Solution Manual Advanced Accounting 11E by Beams 08 chapter PDF

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© 2011 Pearson Education, Inc. publishing as Prentice Hall 8-Chapter 8CONSOLIDATIONS — CHANGES IN OWNERSHIP INTERESTSAnswers to Questions1 Preacquisition earnings and dividends are the earnings and dividends applicable to an investment interest prior to its acquisition during an accounting period. A...

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Chapter 8 CONSOLIDATIONS — CHANGES IN OWNERSHIP INTERESTS Answers to Questions 1

Preacquisition earnings and dividends are the earnings and dividends applicable to an investment interest prior to its acquisition during an accounting period. Assume that P purchases an 80 percent interest in S on July 1, 2011 and that S has earnings of $100,000 between January 1 and July 1, 2011 and pays $50,000 dividends on May 1, 2011. In this case, preacquisition earnings and dividends are $100,000 and $40,000, respectively. Historically, preacquisition earnings purchased were shown as a deduction on the income statement to arrive at consolidated net income. Under current GAAP, this is no longer the case. Instead, the consolidated income statement should only report revenues, expenses, gains and losses subsequent to the acquisition. For example, in a March 31 acquisition, the consolidated income statement would only include income of the subsidiary from April 1 through December 31. GAAP reasons that acquirers purchase assets and assume liabilities, based on their fair values. Acquirers do not “purchase” preacquisition earnings, although fair values of net assets should reflect earning power of the acquired firm.

2

Preacquisition earnings are not recorded by a parent under the equity method because the investor only recognizes income subsequent to acquisition on the interest acquired. Historically, preacquisition earnings purchased were shown as a deduction on the income statement to arrive at consolidated net income. Under current GAAP, this is no longer the case. Instead, the consolidated income statement should only report revenues, expenses, gains and losses subsequent to the combination date. For example, in a March 31 acquisition, the consolidated income statement would only include income of the subsidiary from April 1 through December 31.

3

Noncontrolling stockholders of Sub Company held a 20 percent interest during the first half year and a 10 percent interest during the last half year and at year-end. But noncontrolling interest at year-end is computed for the 10 percent interest held by noncontrolling stockholders at the end of the year. Noncontrolling interest share for the year has two parts: (1) annual income x 50% x 10% plus (2) annual income x 50% x 20%.

4

Preacquisition income is similar to noncontrolling interest share because it represents the income of a subsidiary attributable to stockholders outside the consolidated entity. But preacquisition income is not income of the noncontrolling stockholders at the date of the financial statements. In fact, preacquisition income relates to a previous controlling stockholder group when the interest acquired exceeds 50 percent. In such a case, it seems improper to report this as a deduction in the consolidated income statement. Rather, the fair value of net assets acquired should reflect the acquiree’s earnings history.

5

Under GAAP, a gain or loss is only recorded when the sold interest results in deconsolidation of the subsidiary, i.e., the parent no longer holds a controlling interest. The gain or loss on the sale of an equity interest is the difference between the proceeds from the sale (the fair value) and the recorded book value of the interest sold, provided that the investment is accounted for as a one-line consolidation. If another method of accounting has been used, the investment account must be converted to the equity method so that any gain or loss on sale is the same as if a one-line consolidation had been used previously. When the parent maintains a controlling interest after the sale, the sale is treated as an equity transaction, with no gain or loss recognition. The parent debits cash or other consideration received in the sale, credits the investment account based on percent of carrying value sold, and records the difference as an adjustment to other paid-in capital.

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Consolidations — Changes in Ownership Interests

8-2

6

Conceptually, the income applicable to an equity interest sold during an accounting period should be included in investment income and consolidated net income. In this case, the gain or loss on sale is computed on the basis of the book value of the interest at the time of sale, and income is assigned to the increased noncontrolling interest only after the date of sale. As a practical expedient, a beginning-of-theperiod sale date can be used such that no income is recognized on the interest sold up to the time of sale, and the gain or loss is computed on the book value at the beginning of the period. When this expedient is used, income must be assigned to the increased noncontrolling interest for the entire year of sale. The combined investment income and gain or loss on sale are the same under both approaches provided that the assumptions (beginning of the year and time of sale) are followed consistently. As noted in question 5, gain or loss on the sale of the equity interest is only recognized when the subsidiary is deconsolidated. Other wise, the gain or loss is an adjustment to other paid-in capital.

