Week 5 Hw Solutions

CHAPTER 7CONSOLIDATED FINANCIAL STATEMENTS - OWNERSHIP

PATTERNS AND INCOME TAXES

Chapter Outline

I. Indirect subsidiary control

A. Control of subsidiary companies within a business combination is often of an indirect nature; one subsidiary possesses the stock of another rather than the parent having direct ownership.

1. These ownership patterns may be developed specifically to enhance control or for organizational purposes.

2. Such ownership patterns may also result from the parent company's acquisition of a company that already possesses subsidiaries.

B. One of the most common corporate structures is the father-son-grandson configuration where each subsidiary in turn owns one or more subsidiaries.

C. The consolidation process is altered somewhat when indirect control is present.

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

2. Calculation of the accrual-based income of a subsidiary recognizing the consolidated relationships is an important step in an indirect ownership structure.

a. The determination of accrual-based income figures is needed for equity income accruals as well as for the computation of noncontrolling interest balances.

b. Any company within the business combination that is in both a parent and a subsidiary position must recognize the equity income accruing from its subsidiary before computing its own income.

II. Indirect subsidiary control-connecting affiliation

A. A connecting affiliation exists whenever two or more companies within a business combination hold an equity interest in another member of that organization.

B. Despite this variation in the standard ownership pattern, the consolidation process is essentially the same for a connecting affiliation as for a father-son-grandson organization.

C. Once again, any company in both a parent and a subsidiary position must recognize an appropriate equity accrual in computing its own income.

III. Mutual ownership

A. A mutual affiliation exists whenever a subsidiary owns shares of its parent company.

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B. Parent shares being held by a subsidiary are accounted for by the treasury stock approach.

1. 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.

2. The treasury stock approach is popular in practice because of its simplicity and is now required by SFAS 160.

IV. Income tax accounting for a business combination—consolidated tax returns

A. A consolidated tax return can be prepared for all companies comprising an affiliated group. Any other companies within the business combination file separate tax returns.

B. A domestic corporation may be included in an affiliated group if the parent company (either directly or indirectly) owns at least 80 percent of the voting stock of the subsidiary as well as 80 percent of each class of its nonvoting stock.

C. The filing of a consolidated tax return provides several potential advantages to the members of an affiliated group.

1. Intercompany profits are not taxed until realized.

2. Intercompany dividends are not taxed (although these distributions are nontaxable for all members of an affiliated group whether a consolidated return or a separate return is filed).

3. Losses of one affiliate can be used to reduce the taxable income earned by other members of the group.

D. Income tax expense—effect on noncontrolling interest valuation

1. If a consolidated tax return is filed, an allocation of the total expense must be made to each of the component companies to arrive at the realized income figures that serve as a basis for noncontrolling interest computations.

2. Income tax expense is frequently assigned to each subsidiary based on the amounts that would have been paid on separate returns.

V. Income tax accounting for a business combination—separate tax returns

A. Members of a business combination that are foreign companies or that do not meet the 80 percent ownership rule (as described above) must file separate income tax returns.

B. Companies in an affiliated group can elect to file separate tax returns. Deferred income taxes are often recognized when separate returns are filed due to temporary differences stemming from unrealized gains and losses as well as intercompany dividends.

VI. Temporary tax differences can stem from the creation of a business combination

A. The tax basis of a subsidiary's assets and liabilities may differ from their consolidated values (which is based on the fair market value on the date the combination is created).

B. If additional taxes will result in future years (for example, it the tax basis of an asset is lower than its consolidated value so that future depreciation expense for tax purposes will be less), a deferred tax liability is created by a combination.

C. The deferred tax liability is then written off (creating a reduction in tax expense) in future years so that the net expense recognized (a lower number) matches the combination's book income (a lower number due to the extra depreciation of the consolidated value).

Vll. Operating loss carryforwards

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A. Net operating losses recognized by a company can be used to reduce taxable income from the previous two years (a carryback) or for the future 20 years (a carryforward).

B. If one company in a newly created combination has a tax carryforward, the future tax benefits are recognized as a deferred income tax asset.

C. However, a valuation allowance must also be recorded to reduce the deferred tax asset to the amount that is more likely than not to be realized.

Learning Objectives

Having completed Chapter 7, "Ownership Patterns and Income Taxes—Consolidated Financial Statements," students should be able to fulfill each of the following learning objectives:

1. Differentiate between a father-son-grandson ownership configuration and a connecting affiliation.

2. Calculate realized income figures for all companies in a business combination when either a father-son-grandson or connecting affiliation is in existence.

3. Prepare a consolidation worksheet for both a father-son-grandson ownership pattern and a connecting affiliation.

4. Eliminate a subsidiary's ownership interest in its parent using the treasury stock approach.

5. Explain the rationale underlying the treasury stock approach to a mutual ownership.

6. List the criteria for being a member of an affiliated group for income tax filing purposes.

7. Discuss the advantages to a business combination of filing a consolidated tax return.

8. Allocate the income tax expense computed on a consolidated tax return to the various members of a business combination according to their separate taxable incomes.

9. Compute taxable income for an affiliated group based on information presented in a consolidated set of financial statements.

10. Compute the deferred income tax expense to be recognized when separate tax returns are filed by any of the members of a business combination.

11. Determine the deferred tax liability that is created when the tax bases of a subsidiary's assets and liabilities are below consolidated values.

12. Explain the impact that a net operating loss of an acquired affiliate has on consolidated figures.

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Answers to Questions

1. A father-son-grandson relationship is a specific type of ownership configuration often encountered in business combinations. The parent possesses the stock of one or more companies. At least one of these subsidiaries holds a majority of the voting stock of its own subsidiary. Each subsidiary controls other subsidiaries with the chain of ownership going on indefinitely. The parent actually holds control over all of the companies within the business combination despite having direct ownership in only its own subsidiaries.

2. In a business combination having an indirect ownership pattern, at least one company is in both a parent and a subsidiary position. To calculate the accrual-based income earned by that company, a proper recognition of the equity income accruing from its own subsidiary must initially be made. Structuring the income calculation in this manner is necessary to ensure that all earnings are properly included by each company.

3. Able—100% of income accrues to the consolidated entity (as parent company).Baker—70% (percentage of stock owned by Able).Carter—56% (80% of stock owned by Baker multiplied by the 70% of Baker controlled by

Able).Dexter—33.6% (60% of stock owned by Carter multiplied by the 80% of Carter controlled by

Baker multiplied by the 70% of Baker owned by Able).

4. When an indirect ownership is present, the quantity of consolidation entries will increase, perhaps significantly. An additional set of entries is included on the worksheet for each separate investment. Furthermore, the determination of realized income figures for each subsidiary must be computed in a precise manner. For any company in both a parent and a subsidiary position, equity income accruals are recognized prior to the calculation of that company's realized income. This realized income total is significant because it serves as the basis for noncontrolling interest calculations as well as the equity accruals to be recognized by that company's parent.

5. In a connecting affiliation, two (or more) companies within a business combination own shares in a third member. A mutual ownership, in contrast, exists whenever a subsidiary possesses an equity interest in its own parent.

6. In accounting for a mutual ownership, SFAS 160 requires the treasury stock approach. The treasury stock approach presumes that the cost of the parent shares should be reclassified as treasury stock within the consolidation process. The subsidiary is being viewed, under this method, as an agent of the parent. Thus, the shares are accounted for as if the parent had actually made the acquisition.

7. According to present tax laws, an affiliated group can be comprised of all domestic corporations in which a parent holds 80 percent ownership. More specifically, the parent must own (directly or indirectly) 80 percent of the voting stock of the corporation as well as at least 80 percent of each class of nonvoting stock.


8. Several basic advantages are available to combinations that file a consolidated tax return. First, intercompany profits are not taxed until realized. For companies with large amounts of intercompany transactions, the deferral of unrealized gains causes a delay in the making of significant tax payments. Second, losses incurred by one company can be used to reduce or offset taxable income earned by other members of the affiliated group. In addition, intercompany dividends are not taxable but that exclusion applies to the members of an affiliated group regardless of whether a consolidated or separate tax return is filed.

