DMP3e CH12 Solutions 05.17.10 Revised

Chapter 12 Reporting and Analyzing Intercorporate Investments Learning Objectives – coverage by question Miniexercises LO1 – Explain and interpret the three levels of investor influence over an investee – passive, significant, and controlling.

11, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22, 23

Exercises

Problems

Cases

45, 46, 47,

49, 50, 51,

48

52

44, 47

50, 51, 52

24, 25, 26, 27, 28, 29, 30, 31, 32, 33, 34, 35, 36, 37, 38, 39, 40, 41, 42

LO2 – Describe and analyze accounting for passive investments.

11, 12, 13,

24, 25, 27, 29,

20, 21, 22

32, 35, 36, 37

LO3 – Explain and analyze accounting for investments with significant influence.

13, 14, 15,

26, 30, 31, 32,

16

33, 34, 37, 38

LO4 – Describe and analyze accounting for investments with control.

13, 17, 18,

28, 39, 40, 41,

19, 23

42

LO5 – Appendix 12A – Illustrate and analyze accounting mechanics for equity method investments. LO6 – Appendix 12B – Apply equity method accounting mechanics to consolidations.

42

LO7 – Appendix 12C – Discuss the reporting of derivative securities.

43

44, 47

49, 50, 51, 52

45, 46, 48

49, 51

44, 47

49

45, 46, 48

©Cambridge Business Publishers, 2011 Solutions Manual, Chapter 12

12-1

QUESTIONS Q12-1. a) Trading securities are reported at their fair market value in the balance sheet. b) Available-for-sale securities are reported at their fair market value in the balance sheet. c) Held-to-maturity securities are reported at their amortized cost in the balance sheet. Q12-2. An unrealized holding gain (loss) is an increase (decrease) in the fair market value of an asset (in this case, an investment security) that is still owned. Q12-3. Unrealized holding gains and losses related to trading securities are reported in the current-year income statement (and also retained earnings). Unrealized holding gains and losses related to available-for-sale securities are reported as a separate component of stockholders' equity called Other Comprehensive Income (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 stock is owned. Normally, this is accomplished with a 20% through 50% ownership of the company's voting stock. The equity method is used to account for investments with significant influence. Such an investment is initially recorded at cost; the investment is increased by the proportionate share of the investee company's net income, and equity income is reported in the income statement; the investment account is decreased by dividends received on the investment; and the investment account is reported in the balance sheet at its book value. Unrealized appreciation in the market value of the investment is not recognized. Q12-5. Yetman Company's investment in Livnat Company is an investment with significant influence, and should, therefore, be accounted for using the equity method. 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's voting stock is generally viewed as conferring “control” over the investee company. The investor and investee companies must be consolidated for financial reporting purposes. Q12-7. Consolidated financial statements attempt to portray the financial position, operating results, and cash flows of affiliated companies as a single economic unit so that the scope of the entire (whole) entity is more realistically conveyed.

©Cambridge Business Publishers, 2011 12-2

Financial Accounting, 3rd Edition

Q12-8. The $750,000 investment in Murray Company appearing in Finn Company's balance sheet and the $300,000 common stock and $450,000 retained earnings appearing on Murray Company's balance sheet are eliminated. The two balance sheets (less the accounts eliminated) are then summed to yield the consolidated balance sheet. Q12-9. The $75,000 accounts payable on Dee's balance sheet and the $75,000 accounts receivable on Bradshaw's balance sheet are eliminated. In a consolidation, all intercompany items are eliminated so that the consolidated statements show only the interests of outsiders. Q12-10. Limitations of consolidated statements include the possibility that the performances of poor companies in a group are "masked" in consolidation. Likewise, rates of return, other ratios, and percentages calculated from consolidated statements might prove deceptive because they are composites. Consolidated statements also eliminate detail about product lines, divisional operations, and the relative profitability of various business segments. (Some of this information is likely to be available in the footnote disclosures relating to the business segments of certain public firms.) Finally, shareholders and creditors of subsidiary companies find it difficult to isolate amounts related to their legal rights by inspecting only consolidated statements.


12-3

MINI EXERCISES M12-11 (10 minutes)

a. Available-for-sale securities are reported at market value on the balance sheet. For 2008, this is equal to the original cost ($341 million) plus unrecognized gains ($17 million) and less unrealized losses ($39) million), or $319 million.

b. Unrealized gains (and losses) on available-for-sale securities are reported as a component of Accumulated Other Comprehensive Income on the balance sheet.

M12-12 (15 minutes) 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 in the 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 the stockholders’ equity section of the balance sheet. b. If the investment is accounted for as “trading,” Wasley will report $6,600 of dividend income plus income relating to the increase in the market price of the stock of $6,000 ($13 - $12 price increase for 6,000 shares).

M12-13 (10 minutes) Abbott Laboratories is accounting for its investment securities as available-forsale. As such, the unrealized losses of $49 million are not recognized in current income. Instead, they are reported as a decrease in Accumulated Other Comprehensive Income (AOCI). Abbott Labs’ stockholders’ equity is decreased by the unrealized loss, but not its net income or retained earnings.



M12-14 (20 minutes)

a.

Given the 30% ownership, “significant influence” is presumed and the investment must be accounted for using the equity method. The year-end balance of the investment 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 net income of the investee (Lang Company) multiplied by the percentage of the outstanding common stock owned.

c. (1) In contrast to the market method, the equity method of accounting does not report investments at market value. The unrealized gain of $200,000 is not reflected in either the balance sheet or the income statement. d. 1. 2. 3.

Investment in Lang Company (+A) ................................................. Cash (-A) ................................................................................

1,000,000

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

30,000

Cash (+A) .................................................................................... Investment in Lang Company (-A) .............................................

12,000

1,000,000 30,000 12,000

e. + 3. +

Cash (A) 1,000,000 12,000

1.

Investment in Lang Company (A) 1. 1,000,000 2. 30,000 12,000

Investment Income (R) 30,000

+ 2.

3.

f.

Balance Sheet Transaction Purchase stock in Lang Company. Recognize share of Lang income. Receive dividend from Lang.

Cash Asset

-1,000,000 Cash

Noncash Assets

+

+1,000,000 Investment

+30,000 Investment

+12,000 Cash

-12,000 Investment

= Liabilities +

Contrib. + Capital

Income Statement Earned Capital

Revenues -

= = =

+30,000

+30,000

Retained Earnings

Investment Income

Expenses

=

Net Income

-

=

-

= +30,000

-

=


12-5

M12-15 (10 minutes) Equity income on this investment is computed as the investee company (Penno) earnings multiplied by the percentage of the company owned. In this case, equity earnings equal: $600,000 × 40% = $240,000 Note that dividends are treated as a return of investment (reduce the investment balance by $80,000, computed as $200,000 × 40%), and not as income. Also, the investment 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. M12-16 (15 minutes) a. Merck reports income from its equity method investments at $2,560.6 million on its 2008 income statement. Equity method investments are reported on the balance sheet at adjusted cost, not at current market value. Adjusted cost is the original purchase price plus (minus) Merck’s proportionate share of investee companies’ profits (losses), less dividends received. b. Merck will account for dividends received on equity method investments as a reduction of the investment balance, not as income. M12-17 (10 minutes) The $600,000 investment in Hirst Company appearing on Philipich Company's balance sheet and the $300,000 common stock and $450,000 retained earnings of Hirst Company would be eliminated. In addition, a $150,000 minority interest [20% of ($300,000 + $450,000)] would appear on the consolidated balance sheet. Many analysts treat the minority interest as an equity account, and FASB has issued an exposure draft requiring presentation as such if the proposal becomes GAAP. M12-18 (10 minutes) Benartzi Company net income............................................... 90% of $150,000 Liang Company net income....................... Consolidated net income.......................................................