7

Assuming that no gain or loss is recognized, no adjustment of the parent’s investment account is necessary when the subsidiary sells additional shares to outside parties at book value because the parent’s share of underlying book value does not change. If additional shares are sold above book values, the parent’s share of the underlying equity of the subsidiary increases. This increase is recorded by the parent as follows: Investment in subsidiary Additional paid-in capital

XX XX

If the subsidiary sells additional shares below book value, the parent’s interest is decreased and the parent records decreases in its investment and additional paid-in capital accounts. In all three cases (at book value, above book value, or below book value), the parent’s ownership percentage decreases from 80 percent (8,000 of 10,000 shares) to 66 23 percent (8,000 of 12,000 shares). No gain or loss is recognized, the change in underlying book value, adjusted for one-sixth [(80% – 66 23 %)  80%] of any unamortized cost book value differential is reported as adjustment to additional paid-in capital, since the parent maintains its controlling interest. An alternative computation is to assume that the parent sold one-sixth of its interest for 66 23 percent of the proceeds, the difference being the amount of adjustment to additional paid-in capital. 8

The acquisition of the 2,000 shares directly from the subsidiary increases the parent’s percentage interest from 80 percent (8,000 of 10,000 shares) to 5/6 (10,000 of 12,000 shares, or 83 1/3%). The change in the interest held does not affect the way in which the parent records its additional investment. The parent in all cases increases its investment account by the amount of cash paid or other consideration given for the additional investment. It makes no difference if the purchase price is above or below book value. But, if the purchase price is above the book value of equity acquired, then the excess is assigned to undervalued assets or goodwill. If the purchase price is below the book value of equity acquired, then the excess should be assigned to reduce overvalued identifiable assets or goodwill.

9

Treasury stock transactions by a subsidiary change the parent’s proportionate interest in the subsidiary. Any changes in the parent’s share of the underlying book value of the subsidiary require adjustments in the parent’s investment in subsidiary and additional paid-in capital accounts.

10

Gains and losses to a parent (or equity investor) do not result from the treasury stock transactions of its subsidiaries (or equity investees). Although the parent’s investment interest may increase or decrease from such transactions, the predominate view is that such changes are of a capital nature and should be accounted for by additional paid-in capital adjustments rather than by recorded gains and losses.

11

Stock splits and stock dividends by a subsidiary do not affect the amounts that appear in the consolidated financial statements. But stock dividends by a subsidiary result in capitalization of subsidiary retained earnings and the amounts involved in eliminations for the subsidiary’s stockholders’ equity accounts are affected. © 2011 Pearson Education, Inc. publishing as Prentice Hall

Chapter 8

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SOLUTIONS TO EXERCISES Solution E8-1 Allocation of Set’s net income: Controlling share of income ($100,000  70%  1/2 year) + ($100,000  90%  1/2 year)

$ 80,000

Noncontrolling interest share (30% x $100,000 x ½ year) + (10% x $100,000 x ½) Preacquisition income Note: This does not appear on the consolidated income statement.

$20,000 $ 0

Allocation of Set’s dividends: Dividends to Pie ($30,000  70%) + ($30,000  90%)

$ 48,000

Noncontrolling interest ($30,000 x 30%) + ($30,000 x 10%)

$ 12,000

Preacquisition dividends

$

0

Solution E8-2 1

2.

3

Income from Sip for 2011: 40% interest x $240,000 x 8/12 year 60% interest  $240,000  1/3 year

$64,000 $ 48,000

Total income from Sip $112,000 Preacquisition income: Under GAAP, no preacquisition income appears on the consolidated income statement. The income statement only includes income of the subsidiary earned after the parent obtains its controlling interest. Control was established on September 1, when Pin’s interest increased from 40% to 60%, so the consolidated income statement includes Sip income of $80,000 ($240,000 x 1/3 of year). Noncontrolling interest share for 2011: $80,000  40%

$ 32,000

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Consolidations — Changes in Ownership Interests

8-4

Solution E8-3 (amounts in thousands) Entry to record sale of 15% interest: Cash Investment in Sap Other paid-in capital To record sale of 15% interest in Sap. No gain or loss on sale is recognized since Pet maintains an 85% controlling interest. Entry to record investment income for 2011: Investment in Sap($600  85%) Income from Sap To record income from Sap.

