FAR - F3: Marketable Securities and Business Combinations

Question 1

F3: Intercompany Accounting

**Intercompany Payable?

Answer 1

The intercompany receivable/payable due from Shel to Pare should equal the intercompany receivable from Pare to Shel.

**$12,000 interco payable.

Question 2

F3: Unrealized intercompany profit

Answer 2

**Difference between the combined and the consolidated Inventory.

**Unrealized interco profit will be eliminated.

Question 3

F3: $0 gain from the purchase of Parent stock by Sub.

Answer 3

**The Purchase by the member of a consolidated group of stock of another member of the consolidated group is treated as a treasury stock transaction.

**This follows the theory of consolidated financial statements presenting one economic entity.

**You cannot make money selling stock to yourself.

Question 4

F3: How should the receivable be reported in the consolidated balance sheet.

Answer 4

**The total receivable should be reported separately.

**Rule: When a company owns less then 50% of the common stock of an investee corporation, the investment account can be reported under the cost or equity method, depending on whether significant influence is exercised. Receivables and payables to the investee are reported separately on the balance sheet.

Question 5

F3: How should the summation of the parent and sub income statement items be adjusted?

Answer 5

**Sales and cost of goods sold should be reduced by the intercompany sales.

**Parent’s sales price is sub’s purchase price. When parent sells to an outside party, this amount becomes sub’s cost of sales. The Sales price to the outsider is okay, and the orginal cost of sales on Parent’s books is okay. but the sales and cost of sales are overstated, for a like amount, by the intercompany transaction.

Question 6

F3: The unrealized profit to be eliminated from inventory…

Answer 6

**Unrealized profit is calculated as;

Intercom profit on inventory x % of inventory purchased still on hand
+$48,000 x $60,000/$240,000
=$12,000

Note: No elimination is made related to the transaction with Dean Inc. because Dean is owned less than %50 is not consolidated.

Question 7

F3: What amount parent should report as intercompany receivables?

Answer 7

**100% of all intercompany balances among members of the consolidated group are eliminated.

Question 8

F3: All intercompany billings are eliminated in consolidation.

Answer 8

**Sales by the branch to outside parties are not eliminated.

Question 9

F3: What is the effect of Sub’s purchase of Parent’s bond on the retained earnings and noncontrolling interest amounts reported in Parent’s consolidated balance sheet?

Answer 9

**$100,000 increase in consolidated earnings, $0 effect on noncontrolling interest.

**The purchase of the parent company bond by the subsidiary is treated as the bond were retired when the financial statements are consolidated. Because the bond had a book value of $1,075,000, but was “retired” for $975,000, a gain is recorded upon consolidated.

JE on Consolidated worksheet:
Bond Premium:
Dr - Bond premiun(Parent’s books) $75,000
Dr - Bond Payable(Parents books) $1,000,000
Cr - Bond Investment (Sub’s books) $975,000
Retained earnings - consolidated $100,000
Cr - Noncontrolling interest 0

**Noncontrolling interest is only adjusted if the bonds were originally issued by the subsidiary and, as a result, a porting of the gain must be allocated to the noncontrolling interest. In this problem, the parent issued the bonds, so the elimination has no impact on noncontrolling interest.

Question 10

F3: The effect of the intercompany sale should be eliminated.

Answer 10

**The machine should be shown on the consolidated statements at Poe’s cost of $1,000,000. Depreciation should continue as if the sale had not occurred.

Question 11

F3: Fixed assets cost

Answer 11

Rule: Fixed asset cost is based on original cost from the outside world and remains the same on the consolidated financial statements.

Question 12

F3: In a consolidated balance sheet, the difference between the bond carrying amounts would be included as a decrease to retained earnings because premium was paid to “retire” the bonds.

Answer 12

Rule: When members of a consolidated group have intercompany bond holdings, the bonds are eliminated in consolidation and the difference (gain or loss) between the discounted issue price and the premium on reacquisiton would be included in the retained earnings.

Question 13

F3: How should be reported receivable in the consolidated statement as consolidation method and cost method

Answer 13

**The receivable from Sub (90% of ownership) will be eliminated in the consolidation. The receivable from Carr (20% - Card is not a sub) wil not be eliminated.

