Chapter 6 Intercompany Inventory and Land Profits
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A "rie# description description o# the ma$or points points coered coered in each each case and pro"lem. pro"lem. CA%&% Case 6-1
'n this case( st)dents are as*ed to ill)strate the impact o# intercompany sales and )nreali+ed pro#its in inentory inentory on the separate entity and consolidated #inancial statements. %t)dents are also as*ed to e,plain how "asic acco)nting principles are applied when acco)nting #or these intercompany transactions. Case 6-2
his case( adapted #rom a CA e,am( inoles a change #rom e)ity method to #air al)e method #or an inestment in a company that has e,perienced s)"stantial losses d)ring the period. Case 6-3
his is a m)lti-s)"$ect case #rom a CA e,am. %t)dents are as*ed to resole a n)m"er o# acco acco)nt )nting ing iss) iss)es es incl incl)di )ding ng ree reen)e n)e recogn recognit ition ion(( goer goernme nment nt grant grants( s( conti continge ngency ncy and and intercompany transactions. Case 6-4
'n this case( adapted #rom a CA e,am( st)dents are as*ed to identi#y acco)nting iss)es related to the preparation o# consolidated #inancial statements #or an /0-owned s)"sidiary and a 0-owned 0-owned inestee company. company. 'ntercompany 'ntercompany transactions transactions and ac)isition ac)isition di##erential hae not "een properly acco)nted #or. Case 6-5
'n this case( adapted #rom a CA e,am( management appears to "e manip)lating income to minimi+e the "on)s paid to )nion employees. %t)dents are re)ired to analy+e controersial acco)nting iss)es incl)ding the al)ation o# inentory( p)rchase ret)rns and goodwill. Case 6-6
his is a m)lti-s)"$ect case #rom a CA e,am. %t)dents are as*ed to resole a n)m"er o# acco)nting iss)es incl)ding reen)e and e,pense recognition( contri")tions to a partnership( contingent consideration and o##setting o# assets against lia"ilities. Copyright 2
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R4L&M% Problem 6-1 526 min.7
A short pro"lem re)iring calc)lation o# selected acco)nts #or consolidated statements when ther there e are )nrea )nrealili+e +ed d pro#i pro#its ts in ine inento ntory ry and an e,pla e,planat nation ion o# impa impact ct o# inte interc rcom ompan pany y transactions on non-controlling interest. Problem 6-2 520 min.7
his pro"lem consists o# a consolidated income statement that has "een incorrectly prepared and re)ir re)ires es correc correctin ting. g. 'nterc 'ntercomp ompany any transac transaction tions s and )nreali )nreali+ed +ed pro#its pro#its in opening opening and closing inentory hae "een oerloo*ed. Problem 6-3 520 min.7
A short pro"lem re)iring calc)lation o# selected acco)nts related to land #or separate entity and consolidated #inancial statements statements #or three years when there are )nreali+ed pro#its in and an ac)isition di##erential pertaining to land. Problem 6-4 50 min.7
A parent has )sed the cost method met hod to acco)nt #or its inestments in its two s)"sidiaries. here are )nreali+ed )nreali+ed pro#its pro#its in the inentory inentory o# all three compani companies. es. he pro"lem pro"lem re)ires re)ires the preparat preparation ion o# a consol consolidat idated ed income income stateme statement( nt( a calc)l calc)lati ation on o# consol consolidat idated ed retaine retained d earnings( a calc)lation o# inestment income )nder the e)ity method and an e,planation o# how the reen)e recognition principle is applied when ad$)sting #or )nreali+ed pro#its. Problem 6-5 50 min.7
8nreali+ed inentory and land pro#its are inoled oer a two-year period. he pro"lem calls #or e)ity method $o)rnal entries as well as the calc)lation calc)lation o# consolidated consolidated net income income each year( year( a statement showing changes in non-controlling interest( and a calc)lation o# the "alance in the inestment acco)nt )nder the e)ity method. Problem 6-6 530 min.7
hree related companies companies are inoled in selling goods to each other. he pro"lem re)ires re)ires a calc)lation calc)lation o# consolidated consolidated pro#it and consolidated retained earnings when the parent )sed the cost method. Copyright Solutions Manual, Chapter !
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Problem 6-7 590 min.7
A comprehensie pro"lem re)iring an ac)isition di##erential calc)lation( amorti+ation sched)le( and a consolidated "alance sheet and statement o# changes in e)ity )nder the entity theory pl)s an e,planation o# how the de"t to e)ity ratio wo)ld change )nder the parent compa company ny e,te e,tens nsion ion theor theory y. he he s)"si s)"sidia diary ry was ac)i ac)ired red seen seen years years ago: ago: ther there e are intercompany pro#its 5and losses7 in land and inentory: and the parent has )sed the cost method to acco)nt #or its inestment. Problem 6- 530 min.7
A parent paren t has three s)"sidiaries that cond)ct intercompany transactions with each other and the the pro" pro"le lem m re) re)ir ires es the the pare parent nt;s ;s e)i e)ity ty meth method od $o)r $o)rna nall entr entrie ies s and and calc calc)l )lat atio ions ns o# consolidated net income and consolidated retained earnings. Problem 6-! 526 min.7
A parent has )sed the cost method to acco)nt #or its inestment and an d the pro"lem re)ires r e)ires the calc)lation o# consolidated net income attri")ta"le to the parent
'ntercompany 'ntercompany sales( interest interest and rental reen)e( and )nreali+ed pro#its in opening and closing inentory are inoled in this pro"lem that re)ires the preparation o# a consolidated income statement and a calc)lation o# consolidated retained earnings. he parent has )sed the cost method. Problem 6-11 50 min.7
8nreali+ed pro#its in opening and closing inentory and in land hae to "e ta*en into acco)nt in the preparation o# a consolidated statement o# changes in e)ity when the parent has )sed the cost method. Problem 6-12 526 min.7
A parent paren t has )sed the e)ity method to acco)nt #or its inestment. here are intercompany inentory pro#its inoled. he pro"lem re)ires the preparation o# a consolidated income statement( statement( a calc)lation calc)lation o# consolidated consolidated retained earnings and an e,planation o# the impact o# )sing the parent company e,tension theory on the ret)rn on e)ity. Copyright
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Problem 6-13 590 min.7
his comprehensie pro"lem coers eerything ill)strated to date and re)ires the preparation o# a consolidated consolidated income statement and consolidated consolidated statement o# #inancial #inancial position when the parent has )sed the e)ity method pl)s the calc)lation calc)lation o# goodwill goodwill and non-controlling non-controlling interest interest )nder the parent company e,tension theory. Problem 6-14 590 min.7 5repared "y eter %ecord( %aint Mary
A comprehensie pro"lem re)iring the preparation prep aration o# a consolidated income statement and a statement statement o# #inancial #inancial position when the parent has )sed the e)ity method. Also Also re)ired is a calc)lation o# goodwill and =C' )sing the trading price o# the s)"sidiary
A comprehensie pro"lem re)iring the preparation o# a consolidated income statement and the calc)lation o# speci#ied consolidated "alance sheet acco)nts. Also re)ired is a calc)lation o# goodwill impairment loss and consolidated net income attri")ta"le to =C' when a ")siness al)a al)ator tor meas meas)re )res s the the al) al)e e o# =C' =C' at the the date date o# ac)i ac)isi siti tion. on. her here e are are inte interco rcomp mpany any transactions and )nreali+ed pro#its in land and inentory.
>&4-4A%&? R4L&M% R4L&M% #eb Problem 6-1
he st)dent answers a series o# )estions "ased on the 2011 #inancial statements o# R=A inc.( a Canadian company. he )estions deal with intercompany transactions in inentory and land and the impact o# changes in acco)nting policies #or inentory and land on certain ratios. #eb Problem 6-2
he st)dent answers a series o# )estions "ased on the 2011 #inancial statements o# Ceno)s &nergy 'nc.( a Canadian company. he )estions deal with intercompany transactions in inentory and land and the impact o# changes in acco)nting policies #or inentory and land on certain ratios.
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$%L&'I%($ '% )*+I*# ,&*$'I%($ 1
he pants are similar to a single economic entity composed o# a parent company and its three s)"sidiaries. he trans#er o# economic reso)rces "etween the poc*ets in these pants simply changes the location o# the reso)rces ")t does not represent reen)e or e,pense( or pro#it or loss( to the com"ined entity.
2
he types o# intercompany reen)e and e,penses eliminated in the preparation o# the consolidated income statement incl)de sales and p)rchases( rentals( interest( and management #ees. hese eliminations hae no e##ect on the amo)nt o# consolidated net income or the net income attri")ta"le to non-controlling interest.
3
'ntercompany sales when collected and paid( intercompany cash sales( and intercompany "orrowings do not alter the total cash o# the consolidated entity. 't is the same concept as an indiid)al trans#erring cash among his@her "an* acco)nts( or #rom one poc*et to another.
4
he intercompany pro#it recorded in eriod one is considered to "e reali+ed when the partic)lar asset is sold o)tside the consolidated entity "y the p)rchasing a##iliate.
5
Reen)e sho)ld "e recogni+ed when it is earned with a transaction o)tside o# the reporting entity. he reporting entity #or consolidated #inancial statements encompasses the parent and all o# its s)"sidiaries. %ince intercompany transactions are transactions within the reporting entity 5not o)tside o# the reporting entity7( they m)st "e eliminated when preparing consolidated #inancial statements.
6
his statement is tr)e i# the selling a##iliate has an income ta, rate o# 0. he 1(000 red)ction #rom ending inentory red)ces the consolidated entity;s net income. A corresponding red)ction o# 00 in income ta, e,pense trans#ers the ta, #rom an e,pense to an asset on the consolidated consolidated "alance sheet. >hen the 1(000 pro#it is s)"se)ently reali+ed( the 00 is trans#erred #rom the consolidated "alance sheet to the consolidated income statement in order to achiee a proper matching o# e,pense to reen)e.
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7
he matching principle re)ires that e,penses "e matched to reen)es. >hen intercompany pro#its are eliminated #rom the consolidated #inancial statements( the income ta, e,pense related to those pro#its m)st also "e eliminated. eliminated. >hen the preio)sly )nrecogni+ed intercompany pro#its are recogni+ed in a later period( the income ta, on these pro#its m)st "e e,pensed.
here is no ad$)stment to income ta, e,pense corresponding to the elimination o# intercompany reen)e and e,penses "eca)se there is no change to the income "e#ore ta, #or the consolidated entity: entity: there#ore( there sho)ld "e no change to the ta, e,pense #or the consolidated entity. >hateer ta, was paid or saed #or the two entities will not change #or the consolidated entity since the income "e#ore ta, did not change. 'ncome ta, e,pense is ad$)sted on consolidation when consolidated pro#its are changed d)e to ad$)stments #or )nreali+ed pro#its.