$600,000 135,000 $735,000

M12-19 (10 minutes) Consolidated earnings under the pooling of interests method would be higher because pooling-of-interest does not recognize current market values of assets and goodwill. As a result, consolidated earnings will not be reduced by the depreciation and/or amortization of those additional asset values, nor will subsequent income statements be burdened by any impairment of goodwill. ©Cambridge Business Publishers, 2011 12-6


M12-20 (40 minutes) a. 2010 10/1 12/31 12/31

2011 3/31

4/1

b.

Investment in Skyline, Inc. (+A) ...................................................... Cash (-A) ................................................................................

486,000

Interest receivable (+A) ................................................................. Interest revenue (+R, +SE) .......................................................

8,750

Investment in Skyline, Inc. (+A) ...................................................... Unrealized gain (+R, +SE) ........................................................

4,000

486,000 8,750 4,000

Cash (+A) ................................................................................. Interest receivable (-A) ....................................................... Interest revenue (+R, +SE) ..................................................

17,500

Cash (+A) ................................................................................. Realized gain (+R, +SE) ...................................................... Investment in Skyline, Inc. (-A) ...........................................

492,300

8,750 8,750 2,300 490,000

Assuming the firm’s fiscal year ends 12/31, the unrealized gain of $4,000 in Skyline Inc. bonds is closed to retained earnings in 2007 increasing net income and retained earnings. +

Cash (A)

-

Interest Revenue (R) 8,750 8,750

+ 12/31/10 3/31/11

+ Investment in Skyline Bonds (A) 10/1/10 486,000 12/31/10 4,000 490,000 4/1/11

-

Unrealized Gain (R) 4,000

+ 12/31/10

+ 12/31/10

-

Realized Gain (R) 2,300

3/31/11 4/1/11

486,000

10/1/10

17,500 492,300

Interest Receivable (A) 8,750 8,750

3/31/11

+ 4/1/11

c. Transaction

Cash Asset

10/1/10 Purchase $500000 of Skyline bonds at 97. 12/31/10 Recognize interest revenue. 12/31/10 Record unrealized gain. 3/31/11 Recognize interest income.

- 486,000

4/1/11 Sold Skyline investment.

+492,300

Cash

+

Balance Sheet Noncash Contrib. = LiabilAssets ities + Capital +

+ 486,000

Interest Receivable

=

+4,000

Investment =

Cash

Cash

Revenues - Expenses

=

-

=

-

=

Retained Earnings

Unrealized Gain

=

+8,750

+8,750

Retained Earnings

Interest Revenue

Investment =

+8,750

+17,500


-8,750

Interest = Receivable

-490,000

Investment =

+8,750

+8,750

Retained Earnings

Interest Revenue

+4,000

+4,000

+2,300

+2,300

Retained Earnings

Realized Gain

-

=

-

=

Net Income

+8,750 +4,000 +8,750 +2,300


12-7

M12-21 (40 minutes) a. 2010 11/15 12/22 12/31

2011 1/20

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

72,750

Cash (+A) ..................................................................................... Dividend income (+R, +SE) .......................................................

6,600

Unrealized loss (+E, -SE) ............................................................... Investment in Lane, Inc. (-A) .....................................................

5,250

72,750 6,600 5,250

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

66,900 600 67,500

b. Assuming the firm’s fiscal year ends 12/31, the unrealized loss of $5,250 is closed to the income summary in 2010, reducing net income and retained earnings. + Cash (A) 6,600 72,750 66,900

12/22 1/20

11/15

11/15

+ Investment in Lane Inc (A) 72,750 5,250 67,500 +

1/20 + 12/31

Unrealized Loss (E) 5,250

-

Loss (E) 600

12/31 1/20

-

- Dividend Income (R) + 6,600

12/22

c. Balance Sheet Transaction 11/15 Purchase 6,000 shares of Lane Inc common. 12/22 Dividend income.

Noncash Assets

Liabil = -ities

-72,750

+72,750

Cash

Investment

=

Cash Asset

+

+6,600

=

Cash 12/31 Decrease in Investment. 1/20 Sale of Lane common.

-5,250 Investment

+66,900 Cash

-67,500

=

Investment =

+ Contrib. Capital +


Revenues

-

Expenses

= =

+6,600

+6,600

Retained Earnings

Dividend Income

=

-5,250

+5,250

Retained Earnings

Unrealized Loss

-600

+600

Retained Earnings

Realized Loss

= =


Net Income


+6,600 -5,250 -600

M12-22 (30 minutes) The main effect is to defer the loss in value experienced in 2010 to the year 2011. 2010 11/15 12/22 12/31

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

72,750


6,600

Unrealized loss – AOCI (-SE) .......................................................... Investment in Lane, Inc. (-A) .....................................................

5,250

72,750 6,600 5,250

2011 The adjusting entry can be done on the date of sale or 12/31/2010. 1/20 Cash (+A) ................................................................................. 66,900 Loss on sale of investment in Lane, Inc. (+E, -SE) ........................ 5,850 Unrealized loss – AOCI (+SE) ............................................. Investment in Lane, Inc. (-A) ..............................................

+ Cash (A) 6,600 72,750 66,900

12/22 1/20

11/15

11/15

+ Investment in Lane Inc (A) 72,750 5,250 67,500 +

1/20

+ 12/31

Unrealized Loss (AOCI) 5,250 5,250

1/20

Loss (E) 5,850

5,250 67,500

12/31 1/20

-


11/22

M12-23 (10 minutes) Halen Inc. now owns all of Jolson. The company reports will be consolidated. The total in the consolidated stockholder’s equity section on 1/1 is determined as follows: Common stock………………………………………….. Retained earnings……………………………………….. Total Equity

$600,000 310,000 $910,000

Halen paid cash exactly equal to the net book value of Jolson’s assets. Jolson’s equity accounts are eliminated in the consolidation process. (No goodwill results when the purchase price equals the book value of the acquired company.)


12-9

EXERCISES E12-24 (30 minutes) a. Trading securities 1 2 3 4

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

72,000


6,600

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

4,500

Cash (+A) ..................................................................................... Loss on sale of investment (+E, -SE) ............................................... Investment in Liu, Inc. (-A)........................................................

66,900 600

72,000 6,600 4,500

67,500

b. + Cash (A) 6,600 72,000 66,900

2. 4.

