60 STUDY GUIDE

Question 5

2116.01

Answer 5

The ownership by one entity of a controlling interest in another entity presents a situation of the two entities being separate legal entities but in substance a single economic or accounting entity. In such cases, there is a presumption under current GAAP that consolidated financial statements are more meaningful than separate financial statements.

Question 6

2116.02

Answer 6

As a general rule, current GAAP requires that consolidated financial statements be prepared when one of the entities in the group directly or indirectly has a controlling financial interest in the other entities. FASB ASC 810 specifies that the usual condition for consolidated financial statements is ownership (direct or indirect) of a majority voting interest (i.e., at least one share in excess of 50%).

Question 7

2116.03

Answer 7

In part, due to the attention devoted to the Enron case, the FASB became concerned that strict application of the “majority voting interest requirement” could result in a particular entity not being consolidated because the entity does not own more than 50% of the voting interests even though it has a controlling financial interest through arrangements that do not involve voting interests. As a result, FASB ASC 810-10-30-1 deals with certain specialized issues related to those types of situations that generally should be beyond the scope of the CPA Examination.

Question 8

2116.04

Answer 8

Consolidated financial statements present the results of operations, financial position, and cash flows of a parent company and its subsidiaries as if they were a single company. All intercompany balances and transactions should be eliminated when consolidated statements are prepared.

Question 9

2116.08

Answer 9

The noncontrolling (minority) interest represents a subset of total stockholders’ equity, as demonstrated for a consolidated balance sheet:

Stockholders’ equity:
Controlling interest $XXX
Noncontrolling interest XXX
Total stockholders’ equity $XXX
====

Question 10

2116.09

Answer 10

The noncontrolling interest is reported in the consolidated statement of financial position within equity, separately from the parent’s equity.

Question 11

2116.17

Answer 11

Worksheet for Consolidated Balance Sheet

On December 31, 20X1, P Corporation acquired 800 shares (80%) of S Corporation’s $10 par common stock at book value of $20 per share. The adjusted trial balance of each company at December 31, 20X1, after the acquisition, is shown in the first two columns of the following worksheet. To conserve space, current assets and liabilities are shown as totals only; in practice, the accounts would be listed individually.

Question 12

2116.18

Answer 12

Since P acquired 80% of the stock of S, the balances in the stockholders’ equity accounts of the subsidiary (S Corporation) are eliminated and 20% of the stockholders’ equity accounts is extended to the noncontrolling interest account in the worksheet.

Question 13

2116.19

Answer 13

Revenues, expenses, gains, losses, net income or loss, and other comprehensive income are reported in the consolidated financial statements at the consolidated amounts, which include the amounts attributable to the owners of the parent and the noncontrolling interest. Net income or loss and comprehensive income or loss are attributed to the parent and the noncontrolling interest.

Losses attributable to the parent and the noncontrolling interest in a subsidiary may exceed their interests in the subsidiary’s equity. The excess, and any further losses attributable to the parent and the noncontrolling interest, is attributed to those interests. That is, the noncontrolling interest will continue to be attributed its share of losses even if that attribution results in a deficit noncontrolling interest balance.

Question 14

2116.20

Answer 14

Question 15

2116.21

Comprehensive Worksheet

Assume that P Corporation in the example maintained its 80% investment in S Corporation during all of 20X2. Assume further that S Corporation reported net income during 20X2 of $4,000 and declared dividends of $1,000, as reflected in the adjusted trial balance columns of the comprehensive worksheet presented as follows:

Answer 15

Comprehensive Worksheet

Assume that P Corporation in the example maintained its 80% investment in S Corporation during all of 20X2. Assume further that S Corporation reported net income during 20X2 of $4,000 and declared dividends of $1,000, as reflected in the adjusted trial balance columns of the comprehensive worksheet presented as follows:

Question 16

2116.22

Answer 16

Format of worksheet. The comprehensive worksheet format illustrated for P Corporation is one with which candidates should be familiar. The following points should be noted about the worksheet format:

a. The worksheet contains a section for each financial statement in the order in which the statements are normally prepared.
b. The entire net income line in the income statement section is carried forward to the net income line in the retained earnings section.
c. The end-of-year retained earnings line is carried forward to the retained earnings line in the balance sheet section.
d. The noncontrolling interest’s share of the subsidiary’s net income is shown as a deduction in the consolidated balances column and as an addition to the noncontrolling interest column.