Members of a business combination may be forced to file separate tax returns. Foreign corporations, for example, must always file separately. Domestic companies that do not meet the 80 percent ownership rule are also required to file in this manner. Furthermore, companies that are in an affiliated group may still elect to file separately. If all companies within the combination are profitable and few intercompany transactions are carried out, little advantage may accrue from preparing a consolidated return. With a separate filing, a subsidiary has more flexibility as to accounting methods as well as its choice of a fiscal year-end.

9. The allocation of income tax expense among the component companies of a business combination has a direct bearing on realized income totals and, therefore, noncontrolling interest calculations. Obviously, the more expense that is assigned to a particular company the less realized income is attributed to that concern. Income tax expense can be allocated based on the income totals that would have been reported by various companies if separate tax returns had been filed or on the portion of taxable income derived from each company.

10. In filing a separate tax return (assuming that the two companies do not qualify as members of an affiliated group), the parent must include as income the dividends received from the subsidiary. For financial reporting purposes, however, income is accrued based on the ownership percentage of the realized income of the subsidiary. Because income is frequently recognized by the parent prior to being received in the form of dividends (when it is subject to taxation), deferred income taxes must be recognized.

Either the parent or the subsidiary might also have to record deferred income taxes in connection with any unrealized intercompany gain. On a separate tax return, such gains are reported at the time of transfer while for financial reporting purposes they are appropriately deferred until realized. Once again, a temporary difference is created which necessitates the recognition of deferred income taxes.

11. If the consolidated value of a subsidiary’s assets exceeds their tax basis, depreciation expense in the future will be less on the tax return than is shown for external reporting purposes. The reduced expense creates higher taxable income and, thus, increases taxes. Therefore, the difference in values dictates an anticipated increase in future tax payments. This deferred liability is recognized at the time the combination is created. Subsequently, when actual tax payments do arise, the deferred liability is written off rather than recognizing expense based solely on the


current liability. In this manner, the expense is shown at a lower figure, one that is matched with reported income (which is also a lower balance because of the extra depreciation).

Recognition of this deferred liability at date of acquisition also reduces the net amount attributed to the subsidiary's assets and liabilities in the initial allocation process. Therefore, the residual asset (goodwill) is increased by the amount of any liability that must be recognized.

12. A net operating loss carryforward allows the company to reduce taxable income for up to 20 years into the future. Thus, a benefit may possibly be derived from the carryforward but that benefit is based on Wilson (the subsidiary) being able to generate taxable income to be decreased by the carryforward. To reflect the potential tax reduction, a deferred income tax asset is recorded for the total amount of anticipated benefit. However, because of the uncertainty, unless the receipt of this benefit is more likely than not to be received, a valuation allowance must also be recorded as a contra account to the asset. The valuation allowance may be for the entire amount or just for a portion of the asset.

13. At the date of acquisition, the valuation allowance was $150,000. As a contra asset account, recognition of this amount reduced the net assets attributed to the subsidiary and, hence, increased the recording of goodwill (assuming that the price did not indicate a bargain purchase). If the valuation allowance is subsequently reduced to $110,000, the net assets have increased by $40,000. This change is reflected by a decrease in income tax expense.


Answers to Problems

1. D

2. B

3. D

4. C

5. C

6. C

7. A Damson's accrual-based income:Operational income ................................................................... $200,000Defer unrealized gain ................................................................ (40,000)

Damson's accrual-based income ....................................... $160,000

Crimson's accrual-based income:Operational income ................................................................... $200,000Investment Income (90% of Damson’s realized income) ....... 144,000

Crimson's accrual-based income ....................................... $344,000

Bassett's accrual-based income:Operational income ................................................................... $300,000Investment income (80% of Crimson's realized income) ...... 275,200

Bassett's accrual-based income ........................................ $575,200

8. C Icede's accrual-based income:Operational income ................................................................... $220,000Defer unrealized gain ................................................................ (60,000)

Icede's accrual-based income ............................................ $160,000Outside ownership .................................................................... 20%

Noncontrolling interest ....................................................... $32,000

Healthstone's accrual-based income:Operational income ................................................................... $300,000Defer unrealized gain ................................................................ (30,000)Investment income (80% of Icede's accrual-based income) . 128,000

Healthstone's accrual-based income ................................. $398,000Outside ownership .................................................................... 20%

Noncontrolling interest ....................................................... $79,600

Total noncontrolling interest = $111,600 ($32,000 + $79,600)


9. D Juvyn's Operational Income .......................................................... $50,000Dividend Income ............................................................................. 14,000Juvyn's Income ............................................................................... $64,000Outside Ownership ......................................................................... 10%Noncontrolling Interest .................................................................. $6,400

10. A Equity Income (60% of $200,000) .................................................. $120,000Dividend Income (60% of $40,000) ................................................ 24,000

Tax Difference ............................................................................ $96,000Dividend Deduction upon Eventual Distribution (80%) .............. (76,800)

Temporary Portion of Tax Difference ...................................... $19,200Tax Rate ........................................................................................... 30%

Deferred Income Tax Liability .................................................. $5,760

11.C Unrealized Gain:Total Gain .................................................................................... $30,000Portion Still Held ......................................................................... 20%Unrealized Gain ......................................................................... $6,000

Tax Rate ........................................................................................... 25%Deferred Tax Asset ..................................................................... $1,500

12.A Recognition of this gain is not required on a consolidated tax return.

13.C Because fair value of the subsidiary's assets exceeds the tax basis by $100,000 a deferred tax liability of $30,000 (30%) must be recorded. Goodwill is then computed as follows:

Consideration transferred ....................................... $420,000Fair Value ................................................................ $400,000Deferred Tax Liability ................................................ (30,000) 370,000Goodwill ..................................................................... $50,000

14.(35 Minutes) (Series of reporting and consolidation questions pertaining to a father-son-grandson combination. Includes unrealized inventory gains)

a. Consideration transferred (by Tree) ............................. $252,000Noncontrolling interest fair value ................................. 108,000Limb’s business fair value.............................................. 360,000Book value ................................................................ (300,000)Trade name....................................................................... $60,000Life ................................................................................... 30 yearsAnnual amortization ....................................................... $2,000


14. (continued)

Consideration transferred for Leaf (by Limb) .............. $91,000Noncontrolling interest fair value ................................. 39,000Leaf’s business fair value .............................................. $130,000Book value ................................................................ (100,000)Trade name....................................................................... $30,000Life ................................................................................... 30 yearsAnnual amortization ....................................................... $1,000

a. Investment in Limb $252,000 Limb's reported income-2009 $40,000 Amortization expense (2,000 ) Accrual-based income $38,000 Limb’s percentage ownership 70 % Equity accrual-2009 $26,600 Dividends received 2009 (7,000)Limb's reported income-2010 $60,000 Amortization expense (2,000)Income from Leaf 6,300 Accrual-based income $64,300 Limb’s percentage ownership 70 % Equity accrual-2010 $45,010 Dividends received 2010 (14,000 ) Investment in Limb 12-31-10 $302,610

b. Leaf—2010 income (revenues minus expenses) $10,000 Amortization (1,000 ) Accrual-based income $9,000 Limb's ownership percentage 70 % Equity Income accrual $6,300 Income recognized ($2,000 dividends × 70%) (1,400 ) Retained earnings increase (Limb), 1/1/11 $4,900

Limb—2009 operating income $40,000 Limb—2010 operating income 60,000 Amortization (2 years at $2,000 per year) (4,000)Equity income from ownership of Leaf (above) 6,300 Total income for previous periods 102,300 Tree's ownership percentage 70 % Equity Income accrual 71,610 Income recognized ($10,000 [2009] + $20,000 [2010] dividends × 70% ownership) (21,000 ) Retained earnings Increase (Tree), 1/1/11 $50,610

