Fa4e Sm Ch12

7/27/2019 Fa4e Sm Ch12

1/41

Cambridge Bu siness Publ is hers, 2014

Solut ions Manual, Chapter 12 12-1

Chapter 12

Reporting and Analyzing FinancialInvestments

Learning Objectives coverage by questionMini-

ExercisesExercises Problems

Cases andProjects

LO1Explain and interpret the threelevels of investor influence over aninvestee passive, significant, andcontrolling.

11, 12 - 18,

20 - 23

24 - 33,

35 - 4245 - 48 49 - 52

LO2Describe the term fair valueand the fair value hierarchy.

13 34 51, 52

LO3 Describe and analyzeaccounting for passive investments.

11, 12,

20 - 22

24, 25,

27, 29, 32,

35 - 37

44, 47 50 - 52

LO4 Explain and analyzeaccounting for investments withsignificant influence.

14 - 16, 19

26, 28,

30 - 34,

37, 38

44, 47, 48 49 - 51

LO5 Describe and analyzeaccounting for investments withcontrol.

17, - 19, 23 41, 42 44 - 47 49

LO6 Appendix 12A Illustrate andanalyze accounting mechanics forequity method investments.

48 49

LO7 Appendix 12B Apply equitymethod accounting mechanics toconsolidations.

39, 40, 42 45, 46

LO8 Appendix 12C Discuss thereporting of derivative securities.

43

7/27/2019 Fa4e Sm Ch12

2/41

Cambridge Bu siness Pub l ishers, 2014

12-2 Financial Acco unting, 4thEdit ion

DISCUSSION QUESTIONS

Q12-1. a) Trading securities are reported at their fair value in the balance sheet. b)Available-for-sale securities are reported at their fair value in the balance sheet.c) Held-to-maturity securities are reported at their amortized cost in the balance

sheet.

Q12-2. An unrealizedholding gain (loss) is an increase (decrease) in the fair value ofan asset (in this case, an investment security) that is still owned.

Q12-3. Unrealized holding gains and losses related to trading securities are reported inthe current-year income statement (and also retained earnings). Unrealizedholding gains and losses related to available-for-sale securities are reported asa separate component of stockholders' equity called Other ComprehensiveIncome (OCI).

Q12-4. Significant influence gives the owner of the stock the ability to influence

significantly the operating and financing activities of the company whose stockis owned. Normally, this is accomplished with a 20% through 50% ownership ofthe company's voting stock.

The equity methodis used to account for investments with significant influence.Such an investment is initially recorded at cost; the investment is increased bythe proportionate share of the investee company's net income, and equityincome is reported in the income statement; the investment account isdecreased by dividends received on the investment; and the investmentaccount is reported in the balance sheet at its book value. Unrealizedappreciation in the market value of the investment is not recognized.

Q12-5. Yetman Company's investment in Livnat Company is an investment withsignificant influence, and should, therefore, be accounted for using the equitymethod. At year-end, the investment should be reported in the balance sheet at$258,000 [$250,000 + (40% $80,000) - (40% x $60,000)].

Q12-6. A stock investment representing more than 50% of the investee company'svoting stock is generally viewed as conferring control over the investeecompany. The investor and investee companies must be consolidated forfinancial reporting purposes.

Q12-7. Consolidated financial statements attempt to portray the financial position,operating results, and cash flows of affiliated companies as a single economicunit so that the scope of the entire (whole) entity is more realistically conveyed.

7/27/2019 Fa4e Sm Ch12

3/41



Q12-8. The $750,000 investment in Murray Company appearing in Finn Company'sbalance sheet and the $300,000 common stock and $450,000 retainedearnings appearing on Murray Company's balance sheet are eliminated. Thetwo balance sheets (less the accounts eliminated) are then summed to yield theconsolidated balance sheet.

Q12-9.B The $75,000 accounts payable on Dee's balance sheet and the $75,000accounts receivable on Bradshaw's balance sheet are eliminated. In aconsolidation, all intercompany items are eliminated so that the consolidatedstatements show only the interests of outsiders.

Q12-10. Limitations of consolidated statements include the possibility that theperformances of poor companies in a group are "masked" in consolidation.Likewise, rates of return, other ratios, and percentages calculated fromconsolidated statements might prove deceptive because they are composites.Consolidated statements also eliminate detail about product lines, divisionaloperations, and the relative profitability of various business segments. (Some of

this information is likely to be available in the footnote disclosures relating to thebusiness segments of certain public firms.) Finally, shareholders and creditorsof subsidiary companies find it difficult to isolate amounts related to their legalrights by inspecting only consolidated statements.

7/27/2019 Fa4e Sm Ch12

4/41



MINI EXERCISES

M12-11. (10 minutes)

a. Available-for-sale securities are reported at fair value on the balance sheet. For2011, this is equal to the original cost ($36,135 million) plus unrecognized gains($810 million) and less unrealized losses ($22 million), or $36,923 million.

b. Unrealized gains (and losses) on available-for-sale securities are reported as acomponent of Accumulated Other Comprehensive Income (AOCI) in theshareholders equity section ofthe balance sheet.


a. Wasley will report the dividends received of $6,600 (6,000 shares

$1.10 per share)as income. If the investment is accounted for as available-for-sale, the increase inthe market price of the stock will not be recognized as income until the stock is sold.Unrealized gains (losses) are reported as Other Comprehensive Income in thestockholders equity section of the balance sheet.

b. If the investment is accounted for as trading, Wasley will report $6,600 of dividendincome plus income relating to the increase in the market price of the stock of$6,000 ($13 - $12 price increase for 6,000 shares).


a. All of these investments are marked to fair value, but the determination differs.Level 1 fair values are determined by reference to an active market where identicalassets are traded. Level 2 fair values are determined by using a model (discountedcash flow, prices of similar assets, etc.) for which the inputs and assumptions can befound from observable value. Level 3 fair values are also determined by using amodel, but the inputs and assumptions are not observable except to the reportingcompany.

b. Only Level 1 investments are marked-to-market, the others are marked-to-model.

Level 1 values would be the most objective since they come from an active market.Level 3 would be most subjective because they depend significantly onmanagements judgments.

c. Level 1 assets are most liquid, because they are traded in active markets. Level 3assets are likely to be least liquid because their value depends significantly oninformation that is not publicly known.

7/27/2019 Fa4e Sm Ch12

5/41




a. Given the 30% ownership, significant influence is presumed and the investmentmust be accounted for using the equity method. The year-end balance of theinvestment account is computed as follows:

Beginning balance ............................ $1,000,000% Lang income earned ..................... 30,000 ($100,000 0.3)% Dividends received ....................... (12,000) ($40,000 0.3)Ending balance ................................. $1,018,000

b. $30,000 ($100,000 0.3) - Equity earnings are computed as the reported netincome of the investee (Lang Company) multiplied by the percentage of theoutstanding common stock owned.

c. (1) In contrast to the market method, the equity method of accounting does notreport investments at market value. The unrealized gain of $200,000 is not reflected

in either the balance sheet or the income statement.

d.1. Investment in Lang Company (+A) .................................... 1,000,000

Cash (-A) ....................................................................... 1,000,000

2. Investment in Lang Company (+A) .................................... 30,000Investment income (+R, +SE) ....................................... 30,000

3. Cash (+A) .......................................................................... 12,000Investment in Lang Company (-A) ................................. 12,000

e.+ Cash (A) - - Investment Income (R) +

1,000,000 1. 30,000 2.