Question 17

2116.23

Answer 17

Explanation of eliminating entries. The general approach followed for the eliminating entries is to eliminate the following:

All transactions affecting the investment account during the year
The balance in the investment account as of the beginning of the year
The beginning balance and the changes in the investment account are:

Investment in S
Jan. 1, 20X2, balance $16,000 20X2 sub dividends (80%) $800
20X2 sub income (80%) 3,200

Question 18

2116.24

Answer 18

The eliminating entries in journal form are:

(1) Sub income 3,200
Investment in S 3,200
(2) Investment in S 800
Dividendsa 800
(3) Common stock–S 10,000
Capital in excess of par–S 3,000
Retained earnings–S (Jan. 1) 7,000
Investment in S (Jan. 1 bal) 16,000
Noncontrolling interest (Jan. 1 balance) 4,000

a Retained earnings (sub) is credited if a dividends account is not used.

Question 19

2116.25

Answer 19

One should pay special attention to the debit to retained earnings. The debit is to the beginning-of-year retained earnings, which is included in the retained earnings section of the comprehensive worksheet. Following this approach, the retained earnings shown in the balance sheet section are never debited or credited in an eliminating entry on a comprehensive worksheet.

Question 20

2116.26

Answer 20

Question 21

2116.27

Answer 21

Adjusting and eliminating entries may be categorized as those related to the following:

a. The investment account
b. Current-year changes in the investment account
c. Year-end reciprocal balance sheet accounts
d. Reciprocal income statement accounts
e. Intercompany profits and losses

Question 22

2116.28

Answer 22

The first two types of eliminations have been illustrated in which the cost of the investment was equal to the book value of the parent’s share of the net assets of the subsidiary. Consideration is now given to situations in which the cost of the investment is not equal to book value.

Question 23

2116.29

Answer 23

Excess of Cost Over Book Value

Example: Assume that on December 31, 20X1, P Company acquires 80% of the stock of S Company at a cost of $170,000. The stockholders’ equity of S Company on December 31, 20X1, is as follows:

Common stock ($10 par) $100,000
Retained earnings 50,000
$150,000
========
S Company has a building that at December 31, 20X1, has a book value (BV) of $60,000 and a fair value (FV) of $90,000. In addition, S Company’s inventory has a book value of $10,000 and a fair value of $15,000. The fair values of all other identifiable assets and liabilities are the same as their book values. It is assumed that the fair value of the noncontrolling interest is $42,500. (Total value of S Company = $170,000 ÷ 0.80 = $212,500. Value of noncontrolling interest = $212,500 − $170,000.)

Question 24

2116.29

Answer 24

Excess of Cost Over Book Value

Example: Assume that on December 31, 20X1, P Company acquires 80% of the stock of S Company at a cost of $170,000. The stockholders’ equity of S Company on December 31, 20X1, is as follows:

Common stock ($10 par) $100,000
Retained earnings 50,000
$150,000
========
S Company has a building that at December 31, 20X1, has a book value (BV) of $60,000 and a fair value (FV) of $90,000. In addition, S Company’s inventory has a book value of $10,000 and a fair value of $15,000. The fair values of all other identifiable assets and liabilities are the same as their book values. It is assumed that the fair value of the noncontrolling interest is $42,500. (Total value of S Company = $170,000 ÷ 0.80 = $212,500. Value of noncontrolling interest = $212,500 − $170,000.)

Question 25

2116.30

Answer 25

Question 26

2116.31

Answer 26

Question 27

2116.32

Answer 27

Question 28

2116.33

Answer 28

Continuing the example into 20X2, assume that S Company reports net income in 20X2 of $30,000. Assume also that (a) S Company uses the FIFO inventory method, (b) the building has an estimated remaining life of 10 years as of December 31, 20X1, and (c) goodwill was not impaired in 20X2. Accordingly, the amortization of the excess of cost over book value is as follows:

Inventory $5,000 / 1 year (FIFO method) = $5,000 per year for 1 year
Building $30,000 / 10 years = 3,000 per year for 10 years
$8,000
======

Question 29

2116.34

Answer 29

Question 30

2116.44

Answer 30

Elimination of Year-End Reciprocal Balance Sheet Accounts

Another type of eliminating entry the candidate should look for is that relating to year-end reciprocal balance sheet accounts. The following are examples of such accounts:

Accounts receivable or accounts payable
Notes receivable or notes payable
Advance to sub (parent) or advance from parent (sub)

Question 31

2116.45

Answer 31

The receivable and payable must be associated with another entity included in the consolidation. For example, the accounts receivable must be receivable from one of the affiliated entities.