!
'deally( intercompany losses sho)ld "e eliminated in the same manner as intercompany gains. 'n t)rn( an impairment test wo)ld "e carried o)t. '# the recoera"le amo)nt were less than the carrying amo)nt( amo)nt( an impairment loss wo)ld wo)ld "e reported. >hen the impairment loss is greater than the intercompany loss( one can get to the same res)lt "y not reersing the intercompany loss and simply reporting an impairment loss to "ring the carrying amo)nt down to the recoera"le amo)nt.
1" he elimination o# intercompany sales and p)rchases red)ces sales reen)e and cost o#
goods sold on the consolidated income statement. =o other items on the consolidated statements are a##ected. he elimination o# intercompany pro#its in ending inentory a##ects the #ollowing elements o# the consolidated statementsB cost o# goods sold is increased: income ta, e,pense is decreased: net income is decreased: net income attri")ta"le to the parent is decreased: net income attri")ta"le to the non-controlling interest is decreased 5i# the s)"sidiary was the seller7: the asset inentory is decreased: de#erred income ta, assets are increased: non-controlling interest in net assets is decreased 5i# the s)"sidiary was the seller7: and consolidated retained earnings is decreased. 11 11
or a downstream transaction( the ad$)stment #or )nreali+ed pro#its is applied to the parent
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which is shared "etween the parent and non-controlling interest. 'n other words( words( the noncontrolling interest is a##ected "y elimination o# pro#it on )pstream transactions ")t is not a##ected "y the elimination o# pro#it on downstream transactions. 12 At the end o# o # Dear Dear 1( the )nreali+ed pro#it is remoed #rom ending end ing inentory and an d added to
cost o# goods sold which decreases income. 'n Dear Dear 2( the )nreali+ed pro#it is remoed #rom "eginning inentory( which decreases cost o# goods sold #or Dear 2 and increases income #or Dear Dear 2. Altho)gh Dear Dear 1 and Dear Dear 2 income "oth m)st "e ad$)sted( the ad$)stments are o##setting. here#ore( the com"ined income #or the two two years does not change as a res)lt o# the ad$)stments. 13 't will not "e eliminated again on the consolidated income statement #or s)"se)ent
years. Howeer( i# the land remains within the consolidated entity( the )nreali+ed gain will "e eliminated in the preparation o# all s)"se)ent consolidated "alance sheets and statements o# retained earnings )ntil s)ch time as the land is sold to o)tside parties. 14 Ad$)stments are re)ired on consolidation to "ring the consolidated consolid ated "alances "alance s to the
amo)nts that wo)ld hae "een on the s)"sidiary
'nestment income
,,,
'nestment in s)"sidiary
,,,
where ,,, is e)al to the parent
ending inentory is considered to "e )nreali+ed: since the inestor cannot control the associate or the other shareholders o# the associate( the pro#it in ending inentory times the percentage ownership o# the other shareholders is considered to "e a transaction with o)tsiders. 8nder A%&( the entire pro#it in ending inentory is considered to "e )nreali+ed. A%& states that the )nreali+ed pro#it is same amo)nt that wo)ld "e considered to "e )nreali+ed #or consolidated #inancial statements. or downstream
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transactions "etween a parent and s)"sidiary( the entire amo)nt o# )nreali+ed pro#it is eliminated and charged to the parent
$%L&'I%($ '% C.$*$ Case 6-1 8sing the data proided proided in the )estion( )estion( the #inancial statements statements #or the parent( s)"sidiary s)"sidiary and consolidated entity wo)ld appear as #ollows #or the 3 monthsB Parent
A)g
$/bsidiary
%ept
F)ly
A)g
Consolidated
F)ly
A)g
200
200
%ept
4ALA=C& %H&& 'nentory
20
200
repaid ta,
1!
'=CM& %A&M&= %A&M&= %ales
300
20
20
200
!0
0
'ncome ta, e,pense
2
1!
=et income
3!
2
300 Cost o# goods sold 200 Gross margin 100
he #ollowing comments o)tline how all o# the a"oe #inancial statements present #airly the #inancial position and #inancial per#ormance o# the company in accordance with GAAB 1. he parent parent and s)"sidia s)"sidiary ry are separate legal entities entities.. &ach entity entity will will pay pay income income ta, "ased on the income earned "y the the separate legal entity. here#ore( the s)"sidiary will pay income ta, "ased on the pro#it it earned in A)g)st and the parent will pay income ta, "ased on the pro#it it earned in %eptem"er. 2. he consolidated consolidated statemen statements ts com"ine com"ine the statements statements o# the parent parent and s)"sidiary s)"sidiary as as i# they were one entity i.e.( one set o# statements #or the #amily. 3. Acco)nting Acco)nting principles principles sho)ld sho)ld "e and hae hae "een properly properly applied applied #or all o# the indiid)al indiid)al #inancial statements. he main principles principles inoled with these statements statements are the Copyright 10
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historical cost principle( the reen)e recognition principle( and the matching principle. . he historical historical cost cost principle principle re)ires re)ires that that certain certain items s)ch s)ch as inentory inentory "e reported reported at historical cost. his has "een done #or all 3 #inancial statements. statements. =ote that the historical cost #or the inentory #rom a consolidated perspectie was 200 which is the cost paid "y the s)"sidiary when it p)rchased the goods #rom o)tsiders. 6. he reen)e reen)e recognition recognition principle principle re)ires re)ires that reen)e reen)e "e reported reported when itit is earned i.e.( when the "ene#its and ris*s o# ownership are trans#erred to the ")yer. ")yer. >hen the s)"sidiary sold to the parent( the "ene#its and ris*s were trans#erred to the parent. Accordingly( the s)"sidiary reported reen)e. Howeer( #rom the consolidated perspectie( the #amily retained the "ene#its and ris*s: they were not trans#erred to an o)tside entity. here#ore( no reen)e is reported on the consolidated income statement #or A)g)st. !. >hen the parent sells sells to an o)tside o)tside entity in %eptem"er( %eptem"er( it reports reports reen)e reen)e on its its separate entity income statement. %ince the #amily has sold the inentory to an o)tside entity( the #amily has earned the reen)e. Accordingly( Accordingly( the reen)e is reported in %eptem"er on the consolidated income statement. 9. he matching matching principle principle re)ires re)ires that costs costs "e e,pensed e,pensed in the same same period as the reen)e to which which it relates. his proides the "est meas)re o# per#ormance. %ince the s)"sidiary reported reen)e in A)g)st( it reported cost o# goods sold in A)g)st in order to match e,penses to reen)e in A)g)st. %imilarly( %imilarly( the parent reported cost o# goods sold in %eptem"er to match match e,penses to reen)e in %eptem"er. %ince reen)e was reported in %eptem"er #rom a consolidated iewpoint( the cost o# goods sold is reported as an e,pense in %eptem"er as well. he cost #rom a consolidated iewpoint was the amo)nt paid "y the s)"sidiary when it "o)ght the inentory #rom o)tsiders. /. 'ncome 'ncome ta, m)st m)st also also "e matched matched to the income to which which it relates. relates. 'n A)g)st( A)g)st( the s)"sidiary reported income ta, e,pense o# 1! to match against the pre-ta, income o# 0. %ince no income was was reported in the consolidated income statement #or A)g)st( no ta, e,pense sho)ld "e reported in income. Gien that the s)"sidiary pro"a"ly paid the ta, to the goernment( the ta, is considered to hae "een prepaid #rom a consolidated iewpoint "eca)se the ta, was not yet d)e #rom a consolidated iewpoint.
Case 6-2 %vervie0
he managers o# ing Limited 5ing7 are planning a share iss)e and do not want ing;s Copyright Solutions Manual, Chapter !
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earnings impaired "y the poor per#ormance o# )een Limited 5)een7. he #inancial statements o# ing will "e widely distri")ted d)e to the share iss)e planned #or Dear 1/. he a)ditor m)st "e aware o# management;s "ias and m)st ens)re that earnings and assets are not oerstated. he dr)g ind)stry is highly competitie. he principal assets in this ind)stry are intangi"le d)e to the large e,pendit)res on research and deelopment. he nat)re o# these assets creates pro"lems. =ote disclos)re will "e ery important. he relationship "etween ing and )een is )ncooperatie. 't will( there#ore( "e di##ic)lt to o"tain s)##icient and appropriate a)dit eidence to s)pport the acco)nting method and al)es )sed to record the )een inestment.
.cco/ntin for the investment
he choice o# the appropriate method to acco)nt #or the )een inestment depends primarily on whether ing has signi#icant in#l)ence oer )een. he #ollowing #actors indicate that ing does hae signi#icant in#l)enceB •
ing;s ownership meets the 20 g)ideline:
•
ing had mem"ership on the "oard o# directors( and ol)ntarily gae it )p:
he #ollowing #actors indicate that ing does not hae signi#icant in#l)enceB •
inter-company transactions hae declined and are no longer material:
•
diidends hae not "een paid recently( and perhaps earnings o# )een will not accr)e to ing: and
•
gien the )ncooperatie )ncooperatie nat)re o# )een and ing;s relationship( relationship( it does not appear that ing has signi#icant signi#icant in#l)ence oer )een.
(Students could have discussed other valid factors in determining whether King exerts significant influence over Queen)
'# ing is a"le to e,ert signi#icant in#l)ence oer )een( then it will contin)e to )se the e)ity method o# acco)nting #or the inestment. '# ing no longer has signi#icant in#l)ence( the inestment in )een wo)ld "e reported at #air al)e. 't is di##ic)lt to determine whether management management o# ing manip)lated manip)lated the change in in#l)ence "y ceasing to trade with )een and remoing the ing representatie #rom )een;s "oard o# directors. 'n any case( case( the change in Copyright 12
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method wo)ld "e acco)nted #or prospectiely since the change was made d)e to a change in circ)mstance. here#ore( the prior period ad$)stment reported in the dra#t #inancial statements wo)ld not "e appropriate and sho)ld "e reersed. reersed. (Students should have reached a conclusion on the issue of significant influence and proceeded with their analysis of either either the fair value method or the euity euity method! "his response discusses #oth methods! $owever, students students were not expected to provide an analysis of #oth the euity and the fair value methods!) */ity method
ing m)st re#lect its share o# )een;s c)rrent loss. As shown in Appendi, '( the inestment wo)ld "e written down #rom 29. million to +ero "eca)se ing
'# ing no longer has signi#icant in#l)ence( it wo)ld adopt the #air al)e method starting on the date it lost signi#icant in#l)ence. he "alance in the inestment acco)nt )nder the e)ity method wo)ld "e retained as the initial "alance )nder the #air al)e method. '# the change in signi#icant in#l)ence occ)rred "e#ore )een s)##ered the h)ge loss in Dear 19( the "alance in the inestment acco)nt wo)ld "e 29. million. million. '# the change in signi#icant in#l)ence occ)rred a#ter ing accr)ed its share o# )een
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Gien that )een s)##ered h)ge losses and gien that )een
he #act that )een re#)ses to disclose in#ormation may indicate a li)idity pro"lem that the company is rel)ctant to p)"lici+e. n the other hand( )een may "e trying to maintain con#identiality a"o)t its new dr)g "rea*thro)gh.