3. 12,000

+ Investment in Lang Company (A) -

1. 1,000,0002. 30,000

12,000 3.

f. Balance Sheet Income Statement

TransactionCashAsset

+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital

Revenues - Expenses =Net

Income

Purchase stock inLang Company.

-1,000,000Cash

+1,000,000Investment

= - =

Recognize share ofLang income.

+30,000Investment

=+30,000RetainedEarnings

+30,000Investment

Income- = +30,000

Receive dividendfrom Lang.

+12,000Cash

-12,000Investment

= - =

7/27/2019 Fa4e Sm Ch12

6/41




Equity income on this investment is computed as the investee company (Penno)earnings multiplied by the percentage of the company owned. In this case, equityearnings equal:

$600,000 40% = $240,000

Note that dividends are treated as a return of investment (reduce the investmentbalance by $80,000, computed as $200,000 40%), and not as income. Also, theinvestment is recorded at adjusted cost, not at market value, and unrealized gains(losses) are neither recognized on the balance sheet nor in the income statement.


a. General Mills reports income from its joint ventures at $96.4 million on its 2011

income statement. Equity method investments are reported on the balance sheet atadjusted cost, not at current market value. Adjusted cost is the original purchaseprice plus (minus) General Mills proportionate share of investee companies profits(losses), less dividends received.

b. Merck will account for the $72.7 million in cash dividends received on equity methodinvestments as a reduction of the investment balance, not as income.

c. The starting balance of $398.1 million would have been increased by $96.4 millionby the recognized income and decreased by $72.7 million, leaving a balance of$421.8 million. That would imply that General Mills increased its advances to jointventures by $519.1 million - $421.8 million, or $97.3 million.


The $600,000 investment in Hirst Company appearing on Philipich Company's balancesheet and the $300,000 common stock and $450,000 retained earnings of HirstCompany would be eliminated.

In addition, a $150,000 minority interest [20% of ($300,000 + $450,000)] would appearon the consolidated balance sheet. Many analysts treat the minority interest as anequity account, and FASB has issued an exposure draft requiring presentation as suchif the proposal becomes GAAP.

7/27/2019 Fa4e Sm Ch12

7/41




Benartzi Company net income ................................................... $600,00090% of $150,000 Liang Company net income ........................... 135,000Consolidated net income ............................................................ $735,000


a. If DeFond purchases 100% of Verduzcos common stock, then it must produceconsolidated reports.

DeFondCompany

(beforeinvestment)

DeFondCompany

(afterinvestment)

VerduzcoCompany

Eliminatingentries

DeFondCompany

(Consolidated)

Current assets $ 800 $ 500 $ 100 $ 600

Investment 300 (300)

Noncurrent assets 2,000 2,000 900 2,900

Liabilities 2,200 2,200 700 2,900

Shareholders Equity 600 600 300 (300) 600

b. If DeFond purchases 50% of the common stock of Lin Company, it uses the equitymethod.

DeFond Company(before investment)

DeFond Company(after investment)

LinCompany

Current assets $ 800 $ 500 $ 200

Investment 300

Noncurrent assets 2,000 2,000 1,800

Liabilities 2,200 2,200 1,400

Shareholders Equity 600 600 600

c. If we compare DeFonds consolidated balance sheet to the equity method balancesheet, we can see that the total assets are higher and the liabilities are higher.DeFonds stockholders equity accounts are the same. So, the Debt-to-Equity ratiowill be higher if DeFond purchases the subsidiary rather than investing in the joint

venture. If reported profits are the same under either scenario, then purchasing thesubsidiary would produce a lower Return on Assets than the joint venture. Otherratios would change as well (like the Current Ratio), but not in a predictabledirection.

7/27/2019 Fa4e Sm Ch12

8/41




a. 201310/1 Investment in Skyline, Inc. (+A) ............................... 486,000

Cash (-A) .............................................................. 486,000

12/31 Interest receivable (+A) ............................................ 8,750Interest revenue (+R, +SE) .................................. 8,750

12/31 Investment in Skyline, Inc. (+A) ............................... 4,000Unrealized gain (+R, +SE) ................................... 4,000

20143/31

Cash (+A) ................................................................. 17,500

Interest receivable (-A) ......................................... 8,750

Interest revenue (+R, +SE) .................................. 8,750

4/1 Cash (+A) ................................................................. 492,300Realized gain (+R, +SE) ...................................... 2,300Investment in Skyline, Inc. (-A) ............................ 490,000

b. Assuming the firms fiscal year ends 12/31, the unrealized gain of $4,000 in SkylineInc. bonds is closed to retained earnings in 2013 increasing net income and retainedearnings.

+ Cash (A) - - Interest Revenue (R) +

486,000 10/1/13 8,750 12/31/133/31/14 17,500 8,750 3/31/14

4/1/14 492,300

+ Investment in Skyline Bonds (A) - - Unrealized Gain (R) +

10/1/13 486,000 4,000 12/31/13

12/31/13 4,000 490,000 4/1/14

+ Interest Receivable (A) - - Realized Gain (R) +

12/31/13 8,750 8,750 3/31/14 2,300 4/1/14

continued next page

7/27/2019 Fa4e Sm Ch12

9/41



M12-20. concluded

c.

Balance Sheet Income Statement

TransactionCash

Asset+

Noncash

Assets=

Liabil-

ities+

Contrib.

Capital+

Earned

CapitalRevenues - Expenses =

Net

Income10/1/13 Purchase$500,000 of Skylinebonds at 97.

-486,000Cash

+ 486,000Investment

= - =

12/31/13Recognize interestrevenue.

+8,750Interest

Receivable=

+8,750RetainedEarnings

+8,750Interest

Revenue- = +8,750

12/31/13Record unrealizedgain.

+4,000Investment

=+4,000

RetainedEarnings

+4,000Unrealized

Gain- = +4,000

3/31/14 Recognizeinterest income.

+17,500Cash

-8,750Interest

Receivable=


+8,750Interest

Revenue- = +8,750

4/1/14Sold Skylineinvestment.

+492,300Cash

-490,000Investment

= +2,300RetainedEarnings

+2,300RealizedGain

- = +2,300

M12-21. (40 minutes)a. 2013

11/15 Investment in Lane, Inc. (+A) ................................................. 171,200Cash (-A) ........................................................................... 171,200

12/22 Cash (+A) .............................................................................. 10,000Dividend income (+R, +SE) ............................................... 10,000

12/31 Unrealized loss (+E, -SE) ...................................................... 16,200Investment in Lane, Inc. (-A) .............................................. 16,200

20141/20 Cash (+A) ........................................................................... 150,000

Loss on sale of investment in Lane, Inc. (+E, -SE) ............. 5,000Investment in Lane, Inc. (-A) ...................................... 155,000

continued next page

7/27/2019 Fa4e Sm Ch12

10/41



M12-21. concluded

b. Assuming the firms fiscal year ends 12/31, the unrealized loss of $16,200 is closed tothe income summary in 2013, reducing net income and retained earnings.

