Ch 5 problems - Ch. 5 Intercompany transactions PDF

Preview

Summary

Ch. 5 Intercompany transactions...

Description

Chapter 1 1. Growth in the complexity of the U.S. business environment Has led to increasingly complex organizational structures as management has attempted to achieve its business objectives. Explanation: As companies grow in size and respond to their unique business environment, they often develop complex organizational and ownership structures. • • •

2.

(Has led to increased use of partnerships to avoid legal liability.) Incorrect. The need to avoid legal liability is not a direct result of increased complexity. (Has encouraged companies to reduce the number of operating divisions and product lines so they may better control those they retain.) Incorrect. Part of the reason the business environment is complex is due to the increased number and type of divisions and product lines in companies. (Has had no particular impact on the organizational structures or the way in which companies are managed.) Incorrect. This statement is false. There has been an impact on organizational structure and management.

Which of the following is not an appropriate reason for establishing a subsidiary?

The parent wishes to be able to increase its reported sales by transferring products to the subsidiary at the end of the fiscal year. Explanation: A transfer of product to a subsidiary does not constitute a sale for income purposes and as such would not increase profit for the parent. •(The parent wishes to protect existing operations by shifting new activities with greater risk to a newly created subsidiary.) Incorrect. Shifting risk is a common reason for establishing a subsidiary. •(The parent wishes to avoid subjecting all of its operations to regulatory control by establishing a subsidiary that focuses its operations in regulated industries.) Incorrect. Corporations often establish subsidiaries in other regulatory environments so that the parent company is not explicitly affected by the regulatory control. •(The parent wishes to reduce its taxes by establishing a subsidiary that focuses its operations in areas where special tax benefits are available.) Incorrect. Corporations will often establish subsidiaries to take advantage of tax benefits that exist in different regions.

3 Pale Company was established on January 1, 20X1. Along with other assets, it immediately purchased land for $80,000, a building for $240,000, and equipment for $90,000. On January 1, 20X5, Pale transferred these assets, cash of $21,000, and inventory costing $37,000 to a newly created subsidiary, Bright Company, in exchange for 10,000 shares of Bright’s $6 par value stock. Pale uses straight-line depreciation and useful lives of 40 years and 10 years for the building and equipment, respectively, with no estimated residual values.

Required: a&b.Prepare the journal entry that Pale recorded when it transferred the assets to Bright, and the entry that Bright recorded for the receipt of assets and issuance of common stock to Pale. a

b

Investment in Bright Company common stock 408,000 Accumulated depreciation–Buildings 24,000 Accumulated depreciation–Equipment 36,000 Cash 21,000 Inventory 37,000 Land 80,000 Buildings 240,000 Equipment 90,000 Cash 21,000 Inventory 37,000 Land 80,000 Buildings 240,000 Equipment 90,000 Accumulated depreciation–Buildings 24,000 Accumulated depreciation–Equipment 36,000 Common stock 60,000 Additional paid-in capital 348,000

4. Lester Company transferred the following assets to a newly created subsidiary, Mumby Corporation, in exchange for 40,000 shares of its $3 par value stock: Cost Cash $ 40,000 Accounts Receivable 75,000 Inventory 50,000 Land 35,000 160,00 Buildings 0 240,00 Equipment 0

Book Value $ 40,000 68,000 50,000 35,000 125,000 180,000

Required: a&b. Prepare the journal entry in which Lester recorded the transfer of assets to Mumby Corporation, and the entry in which Mumby recorded for the receipt of assets and issuance of common stock to Lester a Investment in Mumby Corporation common stock 498,000 Accumulated depreciation–Buildings 35,000 Accumulated depreciation–Equipment 60,000 Allowance for uncollectible accounts receivable 7,000 Inventory 50,000 Land 35,000 Buildings 160,000 Equipment 240,000 Accounts receivable 75,000 Cash 40,000

b

Cash Inventory Land Buildings

40,000 50,000 35,000 160,000

Equipment Accounts receivable

240,000 75,000 Accumulated depreciation–Buildings Accumulated depreciation–Equipment Common stock Additional paid-in capital Allowance for uncollectible accounts receivable