Question 32

2116.46

Answer 32

Elimination of Reciprocal Income Statement Accounts

All reciprocal income statement accounts must also be eliminated. For example, if the parent company sells merchandise to the sub, sales and purchases of that amount must be eliminated. Interest income and interest expense are another set of reciprocal income statement accounts often found in consolidation worksheet problems.

Question 33

2116.47

Answer 33

Elimination of Intercompany Profits and Losses

The elimination of intercompany profits and losses is usually a major aspect of any CPA Examination problem involving consolidated worksheets. Accordingly, one should be quite familiar with the issues and procedures related to these eliminations.

Question 34

2116.47

Answer 34

Elimination of Intercompany Profits and Losses

The elimination of intercompany profits and losses is usually a major aspect of any CPA Examination problem involving consolidated worksheets. Accordingly, one should be quite familiar with the issues and procedures related to these eliminations.

Question 35

2116.48

Answer 35

At this point, discussion will be restricted to the elimination of intercompany profit on the sale of land. This discussion will facilitate the demonstration of the treatment of intercompany profits on the worksheets in the remaining part of this section, including their impact on the computation of noncontrolling interest, without the candidate becoming bogged down in excess detail.

Question 36

2116.48

Answer 36

At this point, discussion will be restricted to the elimination of intercompany profit on the sale of land. This discussion will facilitate the demonstration of the treatment of intercompany profits on the worksheets in the remaining part of this section, including their impact on the computation of noncontrolling interest, without the candidate becoming bogged down in excess detail.

Question 37

2116.49

Answer 37

Example: Assume that on December 31, 20X1, Ply Company acquires 80% of Sly Company’s outstanding 10,000 shares of $10 par common stock at their book value of $15 per share. Sly Company on this date has retained earnings of $50,000.

Question 38

2116.49

Answer 38

Example: Assume that on December 31, 20X1, Ply Company acquires 80% of Sly Company’s outstanding 10,000 shares of $10 par common stock at their book value of $15 per share. Sly Company on this date has retained earnings of $50,000.

Question 39

2116.50

Answer 39

The eliminating entry at December 31, 20X1, is:

Common Stock–Sly 100,000
Retained Earnings–Sly 50,000
Investment in Sly 120,000
Noncontrolling Interest in Sly 30,000

Question 40

2116.50

Answer 40

The eliminating entry at December 31, 20X1, is:

Common Stock–Sly 100,000
Retained Earnings–Sly 50,000
Investment in Sly 120,000
Noncontrolling Interest in Sly 30,000

Question 41

2116.51

Answer 41

Assume further that Sly reports net income in 20X2 of $70,000. Included in net income is a $15,000 gain on sale of land to Ply Company on September 1, 20X2; the land had a book value of $48,000 at the time of the sale.

Question 42

2116.52

Answer 42

Question 43

2116.53

Answer 43

From a consolidated entity standpoint, the gain is unrealized and the land is overstated by the amount of the gain. Therefore, the consolidated worksheet should reflect the elimination of this unrealized gain. The gain will be considered as realized only if Ply sells the land to an “outsider.”

Question 44

2116.54

Answer 44

Question 45

2116.55

Answer 45

Special attention should be directed to the eliminating entries for a consolidated balance sheet. Since the worksheet is for a consolidated balance sheet, the only accounts still open are balance sheet accounts. The $15,000 gain was closed into the retained earnings account of Sly. However, since Ply is using the equity method, Ply picked up 80% or $12,000 of the gain when it recorded its share of Sly’s net income. Therefore, the elimination of the gain involves a debit of $12,000 to Ply’s retained earnings and a debit of $3,000 to Sly’s retained earnings. Entry (2) is the normal investment eliminating entry.

