SM Hoyle AdvAcc11e Ch06

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CHAPTER 6
INTERCOMPANY DEBT, CONSOLIDATED STATEMENT OF
CASH FLOWS AND OTHER ISSUES
Chapter Outline
I. Variable interest entities (VIEs)
A. VIEs typically take the form of a trust, partnership, joint venture, or corporation. In most
cases a sponsoring firm creates these entities to engage in a limited and well-defined set
of business activities. For example, a business may create a VIE to finance the acquisition
of a large asset. The VIE purchases the asset using debt and equity financing, and then
leases the asset back to the sponsoring firm. If their activities are strictly limited and the
asset is pledged as collateral, VIEs are often viewed by lenders as less risky than their
sponsoring firms. As a result, such arrangements can allow financing at lower interest
rates than would otherwise be available to the sponsor.
B. Control of VIEs, by design, often does not rest with its equity holders. Instead, control is
exercised through contractual arrangements with the sponsoring firm who becomes the
"primary beneficiary" of the entity. These contracts can take the form of leases,
participation rights, guarantees, or other residual interests. Through contracting, the
primary beneficiary bears a majority of the risks and receives a majority of the rewards of
the entity, often without owning any voting shares.
C. An entity whose control rests a primary beneficiary is referred to by FASB Interpretation
46R "Consolidation of Variable Interest Entities," (FIN 46R) as a variable interest entity.
The following characteristics indicate a controlling financial interest in a variable interest
entity.
1. The direct or indirect ability to make decisions about the entity's activities
2. The obligation to absorb the expected losses of the entity if they occur,
or
3. The right to receive the expected residual returns of the entity if they occur
The primary beneficiary bears the risks and receives the rewards of a variable interest
entity and is considered to have a controlling financial interest.
D. FIN 46R reasons that if a "business enterprise has a controlling financial interest in a
variable interest entity, assets, liabilities, and results of the activities of the variable interest
entity should be included with those of the business enterprise." Therefore, primary
beneficiaries must include their variable interest entities in their consolidated financial
statements consistent with the provisions of SFAS 141R.
II. Intercompany debt transactions

A. No real consolidation problem is created when one member of a business combination
loans money to another. The resulting receivable/payable accounts as well as the interest
McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e 6-1
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income expense balances are identical and can be directly offset in the consolidation
process.
B. The acquisition of an affiliate's debt instrument from an outside party does require special
handling so that consolidated financial statements can be produced.
1. Because the acquisition price will usually differ from the book value of the liability, a
gain or loss has been created which is not recorded within the individual records of
either company.
2. Because of the amortization of any associated discounts and/or premiums, the interest
income being reported by the buyer will not correspond with the interest expense of
the debtor.
C. In the year of acquisition, all intercompany accounts (the liability, the receivable, interest
income, and interest expense) are eliminated within the consolidation process while the
gain or loss (which produced all of the discrepancies because of the initial difference) is
recognized.
1. Although several alternatives exist, this textbook assigns all income effects resulting
from the retirement to the parent company, the party ultimately responsible for the
decision to reacquire the debt.
2. Any noncontrolling interest is, therefore, not affected by the adjustments utilized to
consolidate intercompany debt.
D. Even after the year of retirement, all intercompany accounts must be eliminated again in
each subsequent consolidation; however, the beginning retained earnings of the parent
company is adjusted rather than a gain or loss account.
1. The change in retained earnings is needed because a gain or loss was created in a
prior year by the retirement of the debt, but only interest income and interest expense
were recognized by the two parties.
2. The amount of the change made to retained earnings at any point in time is the original
gain or loss adjusted for the subsequent amortization of discounts or premiums.
III. Subsidiary preferred stock

A. Subsidiary preferred shares not owned by the parent are a component of the
noncontrolling interest.
B. In an acquisition, the fair value of any subsidiary preferred shares not acquired by the
parent is added to any consideration transferred along with the fair value of the
noncontrolling interest in common shares to compute the acquisition-date fair value of the
subsidiary.
IV. Consolidated statement of cash flows

A. Statement is produced from consolidated balance sheet and income statement and not
from the separate cash flow statements of the component companies.
B. Intercompany cash transfers are omitted from this statement because they do not occur
with an outside, unrelated party.
C. The "Noncontrolling Interest's Share of the Subsidiary's Income'' is not included as a cash
flow although any dividends paid to these outside owners is reported as a financing
activity.

6-2 Solutions Manual
V. Consolidated earnings per share

A. This computation normally follows the pattern described in intermediate accounting
textbooks. For basic EPS, consolidated net income is divided by the weighted-average
number of parent shares outstanding. If convertibles (such as bonds or warrants) exist for
the parent shares, their weight must be included in computing diluted EPS but only if
earnings per share is reduced.
1. The subsidiary's diluted earnings per share are computed first to arrive at (1) an
earnings figure and (2) a shares figure.
2. The portion of the shares figure belonging to the parent is computed. That percentage
of the subsidiary's diluted earnings is then added to the parent's income in order to
complete the earnings per share computation.
VI. Subsidiary stock transactions

A. If the subsidiary issues new shares of stock or reacquires its own shares as treasury
stock, a change is created in the book value underlying the parent's investment account.
The increase or decrease should be reflected by the parent as an adjustment to this
balance.
B. The book value of the subsidiary that corresponds to the parent's ownership is measured
before and after the transaction with any alteration recorded directly to the investment
account. The parent's additional paid-in capital (or retained earnings) account is normally
adjusted although the recognition of a gain or loss is an alternate accounting treatment.
C. Treasury stock acquired by the subsidiary may also necessitate a similar adjustment to
the parent's investment account. In addition, any subsidiary treasury stock is eliminated
within the consolidation process.
Learning Objectives
Having completed Chapter 6, students should have fulfilled each of the following learning
objectives:
1. Describe a variable interest entity and primary beneficiary. Also should know when a variable
interest entity is subject to consolidation.
2. Eliminate all intercompany debt accounts and recognize any associated gain or loss created
whenever one company acquires an affiliate's debt instrument from an outside party.
3. Recognize that intercompany debt transactions require a constantly changing consolidation
entry to be prepared for each subsequent period until the debt is formally retired.
4. Compute the appropriate amounts and make the worksheet entry needed in each subsequent
consolidation when one company has purchased the debt of an affiliate directly from an
outside parry.
5. Discuss the various theories as to the appropriate allocation of any income effect created by
intercompany debt transactions and identify the assignment employed in this textbook (and
the rationale for its use).
6. Understand that subsidiary preferred stocks not owned by the parent are initially valued in
consolidated financial reports as noncontrolling interest at acquisition-date fair value.
7. Prepare a consolidated statement of cash flows.
8. Compute basic and diluted earnings per share for a business combination in which the
subsidiary has dilutive convertible securities.

9. Identify subsidiary stock transactions that can impact the underlying book value figure
recorded within the parent's Investment account.
10. Calculate the effect that a subsidiary stock transaction has on the parent's investment balance
and make the required journal entry to record that impact.
Answer to Discussion Question
Who Lost the $300,000?
This case is designed to give life to a theoretical accounting issue discussed within the chapter: If
a subsidiary's debt is retired, should the resulting gain or loss be assigned to the parent or to the
subsidiary? The case attempts to illustrate that no clear-cut solution to this question can be found.
This lack of an absolute answer makes financial accounting both intriguing and frustrating.
Interesting class discussion can be generated from this issue.
Students should note that the decision as to assignment only becomes necessary because of the
presence of the noncontrolling interest. Regardless of the level of ownership all intercompany
balances are simply eliminated on the worksheet with the gain or loss being recognized. Not until
the time that the noncontrolling interest computations are made does the identity of the specific
party become important.
All financial and operating decisions are assumed to be made in the best interest of the business
entity as a whole. This debt would not have been retired unless corporate officials believed that
Penston/Swansan would benefit from the decision. Thus, a strong argument can be made against
any assignment to either separate party.
Students should be required to pick one method and justify its use. Discussion usually centers
on the following issues:
Parent company officials made the actual choice that created the loss. Therefore, assigning
the $300,000 to the subsidiary directs the impact of their reasoned decision to the wrong
party. In effect, the subsidiary had nothing to do with this transaction (as indicated in the case)
so that its financial records should not be affected by the $300,000 loss.
The debt was that of the subsidiary. Because the subsidiary's debt is being retired, all of the
$300,000 should be attributed to that party. Financial records measure the results of
transactions and the retirement simply culminates an earlier transaction made by the
subsidiary. The parent is doing no more than acting as an agent for the subsidiary (as
indicated in the case). If the subsidiary had acquired its own debt, for example, no question as
to the assignment would have existed. Thus, changing that assignment simply because the
parent was forced to be the acquirer is not justified.
Both parties were involved in the transaction so that some allocation of the loss is required. If,
at the time of repurchase, a discount existed within the subsidiary's accounts, this figure would
have been amortized to interest expense (if the debt had not been retired). Thus, the
$300,000 loss was accepted now in place of the later amortization. This reasoning then
assigns this portion of the loss to the subsidiary. Because the parent was forced to pay more
than face value, that remaining portion is assigned to the buyer.
Answers to Questions

1. A variable interest entity (VIE) is a business structure that is designed to accomplish a specific
purpose. A VIE can take the form of a trust, partnership, joint venture, or corporation although
typically it has neither independent management nor employees. The entity is frequently
sponsored by another firm to achieve favorable financing rates.
2. Variable interests are contractual, ownership, or other pecuniary interests in an entity that
change with changes in the entity's net asset value. Variable interests will absorb portions of a
variable interest entity's expected losses if they occur or receive portions of the entity's
expected residual returns if they occur. Variable interests typically are accompanied by
contractual arrangements that provide decision making power to the owner of the variable
interests. Examples of variable interests include debt guarantees, lease residual value
guarantees, participation rights, and other financial interests.
3. The following characteristics are indicative of an enterprise qualifying as a primary beneficiary

with a controlling financial interest in a VIE.
The direct or indirect ability to make decisions about the entity's activities
The obligation to absorb the expected losses of the entity if they occur, or
The right to receive the expected residual returns of the entity if they occur
4. Because the bonds were purchased from an outside party, the acquisition price is likely to
differ from the book value of the debt as found on the subsidiary's records. This difference
creates accounting problems in handling the intercompany transaction. From a consolidated
perspective, the debt has been retired; a gain or loss should be reported with no further
interest being recorded. In reality, each company will continue to maintain these bonds on
their individual financial records. Also, because discounts and/or premiums are likely to be
present, both of these account balances as well as the interest income/expense will change
from period to period because of amortization. For reporting purposes, all individual accounts
must be eliminated with the gain or loss being reported so that the events are shown from the
vantage point of the consolidated entity.
5. If the bonds are acquired directly from the affiliate company, all reciprocal accounts will be
equal in amount. The debt and the receivable will be in agreement so that no gain or loss is
created. Interest income and interest expense should also reflect identical amounts.
Therefore, the consolidation process for this type of intercompany debt requires no more than
the offsetting of the various reciprocal balances.
6. The gain or loss to be reported is the difference between the price paid and the book value of
the debt on the date of acquisition. For consolidation purposes, this gain or loss should be
recognized immediately on the date of acquisition.
7. Because the bonds are still legally outstanding, they will continue to be found on both sets of
financial records. Thus, each account (Bonds Payable, Investment in Bonds, Interest
Expense, and Interest Income) must be eliminated within the consolidation process. Any gain
or loss on the retirement as well as later effects on interest caused by amortization are also
included to arrive at an adjustment to the beginning retained earnings of the parent company.
8. The original gain is never recognized within the financial records of either company. Thus,
within the consolidation process for the year of acquisition, the gain is directly recorded
whereas (for each subsequent year) it is entered as an adjustment to beginning retained
earnings. In addition, because the book value of the debt and the investment are not in
agreement, the interest expense and interest income balances being recorded by the two