14. (continued)


c. Consolidated sales (total for the companies) $1,260,000 Consolidated expenses (total for the companies) (1,025,000)Total amortization expense (see a.) (3,000 ) Consolidated net income for 2011 $232,000

d. Noncontrolling interest in income of LeafRevenues less expenses $30,000 Excess amortization (1,000 ) Accrual-based income $29,000 Noncontrolling interest percentage 30 % Noncontrolling interest in income of Leaf $8,700

Noncontrolling interest in income of Limb:Revenues less expenses $65,000 Excess amortization (2,000)Equity in Leaf income [(30,000-1,000) × 70%] 20,300 Realized income of Limb—2011 $83,300 Outside ownership 30 % $24,990 NCI share of consolidated income $33,690

e. 2010 Realized income of Limb (prior to accounting for unrealized gains) (see a) $64,300 2009 Transfer-gain recognized in 2010 10,000 2010 Transfer-gain to be recognized in 2011 (16,000 ) 2010 Realized income Limb $58,300

2011 Realized Income of Limb (prior to accounting for unrealized gains) (see d.) $83,300 2010 Transfer-gain recognized in 2011 16,000 2011 Transfer-gain to be recognized in 2012 (25,000 ) 2011 Realized income—Limb $74,300

f. In b., an adjustment of $50,610 was made to the beginning 2011 retained earnings. Question e. takes this same question and alters it by including unrealized gains. The $10,000 gain does not affect the answer because the 2010 and 2011 effects cancel each other.

Thus, only the $16,000 gain must be taken into consideration on January 1, 2011. Limb’s realized income in 2010 is reduced by $16,000 because of the deferred gain. The parent's equity accrual would be reduced by $11,200 or 70% of that figure. The adjustment as of January 1, 2011 is $39,410 ($50,610 – $11,200).


15. (15 minutes) (Income and noncontrolling interest with mutual ownership.)

a. Consideration transferred by Uncle .............................. $500,000Noncontrolling interest fair value ................................. 125,000Nephew’s business fair value ....................................... $625,000Book value ....................................................................... 600,000Intangible Assets ............................................................ $25,000Life ................................................................................... 10 yearsAmortization expense (annual) ..................................... $2,500

Income reported by Nephew—2011............................... $50,000Amortization expense (above) ...................................... (2,500)Accrual-based income.................................................... 47,500Uncle's ownership percentage ...................................... 80%Income of subsidiary recognized by Uncle .................. $38,000

b. To the outside owners, the $6,000 intercompany dividends ($20,000 × 30%) paid by Uncle are viewed as income because the book value of Nephew is increasing. Thus, the noncontrolling interest's share of income is $10,700 or 20% of [$47,500 income ($50,000 operational income less $2,500 excess amortization) plus the $6,000 in dividends].

16. (35 Minutes) (Consolidated income for a father-son-grandson combination.)

a. Mesa's operating income $250,000 Butte's operating income 98,000 Valley's operating income 140,000 Amortization expense–Mesa's investment in Butte (22,500)Amortization expense–Butte's investment in Valley (8,000 ) Consolidated net income $457,500

b. Valley's operating income $140,000 Amortization expense (on Butte's investment) (8,000 ) Valley's accrual-based income $132,000 Outside ownership 45 % Noncontrolling interest in Valley's income $59,400 Butte's operating income $ 98,000 Amortization expense (on Mesa's investment) (22,500)Equity accrual from ownership of Valley ($132,000 × 55%) 72,600 Butte's accrual-based income $148,100 Outside ownership 20 % Noncontrolling interest in Butte's income $29,620

Total noncontrolling interest in income of subsidiaries $89,020


16. (Continued)

Mesa’s operating income $250,000 Mesa’s share of Butte’s operating income (80% × $98,000) 78,400Mesa’s share of Valley’s operating income (80% × 55% × $140,000) 61,600Mesa’s share of Butte’s excess amortization (80% × $22,500) (18,000)

Mesa’s share of Valley’s excess amortization (80% × 55% × $8,000) (3,520 ) Controlling interest in consolidated net income $368,480 Noncontrolling interest in consolidated net income 89,020 Consolidated net income $457,500

17. (30 Minutes) (Consolidated income figures for a connecting affiliation)

UNREALIZED GAINS:Cleveland ($12,000 remaining inventory × 25% markup) = $3,000Wisconsin ($40,000 remaining inventory × 30% markup) = $12,000

NONCONTROLLING INTERESTS:CLEVELAND:

Operational income (sales minus cost of goods sold andexpenses) ................................................................... $60,000

Defer unrealized gain (above) ....................................... (3,000)Realized income—Cleveland .................................... $57,000

Outside ownership ......................................................... 20%Noncontrolling interest in Cleveland's income ...... $11,400

WISCONSIN:Operational income (sales minus cost of goods sold and

expenses) ................................................................... $110,000Defer unrealized gain (above) ....................................... (12,000)Investment income (60% of Cleveland's realized income of

$57,000) ..................................................................... 34,200Realized income—Wisconsin ................................... $132,200

Outside ownership ......................................................... 10%Noncontrolling interest in Wisconsin's income ..... $13,220

TOTAL NONCONTROLLING INTERESTS: $24,620 ($11,400 + $13,220)

CONSOLIDATION TOTALS

Sales = $1,590,000 (add the three book values and eliminate intercompany transfers of $40,000 and $100,000)

Cost of Goods Sold = $1,015,000 (add the three book values, eliminate intercompany transfers of $40,000 and $100,000, and defer [add] unrealized gains of $3,000 and $12,000)

17. (continued)


Expenses = $200,000 (add the three book values)

Dividend Income = -0- (eliminated for consolidation purposes)

Consolidated net income = $375,000 (consolidated revenues less consolidated cost of goods sold and expenses)

Noncontrolling Interests in subsidiaries' income = $24,620 (computed above)

Controlling interest in consolidated net income = $350,380 (consolidated net income less noncontrolling interest share)

18.(15 Minutes) (Consolidated income and equity accounts--mutual ownership.)

a. CONSOLIDATED TOTALS Sales = $1,800,000 (add the two book values) Cost of goods sold = $1,020,000 (add the two book values)

Expenses = $352,000 (add the two book values and include the amortization expense of $12,000)

Dividend income = -0- (eliminated for consolidation purposes) Consolidated net income = $428,000 (consolidated revenues less

consolidated cost of goods sold and expenses) Noncontrolling interest in Wonderland's income = $11,400 (10 percent of the

reported balance less $12,000 excess amortization). Dividend income is included because it increases the book value of the subsidiary and, therefore, the noncontrolling interest.)

b. Common Stock = $880,000 (the parent company balance only)

Treasury Stock = $111,000 (cost paid by subsidiary for the shares of the parent company)

19. (25 Minutes) (Tax expense with separate tax returns for a combination.)

a. CONSOLIDATED TOTALS Sales = $790,000 (add the two book values and eliminate the $110,000

intercompany transfer) Cost of Goods Sold = $340,000 (add the book values, eliminate

intercompany transfers of $110,000, recognize [subtract] $30,000 deferred gain from 2010, and defer [add] $40,000 intercompany gain deferred into 2011)

Operating expenses = $234,000 (add the two book values) Dividend Income = -0- (eliminated for consolidation purposes)

Consolidated net income = $216,000 (Revenues less expenses) Noncontrolling interest in Down's Income = $18,000 (20 percent of reported

Income of $100,000 plus $30,000 gain deferred from 2010 less $40,000 gain deferred into 2011)

Controlling interest in consolidated net income = $198,000


19. (continued)

b. On separate returns, the unrealized gains are reported as taxable income. Because Up owns 80 percent of Down's stock, the dividends are tax- free and no deferred tax liability is necessary on the undistributed income.