**Parent reports accounts receivable from affiliates (Carr) of $200,000 in its consolidated balance sheet.

Question 14

F3: Intercompany sales of depreciable assets

Answer 14

** In all intercompany sales of depreciable assets, depreciation expense must be adjusted back to what the expense would have been if the sale had not taken place. This adjustment is made at the time of consolidation.

For Example:
Depreciation expense after intercompany sale: $24,000 ($72,000/3)
Depreciation expense if no intercompany sale: $16,000 ($80,000/5)
—————————–
Difference: $8,000

Question 15

F3: What amount of dividends should reported in the consolidated financial statements?

Answer 15

**Since Jane owns 90% of Dun and 100% of Beech, when they declare and pay dividends, the only amounts that should appear in their year-end consolidated financial statements are the dividends paid to outsiders or external parties.

**Interconpany dividends should be eliminated upon consolidation. In this case, the only non-controlling interest that exists is the 10% of Dun that Jane does not own.

Therefore, just 10% of Dun’s $100,000 dividend, or $10,000 will appear in Jane and sub’s year-end consolidated financial statements, specifically, the consolidated statement of cash flows and the consolidated statement of equity.

Question 16

F3: Intercompany transactions including loans and advance

Answer 16

**All intercompany transactions, including loans and advance, should be eliminated upon consolidation.

**The percentage ownership here is irrelevant. Therefore, none of the $100,000 advance should appear in the consolidated balance sheet.

Question 17

F3: Intercompany profit

Answer 17

**Intercompany profit from the sale that must be eliminated.

For Example:
**Parent sold to Sub $800,000, 25% above the cost:
Cost x 1.25 = $800,000
Cost = $640,000

**So the $160,000 difference between the sales price of $800,000 and the cost of 640,000 is the in the intercompany profit from the sale that must be eliminated.

**At the yerar end sub held $200,000 or 25% of the inventory purchase from Parent in ending inventory, which 75% of the inventory was sold.
Therefore, 25% of the intercompany profit of $160,000 is eliminated from ending inventory and 75% is the emliminated from cost of goods sold.

$160,000 x 25% = $40,000 eliminated from ending inventory
$160,000 x 75% = $120,000 eliminated from COGS.

The eliminating entry would be:

Dr- Intercompany revenue - Parent $800,000
Cr - Intercompany COGS - Parent $640,000
Cr - Cost of Goods sold - Sub $120,000
Cr - Inventory - sub $40,000

Question 18

F3: Intercompany liabilities

Answer 18

**$100,000 note payable to Parent must be eliminated in the consolidated financial statements because the transaction would lack the criteria of being at arm’s length.

**A company cannot owe itself.

Question 19

F3: Combined statements may be used for companies under common management or commonly controlled companies.

Answer 19

Procedure:

1. All intercompany transactions are balances among the related companies are eliminated.
2. Minority interests are treated as in consolidated financial statements.
3. Equity accounts are added across, not eliminated.
4. Income statement accounts are added across.

Question 20

F3: Combined financial statements may be prepared for:

Answer 20

1. Many companies owned by on individual.
2. Many companies under common management.
3. Unconsolidated subsidiaries.

Question 21

F3: What amount inercomapny loans and profits should be included in the combined financial statements?

Answer 21

Rule: “Combined financial statements” do not eliminate “equity” accounts (they are all added across).

**However, all other intercompany “transactions” and “balances” are eliminated in combined financial statements just as they are in the consolidated financial statements.

Question 22

F3: Combined financial statements and Consolidated financial statements

Answer 22

**Combined financial statements are prepared in the same manner as consolidated financial statements except there is no parent company.

**Therefore, there is no investment in sub account to eliminate against sub equity accounts.

**Different fiscal periods and foreign operations are treated in the same manner in the both combined financial statements and consolidated statements.

Question 23

Question: What amount should Type report as unrealized gain (loss) in its Year 2 income statement?

Answer 23

Answer:

Rule:

1. Unrealized gains and losses are reported as follows:
   - Trading securities - reported at fair value with unrealized gains and losses included in earnings (along with “realized” gains and losses, if any)
2. Available-for-sale securities-reported at fair value with unrealized gains and losses reported as a separate component of “Other comprehensive income” until realized.
3. Held-to-Maturity reported as Amortized cost.