companies will differ each year because of the amortization process. This amortization
effectively reduces the difference between the individual retained earnings balances and the
total that is appropriate for the consolidated entity. Consequently, a smaller change is needed
each period to arrive at the balance to be reported. For this reason, the annual adjustment to
beginning retained earnings gradually decreases over the life of the bond.
9. No set rule exists for assigning the income effects that result from intercompany debt
transactions although several different theories have been put forth over the years which
include: (1) assignment of the entire amount to the debtor, (2) assignment of the entire
amount to the buyer, and (3) allocation of the gain or loss between the two parties in some
manner. This textbook attributes the entire income effect (the $45,000 gain in this case) to the
parent company. Assignment to the parent is justified because that party is ultimately
responsible for the decision being made to retire the debt. The answer to the discussion
question included in this chapter analyzes this question in more detail.
10. Subsidiary outstanding preferred shares are part of the noncontrolling interest and are
included in the consolidated financial statements at acquisition-date fair value and
subsequently adjusted for their share of subsidiary income and dividends.
11. The consolidated statement of cash flows is developed from the information found in the
consolidated balance sheet and income statement. Thus, the cash flows generated by
operating, investing, and financing activities are identified only after the consolidation of these
other statements.
12. The noncontrolling interest share of the subsidiarys income is a component of consolidated
net income. Consolidated net income then is adjusted for noncash and other items to arrive at
consolidated cash flows from operations. Any dividends paid by the subsidiary to these
outside owners are listed as a financing activity of the business combination because an
actual cash outflow is created.
13. An alternative to the normal diluted earnings per share calculation is required whenever the
subsidiary has dilutive convertible securities such as bonds or warrants. In this case, the
potential impact of the conversion of subsidiary shares must be factored into the overall
diluted earnings per share computation.
14. Basic Earnings per Share. The existence of subsidiary convertible securities does not affect
consolidated basic EPS. Consolidated basic earnings per share is computed by dividing
consolidated net income by the weighted average number of parent shares outstanding.
Diluted Earnings per Share. The subsidiary's diluted earnings per share is computed by
including both convertible items. The portion of the parent's controlled shares to the total
shares used in this calculation is then determined. Only this percentage (of the income figure
used in the subsidiary's computation) is added to the parent's income in arriving at the diluted
earnings per share for the business combination.
15. Several reasons could exist for a subsidiary to issue new shares of stock to outside parties.
Clearly, additional financing is brought into the company by any such sale. Also, stock
issuance may be used to entice new individuals to join the organization. Additional
management personnel, as an example, might be attracted to the company in this manner.
The company could also be forced to sell shares because of government regulation. Many
countries require some degree of local ownership as a prerequisite for operating within that
country.

16. Because the new stock was issued at a price above book value, the book value per share of
Metcalf's stock has been increased. Consequently, the book value of Washburn's investment
should be increased to reflect this change. To measure the effect, the underlying book value
of Washburn's investment is calculated both before and after the new issuance. Because the
increment is the result of a stock transaction, an increase is made to additional paid-in capital
although recording a gain or loss is currently allowed. Although the subsidiary's shares (both
new and old) are eliminated in the consolidation process, the increase in the parent's APIC (or
gain or loss) does carry into the consolidated figures. In addition, the percentage of the
subsidiary attributed to the noncontrolling interest will have increased.
17. A stock dividend does not alter the book value of the subsidiary company and, thus, creates
no effect on Washburn's investment account or on the consolidated figures. Hence, no entry
is recorded at all by the parent company in connection with the subsidiary's stock dividend.
Answers to Problems
1. D
2. C
3. A
4. D
5. A
6. D Cash Flow from Operations:

Net income ................................................................. $45,000
Depreciation .............................................................. 10,000
Trademark amortization ............................................ 15,000
Increase in accounts receivable ............................... (17,000)
Increase in inventory................................................. (40,000)
Increase in accounts payable ................................... 12,000 (20,000)
Cash Flow from Operations ..................................... $25,000
7. C Cash Flow from Financing Activities:

Dividends to parents interest .................................. ($12,000)
Dividends to noncontrolling interest (20% $5,000) (1,000)
Reduction in long-term notes payable..................... (25,000)
Cash Flow from Financing Activities ....................... ($38,000)
8. C
9. C
10. C Rodgers' Reported Balance ...................................... $200,000

Ferdinal's reported balance ..................................... 80,000

Eliminate interest expenseintercompany ............ 21,000
Eliminate interest incomeintercompany ............. (22,000)
Recognize gain on retirement of debt ($212,000 $199,000) 13,000
Consolidated net income ................................... $292,000
11. B Eliminate interest expenseintercompany ............ $21,000

Eliminate interest incomeintercompany ............. (18,000)
Recognize loss on retirement of debt ($206,000 $189,000) (17,000)
Reduction in retained earnings, 1/1/10 .............. $(14,000)
12. B Ace reported income ................................................ $400,000

Remove intercompany dividends (cost method) .... (7,000) $393,000
Byrd reported income .............................................. 100,000
Gain on extinguishment of debt ($48,300 $46,600) 1,700
Eliminate interest expense on "retired" debt
($48,300 x 10%) .................................................... 4,830
Eliminate interest income on "retired" debt
($46,600 x 12%) .................................................... (5,592)
Consolidated net income .............................. $493,938
13. D 30% of Byrd's reported income of $100,000; the intercompany debt

transaction is attributed solely to the parent company.
14. A For 2010, the adjustment to beginning retained earnings should recognize
the gain on the retirement of the debt, the elimination of the 2009 interest
expense, and the elimination of the 2009 interest income.
Gain on Retirement of Bond
Original book value ............................................................. $10,600,000

20062008 amortization ($600,000 20 yrs. x 3 yrs.) ........ (90,000)
Book value, January 1, 2009 ............................................... $10,510,000
Percentage of bonds retired ............................................... 40%
Book value of retired bonds ............................................... $4,204,000
Cash received ($4,000,000 x 96.6%) ................................... 3,864,000
Gain on retirement of bonds .............................................. $340,000
Interest Expense on Intercompany Debt2009

Cash interest expense (9% x $4,000,000) ........................... $360,000
Premium amortization ($30,000 per year total x 40%
retired portion of bonds) ............................................... (12,000)
Interest expense on intercompany debt ............................ $348,000
Interest Income on Intercompany Debt2009

Cash interest income (9% x $4,000,000) ............................ $360,000
Discount amortization ($136,000 17 yrs.) ........................ 8,000
Interest income on intercompany debt .............................. $368,000

Adjustment to 1/1/10 Retained Earnings

Recognition of 2009 gain on extinguishment of debt (above) .... $340,000
Elimination of 2009 intercompany interest expense (above) ...... 348,000
Elimination of 2009 intercompany interest income (above) ........ (368,000)
Increase in retained earnings, 1/1/10 .........................$320,000

15. D Consideration transferred for preferred stock ............................ $424,000

Consideration transferred for common stock ............................. 3,960,000
Noncontrolling interest fair value for preferred .......................... 1,696,000
Noncontrolling interest fair value for common ........................... 400,000
Acquisition-date fair value ............................................................ 6,480,000
Acquisition-date book value ......................................................... (6,000,000)
Goodwill ......................................................................................... $480,000
16. C Consideration transferred for preferred stock ............................ $106,000

Consideration transferred for common stock ............................. 916,400
Noncontrolling interest fair value for common ........................... 580,000
Acquisition-date fair value ............................................................ $1,602,400
Acquisition-date book value ......................................................... (1,500,000)
Excess fair value ............................................................................ $102,400
to building .................................................................................... 50,000
to goodwill .................................................................................... $52,400
17. A Parents reported sales ............................................ $300,000

Subsidiary's reported sales ..................................... 200,000
Less: intercompany transfers .................................. (40,000)
Sales to outsiders ............................................... $460,000
Eliminate increase in receivables (less cash collected) (30,000)
Cash generated by sales .................................... $430,000
18. B Book value of subsidiary prior to issuing new shares

(12,000 x $40) ....................................................... $480,000
Parent's ownership .................................................. 100%
Book value acquired ................................................ $480,000
Book value of subsidiary after issuing new shares (above

value plus 3,000 shares at $50 each) ................. $630,000
Parent's ownership (12,000 15,000 shares) ......... 80%
Book value acquired ................................................ $504,000
Investment in Nestlum increases by $24,000 ($504,000 less $480,000)
19. A Because the parent acquired 80 percent of the new shares, its proportion of
ownership has remained the same. Because the purchase price will
necessarily equal 80 percent of the increase in the subsidiary's book value,
no separate adjustment by the parent is required.
20. C Adjusted book value of subsidiary ($795,000 + $150,000) .......... $945,000

Current parent ownership (32,000 shs. 50,000 shs.) ................ 64%
Book value acquired ................................................................. $604,800
Book value acquired currently recorded in parent's invest-
ment account ($795,000 x 80%) ............................................... 636,000
Required adjustmentdecrease ....................................... $(31,200)
21. D Adjusted book value of subsidiary ($795,000 $192,000) .......... $603,000

Current parent ownership (32,000 shs. 32,000 shs.) ................ 100%
Book value equivalency of parent's ownership ..................... $603,000
Book value equivalency currently recorded in parent's invest-
ment account ($795,000 x 80%) ............................................... 636,000
Required adjustmentdecrease ........................................ $(33,000)
22. (10 minutes) (Qualification of Primary Beneficiary of a VIE)

Consolidation of a variable interest entity is required if a parent has a
variable interest that will
Absorb a majority of the entity's expected losses if they occur
Receive a majority of the entity's expected residual returns if they occur
Because (1) HCO Medias losses are limited by contract, and (2) Hillsborough
has the right to receive the residual benefits of the sales generated on the
HCO Media internet site above $500,000, Hillsborough should consolidate
HCO Media.
23. (40 minutes) (VIE Qualifications for Consolidation)
a. The purpose of consolidated financial statements is to present the financial

position and results of operations of a group of businesses as if they were a
single entity. They are designed to provide information useful for making
business and economic decisionsespecially assessing amounts, timing,
and uncertainty of prospective cash flows. Consolidated statements also
provide more complete information about the resources, obligations, risks,
and opportunities of an enterprise than separate statements.
b. According to FIN 46R, an entity qualifies as a VIE and is subject to

consolidation if either of the following conditions exist.
The total equity at risk is not sufficient to permit the entity to finance its
activities without additional subordinated financial support from other
parties. In most cases, if equity at risk is less than 10% of total assets, the
risk is deemed insufficient.
The equity investors in the VIE lack any one of the following three
characteristics of a controlling financial interest.
1. The direct or indirect ability to make decisions about an entity's
activities through voting rights or similar rights.
2. The obligation to absorb the expected losses of the entity if they occur
(e.g., another firm may guarantee a return to the equity investors)
23. continued
3. The right to receive the expected residual returns of the entity (e.g.,
the investors' return may be capped by the entity's governing
documents or other arrangements with variable interest holders).
Consolidation is required if a parent has a variable interest that will
Absorb a majority of the entity's expected losses if they occur
Also, a direct or indirect ability to make decisions that significantly affect the
results of the activities of a variable interest entity is a strong indication that
an enterprise has one or both of the characteristics that would require
consolidation of the variable interest entity.
c. Risks of the construction project that has TecPC has effectively shifted to
the owners of the VIE
At the end of the 1st five-year lease term, if the parent opts to sell the
facility, and the proceeds are insufficient to repay the VIE investors,
TecPC may be required to pay up to 85% of the project's cost. Thus, a
potential 15% risk.
During construction 11.1% of project cost potential termination loss.
Risks that remain with TecPC
Guarantees of return to VIE investors at market rate, if facility does not
perform as expected TecPC is still obligated to pay market rates.
If lease is not renewed, TecPC must either purchase the facility or sell it
on behalf of the VIE with a guarantee of Investors' (debt and equity)
balances representing a risk of decline in market value of asset
Debt guarantees
d. TecPC possesses the following characteristics of a primary beneficiary

Direct decision-making ability (end of five-year lease term)
Absorb a majority of the entity's expected losses if they occur (via debt
guarantees and guaranteed lease payments and residual value)
(via use of the facility and potential increase in its market value).

