
Sales to DGR must be recorded at fair value since it is a related party, in accordance with
Clause G of the Agreement. An adjustment would increase the redemption price by $475,000
($380,000 x 1.25).
Accrual of legal fees
Under Clause F of the Agreement, legal costs should be applied to the year in which the patent
infringement occurred. We must examine legal documentation to find out when the infringement
occurred.
Another question is whether Clause F will apply if in the future there is an award (fine) in the
case. If the answer is yes, then a recalculation will need to be made at that time.
CONCLUSION
It is evident from the preceding analysis that some of the accounting policies used in GFL's
March 31, Year 45 financial statements do not comply with the Agreement. Policies that have
changed since the Agreement was signed to accommodate operational changes do not lead to
suspicions about GFL's intent. However, when circumstances have not changed, GFL's sole
reason for making the change may have been to lower the redemption price.
Case 5-6
To: Kin Lo, Partner

From: CPA
Subject: Memo regarding DFT
Attached is my memo describing the accounting issues relevant to Digital Future Technologies
(DFT). You indicated that you were concerned about the impact of any accounting issues on
income due to the new management compensation plan that is based on EBITDA. Many the
issues I have discussed have an impact on interest, taxes, depreciation and amortization, or
elements included in earnings before tax. As a result, I have explained the impact of these
issues on EBITDA as applied in the bonus calculation.
I believe you will need to speak with Anne as soon as she is available with respect to the
bonus. In my conversation with her, she explained that she was confident management would
be getting its bonus and planned to accrue an estimated amount. Based on my revised
projected income, management may not meet the threshold amount, and therefore would not
obtain a bonus. I have also provided some additional comments and considerations with
respect to the new bonus plan.
Performance Measurement and Reporting

As a Canadian public company, DFT is subject to reporting under IFRS, which it adopted
previously. I have identified a few accounting issues, many of which will significantly affect the
projected results for the year, which in turn will directly affect the bonus amount, and could also
lead to material misstatement of the financial statements.
Revenue Recognition
Non-recurring engineering (NRE)
NRE represents a significant revenue stream. DFT has booked a total of $2.5 million in NRE
revenue. The first $1.5 million in NRE revenue, which appeared to have no further obligations
beyond the initial engineering work, was appropriate to recognize under IFRS 15, as it had
been fully earned.
However, the latest arrangement differs from previous NRE revenue. DFT obtained NRE work
in July for $1 million. The difference is that the customer only agreed to this price because DFT
agreed to provide a $225,000 discount, on product that usually sells for $750,000, on sales in
the Year 13 fiscal year. The NRE revenue would not have occurred without this concession by
DFT. Therefore, the NRE revenue is linked to the future sales of product. The transactions are
considered linked and should be looked at as a single transaction. [IFRS 15.17]
The NRE revenue should have a portion of the discount applied to it, since the amount being
charged is determined in conjunction with the pricing of other elements (the product sales) of
the transaction. The total gross sales value is $1.75 million ($1 million NRE plus $750,000
product). Since DFT provided a discount of $225,000 on the product sale to get the entire
contract, a portion of the discount should be attributed to the NRE revenue. As a result, a
portion of the $1 million NRE revenue that would otherwise be recognized must be deferred.
The percentage of the contract performed before year-end, based on revenues $1 million
divided by $1.75 million, is 57%. DFT should therefore allocate 57% of the discount to the NRE
part of the contract by deferring 57% of the discount amount of $225,000 ($128,571). The net
reduction will have a direct impact on the bonus calculation.
Indo-Tech (Indo)
The arrangement with Indo is structured in such a way that revenue is earned either when Indo
takes possession of the inventory or when 60 days have elapsed from receipt at the third-party
warehouse. Because of the agreement in place, all the $1.50 million related to inventory
shipped by June 30 could be recognized by September 30, even if Indo had not taken the
inventory on August 2. It is appropriate to recognize the revenue.
However, the remaining $1.85 million of revenue related to the inventory shipped to the third-
party warehouse cannot be recognized as revenue unless Indo takes the inventory by
September 30, since 60 days will not have passed since its arrival at the warehouse (we don’t
know the exact shipping and arrival dates, but if we assume it was shipped on August 3, it is
about 57 days at September 30). The only revenue that should be recognized by September 30
is the sales value of the items taken by Indo by September 30. The remainder of the items
should be recorded in inventory at cost until the 60 days in the warehouse have passed.
The agreement with Indo is an unusual one in that it passes title to Indo after 60 days for goods
sitting in a warehouse. It seems unlikely that Indo would pay for goods it hasn’t taken from the
warehouse. If the goods sit in the warehouse and are not paid for, there may be issues of
collectability. [IFRS 15.31]
Grant
The government grant revenue has been inappropriately recognized in full upon receipt. DFT’s
government grant of $800,000 would be related to depreciable assets, and therefore should be

recognized in income over the period, and in the same proportion in which the depreciation
expense on those assets is recognized (or it could be used to reduce expenses). Since 75%, or
$600,000, of the related costs remain in deferred development costs (in the information from
Anne), only $200,000 of the grant revenue should be recognized in income. The remaining
$600,000 should be deferred and recognized in income as the related costs are amortized.
Currently, DFT has recorded all the grant monies in revenue (note, therefore, that there is a
classification error).
Therefore, revenue needs to be reduced by the full $800,000. Since $600,000 should be
deferred, the remaining $200,000 is reallocated to research and development. Amortization
expense will also be adjusted. DFT’s policy is to amortize over a period of up to three years;
therefore, the adjustment would be to amortize the grant over the same period of three years,
resulting in an estimated amortization of $200,000 per year (note that the yearly amount then
needs to be pro-rated for the portion of the year that applies).
Note: Some of the grant received is likely for research rather than development. There would
be immediate recognition of the grant income when the research costs were recognized, and
the amortization amount would be adjusted accordingly. [IAS 20.12]
Zeus — Inventory
Zeus was expected to be developed by mid-August. The delayed development, and the
subsequent entry into the market of a competing product before Zeus, may raise concerns
about the valuation of the Zeus inventory (just beginning to be produced). A write-down would
be required if the net realizable value of inventory is below the recorded cost. Given that DFT’s
products generally have a 40% gross margin, a decrease in the planned selling price, while
reducing DFT’s margins, would likely not result in a net realizable value that is below cost, and
therefore, no write-down would likely be required as of September 30. [IAS 2.9]
Since production just began, there is the risk of there being potential quality assurance issues,
which could lead to the need to set up a warranty provision for potential claims. This risk is
increased when considering management’s bias to increase sales to achieve a higher bonus.
Research and Development

Zeus
Unanticipated technical difficulties have caused delays in the development of Zeus. DFT plans
on having sales and producing inventory by the end of the year, but it has just begun
production (it is now two weeks before year-end). Based on the nature of DFT’s business, in
which it is important to stay ahead of the competition and produce new technology, and

considering that the plan for Zeus was to tap into a growth market, the value of the Zeus
product may be questionable, now that a competitor has beaten it to the market. DFT thinks it
will need to sell at a lower price. We may need to assess the likelihood of bringing Zeus to
market (in other words, assess whether the terms for deferment are still being met). [IAS 36]
Ares
The abandoned development of the Ares product would normally indicate the need for a write-
down. Under IAS 38, the conditions for recognizing an intangible asset include the technical
feasibility of and intention to complete the intangible asset so that it will be available for use or
sale, and the probability it will generate future economic benefits. These conditions must be
met at a point in time, such as when evaluating the project. Although the related development
may be at least partially transferable to the new product, Hades, DFT clearly has no intention of
continuing with Ares. At some point in time there would need to be an assessment of Hades to
determine whether the conditions of IAS 38 are met. It would not be possible to link the Ares
costs to the Hades project, unless some of the costs had been identified as applying to both
projects when first initiated. As a result, the related development costs of $450,000 should be
written off. The write-off results in an increase in expenses of $450,000. [IAS 36]
Contingency
The reassessment of $125,000 related to GST/HST has already been paid, and there is no
guarantee that the courts will allow the money to be returned, even though DFT believes there
has been an error. As a result, it is a contingent asset. Because DFT cannot be certain that the
courts will allow the money to be returned, virtual certainty does not exist, and therefore no
asset should be recorded.
Contingent assets are not recognized under IAS 37, but can be disclosed in the notes to the
financial statements when an inflow of economic benefits is probable. It appears to be too early
to determine whether the amount will be realized or not. As a result, the amount should not be
recorded as a prepaid asset, nor should it be disclosed in the financial statements. Rather, DFT
should examine the source of the reassessment — was it due to not charging GST/HST when
it should have, or to claiming an ITC when it was not eligible? Instead of booking as a prepaid,
the amount should be posted where the reassessment indicated the errors were. Either way,
expenses will be increased. The $125,000 is treated as an increase in general and
administrative expenses for now. [IAS 37]
Impairment Loss