+ Cash (A) - + Investment in Lane Inc (A) -

12/22 10,000 171,200 11/15 11/15 171,200 16,200 12/311/20 150,000 155,000 1/20

+ Loss (E) -

1/205,000

+ Unrealized Loss (E) - - Dividend Income (R) +

12/31 16,200 10,000 12/22

c.



+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

11/15 Purchase6,000 shares ofLane Inccommon.

-171,200Cash

+171,200Investment

= =

12/22 Dividendincome.

+10,000Cash


+10,000DividendIncome

= +10,000

12/31 Decrease inInvestment.

-16,200Investment

=-16,200

RetainedEarnings

+16,200Unrealized

Loss= -16,200

1/20 Sale of Lanecommon.

+150,000Cash

-155,000Investment

=-5,000

RetainedEarnings

+5,000Realized

Loss= -5,000

7/27/2019 Fa4e Sm Ch12

11/41




The main effect is to defer the loss in value experienced in 2013 to the year 2014.

201311/15 Investment in Lane, Inc. (+A) ................................................. 171,200

Cash (-A) ........................................................................... 171,200

12/22 Cash (+A) .............................................................................. 10,000Dividend income (+R, +SE) ............................................... 10,000

12/31 Unrealized loss AOCI (-SE) ................................................ 16,200Investment in Lane, Inc. (-A) .............................................. 16,200

2014 The adjusting entry can be done on the date of sale or 12/31/2014.

1/20 Cash (+A) ........................................................................... 150,000

Loss on sale of investment in Lane, Inc. (+E, -SE) ............. 21,200Unrealized loss AOCI (+SE) ................................... 16,200Investment in Lane, Inc. (-A) ...................................... 155,000

+ Cash (A) - + Investment in Lane Inc (A) -

12/22 10,000 171,200 11/15 11/15 171,200 16,200 12/31

1/20 150,000 155,000 1/20

+ Loss (E) -

1/20 21,200

+ Unrealized Loss (AOCI) - - Dividend Income (R) +

12/31 16,200 16,200 1/20 10,000 11/22

Note that most of the loss occurred in 2013, but was not recognized on the incomestatement until management decided to sell the securities in 2014.


Halen Inc. now owns all of Jolson. The company reports will be consolidated. The totalin the consolidated stockholders equity section on 1/1 is the stockholders equitysection of the parent company, determined as follows:

Common stock.. $600,000Retained earnings.. 310,000

Total Equity $910,000

Jolsons equity accounts are eliminated in the consolidation process.

7/27/2019 Fa4e Sm Ch12

12/41



EXERCISES

E12-24. (30 minutes)

a. Trading securities

1 Investment in Liu, Inc. (+A) ........................................................ 72,000Cash (-A) .............................................................................. 72,000

2 Cash (+A) .................................................................................. 6,600Dividend income (+R, +SE) .................................................. 6,600

3 Unrealized loss (+E, -SE) .......................................................... 4,500Investment in Liu, Inc. (-A) ................................................... 4,500

4 Cash (+A) .................................................................................. 66,900Loss on sale of investment (+E, -SE) ........................................ 600Investment in Liu, Inc. (-A) .................................................... 67,500

b.+ Cash (A) - + Investment in Liu (A) -

2. 6,600 72,000 1. 1. 72,000 4,500 3.

4. 66,900 67,500 4.

- Retained Earnings (SE) +

6,600 2.

+ Unrealized Loss (E) - + Loss on Sale (E) -4. 4,500 4. 600

c.Balance Sheet Income Statement


+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

1. Purchased 6,000common shares ofLiu, Inc., for $12per share.

-72,000Cash

+72,000Investment

= - =

2. Received a cash

dividend of $1.10per common sharefrom Liu.

+6,600Cash



- = +6,600

3. Year-end marketprice of Liucommon stock is$11.25 per share.

-4,500Investment

=-4,500

RetainedEarnings

-+4,500

UnrealizedLoss

= -4,500

4. Sold all 6,000common shares ofLiu for $66,900.

+66,900Cash

- 67,500Investment

=600RetainedEarnings

-+600Loss

=600

continued next page

7/27/2019 Fa4e Sm Ch12

13/41



E12-24. concluded

d. Available-for-Sale Securities

1 Investment in Liu, Inc. (+A) ...................................................... 72,000

Cash (-A) ............................................................................ 72,000

2 Cash (+A) ................................................................................ 6,600Dividend income (+R, +SE) ................................................ 6,600

3 Unrealized loss (-SE) ............................................................... 4,500Investment in Liu, Inc. (-A) ................................................. 4,500

4 Cash (+A) ................................................................................ 66,900Loss on sale of investment (+E, -SE) ...................................... 5,100

Unrealized loss (+SE) ........................................................ 4,500

Investment in Liu, Inc. (-A) .................................................. 67,500

+ Cash (A) - + Investment in Liu (A) -

2. 6,600 72,000 1. 1. 72,000 4,500 3.4. 66,900 67,500 4.

- Retained Earnings (SE) +

6,600 2.

+ Unrealized Loss (SE) - + Loss (E) -

3. 4,500 4,500 4. 4. 5,100



+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

1. Purchased 6,000common shares ofLiu, Inc., for $12per share.

-72,000Cash

+72,000Investment

= - =

2. Received a cashdividend of $1.10per commonsharefrom Liu.

+6,600Cash

=+6,600

RetainedEarnings


- =+6,600

3. Year-end market

price of Liucommon stock is$11.25 per share.

-4,500Investment = -4,500 AOCI - =

4. Sold all 6,000common shares ofLiu for $66,900.

+66,900Cash

-67,500Investmen

t=

+4,500AOCI-5,100

RetainedEarnings

-+5,100Loss

=5,100

7/27/2019 Fa4e Sm Ch12

14/41




a. Investments classified as trading securities

1 Investment in Freeman, Inc. (+A) ............................................ 80,000

Cash (-A) ............................................................................ 80,000


3 Investment in Freeman, Inc. (+A) ............................................ 7,500Unrealized gain (+R, +SE) ................................................. 7,500

4 Cash (+A) ................................................................................ 86,400Loss on sale of investment (+E, -SE) ...................................... 1,100

Investment in Freeman, Inc. (-A) ......................................... 87,500

+ Cash (A) - + Investment in Freeman (A) -

2. 6,250 80,000 1. 1. 80,0004. 86,400 3. 7,500 87,500 4.

- Dividend Income (R) +

6,250 2.

- Unrealized Gain (R) + + Loss on Sale (E) -

7,500 3. 4. 1,100



+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

1. Ohlson Co. purchases5,000 common sharesof Freeman Co. at $16cash per share.

-80,000Cash

+80,000Investment

= - =

2. Ohlson Co. receives acash dividend of $1.25per common share fromFreeman.

+6,250Cash

=+6,250

RetainedEarnings

+6,250DividendRevenue

- = +6,250

3. Year-end market priceof Freeman common

stock is $17.50 pershare.