24. (10 minutes) (Consolidation of variable interest entity.)

a. Implied valuation and excess allocation for Softplus.
Noncontrolling interest fair value $ 60,000
Consideration transferred by Pantech 20,000
Total business fair value 80,000
Fair value of VIE net assets 100,000
Excess net asset value fair value $20,000
The $20,000 excess net asset fair value is recognized by PanTech as a

bargain purchase. All SoftPlus assets and liabilities are recognized at their
individual fair values.
Cash $20,000
Marketing software 160,000
Computer equipment 40,000
Long-term debt (120,000)
Noncontrolling interest (60,000)
Pantech equity interest (20,000)
Gain on bargain purchase (20,000)
-0-
b. Implied valuation and excess valuation for Softplus.

Noncontrolling interest fair value 60,000
Consideration transferred by Pantech 20,000
Total business fair value 80,000
Fair value of VIE net identifiable assets 60,000
Goodwill $20,000
When the business fair value of a VIE (that is a business) is greater than
assessed asset values, all identifiable assets and liabilities are reported at
fair values (unless a previously held interest) and the difference is treated
as a goodwill.
Cash $20,000
Marketing software 120,000
Computer equipment 40,000
Goodwill (excess business fair value) 20,000
Long-term debt (120,000)
Noncontrolling interest (60,000)
Pantech equity interest (20,000)
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25. (25 Minutes) (Consolidation entry for three consecutive years to report
effects of intercompany bond acquisition. Straight-line method used.)
a. Book Value of Bonds Payable, January 1, 2009
Book value, January 1, 2007 .................................................. $1,050,000

Amortization20072008 ($5,000 per year
[$50,000 premium 10 years] for two years) .................. 10,000
Book value of bonds payable, January 1, 2009 .................... $1,040,000
Book value of 40% of bonds payable
(intercompany portion), January 1, 2009 ........................ $416,000
Gain on Retirement of Bonds, January 1, 2009

Purchase price ($400,000 x 96%) .......................................... $384,000
Book value of liability (computed above) ............................. 416,000
Gain on retirement of bonds ................................................. $32,000
Book Value of Bonds Payable, December 31, 2009

Book value, January 1, 2009 (computed above) .................. $1,040,000
Amortization for 2009.............................................................. 5,000
Book value of bonds payable, December 31, 2009 ............... $1,035,000
Book value of 40% of bonds payable (intercompany portion),
December 31, 2009............................................................. $414,000
Book Value of Investment, December 31, 2009

Book value of investment, January 1, 2009 (purchase price) $384,000
Amortization for 2009 ($16,000 discount 8-yr. rem. life) ... 2,000
Book value of investment, December 31, 2009 .................... $386,000
Intercompany Interest Balances for 2009

Interest expense:
Cash payment ($400,000 x 9%) ........................................ $36,000
Amortization of premium for 2009 ($5,000 per year
multiplied by 40% intercompany portion) .................. 2,000
Intercompany interest expense ....................................... $34,000
Interest income:
Cash collection ($400,000 x 9%) ...................................... $36,000
Amortization of discount for 2009 (above) ...................... 2,000
Intercompany interest income ......................................... $38,000
CONSOLIDATION ENTRY B (2009)

Bonds Payable .......................................................... 400,000
Premium on Bonds Payable ..................................... 14,000
Interest Income ......................................................... 38,000
Investment in Bonds ............................................ 386,000
Interest Expense ................................................... 34,000
Extraordinary Gain on Retirement of Bonds ...... 32,000
(To eliminate accounts stemming from intercompany bonds [balances
computed above] and to recognize gain on the retirement of this debt.)
25. (continued)
b. In 2010, because straight-line amortization is used, the interest accounts

remain unchanged at $38,000 and $34,000. However, the premium
associated with the bond payable as well as the discount on the
investment are affected by the $2,000 per year amortization. In addition,
the gain now has to be included as a component of beginning retained
earnings. Concurrently, the two interest balances recorded by the
individual companies in 2009 are removed from retained earnings
because they resulted after the intercompany retirement. Gain of $32,000
plus $34,000 expense removal less $38,000 income elimination gives
$28,000 increase in retained earnings.
CONSOLIDATION ENTRY *B (2010)
Bonds Payable ................................................... 400,000

Premium on Bonds Payable ($2,000 amortization) 12,000
Interest Income .................................................. 38,000
Investment in Bonds ($2,000 amortization) . 388,000
Interest Expense ............................................ 34,000
Retained Earnings, 1/1/10 (Darges) .............. 28,000
(To remove intercompany bond accounts that remain on the individual
records of both companies. Both debt and investment balances have
been adjusted for 200910 amortization. Entry to retained earnings brings
the totals reported by the individual companies [interest income and
expense] to the balance of the original gain.)
c. As with part b, new premium and discount balances must be determined

and then removed. The adjustment made to retained earnings takes into
account that another year of interest expense ($34,000) and income
($38,000) have been closed into this equity account by the separate
companies.
CONSOLIDATION ENTRY *B (2011)
Bonds Payable .................................................... 400,000

Premium on Bonds Payable ............................... 10,000
Interest Income ................................................... 38,000
Investment in Bonds ..................................... 390,000
Interest Expense ............................................ 34,000
Retained Earnings, 1/1/11 (Darges) .............. 24,000
(To remove intercompany bond accounts that remain on the individual
records of both companies. Both debt and investment balances have
been adjusted for 2009 2011 amortization. Entry to retained earnings
brings the totals reported by the individual companies to the balance of
the original gain.)

26. (12 Minutes) (Determine consolidated income statement accounts after

acquisition of intercompany bonds.)
Interest Expense To Be Eliminated = $84,000 x 11% = $9,240

Interest Income To Be Eliminated = $108,000 x 8% = $8,640
Loss To Be Recognized = $108,000 $84,000 = $24,000
CONSOLIDATED TOTALS
Revenues and Interest Income = $1,051,360 (add the two book values and
eliminate interest income on intercompany bond)
Operating and Interest Expense = $751,760 (add the two book values and
eliminate interest expense on intercompany bond)
Other Gains and Losses = $152,000 (add the two book values)
Loss on Retirement of Debt = $24,000 (computed above)
Net Income = $427,600 (consolidated revenues, interest income, and
gains less consolidated operating and interest expense and losses)
27. (30 Minutes) (Consolidation entry for two years to report effects of
intercompany bond acquisition. Effective rate method applied.)
a. Loss on Repurchase of Bond

Cost of acquisition ........................................ $121,655
Book value ($668,778 x 1/8) ........................... 83,597
Loss on repurchase ....................................... $38,058
Interest Balances for 2009

Interest income:
$121,655 x 6% ........................................... $7,299
Interest expense:
$83,597 (book value [above]) x 10% ........ $8,360
Investment Balance, December 31, 2009

Original cost, 1/1/09 ........................................ $121,655
Amortization of premium:
Cash interest ($100,000 x 8%) .................. $8,000
Effective interest income (above) ............ 7,299 701
Investment, 12/31/09 ............................ $120,954

27. (continued)
Bonds Payable Balance, December 31, 2009
Book value, 1/1/09 (above) ............................ $83,597
Amortization of discount:
Cash interest ($100,000 x 8%) .................. $8,000
Effective interest expense (above) .......... 8,360 360
Bonds payable, 12/31/09 ...................... $83,957
Entry B12/31/09
Bonds Payable ............................................... 83,957
Interest Income .............................................. 7,299
Loss on Retirement of Debt .......................... 38,058
Investment in Bonds ................................ 120,954
Interest Expense ....................................... 8,360
(To eliminate intercompany debt holdings and recognize loss on
retirement.)
b. Interest Balances for 2010

Interest income: $120,954 (investment
balance for the year) x 6% ....................................... $7,257
Interest expense: $83,957 (liability balance

for the year) x 10% .................................................... $8,396

Book value, January 1, 2010 (part a) ....................... $120,954
Cash interest ($100,000 x 8%) ............................ $8,000
Effective interest income (above) ...................... 7,257 743
Investment balance, December 31, 2010 ....... $120,211

Book value, January 1, 2010 (part a) ....................... $83,957
Cash interest ($100,000 x 8%) ............................ $8,000
Effective interest expense (above) ..................... 8,396 396
Bonds payable balance,
December 31, 2010 ......................................... $84,353
Interest Balances for 2011

Interest income: $120,211 (investment .................... $7,213
balance for the year [above]) x 6%
Interest expense: $84,353 (liability balance

for the year [above]) x 10% ................................. $8,435

27. (continued)

Book value, January 1, 2011 (above) ...................... $120,211
Cash interest ($100,000 x 8%) ............................ $8,000
Effective interest income (above) ...................... 7,213 787
Investment balance, December 31, 2011 ....... $119,424

Book value, January 1, 2011 (above) ...................... $84,353
Cash interest ($100,000 x 8%) ............................ $8,000
Effective interest expense (above) ..................... 8,435 435
Bonds payable balance,
December 31, 2011 ................................... $84,788
Adjustment Needed to Retained Earnings, January 1, 2011

Loss on retirement of debt (part a) ......................... $38,058
Balances currently in retained earnings:
Interest income: 2009 ($7,299)
2010 (7,257) ($14,556)
Interest expense: 2009 $8,360
2010 8,396 16,756 2,200
Reduction needed to beginning retained

earnings to arrive at consolidated total .......................... $35,858
Entry *B12/31/11
Bonds Payable .......................................................... 84,788

Interest Income ......................................................... 7,213
Retained earnings, 1/1/11 (Parent) .......................... 35,858
Investment in Bonds ........................................... 119,424
Interest Expense ................................................. 8,435
(To eliminate intercompany bond holdings and adjust beginning retained
earnings balance of the parent to amount representing loss on retire ment.
Amounts computed above.)