The impairment loss of $100,000, related to obsolete production equipment, should not be
included in amortization of capital assets (adjusted general and administrative), but in cost of
sales.
Practically speaking, since amortization of production-related assets is included in cost of
sales, it could be argued that the impairment charge should also be included in cost of sales
since it is related to the production equipment. In addition, it should be disclosed separately
from amortization in the notes to the financial statements under IAS 1, rather than grouped into
one amount to ensure full disclosure, depending on how material the amount is. Because of
this write-down, management may also need to question the amortization periods.
Consideration should be given to the impact on the bonus calculation. Since the bonus is
based on EBITDA, including the impairment loss in amortization means it is excluded as an
expense in the calculation. If, however, it is separately disclosed, it could be argued that it is
part of cost of sales and should be included in EBITDA. The $100,000 impairment adjustment
should be moved from general and administrative expenses to cost of sales, and should not be
considered amortization. [IAS 1]
Business Acquisition
DFT has control over Sedley by holding 70% of the outstanding common shares. It will have to
include Sedley in its consolidated financial statements from August 31, Year 12. The
acquisition differential for 100% of the value of Sedley at the date of acquisition was
$3,000,000 ($5,600,000 / .7 – [$1,000,000 + $4,000,000]). Contrary to management’s
preference, a portion of this acquisition differential will need to be assigned to the long-term
sales contract with Riceton. Although the agreement does not meet the separability criterion, it
does meet the contractual-legal criterion because Sedley does have a long-term contract with
Riceton. This contract must be valued at fair value using appropriate valuation techniques such
as market value of similar contracts. The excess of $3,000,000 over the fair value of this
contract will be allocated to goodwill. The value assigned to the contract will need to be
systematically amortized over the period of benefit, which would range from the remaining term
on the current contract to the total period involving expected renewals. The amortization of the
contract will increase expenses for Year 12. [IFRS 3.10]
Management Bonus
DFT has a new bonus plan this year. The $300,000 about to be accrued by Anne for the
management bonuses cannot be booked until certain requirements are satisfied. It is
contingent on achieving the set amount of EBITDA.

In this case, the issue is whether the entity has a present legal obligation or a constructive
obligation. There does not appear to be a legal obligation yet because the terms of the bonus
have not been met. The question is whether the bonus might be considered a constructive
obligation. Because this bonus plan was not in place in the past, it does not look like there is a
constructive obligation either. The bonus might be considered a provision. However, there is no
guarantee that the minimum EBITDA will be met; therefore, no accrual should be made at this
point. If the conditions are met at September 30, then a provision can be booked. [IAS 37]
Adjusted Net Income for the Year Ended September 30, Year 12 (in thousands)
DFT adjusted Accounting Revised
projection adjustments Note projection
Revenue $59,224 (2,779) A1 $56,445
Cost of sales 33,872 (1,010) A1, A4 32,862
Gross margin 25,352 (1,769) 23,583
Operating expenses
Research and development 3,991 250 A2, A1 4,241
Sales and marketing 2,622 - 2,622
General and administrative 7,924 25 A3,A4,A5 7,949
Interest 314 - 314
Total operating expenses 14,851 275 15,126
Income before taxes 10,501 (2,044) 8,457
Income taxes 3,150 (613) A6 2,537
Net income $7,351 $(1,431) $5,920
Notes:
Note A1
 Sales have been reduced by $129,000 for 57% of the NRE discount of $225,000.
 Sales have been reduced by $800,000 for government grants since they cannot be
accounted for as revenue. Along with the related deferred development costs, $600,000 should
be deferred. The remaining balance of $200,000 has been moved to R&D expenses.
(Amortization would need to be adjusted too — if amortized over three years, then there would
be $200,000 ($600,000 ÷ 3) more in amortization, which would then also be pro-rated for the
portion of the year.)
 Sales have been reduced by $1.85 million not yet earned for the Indo shipment. Cost of sales
has also been adjusted by $1.11 million based on the 40% product margin (assumed same

margin).
Note A2
 Research and development expenses have been increased by $450,000 for deferred
development costs related to the Ares product (write-off of deferred R&D). They have also
been decreased by $200,000 for the grants reallocated from revenue.
Note A3
 General and administrative expenses have been increased by $125,000 for the GST/HST
reassessment (reclassified from prepaid expense).
Note A4
 DFT recorded $100,000 for impairment of assets. This can be included in cost of sales, not
general and administrative expenses, and should not be considered amortization. Therefore,
move $100,000 from general and administrative to cost of sales.
Note A5
 General and administrative expenses should be increased for the amortization of the Riceton
contract for the month of September. It is unknown until we determine the fair value of the
contract.
Note A6
 Using an estimated tax rate of 30%, there should be a reduction of $613,000 for the
accounting adjustments ($2,044,000 × 30%).
Earnings before interest, taxes, depreciation and amortization (EBITDA) based on revised
projected net income
After
Per DFT July Adjusted DFT accounting
projection projection adjustments COMMENTS
Income before taxes $ 8,681 $ 10,501 $ 8,457 (as adjusted-- see previous
worksheet)
Add back:
Interest 314 314 314
Amortization of
production-related assets 430 430 430
deferred development costs 1,620 1,620 1,620
costs (note 1) (200) related to deferral of

government grant portion
(600K/3yrs estimated)
Adjustment to amort of def dev costs (note 1) 150 related to abandonment of Ares

project (450K/3yrs estimated)
Amortization of capital assets 2,995 3,095 2,995 See note A4
EBITDA for bonus calculation $ 14,040 $ 15,960 13,766 Min to get bonus is $14million
Gross margin of 40% on $1850 Indo Shipment
(if happens before Sept 30) 740 If Indo takes delivery before
Sept 30, bonus could be
achieved
$14,506 Management would get bonus
again
Note: Need EBITDA of $14 million for management to get bonus
Zeus - Consideration of value of project (i.e., Is there any? Unknown Need more information
Is any write-down of inventory required?) to determine
Note 1 - Development costs amortized over estimated life of product, generally 3 years or less
Assume 3 years are remaining on project for which government grant was received and on Ares
Impact of Adjustments on Management Bonus

I had calculated the EBITDA based on an updated forecast from management, adjusted for
accounting changes related to the transactions that occurred between July and September.
The projected results showed an EBITDA of close to $16 million. As a result, management is
likely expecting to be well above the threshold of $14 million required for the bonus, and that
appears to be why Anne has indicated she will accrue a $300,000 bonus.
However, based on the recommended accounting adjustments, adjusted EBITDA would be
approximately $13,766,000, which is under the $14-million threshold. As a result, management
will be very sensitive to any adjustments that are proposed since the bonus threshold is no
longer met. We should make them aware of these adjustments as soon as possible.
Since management has the potential to earn additional compensation based on EBITDA, the
members may have been biased to make decisions that increase EBITDA. They may have had
a bias to recognize revenue sooner, buy versus rent equipment, capitalize expense items, and
classify expenses into categories that get added back to the calculation, such as interest,
taxes, or amortization. Many the errors I have identified for adjustment have this impact.
Examples include the following:
Recognizing revenue sooner — Recognizing the Indo shipment even though Indo has not
taken out the inventory yet, recognizing NRE margin that is partially connected to future
product sales, and recognizing government grants when received although related to products

still in development.
Capitalizing expenses — Continuing to defer development costs related to a specific product
no longer under development, and recording the GST reassessment as a prepaid expense.
Classifying expenses into categories added back for EBITDA — Including impairment related to
production equipment in capital assets amortization expense.
All the above accounting decisions worked in management’s favour, and it seems that
management has done whatever it can to manipulate the financial statements (in other words,
it has used its bias in the selection of accounting policies when there were choices amongst
alternatives or when decisions had to be made). This has been done to meet the EBITDA
threshold and therefore obtain the bonus. We should question management’s integrity and
bring this to the attention of the board of directors.
Ironically, it may not be the decisions of management that result in a bonus being paid or not. It
may well be the decision of Indo to take out inventory prior to September 30 that determines if
management gets a bonus. If Indo takes the entire inventory shipment worth $1.85 million prior
to year-end, DFT will be able to record $1.85 million of sales and $1.11 million of cost of sales
(based on 40% gross margin), resulting in an increase of $740,000 to EBITDA, which will put it
over the $14-million threshold. This type of item affecting the bonus may not have been
anticipated when the plan was set up.
Improvements to Bonus Plan