+7,500

Investment =

+7,500

RetainedEarnings

+7,500

UnrealizedGain - = +7,500

4. Ohlson Co. sells all 5,000common shares ofFreeman for $86,400cash.

+86,400Cash

-87,500Investment

= +-1,100

RetainedEarnings

-+1,100Loss =

-1,100

continued next page

7/27/2019 Fa4e Sm Ch12

15/41



E12-25. concluded

b. Available for Sale Securities

1 Investment in Freeman, Inc. (+A) ............................................ 80,000

Cash (-A) ............................................................................ 80,000


3 Investment in Freeman, Inc. (+A) ............................................ 7,500Unrealized gain (+SE) ........................................................ 7,500

4 Cash (+A) ................................................................................ 86,400Unrealized gain (-SE) .............................................................. 7,500

Gain on sale of investment (+R, +SE) ................................ 6,400

Investment in Freeman, Inc. (-A) ......................................... 87,500

+ Cash (A) - + Investment in Freeman (A) -

2. 6,250 80,000 1. 1. 80,0004. 86,400 3. 7,500 87,500 4.

- Dividend Income (R) +

6,250 2.

- Unrealized Gain (SE) + - Gain on Sale ( R) +

4. 7,500 7,500 3 6,400 4.



+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

1. Ohlson Co. purchases5,000 common sharesof Freeman Co. at $16cash per share.

-80,000Cash

+80,000Investment

= - =

2. Ohlson Co. receives acash dividend of $1.25per common share fromFreeman.

+6,250Cash

=+6,250

RetainedEarnings


- = +6,250

3. Year-end market price

of Freeman commonstock is $17.50 pershare.

+7,500Investment = +7,500AOCI - =

4. Ohlson Co. sells all 5,00common shares ofFreeman for $86,400cash.

+86,400Cash

-87,500Investment

=

-7,500AOCI+6,400

RetainedEarnings

+6,400Gain

- = +6,400

7/27/2019 Fa4e Sm Ch12

16/41




a. The amortized cost of the Coca-Cola shares was $110 thousand, or $0.0023 pershare (the result of many stock splits over the years.). Coca-Colas shares would bea Level 1 fair value, meaning they are marked-to-market at the end of the year.

The value was $2,324,826 thousand, or $48.25 per share. The difference betweenthe two values is an unrealized holding gain that would appear as part of AOCI in theSunTrust shareholders equity section of the balance sheet.

b. Selling all the shares would result in the maximum realized holding gain, which is thesame as the unrealized gain in the footnote table $2,324,716 thousand. After-tax,that would increase net income and retained earnings by (1.0 0.35)$2,324,716thousand, or $1,511,065 thousand (about a billion and a half).

c. The proceeds will be $51.004.605 million = $234,855,000. The original cost of theshares is $0.00234.605 million = $10,592, producing a realized gain of

$234,844,408 (=$234,855,000 - $10,592). The book value of the shares at the endof 2006 is $48.254.605 million = $222,191,250. Therefore, the journal entry will bethe following:

Cash (+A) .......................................................................... 234,855,000Unrealized Gain (-AOCI, -SE) ................. 222,180,658

Common stock of The Coca-Cola Company (-A) ......... 222,191,250Gain on sale of securities (+R, +SE).. 234,844,408


a. 2013:11/1 Investment in Joos, Inc. (+A) ................................................. 306,900

Cash (-A) ............................................................................ 306,900

12/31 Interest receivable (+A) ......................................................... 4,500Interest revenue (+R, +SE) ................................................ 4,500

12/31 Unrealized loss (+E, -SE) ...................................................... 5,400Investment in Joos, Inc. (-A) ............................................... 5,400

2014:4/30 Cash (+A) .............................................................................. 13,500

Interest receivable (-A) ....................................................... 4,500Interest revenue (+R, +SE) ................................................ 9,000

5/1 Cash (+A) .............................................................................. 300,900Loss on sale of investments (+E, -SE) .................................. 600

Investment in Joos, Inc. (-A) ................................................ 301,500

continued next page

7/27/2019 Fa4e Sm Ch12

17/41



E12-27. concluded

b.+ Cash (A) - + Investment in Joos Inc. (A) -

4/30 13,500 306,900 11/1 11/1 306,900 5,400 12/315/1 300,900 301,500 2/1

+ Unrealized Loss (E) - + Interest Receivable (A) -

12/31 5,400 12/31 4,500 4,500 4/30

- Interest Revenue (R) + + Loss on Sale of Investments (E) -

4,500 12/31 5/1 600

9,000 4/30



+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

11/1. Buy$300,000 Joosbonds @102.

-306,900Cash

+306,900Investment

= - =

12/31. Accrueinterest.

+4,500Interest

Receivable=


+4,500Interest

Revenue- = +4,500

12/31. Recognizedecline in valueof bonds.

-5,400Investment

=-5,400

RetainedEarnings

-+5,400

UnrealizedLoss

= -5,400

4/30. Receiveinterest.

+13,500Cash

-4,500InterestReceivable


+9,000InterestRevenue

- = +9,000

5/1. Sold Joosbonds.

+300,900Cash

-301,500Investment

=-600

RetainedEarnings

-+600Loss

= -600

7/27/2019 Fa4e Sm Ch12

18/41




Baylor Company now owns 75% of Reed. The company reports will be consolidated.The total in the consolidated stockholders equity section on 1/1 is determined asfollows:

Common stock. 900,000Retained earnings... 440,000

Baylor Company shareholders equity $1,340,000Noncontrolling interests 200,000

Total equity $1,540,000


a. The equity securities investment portfolio is reported at its current fair value of

$40,241 million. The cost of the portfolio is $37,633 million, there are $3,149 millionin unrealized gains and $541 million of unrealized losses.

b. Because the investments are accounted for as available-for-sale, unrealized gains(losses) on investments are reported in Accumulated Other Comprehensive Income(AOCI), rather than current income. The investments are reported on the balancesheet at current market value on the statement date.

c. Impairment losses are recognized in current income when the securities decline inmarket value and the decline is deemed to be other than temporary. Gains andlosses realized from the sale of securities are recognized in current income. Areclassification adjustment is required in Other Comprehensive Income. Becausethe gains and losses from the sale of securities will be recognized in current income(and retained earnings), they need to be removed from AOCI to avoid double-counting the gains and losses in stockholders equity.

7/27/2019 Fa4e Sm Ch12

19/41

7/27/2019 Fa4e Sm Ch12

20/41




a.1 Investment in Palepu Co. (+A) ................................................ 120,000

Cash (-A) ............................................................................ 120,000

2 Cash (+A) ............................................................................... 12,000Investment in Palepu Co. (-A) ............................................. 12,000

3 Investment in Palepu Co. (+A) ................................................ 30,000Investment revenue (+R, +SE) ........................................... 30,000

4 Cash (+A) ............................................................................... 140,000Gain on sale of investment (+R, +SE) ................................ 2,000Investment in Palepu Co. (-A) ............................................. 138,000

b. + Cash (A) - + Investment in Palepu (A) -2. 12,000 120,000 1. 1. 120,000 12,000 2.4. 140,000 3. 30,000 138,000 4.