28. (35 Minutes) (Consolidation procedures and balances related to intercompany

bonds. Both straight-line and effective interest rate methods are used.)
a. Acquisition price of bonds .............................................................. $283,550

Book value of bonds payable (see Schedule 1)
($443,497 x 50%) .......................................................................... (221,749)
Loss on retirement ........................................................................... $61,801
SCHEDULE 1Book Value of Bonds Payable
Effective
Book Interest Cash Year-End
Date Value (12% Rate) Interest Amortization Book Value
2007 $435,763 $52,292 $50,000 $2,292 $438,055
2008 $438,055 $52,567 $50,000 $2,567 $440,622
2009 $440,622 $52,875 $50,000 $2,875 $443,497
b. Investment in Bloom Bonds

Purchase price12/31/09 ......................................... $283,550
Cash interest ($250,000 x 10%) ................................ $25,000
Effective interest income ($283,550 x 8%) .............. 22,684
Amortization ........................................................ 2,316
Investment in Bloom bonds, 12/31/10 ..................... $281,234
Bonds Payable
Book value12/31/09 (computed above) ............... $443,497
Cash interest ($500,000 x 10%) ................................ $50,000
Effective interest expense ($443,497 x 12%) ........... 53,220
Amortization ........................................................ 3,220
Bonds payable, 12/31/10 .......................................... $446,717
Although not required, the consolidation entry as of 12/31/10 is as follows. The

reduction in retained earnings represents the loss only; no intercompany
interest was recognized in the previous year because the purchase was made
on December 31.
Entry *B (2010)
Bonds Payable ($446,717 x 50%) ............................. 223,359
Interest Income ......................................................... 22,684
Retained Earnings, 1/1/10 ........................................ 61,801
Interest Expense ($53,220 x 50%) ...................... 26,610
Investment in Bloom Bonds ............................... 281,234

28. continued
c. Loss on Retirement of Bond
Because Bloom uses the straight-line method of amortization, the loss on

retirement must be computed again.
Original issue price1/1/07 ........................................................ $435,763

Discount amortization (20072009) ([$64,237 11] x 3 years) ... 17,519
Book value 12/31/09 .................................................................... $453,282
Intercompany portion of bonds payable (50%) ......................... $226,641

Purchase price ............................................................................. 283,550
Loss on retirement ...................................................................... $56,909
Investment in Bloom Bonds

Purchase price12/31/09 ........................................................... $283,550
Premium amortization (2010) ($33,550 8) ................................ (4,194)
Book value 12/31/10 ............................................................... $279,356
Interest Income
Cash interest ($250,000 x 10%) ................................................... $25,000
Premium amortization (above) ................................................... (4,194)
Intercompany interest income2010 ................................... $20,806
Bonds Payable
Original issue price 1/1/07 ........................................................... $435,763
Discount amortization (20072010) [($64,237 11) x 4 years] .. 23,359
Book value 12/31/10 ............................................................... $459,122
Opus ownership ..................................................................... 50%
Intercompany portion12/31/10 ...................................... $229,561
Interest Expense
Cash interest ($250,000 x 10%) ................................................... $25,000
Discount amortization ([$64,237 11] x 1/2) .............................. 2,920
Intercompany interest expense2010 ................................. $27,920
The reduction in retained earnings represents the loss only; no intercompany

interest was recognized in the previous year because the purchase was made
on December 31.
Entry *B (2010)
Bonds Payable .......................................................... 229,561
Interest Income ......................................................... 20,806
Retained Earnings, 1/1/10 ....................................... 56,909
Interest Expense ................................................ 27,920
Investment in Bloom Bonds ............................... 279,356

29. (8 Minutes) (Determine goodwill for a purchase in which subsidiary has both
common stock and preferred stock)
Consideration transferred for common stock $1,600,000

Consideration transferred for preferred stock 630,000
Noncontrolling interest in common stock 400,000
Noncontrolling interest in preferred stock 270,000
Hepners acquisition-date fair value $2,900,000
Book value of Hepner 2,500,000
Goodwill $400,000
30. (30 Minutes) (Consolidation entries for a purchase where subsidiary has
outstanding cumulative preferred stock.)
a. The preferred shares are entitled to the specified cumulative dividend. Thus, the
noncontrolling interest's share of the subsidiary's income equals $160,000 or 8
percent of the preferred stock's par value.
b. Acquisition-Date Fair Value Allocation and Amortization

Consideration transferred .......................................................... $14,040,000
Noncontrolling interest fair value (preferred shares) ................ 2,000,000
Acquisition-date fair value of Smith............................................ 16,040,000
Book value ................................................................................... (16,000,000)
Franchises ................................................................................... $40,000
Period of amortization ................................................................ 40 years
Annual amortization .................................................................... $1,000
Investment in Smith Account, December 31, 2009

Consideration transferred, January 1, 2009 .............................. $14,040,000
Equity accrual (income remaining for common stock
after preferred stock dividend) .............................................. 290,000
Dividends collected ($360,000 total less $160,000
paid to preferred shareholders) ............................................ (200,000)
Amortization for 2009 (above) ........................................................ (1,000)
Investment in Smith account, December 31, 2009 ..................... $14,129,000
c. Consolidation Entries
Entry S and A combined
Preferred Stock (Smith) ........................................... 2,000,000
Common Stock (Smith) ............................................ 4,000,000
Retained Earnings, 1/1/09 (Smith) ........................... 10,000,000
Franchises ................................................................ 40,000
Investment in Smith ........................................ 14,040,000
Noncontrolling Interest in Smith, Inc ............ 2,000,000

(To eliminate subsidiary stockholders equity, record excess fair values, and
record outside ownership of subsidiary's preferred stock at fair value)

30. c. (continued)
Entry I Equity Income of Subsidiary .............................. 285,000

Investment in Smith ....................................... 285,000
(To eliminate equity accrual made in connection with common stock
[$290,000] along with excess amortization recorded by parent.)
Entry D Investment in Smith ............................................ 200,000

Dividends Paid ............................................... 200,000
(To remove intercompany dividend payments made on common stock [see
computation above].)
Entry E Amortization Expense ......................................... 1,000

Franchises ...................................................... 1,000
(To recognize amortization of franchises for current year [see computation
above].)
31. (30 Minutes) (Prepare consolidation entries for a purchase where subsidiary
has outstanding preferred stock)
Consideration transferred for common stock $ 7,368,000

Consideration transferred for preferred stock 3,100,000
Noncontrolling interest in common stock 4,912,000
Acquisition-date fair value for Young $15,380,000
Youngs book value 15,000,000
Excess fair over book value 380,000
to building (5-year life) $200,000
to equipment (10-year life) (100,000) 100,000
to brand name (20-year life) $280,000
CONSOLIDATION ENTRIES
Entries S and A combined
Preferred Stock (Young) .......................................... 1,000,000
Common Stock (Young) .......................................... 4,000,000
Retained Earnings (Young) ..................................... 10,000,000
Brand name ............................................................... 280,000
Building .................................................................... 200,000
Equipment ........................................................... 100,000
Investment in Young's Preferred Stock (100%) . 3,100,000
Investment in Young's Common Stock (60%) ... 7,368,000
Noncontrolling interest ....................................... 4,912,000
(To eliminate subsidiary stockholders equity, record excess acquisition-date

fair values, and record outside ownership of subsidiary's preferred stock at
acquisition-date fair value)
31. (continued)
Entry I1
Dividend Income ...................................................... 80,000
Dividends Paid .................................................... 80,000
(To offset intercompany preferred stock dividend payments recognized as
income by parent$1,000,000 par value x 8% dividend rate.)
Entry I2
Dividend Income ...................................................... 192,000
Dividends Paid .................................................... 192,000
(To eliminate intercompany dividend payments [60% of $320,000] on
common stock. Because the $320,000 in dividends remaining after Entry I1
equals exactly 8 percent of the common stock par value, the participation
factor does not affect the distribution.)
Entry E
Amortization Expense .............................................. 44,000
Equipment ................................................................ 10,000
Building ............................................................... 40,000
Brand name ......................................................... 14,000
(To record 2009 amortization of specific accounts
recognized within acquisition price of preferred stock.)
32. (15 Minutes) (The effect that various events have on a consolidated statement of
cash flows.)
Sale of building. The $44,000 in cash received from the sale is listed as a
cash inflow within the company's investing activities. If the company is
using the direct approach in presenting cash flows from operations, the
$12,000 gain is merely omitted. However, if the indirect approach is in use,
the gain (a positive) must be eliminated from net income by a subtraction.
Intercompany inventory transfers. Because these transactions do not occur
with any parties outside of the business combination, they are not reflected
in the consolidated statement of cash flows.
Dividend paid by the subsidiary. The $27,000 payment to the parent is
eliminated in consolidated statements and is not a cash outflow from the
consolidated entity. The remaining $3,000 payment to the noncontrolling
interest is reported as a cash outflow from a financing activity.
Amortization of intangible asset. This $16,000 noncash expense appears in
the consolidated income statement. If the combined companies are using the
direct approach to present cash flows from operations, this expense is

omitted. If the indirect approach is used, the expense must be removed from
consolidated net income by an addition.
Decrease in accounts payable. Cash payments have been used to reduce
this liability balance during the period. If the direct approach is used to
present cash flows from operations, the change is added to cost of goods
sold as one step in deriving the cash paid during the period for inventory (an
outflow). If the indirect approach is applied, the decrease is subtracted from
net income in arriving at the net cash generated from operations during the
period.
33. (20 Minutes) (Determine cash flows from operations for a consolidated entity.)
NOTECORRECTION TO PROBLEM: The noncontrolling interests share of the

subsidiarys income is $9,800 (not $12,000 as listed on page 285 of text).
DIRECT APPROACH
Cash revenues (add book values, eliminate intercompany transfers,
and add decrease in accounts receivable) .................................. $648,000
Cash inventory purchases (add book values, eliminate
intercompany transfers, eliminate unrealized gains, add increase in
inventory, and add decrease in accounts payable) ..................... (370,000)
Depreciation and amortization (omit as noncash expenses) ........... -0-
Other expenses (add book values) .................................................... (40,000)
Gain on sale of equipment (omit because this is an investing activity) -0-
Equity in earnings of Wallace (not an operating cash flow) ............ -0-
Cash generated from operations ............................................ $238,000
INDIRECT APPROACH
Consolidated net income (computed below) .................................... $216,000
Adjustments:
Depreciation and amortization ................................................ 61,000
Gain on sale of equipment ...................................................... (30,000)
Increase in inventory ............................................................... (11,000)
Decrease in accounts receivable ............................................ 8,000
Decrease in accounts payable ................................................ (6,000)
Cash generated from operations ....................................... $238,000
Consolidated Net Income = $206,200 + 9,800 = $216,000 or computation below:

Revenues (add book values and subtract intercompany transfers) $640,000
Cost of goods sold (add book values, less intercompany
transfers and beginning unrealized gain, plus ending
unrealized gain) ........................................................................ (353,000)
Depreciation and amortization (add book values plus
amortization from excess fair value allocations) ................... (61,000)
Other expenses (add book value) ................................................ (40,000)

Gain on sale of equipment ........................................................... 30,000
Consolidated net income ........................................................ $216,000

34. (30 Minutes) (Compute basic and diluted earnings per share for a business
combination.)
(Note: This question may require students to review earnings per share
fundamentals analyzed in intermediate accounting.)
The following computations assume that Parent acquired its interest in Sub's
bonds directly from Sub. Therefore, no gain or loss was created and interest
income will exactly offset interest expense.
BASIC EARNINGS PER SHAREBUSINESS COMBINATION

CONSOLIDATED NET INCOME
- Parent's reported income ...................................... $150,000
- Sub's reported income .......................................... 130,000
- Amortization expense ............................................ (10,000)
Consolidated net income ................................... $270,000
Parent shares outstanding ................................. 60,000
Basic earnings per share ($270,000 60,000) ........ $4.50
FULLY DILUTED EARNINGS PER SHARESUBSIDIARY