Management is now part of a new bonus program that is based on earnings before interest,
income taxes, depreciation, and amortization (EBITDA). The bonus begins to accumulate once
EBITDA exceeds $14 million. It was instituted at the beginning of fiscal Year 12 with the
objective of “motivating management to contribute to profitability by being innovative and
developing new product ideas.”
The board and management may want to consider whether a bonus plan, based on EBITDA,
will motivate DFT’s management the way it intended. Currently, management is being
rewarded in a manner that is highly dependent on the decisions of a customer (Indo) rather
than because of management’s direct efforts developing a new product. An additional
consideration is that the bonus calculation is affected by non-controllable factors such as the
impairment of equipment and prior-period adjustments. (Using EBIT or a return on capital
employed would eliminate the impact of some of the uncontrollable factors — PPE would be a
cost no matter what.)
It appears that management was attempting to inflate earnings to achieve a higher bonus
payout. Basing your bonus on EBITDA may be causing unintended results.
Bonus plans, structured properly, can be motivating. They can align management’s efforts with
the company’s objectives. DFT needs to determine what it should reward that is linked most
directly to its objective — in this case, “being innovative and developing new product ideas that
contribute to profit.” Using EBITDA may not tie the bonus closely enough to the objective for it
to accomplish what you had hoped.
You may wish to consider a process that is more closely linked to specific measurement
objectives, using the following general approach:
1. Corporate scorecard — You will want management to share the success (or failure) of
the company. This is a good incentive to remain loyal and work towards the company’s
success. The scorecard should be a mix of long-term success planning metrics, short-term
success planning metrics, and employees’ satisfaction surveys. Assign weights to the
components (adding up to 100%) and measure them against the expectations for the year. For
example, you may wish to reward new product ideas that were developed that contributed a
higher-than-set-minimum contribution margin.
Then, if the company reaches expectations (scores exactly 100%), 10% of net income
would be put aside for the bonus pool. If it exceeds expectations (scores 150%, for example),
15% of net income would be put aside, and so on.
2. Individual scorecard — You will want your top performers to receive a higher bonus
than others. Consider tagging performance (for example, with Excellent, Good, Satisfactory,
and Below Expectations) and associate a percent of the bonus pool to each tag (such as
150%, 110%, 90%, and 60%). By doing this, you make sure that two people in the same
position will get different bonuses if their performance differs. Again, performance can be tied to
the aspects that best contribute to the success of the company — for example, creativity,
innovation, customer relations, identify trends in the industry, share price, et cetera.
Also, test the bonus structure before fully implementing it. Consider how can it be twisted and
altered so people gain the bonus with minimum effort. You will likely understand the importance
of this step already, as it appears that management may have attempted to manipulate the
accounting to inflate earnings this year, knowing that a higher EBITDA would increase the
bonus.
You may want to consider a broader compensation plan, not just a bonus. Since DFT is a
public company, you could use stock options or shares and tie their issuance or vesting to
reaching set targets, if you believe it could help achieve the set objective. Since innovation can
translate into long-term financial results, this might be a suitable incentive.
SOLUTIONS TO PROBLEMS
Problem 5-1
Part A
(a)
Carrying amount of assets of CGU $2,094
Recoverable amount of assets of CGU 1,860
Total impairment loss 234
Allocated to goodwill 234
Allocated to other assets $ 0
(b)
Tangible assets, net $1,164
Recognized intangible assets, net 510
Internally developed patent 0
Goodwill (420 – 234) 186
Total $1,860
Part B
(a)
Carrying amount of assets of CGU $2,094
Recoverable amount of assets of CGU 1,450
Total impairment loss 644
Assigned to goodwill 420
Assigned to other assets on a proportionate basis as follows: $224
% Before Loss After
Tangible assets, net 69.5 $1,164 $156 $1,008
Recognized intangible assets, net 30.5 510 68 442
Total 100.0 $1,674 $224 $1,450
(b)
Goodwill (420 – 420) 0
Total $1,450

Part C
Goodwill 106
Total $1,860
When allocating the acquisition cost at the date of acquisition, identifiable net assets are measured
at fair value and any amount paid over the fair value of identifiable net assets is allocated to
goodwill. Fair value accounting is used for identifiable assets.
When checking for impairment at any reporting datesubsequent to the date of acquisition, the
assets are reported at the lesser of carrying amount and recoverable amount. In most cases,
identifiable assets are reported at a historical cost-based amount. Fair values of the identifiable
assets are ignored.
Problem 5-2
Cost of 70% investment $770,000
Implied cost of 100% investment 1,100,000
Carrying amount of Small’s net assets = Carrying amount of Small’s shareholders’ equity
Ordinary shares $560,000
Retained earnings 260,000
820,000
Acquisition differential – Jan. 1, Year 6 $280,000
Allocated:
Inventory 71,000
Patents (90,000) (19,000)
Balance – goodwill $299,000
Balance Balance
Jan. 1 Changes Dec. 31
Year 6 Yr6&7 Year 8 Year 8
Inventory $71,000 $(71,000)
Patents (90,000) 36,000 $ 18,000 $ (36,000)
Goodwill 299,000 0 (20,900) 278,100
$280,000 $(35,000) $(2,900) $242,100
PART A
Year 6 Year 7 Year 8
Investment in Small 770,000
Cash 770,000
Cash 28,700 18,200 39,200
Dividend income 28,700 18,200 39,200
PART B
(i) Goodwill (299,000 – 20,900) $278,100
(ii) Small’s ordinary shares $560,000
Small’s retained earnings (260,000 + 144,000 – 41,000 –
51,000 – 26,000 + 106,000 – 56,000) 336,000
896,000
Undepleted acquisition differential 242,100
$1,138,100
NCI’s share (30%) $341,430
(iii) Large’s retained earnings $660,000
Small’s retained earnings (260,000 + 144,000 – 41,000 -
51,000– 26,000) 286,000
Small’s retained earnings, date of acquisition 260,000
Change since acquisition 26,000
Less: cumulative changes to acquisition differential (35,000)
Adjusted change since acquisition (9,000)
Large’s share (70%) (6,300)
Consolidated retained earnings $653,700
(iv) Large’s profit $360,000

Less: dividends from Small (56,000x 70%) (39,200)
320,800
Small’s profit $106,000
Less: changes to acquisition differential (2,900)
$103,100
Large’s share (70%) 72,170
Consolidated profit attributable to Large’s shareholders $392,970

(v) NCI on income statement (103,100 x 30%) $30,930
PART C
(i) Year 6 Year 7 Year 8
Investment in Small 770,000
Cash 770,000
Investment in Small (70% x Small’s profit) 100,800 (35,700) 74,200
Investment income 100,800 (35,700) 74,200
Cash (70% x Small’s dividends) 28,700 18,200 39,200
Investment in Small 28,700 18,200 39,200
Investment income (70% x changes to AD) 37,100 (12,600) 2,030
Investment in Small 37,100 (12,600) 2,030
(ii) Investment in Small under cost method $770,000

Small’s retained earnings, end of year $336,000
Small’s retained earnings, date of acquisition 260,000
Less: cumulative changes to acquisition differential (37,900)
$38,100
Large’s share (70%) 26,670
Investment in Small under equity method $796,670
Problem 5-3
Cost of 70% investment 84,000
Implied cost of 100% investment 120,000
Carrying amount of Petite’s net assets = Carrying amount of Petite’s shareholders’ equity
Petite Common shares 35,000
60,000
Acquisition differential – Jan. 1, Year 2 60,000
Allocated:
Inventory 10,000
Equipment 20,000 30,000
Balance - goodwill 30,000

Non-controlling interest (30% x 120,000) 36,000 (1)
Balance Balance
Jan. 1 Changes Dec. 31
Year 2 Yrs 2 to 5 Year 6 Year 6
Inventory 10,000 -10,000
Equipment 20,000 -8,000 -2,000 10,000
Goodwill 30,000 0 -2,000 28,000
60,000 -18,000 -4,000 38,000
(a)
Inventory (150,000 + 80,000) 230,000
Equipment, net (326,000 + 160,000 + 10,000) 496,000
Goodwill 28,000
Gros’s retained earnings 270,000

Petite’s retained earnings 50,000
Petite’s retained earnings, date of acquisition 25,000
Less: cumulative amortization of acquisition differential 22,000
3,000
Gros’s share (70%) 2,100
Consolidated retained earnings 272,100
Non-controlling interest on balance sheet (Method 1)

Petite’s common shares 35,000
85,000
123,000
NCI’s share (30%) 36,900
Non-controlling interest on balance sheet (Method 2)

Non-controlling interest – date of acquisition (1) 36,000
Petite’s retained earnings, date of acquisition 25,000
Less: cumulative changes to acquisition differential 22,000
3,000
NCI’s share (30%) 900
Non-controlling interest –December 31, Year 6 36,900
Cost of goods purchased (500,000 + 450,000) 950,000
Change in inventory (20,000 + 12,000) 32,000
Amortization expense (35,000 + 20,000 + 2,000) 57,000
Non-controlling interest on income statement

Petite’s net income 48,000
Less: amortization of acquisition differential 4,000
44,000
NCI’s share (30%) 13,200
Net income
Gros’s net income 90,000
Less: dividends from Petite (10,000 x 70%) (7,000)
83,000
Petite’s net income 48,000
Less: changes to acquisition differential 4,000
44,000
Consolidated net income 127,000
Dividends paid 30,000

(b) If goodwill at December 31, Year 6 was $8,000 rather than $28,000, then:
(i) Consolidated net income attributable to Gros’s shareholders would decrease by $14,000
(70% x (28,000 – 8,000))
(ii) Consolidated retained earnings would decrease by $14,000 (70% x (28,000 – 8,000))
(iii) Non-controlling interest in net income would decrease by $6,000 (30% x (28,000 –
8,000))

Problem 5-4
(a)
Non-controlling interest 280,000/ (600,000+800,000) = 20%
Therefore, Corner owns 80% of Brook.
(b)
Net income of Brook – Year 4 140,000
80%
112,000
Net loss of Corner – Year 4 (60,000)
Consolidated net income attributable to Corner’s shareholders – Year 4 52,000
(c)
Consolidated retained earnings – Dec. 31, Year 4 180,000
Consolidated net income – Year 4 52,000
Corner's retained earnings Dec. 31, Year 3 (equity) 128,000
(d)
640,000 / 80% is shareholders' equity of Brook 800,000
Common shares – Brook 600,000
Retained earnings – Brook – date of acquisition 200,000
Problem 5-5
Implied cost of 100% investment 760,000
Carrying amount of Silk’s net assets = Carrying amount of Silk’s shareholders’ equity
Silk Common shares 500,000
600,000
Acquisition differential – Dec. 31, Year 1 160,000
Allocated:
Inventory 70,000