35,000 60,000 120,000 378,000 7,000

5. Sun Corporation concluded the fair value of Tender Company was $65,000 and paid that amount to acquire its net assets. Tender reported assets with a book value of $51,000 and fair value of $63,000 and liabilities with a book value and fair value of $21,000 on the date of combination. Sun also paid $7,000 to a search firm for finder’s fees related to the acquisition. Required: Prepare the journal entries to be made by Sun to record its investment in Tender and its payment of the finder’s fees. 1 Assets 63,000 Goodwill 23,000 Liabilities 21,000 Cash 65,000 2 Merger expense 7,000 Cash 7,000 6. Spur Corporation reported the following balance sheet amounts on December 31, 20X1: Balance Sheet Item Assets Cash & Receivable s Inventory Land Plant & Equipment Less: Accumulate d Depreciatio n Patent Total Assets

Historical Cost

$

Fair Value

59,000

$

31,000

101,000 49,000

144,000 30,000

410,000

340,000

(160,000)

129,000 $

459,000

$

674,000

Liabilities and Equities Accounts Payable Common Stock Additional Paid-In Capital Retained Earnings

$

71,000

$

76,000

181,000 11,000 196,000

Total Liabilities & Equities

$

459,000

Blanket acquired Spur Corporation's assets and liabilities for $673,000 cash on December 31, 20X1. Prepare the entry that Blanket made to record the purchase. 1

Cash and receivables Inventory Land Plant and equipment Patent Goodwill Accounts payable Cash

31,000 144,000 30,000 340,000 129,000 75,000 76,000 673,000

Explanation: Computation of goodwill Fair value of consideration given Fair value of assets acquired Fair value of liabilities assumed

$ $

Fair value of net assets acquired Goodwill

673,000

674,000 (76,000) 598,000 $

Chapter2 1. Peel Company received a cash dividend from a common stock investment. Should Peel report an increase in the investment account if it uses the cost method or equity method of accounting? Cost Equity No No

75,000

Explanation: Cash dividends received will never cause an increase in the investment account under either method. 2.In 20X0, Neil Company held the following investments in common stock: • 25,000 shares of B&K Inc.’s 100,000 outstanding shares. Neil’s level of ownership gives it the ability to exercise significant influence over the financial and operating policies of B&K. • 6,000 shares of Amal Corporation’s 309,000 outstanding shares. During 20X0, Neil received the following distributions from its common stock investments:

November 6 November 11 December 26

$30,000 cash dividend from B&K $1,500 cash dividend from Amal 3 percent common stock dividend from Amal The closing price of this stock was $115 per share.

What amount of dividend revenue should Neil report for 20X0? $1,500 Explanation: Because the ownership in Amal Corporation is less than 20%, the cost method should be applied. Accordingly, the $1,500 dividend received from Amal is recorded as dividend revenue.

3 Small Company reported 20X7 net income of $40,000 and paid dividends of $15,000 during the year. Mock Corporation acquired 20 percent of Small’s shares on January 1, 20X7, for $105,000. At December 31, 20X7, Mock determined the fair value of the shares of Small to be $121,000. Mock reported operating income of $90,000 for 20X7. Required: Compute Mock's net income for 20X7 assuming it uses a. The cost method in accounting for its investment in Small. b. The equity method in accounting for its investment in Small. c. The fair value method in accounting for its investment in Small.

Explanation: a. Cost method:

Operating income reported by Mock Dividend income from Small ($15,000 × 0.20)

$

90,000 3,000

Net income reported by Mock

$

93,000

b. Equity method: Operating income reported by Mock Income from investee ($40,000 × 0.20)

$

90,000 8,000

Net income reported by Mock

$

98,000

c. Fair value method:

Operating income reported by Mock Unrealized gain on increase in value of Small stock Dividend income from Small ($15,000 × 0.20)

$

90,000 16,000 3,000

Net income reported by Mock

$

109,000

Chapter 3 1. Special-purpose entities generally Have relatively large amounts of preferred stock and convertible securities outstanding. Have a much larger portion of assets financed by equity shareholders than do companies such as General Motors. Have a much smaller portion of their assets financed by equity shareholders than do companies such as General Motors. Pay out a relatively high percentage of their earnings as dividends to facilitate the sale of additional shares. Explanation: SPE’s are typically financed primarily by debt, while equity financing is only a small portion. SPE's tend to be very highly leveraged.