Reported earnings ......................................................... $130,000
Shares outstanding ....................................................... 30,000
Basic earnings per share (130,000 30,000) ................ $4.33 (rounded)
Sub's earnings assuming conversion of Sub's bonds
($130,000 plus $24,000 in interest
saved net of taxes) ................................................... $154,000
Sub's shares assuming conversion of Sub's bonds
(30,000 + 12,000) ....................................................... 42,000
Diluted earnings per share
(154,000 42,000) ..................................................... $3.67 (rounded)
Because diluted earnings per share is below basic earnings per share, the
convertible bonds have a dilutive impact on the computation and should be
included.
PARENT'S SHARE OF SUBSIDIARY'S DILUTED EARNINGS
Total shares used in computation above .................... 42,000
Parent's ownership (30,000 plus 20% of 12,000) ......... 32,400
Parent's portion of shares (32,400 42,000) .......... 77% (rounded)
Sub's earnings used in diluted computation
(above) .................................................................... $154,000
Parent's portion of shares ............................................ 77%
Earnings attributed to business combination ............. $118,580

34. (continued)
DILUTED EARNINGS PER SHAREBUSINESS COMBINATION

Parent's reported income ........................................ $150,000
Subs income applicable to computation
(see above) ............................................................... 118,580
Amortization expense .............................................. (10,000)
Interest saved (net of taxes) on assumed
conversion of Parent's bonds ................................. 32,000
Diluted earnings ............................................................ $290,580
Parent shares outstanding ...................................... 60,000

Additional shares from assumed conversion
of Parent's bonds ..................................................... 10,000
Diluted shares ................................................................ 70,000
($290,580 70,000) ................................................... $4.15 (rounded)
35. (10 Minutes) (Compute consolidated diluted earnings per share. Subsidiary has
stock warrants outstanding.)
Figures For Sonston's Basic Earnings Per Share

Net Income .................................................................... $200,000
Assumed Conversion of Stock Warrants ..................... 10,000
Repurchase of Treasury Stock with Proceeds of Stock
Warrants (10,000 x $10 = $100,000 $20) ..................... (5,000) 5,000
Shares for Basic Earnings Per Share Computation ..... 45,000
Shares Controlled by Primus: 40,000 + (20% of 5,000) = 41,000

Percentage of Total Held by Primus: 41,000 45,000 = 91%
(rounded)
Income to be Included in Consolidated Diluted Earnings
Per Share $200,000 x 91% = $182,000
Earnings Consolidated Diluted Earnings Per Share:

Net Income Primus ..................................................... $600,000
Net Income included from Sonston ............................. 182,000
Earnings .................................................................... $782,000
Outstanding Shares of Primus ..................................... 100,000
CONSOLIDATED DILUTED EARNINGS PER SHARE = $782,000 100,000 = $7.82

36. (15 Minutes) (Compute consolidated diluted earnings per share. Subsidiary has
convertible bonds outstanding.)
Figures For Simon's Diluted Earnings Per Share

Earnings:
Net Income .................................................................... $290,000
Interest Saved if Bonds Are Converted ........................ $80,000
Tax on Saved Interest (30%) ......................................... (24,000) 56,000
Earnings for Diluted Earnings Per Share ..................... $346,000
Shares:
Outstanding ................................................................... 80,000
Assumed Conversion of Bonds .................................... 30,000
Shares For Diluted Earnings Per Share Computation . 110,000
Shares Controlled by Garfun = 80,000 110,000 = 73%

(rounded)
Income to be Included in Consolidated Diluted Earnings
Per Share = $346,000 x 73% = $252,580
Earnings for Consolidated Diluted Earnings Per Share:

Net IncomeGarfun ...................................................... $480,000
Dividends to Garfun's Preferred Stock ........................ (15,000)
Net Income included from Simon (above) ................... 252,580
Earnings .................................................................... $717,580
Shares:
Outstanding Shares of Garfun ...................................... 80,000
CONSOLIDATED DILUTED EARNINGS PER SHARE = $717,580 80,000 = $8.97

(rounded)
37. (35 Minutes) (Compute basic and diluted earnings per share for a business
combination. Subsidiary has stock warrants and convertible bonds.)
The following computations assume that Mason acquired its interest in Dixon's
bonds directly from Dixon. Thus, no gain or loss was created and interest
income and interest expense will exactly offset.

37. (continued)
Reported income (separate)Mason ..................... $110,000
Income of Dixon (80%) ............................................. 52,000
Preferred stock dividends (5,000 x $4) .................... (20,000)
Earnings applicable to basic EPS ...................... $142,000
Mason's outstanding shares ................................... 50,000
Basic earnings per share ($142,000 50,000) ........ $2.84
DILUTED EARNINGS PER SHARE SUBSIDIARY (DIXON)
Net income ................................................................ $90,000
Interest (net of tax) saved assuming bond conversion 30,000
Income applicable to diluted EPS ................ $120,000
Shares outstanding .................................................. 30,000
Assumed conversion of warrants ........................... 10,000
Assumed acquisition of treasury stock with
proceeds of conversion [(10,000 x $20) $25] .. (8,000)
Assumed conversion of bonds ............................... 20,000
Shares applicable to diluted EPS ...................... 52,000
Diluted EPSsubsidiary ($120,000 52,000) ......... $2.31 (rounded)
INCOME APPLICABLE TO PARENTDILUTED EARNINGS PER SHARE

Shares used in diluted EPS computation ............... 52,000
Shares controlled by Parent
(30,000 x 80% plus 15% x 20,000) ....................... 27,000
Portion owned by Parent (27,000 52,000) .. 52% (rounded)
Income used in diluted EPS computation .............. $120,000
Income applicable to Parentdiluted EPS ............. $62,400

Reported income (separate)Mason ..................... $110,000
Income of Dixon (above) .......................................... 62,400
Amortization expense .............................................. (20,000)
Because of assumed conversion, preferred stock
dividends would not be paid .............................. -0-
Earnings applicable to diluted EPS .............. $152,400
Mason's outstanding shares ................................... 50,000

Assumed conversion of preferred stock
(5,000 x 4) ............................................................ 20,000
Shares applicable to diluted EPS ................. 70,000
($152,400 70,000) .............................................. $2.18 (rounded)

38. (8 Minutes) (Effect of subsidiary stock issuance to public at a price above book
value per share)
Book Value of Subsidiary Prior to Issuing New Shares

(40,000 x $12) ............................................................ $480,000
Parent's Ownership ....................................................... 100%
Book Value Equivalency of Ownership ........................ $480,000
Book Value of Subsidiary After Issuing New Shares
(above value plus 10,000 shares at $15.75 each) ... $637,500
Parent's Ownership (40,000 50,000 shares) .............. 80%
Book Value Equivalency of Ownership ........................ $510,000
Investment in Rughty should be increased by $30,000 ($510,000 less $480,000)
39. (20 Minutes) (Effects of two different stock issuances by subsidiary.)
The assumption will be made here that subsidiary stock transactions will affect
the parent's capital accounts rather than being reflected as either a gain or loss.
a. Prior to the issuance of the new shares, Davis owns an 80% interest in Maxwell
(16,000 shares out of 20,000 shares). The underlying book value of this
investment is $640,000 ($800,000 x 80%). Subsequent to the issuance, total book
value of the subsidiary will have risen by $250,000 (the price of the stock) to
$1,050,000. Davis' ownership, however, will only be 64% (16,000 25,000). The
book value underlying Davis' investment is now $672,000 (64% of $1,050,000) so
that a $32,000 increase must be recorded by the parent.
Financial RecordsDavis, Incorporated
Investment in Maxwell ............................................. 32,000
Additional Paid-in Capital ................................... 32,000
b. The book value underlying Davis' investment is $640,000 (see above) prior to
the issuance of the new shares. The 4,000 additional shares increase
subsidiary's total book value by $100,000 (the price of the stock) to $900,000.
Davis' ownership will have decreased to 2/3 (16,000 shares out of a total of
24,000) for a book value equivalency of just $600,000. Reducing the $640,000
(see a) to $600,000 requires a $40,000 decrease.
Financial RecordsDavis, Incorporated
Additional Paid-in Capital ........................................ 40,000
Investment in Maxwell ........................................ 40,000

40. (45 Minutes) (Prepare consolidation entries following the subsidiary's issuance
of shares to outside parties.)
Initially, Abraham owns 18,000 shares (or 90%) of Sparks' outstanding shares
(the total number of shares can be determined by dividing the subsidiary's
Common Stock account by the $10 par value attributed to each share). After
the issuance of the additional 4,000 shares, an adjustment must be prepared
by the parent company to reflect the change in the underlying book value of
the subsidiary. Because that entry has not yet been recorded, it is included
on the consolidation worksheet as Entry C (labeled in this manner because it
is a correction). The remainder of the consolidation procedures follow the
normal pattern described in previous chapters.
Adjustment for Stock Transaction

Adjusted book value of subsidiary on date of transaction
($480,000 + $100,000 + $161,000) ............................................ $741,000
Adjusted parent ownership (18,000 shares 24,000 shares) ..... 75%
Book value equivalency of parent ownership ........................ $555,750
Book value equivalency of parent's investment
account before new issuance ($580,000 x 90%) .................... 522,000
Required increase (Entry C) ............................................... $33,750
Excess Acquisition-Date Fair Value Allocation and Amortization

Fair value (consideration transferred plus NCI fair value) ......... $649,000
Book value ...................................................................................... (480,000)
Payment in excess of book value ................................................. $169,000
Allocated to land based on fair value ........................................... 89,000
Copyrights ..................................................................................... $80,000
Life of Copyrights .......................................................................... 20 years
Annual amortization ...................................................................... $4,000
Entry C
Investment in Sparks ............................................... 33,750
Additional Paid-in Capital (Abraham) ................ 33,750
(To record adjustment necessitated by subsidiary
stock transaction, computation shown above.)
Entry *C
Investment in Sparks ............................................... 82,800
Retained Earnings, 1/1/11 (Abraham) ................ 82,800
(Because initial value method is applied, equity accrual
for 20092010 is needed [$100,000 less the
two years amortization expense $4,000 x 2] x 90%)

40. a. (continued)
Entry S
Common Stock (Sparks) .......................................... 240,000
Additional Paid-in Capital (Sparks) ......................... 104,000
Retained Earnings, 1/1/11 (Sparks) ......................... 380,000
Investment in Sparks (75%) ................................ 543,000
Noncontrolling Interest in Sparks, 1/1/11 (25%) . 181,000
(To eliminate subsidiary stockholders' equity accounts
against corresponding balance in Investment account
and to recognize noncontrolling interest. Stockholders
equity balances have been adjusted for increase in
book value during 20092010 and the issuance by the
subsidiary of 4,000 shares of stock on January 1, 2011.
Entry A
Land ......................................................................... 89,000
Copyrights ................................................................ 72,000
Investment in Sparks .......................................... 144,900
Noncontrolling interest ....................................... 16,100
(To recognize amounts within acquisition price
allocated to land and copyrights. Copyrights balance
has been reduced for 20092010 amortization to arrive
at 1/1/10 balance.)
Entry I
Dividend Income ...................................................... 15,000
Dividends Paid .................................................... 15,000
(To eliminate intercompany dividends recorded by
parent as income [75% x $20,000].)
Entry E
Copyrights ............................................................ 4,000
(To recognize current year amortization.)

41. (50 Minutes) (Prepare consolidation worksheet for business combination.

