Chapter 7: Consolidated Financial Statements

Question 1

Connecting Affiliation

Answer 1

two or more companies own an interest in another member of that organization

Question 2

direct ownership

Answer 2

there is no affiliation between subsidiaries

Question 3

Indirect ownership

Answer 3

One subsidiary possesses the stock of another rather than the parent having direct ownership

Question 4

Why does indirect ownership occur?

Answer 4

developed to enhance control, result from the parent company’s acquisition of a company that already possesses subsidiaries

Question 5

How does the consolidation process change when indirect control is present?

Answer 5

the worksheet entries are effectively doubled by each corporate ownership layer but the concepts underlying the consolidation process are not changed.

Question 6

How is income recognized when there are multiple companies in both a parent and a subsidiary position?

Answer 6

Must recognize the equity income accruing from its own subsidiary before computing its own income.

Question 7

Mutual Ownership

Answer 7

A subsidiary owns shares of its parent company

Question 8

How are parent shares being held by the subsidiary accounted for?

Answer 8

the cost paid to acquire the parent’s stock is reclassified within the consolidation process to a treasury stock account and no income is accrued.

Question 9

According to tax laws do consolidated entities have to file a consolidated return?

Answer 9

A consolidated entity may elect to file a consolidated return encompassing all companies that compose an affiliated group as defined by the IRC. The Code automatically requires all other corporations to submit separate income tax returns.

Question 10

When should a parent include a subsidiary within an affiliated group?

Answer 10

Parent’s ownership is at least 80% of the voting stock and at least 80% of the nonvoting stock. They must be a domestic entity and not a foreign entity.

Question 11

What are some benefits to consolidated tax returns?

Answer 11

↔Intra-entity profits are not taxed until the asset leaves the consolidated entity, losses incurred by one affiliated company can be used to reduce taxable income recognized by other group members, intra-entity dividends are not taxed

Question 12

temporary differences

Answer 12

a variation between an asset or liabilities recorded book value and its tax basis exist, results in differences in taxable income in future years

Question 13

deferred tax liability

Answer 13

additional taxes will result in future years, a DTL is written off in future years so that the net expense recognized matches the combination’s book income

Question 14

when are dividends removed from income in tax accounting?

Answer 14

only if at least 80% of subsidiary’s stock is held

Question 15

what happens is a parents has less than 80% of a subsidiary’s stock, and dividends need to be recognized?

Answer 15

An income tax liability is created based on the dividends collected and a deferred tax liability is recorded for the taxable portion of any income not paid to the parent

Question 16

How does goodwill affect taxes?

Answer 16

the amortization of goodwill and other purchased intangibles is allowed over a 15 year period

Question 17

When are intra-entity profits deferred?

Answer 17

gross profits in inventory are removed until the transferred asset leaves the group

Question 18

What occurs if separate tax returns are filed and intra-entity profits are present?

Answer 18

Tax laws require the inclusion of inventory profits in the period of inventory transfer even though not yet recognized by the consolidated entity

Question 19

What occurs if there are intra-entity profits that are not inventory?

Answer 19

Recognize the related income tax effects in the period in which the transfer occurs.

Question 20

How does a parent company compute income taxes for financial reporting purposes

Answer 20

A parent company includes a single total income tax expense figure on its consolidated income statement.

Question 21

Percentage allocation method

Answer 21

Attributes the GAAP tax expense based on the relative contribution of each affiliate to taxable income

Question 22

Can a company elect to file separate returns if they previously elected to use consolidated returns?

Answer 22

No, unless they obtain permission from the IRS to file separately

Question 23

What temporary differences emerge from income being recognized for consolidated financial reporting versus income tax reporting when filing separately?

Answer 23

The immediate taxation of intra-entity profits and possible future tax effects of the subsidiary income in excess of dividend payments

Question 24

What are delayed tax payments for a parent that waits to pay on profits from subsidiary dividend?

Answer 24

deferred tax liability

Question 25

When are deferred taxes on dividend payments not required?

Answer 25

When ownership equals or exceeds 80%. The tax law provides a 100% dividends-received deduction

Question 26

When do net operating losses benefit the company?

Answer 26

carrying the loss forward reduces subsequent taxable income, this only benefits the company if it has future taxable income

Question 27

How does a parent company account for a subsidiary with a NOL carryforward?

Answer 27

If it is more likely than not that the benefit will be realized than the parent will recognize remaining as goodwill. If the chances the sub will use the benefit are less than 50% than the NOL carryfoward should be recognized as a valuation allowance

Question 28

How does the parent company remove the valuation allowance?

Answer 28

Must be reported as reduction or increase in income tax expense

Question 29

In a father-son-grandson business combination, which of the following is true?
A. The father company always must have its total accrual-based income computed first.
B. The computation of a company’s accrual-based net income has no effect on the accrual-based net income of other companies within a business combination.
C. A f-s-g configuration does not require consolidation unless one company owns shares in all of the other companies.
D. All companies solely in subsidiary positions must have their accrual-based net income computed first within the consolidation process.

Answer 29

D

Question 30

A subsidiary owns shares of its parent company. Which of the following is true concerning treasury stock approach?
a. it is one of several options to account for mutual holdings available under current accounting standards.
b. the original cost of the subsidiary’s investment is a reduction in consolidated stockholder’s equity.
c. the subsidiary accrues income on its investment by using the equity method.
d. the treasury stock approach eliminates these shares entirely within the consolidation approach?

Answer 30

B

Question 31

On January 1, Balanger Company buys 10 percent of the outstanding shares of its parent, Altgeld, Inc, Although the total book and fair value of Altgeld’s assets equaled 3.2 million, the price paid for shares was 340,000. During the year, Altgeld reported 415,000 of separate operating income and declared dividends of 35,000. How are the shares of the parents owned by the subsidiary reported at December 31?
a. consolidate SE is reduced by 340,000
b. an investment balance of $378000 is eliminated
c. Consolidated SE is reduced by 378,000
d. an investment balance of 358,000 is eliminated

Answer 31

A

Question 32

Which of the following is correct for two companies that want to file a consolidated tax return as an affiliated group?
a. one company must hold at least 51% of voting stock
b. one company must hold at least 65%
c. one company must hold at least 80%
d. they cannot file unless one company owns 100%

Answer 32

C

Question 33

How does the amortization of tax-deductible goodwill affect the computation of a parent’s company’s income taxes?
a. it is a deductible expense only if the parents owns at least 80% of subs voting stock
b. it is deductible only as impairments are recognized
c. it is deductible item over a 15 year period
d. it is deductible only if a consolidated tax return is filed

Answer 33

C