Balance – patents 90,000
Non-controlling interest (15% x 760,000) 114,000 (a)
Balance Balance
Dec. 31 Changes Dec. 31
Year 1 Year 2 Year 3 Year 3
Inventory 70,000 -70,000
Patents 90,000 -9,000 -9,000 72,000
160,000 -79,000 -9,000 72,000
(a)
Non-controlling interest in profit
Year 2 15%  (30,000 – 79,000) (7,350)

Year 3 15%  (52,000 – 9,000) 6,450
(b)
Year 2 Year 3
Profit (loss) Pen 28,000 (45,000)
Dividends from Silk
Year 2 0
Year 3 (85%  15,000) (12,750)
28,000 (57,750)
Share of Silk’s profit
85%  (30,000 – 79,000) (41,650)
85%  (52,000 – 9,000) _ 36,550_
Consolidated profit (loss) attributable to Pen’s shareholders (13,650) (21,200)
(c)
Retained earnings Pen – Dec. 31, Year 3 (cost method) 91,000
Retained earnings Silk – Dec. 31, Year 3
(100,000 + 30,000 + 52,000 – 15,000) 167,000
Acquisition retained earnings 100,000
Increase since acquisition 67,000

Less: changes to acq. diff. to date (79,000 + 9,000) 88,000
Adjusted increase since acquisition (21,000) (a)
85% (17,850)
Consolidated retained earnings – Dec. 31, Year 3 73,150
(d)
Method 1:
Silk – Common shares 500,000
Retained earnings Dec. 31, Year 3 167,000
667,000
739,000
15%
Non-controlling interest – Dec. 31, Year 3 110,850
Method 2:
Non-controlling interest – date of acquisition (a) 114,000
(100,000 + 30,000 + 52,000 – 15,000) 167,000
(21,000)
NCI’s share 15% (3,150)
(e)
Cost of investment 646,000
(100,000 + 30,000 + 52,000 – 15,000) 167,000
(21,000)

85% (17,850)
Invest. account – equity method as at Dec. 31, Year 3 628,150
(f)
See changes to acq. Diff. schedule above.
Alternative calculation:
Invest. account – equity Dec. 31, Year 3 628,150

Implied value of 100% (628,150 / 85%) 739,000
Silk – Common shares 500,000
667,000
Balance undepletedacq. diff. – Patents 72,000
Problem 5-6
The following answers were determined using the 2017 financial statements of Empire
Company Limited and are in millions of dollars:
(a) As per note 3(b), Goodwill arising on acquisition is recognized as an asset and
represents the excess of acquisition cost over the fair value of the Company’s share of
the identifiable net assets of the acquiree at the date of the acquisition. Therefore,
Empire is using the identifiable net assets method of consolidation to value the non-
controlling interest at the date of acquisition.
(b) As per note 1, the consolidated financial statements include subsidiary companies and
certain enterprises considered structured entities (“SEs”), where control is achieved on a
basis other than through ownership of a majority of voting rights. As per note 3(a), SEs
are entities controlled by the Company which were designed so that voting or similar
rights are not the dominant factor in deciding who controls the entity. SEs are
consolidated if, based on an evaluation of the substance of its relationship with the
Company, the Company concludes that it controls the SE. SEs controlled by the
Company were established under terms that impose strict limitations on the decision
making powers of the SEs management and that results in the Company receiving the
majority of the benefits related to the SEs operations and net assets, being exposed to
the majority of risks incident to the SEs activities, and retaining the majority of the
residual or ownership risks related to the SEs or their assets.

(c) Non-controlling interest is 1.6% (58.5 / 3,702.7) of shareholders’ equity as per the
consolidated balance sheet. Approximately 8.1% (14 / 172.5) of the company’s net
earnings is attributable to non-controlling interest as per the consolidated statement of
earnings.
(d) As per note 11, the portion of additions to intangible assets arising from acquisitions was
12.7% (3.5 / [3.5 + 24.1]) and the portion arising from direct purchases was 87.3%.
(e) The goodwill impairment loss for 2016 was $2,878.5 million and $.9 million for 2017 as
per note 12. The primary reasons for the loss in 2016, as per note 12, operational
challenges the Company had experienced under the Safeway banner, the outcome of
the property and equipment impairment test, and the overall challenging economic
climate mainly in the Alberta and Saskatchewan markets.
(f) As per note 12, management determined the recoverable amount of the CGUs based on
VIU calculations which require the use of certain key assumptions. VIU was calculated
from cash flow projections for five years using financial data from the Company’s most
up-to-date internal forecasts and budgets that were formally approved by management.
The key assumptions used in the forecasts were cash flows for the first five years,
growth rate beyond five years, pre-tax discount rate and operating margins,
(g) The performance bonuses will be reduced in 2016 due to the immediate effect of the
impairment loss on net income. However, the performance bonuses in future years may
be improved because there is less goodwill to be written down.
(h) The discount rates incorporate the risk associated with future cash flows; the higher the
uncertainty of future cash flows, the higher the discount rate. When the discount rates
increase, the present value of future cash flows decrease, which would cause a
decrease in the recoverable amount of the goodwill and thus the recognition of an
impairment loss.
(i) Goodwill, goodwill impairment losses and non-controlling interest would be higher under
the fair value enterprise method because they include the non-controlling interest’s
share of the subsidiary’s goodwill. Net income would have been lower due to a larger
goodwill impairment loss. Equity would also be higher because NCI is higher. It is likely
that the impact on the numerator would be more substantial than the impact on the
denominator to cause an overall reduction in the return on total shareholders’ equity.
Problem 5-7
Grant NCI
Cost of 80% Interest in Lee 70,000
Fair value of NCI’s Interest in Lee (7 x 2,000 shares) 14,000
Carrying amount of Lee’s net assets = Carrying amount of Lee’s shareholders’ equity
Common shares 25,000
55,000
Shareholders’ interest 44,000 11,000
Acquisition differential 26,000 3,000
Allocated:
FV – CA
Inventory 5,000 4,000 1,000
Patent 10,000 8,000 2,000
Goodwill 14,000 -0-
Bal Changes Bal

Jan. 1/Yr4 To Dec. 31/Yr6 Yr7 Dec.31/Yr7
Inventory 5,000 -5,000
Patent 10,000 -6,000 -2,000 2,000
Goodwill* 14,000 -4,000 10,000
29,000 -11,000 -6,000 12,000
* all pertaining to Grant’s 80% ownership
(a)
Calculation of consolidated retained earnings – Dec 31, Year 7

Retained earnings – Grant 300,000
Retained earnings – Lee 65,000
Acquisition 30,000
Increase 35,000
80% 28,000
Less: Changes to acq. diff.
[(11,000 + 2,000) x 80% + 4,000] (14,400)
313,600

Calculation of Year 7 net income attributable to Grant’s Shareholders
Net income Grant 230,000
Net income Lee 23,000
Grant’s % interest 80%
18,400
Less: Grant’s share of changes to acq. diff.
(2,000 x 80% + 4,000) 5,600
12,800
242,800
(b) Grant Corporation
Consolidated Income Statement
Year ended December 31, Year 7
Sales (900,000 + 360,000) 1,260,000
Cost of goods sold (340,000 + 240,000) 580,000
Gross margin 680,000
Distribution expense (30,000 + 25,000 + 2,000) 57,000
Other expenses (180,000 + 56,000 + 4,000) 240,000
Income taxes (120,000 + 16,000) 136,000
Total 433,000
Net income 247,000
Attributable to:
Grant’s shareholders 242,800
Non-controlling interest [20% x (23,000 – 2,000)] 4,200
247,000

Grant Corporation
Consolidated Balance Sheet – December 31, Year 6
Cash (5,000 + 18,000) 23,000
Accounts receivable (185,000 + 82,000 – 30,000) 237,000
Inventory (310,000 + 100,000) 410,000
Equipment (230,000 + 205,000) 435,000
Patent (0 + 2,000 + 2,000) 4,000
Goodwill 10,000
1,119,000
Accounts payable (190,000 + 195,000 – 30,000) 355,000
Other accrued liabilities (60,000 + 50,000) 110,000
Income taxes payable (80,000 + 72,000) 152,000
Non-controlling interest (Note 1) 18,400
1,119,000
Note 1:
Non-controlling interest (Method 1)
Lee’s shareholders’ equity 90,000
Undepleted acquisition differential on identifiable net assets 2,000
92,000
NCI’s share @20% 18,400
Non-controlling interest (Method 2)