DUE TO GOVERNMENT: (separate returns)UP:Income (without dividend income) ............................... $126,000Tax rate ........................................................................... 30%

Currently payable to government ............................ $37,800

DOWN:Reported income ............................................................ $100,000Tax rate ........................................................................... 30%

Currently payable to government ............................ $30,000

Total Income Tax Payable: Current = $67,800 ($37,800 + $30,000)

CURRENT EXPENSE:Consolidated net income (part a.) ........................... $198,000Eliminate noncontrolling interest ............................ +18,000

Income to be taxed .............................................. $216,000Tax rate ................................................................... 30%Income tax expense .................................................. $64,800

The $3,000 difference between the liability and the expense is an increase in the Deferred Income Tax Asset account. It is created by the tax effect (30%) on the net unrealized gain for the period ($10,000 or $40,000 – $30,000).

20. (45 Minutes) (Series of questions requires computation of income tax expense and the related payable balance)

a. $260,000 ($650,000 × 40%)

The affiliated group would be taxed on its operating income of $650,000 (the net unrealized gain is deferred on a consolidated return). The intercompany income and dividends are not relevant since a consolidated return is filed.

b. $260,000 ($650,000 × 40%)

The affiliated group would be taxed on its operating income of $650,000 (the net unrealized gain is deferred on a consolidated return). The intercompany income and dividends are not relevant because a consolidated return is filed. The percentage ownership does not affect the figures on a consolidated return.


20. (continued)

c. $296,000 ($96,000 + $200,000)Rogers would pay $96,000 or 40% of its $240,000 operating income. Clarke would pay $200,000 or 40% of its $500,000 operating income. The unrealized gain is not deferred when separate returns are filed. Intercompany dividends are not taxable because the parties qualify as an affiliated group even though separate returns are being filed. Answer (c.) differs from (a.) and (b.) because tax on the $90,000 unrealized gain (40% or $36,000) is paid immediately.

d. $268,064Rogers would record income tax expense of $96,000 or 40% of its $240,000 operating income.

Clarke must record its expense based on the revenue recognized during the period. Thus, the tax expense is based on operating income of $410,000 (the net unrealized gain is not being recognized in this period) plus equity income accruing from Rogers of $100,800 (70% of that company's after-tax income). Clarke will record an income tax expense of $164,000 in connection with the operating income ($410,000 × 40%). The expense recognized in connection with the equity accrual is affected by the dividends-received deduction:

Equity income of subsidiary........................................... $100,800Dividends-received deduction (when received) (80%). 80,640Income subject to taxation ............................................ $20,160Tax rate ........................................................................... 40%Income tax expense—equity income (Clarke) ............. $8,064Income tax expense—operating income (Clarke)

(above) ........................................................................ 164,000 $172,064Income tax expense—operating income (Rogers)

(above) ........................................................................ 96,000Income tax expense ........................................................ $268,064

e. $204,480Clarke will pay $200,000 in connection with its operating income ($500,000 × 40%) because the unrealized gain cannot be deferred. Clarke also receives $56,000 in dividends from Rogers ($80,000 × 70%). Tax payment on these dividends is $4,480 ($56,000 × 20% × 40%). The difference between the payment by Clarke ($204,480) and the company's expense in (d.) ($172,064) is created by the premature payment of the tax (a deferred tax asset) on the unrealized gain ($90,000) less the deferred tax liability on the parent's equity accrual ($100,800) in excess of dividends received ($56,000).


21. (20 Minutes) (Comparison of income tax expense and payable on separate and consolidated tax returns.)

a. Consolidated Return—2010

Piranto income 2010 (sales less expenses) ...................................... $300,000Slinton income 2010 (sales less expenses) ...................................... 100,0002009 gain realized in 2010.................................................................... 120,0002010 deferred gain................................................................................ (150,000)

Taxable income ............................................................................... $370,000Tax rate ................................................................................................ 40%

Income tax payable—current ......................................................... $148,000

Because no temporary differences exist in this problem, the income tax expense would also be $148,000. The unrealized gain is not taxed until realized. Dividend income is not important because a consolidated return is being filed.

b. Separate Returns—2010On its separate tax return, Piranto will report taxable income of $300,000—the unrealized gains cannot be deferred. The dividends would not be taxable because Slinton still meets the criteria to be a member of an affiliated group. A consolidated return is not a requirement for these dividends to be excluded. Thus, income taxes payable by Piranto would be $120,000 ($300,000 × 40%).

To determine the income tax expense for Piranto, the two temporary differences must be taken into account:

Taxable income ............................................................... $300,000Gain taxed in 2009 although realized

in 2010 ........................................................................ 120,000Gain taxed in 2010 although not yet realized............... (150,000)2010 realized income subject to taxation ..................... $270,000Tax rate ............................................................................ 40%Income tax expense ........................................................ $108,000

The $12,000 difference between the expense and the payable is the tax effect on the net unrealized gain ($30,000 × 40%).

Slinton will have an expense and payable of $40,000 ($100,000 × 40%).


22.(45 Minutes) (Comparison of income tax expense and payable on separate and consolidated tax returns. Includes question on mutual ownership and the conventional approach.)

a. Total income tax expense is $156,877. Because of the level of ownership, separate returns must be filed. Unrealized gains are taxed immediately as are intercompany dividends.

Because the unrealized gains are deferred on the consolidated financial statements, Boxwood's expense would be $34,400 or 40% of $86,000 in realized income ($100,000 + $18,000 – $32,000).

Lake's income subject to taxation includes its $300,000 in operating income plus $30,960 in income accruing from its investment in Boxwood (60% of the after-tax Income of $51,600 [$86,000 – $34,400]). Income tax expense for Lake is computed as follows:

Operating income ........................................................... $300,000Equity income ................................................................. $30,960Taxable portion ............................................................... 20% 6,192Income eventually subject to taxation .......................... $306,192Tax rate............................................................................. 40%Income tax expense Lake (rounded)............................. $122,477Income tax expense Boxwood (above)......................... 34,400Total income tax expense .............................................. $156,877

b. Boxwood will pay $40,000 ($100,000 × 40%) because separate returns are filed. Lake, however, will pay its taxes based on dividends received rather than on the equity accrual. A deferred income tax liability would be established for the difference. Lake's payment for the current year is computed as follows:

Operating income............................................................ $300,000Dividend income (60% × $10,000) ................................. $6,000Taxable portion ............................................................... 20% 1,200Income currently taxable ............................................... $301,200Tax rate ........................................................................... 40%Income tax payable—Lake ............................................. $120,480Income tax payable—Boxwood (above) ....................... 40,000Total Income tax payable current ................................. $160,480


22. (continued)

The $3,603 difference between the expense in a. and the payable in b. is created by the following two effects:

Deferred income tax liability on equity income accrual not yet taxed($30,960 – $6,000 = $24,960 × 20% × 40%).................................. $1,997

Deferred income tax asset on net unrealized gain($32,000 – $18,000 = $14,000 × 40%)........................................... 5,600

Net decrease in expense.................................................................... $3,603

c. Because a consolidated tax return is filed, unrealized gains are deferred in the same manner as for external reporting purposes. Dividend income is not taxable.

Lake's operating income ................................................ $300,000Boxwood's operating income ........................................ $100,000Prior year unrealized gain .............................................. 18,000Current year unrealized gain ......................................... (32,000) 86,000Income subject to taxation (and currently taxable)..... $386,000Tax rate ............................................................................ 40%Income tax expense ........................................................ $154,400

23. (30 Minutes) (Computation of income tax expense and income tax payable on consolidated and separate tax returns.)

a. Operating Income ........................................................... $450,000Tax rate ............................................................................ 40%Taxes to be paid ............................................................. $180,000

The affiliated group would be taxed on its operating income of $450,000 (the $50,000 unrealized gain is deferred). Intercompany income and dividends are not relevant because a consolidated return is filed.

b. Total taxes to be paid are $200,000. Robertson would have to pay $80,000 or 40% of its $200,000 operating income. Garrison would pay $120,000 or 40% of its $300,000 operating income. The unrealized gain is not deferred because separate returns are being filed. Intercompany dividends are not taxable because the parties still qualify as an affiliated group even though separate returns are being filed.

c. Robertson must report an income tax expense of $80,000 or 40% of its $200,000 operating income.