Question 46

2116.56

Answer 46

The noncontrolling interest’s share of Sly’s 20X2 net income is determined as follows:

Net income reported by Sly $70,000
Unrealized gain included in Sly’s net income 15,000
Confirmed (or realized) net income of Sly 55,000
Noncontrolling interest percentage × .20
Noncontrolling interest’s share of net income $11,000
=======

Question 47

2116.57

Answer 47

Ply’s share of Sly’s net income then is:

Confirmed net income of Sly $55,000
Controlling interest percentage × .80
Ply’s share of Sly’s net inc $44,000
=======

Question 48

2116.61

Answer 48

Question 49

2116.61

Answer 49

The following assumptions are made for P Corporation and S Corporation:

On January 1, 20X1, P Corporation acquired 80% of the 5,000 outstanding shares of S Corporation’s $10 par common stock for $76,000.
S Corporation’s stockholders’ equity on January 1, 20X1, consisted of common stock, $50,000, and retained earnings, $20,000.
P Corporation uses the equity method but does not record the amortization of any differential or the impairment of any goodwill after the consolidated financial statements are prepared. Thus, with regard to its investment in S Corporation, in 20X1 P Corporation recorded on its own books its initial investment in the stock of S, its share of the net income of S, and its share of the dividends of S.
The fair values of S Corporation’s identifiable assets and liabilities on January 1, 20X1, were the same as their book values, except for buildings which had a book value of $30,000 and a fair value of $40,000. Thus, $10,000 of the excess of cost over book value was attributable to undervalued buildings and $15,000 to goodwill, as shown:

Cost of investment $76,000
Fair value of noncontrolling interest 19,000
S Corporation’s acquisition-date fair value $95,000
Less the book value of S 70,000
Excess of cost over book value $25,000
Allocated to building 10,000
Goodwill $15,000
=======

S Corporation’s buildings have an estimated remaining life of 10 years. (The portion of the differential that is attributable to undervalued buildings is to be amortized over 10 years.)
P Corporation determined at the end of 20X1 that goodwill related to its investment in S Corporation had been impaired in the amount of $2,000.
During 20X1, S Corporation sold land with a book value of $30,000 to P Corporation for $40,000. P Corporation still owns the land at December 31, 20X1.
At December 31, 20X1, S Corporation owes P Corporation $5,000 on open account.
During 20X1, P Corporation sold merchandise to S Corporation at cost for $8,000.

Question 50

2116.62

Answer 50

Question 51

2116.63

Answer 51

The noncontrolling interest’s share of net income, shown as a deduction in the consolidated column and as an addition in the noncontrolling interest column, is determined as follows:

Reported net income of S $16,000
Less: Unrealized gain on sale of land 10,000
Confirmed net income of S $ 6,000
Noncontrolling interest percentage x .20
Noncontrolling interest’s share of net income $ 1,200
=======
The noncontrolling interest, shown as part of the stockholders’ equity section, is determined as follows:

Noncontrolling interest, Jan. 1 $19,000
Noncontrolling interest’s share of net income 1,200
Less: Dividends paid to noncontrolling
interest (20% of $5,000) 1,000
Noncontrolling interest, Dec. 31 $19,200
=======

Question 52

2116.83

Answer 52

Intercompany Bond Investments

The acquisition by one entity of another unrelated (unaffiliated) entity’s outstanding bonds presents no special problems. The issuer must account for its bonds payable, whereas the acquiring entity must account for its investments in bonds. No gain or loss is recognized by the issuer when the bonds are sold nor by the acquirer when the outstanding bonds are purchased.

Question 53

2116.84

Answer 53

The same is true from the standpoint of the separate entities if the two entities are affiliates of each other. However, from a consolidated entity standpoint the acquisition of an affiliate’s outstanding bonds constitutes the consolidated entity’s reacquisition of its own bonds. Accordingly, any difference between the carrying amount of the bonds and their acquisition price should be recognized as a gain or loss for consolidation purposes.

Question 54

2116.85

Answer 54

Eliminations related to inventory and fixed assets involve the elimination of recorded but unrealized gains and losses. On the other hand, eliminations related to bonds involve the recognition of realized but unrecorded gains and losses.