NCI, date of acquisition (7 x 2,000 shares) 14,000
Change in Lee’s retained earnings (a) 35,000
Changes toacq. diff. on identifiable net assets 13,000
22,000
NCI’s share at 20% 4,400
Problem 5-8
(a)
Cost of investment $914,000
Fazli’sshareholders’ equity
Retained earnings 200,000 684,000
Acquisition differential – Jan. 1, Year 4 230,000
Allocated:
Investment in bonds 12,988
Balance Balance
Jan. 1 Changes in Dec. 31
Year 4 Year 4 Year 5 Year 5
Investment in bonds $12,988 $-2,351 $-2,468 $8,169 (a)
Goodwill 217,012 -17,012 0 200,000 (b)
$230,000 $-19,363 $-2,468 $208,169
(b)
Investment in bonds (0 + 300,000 + (a) 8,169) 308,169
Goodwill (b) 200,000
(c) Cost Equity
Investment income = dividends paid 42,000
Income reported by Fazli 134,000
Changes to acquisition differential (a) (2,468)
131,532
Investment in Fazli = acquisition cost 914,000

Acquisition cost 914,000
Income reported by Fazli for Year 4 80,000
Changes to acquisition differential for Year 4 (19,363)
Dividends received in Year 4 (30,000)
Income reported by Fazli for Year 5 134,000
Changes to acquisition differential for Year 5 (2,468)
Dividends received in Year 5 (42,000)
Balance, end of Year 5 1,034,169
(d) The reported consolidated balances are not affected by the parent’s method of accounting
for its investment. Thus, consolidated expenses of $1,384,000 ($674,000 + $710,000) are
the same regardless of whether the cost method or equity method is used by Cyrus. The
amortization of the premium on investment in bonds would be an adjustment to investment
revenue not expenses.
(e) The reported consolidated balance of $308,169 as calculated in (b) is not affected by the
parent’s method of accounting for its investment.
(f) Cost Equity
Retained earnings, January 1, Year 5, cost method 814,000
Parent’s retained earnings, January 1, Year 5, cost method 814,000
Subsidiary’s change in retained earnings since acquisition
(250,000 – 200,000) x parent’s share of 100% 50,000
Cumulative changes to acquisition differential (Year 4) (19,363)
Parent’s retained earnings, January 1, Year 5, equity method 844,637
(g)
Consolidated retained earnings at January 1, Year 5 are $844,637. It is equal to the parent’s
retained earnings under the equity method as calculated in (f). It is not affected by the method
used by the parent to account for its investment in the subsidiary for internal record keeping.

Problem 5-9
(a)
Implied value of 100% 152,600
Carrying amount of Little’s net assets = Carrying amount of Little’s shareholders’ equity
– July 1, Year 5
86,400
Acquisition differential 66,200
Allocated: FV – CA
Government contract 50,000
Equipment (21,600)
28,400
Balance – goodwill 37,800
Balance Changes to Balance

July 1 year ending June 30
Year 5 June 30, Year 6 Year 6
Equipment (8 years) –21,600 2,700 –18,900
Government contract (5 years)50,000 -10,000 40,000
Goodwill 37,800 -17,800 20,000
66,200 -25,100 41,100
The government contract should be recognized as an identifiable asset because it can meet the
separability test. It can be sold separately and provides future economic benefits.
(b)Calculation of consolidated net income attributable to Big’s shareholders – Year 6

Income of Big 109,620
Less: dividends from Little (13,500  80%) 10,800
98,820
Income of Little 39,420
Less: changes to acquisition differential 25,100
14,320
80% 11,456

110,276
Big
for the Year Ended June 30, Year 6
Sales (270,000 + 162,000) 432,000

Cost of sales (140,100 + 94,380) 234,480
Misc. expense (31,080 + 28,200 – 2,700 + 10,000) 66,580
Goodwill impairment loss 17,800
318,860
Net income 113,140
Attributable to:
Big’s shareholders 110,276
Non-controlling interest [20%  (39,420 – 25,100)] 2,864

113,140
Big
Consolidated Retained Earnings Statement
for the Year Ended June 30, Year 6
Balance July 1, Year 5 459,000
Net income 110,276
569,276
Dividends 32,400
Balance June 30, Year 6 536,876
Calculation of non-controlling interest – June 30, Year 6
Little – Common shares 54,000

112,320
153,420
20%
30,684
Big
Consolidated Balance Sheet
June 30, Year 6
Miscellaneous assets (835,940 + 128,820) 964,760

Equipment (162,000 + 95,600 - 21,600 – 20,000) 216,000
Accumulated depreciation (60,000 + 50,000 - 20,000 - 2,700) (87,300)
Government contract 40,000
Goodwill 20,000
1,153,460
Liabilities (253,800 + 62,100) $315,900

Non-controlling interest 30,684
1,153,460
(c) Changes in non-controlling interest
Bal. July 1, Year 5 [20%  (86,400 + 66,200)] 30,520

Allocation of entity net income 2,864
33,384
Dividends (20%  13,500) 2,700
Balance June 30, Year 6 30,684
(d)
Total Parent NCI
100% 80% 20%
Total value of Little at date of acquisition 147,080 122,080 25,000
Carrying amount of Little’s net assets 86,400 69,120 17,280
Acquisition differential 60,680 52,960 7,720
Fair value excess for identifiable assets 28,400 22,720 5,680
Balance – goodwill, date of acquisition 32,280 30,240 2,040
Goodwill impairment for the year 12,280 11,504* 776
Goodwill, June 30, Year 6 20,000 18,736 1,264
* 12,280 x (30,240 / 32,280)
Problem 5-10
Cost of 80% of Storm $350,000
Implied value of 100% $437,500
Carrying amount of Storm’s net assets
= Carrying amount of Storm’s shareholders’ equity
304,000
Acquisition differential $133,500
Plant assets $44,000
Trademarks 36,000 80,000
Goodwill $53,500
Bal Changes Bal
Dec. 31/Yr2 to Dec.31/Yr5 Yr6 Yr6 Dec. 31/Yr6
Amort Impairment
Plant assets $44,000 $-16,500 $ -5,500 $22,000
Trademarks 36,000 -9,000 -3,000$-9,650 14,350
Goodwill 53,500 ----- ----- -3,500 50,000
$133,500 $-25,500 $-8,500$-13,150$86,350
Calculation of consolidated profit attributable to Palm’s shareholders

Palm profit $108,000
Less: Dividend income (80% x 24,000) 19,200
88,800
Storm profit $62,000
Changes to acq. diff. (-8,500 – 13,150) -21,650
40,350
80% 32,280

$121,080
(a) Palm Inc.

Year ended December 31, Year 6
Sales (910,000 + 555,000) $1,465,000

Interest income (38,000 – 19,200 + 6,000) 24,800
1,489,800
Cost of goods sold (658,000 + 380,000) 1,038,000
Selling expenses (26,000 + 39,000 + 8,500) 73,500
Other expenses (156,000 + 80,000 + 13,150) 249,150
1,360,650
Profit $129,150
Attributable to:
Palm’s shareholders $121,080
Non-controlling interest [20% x (62,000 – 8,500 – 13,150)] 8,070
$129,150
Calc. of consolidated retained earnings December 31, Year 6

Palm retained earnings Dec. 31, Year 6 $150,000
Storm retained earnings Dec. 31, Year 6 $190,000
Less: Acquisition retained earnings 64,000
Increase 126,000
Less: Changes to acq. diff. to Dec. 31, Year 6 -47,150
Adjusted change since acquisition 78,850
80% 63,080 (a)
$213,080
Palm Inc.
Consolidated Statement of Financial Position
December 31, Year 6
Plant assets (270,000 + 200,000 + 22,000) $492,000

Trademarks 14,350
Goodwill 50,000

Investments (86,000 + 26,000) 112,000
Notes receivable 14,000
Inventory (140,000 + 220,000) 360,000
Accounts receivable (92,000 + 180,000) 272,000
Cash (24,000 + 34,000) 58,000
$1,372,350

Non-controlling interest [20% x (430,000 + 86,350)] 103,270
Notes payable (150,000 + 120,000) 270,000
Other current liabilities (14,000 + 54,000) 68,000
Accounts payable (108,000 + 70,000) 178,000
$1,372,350
(b) If none of the acquisition differential had been allocated to trademarks, the schedule to
amortize the acquisition differential would have been as follows:
Bal Changes Bal
Dec. 31/Yr2 to Dec.31/Yr5 Yr6 Dec. 31/Yr6
Plant assets $44,000 $-16,500 $-5,500 $22,000
Goodwill 89,500 0 -39,500 50,000
$133,500 $-16,500 $-45,000$72,000
(i) The return on equity would decrease because net income would decrease by
$23,350(($39,500 - $13,150) + ($5,500 - $8,500))i.e., the change in the acquisition
differential for Year 6 and total shareholders’ equity would only decrease by $14,350
($86,350 - $72,000)i.e., the change in undepleted acquisition differential at the end of
the year.
(ii) The debt to equity ratio would increase because debt would not change but total
shareholders’ equity would decrease.
Problem 5-11
Cost of 80% investment – July 1, Year 4 543,840
Implied value of 100% investment 679,800
Carrying amount of Bondi’s net assets