23. (continued)

Garrison records its expense based on the revenue recognized during the period. Thus, the expense is computed on an operating income of $250,000 (the net unrealized gain is not recognized in this period) along with equity income from Robertson of $84,000 (70% of that company's $120,000 after-tax income). Garrison will record an income tax expense of $100,000 in connection with the operating income ($250,000 × 40%) and $6,720 resulting from its equity income ($84,000 × 20% × 40%). Total expense to be reported amounts to $186,720 for Garrison and Robertson ($80,000 + $100,000 + $6,720).

d. Garrison will pay $120,000 in connection with its operating income ($300,000 × 40%) and $2,400 because of the dividends received from Robertson. Garrison will receive $30,000 in dividends based on its 60% ownership. Of this total, only $6,000 (20%) is taxable. Thus, at a 40% rate, the tax on the dividends would amount to $2,400 ($6,000 × 40%). The total income taxes payable by Garrison is $122,400 ($120,000 + $2,400).

24.(10 Minutes) (Impact on goodwill of assets with a different tax vs. book value.)

The assets and liabilities of Kew (the subsidiary) will be consolidated at their individual fair values (netting to $500,000). However, both the buildings and equipment have a tax basis that is lower than fair value. Thus, for tax purposes, future depreciation expense will be lower on the tax return so that taxable income will exceed book income. The higher taxable income (anticipated in the future) creates a deferred tax liability at the time the combination is created.

Tax Fair TemporaryBasis Value Difference

Buildings ......................................... $140,000 $180,000 $40,000Equipment ....................................... 150,000 200,000 50,000

Total temporary difference ....... $90,000Tax rate ...................................... 30%Deferred tax liability .................. $27,000

Consequently, Kew's accounts will be consolidated as follows: (parentheses indicate a credit balance)

Accounts receivable ....................................................... $110,000Inventory .......................................................................... 130,000Land ................................................................................ 100,000Buildings ......................................................................... 180,000Equipment........................................................................ 200,000

24. (continued)


Liabilities.......................................................................... (220,000)Deferred tax liability ....................................................... (27,000)Assigned to specific accounts ...................................... 473,000Purchase price ................................................................ 650,000Excess assigned to goodwill ......................................... $177,000

25.(55 Minutes) (Consolidation worksheet for a father-son-grandson combination. Includes intercompany inventory transfers.)

The following computations are needed before the consolidation worksheet is prepared: calculation of the deferred gains in beginning and ending inventory.

Beginning Unrealized Gain (Wilson)(January 1, 2011 Inventory Transfer Price (goods remaining) =

Balance) Cost + .25 Cost$60,000 = 1.25 Cost$48,000 = Cost$12,000 is Unrealized Gain

Ending Unrealized Gain (Wilson)(December 31, 2011 Inventory Transfer Price (goods remaining) =

Balance) Cost + .25 Cost $90,000 = 1.25 Cost$72,000 = Cost$18,000 is Unrealized Gain

CONSOLIDATION ENTRIESEntry *G

Retained Earnings, 1/1/11 (Wilson) .......................... 12,000Cost of Goods Sold ............................................. 12,000

(To recognize income on intercompany inventory transfers made in previous year but not resold until current year as per above computation.)

Entry *CRetained Earnings, 1/1/11 (House) ................................ 11,200

Investment in Wilson Company .......................... 11,200(To convert investment account from partial equity method to equity method. Unrealized gain shown in Entry *G is not properly reflected by parent under partial equity method [12,000 × 70% = $8,400 income decrease] nor would the $2,800 in amortization expense for 2009–2010. Thus, a reduction of $11,200 is required. Because Cuddy is a current year acquisition, no prior conversion to equity method is required for the investment.)


25. (continued)

Entry S1Common Stock (Cuddy) ................................................. 150,000Retained Earnings, 1/1/11 (Cuddy) ............................... 150,000

Investment in Cuddy Company (80%)...................... 240,000Noncontrolling Interest in Cuddy Common Stock (20%) 60,000

(To eliminate Cuddy's stockholders' equity against the corresponding investment balance and to recognize noncontrolling interest on common stock.)

Entry S2Common Stock (Wilson) ................................................ 310,000Retained Earnings, 1/1/11 (Wilson)

(adjusted by Entry *G) ............................................... 578,000Investment in Wilson Company (70%) ............... 621,600Noncontrolling Interest in Wilson (30%) ............ 266,400

(To eliminate Wilson's stockholders' equity against corresponding investment balance and to recognize noncontrolling interest.)

Entry ABuildings.......................................................................... 54,000Franchise Contracts ....................................................... 32,000Goodwill............................................................................ 140,000

Equipment .................................................................. 10,000Investment in Wilson Company ............................... 151,200Noncontrolling interest in Wilson Company........... 64,800

(To allocate excess payment made in connection with purchase of Wilson shown above. Amortization for 2009 and 2010 has been taken into account in determining the January 1, 2011 value for each account.)

Entry I1Income of Cuddy Company ...................................... 56,000

Investment in Cuddy Company .......................... 56,000(To eliminate intercompany income accrued by both House and Wilson during the year.)

Entry I2Income of Wilson Company ..................................... 91,000

Investment in Wilson Company .......................... 91,000(To eliminate intercompany income accrued by House during the year.)

Entry D1Investment in Cuddy Company ................................ 40,000

Dividends Paid (80%) (Cuddy) ............................ 40,000(To eliminate effects of intercompany dividend payments.)


25. (continued)

Entry D2Investment in Wilson Company ............................... 67,200

Dividends Paid (70%) (Wilson) ........................... 67,200(To eliminate effects of intercompany dividend payments.)

Entry EOperating Expenses .................................................. 2,000Equipment ................................................................ 5,000

Franchise Contracts ............................................ 4,000Buildings................................................................ 3,000

(To record 2011 amortization on excess payment made in connection with acquisition of Wilson Company.)

Entry TISales and Other Revenues ....................................... 200,000

Cost of Goods Sold ............................................. 200,000(To eliminate intercompany inventory sales for the current year.)

Entry GCost of Goods Sold ................................................... 18,000

Inventory................................................................18,000

(To defer unrealized gain in ending inventory.)

Noncontrolling Interest in Net Income of Cuddy

Reported net income $70,000Outside ownership 20 % Noncontrolling interest in Cuddy income—common $14,000

Noncontrolling Interest in Net Income of Wilson*

Reported operational income $130,000Equity income of Cuddy ($70,000 × 40%) 28,000Excess amortization..................................................................... (2,000)Recognition of 2010 gain (Entry *G) 12,000Deferral of 2011 unrealized gain (Entry G) (18,000)Realized income $150,000Outside ownership 30 % Noncontrolling interest in net income of Wilson $45,000


25. (continued)HOUSE CORPORATION AND CONSOLIDATED SUBSIDIARIES

Consolidation WorksheetDecember 31, 2011

Accounts House Wilson Cuddy Consolidation EntriesNoncontrollingConsolidated Corp. Company Company Debit Credit Interest Balance

Sales and other revenue (900,000) (700,000) (300,000) (TI) 200,000 (1,700,000)

Cost of goods sold 551,000 300,000 140,000 (G) 18,000 (*G) 12,000 797,000(TI) 200,000

Operating expenses 219,000 270,000 90,000 (E) 2,000 581,000Income of Wilson Company (91,000) (I2) 91,000 -0-Income of Cuddy Company (28,000 ) (28,000 ) (I1) 56,000 -0-

Net Income (249,000) (158,000) (70,000) Consolidated net income (322,000)Noncontrolling interest in