1.

1.

+ Investment in Liu (A) 72,000 4,500 67,500 - Retained Earnings (SE) 6,600

+ 4.

Unrealized Loss (E) 4,500

4.

3. 4. + 2.

+ Loss on Sale (E) 600

c. Balance Sheet Transaction 1. Purchased 6,000 common shares of Liu, Inc., for $12 per share. 2. Received a cash dividend of $1.10 per common share from Liu. 3. Year-end market price of Liu common stock is $11.25 per share. 4. Sold all 6,000 common shares of Liu for $66,900.

Cash Asset

Noncash Assets

= Liabilities +

-72,000

+72,000

Cash

Investment

=

+

+6,600

=

Cash

-4,500 Investment

+66,900 Cash

- 67,500 Investment

=

=

Income Statement Contrib. + Capital

Earned Capital

Revenues - Expenses

+6,600

+6,600

Retained Earnings

Dividend Income

-4,500 Retained Earnings

–600 Retained Earnings

= Net Income

-

=

-

=

+6,600

=

-4,500

=

–600

-

-

+4,500 Unrealized Loss

+600 Loss



d. Available-for-Sale Securities 1 2 3 4

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

72,000


6,600

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

4,500

Cash (+A) ..................................................................................... Loss on sale of investment (+E, -SE) ............................................... Unrealized loss (+SE) .............................................................. Investment in Liu, Inc. (-A)........................................................

66,900 5,100

+ Cash (A) 6,600 72,000 66,900

2. 4.

3.

+ Unrealized Loss (SE) 4,500 4,500

1.

1.

4.

Transaction

1. Purchased 6,000 common shares of Liu, Inc., for $12 per share. 2. Received a cash dividend of $1.10 per common share from Liu. 3. Year-end market price of Liu common stock is $11.25 per share.

+ Noncash Assets

-72,000

+72,000

Cash

Investment

+6,600

= Liabilities +

Cash

-4,500 Investment

4. Sold all 6,000 common shares of +66,900 Cash Liu for $66,900.

=

4,500 67,500

- Retained Earnings (SE) + 6,600

2.

+ Loss (E) 5,100

Income Statement +

Earned Capital

Revenues

=

=

4,500

3. 4.

4.

Contrib. Capital

6,600

+ Investment in Liu (A) 72,000 4,500 67,500

Balance Sheet Cash Asset

72,000

+6,600

+6,600

Retained Earnings

Dividend Income

-4,500 AOCI

-

Expenses

=

-

=

-

=

-

=

Net Income

+6,600

+4,500 -67,500 Investment

AOCI =


-

+5,100 Loss

= –5,100


12-11

E12-25 (30 minutes) a. Investments classified as trading securities 1 2 3 4

2. 4.

Investment in Freeman, Inc. (+A) .................................................... Cash (-A) ................................................................................

80,000


6,250

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

7,500

Cash (+A) ..................................................................................... Loss on sale of investment (+E, -SE) ............................................... Investment in Freeman, Inc. (-A)................................................

86,400 1,100

+ Cash (A) 6,250 80,000 86,400

1.

- Unrealized Gain (R) + 7,500

3.

1. 3.

4.

Transaction

1. Ohlson Co. purchases 5,000 common shares of -80,000 Freeman Co. at $16 cash Cash per share. 2 Ohlson Co. receives a cash dividend of $1.25 per +6,250 common share from Cash Freeman. 3 Year-end market price of Freeman common stock is $17.50 per share. 4. Ohlson Co. sells all +86,400 5,000 common shares of Cash Freeman for $86,400 cash.

+

Noncash Assets

= Liabilities +

+80,000

=

Investment

=

+7,500 Investment

-87,500 Investment

=

=

6,250 7,500

87,500

+ Investment in Freeman (A) 80,000 7,500 87,500

4.


2.

+ Loss on Sale (E) 1,100

Balance Sheet Cash Asset

80,000


Earned Capital

Revenues

-

Expenses

+6,250

+6,250

Dividend Revenue

+7,500

+7,500

= +6,250

= +7,500

Retained Unrealized Earnings Gain

-1,100

+ Retained Earnings

-

+1,100 Loss

=


Net Income

=

-

Retained Earnings

=


-1,100

b. Available for Sale Securities 1 2 3 4

2. 4.

4.

Investment in Freeman, Inc. (+A) .................................................... Cash (-A) ................................................................................

80,000


6,250

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

7,500

Cash (+A) ..................................................................................... Unrealized gain (-SE) .................................................................... Gain on sale of investment (+R, +SE) ........................................ Investment in Freeman, Inc. (-A)................................................

86,400 7,500

+ Cash (A) 6,250 80,000 86,400

1.

- Unrealized Gain (SE) + 7,500 7,500

1. 3.

Cash Asset

+

1. Ohlson Co. purchases 5,000 -80,000 common shares of Cash Freeman Co. at $16 cash per share. 2. Ohlson Co. receives a cash dividend of $1.25 +6,250 per common share from Cash Freeman. 3. Year-end market price of Freeman common stock is $17.50 per share. 4. Ohlson Co. sells all 5,000 common shares of +86,400 Freeman for $86,400 Cash cash.

+80,000

=

Investment

=

+7,500 Investment

=

+

6,400 87,500


2.

-

= Liabilities

7,500

4.

3

Noncash Assets

6,250

+ Investment in Freeman (A) 80,000 7,500 87,500

Gain on Sale ( R) + 6,400

Balance Sheet Transaction

80,000

4.

Income Statement Contrib. Capital

+

Earned Capital

Revenues

+6,250

+6,250

Retained Earnings

Dividend Revenue

+7,500 AOCI

- Expenses

Net = Income

-

=

-

= +6,250

-

=

-

= +6,400

-7,500 -87,500 Investment

AOCI =

+6,400

+6,400

Retained Earnings

Gain


12-13

E12-26 (15 minutes) a. The equity securities investment portfolio is reported at its current market value of $59,479 = $2,308 + $57,171 thousand. The amount includes the unrealized loss on the Auction Rate Certificates, the unrealized loss on the Stock Mutual Fund, and the unrealized gain on the Bond Mutual Fund. b. None c. The net unrealized investment loss is $1,657 thousand, calculated as $2,304 + $389 - $12 = $2,681 thousand less tax savings of $1,024 thousands (38.2% x $2,681) = $1,657 thousand



E12-27 (30 minutes) a. 2010: 11/1 12/31 12/31 2011: 4/30

5/1

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

306,900

Interest receivable (+A) ................................................................ Interest revenue (+R, +SE) .......................................................

4,500

Unrealized loss (+E, -SE) .............................................................. Investment in Joos, Inc. (-A) .....................................................

5,400

Cash (+A) ................................................................................... Interest receivable (-A) ............................................................ Interest revenue (+R, +SE) .......................................................

13,500

Cash (+A) ................................................................................... Loss on sale of investments (+E, -SE) ............................................ Investment in Joos, Inc. (-A)......................................................