•
%toc* prices hae "een olatile( so the stoc* price cannot "e relied on as an indication o# al)e )nless the olatility can "e e,plained "y speci#ic economic eents 5e.g.( generic dr)g competition( new iral dr)g7.
•
)een has e,perienced seere losses this year: this sit)ation may "e considered )n)s)al.
•
here is no eidence to s)ggest that )een will contin)e to inc)r losses )nless economic circ)mstances hae changed. '#( #or e,ample( competition has increased( rec)rring writeo##s o# research research and deelopment deelopment e,pendit)res can "e e,pected. e,pected.
•
here is no eidence that the mar*et al)e o# ing;s share o# )een has "een less than the carrying al)e #or a prolonged period.
hese #actors s)ggest that the decline in #)t)re cash #lows is not permanent and that the mar*et price o# 13 may "e a reasona"le re#lection o# the #air al)e o# )een. Howeer( the mar*et price o# )een;s shares a#ter year-end may proide additional eidence s)pporting this concl)sion. (Students should have reached a conclusion on the reasona#ility of the trading price as a reflection of the fair value of the Queen%s shares!)
he c)rrent sit)ation is )n)s)al and will re)ire detailed note disclos)re to descri"e the change in reporting method and the impact on the #inancial statements. .PP*(I I +al/ation +al/ation of Investment .cco/nt
5in tho)sands o# dollars7 Carrying amo)nt per dra#t #inancial statements Copyright 1
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Reerse ad$)stment #or prior period ad$)stment
2(00
Restated "alance )nder e)ity method( "eginning o# year
29(00
&ntries #or year )nder e)ity methodB Reali+ed pro#it in "eginning inentory 522 , 6(0007
1(100
8nreali+ed pro#it in ending inentory 522 , 1(0007
52207
%hare o# )een
52/(2/07
4alance )nder e)ity method( end o# year
-oJ
=ote 1B he ad$)stment sho)ld "e the amo)nt re)ired to "ring the inestment acco)nt to +ero.
Case 6-3 Memo toB
Linda resner( artner
romB
CA
%)"$ectB
Acco)nting iss)es regarding Metal Caissons Limited 5MCL7
%vervie0 of the enaement
he #inancial statements o# MCL will "e )sed "y the two shareholders( the "an* and the ?epartment o# =ational ?e#ence 5?=?7. heir needs m)st "e considered when assessing appropriate acco)nting policies and disclos)res. Fohn Ladd and a)l inch wish to present #inancial statements coneying a pict)re o# pro#ita"ility and a strong #inancial position to the "an* and the ?=?. Howeer( it wo)ld "e in their "est interests to adopt policies that will also minimi+e corporate ta,es. he "an* and the ?=? wo)ld li*ely e,pect generally accepted acco)nting principles #or priate enterprises 5A%&7 to "e )sed in all instances. (Most candidates devoted too much time to the definition of the users of MC&%s MC&%s financial statements and their needs! "hese candidates failed to incorporate this analysis in their analysis of the accounting issues!) oin concern
his iss)e m)st "e assessed to determine whether the #inancial statements sho)ld "e stated on the "asis o# historical costs or li)idation al)es. A potential going concern pro"lem is s)ggested "y the #ollowingB
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•
4y e,cl)ding the goernment grants #rom reen)es( MCL wo)ld "e in a loss position. '# the year-to-date res)lts are typical( the long-term pro#ita"ility o# MCL may "e marginal. Howeer( s)ch losses may( howeer( "e normal in a start-)p sit)ation.
•
?=? is the sole client and can cancel the contract i# the terms o# the contract are not met. ?eliery dates hae "een missed: howeer( recent delieries hae "een made on time.
•
MCL;s wor*ing-capital position indicates potential insolency i# goernment grants are not receied. MCL has not met the terms o# the $o"-creation grant( and this may e,plain why the grant has not yet "een receied.
•
he wor*ing-capital position has deteriorated #)rther "eca)se ?=? has not paid #or the caissons receied to date. he metal caissons m)st meet high standards o# )ality( and ?=?;s inspection process may hae slowed down approals. Alternatiely( the #act that ?=? has not paid may mean that there are pro"lems that hae not yet "een disclosed to )s.
•
here is nothing to indicate that the contract with ?=? will "e renewed at the end o# #ie years or that the man)#act)ring process can "e changed to another prod)ct at that time.
•
he laws)it pending against MCL( i# s)ccess#)l( co)ld drie the company into "an*r)ptcy.
•
Altho)gh there th ere are many #actors that th at raise a concern a"o)t a" o)t the a"ility o# MCL to to contin)e as a going concern( MCL contin)es to operate as a going concern. ?=? has not yet cancelled the contract and the "an* has not called the loan. here#ore( MCL sho)ld contin)e to report on a going-concern "asis. Howeer( they sho)ld disclose their reliance on the ?=? contract and the signi#icant ris*s that may "ear on their a"ility to contin)e as a going concern.
(Candidates were expected to address the going'concern issue! "he #etter responses presented some uantitative analysis! Most candidates failed to address this maor issue in adeuate depth!) overnment rants
At present( 9E o# o # MCL;s total wor*#orce is employed in the plant( which is "elow the /6 speci#ied in the $o"-creation grant. '# the conditions cannot "e met "y their d)e date( the grant receia"le will need to "e written o##.
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he recording o# the grants as reen)e is inappropriate )nder GAA since the grants pertain to the cost o# the plant and cost o# employees. he grants do not pertain to the sale o# goods or proision o# serices. he ")ilding grant sho)ld "e netted against the capitali+ed cost o# the plant( or recorded as a de#erred credit and amorti+ed to income oer the li#e o# the plant. he $o"-creation grant sho)ld "e de#erred de# erred and amorti+ed to income oer the three-year period o# the agreement. 't will "e necessary to disclose the terms o# the grants. (Most candidates discussed the accounting implications of government grants in adeuate depth!) Late delivery penalties
)rther reiew o# the contract with ?=? is re)ired. 't is apparent that the late deliery penalties 5110(000 #or 66 days at 2(000 per day7 #or the #irst three caissons hae not "een accr)ed( and this iss)e m)st "e disc)ssed with management. ?=? sho)ld "e contacted to #ind o)t whether the penalties will "e en#orced or waied and whether speci#ications hae "een met on all the caissons deliered to date. '# the penalty is not waied( an accr)al #or the amo)nt o# the penalty will "e re)ired. Clari#ication is needed on the proced)res to "e #ollowed i# a caisson proes )naccepta"le. o date no caissons hae "een ret)rned: howeer( the amo)nt o# the penalties may increase with each day that the speci#ications contin)e not to "e met. Related disclos)res #or the contracts( incl)ding the penalties( will "e re)ired. (Most candidates did not uantify the amount of the possi#le penalty payment!) Investment in $I
>ith a !0 ownership interest( MCL li*ely has control oer M%'. 8nder A%&( the inestment in M%' can "e reported on a consolidated "asis or )sing the cost method or e)ity method. %ince M%' is reporting pro#it in e,cess o# diidends paid( the consolidated statements or the e)ity method wo)ld increase pro#its #or MCL. %ince consolidated statements are generally iewed as more )se#)l( ' will ass)me that MCL will choose to report its inestment on a consolidated "asis. %ince M%' reported a pro#it o# 0(000( the consolidated net income attri")ta"le to MCL
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goods sold "y 30(000. %ince the pro#it o# 30(000 was initially reported "y M%'( "oth the shareholders o# MCL and the non-controlling interests in M%' will "e a##ected when the pro#it is eliminated. he portion attri")ta"le to the shareholders o# MCL is 1/(000 5!0 , 30(0007. here#ore( the consolidated net income attri")ta"le to MCL
Capitali+ing costs is appropriate only i# a li*ely #)t)re "ene#it is associated with the e,pendit)re. he capitali+ed e,pendit)res will li*ely "e reclassi#ied as #ollowsB *9pendit/re
.cco/ntin 'reatment
##ice #)rnit)re
Amo)nts spent on the p)rchase o# o##ice e)ipment sho)ld "e added to the capital asset asset acco)nt and depreciated oer the li#e o# these assets.
rael costs
Costs related to to the search o# the plant site sho)ld "e incl)ded in in the cost o# land.
Calls #or tender
he cost o# calls #or te tender sh sho)ld "e "e incl)ded in in the cost o# th the plant and depreciated oer the li#e o# the plant.
rod)ct deelopment deelopment costs costs hese costs costs sho)ld "e "e capitali+ed capitali+ed as deelopment deelopment costs costs i# the costs can "e recoered thro)gh #)t)re sales o# prod)cts or serices. he costs sho)ld "e amorti+ed oer the li#e o# the related prod)ct. Grant negot egotiiatio ation ns
he hese co costs sho)ld "e net netted agai gainst nst the am amo)nt )nt o# o# th the gr grants receied and amorti+ed on the same "asis as the grants.
Cont Contra ract ct nego negoti tiat atio ions ns
hes hese e cos costs ts sho) sho)ld ld "e capi capita talili+e +ed d as as a cost cost o# the the ?=? ?=? cont contra ract ct and amorti+ed oer the li#e o# the contract.
Admin K legal costs
hese costs and the incorporation costs sho)ld sho) ld "e e,pensed e,pense d as inc)rred since they do not proide any meas)ra"le #)t)re "ene#it
(Most candidates addressed capitalied expenditures in adeuate depth!) Copyright 1/
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iscellaneo/s iss/es
he #ollowing iss)es m)st also "e consideredB 1. >e m)st disc)ss with with management whether there are plans to man)#act)re prod)cts prod)cts #or c)stomers other than the ?=?. MCL is economically dependent on the ?=? contract( and this relationship m)st "e disclosed.
2. A#ter reiewing reiewing the goernment contract and a#ter disc)ssions disc)ssions with management management and the ?=?( we sho)ld consider whether the present method o# recording reen)e at the time the prod)ct is shipped is appropriate. erhaps( reen)e sho)ld not "e recogni+ed )ntil the client con#irms that the detailed speci#ications hae "een met.
3. MCL;s lawyers lawyers will "e contacted to assess the progress o# the ?e)tsch rod)ction laws)it. &ither the amo)nt o# the potential damages m)st "e accr)ed or the appropriate disclos)re made a"o)t the contingent lia"ility depending on the certainty with respect to the o)tcome o# the laws)it. his is a critical iss)e considering the materiality o# the amo)nt and its impact on MCL as a going concern.