Question 24

Question: When the fair value of an investment in debt securities exceeds its amortized cost, how should each of the following debt securities be reported at the end of the year?

Answer 24

Answer:

1. Debt securities (bonds) classified as “held-to maturity” are reported at amortized cost (that is, cost adjusted for amortization of premium or discount; approaches face value).
2. Debt securities classified as available-for-sale are reported at fair value.

Question 25

Question: What amount should Wynn report for available-for-sale investments in debt securities?

Answer 25

Answer: The security would be recorded at fair value on July 2, Year 1, or $910,000. Accrued interest is a receivable and does not affect cost. The $90,000 discount is not amortized or short-term investments. On December 31, Year 1, the investment would be adjusted to fair value, $945,000. The unrealized holding gain of $35,000 would be reported as a separate component of other comprehensive income.

**The accrued interest of $40,000 at 12/31/Y1 would be recorded as “interest receivable”, not as part of the “investment account.”

Question 26

Question: What amount of loss from investment should Sun report in its Year 2 income statement?

Answer 26

Answer: $45,000 loss should be reported in the Year 2 Income statement.

**Rule: When marketable equity securities are transferred between trading and available-for-sale, the transfer is made at fair value, and the difference (if any) is recorded as unrealized loss and changed tot he income statement. The new carrying amount becomes the basis for any future gain or loss.

Orginal cost: $650,000
Unrealized I/S loss for Year 1: (75,000)
———————————————————–
FMV at 12/31/ Year 1 $575,000
FMV at 6/30/Year 2 (530,000)
——————————————————-
Unrealized loss in Year 2 I/S $45,000

Question 27

Question: What amount should Sun report as net unrealized loss on available-for-sale marketable equity securities in its Year 2 statement of stockholders’ equity?

Answer 27

Answer: $40,000 net unrealized loss on available-for-sale marketable equity securities in its Year 2 statement of stockholders’ equity.

Rule: Available-for-sale marketable equity securities are recorded at the fair value, and any temporary difference is reported as “Net unrealized loss on available-for-sale marketable equity securities” in other comprehensive income on the statement of stockholders’ equity.

Carrying amount 6/30/Year 2 $530,000

Question 28

Question: What amount should Sun report as net unrealized loss on available-for-sale marketable equity securities in its Year 2 statement of stockholders’ equity?

Answer 28

Answer: $40,000 net unrealized loss on available-for-sale marketable equity securities in its Year 2 statement of stockholders’ equity.

Rule: Available-for-sale marketable equity securities are recorded at the fair value, and any temporary difference is reported as “Net unrealized loss on available-for-sale marketable equity securities” in other comprehensive income on the statement of stockholders’ equity.

Carrying amount 6/30/Year 2 $530,000
FMV December 31, Year 2 (490,000)
———————————————————–
Net unrealized loss at 12/31/Year 2: $40,000

Question 29

Question: What amount of loss from investment should Sun report in its Year 2 income statement?

Answer 29

Answer: $45,000 loss should be reported in the Year 2 Income statement.

**Rule: When marketable equity securities are transferred between trading and available-for-sale, the transfer is made at fair value, and the difference (if any) is recorded as unrealized loss and changed tot he income statement. The new carrying amount becomes the basis for any future gain or loss.

Orginal cost: $650,000
Unrealized I/S loss for Year 1: (75,000)
———————————————————–
FMV at 12/31/ Year 1 $575,000
FMV at 6/30/Year 2 (530,000)
——————————————————-
Unrealized loss in Year 2 I/S $45,000

**There will be unrealized loss of $40,000 will be reported to OCI.

Question 30

Question: What amount should Sun report as net unrealized loss on available-for-sale marketable equity securities in its Year 2 statement of stockholders’ equity?

Answer 30

Answer: $40,000 net unrealized loss on available-for-sale marketable equity securities in its Year 2 statement of stockholders’ equity.