Wilson net income (45,000) 45,000Noncontrolling interest in

Cuddy net income (14,000) 14,000To House Corporation (263,000 ) Retained earnings, 1/1/11:—House Corporation (820,000) (*C) 11,200 (808,800)—Wilson Company (590,000) (*G) 12,000 -0-

(S2)578,000—Cuddy Company (150,000) (S1)150,000 -0-Net Income (249,000) (158,000) (70,000) (263,000)Dividends paid —House Corporation 100,000 100,000—Wilson Company 96,000 (D2) 67,200 28,800 -0-—Cuddy Company 50,000 (D1) 40,000 10,000 -0-Retained earnings, 12/31/11 (969,000) (652,000) (170,000) (971,800)


25. (continued)

Accounts House Wilson Cuddy Consolidation EntriesNoncontrollingConsolidated Corp. Company Company Debit Credit Interest Balance

Cash and receivables 220,000 334,000 67,000 621,000Inventory 390,200 320,000 103,000 (G) 18,000 795,200Investment in Wilson Company 807,800 (D2) 67,200 (*C) 11,200 -0-

(S2) 621,600(I2) 91,000(A) 151,200

Investment in Cuddy Company 128,000 128,000 (D1) 40,000 (S1) 240,000 -0-(I1) 56,000

Buildings 385,000 320,000 144,000 (A) 54,000 (E) 3,000 900,000Equipment 310,000 130,000 88,000 (E) 5,000 (A) 10,000 523,000Land 180,000 300,000 16,000 496,000Goodwill (A) 140,000 140,000Franchise Contracts (A) 32,000 (E) 4,000 28,000Total assets 2,421,000 1,532,000 418,000 3,503,200

Liabilities (632,000) (570,000) (98,000) (1,300,000)Noncontrolling interest in Cuddy (S1) 60,000 (60,000)Noncontrolling interest in Wilson (S2) 266,400Noncontrolling interest in (A) 64,800 (331,200 )

subsidiary companies 411,400 (411,400)Common stock (820,000) (310,000) (150,000) (S1) 150,000 (820,000)

(S2) 310,000Retained earnings (above) (969,000 ) (652,000 ) (170,000 ) (971,800 ) Total liabilities and equities (2,421,000) (1,532,000) (418,000) 1,916,400 1,916,400 (3,503,200)

Parentheses indicate a credit balance.


26. (20 Minutes) (Consolidation entries for a mutual holding business combination)

a. Acquisition Price Allocation and Amortization Mighty's Purchase of LowlyConsideration transferred ............................................. $420,000Noncontrolling interest fair value ................................. 280,000Lowly’s business fair value............................................ 700,000Book value acquired........................................................ (600,000)Trademarks....................................................................... $100,000Annual amortization (20-year life).................................. $5,000

CONSOLIDATION ENTRIESEntry *C

Investment in Lowly .................................................. 117,000Retained Earnings, 1/1/10 (Mighty) .................... 117,000

(To record $180,000 income accruing to parent during the previous years as measured by increase in book value [$200,000 × 60%] and amortization expense of $3,000 [$5,000 × 60%] for the previous year.)

Entry S1Common Stock (Lowly) ............................................ 300,000Retained Earnings, 1/1/10 (Lowly) ........................... 500,000

Investment in Lowly (60%) .................................. 480,000Noncontrolling Interest in Lowly 1/1/10 (40%) . . 320,000

(To eliminate subsidiary stockholders' equity accounts against investment account and to recognize noncontrolling interest ownership.)

Entry S2Treasury Stock .......................................................... 240,000

Investment in Mighty ........................................... 240,000(To reclassify cost of parent shares as treasury stock.)

Entry ATrademarks ................................................................ 95,000

Investment in Lowly ............................................. 57,000Noncontrolling Interest in Lowly 1/1/10 (40%) . . 38,000

(To recognize unamortized portion of acquisition-date excess fair value.)

Entry EAmortization Expense ............................................... 5,000

Trademarks ........................................................... 5,000(To record trademarks amortization expense for 2010.)

Noncontrolling interest in subsidiary income = 40% × ($40,000 - $5,000) = $14,000


27.(80 Minutes) (Prepare consolidation worksheet for a father-son-grandson combination. Also asks about income taxes paid on both a separate and a consolidated return)

a. Acquisition-Date Allocation and AmortizationThe January 1, 2009 book values are determined by removing the 2009 income from the January 1, 2010 book values (based on equity accounts).

Consideration transferred for Stookey.......................... $344,000Noncontrolling interest fair value ................................. 86,000Stookey business fair value .......................................... $430,000Stookey book value ........................................................ (380,000)Customer List................................................................... $50,000Life ................................................................................... 10 YearsAnnual amortization ....................................................... $5,000

Consideration transferred for Yarrow............................ $720,000Noncontrolling interest fair value ................................. 80,000Yarrow business fair value ............................................ $800,000Yarrow book value........................................................... 740,000Copyright ......................................................................... $60,000Life ................................................................................... 15 YearsAnnual amortization ....................................................... $4,000

CONSOLIDATION ENTRIES

Entry *GRetained Earnings, 1/1/10 (Stookey) ....................... 7,680

Cost of Goods Sold ............................................. 7,680(To give effect to unrealized gain from 2009. Amount is calculated based on normal 48% markup [found from Income Statement] multiplied by $16,000 retained inventory [20% of $80,000])

Entry *C1Investment in Stookey .............................................. 85,856

Retained Earnings, 1/1/10 (Yarrow) .................... 85,856(To recognize equity income accruing from Yarrow's investment in Stookey during 2009. Because the initial value method is applied and no dividends paid, no income has been recognized in connection with the 2009 ownership of Stookey. Reported income of $120,000 [2009] less unrealized gain of $7,680 deferred above indicates income of $112,320. Based on 80% ownership, an $89,856 accrual is needed, which is reduced by the $4,000 amortization (80% × $5,000) for that year.

27. (continued)


Entry *C2Investment in Yarrow ................................................ 217,670

Retained Earnings, 1/1/10 (Travers) ................... 217,670(To recognize equity income accruing from Travers' investment in Yarrow during 2009. Because the initial method is applied and no dividends paid, income has not been recognized in connection with the 2009 ownership of Yarrow. Income of $245,856 is calculated based on reported income of $160,000 [2009] plus the $85,856 accrual recognized in Entry *C1. Ownership of 90% dictates a $221,270 accrual that is then reduced to $217,670 by the $3,600 [90% × $4,000] amortization applicable to 2009.)

Entry S1Common Stock (Stookey) ......................................... 200,000

Retained Earnings, 1/1/10 (Stookey, as adjustedby Entry *G) .......................................................... 292,320

Investment in Stookey (80%) ......................... 393,856Noncontrolling Interest in Stookey (20%) .... 98,464

(To eliminate stockholders' equity accounts of subsidiary [Stookey] against corresponding balance in investment account and to recognize noncontrolling interest ownership.)

Entry S2Common Stock (Yarrow) ........................................... 300,000

Retained Earnings, 1/1/10 (Yarrow, as adjustedby Entry *C1) ......................................................... 685,856

Investment in Yarrow (90%) ........................... 887,270Noncontrolling Interest in Yarrow (10%) ...... 98,586

(To eliminate stockholders’ equity accounts of subsidiary Yarrow against corresponding balance in investment account and to recognize noncontrolling interest ownership.)

Entry A1Customer List............................................................. 45,000

Investment in Stookey ......................................... 36,000Noncontrolling Interest in Stookey (20%) ......... 9,000

(To recognize January 1, 2010 unamortized portion of acquisition price assigned to Stookey’s customer list.)


27. (continued)

Entry A2Copyright .................................................................... 56,000

Investment in Yarrow ........................................... 50,400Noncontrolling interest in Yarrow....................... 5,600

(To recognize January 1, 2010 unamortized portion of acquisition price assigned to copyright.)

Entry EOperating Expenses .................................................. 9,000

Customer List........................................................ 5,000Copyright............................................................... 4,000

(To recognize amortization expense for 2010—$5,000 in connection with Travers' investment and $3,000 in connection with Yarrow's investment.)