300,900 600

306,900 4,500 5,400

4,500 9,000

301,500

b. 4/30 5/1

12/31

+ Cash (A) 13,500 306,900 300,900 + Unrealized Loss (E) 5,400

11/1

11/1

12/31

- Interest Revenue (R) + 4,500 9,000

+ 12/31 4/30

5/1

+ Investment in Joos Inc. (A) 306,900 5,400 301,500

12/31 2/1

+ Interest Receivable (A) 4,500 4,500

4/30

Loss on Sale of Investments (E) 600

c. Balance Sheet Transaction

11/1. Buy $300,000 Joos bonds @102.

Cash Asset

5/1. Sold Joos bonds.

+

-306,900

+306,900

Cash

Investment

12/31. Accrue interest. 12/31. Recognize decline in value of bonds. 4/30. Receive interest.

Noncash Assets

+4,500 Interest Receivable

-5,400 Investment

= Liabilities

=

=

= Interest Receivable

Cash

+300,900

-301,500

Cash

Investment


Revenues

=

-4,500

+13,500

+ Contrib. Capital +

=

+4,500

+4,500

Retained Earnings

Interest Revenue

-5,400 +9,000

+9,000

Retained Earnings

Interest Revenue

-600

Expenses

=

Net Income

-

=

-

=

+4,500

=

-5,400

=

+9,000

=

-600

-

Retained Earnings

Retained Earnings

-


-

-

+600 Loss


12-15

E12-28 (10 minutes) 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 as follows: Minority interest in Reed Company. ………………...… $200,000 Common stock……………………………………………. 900,000 Retained earnings………………………………….…….. 440,000 Total equity $1,540,000

E12-29 (15 minutes) a. The equity securities investment portfolio is reported at its current market value of $29,758 million. The cost of the portfolio is $35,171 million, there are $654 million in unrealized gains and $6,067 million ($2,774 million + $3,293 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 balance sheet at current market value on the statement date. c. Impairment losses are recognized in current income when the securities decline in market value and the decline is deemed to be other than temporary. Gains and losses realized from the sale of securities are recognized in current income. A reclassification adjustment is required in Other Comprehensive Income. Because the 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.



E12-30 (30 minutes) a. 1 2 3 4

Investment in Barth Co. (+A) ......................................................... Cash (-A) ................................................................................

108,000

Cash (+A) .................................................................................... Investment in Barth Co. (-A) .....................................................

15,000

108,000 15,000

Investment in Barth Co. (+A) ......................................................... Investment revenue (+R, +SE) ..................................................

24,000

Cash (+A) .................................................................................... Gain on sale of investment (+R, +SE) ........................................ Investment in Barth Co. (-A) .....................................................

120,500

24,000 3,500 117,000

b. 2. 4.

+ Cash (A) 15,000 108,000 120,500

1.

- Gain (R) + 3,500

1. 3.

+ Investment in Barth (A) 108,000 15,000 24,000 117,000

2. 4.

- Investment Revenue (R) + 24,000

3.

4.


Cash Asset

1. Buy 30% of -108,000 Barth stock. Cash 2. Receive +15,000 dividend. Cash 3. Recognize share of net income of Barth. 4. Sold Barth investment.

Noncash Assets

+

+108,000 Investment

-15,000 Investment

=

+120,500 Cash

-117,000

Earned Capital

Revenues

-

Expenses

-

=

=

-

=

Investment Revenue

=

+24,000 =

Investment =

Retained Earnings

+24,000

+3,500

+3,500

Retained Earnings

Gain

Net Income

=

=

+24,000 Investment

Liabilities

Income Statement + Contrib. Capital +

+24,000

-

=


12-17

+3,500

E12-31 (30 minutes) a. 1 2 3 4

Investment in Palepu Co. (+A) ....................................................... Cash (-A) ................................................................................

120,000

Cash (+A) .................................................................................... Investment in Palepu Co. (-A) ...................................................

12,000

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

30,000

Cash (+A) .................................................................................... Gain on sale of investment (+R, +SE) ........................................ Investment in Palepu Co. (-A) ...................................................

140,000

120,000 12,000 30,000 2,000 138,000

b. 2. 4.

+ Cash(A) 12,000 120,000 140,000

1.

- Gain(R) + 2,000

1. 3.

+ Investment in Palepu(A) 120,000 12,000 30,000 138,000

2. 4.

- Investment Revenue (R) + 30,000

3.

4.


1. Buy 25% of Palepu stock. 2. Receive dividend. 3. Recognize share of net income of Palepu. 4. Sold Palepu investment.

Cash Asset

Income Statement

Noncash Assets

=

-120,000

+120,000

Cash

Investment

=

-

=

=

-

=

+

+12,000

-12,000

Cash

Investment

+30,000 Investment

+140,000

-138,000

Cash

Investment

=

=

Liabilities

+

Contrib. + Capital

Earned Capital

+30,000 Retained Earnings


Revenues

-

+30,000

Investment Revenue

+2,000 Gain

-

Expenses

=

= +30,000 = +2,000


Net Income


E12-32 (40 minutes) a. Market Value Method (AFS Securities) 1. 1 Investment in Leftwich Co. (+A) ..................................................... Cash (-A) ................................................................................

150,000 150,000

2

No entry

3

Cash (+A)..................................................................................... Dividend revenue (+R, +SE) ......................................................

11,000

Investment in Leftwich Co. (+A) ..................................................... Unrealized gain (+SE) ..............................................................

40,000

4

11,000 40,000

2. + Cash (A) 11,000 150,000

3.

1.

- Unrealized Gain (AOCI) + 40,000

1. 4.

+ Investment in Leftwich (A) 150,000 40,000 -

4.

Dividend Income (R) + 11,000

3.

3. Balance Sheet Transaction

1. Purchase Common shares. 2. No entry. 3. Received a cash dividend of $1.10 per common share. 4. Recognize increase in investment value at yearend .

Cash Asset

Noncash Assets

+

-150,000

+150,000

Cash

Investment

+11,000

= Liabilities

+40,000 Investment

+

Earned Capital

Revenues

-

Expenses

=

-

=

=

-

=

-

= +11,000

-

=

+11,000

+11,000

Retained Earnings

Dividend Revenue

+40,000 =

AOCI


Net Income

=

=

Cash


12-19

b. Equity Value Method 1. 1 2 3 4

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

150,000

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

24,000

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

11,000

150,000 24,000 11,000

No entry required

2. + Cash (A) 11,000 150,000

3.

1.

+ Investment in Leftwich (A) 150,000 11,000 24,000

1. 2.

3.

- Investment Income (R) + 24,000

2.


Cash Asset

1. Purchase -150,000 Common shares. Cash 2. Recognize 30% portion of Leftwich net income. 3. Received a cash dividend of $1.10 +11,000 per common Cash share. 4. No entry.