Rule: Available-for-sale marketable equity securities are recorded at the fair value, and any temporary difference is reported as “Net unrealized loss on available-for-sale marketable equity securities” in other comprehensive income on the statement of stockholders’ equity or “Other comprehensive Income”

Carrying amount 6/30/Year 2 $530,000
FMV December 31, Year 2 (490,000)
———————————————————–
Net unrealized loss at 12/31/Year 2: $40,000

Question 31

Question: When the market value of an investment in debt securities in which the company has a positive intent and ability to hold to maturity exceeds its carrying amount, how should each of the following assets be reported at the end of the year?

Answer 31

Answer:

• Long-term marketable debt securities - Carrying amount
• Short-term marketable debt securities - Carrying amount

Rule: Marketable debt securities that the company has the intent and ability to hold to maturity, both “long” and “short” term are reported at carrying amount (amortized cost) unless there is a permanent decline in market value.

Question 32

Question: Ace, Ltd, reports under IFRS.

• What amount that Ace will report as other comprehensive income is:
• Stock A, unrealized gain of $5,000
• Stock B, foreign exchange gain of $1,500
• Bond A, foreign exchange loss of $2,300
• Bond B, unrealized loss of $450

Answer 32

Answer: Under IFRS, unrealized gains and losses for all available for sale securities and foreign exchange gains and losses for available for sale equity securities are reported as Other comprehensive income.

**Foreign exchange gain and losses on available for sale debt securities are reported on the income statement.
($5,000 + $1,500 - $450) = $6050 should all be included in other comprehensive income.

**The foreign exchange loss of $2,300 for Bond A should be reported on the income statement.

Question 33

Question: What amount should Bard include as liabilities in its consolidated balance sheet at December 31?

Answer 33

Answer: $16,000.

**The liabilities of any company which is greater than 50% owned by Bard Co. should be included as liabilities in the consolidated financial statements at December 31..

Question 34

Question: The amount of dividend revenue that should be reported in the investor’s income statement for this year would be:

Answer 34

**The amount of dividend revenue that should be reported in the investor’s income statement for this year would be the portion of the dividends received this year that were not in excess of the investor’s share of investee’s undistributed earnings since the date of investment.

Rule: Dividend revenue, under the cost method, should be recognized to the extent of cumulative earnings since acquisition and “return of capital” beyond that point.

Question 35

Question: Pal Corp’s Year 1 dividend income included only part of the dividend received from its Ima corp. investment. The balance of the dividend reduced Pal’s carrying amount for its Ima investment. This reflects that Pal accounts for its Ima investment by the:

Answer 35

Answer; Cost method, and only a portion of Ima’s Year 1 dividends represent Pal’s earnings after Pal’s acquisition.

Rule:

Question 36

Question: Pal Corp’s Year 1 dividend income included only part of the dividend received from its Ima corp. investment. The balance of the dividend reduced Pal’s carrying amount for its Ima investment. This reflects that Pal accounts for its Ima investment by the:

Answer 36

Answer; Cost method, and only a portion of Ima’s Year 1 dividends represent Pal’s earnings after Pal’s acquisition.

**The facts indicate a portion of the dividends were considered income and a portion a return of capital.

**This implies the cost method and dividends in excess of earnings.

Rule: Under the cost method, dividends (not earnings) are reflected as income by the investor. The cost basis investment account is reduced only if:

1. Share of stock are sold, or
2. Cumulative dividneds exceed cumulative earnings (a return of capital) or
3. Subsidiary incurs losses that substantially reduced net worth.

Question 37

Question: When the equity method is used to account for investments in common stock, which of the following affects the investor’s reported investment income

Answer 37

Answer:

• A change in market value of investee’s common stock- NO
• cash dividends from investee - NO

Question 38

Question: When the equity method is used to account for investments in common stock, which of the following affects the investor’s reported investment income

Answer 38

Answer:

• A change in market value of investee’s common stock- NO
• cash dividends from investee - NO

Rule: Investor records as revenue its “Share of the investee’s earnings” (not dividends received) under the equity method.

2. Dividends from an investee company are recorded by the investor as a reduction in the carrying amount of the investment on the balance sheet of the investor.
3. Changes in the market value of investee’s common stock are not considered income to the parent under the equity method.
4. Under the cost method, receipt of a dividend is recorded as income and does not affect the investment account.

Question 39

Question: What amount of dividend revenue should Green report in its income statement for the year ended December 31, Year 1?