Assets 936,000
Liabilities 307,200
628,800
Accounts receivable 24,004
Inventory 48,000
Plant assets (90,000)
Bonds payable 13,466 (4,530)
Balance – goodwill 55,530
Bond Carrying
Cash Interest Premium Amount
Date Paid Expense Amortization of Bonds
July 1/ Year 4 $186,534
Dec 31/ Year 4 $6,0001 $7,4612 $1,4613 187,9954
June 30, Year 5 6,000 7,520 1,520 189,515
Dec 31/ Year 5 6,000 7,580 1,580 191,095
June 30, Year 6 6,000 7,644 1,644 192,739
Dec 31/ Year 6 6,000 7,710 1,710 194,449
1 2
$200,000 x 6% x 6/12 = $6,000 $186,534 x 4% = $7,461
3 4
$7,461 – $6,000 = $1,461 $186,534 + $1,461 = $187,995
Balance Changes Balance

July 1 Dec. 31 Dec. 31 Dec. 31 Dec. 31
YR 4 YR 4 YR 5 YR 6 YR 6
Accounts receivable 24,004 -24,004
Inventory 48,000 -48,000
Plant assets -90,000 3,000 6,000 6,000 -75,000
Bonds payable 13,466 -1,461 -3,100 -3,354 5,551
Goodwill 55,530 – -8,329 -5,553 41,648
51,000 -22,465 -53,429 -2,907 -27,801

Calculation of consolidated profit attributable to NCI – Year 6
Profit Bondi 8,400
Less: Change to acquisition differential 2,907
5,493
20%
1,099
Calculation of non-controlling interest – Dec. 31, Year 6 (Method 1)

Ordinary shares Bondi 120,000
Undepleted acquisition differential (27,801)
650,399
20%
130,080
NCI, date of acquisition (20% x [543,840 / .80]) 135,960
Bondi’s retained earnings, end of Year 6 558,200
Bondi’s retained earnings, date of acquisition 508,800
Cumulative changes to acquisition differential (78,801)
Adjusted change in Bondi’s retained earnings (a) (29,401)
NCI’s share at 20% (5,880)
(a)
Aaron Co.
Consolidated Financial Statements
December 31, Year 6
Income Statement

Sales (1,261,000 + 1,200,000) 2,461,000
Income – other investments 25,000
2,486,000
Raw materials used (880,000 + 1,005,000) 1,885,000
Change in inventory (-40,000 + 15,000) (25,000)
Depreciation (60,000 + 54,000 – 6,000) 108,000
Interest (37,000 + 26,400 + 3,354) 66,754
Other (227,000 + 91,200) 318,200
Goodwill impairment 5,553
2,358,507
Profit 127,493
Attributable to:
Aaron’s shareholders (= profit under equity method) 126,394
127,493
Statement of Financial Position
Plant assets (net) (720,000 + 540,000 - 75,000) 1,185,000

Other investments 250,666
Goodwill 41,648
Inventory (300,000 + 276,000) 576,000
Cash (120,000 + 84,000) 204,000
2,551,314
Ordinary shares 300,600

Retained earnings 1,295,185
Bonds payable (315,000 + 200,000 – 5,551) 509,449
Current liabilities (180,200 + 135,800) 316,000
2,551,314

(b)
Goodwill impairment loss – fair value enterprise method 5,553
Less: NCI’s share @20% 1,111
Goodwill impairment loss – identifiable net assets method 4,442
NCI – fair value enterprise method 1,099
NCI’s share of goodwill impairment loss 1,111
NCI – identifiable net assets method 2,210
(c)
Goodwill– fair value enterprise method 41,648
Less: NCI’s share @20% 8,330
Goodwill– identifiable net assets method 33,318
NCI’s share of goodwill 8,330

Problem 5-12
Total Rabb NCI
100% 75% 25%
Consideration given for share ownership 152,000 117,000 35,000
Carrying amount of Rabb’s net assets
= Carrying amount of Rabb’s shareholders’ equity
– common shares 50,000
– retained earnings 30,000
80,000 60,000 20,000
Acquisition differential 72,000 57,000 15,000
Allocated:
Inventory (11,000)

Equipment 24,000
Software 15,000
28,000 21,000 7,000
Goodwill 44,000 36,000 8,000
Bal Changes Bal

Jan. 1/Yr3 to Dec.31/Yr5 Yr6 Dec.31/Yr6
Inventory - 11,000 11,000
Equipment 24,000 -12,000 -4,000 8,000
Software 15,000 -4,500-2,500 8,000
28,000 -5,500 -6,500 16,000
Goodwill – parent 36,000 -19,636 16,364
Goodwill - NCI 8,000 -4,364 3,636
72,000 -5,500 -30,500 36,000
(a)
Calculation of consolidated net income attributable to Foxx’s shareholders – Year 6
Net income Foxx 120,000

Less Dividends from Rabb (.75 x 20,000) 15,000
105,000
Net income Rabb 48,000

Foxx’s share @75% 36,000
141,000
Less: Changes to Acq. Diff.
Identifiable assets [5,500 + 1,000] x 75% - 4,875
Goodwill impairment loss - 19,636
116,489
Calculation of consolidated net income attributable to NCI – Year 6
Net income Rabb 48,000

NCI’s share @25% 12,000
Less: Changes to Acq. Diff.
Identifiable assets [5,500 + 1,000] x 25% - 1,625
Goodwill impairment loss - 4,364
6,011

Foxx Corp.
Year 6 Consolidated Income Statement
Sales (821,000 + 320,000) 1,141,000
Investment income (15,000 – 15,000 + 3,600) 3,600
1,144,600
Cost of sales (480,000 + 200,000) 680,000
Administrative expenses (40,000 + 12,000 + 5,500) 57,500
Miscellaneous expense (116,000 + 31,600 + 1,000 + 19,636 +4,364) 172,600
Income tax (80,000 + 32,000) 112,000
1,022,100
Net income 122,500
Attributable to:
Foxx’s shareholders 116,489

122,500
Calculation of consolidated retained earnings January 1, Year 6

Foxx retained earnings 153,000
Rabb retained earnings 92,000
Rabb retained earnings – acquisition date 30,000
Less: Changes to acq. diff. 5,500
56,500
Foxx’s share 75% 42,375
195,375
Year 6 Consolidated Retained Earnings Statement
Balance January 1 195,375
Net income 116,489
311,864
Less: Dividends 30,000
Balance December 31 281,864
Consolidated Balance Sheet – December 31, Year 6

Cash 10,000
Notes receivable (0 + 40,000 – 40,000) 0
Inventory (66,000 + 44,000) 110,000
Equipment (220,000 + 76,000 + 8,000) 304,000
Land (150,000 + 30,000) 180,000
Software 8,000
Goodwill 20,000
702,000
Bank indebtedness 90,000

Notes payable (40,000 + 0 – 40,000) 0
Non-controlling interest [.25 x (170,000 + 16,000) + 3,636] 50,136
702,000
(b)
Goodwill impairment loss – fair value enterprise method (19,636 + 4,364) 24,000
Less: NCI’s share 4,364
Goodwill impairment loss – identifiable net assets method 19,636
(c)
If Foxx had used the identifiable net assets method rather than the fair value enterprise method,
the debt to equity ratio would have increased because shareholders’ equity would have
decreased due to the decrease in non-controlling interest while debt would remain the same.

Problem 5-13
Cost of 80% investment $3,300,000
Implied value of 100% $4,125,000
Carrying amount of Silver’s net assets = Carrying amount of Silver’s shareholders’ equity
Common shares $2,050,000
2,495,000
Acquisition differential $1,630,000
Allocated:
Inventory (20%) $326,000
Equipment (40%) 652,000 978,000
Balance – goodwill (40%) $652,000
NCI (20% x 4,125,000) 825,000 (a)

July 1 Dec. 31 Dec. 31 Dec. 31 Dec. 31
Year 2 Year 2 Years 3 to 5 Year 6 Year 6
Inventory $326,000 $-326,000
Equipment 652,000 -40,750 $-244,500 $-81,500 $285,250
Goodwill 652,000 -79,000 -29,000 544,000
$1,630,000 $-366,750 $-323,500 $-110,500 $829,250
Calculation of consolidated net income attributable to Pearl’s shareholders – Year 6
Net income Pearl $1,343,000

Less: Dividends from Silver (290,00080%) (232,000)
1,111,000
Net income Silver $697,000
Less: Changes to acquisition differential (110,500)
586,500
80% 469,200
$1,580,200
Calculation of consolidated retained earnings Jan. 1, Year 6

Retained earnings Pearl – Jan. 1 $3,800,000
Retained earnings Silver – Jan.1 $890,000
Less: Changes to acq. diff. to end of Year 5
(366,750 + 323,500) (690,250)
(245,250)
80% (196,200)
$3,603,800
Calculation of non-controlling interest – Dec. 31, Year 6

Silver – Common shares $2,050,000
3,347,000
4,176,250
20%
$835,250
(a)
Pearl Company
for the Year Ended December 31, Year 6
Sales (4,450,000 + 1,450,000) $5,900,000

Cost of sales (2,590,000 + 490,000 + 81,500) 3,161,500
Miscellaneous expense (365,000 + 79,000) 444,000
Admin expense (89,000 + 19,000 + 29,000) 137,000
Income tax (295,000 + 165,000) 460,000
4,202,500
Net income $1,697,500
Attributable to:
Pearl’s shareholders $1,580,200

$1,697,500
Pearl Company
Consolidated Retained Earnings Statement
Balance Jan. 1 $3,603,800

Net income 1,580,200
5,184,000
Dividends 590,000
Balance Dec. 31 $4,594,000
Pearl Company
December 31, Year 6
Cash (390,000 + 190,000) $580,000