Intercompany bond acquisition is made during the current year.)
Acquisition-date fair-value allocation and amortization:
Equipment $30,000 10-year life $3,000 annual amortization

Trademarks $40,000 20-year life $2,000 annual amortization
As indicated in the problem, the parent is applying the partial equity method.
Hence an Entry *C must be recorded on the worksheet to convert the recorded
figures (amortization is needed for the three years prior to 2012) to equity
balances:
Amortization expense ($5,000 3 years) = ............. $15,000 (Entry *C)
Unrealized gain in ending inventory (downstream):

Ending balance ......................................................... $10,000
Markup ($20,000 $100,000) .................................... 20%
Unrealized gain to be eliminated ............................. $2,000 (Entry G)
Loss on extinguishment of bonds:

Book value at date of repurchase ................................. $282,000
Percentage repurchased ............................................... 50%
Equivalent book value ................................................... $141,000
Amount paid ................................................................... 145,500
Loss on extinguishment of bonds ............................... $4,500 (Entry B)
Amortization during 2012 changed the carrying value of the bond payable from
$282,000 to $288,000 (found in the balance sheet) and the investment from
$145,500 to $147,000. This amortization also affects interest income and
expense accounts.
Entry A reflects remaining values after three years of amortizations.

41. continued Pavin and Stabler

Consolidation Worksheet
Year Ending December 31, 2012
Consolidation Entries Consolidated
Accounts Pavin Stabler Debit Credit Totals
Revenues ............................................... $(740,000) $(505,000) (TI)100,000 $(1,145,000)
Cost of goods sold ............................... 455,000 240,000 (G) 2,000 (TI) 100,000 597,000
Expenses ............................................... 125,000 158,500 (E) 5,000 288,500
Interest expensebonds .................... 36,000 -0- (B) 18,000 18,000
Interest incomebond investment ..... -0- (16,500) (B) 16,500 -0-
Loss on extinguishment of bonds ...... -0- -0- (B) 4,500 4,500
Equity in income of Stabler .................. (123,000) -0- (I) 123,000 -0-
Net income ......................................... $(247,000) $(123,000) $(237,000)
Retained earnings, 1/1/12 ..................... $(345,000) (*C) 15,000 $(330,000)

Retained earnings, 1/1/12 ..................... $(361,000) (S) 361,000 -0-
Net income (above) ............................... (247,000) (123,000) (237,000)
Dividends paid ...................................... 155,000 61,000 (D) 61,000 155,000
Retained earnings, 12/31/12 ................. $(437,000) $(423,000) $(412,000)
Cash and receivables ........................... $217,000 $35,000 (P) 33,000 $219,000

Inventory ................................................ 175,000 87,000 (G) 2,000 260,000
Investment in Stabler ............................ 613,000 -0- (D) 61,000 (*C) 15,000
(S) 481,000
(A) 55,000 -0-
(I) 123,000
Investment in Pavin bonds ................... -0- 147,000 (B) 147,000 -0-
Land, buildings, and equipment (net) . 245,000 541,000 (A) 21,000 (E) 3,000 804,000
Trademarks ........................................... -0- -0- (A) 34,000 (E) 2,000 32,000
Total assets ........................................ $1,250,000 $810,000 $1,315,000
Accounts payable ................................. $(225,000) $(167,000) (P) 33,000 $(359,000)

Bonds payable ...................................... (300,000) (100,000) (B) 150,000 (200,000)
Discount on bonds ............................... 12,000 -0- (B) 6,000 6,000
Common stock ...................................... (300,000) (120,000) (S) 120,000 (300,000)
Retained earnings (above) ................... (437,000) (423,000) (412,000)
Total liabilities and stockholders equity $(1,250,000) $(810,000) 1,046,000 1,046,000 $(1,315,000)

42. (40 Minutes) (Prepare consolidation entries after intercompany bond

acquisition.)
a. Allocation of Acquisition-date Excess Fair Value

Consideration transferred ..................... $312,000
Noncontrolling interest fair value ............. 208,000
Acquisition-date fair value ....................... $520,000
Book value acquired ................................. 300,000
Fair value in excess of book value ......... $220,000 Annual Excess
Excess allocated to patents based Life Amortizations
on fair value ............................................. 90,000 12 years $7,500
Customer List ........................................... $130,000 10 years 13,000
Total $20,500
Entry *TL
Investment in Herman .............................................. 7,000
Land .................................................................... 7,000
(To eliminate unrealized gain created by previous intercompany transfer.
Investment is adjusted here because transfer was downstream and equity
method has been applied by parent. Thus, retained earnings have already
been corrected.)
Entry *G
Retained Earnings 1/1/11 (Herman) ......................... 8,000
Cost of Goods Sold ............................................ 8,000
(To remove unrealized inventory gain from prior year so that it can be
properly realized in current year. Amount is computed as shown below.)
Intercompany profit2010 ...................................... $25,000

Transfer price2010 ................................................ $125,000
Markup ($25,000 $125,000) .................................... 20%
Unrealized gain in 1/1/11 inventory
($40,000 x 20%) .................................................... $8,000
Entry S
Common Stock (Herman) ........................................ 100,000
Retained Earnings, 1/1/11 (Herman)
(adjusted for Entry *G) ........................................ 292,000
Investment in Herman (60%) ......................... 235,200
Noncontrolling Interest in Herman (40%) ..... 156,800
(To eliminate Herman's stockholders' equity accounts and to record
beginning of year balance for noncontrolling interest.)

42. a. (continued)
Entry A
Patents .................................................................... 75,000
Customer List ............................................................ 104,000
Investment in Herman ......................................... 107,400
Noncontrolling interest ....................................... 71,600
(To recognize unamortized balances as of 1/1/11 of amounts allocated within
original acquisition price. Allocations have been reduced by two years of
amortizations.)
Entry I
Equity Income of Herman ......................................... 3,000
Investment in Herman .................................... 3,000
(To eliminate intercompany equity income accrual)
Hermans income ............................................................ $25,000
Excess amortizations ..................................................... (20,500)
2010 intercompany inventory gross profit .................... 8,000
2011 intercompany inventory gross profit .................... (7,500)
Accrual-based income .................................................... $5,000
Freds ownership percentage ........................................ 60%
Equity in earnings of Herman ........................................ $3,000
Entry D
Investment in Herman .............................................. 2,400
Dividends Paid .................................................... 2,400
(To eliminate intercompany dividend payments.)
Entry E
Patents .................................................................. 7,500
Customer List ....................................................... 13,000
(To recognize current year amortization expense.)
Entry P
Accounts Payable ..................................................... 60,000
Accounts Receivable .......................................... 60,000
(To remove intercompany debt created by inventory transfers.)

42. a. (continued)
Entry B
Bonds Payable .......................................................... 20,000
Premium on Bonds Payable .................................... 1,069
Interest Income ......................................................... 1,873
Investment in Parent Bonds ............................... 19,005
Gain on Retirement of Bond ............................... 2,654
(To eliminate effect created by bond acquisition and recognize the related
retirement gain [$21,386 $18,732]. Amounts are calculated below.)
Book Cash Year-End
Value Effective Interest Excess Book
(given) Interest (8%) Amortizations Value
Investment $18,732 $1,873 (10%) $1,600 $273 $19,005
Liability 21,386 1,283 (6%) 1,600 317 21,069
Entry Tl
Sales .......................................................................... 120,000
Cost of Goods Sold (or Purchases) ................... 120,000
(To eliminate intercompany transfers made during current year.)
Entry G
Cost of Goods Sold .................................................. 7,500
Inventory............................................................... 7,500
(To defer recognition of inventory transfer gains until subsequent year.
Amount calculated as follows.)
Intercompany profit ............................................ $30,000
Transfer price 2011 ............................................. $120,000
Markup ($30,000 $120,000) .............................. 25%
Unrealized gain in ending inventory
($30,000 x 25%) .................................................. $7,500
b. Herman's reported income for 2011 ........................................ $25,000

Excess fair value amortization ................................................ (20,500)
2010 unrealized gain recognized in 2011 (Entry *G) .............. 8,000
2011 unrealized gain (Entry G) ................................................ (7,500)
Herman's realized income for 2011 .......................................... $5,000
Noncontrolling interest ownership ......................................... 40%
Noncontrolling interest's share of the subsidiary's income .. $2,000
Noncontrolling interest, 1/1/11 (Entry S) ................................ $156,800

Noncontrolling interest's share of Herman's income (above) 2,000
Noncontrolling interest's share of Herman's dividends
($4,000 x 40%) ..................................................................... (1,600)
Noncontrolling interest, 12/31/11 ............................................. $157,200
42. (continued)
c. The balances in the individual records as of December 31, 2012 pertaining to
the Intercompany bonds are as follows:
Beginning
Book Cash Year-End
Value Effective Interest Excess Book
(see part a.) Interest (8%) Amortizations Value
Investment $19,005 $1,901 (10%) $1,600 $301 $19,306
Liability 21,069 1,264 (6%) 1,600 336 20,733
The adjustment to recognize the original gain by the parent can be computed as
follows:
Original gain on retirement (see part a) ....................... $2,654

Interest income recorded on investment in 2011
(see part a) ................................................................ $1,873
Interest expense recorded on liability in 2011
(see part a) ............................................................... 1,283 590
Required increase as of January 1, 2012 ..................... $2,064
Entry *B (as of December 31, 2012)

Bonds Payable........................................................... 20,000
Premium on Bonds Payable .................................... 733
Interest Income ......................................................... 1,901
Investment in Herman ......................................... 2,064
Investment in Parent Bonds ............................... 19,306
(To remove accounts pertaining to intercompany bonds. "Investment in
Herman" is adjusted here rather than retained earnings because equity
method is being applied and gain is attributed to the parent.)

43. (50 Minutes) (Prepare consolidation entries for intercompany preferred stock
and bonds. Determine specified account balances. Preferred stock is a debt
instrument.)
a. Consideration transferred for common stock .................. $552,800

Consideration transferred for preferred stock ................. 65,000
Noncontrolling interest in common stock ........................ 138,200
Noncontrolling interest in preferred stock ....................... 34,000
Lisas acquisition-date fair value ...................................... $790,000
Book value of Lisa .............................................................. 750,000
Excess assigned to franchises .......................................... $40,000
CONSOLIDATION ENTRIES 1/1/09
Entry S and A combined
Preferred Stock (Lisa) .............................................. 100,000
Common Stock (Lisa) .............................................. 200,000
Retained Earnings, 1/1/09 (Lisa) .............................. 450,000
Franchises ................................................................ 40,000
Investment in Lisa-common stock ................ 552,800
Investment in Lisa-preferred stock................ 65,000
Noncontrolling Interest in Lisa, Inc ............... 172,200
(To eliminate subsidiary stockholders equity, record excess acquisition-date

fair values, and record outside ownership of subsidiary's preferred and
common stock at acquisition-date fair values.)
b. Acquisition price of bonds, 1/2/09 .......................... $53,310

Book value of bonds payable ( acquired) ............ (44,175)
Loss on extinguishment of debt ........................ $9,135
Interest incomeMona ($53,310 x 8%) ................... (rounded) $4,265
Interest expenseLisa ($44,175 x 14%) .................. (rounded) $6,185
Investment in Lisabonds (book value)
Book valuedate of acquisition, 1/2/09 ............ $53,310
Cash interest ($50,000 x 10%) ............................ $5,000
Effective interest (above) .................................... 4,265 735
Investment in Lisabonds
(book value as of 12/31/09) ........................... $52,575