750 660 90

510 510

Check: Investment balance January 1, 2011 Less: Book value of interest sold Add: Income from Sap Investment balance December 31, 2011 Underlying equity ($4,600  85%) Add: 85% of Goodwill * Investment balance December 31, 2011 * Note that implied total goodwill is $400 ($340 / 85%).

$4,400 (660) 510 $4,250 $3,910 340 $4,250

Solution E8-4 (amounts in thousands) Gain on sale of 20% interest: No gain or loss is recognized since Pal maintains a 60% controlling interest. Beginning of the period sale assumption Selling price $130 Book value of interest ($436 investment 109 account balance  20%/80%) Adjustment to other paid-in capital $ 21

1

Actual sale date assumption Selling price Book value of interest sold: Beginning of the period balance Add: Income ($150  1/3 year  80%) Interest sold Adjustment to increase additional paid-in capital 2 Income from Sag Beginning of the period sale assumption Income from Sag($150  60%) Actual sale date assumption January 1 to May 1: Share of Sag’s income ($150  80%  1/3 year) May 1 to December 31: Share of Sag’s income ($150  60%  2/3 year) Income from Sag

$130 $436 40 476 25%

119 $ 11

$ 90

$ 40 60 $100

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Chapter 8

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Solution E8-4 (continued) 3

Investment in Sag December 31, 2011

Investment balance January 1 Book value of interest sold Income from Sag Dividends Investment balance December 31, 2011

Beginning of Period Sale Assumption $436 (109) 90 (48) $369

Actual Sale Date Assumption $436 (119) 100 (48) $369

Solution E8-5 (amounts in thousands) 1a

Fair value — book value differential Cost Implied fair value of Set ($1,274 / 70%) Book value ($1,480 January 1 balance + $100 income for 5 months - $60 dividends in January and April) Goodwill

1b

$1,274 $1,820 (1,520) $ 300

Income from Set (Note: Only include earnings subsequent to the acquisition date). $

Income from Set ($240,000  7/12 year  70%) 1c

Investment in Set at December 31 Investment cost Add: Income from Set Deduct: Dividends ($60,000  70%) Investment in Set December 31, 2011

2

98

$1,274 98 (42) $1,330

Consolidation working paper entries: a

Income from Set 98 Investment in Set 56 Dividends 42 To eliminate income and dividends from Set and adjust investment account to its cost on June 1.

b

1,000 Common stock, $10 par — Set 580 Retained earnings — Set Goodwill 300 Investment in Set 1,274 Noncontrolling interest 564 Dividends 42 To eliminate reciprocal investment and equity balances, record preacquisition income and beginning noncontrolling interest, and eliminate preacquisition dividends.

c Noncontrolling interest share 240,000 x 7/12 x 30% Dividends 120,000 x 30%

42,000 36,000

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Consolidations — Changes in Ownership Interests

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Noncontrolling interest

6,000

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Chapter 8

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Solution E8-6 Investment in Sow (in thousands)

1

Investment balance December 31, 2011 ($9,000  80%) Cost of new shares ($25  60,000 shares) Investment in Sow after new investment

$ 7,200 1,500 $ 8,700

Goodwill from new investment

2

*

Sow’s stockholders’ equity after issuance ($9,000 + $1,500) Pal’s ownership percentage (480,000 + 60,000 shares)/660,000 shares Pal’s book value after issuance Less: Pal’s book value before issuance Increase in book value from purchase (book value acquired)

$ 1,391.1

Cost of 60,000 shares Book value acquired Goodwill from acquisition of new shares*

$ 1,500 (1,391.1) $ 108.9

$10,500 .8182 8,591.1 (7,200)

This implies total goodwill is equal to $136,125.