Accounts receivable (290,000 – 84,000) 206,000
Inventory (2,450,000 + 510,000) 2,960,000
Plant and equipment (3,450,000 + 3,590,000 + 652,000 – 69,000) 7,623,000
Accumulated depreciation (840,000 + 400,000 + 366,750 – 69,000) (1,537,750)
Goodwill 544,000
$10,375,250
Liabilities (737,000 + 543,000 – 84,000) $1,196,000

Common shares 3,750,000
$10,375,250
(b)
Goodwill impairment loss – fair value enterprise method $29,000
Less: NCI’s share @ 20% 5,800
Goodwill impairment loss – identifiable net assets method $23,200
NCI – fair value enterprise method $117,300

NCI – identifiable net assets method $123,100

(c)
Goodwill– fair value enterprise method $544,000
Less: NCI’s share @ 20% 108,800
Goodwill – identifiable net assets method $435,200
NCI – fair value enterprise method $835,250

NCI – identifiable net assets method $726,450
(d)
CONSOLIDATED FINANCIAL STATEMENT WORKING PAPER
PEARL
CONSOLIDATED FINANCIAL STATEMENTS
December 31, Year 6
Eliminations
PEARL SILVER Dr. Cr. Consolidated
Income Statements - Year 6
Sales $ 4,450,000 $1,450,00 $5,900,000
Dividend income 232,000 0 2 $ 232,000 0
4,682,000 1,450,000 5,900,000
Cost of sales 2,590,000 490,000 7 81,500 3,161,500
Miscellaneous expenses 365,000 79,000 444,000
Administrative expense 89,000 19,000 7 29,000 137,000
Income tax expense 295,000 165,000 460,000
Total expenses 3,339,000 753,000 4,202,500
Net income $ 1,343,000 $ 697,000 $1,697,500
Attributable to:
Pearl's Shareholders $1,580,200
Non-controlling interest 8 117,300 117,300
$459,800 $ - $1,697,500
Retained Earnings Statements-Year
6
Balance, January 1 $ 3,800,000 $890,000 1 $196,200
4 890,000 $3,603,800
Net income 1,343,000 697,000 459,800 1,580,200
5,143,000 1,587,000 5,184,000
Dividends 590,000 290,000 2 $ 232,000 590,000
1
0 58,000
$1,297,00 $1,546,00
Balance, December 31 $4,553,000 0 0 $ 290,000 $4,594,000

Statement of Financial Position-December 31,
Year 6
$ $
Cash
390,000 190,000 $ 580,000
Accounts receivable 290,000 0 8 $ 206,000

84,000
Inventory 2,450,000 510,000 2,960,000
$
Plant and equipment 3,590,000
3,450,000 5 652,000 6 69,000 7,623,000
Accumulated
depreciation (840,000) (400,000) 6 69,000 5 285,250 (1,537,750)
7 81,500
Investment in Silver
Company 3,300,000 0 3 775,950 1 196,200 0
4 3,879,750
Acquisition differential 0 0 4 939,750 5 939,750 0

Goodwill 0 0 5 573,000 7 29,000 544,000
$ $3,890,00
9,040,000 0 $10,375,250

$ $ $
Liabilities
737,000 543,000 8 84,000 1,196,000
Common shares 3,750,000 2,050,000 4 2,050,000 3,750,000
Retained earnings 4,553,000 1,297,000 1,546,000 290,000 4,594,000
1
Non-controlling interest
0 58,000 9 117,300 835,250
3 775,950
$ $3,890,00
9,040,000 0 $10,375,250
$6,747,70 $6,747,70
0 0
JOURNAL ENTRIES
1 Retained earnings 196,200

Investment in Silver 196,200
To adjust retained earnings to equity method at beginning of year
2 Dividend income - Pearl 232,000

Dividends - Silver 232,000
To eliminate dividend revenue from Silver
3 Investment in Silver 775,950

To establish non-controlling interest at beginning of year
4 Retained earnings, Jan 1 - Silver 890,000

Common shares - Silver 2,050,000
Investment in Silver 3,879,750
` To eliminate investment account and set up acquisition differential at beginning of year
5 Equipment 652,000
Accumulated depreciation 285,250
Goodwill 573,000
To allocate the acquisition differential at beginning of year
6 Accumulated depreciation 69,000

PP&E 69,000
To eliminate Bell's accumulated depreciation at date of acquisition
7 Cost of Sales (Equip amortization) 81,500

Admin expense (Goodwill impairment
loss) 29,000
Accumulated depreciation 81,500
Goodwill 29,000
To record changes to acquisition differential for the
year
8 Accounts payable 84,000

Accounts receivable 84,000
To eliminate intercompany receivables
9 Non-controlling interest-P&L 117,300

Non-controlling interest-SFP 117,300
To record NCI's share of income for the year
10 Non-controlling interest-SFP 58,000

Dividends – Silver 58,000
To record NCI's share of dividends paid .

Total of debits and credits $ 6,747,700 $ 6,747,700
Note
s
a Consolidated retained earnings, beginning of Year 6
$
(= Pearl's retained earnings, beginning of Year 6 under equity method) 3,603,800
Pearl's retained earnings, beginning of Year 6 under cost method 3,800,000
Difference between cost and equity method, beginning of Year 6 $ (196,200)
$
b NCI, end of Year 6 835,250
Less: NCI's share of consolidated net income for Year 6 (117,300)
Add: NCI's share of Silver's dividends for Year 6 (20% x 290,000) 58,000
NCI, beginning of Year 6 $ 775,950
Problem 5-14
Implied value of 100% investment 340,000

Carrying amount of Bach’s net assets = Carrying amount of Bach’s shareholders’ equity
230,000
Inventory (50,000 – 20,000) 30,000
Land (45,000 – 25,000) 20,000
Equipment (78,000 – 60,000) 18,000
Misc. intangibles (42,000 – 0) 42,000 110,000
Goodwill 0
Non-controlling interest (20% x 340,000) 68,000 (a)
Changes to Acquisition Differential Schedule

Jan. 1 Dec. 31 Dec. 31 Dec. 31
Year 3 Years 3, 4, and 5 Year 6 Year 6
Inventory 30,000 -30,000
Land 20,000 20,000
Equipment 18,000 -3,600 -1,200 13,200
Misc. intangibles 42,000 -6,300 -2,100 33,600
110,000 -39,900 -3,300 66,800
Calculation of consolidated net income attributable to Albeniz’s shareholders – Year 6
Net income Albeniz 29,700

Less: Dividends from Bach (8,000  80%) 6,400
23,300
Net income Bach 17,500
Less: Changes to acq. diff. 3,300
14,200
80% 11,360
34,660
Calculation of consolidated retained earnings Dec. 31, Year 6

Retained earnings Albeniz 170,000
Retained earnings Bach 163,500
Less: Changes to acq. diff. (39,900 + 3,300) 43,200
Adjusted increase since acquisition 90,300 (b)
80% 72,240
242,240

Bach – Common shares 200,000
363,500
430,300
20%
86,060
NCI, date of acquisition (a) 68,000
Adjusted change in Bach’s retained earnings (b) 90,300
NCI’s share at 20% 18,060
(a) Albeniz Company

Sales (600,000 + 400,000) 1,000,000
Interest income 6,700
1,006,700
Cost of goods sold (334,000 + 225,000) 559,000
Distribution expense (20,000 + 70,000 + 1,200 + 2,100) 93,300
Selling and admin. (207,000 + 74,000) 281,000

Financing expense (1,700 + 6,000) 7,700
Income taxes (20,700 + 7,500) 28,200
969,200
Net income 37,500
Attributable to:
Albeniz’s shareholders 34,660

37,500
(b)
Albeniz Company
December 31, Year 6
Cash (40,000 + 21,000) 61,000

Inventories (56,000 + 45,000) 101,000
Land (20,000 + 60,000 + 20,000) 100,000
Plant and equipment (200,000 + 700,000 - 240,000 + 18,000) 678,000
Accumulated deprec. (80,000 + 350,000 – 240,000 + 4,800) (194,800)
Miscellaneous intangibles 33,600
954,800

Advances payable (0 + 100,000 – 100,000) 0
954,800
Problem 5-15
Cost of 80% investment $4,320,000

Implied value of 100% investment $5,400,000
Carrying amount of Partridge’s net assets
= Carrying amount of Partridge’s shareholders’ equity
Ordinary shares $2,021,000
4,641,000
Acquisition differential $759,000
Allocated: FV - CA
Inventory $220,000
Patents 520,000
Bonds payable (320,000) 420,000
Changes to Acq. Diff. Schedule