Answer 39

Answer: $60,000

**Because Green, the investor, exercises significant influence over the investee corporation, it must use the equity method for recording common stock dividends.

**Under the equity method, the common stock dividends are recorded as a reduction to the investment account.

**Preferred stock ownership does not allow the investor to exercise influence, so the preferred stock investment is accounted for using the cost method and the preferred stock dividends of $60,000 are recorded as dividend revenue on the income statement.

Question 40

Question: An investor in common stock received dividends in excess of the investor’s share of investee’s earnings (liquidating dividends) subsequent tot he date of the investment. How will the investor’s investment account be affected by those dividneds under each of the following accounting methods?

Answer 40

Cost Method - Decrease
Equity Method - Decrease

Rule:
Under both the cost and equity methods, liquidating dividends reduce the carrying amount of the investment account.

Question 41

Question The correct accounting for this goodwill during the current year is:

Answer 41

**No Accounting necessary.

**Any goodwill created in an investment accounted for under the equity method is ignored.

**It is neither amortized nor tested for impairment.

**The entire investment (using the equity method) is subject to the impairment test.

Question 42

Question: What amount should be included in the current liability section of Bake’s December 31, Year 1, balance sheet?

Answer 42

Answer: All of the items listed will be included in the current liabilities section of Bake’s December 31, year 1 balance sheet.

**Accounts payable are current liabilities.

**The bond payable, less the discount, is classified as a current liability because it will be paid in the next operation period.

**The deferred tax liability is classified as current because it is not related to an asset and will reverse during the next operation period.

A/P   $80,000
B/P    300,000
Bond discount: (15,000)
Deferred tax liability: 25,000
------------------------------------------------
Total current lib:     $390,000

Question 43

Question: When the allowance method of recognizing uncollectible accounts is used, how would the collection of an account previously written off affect accounts receivable and the allowance for uncollectible accounts?

**Write off JE:

Dr - Allowance for Uncollectible accounts (AUA)
Cr - Account Receivable

Answer 43

Answer:
Accounts Receivable - No Effect
Allowance for uncollectible accounts - increase

**Under the allwance method, the following Journal Entries are recorded when an account previously written off is subsequently collected.

JE #1 - To restore the account previously written off (Just switch the write off JE)

Dr - Accounts Receivable
Cr - Allowance for Uncollectible Accounts.

JE #2 - To record the cash collection on the account:
DR - Cash
CR - Accounts Receivable.

**The debit to account receivable in JE #1 is offset by the credit to acc

Question 44

Question: When the allowance method of recognizing uncollectible accounts is used, how would the collection of an account previously written off affect accounts receivable and the allowance for uncollectible accounts?

**Write off JE:

Dr - Allowance for Uncollectible accounts (AUA)
Cr - Account Receivable

Answer 44

Answer:
Accounts Receivable - No Effect
Allowance for uncollectible accounts - increase

**Under the allwance method, the following Journal Entries are recorded when an account previously written off is subsequently collected.

JE #1 - To restore the account previously written off (Just switch the write off JE)

Dr - Accounts Receivable
Cr - Allowance for Uncollectible Accounts.

JE #2 - To record the cash collection on the account:
DR - Cash
CR - Accounts Receivable.

**The debit to account receivable in JE #1 is offset by the credit to accounts receivable in JE #2.

**So there is no effect on accounts receivable. The credit to the allowance for uncollectible accounts in JE # 1 increase the allowance.

Question 45

Question: What amount should the company include in the current liability section of the balance sheet?

Answer 45

Answer: The $16,000 current portion of the mortgage-note payable must be reported as a current liability.

**The non-current portion of the mortgage-note payable, the short-term debt that is being refinanced with long-term debt and the depreciation-related deferred tax liability must be reported as non-current liabilities.

Note: deferred tax liability is reported as current asset if it is not related to asset.

Question 46

Question: What amount should the company include in the current liability section of the balance sheet?

Answer 46

Answer: The $16,000 current portion of the mortgage-note payable must be reported as a current liability.

**The non-current portion of the mortgage-note payable, the short-term debt that is being refinanced with long-term debt and the depreciation-related deferred tax liability must be reported as non-current liabilities.

Note: deferred tax liability is reported as current asset if it is not related to asset (e.g. Deferred income tax liability)