43. b. (continued)
Bonds payable (book value)
Book valuedate of acquisition, 1/2/09 ............ $44,175
Cash interest ($50,000 x 10%) ............................ $5,000
Effective interest (above) .................................... 6,185 1,185
Bonds payable (book value as of 12/31/09) .. $45,360
CONSOLIDATION ENTRY BDecember 31, 2009

(all figures computed above)
Bonds Payable .......................................................... 50,000
Interest Income (or Other Revenues) ...................... 4,265
Extraordinary Loss on Retirement of Debt ............. 9,135
Discount on Bonds Payable ($50,000 $45,360) 4,640
Interest Expense .................................................. 6,185
Investment in LisaBonds ................................ 52,575
c. December 31, 2009 book values based on historical cost figures:

Cost of fixed assets ................................................. $100,000
Depreciation expense ($40,000 book value over
a 10-year life) ....................................................... 4,000
Accumulated depreciation (including current
expense) .............................................................. 64,000
December 31, 2009 book values based on transfer price:

Cost of fixed assets ................................................. $120,000
Depreciation expense (10-year life) ......................... 12,000
Accumulated depreciation ....................................... 12,000
Gain on transfer of fixed assets
($120,000 $40,000) book value ........................ 80,000
CONSOLIDATION ENTRY TADecember 31, 2009
Gain on Transfer of Fixed Assets (to remove) ....... 80,000

Accumulated Depreciation ($64,000 $12,000).. 52,000
Depreciation Expense ($12,000 $4,000) ......... 8,000
Fixed Assets ($120,000 $100,000) ................... 20,000

43. (continued)
d. Original allocation to franchises (given) ...................... $40,000

Amortization at $1,000/year (20092010) ................. (2,000)
Consolidated franchises12/31/10 ......................... $38,000
Fixed assets (book values):

Mona, Inc. ................................................................. $1,100,000
Lisa Co. .................................................................... 800,000
Reduction necessitated by intercompany sale
($120,000 transfer price reduced to $100,000
original cost) (see part c) ................................... (20,000)
Consolidated fixed assets12/31/10 ...................... $1,880,000
Accumulated depreciation (book values):

Mona, Inc ................................................................... $300,000
Lisa Co. .................................................................... 200,000
Increase needed to eliminate intercompany
sale ($60,000 accumulated depreciation at time
of transfer less excess depreciation expense
[$12,000 - $4,000] for 2009 and 2010) ...................... 44,000
Consolidated Acc. Depr.12/31/10 .......................... $544,000
Expenses (book values):

Mona, Inc .............................................................. $220,000
Lisa Co. ................................................................ 120,000
Recognition of amortization on Franchises ........... 1,000
Elimination of interest expense on intercom-
pany debt ($45,360 [see part b] x 14%) (rounded) (6,350)
Elimination of excess depreciation from
intercompany transfer of fixed assets
($12,000 $4,000) ................................................. (8,000)
Consolidated expenses ........................................... $326,650

44. (35 Minutes) (Prepare statement of cash flows for a business combination.)
(Note: before working this problem, students may wish to review the statement
of cash flows in an intermediate accounting textbook.)
Development of Cash Flow Balances
OPERATING ACTIVITIES2009
Revenues (the consolidated balance plus the decrease in
accounts receivable) ..................................................................... $890,000
Cost of goods sold (cash purchases) (the consolidated
balance plus the increase in inventory plus the
decrease in accounts payable) ..................................................... 720,000
Depreciation and amortization (not cash expenses) ........................ -0-
Gain on sale of building (sales price is shown below as
an investing activity) ..................................................................... -0-
Interest expense (the consolidated balance) .................................... 30,000
Noncontrolling interest in subsidiary's income (does not
represent a cash flow although dividends paid to these
outside owners is shown below as a financing activity) .......... -0-
INVESTING ACTIVITIES2009
Sale of building ($30,000 book value sold at a $20,000 gain) ........... $50,000
Purchase of equipment (Buildings and Equipment account
increased by $50,000. Building with a $30,000 book value
was sold [a decrease]. Depreciation [without Databases
amortization] was $95,000 [a decrease]. Only a purchase
of $175,000 would turn these two decreases of $125,000 into
an increase of $50,000) ................................................................. 175,000
FINANCING ACTIVITIES2009
Dividends paid by parent (the consolidated balance) ..................... $100,000
Dividends paid by subsidiary (amount paid to
noncontrolling interest20%) ...................................................... 2,000
Issuance of bonds .............................................................................. 100,000
Issuance of common stock by the parent (increase in
common stock and additional paid-in capital) ............................ 47,000

44. (continued)
ROGERS COMPANY AND CONSOLIDATED SUBSIDIARY

Statement of Cash Flows
CASH FROM OPERATIONS

Revenues .................................................................. $890,000
Purchases ................................................................. (720,000)
Expenses .................................................................. (30,000)
Cash from operations ......................................... 140,000
CASH FLOWSINVESTING ACTIVITIES

Sale of building ........................................................ $50,000
Purchase of equipment ............................................ (175,000)
Cash from investing activities ............................ (125,000)
CASH FLOWSFINANCING ACTIVITIES

Dividends paid .......................................................... $(102,000)
Issuance of bonds .................................................... 100,000
Issuance of common stock ..................................... 47,000
Cash from financing activities ........................... 45,000
Net increase in cash during 2009 ................................. 60,000
Cash, January 1, 2009 ................................................... 80,000
Cash, December 31, 2009 .............................................. $140,000
The above statement uses the direct approach for computing cash flows from
operations. If the indirect approach were to be used, the following computation
would be appropriate.
CASH FROM OPERATIONS

Consolidated net income ............................................... $230,000
Adjustment from accrual to cash:
Depreciation and amortization ................................ 100,000
Gain on sale of building .......................................... (20,000)
Decrease in accounts receivable ............................ 10,000
Increase in inventory ................................................ (140,000)
Decrease in accounts payable ................................. (40,000)
Cash from operations ......................................... $140,000

45. (40 Minutes) (Compute basic and diluted earnings per share. Subsidiary has
stock warrants outstanding and convertible debt.)
The subsidiary has two convertibles: warrants and bonds. Thus the
subsidiarys diluted earnings per share must be computed as a preliminary step
to the calculations made for the business combination as a whole.
Based on the amount of the "noncontrolling interest in Raleigh's income,"

outside ownership must be 20 percent so that the parent, Alexander, holds an
80 percent interest in Raleigh (or 24,000 shares).

Reported income (partial equity)Alexander .............. $304,000
Adjust for impact of intercompany transfers (consoli-
dated gross profit is $5,000 higher than the individual
figures; thus, deferred figure being recognized is that
much higher than the amount being deferred) ...... 5,000
Amortization expense (increase in consolidated
expenses parents 80% ownership) ...................... (20,000)
Preferred stock dividends ............................................. (40,000)
Earnings applicable to basic EPS ........................... $249,000
Alexander's outstanding common shares ................... 50,000

Basic earnings per share ($249,000 50,000) .............. $4.98
DILUTED EARNINGS PER SHARESUBSIDIARY (RALEIGH)

Net income .................................................................... $130,000
Interest saved assuming conversion of bonds
(net of taxes) ............................................................. 22,000
Income applicable to diluted EPS ................................ $152,000
Assumed conversion of warrants ................................ 5,000
Assumed acquisition of treasury stock with proceeds
of conversion ([5,000 x $10] $20) .......................... (2,500)
Assumed conversion of bonds ..................................... 10,000
Shares applicable to diluted EPS ............................ 42,500
Diluted earnings per sharesubsidiary
($152,000 42,500) ................................................... $3.58 (rounded)

45. (continued)
INCOME APPLICABLE TO PARENTDILUTED EARNINGS PER SHARE
Shares used in diluted EPS computation .................... 42,500

Shares controlled by parent (24,000 plus 50% of incre-
ment created by warrants [or 1,250]) ...................... 25,250
Portion owned by parent (25,250 42,500) ....... 59.4% (rounded)

Income applicable to parentdiluted EPS (59.4% of
$152,000) ................................................................... $90,288

Reported income Alexander ......................................... $304,000
Eliminate equity in earnings of Raleigh ....................... (104,000)
Adjust for impact of intercompany transfers (consoli-
dated gross profit is $5,000 higher than the individual
figures; thus, the deferred figure being recognized is
that much higher than the amount being deferred) 5,000
Amortization expense (increase in consolidated
expenses parents 80% ownership) ..................... (20,000)
Income of Raleigh (computed above) .......................... 90,288
Because of assumed conversion, preferred stock divi-
dends would not be paid ......................................... -0-
Earnings applicable to diluted EPS .............................. $275,288
Alexander's outstanding common shares ................... 50,000

Assumed conversion of preferred stock
(10,000 x 2 shares) .................................................... 20,000
Shares applicable to diluted EPS ................................. 70,000
($275,288 70,000) ................................................... $3.93 (rounded)

46. (50 Minutes) (Determine consolidated totals. Subsidiary has preferred shares
outstanding that are equity instruments.)
Consideration transferred for common and preferred stock $560,000

Skylers book value 450,000
Excess fair value assigned to intangible asset (10-year life) $110,000
Annual amortization $11,000

Ending Unrealized Gain
Ending inventory (at transfer price) ............................. $18,000
Markup ($30,000 $90,000) ...................................... 33%
Ending unrealized gain (increase made to cost
of goods sold to defer gain) ............................... $6,000

46. (continued)
Paisley, Inc. and Skyler Corp.
Consolidation Worksheet
Consolidation Entries Consolidated
Accounts Paisley, Inc. Skyler Corp. Debit Credit Totals
Sales .................................................. $(800,000) $(400,000) (TI) 90,000 $(1,110,000)
Cost of goods sold .......................... 528,000 260,000 (G) 6,000 (TI) 90,000 704,000
Expenses .......................................... 180,000 130,000 (E) 11,000 (ED) 2,000 319,000
Gain on sale of equipment.............. (8,000) -0- (TA) 8,000 -0-
Net income ..................................... $(100,000) $(10,000) $(87,000)
Retained earnings, 1/1/09 ............... $(400,000) $(150,000) (S) 150,000 $(400,000)
Net income ........................................ (100,000) (10,000) (87,000)
Dividends paid ................................. 60,000 -0- 60,000
Retained earnings, 12/31/09 ........ $(440,000) $(160,000) $(427,000)
Cash .................................................. $30,000 $40,000 $70,000
Accounts receivable ........................ 300,000 100,000 (P) 28,000 372,000
Inventory ........................................... 260,000 180,000 (G) 6,000 434,000
Investment in Skyler Corp. ............. 560,000 -0- (S) 450,000 -0-
(A) 110,000
Land, buildings, and equipment .... 680,000 500,000 (TA) 10,000 1,190,000
Accumulated depreciation .............. (180,000) (90,000) (ED) 2,000 (TA) 18,000 (286,000)
Intangible Asset ............................... -0- -0- (A) 110,000 (E) 11,000 99,000
Total assets ................................... $1,650,000 $730,000 $1,879,000
Accounts payable ............................ $(140,000) $(90,000) (P) 28,000 $(202,000)
Long-term liabilities ......................... (240,000) (180,000) (420,000)
Preferred stock................................. -0- (100,000) (S) 100,000 -0-
Common stock ................................. (620,000) (200,000) (S) 200,000 (620,000)
Additional paid-in capital ................ (210,000) -0- (210,000)
Retained earnings, 12/31/09 ........... (440,000) (160,000) (427,000)
Total liabilities and stockholders equity $(1,650,000) $(730,000) $(1,879,000)