- Gain (R) + - Investment Revenue (R) +

2,000 4. 30,000 3.


Transaction CashAsset

+ NoncashAssets

= Liabil-ities

+ Contrib.Capital

+ EarnedCapital

Revenues - Expenses = NetIncome

1. Buy 25% ofPalepu stock.

-120,000Cash

+120,000Investment

= - =

2. Receivedividend.

+12,000Cash

-12,000Investment

= - =

3. Recognizeshare of netincome ofPalepu.

+30,000Investment


+30,000InvestmentRevenue

- = +30,000

4. Sold Palepuinvestment.

+140,000Cash

-138,000Investment

=+2,000

RetainedEarnings

+2,000Gain

- = +2,000

7/27/2019 Fa4e Sm Ch12

21/41




a. 1. Market Value Method (AFS Securities)

1 Investment in Leftwich Co. (+A) ........................................ 150,000Cash (-A) ....................................................................... 150,000

2 No entry

3 Cash (+A) ........................................................................... 11,000

Dividend revenue (+R, +SE) ......................................... 11,000

4 Investment in Leftwich Co. (+A) ........................................ 40,000Unrealized gain (+SE) ................................................... 40,000

2.+ Cash (A) - + Investment in Leftwich (A) -

3. 11,000 150,000 1. 1. 150,000

4. 40,000

- Unrealized Gain (AOCI) + - Dividend Income (R) +

40,000 4. 11,000 3.

3.Balance Sheet Income Statement


+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

1. PurchaseCommon shares.

-150,000Cash

+150,000Investment = - =

2. No entry. = - =

3. Received a cashdividend of $1.10per commonshare.

+11,000Cash



- = +11,000

4. Recognizeincrease ininvestment valueat yearend .

+40,000Investment

=+40,000AOCI - =

continued next page

7/27/2019 Fa4e Sm Ch12

22/41



E12-32. concluded

b. 1. Equity Value Method

1 Investment in Leftwich Co. (+A) ................................................ 150,000Cash (-A) .............................................................................. 150,000

2 Investment in Leftwich Co. (+A) ................................................ 24,000Investment revenue (+R, +SE) ............................................. 24,000

3 Cash (+A) ................................................................................. 11,000Investment in Leftwich Co. (-A) ............................................. 11,000

4 No entry

2.+ Cash (A) - + Investment in Leftwich (A) -

3. 11,000 150,000 1. 1. 150,000 11,000 2. 24,000

- Investment Income (R) +

24,000



+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

1. PurchaseCommon shares.

-150,000Cash

+150,000Investment

= - =

2. Recognize 30%portion of Leftwichnet income.

+24,000Investment


+24,000Investment

Income- = +24,000

3. Received a cashdividend of $1.10per commonshare.

+11,000Cash

-11,000Investment

= - =

4. No entry. = - =

7/27/2019 Fa4e Sm Ch12

23/41




a. Coca-Colas Equity Method Investments asset account would be increased by theirshare of Equity Income and decreased by their share of dividends received from thebottlers. Therefore, $6,954 million + $690 million Dividends = $7,234 million, or

Dividends = $410 million.

b. There is a relatively modest difference between the $421 million reported by Coca-Cola and the $410 million we found in part a. There must have been some otherevent (or events) that resulted in an $11 million increase in the asset. It may be thatCoca-Cola increased its investments in the equity method companies.In an indirectmethod statement of operating cash flows, the equity income of $690 million isincluded in the top line (net income), while the actual cash flow (which should beincluded in the bottom line cash from operations) is $421 million. Therefore, theadjustments to net income in arriving at cash from operations should include anadjustment subtracting the difference $269 million.

c. The $1,575 million difference is goodwill from Coca-Colas original investment inthese bottling companies. When we use the equity method, goodwill is not listedseparately, but it is a part of the asset Equity Method Investments. Goodwill is notamortized, though it must be tested annually for impairment.

d. In consolidating its bottling companies, Pepsico would include their liabilities in theconsolidated liabilities. However, when Coca-Cola uses the equity method, none ofits bottlers liabilities show up on the consolidated balance sheet. The financialstatements of Coca-Cola and Pepsico are reporting about two different types oforganizations, and are, therefore, not easily compared. Other ratios would also beaffected.

.

7/27/2019 Fa4e Sm Ch12

24/41




a. The amounts reported for all these separately-identifiable assets and liabilities mustbe fair values at the date of the acquisition. So, any inventory would be reported atwhat we would expect to get for it, rather than historical cost. Any financial liabilities

would be estimated at the value required to discharge them at the date of theacquisition. In the fair value hierarchy, most of these amounts will be determinedusing Level 2 or Level 3 approaches.

b. Goodwill is equal to the amount of consideration given for the transaction minus thefair value of the net assets acquired. Other than goodwill, the asset fair value is$230 million and the fair value of liabilities is $81 million. So, the fair value ofseparately-identifiable net assets is $149 million (= $230 million - $81 million). As aresult, the goodwill is $348 million (= $497 million - $149 million). This amount wouldnot be amortized in the future, but Medtronic would have to assess its value annuallyfor impairment. If the goodwill value is impaired, the goodwill asset is reduced and a

charge is recognized in income.

c. Investors are likely to prefer acquisitions of identifiable net assets (even ifintangible), rather than vaguely-defined synergy effects. When the acquiredcompany goes to the highest bidder, there is a real risk that the highest bidder wasthe one that most overestimated the potential for future synergies. When purchaseprice allocations are disclosed subsequent to the acquisition, stock prices respondfavorably (unfavorably) to the disclosure that less (more) goodwill was acquired.

7/27/2019 Fa4e Sm Ch12

25/41




a. 2013:11/15 Investment in Core, Inc. (+A) .................................................. 80,900

Cash (-A) ............................................................................ 80,900

12/22 Cash (+A) ............................................................................... 6,250Dividend income (+R, +SE) ................................................ 6,250

12/31 Investment in Core, Inc. (+A) .................................................. 6,600Unrealized gain (+R, +SE) .................................................. 6,600

2014:1/20 Cash (+A) ............................................................................... 86,400

Loss on sale of investment (+E, -SE) ..................................... 1,100Investment in Core, Inc. (-A) ............................................... 87,500

b. Assuming the firms fiscal year ends 12/31, the unrealized gain of 6,600 increasesnet income and retained earnings in 2013.

+ Cash (A) - + Investment in Core Inc (A) -

12/22/13 6,250 80,900 11/15/13 11/15/13 80,9001/20/14 86,400 12/31/13 6,600 87,500 1/20/14

+ Loss on Sale of Investment (E) -

1/20/14 1,100

- Unrealized Gain (R) + - Dividend Income (R) +

6,600 12/31/13 6,250 12/22/13



+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

11/15 Purchase5,000 shares ofCore Inccommon.

-80,900Cash

+80,900Investment

= =

12/22 Dividend

income.