Solution E8-7 1

Sod issues 30,000 shares to Pod at $20 per share Pod’s ownership interest before issuance: 176,000/220,000 shares = 80% Pod’s ownership interest after issuance: 206,000/250,000 shares = 82.4%

2

Sod sells 30,000 shares to the public at $20 per share Pod’s ownership interest after issuance: 176,000/250,000 shares = 70.4%

3

Sod sells 30,000 shares to the public; no gain or loss recognized: Investment in Sod 115,200 Additional paid-in capital 115,200 To record increase in investment in Sod computed as follows: Book value before issuance ($3,200,000  80%) Book value after issuance ($3,800,000  70.4%) Additional paid-in capital

$2,560,000 2,675,200 $ 115,200

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Consolidations — Changes in Ownership Interests

8-8

Solution E8-8 Pam buys shares Percentage ownership after additional investment:

1a

700,000/1,000,000 = 70% Goodwill from additional investment (in thousands):

1b

Book value of interest after sale $2,600  70% Book value of interest before sale $2,100  2/3 Book value of interest acquired Cost of interest Goodwill from additional investment * *

$1,820 1,400

$

420 500 80

This implies total goodwill is now equal to $114,286.

Outsiders buy shares 2a

Percentage ownership after sale: 600,000/1,000,000 = 60%

2b

Change in underlying book value of investment in Sat: Sat’s underlying equity after sale Pam’s interest Book value of Pam’s investment in Sat after the sale Less: Book value before the sale Increase in book value of investment

2c

$2,600,000 60% 1,560,000 1,400,000 $ 160,000

Entry to adjust investment account: Investment in Sat Additional paid-in capital

160,000 160,000

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Chapter 8

8-9

Solution E8-9 Preliminary computations of fair value — book value differentials: April 1, 2011 acquisition Cost of 4,000 shares (20% interest) $ 64,000 Implied total fair value of Sum ($64,000 / 20%) $320,000 Book value of Sum on april 1 acquisition date: Beginning stockholders’ equity $280,000 20,000 Add: Income for 3 months ($80,000  ¼ year) Stockholders’ equity April 1 300,000 Goodwill $ 20,000 July 1, 2012 acquisition Cost of 8,000 shares (40% interest) Implied total fair value of Sum ($164,000 / 40%) Book value on July 1 acquisition date: Beginning stockholders’ equity Add: Income for 6 months ($80,000  1/2 year) Less: Dividends May 1 Stockholders’ equity July 1 Goodwill (amount is unchanged by this transaction) 1

2

$164,000 $410,000 $360,000 40,000 (10,000) 390,000 $ 20,000

Income from Sum 2011 Income from Sum for 2011 ($80,000  20%  3/4 year)

$ 12,000

2012 Income from Sum 20% share of reported income ($80,000  20%) 40% share of reported income ($80,000  40%  1/2 year) Income from Sum

$ 16,000 16,000 $ 32,000

Noncontrolling interest December 31, 2012 (($420,000 book value + $20,000 goodwill) 40%)

$176,000

3

Preacquisition income does not appear in income statement.

4

Investment balance at December 31, 2012 Cost of 20% investment Income from Sum for 2011 Cost of 40% investment Income from Sum for 2012 Gain on revaluation of investment Less: Dividends ($2,000 + $6,000) Investment in Sum

$ 64,000 12,000 164,000 32,000 18,000 (8,000) $282,000

Implied fair value of Sum ($164,000/0.4)

$410,000

Fair value of original investment($410,000 x 20%) Less: Cost of original investment Gain on revaluation of investment

82,000 (64,000) $ 18,000

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Consolidations — Changes in Ownership Interests

8-10

Solution E8-10 Preliminary computations Investment cost July 1, 2012

$675,000

Implied total fair value of Sad ($675,000 / 90%) Less: Book value of Sad at acquisition: Equity of Sad December 31, 2011 Add: Income for 1/2 year Equity of Sad July 1, 2012 Excess (book value = underlying equity)

$750,000

1

$700,000 50,000 750,000 0

Investment income from Sad Income from Sad — 2012 ($100,000  1/2 year  90%) Income from Sad — 2013: January 1 to July 1 ($80,000  1/2 year  90%) July 1 to December 31 ($80,000  1/2 year  80%)

$ 45,000

$ 36,000 32,000 $ 68,000

Investment in Sad Cost July 1, 2012 Add: Income from Sad — 2012 Less: Dividends paid in December ($50,000  90%)

$675,000 45,000 (45,000)

Investment balance December 31, 2012

675,000

Less: Book value of 1/9 interest sold on July 1, 2013 a Add: Income from Sad — 2013 Less: Dividends paid in December ($30,000  80%) Investment balance December 31, 2013 a

(79,000) 68,000 (24,000) $640,000

Sale of 10% interest July 1, 2013: Equity of Sad December 31, 2011 Add: Income less dividends — 2012 Add:...