Entry TlSales ........................................................................... 100,000

Cost of Goods Sold ............................................. 100,000(To eliminate intercompany inventory transfers made during 2010.)


Inventory (current assets) ................................... 9,600(To defer unrealized gain on ending inventory—$20,000 × 48% markup.)

Noncontrolling Interest in Stookey's Net Income2010 Reported net income ............................................. $100,000Customer list amortization ............................................ (5,000)Realization of 2009 deferred income (*G) ..................... 7,680Deferral of 2010 unrealized gain (G) ............................. (9,600)Realized income 2010 ..................................................... $93,080Outside ownership ......................................................... 20%Noncontrolling interest in Stookey's net income ........ $18,616

Noncontrolling Interest in Yarrow's Net Income2010 Reported net income ............................................. $200,000Copyright amortization .................................................. (4,000)Accrual of Stookey's income (80% of $93,080

realized income [computed above]) ........................ 74,464Realized Income—2010 .................................................. $270,464Outside ownership ......................................................... 10%Noncontrolling interest in Yarrow's net income .......... $27,046


.27. (continued) TRAVERS COMPANY AND CONSOLIDATED SUBSIDIARIES

Consolidation WorksheetDecember 31, 2010

Travers Yarrow Stookey Consolidation EntriesNoncontrollingConsolidated Accounts Company Company Company Debit Credit Interest Balances Sales and other revenues (900,000) (600,000) (500,000) (Tl) 100,000 (1,900,000)Cost of goods sold 480,000 320,000 260,000 (G) 9,600 (*G) 7,680 961,920

(TI) 100,000Operating expenses 100,000 80,000 140,000 (E) 9,000 329,000Separate company net income (320,000) (200,000) (100,000)Consolidated net income (609,080)NCI in Yarrow's net income (27,046) 27,046NCI in Stookey's net income (18,616) 18,616 To controlling interest (563,418)Retained earnings, 1/1/10:

Travers Company (700,000) (*C2) 217,670 (917,670)Yarrow Company (600,000) (S2) 685,856 (*C1) 85,856 -0-Stookey Company (300,000) (*G) 7,680 -0-

(S1) 292,320Net Income (above) (320,000) (200,000) (100,000) (563,418)

Dividends paid 128,000 128,000Retained earnings, 12/31/10 (892,000) (800,000) (400,000) (1,353,088)

Current assets 444,000 380,000 280,000 (G) 9,600 1,094,400Investment in Yarrow Company 720,000 (*C2) 217,670 (S2) 887,270 -0-

(A2) 50,400Investment in Stookey Company 344,000 (*C1) 85,856 (S1) 393,856 -0-

(A1) 36,000Land, buildings, & equipment (net) 949,000 836,000 520,000 2,305,000Customer List (A1) 45,000 (E) 5,000 40,000Copyright (A2) 56,000 (E) 4,000 52,000 Total assets 2,113,000 1,560,000 800,000 3,491,400

Liabilities (721,000) (460,000) (200,000) (1,381,000)Common stock (500,000) (300,000) (200,000) (S1) 200,000

(S2) 300,000 (500,000)Retained earnings, 12/31/10 (above) (892,000) (800,000) (400,000) (S1) 98,464 (1,353,088)NCI interest in Stookey, 1/1/10 (A1) 9,000 (107,464)

(S2) 98,586Noncontrolling interest in Yarrow, 1/1/10 (A2) 5,600 (104,186 ) Noncontrolling interests in subsidiaries (257,312) (257,312 ) Total liabilities and equities (2,113,000) (1,560,000) (800,000) 2,008,982 2,008,982 (3,491,400)

27. (continued)

b. Travers' reported income .................................................................... $320,000Yarrow's reported income ................................................................... 200,000Dividend income (none collected) ...................................................... -0-Intercompany gains (no transfers) ..................................................... -0-Amortization expense .......................................................................... (9,000)Taxable income .................................................................................... $511,000Tax rate .................................................................................................. 45%Income tax payable .............................................................................. $229,950

c. Stookey's reported income ................................................................. $100,000(Unrealized gains are not deferred on a separate

tax return.)Tax rate .................................................................................................. 45%Income tax payable .............................................................................. $45,000

d. (1) Because 80% of Stookey's stock is owned by Yarrow, intercompany dividends would be nontaxable. Consequently, no temporary difference is created by Stookey's failure to pay a dividend.

(2) Stookey's unrealized gains are recognized in one time period for financial reporting purposes and in a different time period for tax purposes. A temporary difference is created. The net effect is an increase in taxable income by $1,920 over reported income:

2010 Unrealized gain taxed in 2010..................................................... $9,6002009 Unrealized gain taxed previously in 2009.................................. (7,680)Increase in taxable income ................................................................. $1,920Tax rate .................................................................................................. 45%Deterred income tax asset .................................................................. $864

Income Tax Expense:Travers and Yarrow—payable (part b) .......................................... $229,950Stookey—payable (part c) .............................................................. 45,000Total taxes to be paid—2010.......................................................... $274,950Prepayment (Asset) (above) .......................................................... (864)Income tax expense 2010................................................................ $274,086

27.d. (continued)

Because a single rate is used, income tax expense can also be computed by taking consolidated net income (prior to noncontrolling interest reduction) of $609,080 (part a.) and multiplying by the 45% tax rate to obtain $274,086.

Income Tax Expense—Current ...................................... 274,086Deferred Income Tax—Asset ......................................... 864

Income Tax Payable .................................................. 274,950

28.(40 Minutes) (Series of questions about a business combination and its income tax reporting)

a. Partial equity method. "Income of Soludan" is 80% of Soludan's reported total.

b. $12,000. Reduction is evidenced by a $338,000 figure reported for consolidated inventory rather than the $350,000 total for the two companies.

c. $37,500. Consolidated operating expenses have increased by $2,500, evidently the annual amortization. Because a 15-year life is assumed by the combination, the amount originally allocated to trademarks must have been $37,500.

d. $120,000. Decrease shown in consolidated sales account.

e. Upstream. "Noncontrolling interest in Soludan Company's income" is $18,700. Because this amount is not equal to 20% of Soludan's reported income less excess amortization ($100,000 – $2,500), realized income must have been adjusted for unrealized gains. Subsidiary income is only adjusted to show the effects of upstream transfers.

f. $20,000. For both receivables and liabilities, the consolidated total is $20,000 less than the sum of the two companies.

g. $8,000. Consolidated cost of goods sold is decreased by $120,000 (to $780,000) in eliminating intercompany sales. The increase of $12,000 created by the ending unrealized gain (see part b.) would then leave a $792,000 balance. Because $784,000 is the ending balance reported for consolidated cost of goods sold, an $8,000 unrealized gain must have been deferred from the previous year.

28. (continued)

h. Because the trademarks balance now stands at $32,500, amortization expense of $2,500 has been recognized, $2,500 in the previous year. In addition, an $8,000 unrealized gain from the prior year (see part g.) is recognized.

Amortization expense—prior years × 80%.................... $2,000Unrealized gain—upstream effect on

parent's retained earnings is $8,000 × 80%............. 6,400Adjustment to parent’s beginning retained earnings. . $8,400

i. This figure is computed as follows:Book value of subsidiary—1/1 ...................................... $370,000Unrealized gain in beginning inventory (see above) . . (8,000)Realized book value ..................................................... $362,000Excess allocation ..................................................... 35,000Total to noncontrolling interest .................................... 397,000Outside ownership ......................................................... 20% $79,400Noncontrolling interest in Soludan's income

(as reported) .............................................................. 18,700Noncontrolling interest in Soludan's dividends

($20,000 × 20%) .......................................................... (4,000)Ending noncontrolling interest ..................................... $94,100

j. For a consolidated return, unrealized gains are deferred as in the consolidated statements. At a 40% rate, both the expense and payable would be $117,400.