+6,250

Cash

=+6,250

Retained

Earnings

+6,250Dividend

Income

= +6,250

12/31 Increase inInvestment.

+6,600Investment

=+6,600

RetainedEarnings

+6,600Unrealized

Gain= +6,600

1/20 Sale of Corecommon.

+86,400Cash

-87,500Investment

=-1,100

RetainedEarnings

+1,100Loss on

Sale= -1,100

7/27/2019 Fa4e Sm Ch12

26/41



E12-36 (30 minutes)

a. 2013:11/15 Investment in Core, Inc. (+A) .................................................. 80,900

Cash (-A) ............................................................................ 80,900

12/22 Cash (+A) ............................................................................... 6,250Dividend income (+R, +SE) ................................................ 6,250

12/31 Investment in Core, Inc. (+A) .................................................. 6,600Unrealized gain (+SE) ........................................................ 6,600

2014:1/20 Cash (+A) ............................................................................... 86,400

Unrealized gain (-SE) ............................................................. 6,600Investment in Core, Inc. (-A) ............................................... 87,500

Gain on sale of investment (+R, +SE) ................................ 5,500

b.+ Cash (A) - + Investment in Core Inc (A) -

12/22/13 6,250 80,900 11/15/13 11/15/13 80,9001/20/14 86,400 12/31/13 6,600 87,500 1/20/14

- Gain on Sale of Investment (R) +

5,500 1/20/14

- Unrealized Gain (AOCI) + - Dividend Income (R) +

1/20/14 6,600 6,600 12/31/13 6,250 12/22/13



+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

11/15 Purchase5,000 shares ofCore Inccommon.

-80,900Cash

+80,900Investment

= - =

12/20 Dividendincome.

+6,250Cash

=+6,250

RetainedEarnings


- = +6,250

12/31 Increasein Investment.

+6,600Investment

=+6,600AOCI

- =

1/20 Sale ofCore common.

+86,400Cash

-87,500Investment

=

-6,600AOCI+5,500

RetainedEarnings

+5,500Gain

- = +5,500

7/27/2019 Fa4e Sm Ch12

27/41




a. The trading stock investments will be reported at $225,300. This amount is computedusing their market values at year-end; specifically, $65,300 + $160,000, or $225,300.

b. The available-for-sale stock investments will be reported at $346,700. This amount iscomputed using their market values at year-end; specifically, $192,000 + 154,700, or$346,700.

c. The equity method stock investments will be reported at $236,000. This amount iscomputed using their equity method value at year-end; specifically, $100,000 +$136,000, or $236,000.

d. Unrealized holding losses of $5,200 will appear in the 2013 income statement. Theselosses relate to the trading securities; specifically Barth: $68,000 - $65,300 = $2,700;Foster: $162,500 - $160,000 = $2,500; total of $2,700 + $2,500 = $5,200.

e. (i) Unrealized holding losses of $7,300 will appear in the stockholders' equity section ofthe December 31, 2013, balance sheet under other comprehensive income. Theselosses relate to the available-for-sale securities; specifically McNichols: $197,000- $192,000 = $5,000; Patell: $157,000 - $154,700 = $2,300; total of $5,000 +$2,300 = $7,300.

(ii) Unrealized holding losses of $5,200 will appear in the stockholders equity section ofthe December 31, 2013, balance sheet under retained earnings. These lossesrelate to the trading securities; specifically Barth: $68,000 - $65,300 = $2,700;Foster: $162,500 - $160,000 = $2,500; total of $2,700 + $2,500 = $5,200.

(iii) Total unrealized holding losses in equity of $12,500total of (i) & (ii)

f. (i) A fair value adjustment to investments of $7,300 will appear in the December 31,2013, balance sheet. This adjustment relates to the available-for-sale securities.See part (e) for the supporting computations. The fair value adjustment decreasesthe book value of the available-for-sale securities to their year-end market value.

(ii) A fair value adjustment to investments of $5,200 will appear in the December 31,2013, balance sheet. This adjustment relates to the trading securities. See part (e)for supporting computations. The fair value adjustment decreases the book value ofthe trading securities to their year-end market value.

(iii) Total fair value adjustment is $12,500total of (i) & (ii)

7/27/2019 Fa4e Sm Ch12

28/41




(Entries in $ millions)a. Record share of income:

DR Investment in affiliates (+A) $610Income from affiliates (+R, +SE) $610

b. Record receipt of cash dividends:

DR Cash (+A) $216CR Investment in affiliates (-A) $216

c. Record divestiture of JJMCP:

DR Cash (+A) $175

CR Gain on JJMCP disposal (+R, +SE) $136CR Investment in affiliates-JJMCP (-A) $39

d. The ending balance should be $494 million + $610 million - $216 million - $39 million= $849 million. The actual balance, $886 million, was $37 million higher. Thisdifference could be due to advances (loans) made to the affiliates or AOCIadjustments at the affiliates or some other transactions (or adjustments) besides theones described above.


1 & 2.

Healy MillerConsolidatingAdjustments Consolidated

Current assets

Investment in Miller

$1,700,000

500,000

$ 120,000

$(500,000)

$ 1,820,000

0

Plant assets ....................... 3,000,000 410,000 15,000 3,425,000

Goodwill............................. . . 45,000 45,000

Total assets ....................... $5,200,000 $530,000 $5,290,000

Liabilities............................ $ 700,000 $90,000 $790,000

Contributed capital ............ 3,500,000 400,000 (400,000) 3,500,000

Retained earnings ............. 1,000,000 40,000 (40,000) 1,000,000

Total liabilities &stockholders equity ....... $5,200,000 $530,000 $5,290,000

continued next page

7/27/2019 Fa4e Sm Ch12

29/41



E12-39. concluded

3. Miller contributed capital (-SE) ......................................... 400,000Miller retained earnings (-SE) ........................................... 40,000Plant assets (+A) ............................................................. 15,000

Goodwill (+A) ................................................................... 45,000Investment in Miller Co. (-A) .................................. 500,000

4.+ Investment in Miller Co. (A) - + Goodwill (A) -

500,000 1/1 1/1 45,000

- Miller Contributed Capital (SE) +

1/1 400,000

+ Plant Assets (A) - - Miller Retained Earnings (SE) +

1/1 15,000 1/1 40,000



+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

1/1 ToconsolidateHealy & Miller.

-500,000Investment

in Miller

+45,000Goodwill

+15,000Plant Assets

=

-400,000Miller

ContributedCapital

-40,000Miller Retaine

Earnings

- =

7/27/2019 Fa4e Sm Ch12

30/41




1 & 2.