. >e m)st #ind o)t why no principal principal payments o# long-term de"t de"t hae "een recorded on the #inancial statements. '# re)ired payments hae not "een made( MCL co)ld "e in de#a)lt( and this wo)ld "e yet another consideration in the assessment o# whether MCL is a going concern. rincipal payments may also hae "een erroneo)sly charged as interest e,pense.
6. he c)rrent portion portion o# the long-term de"t sho)ld "e classi#ied classi#ied separately and disclos)re disclos)re made o# the de"t agreement and the principal payments payments to "e made oer the ne,t #ie years.
!. 'nterest 'nterest can "e capitali+ed capitali+ed d)ring the constr)ction constr)ction period only )ntil prod)ction commences. commences. 't appears that interest has "een capitali+ed "eyond this period and an ad$)stment sho)ld "e made. nce properly calc)lated( the amo)nt sho)ld "e disclosed in the notes to the #inancial statements.
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9. ?epreciation ?epreciation has "een calc)lated calc)lated on plant e)ipment at what appears to "e a low rate. he appropriateness o# the rate will hae to "e assessed giing regard to the )se#)l li#e o# the related assets "eing depreciated.
Case 6-4 Memo toB A)dit artner romB
A)dit %enior
ReB
? Ltd. J Consolidated inancial %tatements
As re)ested( ' hae prepared pr epared the #ollowing # ollowing memorand)m( which o)tlines the impor tant #inancial acco)nting iss)es o# ? and =( its s)"sidiary( and ( its inestee company. 1. he shares iss)ed iss)ed "y ? to p)rchase = and sho)ld "e meas)red at their #air al)e at the date o# ac)isition. or now( now( ' will ass)me that the #air al)e o# 1!0(000 common shares was 2(000(000 when ? p)rchased its inestments in = and . 2. 't appears that that there has "een no allocation allocation o# the !0(000 ac)isition cost e,cess e,cess #or = in the consolidated #inancial statements. he e,cess sho)ld "e #irst "e allocated to identi#ia"le assets. Any remaining e,cess sho)ld "e allocated allocated to goodwill. he goodwill sho)ld "e chec*ed #or impairment at the end o# each year and written down i# there is an impairment loss. 3. Gien that = had capitali+ed some research research and deelopment e,pendit)res( e,pendit)res( there may "e some al)e in what what they were deeloping. he pro$ects that met the conditions #or capitali+ation sho)ld "e meas)red at #air al)e at the date o# ac)isition ass)ming that the assets can "e separately separately identi#ied and relia"ly meas)red. 'n t)rn( these assets sho)ld "e amorti+ed oer their )se#)l lies. Amorti+ation sho)ld commence once the assets are "eing )sed in operations and are generating reen)e #or the company. . ? can )se either the entity theory or parent company e,tension e,tension theory in preparing the consolidated #inancial statements. 8nder these theories( =
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Ac)isition cost #or /0 interest in =
(000(000
'mpl 'mplie ied d al al)e )e #or #or 100 100 int inter eres estt in in = 5(00 5(000(0 0(000 00 @ ./7 ./7
6(000 6(000(00 (000 0
=C'
1(000(000
his ass)mes that there is a linear relationship "etween the al)e o# /0 and the al)e o# 100 o# =. 6. 'ntercompany 'ntercompany transaction transactions s and "alances "etween "etween ? and m)st "e eliminated. eliminated. %ales and cost o# sales sales sho)ld "e red)ced "y the intercompany sales o# 1(200(000. 1(200(000 . he )nreali+ed pro#it o# 200(000 51(200(000 J 1(000(0007 sho)ld "e ta*en o)t o# ending inentory and added to cost o# goods sold. %ince this was was an )pstream sale( non-controlling interest will will "e a##ected "y this ad$)stment. !. he inestment inestment in has "een acco)nted acco)nted #or )sing the cost method. method. his method method is not accepta"le )nder 'R%s. >ith a 0 interest in ( ? wo)ld normally hae signi#icant in#l)ence. '# so( so( the e)ity method wo)ld wo)ld "e appropriate. or the p)rpose o# this disc)ssion( ' will ass)me that ? does hae signi#icant in#l)ence and the e)ity method sho)ld "e )sed. 9. 8nder the e)ity method( method( the ac)isition ac)isition cost wo)ld hae to "e allocated allocated in a manner similar to what is done done #or consolidation p)rposes. he ac)isition di##erential wo)ld "e allocated to identi#ia"le net assets where the #air al)e is di##erent than carrying amo)nt. his #air al)e di##erence wo)ld hae to "e amorti+ed and an ad$)stment made to the inestment acco)nt on an ann)al "asis. >e do not hae s)##icient in#ormation at this point to determine the ad$)stment #or Dear 1. /. %ince ? paid less than the #air al)e o#
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10.
4ased 4ased on the disc) disc)ssi ssion on a"oe( a"oe( ' hae hae recalc recalc)lat )lated ed the #ollo #ollowin wing g acco)nt acco)nt "alance "alances s #or
the consolidated #inancial statements in the sched)les "elowB Goodwill 'nestment in 5)nder e)ity method7 =on-controlling interest on "alance sheet ro#it .llocation and amorti8ation of ac/isition cost for investment in (
Cost o# /0 inestment( %eptem"er( Dear 1
(000(000
'mplied al)e o# 100 inestment 5(000(000 @ ./7
6(000(000
Carrying amo)nts o# =
1(000(000
Retained earnings
1(/60(000
otal shareholders; e)ity
2(/60(000
Ac)isition di##erential
2(160(000
AllocationB
N J CA
Land
/00(000
lant and e)ipment
900(000
Research and deelopment e,pendit)res
- E0(000
&,isting goodwill
- !0(000
4alance J newly calc)lated goodwill
/00(000
:alance
.morti8ation
$ept 1 ;ear ;ear 1
:alance ./ 31
;ear ;ear 2
;ear ;ear 2
Land
/00(000
lant and e)ipment
900(000
Research and deelopment
- E0(000
- E0(000
ld goodwill
- !0(000
- !0(000
=ew goodwill
1(360(000
/00(000 90(000
/00(000
!30(000
/00(000 2(160(000
90(000
2(0/0(000
Investment in <
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Retained earnings o# ( A) A)g. 31( Dear 2
1(910(000
Retained earnings o# ( at ac)isition
1(9!0(000
Change
- 60(000
LessB pro#it in ending inentory 5200(000 , 1 - .7
- 120(000
Ad$)sted increase
- 190(000
?
0
'nestment in ( A)g. 31( Dear 2
- !/(000 2(032(000
(on-controllin interest on balance sheet
Common shares o# =
1(000(000
Retained earnings o# =
1(E60(000
LessB )nreali+ed pro#it in ending inentory 5/60(000 J !30(000 , .!7
- 132(000
otal shareholders; e)ity
1(/1/(000 2(/1/(000
8namorti+ed ac)isition di##erential
2(0/0(000 (/E/(000
=on-controlling interest( A)g. 31( Dear 2
20 E9E(!00
Calc/lation of consolidated profit = ;ear 2
ro#it o# ?
!00(000
LessB ?iidends #rom = 5200(000 , /07
1!0(000
?iidends #rom 5160(000 , 07
!0(000
220(000 3/0(000
ro#it o# =
300(000
LessB pro#it in closing inentory 5220(000 , .!7
- 132(000
amorti+ation o# ac)isition di##erential
- 90(000
Ad$)sted pro#it
E/(000
ro#it o#
100(000
LessB pro#it in closing inentory 5200(000 , .!7
- 120(000
Ad$)sted pro#it
- 20(000
?
0
Consolidated pro#it( Dear 2
- /(000 90(000
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%hareholders o# ? =on-controlling interests 520 , E/(0007
60(00 1E(!00 90(000
Case 6-5 )*P%)' %( .CC%&('I( .CC%&('I( P%LICI*$ &$* I( '>* I(.(CI I(.(CI.L .L $'. $'.'**('$ % %% ,&.LI'; .&'% P.)'$ LII'* %) '>* ;*.) *(* *:)&.); 2? ;ear 11
o the mem"ers o# the )nion( Good )ality A)to arts LimitedB ' hae "een engaged to analy+e the #inancial statements o# Good )ality A)to arts Limited 5G7 #or the year ended e"r)ary 2/( Dear 11 and determine whether there are any controersial acco)nting iss)es. or the p)rposes o# this report( Ocontroersial acco)nting iss)esO will "e de#ined as acco)nting policies that hae the e##ect o# red)cing payments )nder the pro#it-sharing plan to the )nion mem"ers. he e,istence o# the pro#it-sharing contract creates incenties #or the management o# G to ma*e acco)nting choices that red)ce net income and there"y red)ce the payments that m)st "e made to the )nion mem"ers. Acco)nting standards #or priate enterprises 5A%&7 allow considera"le #le,i"ility and $)dgment "y the preparers o# #inancial statements in selecting acco)nting policies. %ince the company is priately owned( the costs 5real or perceied7 o# reporting lower income may "e small relatie to the saings generated. or e,ample( the e##ect o# lower income on new or e,isting lenders may "e considered less important than the saings deried #rom red)ced pro#it sharing. 'n addition since the term o# the contract is only three years( some o# the income de#erral may yield permanent saings i# the pro#it-sharing component is not renewed in s)"se)ent contracts. 'n analy+ing the acco)nting policies( ' will "e ta*ing as strong a position as can "e $)sti#ied to s)pport the )nion;s o"$ectie o# ma*ing net income as large as possi"le. his is in con#lict with the o"$ectie o# management( which is to red)ce net income. Inventory 0rite-do0n
Acco)nting practice re)ires re )ires that inentory "e " e meas)red at the lower o# cost and net ne t reali+a"le al)e. h)s( i# the inentory cannot "e sold( management can $)sti#y its write-o##. Howeer( since m)ch o# the inentory has "een on hand #or seeral years( the decision to write it o## this Copyright 2
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year raises a )estion as to the motiation #or the write-o##. Management co)ld "e writing o## the inentory solely to red)ce income( there"y red)cing the payments re)ired )nder the pro#it-sharing plan. he pro"lem m)st "e considered #rom two points o# iew. irst( is the inentory gen)inely )nsalea"leP '# not( then the entry to write down the inentory m)st "e reersed( res)lting in a higher net income #ig)re. Ass)ming that the inentory is )nsalea"le( the ne,t )estion is whether the write-o## legitimately "elongs in the c)rrent period. '# the inentory "ecame )nsalea"le in the c)rrent year( then the write "elongs in the c)rrent period. '# the inentory was )nsalea"le in prior years( it sho)ld hae "een written down in prior years. 'n that case( the #inancial statements sho)ld "e retroactiely restated to correct the error in the appropriate period. .llo0ance for ret/rns
he ret)rn estimate represents a legitimate cost o# doing ")siness d)ring the period. >hat is in )estion is whether the more conseratie estimate represents a gen)ine re#lection o# a change in economic conditions or an opport)nistic )se o# acco)nting $)dgment to red)ce net income. G;s a)ditor wo)ld pro"a"ly not o"$ect to the increased e,pense since conseratism is a *ey acco)nting principle. Howeer( the )nion;s interests are not sered "y conseratism. &se of accelerated depreciation
here is no re)irement that all assets owned "y a #irm "e depreciated in the same way. h)s( G can arg)e that the )se o# an accelerated method on the new e)ipment "etter re#lects the pattern in which the assete can arg)e that the port#olio o# man)#act)ring e)ipment ac)ired to prod)ce similar prod)cts sho)ld "e acco)nted #or similarly. '# there is no di##erence "etween the new and old e)ipment with respect to the e##ect o# technological o"solescence( then either the new asset sho)ld "e depreciated on a straight-line "asis or similar assets ac)ired preio)sly sho)ld "e depreciated on the accelerated method. he #inancial impact o# )sing the same depreciation method #or "oth cannot "e determined at this point. #rite-off of ood0ill
Goodwill sho)ld "e written down or written o## i# there has "een a permanent impairment o# its al)e i.e. i# the recoera"le amo)nt o# the cash generating )nit in which the goodwill is located is less than the carrying amo)nt o# the net assets( incl)ding goodwill( o# the cash generating )nit. he #act that the a)to parts ind)stry is s)##ering thro)gh poor economic times does not necessarily imply that what was p)rchased 5the company name( its c)stomers( etc.7 no longer Copyright Solutions Manual, Chapter !