•

(Have a much larger portion of assets financed by equity shareholders than do companies such as General Motors.) Incorrect. Equity financing is typically much smaller in SPE’s than in companies such as General Motors. SPE’s tend to be very highly leveraged. • (Have relatively large amounts of preferred stock and convertible securities outstanding.) Incorrect. SPE’s are generally financed through debt, not equity. • (Pay out a relatively high percentage of their earnings as dividends to facilitate the sale of additional shares.) Incorrect. SPE’s are not typically designed to distribute large dividends as a function of their typical business purpose.

2. Variable interest entities may be established as Corporations. Trusts. Partnerships. All of the above. Explanation: A VIE is generally not limited as to the legal form of business that it takes (i.e. corporation, partnership, joint venture, trust, etc.). • (Corporations.) Incorrect. This type of entity can be a VIE. • (Trusts.) Incorrect. This type of entity can be a VIE. • (Partnerships.) Incorrect. This type of entity can be a VIE. 3. An enterprise that will absorb a majority of a variable interest entity’s expected losses is called the Qualified owner. Major facilitator. Primary beneficiary. Critical management director. Explanation: A primary beneficiary is defined as an enterprise that will absorb the majority of the VIE's expected losses, receive a majority of the VIE’s expected residual returns, or both. However, if one entity receives the residual returns and another absorbs the expected losses, the entity absorbing the majority of the losses is deemed to be the primary beneficiary. • • •

(Qualified owner.) Incorrect. A qualified owner would not absorb a majority of the VIE’s expected losses. (Major facilitator.) Incorrect. A major facilitator would not absorb a majority of the VIE’s expected losses. (Critical management director.) Incorrect. A critical management director would not absorb a majority of the VIE’s expected losses.

4. In determining whether or not a variable interest entity is to be consolidated, the FASB focused on Legal control. Proportionate size of the two entities. Share of profits and obligation to absorb losses. Frequency of intercompany transfers. Explanation: The company that has the most at stake is typically required to consolidate the VIE. This has

been defined as the entity receiving a majority of the VIE’s profits, and/or absorbing the majority of its losses. • (Legal control.) Incorrect. Contrary to requirements for consolidating other entities, legal control is not enough to require consolidation for VIE’s. • (Frequency of intercompany transfers.) Incorrect. Intercompany transfers have no effect on determining whether to consolidate. • (Proportionate size of the two entities.) Incorrect. VIE’s can vary in size in relation to their owning companies, thus the proportionate size of the two entities is irrelevant.

5 Potter Company acquired 90 percent of the voting common shares of Stately Corporation by issuing bonds with a par value and fair value of $121,500 to Stately's existing shareholders. Immediately prior to the acquisition, Potter reported total assets of $510,000, liabilities of $320,000, and stockholders' equity of $190,000. At that date, Stately reported total assets of $350,000, liabilities of $215,000, and stockholders’ equity of $135,000. Required: Immediately after Potter acquired Stately's shares a. What amount of total assets did Potter report in its individual balance sheet? b. What amount of total assets was reported in the consolidated balance sheet? c. What amount of total liabilities was reported in the consolidated balance sheet?

d. What amount of stockholders' equity was reported in the consolidated balance sheet? Explanation: a. $631,500 = $510,000 + $121,500 (investment) b. .$860,000 = $510,000 + $350,000 c. $641,500 = ($320,000 + $121,500) + $215,000 d.

Acquisition price ÷ percent purchased Total fair value of Stately Corporation's NA NCI in NA of Stately Corporation

$

121,500 90%

$

135,000 $

13,500

Potter Company's Stockholder's Equity

190,000

Total Consolidated Stockholder's Equity

$

203,500

Chapter 4 1 Reed Corporation acquired 100 percent of Thorne Corporation's voting common stock on December 31, 20X4, for $395,000. At the date of combination, Thorne reported the following: Assets Cash

$

Inventory Buildings (net)