Rayburn Company purchased all of Kanodia Company's common stock for cash on

January 1, after which the separate balance sheets of the two corporations appearedas follows:

Rayburn KanodiaConsolidatingAdjustments Consolidated

Investment in Kanodia ................ $ 600,000 (600,000) $ 0

Other assets ................................ 2,300,000 $ 700,000 20,000 3,020,000

Goodwill ....................................... . . 40,000 40,000

Total assets ................................. $2,900,000 $700,000 $3,060,000

Liabilities ...................................... $ 900,000 $160,000 $1,060,000

Contributed capital ...................... 1,400,000 300,000 (300,000) 1,400,000

Retained earnings ....................... 600,000 240,000 (240,000) 600,000

Total liabilities & stockholdersequity ........................................ $2,900,000 $700,000 $3,060,000

3. Kanodia contributed capital (-SE) .................................... 300,000Kanodia retained earnings (-SE) ...................................... 240,000Other assets (+A) ............................................................. 20,000Goodwill (+A) ................................................................... 40,000

Investment in Miller Co. (-A) ................................... 600,000

4.+ Investment in Kanodia Inc. (A) - + Goodwill (A) -

600,000 1/1 1/1 40,000

-Kanodia Contributed Capital (SE) +

1/1 300,000

+ Other Assets (A) - - Kanodia Retained Earnings (SE) +

1/1 20,000 1/1 240,000

5. Balance Sheet Income Statement


+NoncashAssets

=Liabil-ities

+Contrib.Capital

+ Earned Capital evenues - Expenses =Net

Income

1/1 ToconsolidateRayburn &Kanodia.

-600,000Investmentin Kanodia+40,000Goodwill+20,000

Plant Assets

=

-300,000Kanodia

ContributedCapital

-240,000KanodiaRetainedEarnings

=

7/27/2019 Fa4e Sm Ch12

31/41




a. The investment is initially recorded on Engels balance sheet at the purchase price of$16.8 million, including $600,000 of goodwill. Because the fair value of Ball is less thanthe carrying amount of the investment on Engels balance sheet, the goodwill may be

deemed to be impaired. To determine impairment, the imputed value of the goodwill isdetermined to be 12.5 million - $12.3 million = $200,000. Because this is less than thecarrying amount of the goodwill, it is deemed to be impaired.

b. Goodwill must be written down by $400,000. The write-down will reduce the carryingamount of goodwill by $400,000, and the write-down will be recorded as a loss inEngels income statement, thereby reducing retained earnings by that amount.

E12-42.B (60 minutes)

a. Cash paid .......................................................................... $210,000Fair market value of shares issued ................................... 180,000Purchase price .................................................................. 390,000Less: Book value of Harris ................................................ 280,000Excess payment................................................................ 110,000Excess payment assigned to specific

accounts based on fair market value:Buildings ........................................................................... 40,000Patent ............................................................................... 30,000Goodwill ............................................................................ $ 40,000

$110,000

b.Easton, Harris Consolidation Consolidated

Accounts Company Co. Entries Totals

Cash $ 84,000 $ 40,000 $ 124,000

Receivables 160,000 90,000 250,000

Inventory 220,000 130,000 350,000

Investment in Harris 390,000 [S] $(280,000) -

[A] (110,000)

Land 100,000 60,000 160,000

Buildings, net 400,000 110,000 [A] 40,000 550,000

Equipment, net 120,000 50,000 170,000Patent 0 - [A] 30,000 30,000

Goodwill - - [A] 40,000 40,000

Totals $1,474,000 $ 480,000 $1,674,000

continued next page

7/27/2019 Fa4e Sm Ch12

32/41

7/27/2019 Fa4e Sm Ch12

33/41

7/27/2019 Fa4e Sm Ch12

34/41



P12-45. (30 minutes)

Gem AlpineConsolidatingAdjustments Consolidated

Current assets

Investment in Alpine

$258,000

392,000

$160,000

$(392,000)

$ 418,000

0Plant assets (net) 265,000 460,000 725,000

Total assets ....................... $915,000 $620,000 $1,143,000

Liabilities $ 50,000 $ 60,000 $ 110,000

Common stock ................... 700,000 420,000 (420,000) 700,000

Retained earnings ............. 165,000 140,000 (140,000) 165,000

Noncontrolling interest 168,000 168,000

Total liabilities &

stockholders equity ........ $915,000 $620,000 $1,143,000


a. (in $millions)

Cash and cash equivalents ...................................................... 1,267Accounts receivable ................................................................. 764Inventories ................................................................................. 925

Property, plant, and equipment ................................................ 1,933

Non-current financial assets 102Total tangible assets 4,991Other intangible assets ............................................................ 10,063Goodwill .................................................................................. 4,086Total intangible assets ............................................................... 14,149

The intangible assets were valued by Sanofi at 74% of Genzymes value. However,only 21% of the total assets acquired was allocated to Goodwill.

b. All assets of the acquired company are reported on the consolidated balance sheet at

their fair market values on the date of the acquisition, not at the their net book value.

c. The tangible assets are accounted for just like any other acquired asset: thereceivables are removed when collected, inventories affect future cost of goods sold,and depreciable assets are depreciated over their estimated remaining useful lives.Intangible assets with a determinable life are amortized (depreciated) over that usefullife. Finally, intangible assets with an indefinite useful life (e.g., goodwill) are notamortized, but are tested annually for impairment, or more often if circumstancesrequire.

7/27/2019 Fa4e Sm Ch12

35/41




a. The trading security investments will be reported at $375,300. This value is computedusing their market values at year-end; specifically, $105,300 + $270,000.

b. The available-for-sale investments will be reported at $359,000. This value iscomputed using their market values at year-end; specifically, $199,000 + 160,000.

c. The held-to-maturity bond investments will be reported at $237,200. This value iscomputed using their amortized cost value at year-end; specifically, $101,200 +$136,000.

d. Unrealized holding gains of $10,400 will appear in the 2013 income statement. Thesegains relate to the trading securities; specifically Ling: $105,300 - $102,400 = $2,900gain; Wren: $270,000 - $262,500 = $7,500; total of $2,900 + $7,500 = $10,400. Thecalculation is only possible because this is the first year the bonds have been held.Therefore, the entire price difference occurred this year.

e. (i) Unrealized holding gains of $8,000 will appear in the stockholders' equity section ofthe December 31, 2013, balance sheet under accumulated other comprehensiveincome (AOCI). These losses relate to the available-for-sale securities; specifically Olanamic: $199,000 - $197,000 = $2,000; Fossil: $160,000 - $154,000 = $6,000;total of $2,000 + $6,000 = $8,000.

(ii) Unrealized holding gains of $10,400 will appear in the stockholders equity sectionof the December 31, 2013, balance sheet under retained earnings (see answer torequirement d).

(iii) Total unrealized holding gains in equity of $18,400totals of (i) & (ii).

f. (i) A fair market value adjustment to investments of $8,000 will appear in theDecember 31, 2013, balance sheet. This adjustment relates to theavailable-for-sale securities. See part (e) for the supporting computations. The fairvalue adjustment increases the book value of the available-for-sale securities totheir year-end market value.

(ii) A fair market value adjustment to investments of $10,400 will appear in theDecember 31, 2013, balance sheet. This adjustment relates to the tradingsecurities. See part (d) for supporting computations. The fair value adjustment

increases the book value of the trading securities to their year-end market value.

(iii) No fair market adjustment is made to the bonds to be held to maturity. However,the reported value of each bond is adjusted for the amortization of premium ordiscount. Thus the Meander bond will be shown at a value of $101,200 and theResin bond will be valued at $136,000. The changes in these asset values on theColumbia Company balance sheet will be matched by the related interest revenue.