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has any al)e. he a)to ind)stry is ery sensitie to economic cycles( and it is e,pected that s)ch downt)rns will occ)r. 5'ndeed( their occ)rrence sho)ld hae "een #actored into the ac)isition cost paid "y G7. 8nless G can come )p with strong eidence that the intangi"les p)rchased hae "een impaired( there is no $)sti#ication #or the write-o## een tho)gh G;s a)ditors s)pported it. 't is important to emphasi+e that their s)pport may rest in conseratismB a)ditors are willing to accept acco)nting treatments that are conseratie. Howeer( conseratism is inconsistent with the )nion;s o"$ecties. he al)e o# the asset ac)ired in Dear 6 m)st still e,ist )nless there is speci#ic eidence o# its impairment. G sho)ld proide eidence o# impairment. &nreali8ed profits from intercompany sales
he )nreali+ed pro#it #rom intercompany sales sho)ld "e eliminated when preparing consolidated #inancial statements. CG has not made any ad$)stments #or these intercompany transactions #or Dear 11. he )nreali+ed pro#it in ending inentory is 2/(000 510 , /00(000 , 367. >hen this pro#it is eliminated( CGhen ad$)sting #or this pro#it( CG
he compensation approach selected "y the senior managers has a signi#icant e##ect on the money paid to the )nion mem"ers. %ince "on)ses are ded)cted #rom income whereas diidends are not( the ma,im)m e##ect o# the change in compensation #or )nion mem"ers is 600(000 5an aerage o# 2(600 per employee7. employee7. '# the amo)nt o# compensation has remained remained more or less the same as in prior years( with only the method o# payment changing( then an arg)ment can "e made that G is iolating the spirit o# the contract "y changing the method. Chane to ta9 allocation allocation
8nder A%&( CG has the choice to )se either the ta,es-paya"le method or the lia"ility method o# acco)nting #or income ta,es. Accordingly( the new method is accepta"le )nder A%&. >e co)ld arg)e that the change is in iolation o# the contract( as the contract was signed on the )nderstanding that ma$or acco)nting policies wo)ld remain the same. he ar"itrator may accept this arg)ment. he ar"itrator( howeer( wo)ld li*ely demand consistent treatment o# acco)nting changes.
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Case 6-6 )*P%)' '% P.)'(*) %( PL*-. PL*- .* * C%)P%).'I%( %vervie0
C is a p)"lic corporation. corporation. here#ore( here#ore( the #inancial statements statements will "e )sed "y sta*eholders #or a ariety o# p)rposes( p)rposes( incl)ding the eal)ation eal)ation o# the company and its management. management. As a res)lt( the managers hae incenties to increase or smooth earnings to in#l)ence the share price or present present a #ao)ra"le impression impression o# themseles themseles to the sta*eholders. sta*eholders. 'n addition( addition( the company is e,panding e,panding rapidly and( there#ore( there#ore( may need to raise capital. capital. 4y )sing acco)nting acco)nting choices choices to increase increase earnings or otherwise improe the appearance o# the #inancial statements( management may "e attempting to red)ce the cost o# capital "y lowering the cost o# de"t or increasing increasing the selling price o# the shares. he company company may hae a competing o"$ectie o"$ectie o# minimi+ing ta, "y choosing acco)nting policies that red)ce income in cases where Reen)e Canada re)ires #or ta, p)rposes the same acco)nting policies that are )sed in the generalp)rpose #inancial statements. C also wants to ens)re it does not iolate the de"t coenant and wants to *eep the de"t to e)ity ratio "elow 2B1. Gien that C is a p)"lic company and that it may raise capital( it is li*ely that management wo)ld choose acco)nting acco)nting policies policies that increase increase income. 'ts #inancial #inancial statements statements m)st "e in compliance with 'nternational inancial Reporting %tandards 5Q'R%s7. he iss)es iss)es are disc)sse disc)ssed d "elow "elow.. he impact impact o# the acco)nting acco)nting and reporti reporting ng on the *ey metr metric ics s 5inco 5income me(( de"t de"t and e)ity e)ity77 are show shown n in the the append appendice ices. s. Appen Appendi di, , ' show shows s the acco)nting impact #or the iss)es where the acco)nting was not speci#ied in the case. Appendi, '' shows the impact when the company
C receied a 2 million payment #rom a contractor who ")ilt a theatre comple, #or C in Montreal. Montreal. he payment payment was #or completing completing the pro$ect late. 'n its attempt attempt to increase increase income( management will want to record the penalty as reen)e. Arg)ments co)ld "e made #or treating the penalty payment either as income 5reen)e or Copyright Solutions Manual, Chapter !
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red)ction o# e,penses7 or as a red)ction in the capital cost o# the comple, 5"alance sheet7. '# C inc)rred additional costs "eca)se o# the delay in opening the new comple,( and the penalty was compensation #or those additional costs inc)rred( then the penalty sho)ld "e )sed to o##set those costs inc)rred. '# the additional costs inc)rred related to the capital cost o# the comple,( then the penalty sho)ld "e )sed to red)ce the capital cost o# the comple,. Analogies might might "e draw drawn n with with the the 'R% 'R% standar standard d on goer goernm nment ent grants grants 5'A% 5'A% 207. 207.
his his secti section on
recommends recommends that payments s)ch as grants sho)ld sho)ld "e treated as cost red)ctions. red)ctions. he parallel parallel here is that the penalty payment is li*e a grant and there#ore sho)ld "e treated as a red)ction in the capital cost o# the comple, or in costs e,pensed as inc)rred. n the the other other hand( hand( i# the penal penalty ty payme payment nt was was comp compens ensati ation on #or lost lost ree reen) n)e( e( then then an arg)ment arg)ment might might "e made made #or treatin treating g the penalty penalty as reen)e. reen)e. '# the penalty penalty is treated treated as reen)e( then we m)st consider consider whether it sho)ld "e disclosed separately separately.. %ince the penalty payment is non-rec)rring( #inancial statement )sers wo)ld #ind separate disclos)re in#ormatie "eca)se the portion o# reen)e and income that is non-rec)rring can "e al)ed di##erently "y the the mar* mar*et et and "y indi indiid) id)al al ine inest stor ors s and and in#l) in#l)enc ence e the the eal) eal)ati ation on o# manag manageme ement. nt. here#ore( i# material( the penalty sho)ld "e disclosed as a separate reen)e item either on the #ace o# the income statement or in the notes. @)/e $t Aac/esB
ic*et proceeds C wo)ld pre#er to recogni+e reen)e as early as possi"le with the earliest date "eing the sale o# the tic*ets. Howeer( Howeer( the most appropriate appropriate treatment #or recogni+ing recogni+ing reen)e #or QR)e %t. Fac)es is when the show is per#ormed. *AS +, paragraph +-' Admission fees, re)ires Qreen)e #rom artistic per#ormances( "an)ets
and other special eents is recogni+ed when the eent ta*es place. >hen a s)"scription to a n)m"er o# eents is sold( the #ee is allocated to each eent on a "asis which re#lects the e,tent to which serices are per#ormed at each eent. er#ormance er#ormance is the critical critical eent in the earnings process( process( and there#ore reen)e is not earned )ntil the show is p)t on. here is no ass)rance ass)rance that the prod)ction will will "e completed( or that Copyright 2/
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any per#ormance #or which tic*ets are sold will ta*e place 5#or e,ample( the show co)ld "e closed closed down "e#ore "e#ore it "egins "egins its r)n or een een a#ter a#ter it "egins "egins its r)n7. 'n that case( case( it will will "e necessary to re#)nd the ac)isition cost o# tic*ets to ")yers. 'nterest on tic*et proceeds C earns a signi#icant amo)nt o# interest "y holding the money paid in adance "y tic*et p)rchase p)rchasers. rs. he interes interestt reen)e reen)e co)ld co)ld "e treated treated as either either income income or de#erred de#erred reen)e reen)e depending on the #acts and circ)mstan circ)mstances. ces. Managemente m)st determine determine whether these costs sho)ld "e capitali+ed and amorti+ed( amorti+ed( or e,pensed as inc)rred. C wo)ld li*ely pre#er to capitali+e costs since this treatment wo)ld minimi+e the c)rrent e##ect on income income at a time when it is considering considering going to the capital mar*ets. mar*ets. 'n principle( principle( capitali+ation capitali+ation and amorti+ation amorti+ation o# the costs oer oer the li#e o# the show appears reasona"le. reasona"le. he iss)e is whether the show will generate ade)ate reen)es 5in e,cess o# the capitali+ed costs7 to $)sti#y $)sti#y incl)ding incl)ding them on the "alance "alance sheet as assets assets..
't is ery di##ic) di##ic)lt( lt( howeer howeer(( to
determine determine whether a theatre prod)ction will will "e s)ccess#)l. 'ndications 'ndications are that the show will "e a s)ccess( gien its long long r)n in aris and the e,tent o# adance tic*et tic*et sales. hese #acts s)pport s)pport capital capitali+a i+ation tion:: e,pensi e,pensing ng wo)ld wo)ld li*ely li*ely "e too conser conserati atie e in light light o# these these #acts. #acts. Howeer( despite these indicators o# s)ccess( the show co)ld still "om" i# costs are e,cessie or it does not s)it the tastes tastes o# Canadian theatre goers. goers. As long long as the de#inition o# as asset can "e met( setting it )p as an asset is accepta"le. Copyright Solutions Manual, Chapter !