+

Noncash Assets

+150,000 Investment

+24,000 Investment

-11,000 Investment

= Liabilities

+


+

Earned Capital

Revenues

-

Expenses

=

-

=

-

= +24,000

=

-

=

=

-

=

= =

+24,000

+24,000

Retained Earnings

Investment Income


Net Income


E12-33 (25 minutes) a. DuPont’s equity method investments are reported at adjusted cost, not market value. Adjusted cost is the purchase price of the investment, plus the investor’s proportionate share of investee company profits (losses) and less dividends received. b. DuPont’s investment balance of $844 million is approximately 60% of the net assets of the affiliates ($844 / [$2,942 - $1,529]). However, if DuPont purchased these investments at a price that was greater than the book value of the investee’s equity, the actual percentage ownership would be lower. c. The reconciliation of the investment balance from 2007 to 2008 is approximated as follows: (in $ million) Beginning balance ..................................................... Equity in net profit of affiliates ................................. Dividends received..................................................... Ending balance...........................................................

$818 81 (87) $812

There is a $32 million unexplained difference between our computed amount and the $844 reported in DuPont’s footnote. We are unable to explain the change based on the data available. d. The equity method reports only the equity owned as an investment on the balance sheet and equity in earnings on the income statement. As a result, use of this method arguably omits assets and liabilities from the face of the balance sheet and sales and expenses from the income statement (compared with the assets and liabilities and sales and expenses that would be recorded with consolidation). Net income and stockholders’ equity are the same whether the equity method or consolidation is used. Consequently, ROE is the same. However, profit margins (income/sales) and asset turnover rates (sales / average assets) will differ with the omission of assets and sales.


12-21

E12-34 (25 minutes) a. The investee company reports total assets of $462 million, liabilities of $318 million, and equity of $144 million. CAT’s investment balance of $66 million is less than its proportionate (50%) interest ($144 million × 50% = $72 million), indicating that the investment was acquired for less than book value. b. CAT reports the investment on its balance sheet at $66 million. Because CAT reports an asset of only $66 million, most of the assets and all of the liabilities of the investee company are not reported on CAT’s balance sheet. If this investment is critical to CAT’s strategic plan, it arguably does not present a clear picture of the capital investment required to conduct CAT’s business or the degree of financial leverage inherent in its operations, even though its accounting is in conformity with GAAP. c. If the investee company were to fail, would CAT have to invest additional capital to support it? Probably not from a strictly legal standpoint. Yet, if this type of investment is necessary for CAT’s strategic plans, it might find it difficult to finance future ventures of this type if it does not support the failing investee. These conditions mean that there can be an effective liability even when no legal liability exists. Analysts can, of course, replace the equity investment with the assets and liabilities to which it relates (constructive consolidation for analysis purposes) if they feel it to be a better representation of the balance sheet and income statement of the company. d.

The equity method reports only the equity owned as an investment on the balance sheet and equity in earnings on the income statement. As a result, use of this method arguably omits assets and liabilities from the face of the balance sheet and sales and expenses from the income statement (compared with the assets and liabilities and sales and expenses that would be recorded with consolidation). Net income and stockholders’ equity are the same whether the equity method or consolidation is used. Thus, ROE is the same, but profit margins (net income/sales) and asset turnover rates (sales / average net operating assets) will differ with the omission of assets and sales.



E12-35 (30 minutes) a. 2010 11/15 12/22 12/31 2011 1/20

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

80,900

Cash (+A) .................................................................................... Dividend income (+R, +SE) .......................................................

6,250

Investment in Core, Inc. (+A) ......................................................... Unrealized gain (+R, +SE) ........................................................

6,600

Cash (+A) .................................................................................... Loss on sale of investment (+E, -SE) .............................................. Investment in Core, Inc. (-A) .....................................................

86,400 1,100

80,900 6,250 6,600

87,500

b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of 6,600 increases net income and retained earnings in 2010. + Cash (A) 6,250 80,900 86,400

12/22/10 1/20/11

11/15/10

+ Investment in Core Inc (A) 11/15/10 80,900 12/31/10 6,600 87,500 1/20/11 + Loss on Sale of Investment (E) 1/20/11 1,100

-

Unrealized Gain (R) + 6,600 12/31/10


-

12/22/10


11/15 Purchase 5,000 shares of Core Inc common.

Cash Asset

Noncash Assets

= Liabilities

-80,900

+80,900

Cash

Investment

=

+

12/22 Dividend +6,250 income. Cash

+6,600

12/31 Increase in Investment. 1/20 Sale of Core common.

=

Investment

+86,400

-87,500

Cash

Investment

=

=

Income Statement + Contrib. Capital +

Earned Capital

Revenues

-

Expenses

=

Net Income

= +6,250

+6,250

Retained Earnings

Dividend Income

+6,600

+6,600

Retained Earnings

Unrealized Gain

= +6,250 = +6,600

-1,100

+1,100

Retained Earnings

Loss on Sale

= -1,100


12-23

E12-36 (30 minutes) a. 2010 11/15 12/22 12/31 2011 1/20

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

80,900

Cash (+A) .................................................................................... Dividend income (+R, +SE) .......................................................

6,250

Investment in Core, Inc. (+A) ......................................................... Unrealized gain (+SE) ..............................................................

6,600

Cash (+A) .................................................................................... Unrealized gain (-SE) .................................................................... Investment in Core, Inc. (-A) ..................................................... Gain on sale of investment (+R, +SE) ........................................

86,400 6,600

80,900 6,250 6,600

87,500 5,500

b. + Cash (A) 6,250 80,900 86,400

12/22/10 1/20/11

11/15/10

11/15/10 12/31/10

+ Investment in Core Inc (A) 80,900 6,600 87,500 1/20/11

- Gain on Sale of Investment (R) + 5,500 1/20/11 1/20/11

Unrealized Gain (AOCI) 6,600 6,600

+ 12/31/10


12/22/10

c. Income Statement

Balance Sheet Transaction

11/15 Purchase 5,000 shares of Core Inc common. 12/20 Dividend income.

Cash Asset

+

Noncash Assets

-80,900

+80,900

Cash

Investment

+6,250 +6,600 Investment

+

+

Earned Capital

Revenues

=

=

Cash

12/31 Increase in Investment.

= Liabilities

Contrib. Capital

=

+6,250

+6,250

Retained Earnings

Dividend Income

+6,600 AOCI

-

Expenses

=

Net Income

-

=

-

= +6,250

-

=

-

= +5,500

-6,600 1/20 Sale of Core common.

+86,400 Cash

-87,500 Investment

AOCI =


+5,500 Gain



E12-37 (30 minutes) a.

The trading stock investments will be reported at $225,300. This amount is computed using 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 is computed 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 is computed 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 2010 income statement. These losses 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 of the December 31, 2010, balance sheet under other comprehensive income. These losses 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 of the December 31, 2010, balance sheet under retained earnings. These losses 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. (iii) Total unrealized holding losses in equity of $12,500—total of (i) & (ii)

f.