Income Tax Expense ...................................................... 117,400Income Tax Payable .................................................. 117,400

Consolidated Taxable Income:Sales ............................................................................................... $1,280,000Cost of goods sold ........................................................................ (784,000)Operating expenses ...................................................................... (202,500)

Taxable income ........................................................................ $293,500

k. On a separate return, Politan would report its operating income of $200,000 leading to a tax expense and payable of $80,000. Because of the level of ownership, intercompany dividend (or investment) income is omitted.

Income Tax Expense ...................................................... 80,000Income Tax Payable .................................................. 80,000

28.k. (continued)

On a separate return, Soludan would report $100,000 operating income for a payable of $40,000. The unrealized gains are accounted for in different time periods in the financial statements, thus, a temporary difference is created. The beginning gain of $8,000 was taxed in the previous year rather than currently. The current gain of $12,000 is taxed now rather than next year; the tax paid this year on the net $4,000 ($1,600) is a prepayment.

Income Tax Expense ...................................................... 38,400Deferred Income Tax - Asset ......................................... 1,600

Income Tax Payable .................................................. 40,000

Soludan's entry can also be computed as follows:Reported Income ............................................................................. $100,000Unrealized gain from previous period realized currently ........... 8,000Deferral of current unrealized gain ............................................... (12,000)Realized Income .............................................................................. $96,000Tax rate ..................................................................................... 40%Income tax expense ........................................................................ $38,400Taxes payable.................................................................................. 40,000

Deferred tax asset ................................................................................ $1,600

29.(45 Minutes) Develop worksheet entries that were used to consolidate the financial statements of a father-son-grandson combination.

Entry *GRetained Earnings, 1/1/11 (Delta) ............................. 15,000

Cost of Goods Sold ............................................. 15,000(To recognize gain that was unrealized in 2010 [amount provided].)

Entry *C1Retained Earnings, 1/1/11 (Delta) ............................. 7,000

Investment in Omega Company ......................... 7,000(To recognize amortization expense from Delta’s acquisition for 2010.)

29. (continued)

Entry *C2Retained Earnings, 1/1/11 (Alpha) ........................... 27,600

Investment in Delta Company ............................. 27,600To recognize accrual adjustments for excess amortization and inventory deferral as follows:Excess amortization from Delta acquisition (80% × $6,250 × 2 years)........................................ $10,000Deltas’ share of excess amortization from Omega acquisition (80% × [70% × $10,000] × 1 year)........................... 5,600Inventory profit deferral at 1/1/11 (80% × $15,000).. (12,000)*C2 adjustment........................................................... $27,600

Entry S1Common Stock (Omega) .......................................... 100,000Retained Earnings, 1/1/11 (Omega) ......................... 100,000

Investment in Omega (70%) ................................ 140,000Noncontrolling Interest in Omega (30%) ........... 60,000

(To eliminate stockholders' equity accounts of Omega against parent's Investment account and to recognize outside ownership.)

Entry S2Common Stock (Delta) .............................................. 120,000Retained Earnings, 1/1/11 (Delta, as adjusted) ....... 378,000

Investment in Delta (80%) ................................... 398,400Noncontrolling Interest in Delta (20%) ............... 99,600

(To eliminate stockholders' equity accounts of Delta [as adjusted as Entry *G and Entry *C1] against corresponding balance in Investment account and to recognize outside ownership.)

Entry ACopyrights ................................................................. 222,500

Investment in Delta .............................................. 90,000Investment in Omega ........................................... 77,000Noncontrolling interest in Delta.......................... 22,500Noncontrolling interest in Omega....................... 33,000

(To recognize January 1, 2011 unamortized copyrights, 2 years amortization recorded on first investment but only one year for second.)

Entry I1Income of Subsidiary ................................................ 144,000

Investment in Delta .............................................. 144,000(To eliminate intercompany income accrual found on Alpha's records.)

29. (continued)

Entry I2Income of Subsidiary ................................................ 49,000

Investment in Omega ........................................... 49,000(To eliminate intercompany income accrual found on Delta's records.)

Entry D1Investment in Delta ................................................... 32,000

Dividends Paid (Delta) ......................................... 32,000(To eliminate intercompany dividend payments, 80% of Delta's payment.)

Entry D2Investment in Omega ................................................ 35,000

Dividends Paid (Omega) ...................................... 35,000(To eliminate intercompany dividend payments, 70% of Omega's payment.)

Entry EOperating Expenses .................................................. 16,250

Copyrights ............................................................ 16,250(Current year amortization, $6,250 on first acquisition and $10,000 on second.)

Entry TlSales ........................................................................... 200,000

Cost of Goods Sold ............................................. 200,000(To eliminate intercompany inventory transfer.)


Inventory................................................................22,000

(To defer ending unrealized gain on intercompany transfers.)

Noncontrolling Interest in Omega's Income:Reported income ............................................................ $70,000Excess fair value amortization ...................................... (10,000 ) Accrual-based income.................................................... 60,000Outside ownership ......................................................... 30 % Noncontrolling interest in Omega’s income ................ $18,000

29. (continued)

Noncontrolling Interest in Delta's Income:Reported operating income ........................................... $131,000Equity income investment in Omega (70% × $60,000) 42,000Amortization expense .................................................... (6,250)2010 Unrealized income realized in 2011...................... 15,0002011 Unrealized income realized in 2011 ..................... (22,000)Accrual-based income—Delta (2011) ............................ $159,750Outside ownership ......................................................... 20 % Noncontrolling interest in Delta's income (2011) ........ $31,950

Noncontrolling interest in Delta Company....................Noncontrolling interest, 1/01/11 (Entry S2).............. $99,600Noncontrolling interest, 1/01/11 (Entry A)............... 22,500Noncontrolling interest in Delta’s income (above). 31,950Dividends paid to noncontrolling interest ($40,000 × 20%)........................................................ (8,000)

Noncontrolling interest in Delta, 12/31/11.......... $146,050

Noncontrolling interest in Omega Company................Noncontrolling interest, 1/01/11 (Entry S1).............. $60,000Noncontrolling interest in Omega’s income (above) 18,000Noncontrolling interest, 1/01/11 (Entry A)............... 33,000Dividends paid to noncontrolling interest ($50,000 × 30%) (15,000)

Noncontrolling interest in Omega, 12/31/11....... $96,000

Chapter 7 Excel Case Solution

Operating Dividends Excess income paid amortizations Summit $345,000 $150,000Treeline $280,000 $100,000 $20,000Basecamp $175,000 $40,000 $25,000

Ownership percentagesSummit-->Treeline 90%Treeline-->Basecamp 70%

Treeline's share of Basecamp income:Basecamp operating income $175,000 Excess amortization (25,000 ) Accrual based income $150,000 Treeline ownership percentage 70 % Equity income from Basecamp $105,000

Summit's share of Treeline income:Treeline operating income $280,000 Equity income from Basecamp 105,000 Excess amortization (20,000 ) Treeline adjusted income $365,000 Summit ownership percentage 90 % Summit's share of reported income $328,500

Controlling interest in net incomeSummit's operating income $345,000 Equity earnings in Treeline and Basecamp 328,500 Summit’s net income $673,500

ComparisonConsolidated net income (operating incomes less amortizations) $755,000Noncontrolling interest in consolidated net income (30% × $150,000 plus 10% × $365,000) $81,500Controlling interest in consolidated net income $673,500

Difference between Summit’s net income and controlling interest in consolidated net income = -0-

RESEARCH CASE: CONSOLIDATED TAX EXPENSE

At www.thecoca-colacompany.com the annual financial statements and 10-K provide an excellent set of statements and footnotes to review disclosures for consolidated income tax issues.

In particular Note 17 provides details of the consolidated tax expense in Coca-Cola’s 2006 annual report. The excerpt below shows the portion of the footnote relating to components of deferred tax assets and liabilities and carryforwards.

http://www.thecoca-colacompany.com/

Week 5 Hw Solutions

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