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'# C C choos chooses es to capit capitali ali+e +e the pre-p pre-prod rod)c )cti tion on cost costs( s( they they m)st m)st "e amort amorti+ i+ed ed oer oer a reasona"le period o# time. ne method is to e,pense costs against net reen)es dollar #or dollar )ntil )ntil the pre-prod)ction pre-prod)ction costs are coered coered 5i.e. cost recoery recoery #irst #irst method7. >ith this method the show will generate no income income )ntil the pre-prod)ction pre-prod)ction costs hae "een recoered. recoered. A second alternatie is to amorti+e am orti+e oer the estimated li#e o# the show. # co)rse( once the show opens( ongoing prod)ction costs sho)ld "e e,pensed as inc)rred. .dvertisin and promotion
C paid 12 million #or adertising and promotion costs a large part o# which related to the QR)e %t. Fac)es show.hese costs sho)ld "e e,pensed as inc)rred "eca)se it is di##ic)lt to assess the e##ectieness o# adertising costs i.e. to determine whether they proide #)t)re "ene#it. ebt defeasance
C has str)ct)red the de"t-retirement transaction as an in-s)"stance de#easance o# de"t. he e##ect o# the transaction transaction is to remoe de"t #rom the "alance sheet and there"y red)ce the amo) amo)nt nt o# de"t de"t repo report rted ed 5th) 5th)s( s( #or #or e,am e,ampl ple( e( decr decrea easi sing ng the the de"t de"t-t -too-e e)i )ity ty rati ratio7 o7.. 8n#ort)nately( 'R%s do not allow the )se o# this type o# arrangement. 'A% 1( paragraph 32 states QAn entity shall not o##set assets and lia"ilities or income and e,penses( e,penses( )nless re)ired or permitted permitted "y an 'R%. 'R%. aragraph 33 states QAn entity reports reports separately separately "oth assets and lia"ilities( lia"ilities( and income and e,penses. e,penses. ##setting ##setting in the statements statements o# comp compreh rehens ensi ie e inco income me or #inan #inanci cial al posit position ion or in the the separa separate te inco income me stat statem ement ent 5i# 5i# presented7( e,cept when o##setting re#lects the s)"stance o# the transaction or other eent( detract detracts s #rom #rom the a"ility a"ility o# )sers )sers "oth to )ndersta )nderstand nd the transacti transactions( ons( other eents eents and conditions that hae occ)rred and to assess the entity
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a.
c)rr c)rrent ently ly has has a legal legally ly en#or en#orce cea"l a"le e righ rightt to to set set o## o## the the rec recogn ogni+ i+ed ed amo) amo)nt nts: s: and
".
inte intend nds s eith either er to set settle tle on a net net "asi "asis s( or to real realii+e the the asse assett and and sett settle le the the lia" lia"il iliity sim)ltaneo)sly.
4oth o# these conditions m)st "e met in order to o##set a #inancial asset and a #inancial lia"ility. Howeer( the #acts indicate that the holders o# the company
C "egan selling theatres recently where economic conditions $)sti#ied the sale o# a partic)lar theatre. his year( year( a signi#icant part o# net income income was generated thro)gh the sale o# theatres. C has incl)ded the proceeds #rom these sales as reen)e on the income statement 5as opposed to treating them as gains or losses on disposition7 "eca)se it considers s)ch sales as an ongoing part o# its operations. operations. Howeer( Howeer( the sales co)ld co)ld also "e considered incidental incidental to ongoing operations( with only gains or losses on disposition "eing reported in the income statem statement. ent.
'n the latter latter case( the gains and losses losses wo)ld not "e incl)de incl)ded d in reen)es reen)es..
'ncl)ding 'ncl)ding the proceeds #rom the sale o# theatres theatres is consistent consistent with management
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4ased on the in#ormation aaila"le( it is not possi"le to concl)de whether these sales do represe represent nt part part o# ongoing ongoing operatio operations. ns. >e sho)ld sho)ld reiew reiew the sale sale agreemen agreements ts and "oard "oard min)tes to con#irm that these sales are indeed Qongoing. '# the sales are ongoing( the theatres wo)ld hae to "e reported as a c)rrent asset similar to inentory. '# the theatres contin)e to "e reported as part o# property( plant and e)ipment( then it wo)ld "e inappropriate to report the sales thro)gh reen)e: the sales sho)ld "e reported as gains on sale. '# the sales can "e considered part o# ongoing operations( consideration sho)ld "e gien to whether there sho)ld sho)ld "e separate disclos)re disclos)re o# the reen)e #rom theatre sales. 4)rying 4)rying the reen)es #rom theatre sales will ma*e it more di##ic)lt #or )sers and the capital mar*ets to al)e al)e the the comp company any "eca "eca)se )se reen reen)e )e #rom #rom sale sales s o# theat theatre res s may may not "e as reg)l reg)lar ar or predicta"le as reen)es #rom other so)rces. '# s)ch sales are material( material( separate disclos)re o# reen)e sho)ld "e made either on the #ace o# the income statement statement or in the notes. %elling o## a signi#icant n)m"er o# theatres raises the )estion o# whether the n)m"er "eing sold is large eno)gh to "e considered a discontin)ed operation( re)iring separate disclos)re o# in#or in#orma matio tion. n.
or or the the theat theatre re sale sales s to )ali# )ali#y y as a disc discon ontin tin)ed )ed operat operatio ion( n( they they m)st m)st
repre represe sent nt a separ separat ate e ma$o ma$orr line line o# ")si ")sines ness s or geograph geographica icall area area o# opera operatio tions ns..
My
assessment is that the sale o# theatres sho)ld not "e considered a discontin)ed operation "eca)se "eca)se C is contin) contin)ing ing in the theatre theatre ")siness. ")siness. '#( #or e,ample( e,ample( C were ceasing ceasing to opera operate te all all o# its its moi moie e theatr theatres es to #oc)s #oc)s on lie lie theat theatre( re( an arg)m arg)ment ent #or disc discont ontin) in)ed ed operations operations might "e made. 'n this case( the sale o# theatres appears to "e part o# a contin)ing contin)ing reassessment o# its port#olio o# theatres. he sale sales s #or pro#i pro#itt are are cons consis iste tent nt with with mana managem gement ent
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#or sale7 are presented separately on the "alance sheet. Partnership areement
C #ormed a partnership partnership with an )nrelated )nrelated company where"y the other company contri")ted cash and C contri")ted teleision teleision prod)ction e)ipment. e)ipment. As part o# the deal( C withdrew the cash contri")ted contri")ted "y the other company #or its own own )se. he s)"stance s)"stance o# the transaction transaction appears to "e the sale 5rather than contri")tion7 contri")tion7 o# assets to the partnership and the recording recording o# the gain gain on sale. 4y )sing )sing this this approach( approach( management management may "e attemptin attempting g to increas increase e income arti#icially "y recogni+ing the #)ll gain. he #acts s)ggest s)ggest that this transaction transaction is a partial sale sale o# assets. '# this is the case( case( the #)ll gain sho)ld not "e recogni+ed. recogni+ed. he #acts #acts s)pporting s)pporting this assertion assertion are as #ollows. #ollows. irst( irst( cash can "e withdr withdrawn awn immediat immediately ely:: th)s th)s the partnersh partnership ip acted acted as a cond)it cond)it #or sellin selling g o# the assets. assets. %econd( the deal is "ased on #)t)re pro#its: that is( the al)e o# C
hird( hird( dyssey dyssey
appears to "e o##ering little e,pertise to the partnership and th)s cash is simply "eing #)nneled to C ia the partnership. partnership. '# this transaction transaction is $)st $)st a partial sale o# assets( the gain sho)ld sho)ld only "e 10.96 million 50 million -0.6 5portion o# assets sold7 , !6 million 5carrying amo)nt o# assets sold77 rather than 26 million. he method pre#erred "y C 5recording #)ll sale o# the assets7 might "e s)pported "y the #act that #)t)re pro#its will "e shared( s)ggesting that this is a legitimate partnership arrangement. Howeer( more in#ormation is re)ired to )nderstand how the al)e o# Ce will hae to disc)ss the transaction with management and reiew pertinent doc)ments to deter determi mine ne its s)"stan s)"stance. ce.
>e can can then then #orm #orm an opini opinion on on the approp appropria riate te method method o#
acco)nting. he acco)nting #or the inestment inestment in the partnership partnership depends on Cith a 66 interest( C may "e a"le Copyright Solutions Manual, Chapter !
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to determine these policies and wo)ld hae control oer the partnership. '# so( they wo)ld consolidate the partnership #inancial statements with their own #inancial statements. '# "oth parties to the partnership hae e)al say oer the policies o# the partnership( then the partnership wo)ld "e deemed to "e a $oint ent)re. 8nder 'R% 11( C co)ld report its inestment )sing the e)ity method. Concl/sion
As indicated in Appendi, '( income wo)ld decrease i# the pre-prod)ction pre-prod)ctio n costs and@or adertising costs hae "een capitali+ed and sho)ld hae "een e,pensed. As indicated in Appendi, ''( income sho)ld "e red)ced #or the )nreali+ed gain g ain on the trans#er o# assets to the partnership and de"t sho)ld "e increased to reerse the de"t de#easance transaction. A#ter ad$)stment( the ret)rn on e)ity on an ann)ali+ed "asis is only 1/./( which is "elow the companye will need to reiew ma$or transactions in the last month o# the year to ens)re they are acco)nted #or correctly. therwise( the company co)ld "e in iolation o# their de"t coenant. his wo)ld raise concerns o# the company
Income
ebt
*/ity
)%* ebtE*/ity
Penalty Payment - report as income
2
2
IF
F
17
17
I
- report as red/ction of capital cost
R)e %t. Fac)es tic*et - report as /nearned reven/e 'nterest on tic*et proceeds - report as income - report as deferred reven/e
re-prod)ction costs
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- capitali8e and later e9pense - e9pense as inc/rred
15D
15D
I
12D
12D
I
5
5
I
Adertising K promotion costs - capitali8e and later e9pense - e9pense as inc/rred
?e"t de#easance - if loss 0as previo/sly recorded - if deferred deferred chare 0as recorded
%ale o# theatres as reen)e 'nestment in partnership - if f/ll consolidation
I
I
- if proportionate consolidation
I
I
F (otationsE
' I increase ? I decrease =H'=G =&? I no change
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.PP*(I II IP.C' IP.C' % .CC%&('I( C>.(*$ %( <*; *')IC$ in millionsD .dG/stment
&nadG/sted position
Interest on ticets deferred
Income
ebt
*/ity
147
1?4!"