46. (continued)
Effect of Intercompany Equipment Transfer
Transfer price
Recorded value............................................................................... $20,000
Depreciation expense ($20,000 4) .............................................. 5,000
Accumulated depreciation ............................................................. 5,000
Gain on sale ($20,000 $12,000) ................................................... 8,000
Historical cost
Recorded value............................................................................... $30,000
Depreciation expense ($12,000 4) .............................................. 3,000
Accumulated depreciation ($18,000 + $3,000) .............................. 21,000
CONSOLIDATED TOTALS
Sales = $1,110,000 (add book values and eliminate intercompany transfers)

Cost of Goods Sold = $704,000 (add book values, eliminate intercompany
transfers, and eliminate ending unrealized gain [computed above])
Expenses = $319,000 (add book values and include amortization of
intangibles and eliminate $2,000 excess equipment depreciation)
Gain on Sale of Equipment = $0 (intercompany balance is eliminated)
Net Income = $87,000 (consolidated revenues less consolidated expenses)
Retained Earnings, 1/1/09 = $400,000 (parent company figure only because
subsidiary was not acquired until current year)
Dividends Paid = $60,000 (parent balance only)
Retained Earnings, 12/31/09 = $427,000 (consolidated beginning retained
earnings plus net income less dividends paid)
Cash = $70,000 (add book values)
Accounts Receivable = $372,000 (add book values after eliminating inter-
company balance)
Inventory = $434,000 (add book values after eliminating unrealized gain)
Investment in Skyler Corporation = $0 (intercompany account is eliminated
so that individual asset and liability accounts of subsidiary can be included)
Land, Buildings, and Equipment = $1,190,000 (add book values and increase
transferred asset from transfer price to historical cost [see above])
Accumulated Depreciation = $286,000 (add book values and adjust balance
for transferred asset from transfer price figure to historical cost (see above])
Intangible Asset = $99,000 (original allocations less one year amortization)
Total Assets = $1,879,000 (summation of consolidated accounts)
Accounts Payable = $202,000 (add book values and remove intercompany
balance)
Long-Term Liabilities = $420,000 (add book values)
Preferred Stock = $0 (subsidiary outstanding shares are eliminated)
46. (continued)
Common Stock = $620,000 (parent balance only)

Additional Paid-in Capital = $210,000 (parent balance only)
Retained Earnings, 12/31/09 = $427,000 (computed above)
Total Liabilities and Equities = $1,879,000 (summation of consolidated
accounts)
Many students may choose to prepare a worksheet for this problem. Thus, the
following is an explanation of that approach.
CONSOLIDATED ENTRIES
Entry S
Preferred Stock (Skyler) ............................................ 100,000
Common Stock (Skyler) ............................................ 200,000
Retained Earnings, 1/1/09 ......................................... 150,000
Investment in Skyler Corp. .................................. 450,000
(To eliminate stockholders equity of subsidiary allocable to common and
preferred stockholdings.)
Entry A
Intangible Asset ........................................................ 110,000
Investment in Skyler Corp. .................................. 110,000
(To recognize amounts paid within acquisition prices that are attributed to
Intangible Asset.)
Entry E
Amortization Expense ............................................... 11,000
Intangible Asset ................................................... 11,000
(To record current years amortization of intangible asset.)
Entry P
Accounts Payable...................................................... 28,000
Accounts Receivable ........................................... 28,000
(To eliminate intercompany debt.)
Entry TA
Equipment ................................................................. 10,000
Gain on Sale of Equipment ....................................... 8,000
Accumulated Depreciation .................................. 18,000
(To eliminate financial effects as of 1/1/09 created by intercompany transfer
of equipment.)
Entry TI
Sales ......................................................................... 90,000
Cost of Goods Sold ............................................. 90,000

(To eliminate intercompany inventory transfers for the current year.)
46. (continued)
Entry G
Cost of Goods Sold ................................................... 6,000
Inventory............................................................... 6,000
(To defer unrealized intercompany gain remaining at the end of the current
year. Markup is 33% [$30,000 gross profit $90,000 transfer price]
indicating that the ending inventory of $18,000 contains an unrealized profit
of $6,000 [$18,000 x 33%].)
Entry ED
Accumulated Depreciation ....................................... 2,000
Depreciation Expense .......................................... 2,000
(To eliminate excess depreciation resulting from intercompany gain of $8,000
on transfer of equipment [see Entry TA]. Equipment is being depreciated
over a remaining life of four years.)
47. (30 minutes) (Consolidated Cash Flow Statement with current year business
combination)
Plaster Inc. and Subsidiary Stucco Company

Consolidated Statement of Cash Flows
For the year ended 12/31/09
Consolidated net income $274,000

Depreciation expense $187,500
Amortization expense 8,750
Decrease in accounts receivable (net of acquisition) 3,600
Increase in inventory (net of acquisition) (102,000)
Decrease in accounts payable (net of acquisition) (8,000) 89,850
Net cash provided by operations $363,850
Purchase of Stucco Company assets (net of cash acquired)

Net cash used in investing activities (856,000)
Issue long-term debt $800,000

Dividends (108,000)
Net cash provided by financing activities 692,000
Increase in cash 1/1/09 to 12/31/09 199,850
Beginning Cash, 1/1/09 43,000

Ending cash, 12/31/09 $242,850
Excel CaseIntercompany Bonds
Bonds with a stated rate of 11% sold to yield 12%
Eff. Yield
12% 1,000,000.00 0.32197 321,973.24
110,000.00 5.65022 621,524.53
943,497.77 56,502.23
2008 943,497.77 113,219.73 110,000.00 3,219.73

2009 946,717.50 113,606.10 110,000.00 3,606.10
2010 950,323.60 114,038.83 110,000.00 4,038.83
2011 954,362.43 114,523.49 110,000.00 4,523.49
2012 958,885.93 115,066.31 110,000.00 5,066.31
2013 963,952.24 115,674.27 110,000.00 5,674.27
2014 969,626.51 116,355.18 110,000.00 6,355.18
2015 975,981.69 117,117.80 110,000.00 7,117.80
2016 983,099.49 117,971.94 110,000.00 7,971.94
2017 991,071.43 118,928.57 110,000.00 8,928.57
1,000,000.00 56,502.23
Consolidated Worksheet Entry 12/31/10

Bonds Payable 954,362.43
Interest Revenue 117,523.20
Loss on retirement 0.00
Gain on retirement 46,299.01
Investment in Bonds 911,547.79
Interest Expense 114,038.83
Bonds retired by affiliate on 1/1/10 at 904,024.59

Eff. Yield
13% 1,000,000.00 0.37616 376,159.86
110,000.00 4.79877 527,864.73
904,024.59 95,975.41
2010 904,024.59 117,523.20 110,000.00 7,523.20

2011 911,547.79 118,501.21 110,000.00 8,501.21
2012 920,049.00 119,606.37 110,000.00 9,606.37
2013 929,655.37 120,855.20 110,000.00 10,855.20
2014 940,510.57 122,266.37 110,000.00 12,266.37
2015 952,776.95 123,861.00 110,000.00 13,861.00
2016 966,637.95 125,662.93 110,000.00 15,662.93
2017 982,300.88 127,699.12 110,000.00 17,699.12
1,000,000.00 95,975.41
Financial Reporting Research and Analysis Case
The number of potential solutions is large. Searches in Lexis-Nexis, Edgar, etc. will
produce numerous examples of consolidations of VIEs. For example, Walt Disney
Company prepares a before and after disclosure of its newly consolidated VIEs
Euro Disney and Hong Kong Disneyland as follows (12-31-04):
Before Euro
Disney and Hong Euro Disney, Hong
Kong Disneyland Kong Disneyland
Consolidation and Adjustments Total
Cash and cash equivalents $1,730 $312 $2,042
Other current assets 7,103 224 7,327
Total current assets 8,833 536 9,369
Investments 1,991 (699) 1,292

Fixed assets 12,529 3,953 16,482
Intangible assets 2,815 -- 2,815
Goodwill 16,966 -- 16,966
Other assets 6,843 135 6,978
Total assets $49,977 $3,925 $53,902
Current portion of borrowings $1,872 $2,221 $4,093

Other current liabilities 6,349 617 6,966
Total current liabilities 8,221 2,838 11,059
Borrowings 8,850 545 9,395

Deferred income taxes 2,950 -- 2,950
Other long term liabilities 3,394 225 3,619
Minority interests 487 311 798
Shareholders' equity 26,075 6 26,081
Total liabilities and shareholders' equity $49,977 $3,925 $53,902


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II. Intercompany debt transactions

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

III. Subsidiary preferred stock

IV. Consolidated statement of cash flows

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

V. Consolidated earnings per share

VI. Subsidiary stock transactions

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

Answer to Discussion Question

Who Lost the $300,000?

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

3. The following characteristics are indicative of an enterprise qualifying as a primary beneficiary

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

6. D Cash Flow from Operations:

7. C Cash Flow from Financing Activities:

10. C Rodgers' Reported Balance ...................................... $200,000

Ferdinal's reported balance ..................................... 80,000

11. B Eliminate interest expenseintercompany ............ $21,000

12. B Ace reported income ................................................ $400,000

13. D 30% of Byrd's reported income of $100,000; the intercompany debt

Gain on Retirement of Bond

Original book value ............................................................. $10,600,000

Interest Expense on Intercompany Debt2009

Interest Income on Intercompany Debt2009

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

Adjustment to 1/1/10 Retained Earnings

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

15. D Consideration transferred for preferred stock ............................ $424,000

16. C Consideration transferred for preferred stock ............................ $106,000

17. A Parents reported sales ............................................ $300,000

18. B Book value of subsidiary prior to issuing new shares

Book value of subsidiary after issuing new shares (above

Investment in Nestlum increases by $24,000 ($504,000 less $480,000)

20. C Adjusted book value of subsidiary ($795,000 + $150,000) .......... $945,000

Required adjustmentdecrease ....................................... $(31,200)

21. D Adjusted book value of subsidiary ($795,000 $192,000) .......... $603,000

22. (10 minutes) (Qualification of Primary Beneficiary of a VIE)

23. (40 minutes) (VIE Qualifications for Consolidation)

a. The purpose of consolidated financial statements is to present the financial

b. According to FIN 46R, an entity qualifies as a VIE and is subject to

d. TecPC possesses the following characteristics of a primary beneficiary

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

24. (10 minutes) (Consolidation of variable interest entity.)

The $20,000 excess net asset fair value is recognized by PanTech as a

b. Implied valuation and excess valuation for Softplus.

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

a. Book Value of Bonds Payable, January 1, 2009

Book value, January 1, 2007 .................................................. $1,050,000

Gain on Retirement of Bonds, January 1, 2009

Book Value of Bonds Payable, December 31, 2009

Book Value of Investment, December 31, 2009

Intercompany Interest Balances for 2009

CONSOLIDATION ENTRY B (2009)

b. In 2010, because straight-line amortization is used, the interest accounts

CONSOLIDATION ENTRY *B (2010)

Bonds Payable ................................................... 400,000

c. As with part b, new premium and discount balances must be determined

CONSOLIDATION ENTRY *B (2011)

Bonds Payable .................................................... 400,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2009

26. (12 Minutes) (Determine consolidated income statement accounts after

Interest Expense To Be Eliminated = $84,000 x 11% = $9,240