7/27/2019 Fa4e Sm Ch12

36/41




a. Yes, each individual company (e.g., parent and subsidiary) maintains its ownfinancial statements. This approach is necessary to report on the activities of theindividual units and to report to the respective stakeholders of each unit.

The purpose of consolidation is to combine these separate statements to moreclearly reflect the operations and financial condition of the combined (whole) entity.

b. The Investment in Financial Products Subsidiaries is reported on the parents(Machinery and Power Systems) balance sheet at $4,035 million.

This amount is the same balance as reported for stockholders equity of theFinancial Products subsidiary.

This relation will always exist so long as the investment is originally purchased at

book value (e.g., no goodwill from the purchase).

c. The consolidated balance sheet more clearly reflects the actual assets and liabilitiesof the combined company vis--vis that revealed in the equity method of accounting.That is, it better reflects operations as one entity as far as investors and creditors areconcerned.

The equity method of accounting that is used by the parent company to account forits investment in the subsidiary reflects only its proportionate share (100% in thiscase) of the investee company stockholders equity and does not report theindividual assets and liabilities comprising that equity.

d. The consolidating adjustments generally accomplish three objectives:

(i) They eliminate the equity method investment on the parents balance sheet andreplace it with the actual assets and liabilities of the investee company to which itrelates.

(ii) They record any additional assets that are included in the investment balancethat may not be reflected on the subsidiarys balance sheet, like goodwill, forexample.

(iii) They eliminate any intercompany sales and receivables/payables.

e. The consolidated stockholders equity and the stockholders equity of the parentcompany are equal. This equality will always be the case. The consolidation processreplaces the investment account with the assets and liabilities to which it relates.Thus, stockholders equity remains unaffected.

continued next page

7/27/2019 Fa4e Sm Ch12

37/41



P12-48. concluded

f. Consolidated net income will equal the net income of the parent company. Thereason for this result is that the parent reflects the income of the subsidiary via theequity method of accounting for its investment. The consolidation process merely

replaces the equity income account with the actual and individual sales andexpenses to which it relates. Net income is unaffected.

g. The equity method of accounting reports investments at adjusted cost (beginningbalance plus equity earnings and less dividends received)this contrasts with themarket method. Unrealized gains for a subsidiary are, therefore, not reflected on theconsolidated balance sheet and income statement. Instead, the subsidiary isreflected on the balance sheet at its purchase price net of depreciation andamortization, just like any other asset. The consolidation process merely replacesthe investment account with the actual assets and liabilities to which it relates. Thus,there can exist substantial unrealized gains subsequent to the acquisition that are

not reflected in the consolidated financial statements.

7/27/2019 Fa4e Sm Ch12

38/41



CASES

C12-49. (60 minutes)

a. Vodafones opening balance for investments in associates is 38,105 millionreported as Share of equity shareholders funds in associates. The Share in resultin associates of4,963 million is Vodafones proportionate share of the income inthese equity method investments. This amount is included in the income statementand increases the balance in the investment in associates.

b. The investing section of Vodafones statement of cash flows shows dividendsreceived from associates of4,023 million. This amount would increase cash anddecrease the investments in associates.

c. The entries in parts a and b would increase the balance of investment in associates

from 38,105 million to 38,105 + 4,963 - 4,023 = 39,045. But the endingbalance was only 35,108, so there must have been other items affecting thisaccount that reduced it by approximately 4 billion. One change that can be seen inthe footnote information is that Vodafone sold its investment in Societ Franaise duRadiotlphone S.A, (SFR). Footnote 32 of the previous years annual report saidthat this investment had a carrying value of 4.2 billion. When Vodafone sold itsinvestment in SFR during fiscal year 2012, the investment in associates accountwould be reduced by this amount. Other adjustments would account for theremaining difference.


a. 2013:1/2 Investment in Dye, Inc. (+A) .................................................. 420,000

Cash (-A) ............................................................................ 420,000

12/31 Dividend receivable (+A) ....................................................... 16,000Dividend income (+R, +SE) ................................................ 16,000

12/31 Unrealized loss (+E, -SE) ...................................................... 60,000Investment in Dye, Inc. (-A) ................................................ 60,000

2014:1/18 Cash (+A) .............................................................................. 16,000

Dividend receivable (-A) ..................................................... 16,000

continued next page

7/27/2019 Fa4e Sm Ch12

39/41

7/27/2019 Fa4e Sm Ch12

40/41



C12-50. concluded

e.+ Cash (A) - + Investment in Dye Inc. (A) -

1/18/11 16,000 420,000 1/2/10 1/2/10 420,00012/31/10 112,000 16,000 12/31/10

+ Investment Revenue (R) - + Dividend Receivable (A) -

112,000 12/31/10 12/31/10 16,000 16,000 1/18/11

f.Balance Sheet Income Statement


+NoncashAssets

=Liabil-ities

+Contrib.Capital

+EarnedCapital


Income

1/2/10 Buy

20,000 sharesof Dye.

-420,000Cash

+420,000Investment = - =

12/31/10Declaredividend$.8/share.

+16,000Dividend

Receivable

-16,000Investment

= - =

12/31/10Recognizeincome frominvestment.

+112,000Investment

=+112,000

RetainedEarnings

+112,000InvestmentRevenue

- = +112,000

1/18/11Receipt ofdividend.

+16,000

Cash

-16,000Dividend

Receivable

= - =

7/27/2019 Fa4e Sm Ch12

41/41


a. Consolidated statements present the total assets and liabilities of all firms in whichthe reporting firm has more than a fifty percent ownership with intercompanyaccounts and transactions eliminated.

b. Demski has a controlling interest in Asare and Demski Finance. Therefore, theirassets and liabilities are all added to those of Demski Inc. Demski does not have acontrolling interest in Knechel. Therefore, it must show its investment in Knechel Inc.as a financial asset.

c. This excess is the amount paid to Asare in excess of the net book value of Asaresassets (assets less liabilities assumed) when Asare was acquired by Demski. Theamount is known more commonly as Goodwill and reflects the fact that Demskibelieved the company was worth more than the net book value of its assets.

d. The amount represents the outside ownership claim onAsares net assets, whichare aggregated in the balances of Demskis accounts.


a. While the approach recommended by Gayle is not disallowed by a specificaccounting standard, it is not consistent with the intent of GAAP. Certainly from aposition of representational faithfulness, it specifically does not represent howmanagement regards the investment or intends to treat it in the future. The approachrecommended is a flagrant attempt to violate the spirit of GAAP in order to manageearnings.

Such practice may get by the firm s auditors once or twice, but failure to beconsistent in the accounting treatment over time is unlikely to be tolerated underSOX and the increased scrutiny applied by the SEC in the wake of the numerousaccounting scandals of the recent past.

Further, such practice can lead to lawsuits by investors who can argue thatmanagement was not accounting truthfully.

b. We believe the practice to be highly unethical.

Fa4e Sm Ch12

Documents

Transcript of Fa4e Sm Ch12