7"
17D
)%* ebtE*/ity
1H
1!1
172H
1!
17D
ebt defeasance
25
Investment in partnership - red/ce ain to 1"75
1425D
.dG/sted position
131.06
1425D
1(616
9!.06
.nn/ali8ed to 12 months times 12J11D
1H
'aret )%*
2""H
a9im/m debt to e/ity ratio
2""
$%L&'I%($ '% P)%:L*$ Problem 6-1 aD Intercompany balances
%ales and p)rchases #or Dear 3
1/0(000 5a7
Acco)nts receia"le and a nd paya"le at end o# Dear 3 Intercompany inventory profits
0(000 5"7 :efore
4"H
.fter
ta9
ta9
ta9
pening inentory J %)" selling 5!0(000 , .37
1/(000
9(200
10(/00 5c7
Closing inentory J %)" selling 590(000 , .37
21(000
/(00
12(!00 5d7
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Consolidated acco/nt balances
'nentory 5600(000 T 300(000 J 5d7 21(0007
99E(000
Acco)nts paya"le 5!00(000 T 320(000 3 20(000 J 5"7 0(0007 0(0007
//0(000
Retained Retained earnings( earnings( "eginning o# year A A
2(00(000
%A R@&( "eginning o# year
1(100(000
%A R@&( date o# ac)isition
E00(000
Change since ac)isition
200(000
LessB )nreali+ed pro#it in "eginning inentory 5c7 - 10(/00 1/E(200 A
, E0
190(2/0
Consolidated retained earnings
2(690(2/0
%ales 5(000(000 T 2(600(000 J 5a 5a7 1/0(0007
!(320(000
Cost Cost o# sale sales s 53(10 53(100( 0(00 000T 0T1( 1(90 900( 0(00 000J 0J5a 5a71 71/0 /0(0 (000 00T5 T5d7 d7 21(0 21(000 00J5 J5c7 c71/ 1/(0 (000 0077
(!2 (!23( 3(00 000 0
'ncome ta, e,pense 5/0(000 T 60(000 J 5d7/(00 T 5c79(2007
12/(/00
bD %ince the s)"sidiary was the seller o# the intercompany sales( these transactions are )pstream transactions and the non-controlling interest 5=C'7 will a"sor" their share o# the ad$)stments to eliminate the )nreali+ed pro#its. =C' on the income statement will will decrease "y 1(2!0 510 , 12(!007 #or its share o# )nreali+ed a#ter-ta, pro#its in ending inentory and increase "y 1(0/0 510 , 10(/007 #or its share o# a#ter-ta, pro#its in "eginning inentory. =C' on the "alance sheet will decrease "y 1(2!0 510 , 12(!007 #or its share o# )nreali+ed a#ter-ta, pro#its in ending inentory.
Problem 6-2 aD Intercompany reven/es and e9penses
%ales and p)rchases 5100(000 T /0(0007
1/0(000 5a7
Rent reen)e and e,pense
2(000 5" 5"7
'nterest reen)e and e,pense 590 , 60(0007
36(000 5c7
Intercompany inventory profits
pening inentory J %)" selling
:efore
4"H
.fter
ta9
ta9
ta9
2(000
3(000 5d7
6(000
Closing inentory J arent selling Copyright Solutions Manual, Chapter !
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5100(000 , .60 , .307
16(000
!(000
E(000 5e7
Calc/lation of non-controllin interestE
'ncome o# s)"sidiary 5E(000 @ 107
E0(000
AddB opening openin g inentory pro#it
5d7 3(000
Ad$)sted
E3(000 10 E(300 5#7 Parent Company Consolidated Income $tatement for the C/rrent ;ear
%ales 5600(000 J 5a7 1/0(0007
320(000
Rental reen)e 52(000 J 5"7 2(0007 'nterest reen)e 560(000 J 5c7 36(0007 otal reen)e
16(000 336(000
Cost o# goods sold 5360(000 J 5a7 1/0(000 J 5d7 6(000 T 5e7 16(0007
1/0(000
Rent e,pense 52(000 J 5"7 2(0007 'nterest e,pense 536(000 J 5c7 36(0007 Administration e,penses
6(000
'ncome ta, e,pense 52(000 T 5d7 2(000 J 5e7 !(0007
3/(000
otal e,pense ro#it
2!3(000 92(000
Attri")ta"le toB %hareholders o# parent =on-controlling interests 5#7
!2(900 E(300 92(000
Proof:
ro#it preio)sly reported AddB opening openin g inentory pro#it 53(000 , E07
!E(000 2(900 91(900
LessB closing inentory pro#it Consolidated pro#it attri")ta"le to shareholders o# parent Copyright 3/
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5"7 he matching principle re)ires that e,penses "e matched to reen)es. >hen intercompany intercompan y reen)es are eliminated #rom the consolidated #inancial statements( the related cost o# goods sold sho)ld also "e eliminated. >hen pro#its are eliminated( income ta, e,pense related to those pro#its sho)ld also "e eliminated. >hen the preio)sly )nrecogni+ed intercompany pro#its are recogni+ed in a later period( the income ta, on these pro#its sho)ld "e e,pensed.
Problem 6-3 .i/e
Spi/e
Consolidate d
?ecem"er 31( Dear 1 Land Gain on %ale
100(000
116(000U
'ncome a, a, on Gain ?ecem"er 31( Dear 2 Land Gain on %ale
12/(000
116(000U 2/(000
'ncome a, on Gain
11(200UUU
?ecem"er 31( Dear 3 Land Gain on %ale
12(000
'ncome a, on Gain U I #air al)e o# land at date o# ac)isition
26(000UU
(/00UUU
10(000UUU
UU I selling price to o)tsiders less amo)nt paid at ac)isition I 10(000 J 116(000 UUU I 0 , gain on sale o# land
Problem 6-4 aD .c/isition differential amorti8ation
lant J >aste Dears 1J 6 516(000 @ / years , 6 years7
E(396 5a7
Dear ! 516(000 @ / years7
1(/96 5"7
Goodwill J 4aste Copyright Solutions Manual, Chapter !
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Dears J 6
1E(000 5c7
Dear !
J0J
Intercompany )even/es and *9penses
%ales 5E0(000 T 190(000 T 160(0007
10(000 5d7
Rent 526(000 T 1(0007
3E(000 5e7
'nterest
10(000 5#7
?iid iiden end d 'nc 'ncom omeB eB All inter nterc compa ompany ny #rom #rom >ast >aste e K 4as 4aste
3(9 3(960 60 5g7 5g7
Intercompany Profits
:efore ta9
4"H ta9
.fter ta9
penin pening g in inent entory ory J >aste >aste sell selling ing 516(000 , .307 &ndi &nding ng inen nento tory ry
(600
1(/00
2(900 5h7
1/(000
9(200
10(/00 5i7
!(!00
2(!0
3(E!0 5$ 5$7
1/(000
9(200
10(/00 5*7
2(!00
19(00
26(6!0 7 5l7
J 4ast 4aste e sel selling ling 5!0(000 , .307 J aste selling 522(000 , .307 J >aste selling 5!0(000 , .307
Paste Company Consolidated Income $tatement for the ;ear *nded ecember 31? ;ear 6
%ales 560(000 T 290(000 T 1E0(000 J 5d710(0007
600(000
?iidends 53(960 J 5g7 3(9607 'nterest 510(000 J 5#7 10(0007 Rent 5130(000 J 5e7 3E(0007 otal income Copyright 0
© 2013
E1(000 6E1(000
McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, %eenh &dition
Cost o# sales 5300(000 T 1!3(000 T 16(000 J 5d7 10(000 J 5h7 (600 T 5l7 2(!00 T 5"7 1(/967
239(E96
General K administratie 5E3(000 T /(000 T 2E(000 J 5e7 3E(0007
131(000
'nterest 510(000 J 5#7 10(0007 'ncome ta, 529(000 T 96(000 T 9(000 T 5h7 1(/00 J 5l7 19(007
E3(9!0
otal e,penses
!2(936
ro#it
12/(2!6
Attri")ta"le toB %hareholders o# aste
10E(E10
=on-controlling interests 520 , E(026U T 26 , -1(/00U7
1/(366 12/(2!6
U see part 5c7 #or calc)lation o# E(026 and J1(/00
bD Calc/lation of consolidated retained earnins = ecember 31? ;ear 6
Retained earnings o# aste ?ecem"er 31( Dear !
903(960
ro#it in ending inentory
5$7
Retained earnings o# >aste ?ecem"er 31( Dear !
53(E!07
1!(000
Retained earnings o# >aste J ac)isition
0(000
'ncrease
10!(000
LessB pro#it in ending inentory
5*7
10(/00
amorti+ation amorti+ation o# ac)isiti ac)isition on di##erential di##erential 5a7 E(396 T 5"7 1(/96 11(260 11(260 Ad$)sted increase
/3(E60
aste;s ownership
/0
Retained earnings o# 4aste ?ecem"er 31( Dear !
9E(000
Retained earnings o# 4aste J ac)isition
/0(000
?ecrease
51(0007
LessB LessB amor amorti ti+a +ati tion on o# ac)i ac)isi siti tion on di## di##ere erenti ntial al #or #or 4aste 4aste 5c7 5c7
1E(000 1E(000
pro#it in ending inentory
5i7
!9(1!0
10(/00 530(/007
aste;s ownership
96
Consolidated retained earnings ?ecem"er 31( Dear ! Copyright Solutions Manual, Chapter !
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McGraw-Hill Ryerson Limited. All rights resered. 1
5c7
ro#it o# >aste
10(000
AddB pro#it in opening o pening inentory inent ory
5h7
2(900 10!(900
LessB pro#it in ending inentory amorti+ation o# ac)isition di##erential
5*7
10(/00
5"7
1(/96 E(026
aste
, /0
ro#it o# 4aste
E(000
LessB pro#it in ending inentory
5i7
96(220
10(/00 51(/007
aste
, 96
- 1(360
5$7
- 3(E!0 !E(E10
dD Reen)e sho)ld "e recogni+ed when it is earned i.e.( when the "ene#its and ris*s hae "een trans#erred to an entity o)tside o# the reporting entity. he reporting entity #or consolidated #inancial statements encompasses the parent and all o# its s)"sidiaries. %ince intercompany transactions are transactions within the reporting entity 5not o)tside o# the reporting entity7( they m)st "e eliminated when preparing consolidated #inancial statements. >hen the inentory is sold o)tside o# the consolidated entity( the di##erence "etween the selling price and the original cost to the consolidated entity wo)ld "e reported as pro#it o# the consolidated entity.