(i) A fair market value adjustment to investments of $7,300 will appear in the December 31, 2010, balance sheet. This adjustment relates to the available-for-sale securities. See part (e) for the supporting computations. The fair value adjustment decreases the book value of the available-for-sale securities to their year-end market value. (ii) A fair market value adjustment to investments of $5,200 will appear in the December 31, 2010, balance sheet. This adjustment relates to the trading securities. See part (e) for supporting computations. The fair value adjustment decreases the book value of the trading securities to their year-end market value. (iii) Total market value adjustment is $12,500—total of (i) & (ii)


12-25

E12-38 (30 minutes) a. $158.5 million = 50% × ($1,354 million - $1,037 million) b. The receipt of dividends is treated as a reduction of the equity method investment. The reduction in the investment account is offset by an increase in cash, and total assets are unaffected. No income is recorded upon the receipt of the dividend. c. Abbott Laboratories reports equity income equal to its proportionate share of TAP’s net income or $498 million (50% × $996 million). d. Undistributed earnings are earnings that have not yet been paid out as dividends, or retained earnings. Of TAP’s $317 million of stockholders’ equity, $136 is, apparently, retained earnings. Given the profitability of this company, it appears to pay out a substantial portion of its earnings in dividends. (In fact, the footnotes to Abbott Laboratories’ 2007 10-K reveal that TAP paid it $502 in dividends in 2007, more than Abbott Labs recorded in equity earnings for that year). e. The equity method reports only the equity owned as an investment on the balance sheet and equity in earnings on the income statement. As a result, use of this method arguably omits assets and liabilities from the face of the balance sheet and sales and expenses from the income statement (compared with the assets and liabilities and sales and expenses that would be recorded with consolidation). Net income and stockholders’ equity are the same whether the equity method or consolidation is used. Thus, ROE is the same. But profit margins (net income/sales) and asset turnover rates (sales / average net operating assets) will differ with the omission of the investee’s assets and sales.



E12-39 (40 minutes) 1 & 2. Healy Current assets Investment in Miller Plant assets..................... Goodwill........................... Total assets.....................

Miller

$1,700,000 $ 120,000 500,000 3,000,000 410,000 . . $5,200,000 $530,000

Liabilities......................... $ 700,000 Contributed capital......... 3,500,000 Retained earnings.......... 1,000,000 Total liabilities & $5,200,000 stockholders’ equity.......

Consolidating adjustments Consolidated $ 1,820,000 $(500,000) 0 15,000 3,425,000 45,000 45,000 $5,290,000

$90,000 400,000 40,000

(400,000) (40,000)

$530,000

$790,000 3,500,000 1,000,000 $5,290,000

3. Miller contributed capital (-SE) ..................................................... Miller retained earnings (-SE)........................................................ Plant assets (+A) ........................................................................... Goodwill (+A) ................................................................................. Investment in Miller Co. (-A) ..............................................

400,000 40,000 15,000 45,000 500,000

4. + Investment in Miller Co. (A) 500,000

1/1

+ Goodwill (A) 45,000

1/1 -

Miller Contributed Capital (SE) + 400,000

1/1

1/1

+ Plant Assets (A) 15,000

1/1

Miller Retained Earnings (SE) + 40,000


1/1 To consolidate Healy & Miller.

Cash Asset

+

Noncash Assets

= Liabilities +


+

Earned Capital

Revenues

-500,000

-400,000

Investment in Miller

Miller Contributed Capital

+45,000 Goodwill

+15,000 Plant Assets

=

-40,000

- Expenses

=

-

=

Net Income

Miller Retained Earnings


12-27

E12-40 (30 minutes) 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 appeared as follows:

Investment in Kanodia.... Other assets..................... Goodwill............................ Total assets......................

$ 600,000 2,300,000 . $2,900,000

Consolidating adjustments Consolidated (600,000) $ 0 $ 700,000 20,000 3,020,000 . 40,000 40,000 $700,000 $3,060,000

Liabilities.......................... Contributed capital.......... Retained earnings............ Total liabilities & stockholders’ equity........

$ 900,000 1,400,000 600,000

$160,000 300,000 240,000

$2,900,000

$700,000

Rayburn

3.

Kanodia

$1,060,000 1,400,000 600,000

(300,000) (240,000)

$3,060,000

Kanodia contributed capital (-SE) ........................................ Kanodia retained earnings (-SE) .......................................... Other assets (+A) ............................................................... Goodwill (+A) ..................................................................... Investment in Miller Co. (-A).......................................

300,000 240,000 20,000 40,000 600,000

4. + Investment in Kanodia Inc. (A) 600,000

1/1

1/1

1/1

1/1

+ Goodwill (A) 40,000

+ Other Assets (A) 20,000

-Kanodia Contributed Capital (SE) + 300,000 -

1/1

Kanodia Retained Earnings (SE) + 240,000


1/1 To consolidate Rayburn & Kanodia.

Cash Asset

+

Noncash Assets

= Liabilities +

Contrib. + Capital


-600,000

-300,000

Investment in Kanodia

Kanodia Contributed Capital

+40,000 Goodwill

+20,000 Plant Assets

=

-240,000

Revenues

-

Expenses

=

=

Kanodia Retained Earnings



Net Income

E12-41 (20 minutes) a. The investment is initially recorded on Engel’s balance sheet at the purchase price of $16.8 million, including $600,000 of goodwill. Because the market value of Ball is less than the carrying amount of the investment on Engel’s balance sheet, the goodwill may be deemed to be impaired. To determine impairment, the imputed value of the goodwill is determined to be 12.5 million - $12.3 million = $200,000. Because this is less than the carrying 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 carrying amount of goodwill by $400,000, and the write-down will be recorded as a loss in Engel’s income statement, thereby reducing retained earnings by that amount. E12-42B (60 minutes) a. Cash paid........................................................................... Fair market value of shares issued................................. Purchase price................................................................. Less: Book value of Harris.............................................. Excess payment................................................................ Excess payment assigned to specific accounts based on fair market value: —Buildings........................................................................ —Patent............................................................................. Goodwill.............................................................................

$210,000 180,000 390,000 280,000 110,000 40,000 30,000 $ 40,000


12-29

b. Easton, Company

Harris Co.

Consolidation Consolidated Entries Totals

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

Land Buildings, net

100,000 400,000

60,000 110,000

Equipment, net

120,000

50,000

Accounts Cash

$

Patent Goodwill Totals

-

$1,474,000

$ 480,000

Accounts payable $ 160,000 Long-term liabilities 380,000

$ 30,000 170,000

Common stock Additional paid-in capital Retained earnings Totals

c.

0

[S] $(280,000) [A] (110,000)

500,000

40,000

74,000 360,000

240,000

$1,474,000

$ 480,000

[A]

40,000

160,000 550,000 170,000

[A]

30,000

30,000

[A]

40,000

40,000 $1,674,000 $ 190,000 550,000

[S]

[S]

(40,000)

500,000

(240,000)

74,000 360,000 $1,674,000

The tangible assets are accounted for just like any other acquired asset. The receivables are removed when collected, inventories affect future cost of goods sold, and depreciable assets are depreciated over their estimated useful lives. Intangible assets with a determinable life are amortized (depreciated) over that useful life. Finally, intangible assets with an indeterminate useful life (such as goodwill) are not amortized, but are either tested annually for impairment, or more often if circumstances require.