Liabilities 120,000 Current Liabilities Long-Term 100,000 Liabilities

$

200,000

420,000 Common Stock

120,000

Retained Earnings Total

$

640,000 Total

80,000

240,000 $

640,000

At December 31, 20X4, the book values of Thorne's net assets and liabilities approximated their fair values, except for buildings, which had a fair value of $20,000 less than book value, and inventories, which had a fair value $36,000 more than book value. Required: Reed Corporation wishes to prepare a consolidated balance sheet immediately following the business combination. Prepare the consolidating entry or entries needed to prepare a consolidated balance sheet at December 31, 20X4. Explanation: Equity Method Entries on Reed Corp.'s Books: Event

General Journal Investment in Thorne Corp. Cash

Debit 395,000

Credit 395,000

Book Value Calculations: Retained Common Total Book + = Earnings Stock Value Book value at acquisition

360,000

120,000

240,000

Excess Value (Differential) Calculations: Total Balances

=

Buildings

35,000

+

(20,000)

Inventory

+

Goodwill

36,000

19,000

Investment in Thorne Corp.

Acquisition Price

395,000 360,000 35,000

Basic Excess Reclass

0 2. Top Corporation acquired 100 percent of Sun Corporation's common stock on December 31, 20X2. Balance sheet data for the two companies immediately following the acquisition follow: Item Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Sun Corporation Stock

49,000 110,000 130,000 80,000 500,000

Sun Corporation $ 30,000 45,000 70,000 25,000 400,000

(223,000)

(165,000)

Top Corporation $

198,000

Total Assets

$

844,000

$

405,000

Accounts Payable Taxes Payable Bonds Payable Common Stock Retained Earnings

$

61,500 95,000 280,000 150,000 257,500

$

28,000 37,000 200,000 50,000 90,000

Total Liabilities & Stockholders’ Equity

$

844,000

$

405,000

At the date of the business combination, the book values of Sun's net assets and liabilities approximated fair value except for inventory, which had a fair value of $85,000, and land, which had a fair value of $45,000. 2 Required: For each question, indicate the appropriate total that should appear in the consolidated balance sheet prepared immediately after the business combination. 1. What amount of inventory will be reported? $215,000. Explanation: $130,000 + $85,000 = $215,000 2. What amount of goodwill will be reported? $23,000. Explanation: $198,000 − ($405,000 − $265,000 + $15,000 + $20,000) = $23,000

3. What amount of total assets will be reported? $1,109,000. Explanation: Total Assets of Top Corp. Less: Investment in Sun Corp.

$

844,000 (198,000)

Book value of assets of Top Corp. Book value of assets of Sun Corp.

$

646,000 405,000

$

1,051,000

Total book value Payment in excess of book value ($198,000 − $140,000) Total assets reported

58,000 $

1,109,000

4. What amount of total liabilities will be reported? $701,500.

Explanation: ($61,500 + $95,000 + $280,000) + ($28,000 + $37,000 + $200,000) = $701,500

5. What amount of consolidated retained earnings will be reported? $257,500. Explanation: The amount reported by Top Corporation.

6.

What amount of total stockholders’ equity will be reported? $407,500.

Explanation: The amount reported by Top Corporation.

Chapter 5 1. If A Company acquires 80 percent of the stock of B Company on January 1, 20X2, immediately after the acquisition, which of the following is correct? Consolidated retained earnings and A Company retained earnings will be the same. Explanation: Under the equity method, consolidated retained earnings will always equal the retained earning balance of the acquiring company (A company) at the date of acquisition regardless of the percentage owned. The retained earnings balance of the acquired company (B Company) is eliminated in consolidation. This will continue to be true if the parent uses the fully-adjusted equity method to account for its investment. • (Consolidated retained earnings will be equal to the combined retained earnings of the two companies)Incorrect. The retained earnings of B Company is eliminated during consolidation. • (Goodwill will always be reported in the consolidated balance sheet) Incorrect. Goodwill does not arise in every consolidation. If goodwill were to arise in this acquisition, it would appear on the consolidated balance sheet. However, there is insufficient data to determine the

existence of goodwill. • (A Company’s additional paid-in capital may be reduced to permit the carryforward of B Company retained earnings) Incorrect. B Company’s retained earnings are never carried forward, rather they are eliminated during consolidation. 2.

Which of the following is correc...