Jan. 2 Dec. 31 Dec. 31 Dec. 31
Year 4 Years 4&5 Year 6 Year 6
Inventory $220,000 $-220,000
Patents 520,000 -104,000 $-52,000 $364,000
Bonds payable -320,000 64,000 32,000 (224,000)
Goodwill 339,000 -31,000 -18,000 290,000
$759,000 $-291,000 $-38,000 $430,000
Brady Ltd.
Sales (10,100,000 + 5,100,000) $15,200,000
Cost of goods purchased (6,950,000 + 2,910,000) 9,860,000
Change in inventory (72,000 + 120,000) 192,000
Depreciation expense (920,000 + 402,000) 1,322,000
Patent amortization (120,000 + 52,000) 172,000
Interest expense (490,000 + 310,000 – 32,000) 768,000
Other expense (700,000 + 870,000) 1,570,000
Goodwill impairment loss 18,000
Income tax (620,000 + 160,000) 780,000
14,682,000
Profit $518,000
Attributable to:
Brady’s shareholders = profit under equity method $484,000
$518,000
Calculation of non-controlling interest – Dec. 31, Year 6
Partridge – Ordinary shares $2,021,000

5,300,000
5,730,000
20%
$1,146,000
Brady Ltd.
Consolidated Statement of Financial Position
December 31, Year 6
Plant and equipment (8,200,000 + 5,200,000) $13,400,000
Patents (720,000 + 364,000) 1,084,000
Goodwill 290,000
Inventory (4,800,000 + 2,000,000) 6,800,000
Accounts receivable (1,100,000 + 1,400,000) 2,500,000
Cash (420,000 + 620,000) 1,040,000
$25,114,000
Ordinary shares $5,100,000

Retained earnings (= retained earnings under equity method) 6,382,000
Non-controlling interest 1,146,000
Bonds payable (4,100,000 + 3,100,000 + 224,000) 7,424,000
Accounts payable (3,522,000 + 1,540,000) 5,062,000
$25,114,000

(b)
Only retained earnings and investment in Partridge would be different.
The investment in Partridge would be $4,320,000, which is the original acquisition cost of the
investment. This represents a decrease of $264,000 ($4,584,000 – $4,320,000) from the
balance under the equity method.
Retained earnings under the cost method would also be decreased by $264,000. It would
change from $6,382,000 under the equity method to $6,118,000 ($6,382,000 - $264,000) under
the cost method.
(c)
(in 000s) Equity Cost Consolidation
Current assets $6,320 $6,320 $10,340
Current liabilities $3,522 $3,522 $5,062
Current ratio 1.79 1.79 2.04
Total debt $7,622 $7,622 $12,486

Total equity $11,482 $11,218 $12,628
Debt-to-equity ratio 0.66 0.68 0.99
Net income $484 $436* $518

Total shareholders’ equity $11,482 $11,218 $12,628
Return on equity 4.2% 3.9% 4.1%
* $484– equity method income of $136 + dividend income of $110 x 80% = $436
(d)
 The consolidation method shows the highest liquidity because it had the highest current
ratio.
 The consolidation method shows the highest risk of insolvency because it had the
highest debt-to-equity ratio.
 The equity method reported the highest profitability because it had the highest return on
equity
(e)
CONSOLIDATED FINANCIAL STATEMENT WORKING PAPER
BRADY
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, YEAR 6
Eliminations
PARTRIDG Consolidate
BRADY E Dr. Cr. d
Income Statements - Year 6
Sales $ $ $
10,100,000 5,100,000 15,200,000
Equity method
income 136,000 1 136,000 0
10,236,000 5,100,000 15,200,000
Cost of goods
purchased 6,950,000 2,910,000 9,860,000
Change in inventory 72,000 120,000 192,000
Depreciation
expense 920,000 402,000 1,322,000
Patent amortization
expense 0 120,000 5 52,000 172,000
Interest expense 5
490,000 310,000 32,000 768,000
Other expenses 700,000 870,000 1,570,000
Goodwill impairment
loss 0 0 5 18,000 18,000
Income taxes 620,000 160,000 780,000
Total expenses 9,752,000 4,892,000 14,682,000
$ $ $
Net income 484,000 208,000 518,000
Attributable to:
$
Brady's Shareholders 484,000
Non-controlling
interest 6 34,000 34,000
$ $ $
Total 240,000 32,000 518,000

Retained Earnings Statements - Year 6
$ $
Balance, January 1 5,898,000 3,181,000 3 3,181,000 5,898,000
Abov
Net income 484,000 208,000 e 240,000 32,000 484,000
6,382,000 3,389,000 6,382,000
1
Dividends 0 110,000 88,000 0
7
22,000
Balance, December $ $ $ $ $
31 6,382,000 3,279,000 Total 3,421,000 142,000 6,382,000

Statement of Financial Position - December 31,
Year 6

Plant and equipment $ $ $
(net) 8,200,000 5,200,000 13,400,000
5
Patents (net) 720000
0 4 416,000 52,000 1,084,000
Goodwill 5
0 0 4 308,000 18,000 290,000
Investment in
Partridge (equity 1
method) 4,584,000 0 2 1,134,000 48,000 0
3
5,670,000
Acquisition 4
differential 0 0 3 468,000 468,000 0

Inventory 4,800,000 2,000,000 6,800,000
Accounts receivable 1,100,000 1,400,000 2,500,000
Cash 420,000 620,000 1,040,000
$ $ $
19,104,000 9,940,000 25,114,000

$ $ $
Ordinary shares
5,100,000 2,021,000 3 2,021,000 5,100,000
Abov
Retained earnings
6,382,000 3,279,000 e 3,421,000 142,000 6,382,000
Non-controlling 2
interest 0 0 7 22,000 1,134,000 1,146,000
6
34,000
4
Bonds payable
4,100,000 3,100,000 5 32,000 256,000 7,424,000
Accounts payable 3,522,000 1,540,000 5,062,000
$ $ $
19,104,000 9,940,000 25,114,000
$ $7,822,00
7,822,000 0
JOURNAL ENTRIES
1 Investment revenue 136,000

Investment in Partridge 48,000
Retained earnings - Dividends paid (80% x 110,000) 88,000
To adjust investment account to balance at beginning of year
2 Investment in Partridge 1,134,000

Non-controlling interest (note a) 1,134,000
To establish non-controlling interest at beginning of year
3 Retained earnings, Jan 1 - Partridge 3,181,000

Ordinary shares - Partridge 2,021,000
Investment in Partridge 5,670,000
To eliminate investment account and set up acquisition differential at beginning of year
4 Patents 416,000
Goodwill 308,000
Bonds payable 256,000
To allocate the acquisition differential at the beginning of the year
5 Goodwill impairment loss 18,000

Goodwill 18,000
Patent amortization 52,000
Patents 52,000
Bonds payable 32,000
Interest expense 32,000
To record change toacquisition differential
6 Non-controlling interest-P&L 34,000

Non-controlling interest-SFP 34,000
To record NCI's share of income for the year
7 Non-controlling interest-SFP 22,000

Retained earnings - Dividends paid 22,000
To record NCI's share of dividends paid .

Total of debits and credits $ 7,822,000 $ 7,822,000
Notes
$1,146,00
a NCI, end of Year 6 0
Less: NCI's share of consolidated net income for Year 6 -34,000
Add: NCI's share of Partridges’ dividends for Year 6 (20% x 110,000) 22,000
NCI, beginning of Year 6 $1,134,000


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Chapter 5

Copyright  2019 McGraw-Hill Education. All rights reserved.

Copyright  2019 McGraw-Hill Education. All rights reserved.

Problem 5-1 (20 min.)

Problem 5-2 (30 min.)

Problem 5-3 (25 min.)

Problem 5-4 (15 min.)

Problem 5-5 (25 min.)

Problem 5-6 (40 min.)

Copyright  2019 McGraw-Hill Education. All rights reserved.

Problem 5-8 (25 min.)

Problem 5-9 (40 min.)

Problem 5-10 (60 min.)

Problem 5-11(50 min.)

Problem 5-12 (55 min.)

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Problem 5-14 (55 min.)

Problem 5-15 (50 min.)

SOLUTIONS TO REVIEW QUESTIONS

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4. Under the equity method:

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9. The undepleted acquisition differential was:

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Copyright  2019 McGraw-Hill Education. All rights reserved.

Copyright  2019 McGraw-Hill Education. All rights reserved.

As requested, I have prepared a report recommending appropriate accounting and reporting

Users and Needs

The users of GIL’s financial statements are as follows:

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Special Purpose Balance Sheet

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General Purpose Financial Statements

The non-interest-bearing note receivable should be valued at $1,895,000, as calculated above,

REPORT ON MANAGEMENT ASSISTANCE AT TOTAL PROTECTION LIMITED

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Copyright  2019 McGraw-Hill Education. All rights reserved.

Cost control of warranty work

Cash management and investment

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REPORT ON ACCOUNTING POLICIES

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Warranty liabilities and expenses

The market-decline provision due to faulty construction is unique in this industry, so no

Revenue can be recognized in several ways:

1. Recognize all revenues from warranties sold, including discounted maintenance

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4. Recognize revenues on a percentage-of-completion basis, based on estimated warranty

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Other accounting issues

Commission expense should be recognized on the same basis as the revenue-recognition

Warranty Revenues and Repair Costs*

Larkview Towne Granite Kings Safe-Way Others Total

Number of warranties 50 85 190 250 175 465 1,215

Warranty revenue $120,000 $165,000 $395,000 $90,000 $160,000 $705,000

Per warranty 2,400 1,941 2,079 360 914 1,516 1,346

Repair costs 6,000 9,000 21,000 42,000 39,000 107,000 224,000

Per warranty 120 106 111 168 223 230 184

Determination and Allocation of Acquisition cost