E12-43 (20 minutes)

a. Companies use derivative securities in order to mitigate risks, such as commodity price risks, risks relating to foreign exchange fluctuations, or risks relating to fluctuations in interest rates.

b. Derivatives are reported on the balance sheet as are the assets or liabilities to which they relate. Generally, derivatives and the related assets/liabilities are reported on the balance sheet at their fair market value.

c. The unrealized gains (losses) on HP’s derivatives are reported in the Other Comprehensive Income section of its stockholders’ equity. This reporting indicates that they have not yet affected HP’s profits. Once the underlying transaction is settled, these unrealized gains (losses) will be removed from OCI and transferred into current income, thus affecting HP’s profitability.


12-31

PROBLEMS P12-44 (50 minutes) a.

Available-for-sale investments are reported at market value on the balance sheet. Thus, Met Life’s bond investments are reported at: $188,251 million as of 2008 $232,336 million as of 2007

b.

Net unrealized gains (losses) for 2008 are $(21,257) million ($7,564 million - $28,821 million) Net unrealized gains (losses) for 2007 are $2,982 million ($7,250 million - $4,268 million) Because the investments are accounted for as available-for-sale, these unrealized gains (losses) did not affect reported income for 2008 and 2007. (Note: Had these investments been accounted for as trading securities, those unrealized gains (losses) would have affected reported income.)

c.

Realized gains (losses) are gains (losses) that occur as a result of sales of securities. These are reported in the income statement and affect reported income. Unrealized gains (losses) reflect the difference between the current market price of the security and its acquisition cost. Only unrealized gains (losses) from trading securities are reported in income.

d. The evaluation of investment performance is difficult as companies have discretion over the timing of realized investment gains (losses) and can, thereby, affect reported income. By including unrealized gains (losses) in the analysis, we are able to get a clearer picture of overall investment performance—albeit, with an understanding that these gains and losses are not yet realized. These returns could then be compared with those of competitors and market rates in general for investments of comparable risk. We believe this reporting metric provides useful insights as noted.



P12-45 (30 minutes) Gem Current assets $200,000 450,000 Investment in Alpine Plant assets (net)…… 265,000 Goodwill............................ . Total assets...................... $915,000 Liabilities $ 50,000 Minority interest .............. 0 Common stock................. 700,000 Retained earnings............ 165,000 Total liabilities & $915,000 stockholders’ equity........

460,000 . $620,000 $ 60,000 0 420,000 140,000

Consolidating adjustments Consolidated $ 360,000 $(450,000) 0 34,800 759,800 23,200 23,200 $1,143,000 $ 110,000 168,000 168,000 (420,000) 700,000 (140,000) 165,000

$620,000

$1,143,000

Alpine $160,000


12-33

P12-46 (40 minutes)

a. (in $millions) Current assets, principally cash and marketable securities... $ 252 Deferred tax assets................................................................ 290 Property, plant, and equipment............................................... 220 Other assets............................................................................ 75 Liabilities: principally debt (743) Total tangible assets............................................................... $ (94) Acquired IPR&D...................................................................... Identifiable intangible assets, product technology and core technology............................. Goodwill.................................................................................. Total intangible assets.................................................................

$ 1,101 320 684 $2,105

The intangible assets were valued by Amgen at more than 100% of the Abgenix’s value. Essentially the value of the acquired company was captured by its research and development potential. 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: the receivables are removed when collected, inventories affect future cost of goods sold, and depreciable assets are depreciated over their estimated useful lives. Intangible assets with a determinable life are amortized (depreciated) over that useful life. Finally, intangible assets with an indeterminate useful life are not amortized, but are tested annually for impairment, or more often if circumstances require. d. In-process R&D is valued at the discounted present value of expected future cash flows. This approach is very imprecise and involves significant estimates, both of the expected cash flows and of the discount rate. e. If the in-process R&D were estimated at a lesser amount, more of the purchase price would be allocated to goodwill. Current profitability would be higher (less in-process R&D expense), and future earnings would be impacted only if the goodwill is deemed to be impaired and written down.



P12-47 (40 minutes) a.

The trading security investments will be reported at $375,300. This value is computed using 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 is computed 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 is computed using their amortized cost value at year-end; specifically, $101,200 + $136,000.

d.

Unrealized holding gains of $10,400 will appear in the 2010 income statement. These gains relate to the trading securities; specifically— Ling: $105,300 $102,400 = $2,900 gain; Wren: $270,000 - $262,500 = $7,500; total of $2,900 + $7,500 = $10,400. The calculation 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 of the December 31, 2010, balance sheet under accumulated other comprehensive income (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 section of the December 31, 2010, balance sheet under retained earnings (see answer to requirement d). (iii) Total unrealized holding gains in equity of $18,400—totals of (i) & (ii).

f.

(i) A fair market value adjustment to investments of $8,000 will appear in the December 31, 2010, balance sheet. This adjustment relates to the available-for-sale securities. See part (e) for the supporting computations. The fair value adjustment increases the book value of the available-for-sale securities to their year-end market value. (ii) A fair market value adjustment to investments of $10,400 will appear in the December 31, 2010, balance sheet. This adjustment relates to the trading securities. 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 or discount. Thus the Meander bond will be shown at a value of $101,200 and the Resin bond will be valued at $136,000. The changes in these asset values on the Columbia Company balance sheet will be matched by the related interest revenue.


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P12-48 (60 minutes) a. Yes, each individual company (e.g., parent and subsidiary) maintains its own financial statements. This approach is necessary to report on the activities of the individual units and to report to the respective stakeholders of each unit. The purpose of consolidation is to combine these separate statements to more clearly reflect the operations and financial condition of the combined (whole) entity. b.

The Investment in Financial Products Subsidiaries is reported on the parent’s (Machinery and Engine’s) balance sheet at $3,727 million. This amount is the same balance as reported for stockholders’ equity of the Financial 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 liabilities of the combined company vis-à-vis that revealed in the equity method of accounting. That is, it better reflects operations as one entity as far as investors and creditors are concerned. The equity method of accounting that is used by the parent company to account for its investment in the subsidiary reflects only its proportionate share (100% in this case) of the investee company stockholders’ equity and does not report the individual assets and liabilities comprising that equity. d. The consolidating adjustments generally accomplish three objectives: (i) They eliminate the equity method investment on the parent’s balance sheet and replace it with the actual assets and liabilities of the investee company to which it relates. (ii) They record any additional assets that are included in the investment balance that may not be reflected on the subsidiary’s balance sheet, like goodwill, for example. (iii) They eliminate any intercompany sales and receivables/payables. e. The consolidated stockholders’ equity and the stockholders’ equity of the parent company are equal. This equality will always be the case. The consolidation process replaces the investment account with the assets and liabilities to which it relates. Thus, stockholders’ equity remains unaffected. f. Consolidated net income will equal the net income of the parent company. The reason for this result is that the parent reflects the income of the subsidiary via the equity method of accounting for its investment. The consolidation process merely replaces the equity income account with the actual and individual sales and expenses to which it relates. Net income is unaffected.



g. The equity method of accounting reports investments at adjusted cost (beginning balance plus equity earnings and less dividends received)—this contrasts with the market method. Unrealized gains for a subsidiary are, therefore, not reflected on the consolidated balance sheet and income statement. Instead, the subsidiary is reflected on the balance sheet at its purchase price net of depreciation and amortization, just like any other asset. The consolidation process merely replaces the 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.


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CASES C12-49 (60 minutes) a. General Mills accounts for the investments in its joint ventures using the equity method—see middle of its note disclosure. Consolidation is not appropriate because General Mills does not control these entities (not >50% equity interest); also, the market method is inappropriate because General Mills is able to exert “significant influence” in the management of these businesses. Under the equity method, these investments are reflected on General Mills’ balance sheet at adjusted cost (e.g., beginning balance plus proportionate share of investee company earnings less any dividends received). The proportionate share of investee company earnings is recorded as income by the investor company. Dividends are not income. Instead, under the equity method, they are treated as a return of the investment. b. The investment balance is always equal to the investor’s proportionate share of the stockholders’ equity of the investee company. In the case of General Mills, the combined net assets (stockholders’ equity) of all joint ventures is $355.0 million ($1,021.5 million current assets + $1,002.0 million noncurrent assets - $1,592.6 million current liabilities - $75.9 million noncurrent liabilities); these details are in the table at the end the footnote. Because the investment balance is equal to $278.6 million, it owns 78.5% ($278.6 million / $355.0 million), on average. General Mills will, therefore, report approximately 78.5% of the investee company earnings or approximately $149.5 million ($190.4 million × 78.5%). c. The $278.6 million investment balance on General Mills’ balance sheet represents the net equity of the joint ventures that it owns. Its proportionate share of the assets of the joint ventures as well as its proportionate share of the joint ventures’ liabilities is not reflected on its balance sheet, only the net equity. As a result, the actual investing and actual financing amounts required to conduct these operations is not reflected on-balance-sheet. This omission is the primary criticism of equity method accounting. d. Although General Mills does not have legal liability for the obligations of most, if not all, of its joint ventures, it often has an implicit obligation to stand behind the entities that it has created (which includes their financing). That is, General Mills would be hard-pressed to walk away from one of these entities should it fail to provide sufficient funds to satisfy its liabilities.



e. Equity method accounting presents at least two challenges for analysis purposes. (i) Equity method accounting obscures the actual assets and liabilities of the investee company on the books of the investor company. (ii) The equity investments are reported at adjusted cost. As a result, unrealized gains (say, from market value adjustments) are not reflected on the balance sheet or in the income statement. C12-50 (50 minutes) a. 2010 1/2 12/31 12/31 2011 1/18

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

420,000

Dividend receivable (+A) .............................................................. Dividend income (+R, +SE) .......................................................

16,000

Unrealized loss (+E, -SE) .............................................................. Investment in Dye, Inc. (-A) ......................................................

60,000

Cash (+A) ................................................................................... Dividend receivable (-A) ...........................................................

16,000

420,000 16,000 60,000

16,000

b. 1/18/11

+ Cash (A) 16,000 420,000

1/2/10

1/2/10

+ Investment in Dye Inc. (A) 420,000 60,000 12/31/10

+ Dividend Receivable (A) 12/31/10 16,000 16,000

12/31/10

+ Unrealized Loss (E) 60,000


1/18/11

12/31/10


1/2/10 Buy 20,000 shares of Dye.

Cash Asset

+

-420,000

+420,000

Cash

Investment

+16,000

12/31/10 Declare dividend $.8/share.

Dividend Receivable

12/31/10 Recognize decline in investment. 1/18/11 Receipt of dividend.

Noncash Assets

-60,000 Investment

+16,000 Cash

-16,000

= Liabilities

+


Earned Capital

Revenues

= =

=

Dividend = Receivable

+16,000

+16,000

Retained Earnings

Dividend Income


-

Expenses

=

Net Income

-

=

-

= +16,000

-

-


= -60,000 =


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d. 2010 1/2 12/31 12/31 2011 1/18

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

420,000

Dividend receivable (+A) .............................................................. Investment in Dye, Inc. (-A) ......................................................

16,000

Investment in Dye, Inc. (+A) .......................................................... Investment revenue (+R, +SE) ..................................................

112,000

Cash (+A) ................................................................................... Dividend receivable (-A) ...........................................................

16,000

420,000 16,000 112,000

16,000

e. + Cash (A) 16,000 420,000

1/18/11

1/2/10

1/2/10 12/31/10

+ Investment Revenue (R) 112,000 12/31/10

12/31/10

+ Investment in Dye Inc. (A) 420,000 112,000 16,000 12/31/10

+ Dividend Receivable (A) 16,000 16,000

1/18/11

f. Balance Sheet Transaction

1/2/10 Buy 20,000 shares of Dye.

Cash Asset

+

Noncash Assets

-420,000

+420,000

Cash

Investment

= Liabilities

+


Earned Capital

Revenues

-

Expenses

=

=

-

=

=

-

=

Net Income

+16,000 Dividend Receivable

12/31/10 Declare dividend $.8/share.

-16,000 Investment

12/31/10 Recognize income from investment. 1/18/11 Receipt of dividend.

+112,000 Investment

+16,000 Cash

-16,000

=

Dividend = Receivable

+112,000 +112,000 Retained Earnings

Investment Revenue -

= +112,000 =



C12-51 (15 minutes) a. Consolidated statements present the total assets and liabilities of all firms in which the reporting firm has more than a fifty percent ownership with intercompany accounts and transactions eliminated. b. Demski has a controlling interest in Asare and Demski Finance. Therefore, their assets and liabilities are all added to those of Demski Inc. Demski does not have a controlling interest in Knechel. Therefore, it must show its investment in Knechel Inc. as an asset. c. This excess is the amount paid to Asare in excess of the net book value of Asare’s assets (assets less liabilities assumed) when Asare was acquired by Demski. The amount is known more commonly as Goodwill and reflects the fact that Demski believed the company was worth more than the net book value of its assets. d. The amount represents the 25% of outside ownership of Asare’s assets, which are aggregated in the balances of Demski’s accounts. e. Under GAAP, the value is the pre-acquisition value of the net assets involved. Under IFRS, the minority interest would be valued at the fair market vaue of the assets. C12-52 (30 minutes) a. While the approach recommended by Gayle is not disallowed by a specific accounting standard, it is not consistent with the intent of GAAP. Certainly from a position of representational faithfulness, it specifically does not represent how management regards the investment or intends to treat it in the future. The approach recommended is a flagrant attempt to violate the spirit of GAAP in order to manage earnings. Such practice may get by the firm’s auditors once or twice, but failure to be consistent in the accounting treatment over time is unlikely to be tolerated under SOX and the increased scrutiny applied by the SEC in the wake of the numerous accounting scandals of the recent past. Further, such practice can lead to lawsuits by investors who can argue that management was not accounting truthfully. b. We believe the practice to be highly unethical.


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DMP3e CH12 Solutions 05.17.10 Revised

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