Problem 6-5 aD
Ks e/ity method Go/rnal entries
;ear ;ear 1
Copyright 2
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Cash
1/(960
'nestment in D Co.
1/(960
96 , 26(000 diidends. 'nestment in D Co.
E9(600
'nestment income
E9(600
96 , 130(000 net income. 'nestment income
13(600
'nestment in D Co.
13(600
o hold "ac* 96 o# the 1/(000 a#ter-ta, inentory pro#it J D selling 5!0 , 30(000 I 1/(0007. 'nestment income
22(200
'nestment in D Co.
22(200
o hold "ac* the a#ter-ta, land pro#it J V selling 5!0 , 39(000 I 22(2007. 'nestment income
9(260
'nestment in D Co.
9(260
Ac)isition di##erential amorti+ation J Dear Dear 1 'nentory &)ipment
!0(000 6(000@16 I
3(000 !3(000
, Co.
9(260
(oteE Dear 1 inestment income is 1(660 5E9(600 J 13(600 J 22(200 J 9(2607
;ear ;ear 2
Cash
3(960
'nestment in D Co.
3(960
96 , 6(000 diidends. 'nestment income
12(000 Copyright
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McGraw-Hill Ryerson Limited. All rights resered. 3
'nestment in D Co.
12(000
96 , 1!(000 net loss. 'nestment income
2(260
'nestment in D Co.
2(260
Ac)isition di##erential 5e)ipment7 amorti+ation. 53(000 53(00 0 , 967 'nestment in D Co.
13(600
'nestment income
13(600
o reali+e opening inentory pro#it J D selling. 'nestment in D Co.
22(200
'nestment income
22(200
o reali+e land pro#it J V %elling 'nestment income
9(200
'nestment in D Co.
9(200
o hold "ac* a#ter-ta, inentory pro#it J V selling 5!0 , 12(0007 (oteE Dear 2 inestment income is 1(260 5J12(000 J 2(260 T 13(600 T 22(200 J 9(2007
bD Calc/lation of consolidated net income = ;ear 1 =et income o# V
00(000
LessB Land pro#it
22(200
Ad$)sted
399(/00
=et income o# D
130(000
LessB closing inentory pro#it
51/(0007
ac)isition di##erential amorti+ation Ad$)sted
5!3(0007 E(000
Consolidated net income
2!(/00
Attri")ta"le toB %hareholders o# V Copyright
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1(660
McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, %eenh &dition
=on-controlling interests 526 , E(0007
12(260 2!(/00
Calc/lation of Consolidated (et income = ;ear 2
=et income o# V
92(000
LessB closing inentory pro#it
9(200 !(/00
AddB land pro#it pr o#it reali+ed
22(200
Ad$)sted net income
/9(000
=et income 5loss7 o# D
51!(0007
AddB opening openin g inentory pro#it reali+ed
1/(000
LessB ac)isition di##erential amorti+ation
53(0007
Ad$)sted net income
51(0007
Consolidated net income
/!(000
Attri")ta"le toB %hareholders o# V
/!(260
=on-controlling interests 526 , -1(0007
52607 /!(000
cD Chanes in (on-controllin Interest ;ears ;ears 1 and 2
4alance Fan. 1 Dear 1 26 , 5190(000 T 106(0007
!/(960
Allocation o# D Co.
12(260 /1(000
LessB diidends 526 , 26(0007
!(260
4alance ?ec. 31( Dear 1
9(960
Allocation o# D Co.
52607 9(600
LessB diidends 526 , 6(0007
1(260
4alance ?ec. 31( Dear 2
93(260
Copyright Solutions Manual, Chapter !
© 2013
McGraw-Hill Ryerson Limited. All rights resered. 6
Proof:
D - Common shares
100(000
- Retained earnings 590(000 T 130(000 − 26(000 − 1!(000 − 6( 6(0007
16(000
- %hareholders; e)ity ?ec. 31( Dear 2
26(000
- 8namorti+ed ac)isition di##erential
3E(000 2E3(000 26 93(260
Copyright !
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McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, %eenh &dition
dD Calc/lation of Investment in ; Co */ity ethodD .s at ecember 31? ;ear 2
%hareholders; e)ity o# D Fan. 1( Dear 1
190(000
Ac)isition di##erential 106(000 296(000 V;s ownership
96
Cost o# 96 inestment in D Fan. 1( Dear 1
20!(260
'nestment income J Dear 1
1(660
Dear 2
1(260
2/(/00 236(060
LessB LessB ?iiden ?iidends ds receie receied d Dear 1 596 , 26(0007
1/(960
Dear 2 596 , 6(0007
3(960
'nestment in D ?ec. 31( Dear 2
22(600 212(660
Proof:
%hareholders; e)ity o# D 4alance( )namorti+ed e)ipment
26(000 56(000 − !(0007
3E(000 2E3(000
V;s ownership
96 21E(960
LessB Hold"ac* o# inentory pro#it J V selling
9(200
'nestment in D( ?ecem"er 31( Dear 2
212(660
Problem 6-6 Intercompany profits
:efore ta9
4"H ta9
.fter ta9
pening inentory selling
/0(000
32(000
/(000 5a7
L selling
62(000
20(/00
31(200 5"7
&nding inentory
selling
36(000
1(000
21(000 5c7
L selling
11/(000
9(200
90(/00 5d7
aD Calc/lation of consolidated profit ro#it o# L
6/0(000
Less LessBB ?ii ?iide dends nds rom M 5/0 , 200(0007
1!0(000
rom 590 , 160(0007
106(000
&nding inentory pro#it
5d7
90(/00
336(/00 2(200
AddB opening openin g inentory pro#it
5"7
31(200
Ad$)sted pro#it
296(00
ro#it o# M
3!0(000
ro#it o# LessB ending inentory pro#it
20(000 5c7
21(000 21E(000
AddB opening openin g inentory pro#it
5a7
/(000 2!9(000
Consolidated pro#it
E02(00
Attri")ta"le toB %hareholders o# L
960(300
=on-controlling interests 520 , 3!0(000 T 30 , 2!9(0007
162(100 E02(00
bD Calc/lation of consolidated retained earnins = beinnin of c/rrent year
Retained earnings o# L
E9!(000
LessB opening inentory pro#it
5"7
Ad$)sted
31(200 E(/00
Retained earnings o# M
/3(000
Ac)isition retained earnings
600(000
'ncrease
33(000
L;s ownership
/0
Retained earnings o#
29(00
!/2(000
Ac)isition retained earnings
60(000
'ncrease
!32(000
LessB opening inentory pro#it
5a7
Ad$)sted increase
/(000 6/(000
L;s ownership
90
Consolidated retained earnings J "eginning o# year
0/(/00 1(!2/(000
Problem 6-7 Calc/lation? allocation? and amorti8ation of ac/isition differential
Cost o# /0 inestment( Fan. 1( Dear 3
1(!00(000
'mplied al)e o# 100 inestment
2(000(000
Carrying amo)nts o# Least;s net assetsB Assets
3(000(000
Lia"ilities
1(600(000
otal shareholders; e)ity
1(600(000
Ac)isition di##erential
600(000
AllocationB
N - CA
Acco)nts receia"le
- 20(000
'nentories
- 60(000
lant and e)ipment 5net7
36(000
Long-te -term lia"ilities
100(000
4alance J goodwill
36(000 :alance
.morti8ation
:alance
Aan 1
ec 31
;ear ;ear 3
;ears ;ears 3 to
Acco)nts receia"le
- 20(000
- 20(000
'nentories
- 60(000
- 60(000
36(000
2!(260
100(000
100(000
lant and e)ipment 5net7 Long-term lia"ilities
!6(000
;ear ;ear !
(396
;ear ;ear !
(396 5a7
Goodwill
36(000
62(200
600(000
10/(60 5c7
/(900
39(100 5"7
13(096 5d7 39/(96
Intercompany reven/es and e9penses
%ales and p)rchases 52(000(000 T 1(600(0007
3(600(000 5e7
Intercompany profits
:efore ta9
4"H ta9
.fter ta9
Loss on land( F)ly 1( Dear 9 reali+ed in Dear E
J Most selling
60(000
20(000
30(000 5#7
!2(600
26(000
39(600 5g7
269(12
102(/69
16(2/6 5h7
31E(!2
129(/69
1E1(9/6 5i7
100(000
0(000
!0(000 5$7
21(2/
/6(91
12/(690 5*7
pen penin ing g inen inento tory ry J Most ost sel selling ling 5312(600 , 0.207 J Least selling 5/69(10 , 0.307
&nding in inentory
J Most se selling 5600(000 , 0.207 J Least selling 591(2/0 , 0.307
31(2/ 5l7 'ntercompany diidends declared ")t not paid 5/0 , 100(0007 ?e#erred income ta,es J ending inentory
50(000 T /6(917
126(91
1//(690 /0(000 5m7 126(91 5n7 5n7
Calc/lation of consolidated retained earnins = Aan 1 ;ear !
Retained earnings o# Most( Fan. 1( Dear E 510(00(000 J 1(000(000 T 360(0007
E(960(000
LessB ro#it in opening inentory
5g7
39(600
E(912(600 AddB land loss
5#7
Ad$)sted retained earnings
30(000 E(92(600
Retained earnings o# Least( Fan. 1( Dear E 52(300(000 J 00(000 T 100(0007
2(000(000
Retained earnings o# Least at ac)isition
1(000(000
'ncrease LessB pro#it in opening inentory amorti+ation o# ac)isition di##erential
1(000(000 5h7 16(2/6 5c7 10/(60
Ad$)sted increase
939(2!6
Most;s ownership
5o7
/0
Consolidated retained earnings( Fan. 1( Dear E
6/E(/12 10(332(312
Calc/lation of consolidated net income = ;ear !
=et income o# Most
1(000(000
LessB ?iidends #rom Least 5100(000 , /07
/0(000
ro#it in closing inentory
5$7
!0(000
Land loss
5#7
30 30(000
190(000 /30(000
AddB pro#it in opening o pening inentory inent ory
5g7
Ad$)sted net income
/!9(600
=et income o# Least AddB pro#it in opening o pening inentory inent ory
39(600
00(000 5h7 16(2/6 66(2/6
LessB pro#it in closing inentory amorti+ation o# ac)isition di##erential Ad$)sted net income Consolidated net income
5*7 12/(690 5d7
13(096 12(!0 1(2/0(10
Attri")ta"le toB %hareholders o# Most =on-controlling interests 520 , 12(!07
1(1E9(!12 /2(62/ 1(2/0(10
Calc/lation of consolidated non-controllin interests = Aan 1 ;ear ! ethod 1D
Least
600(000
Retained earnings o# Least( Fan. 1( Dear E
2(000(000
LessB pro#it in opening inentory
5h7 16(2/6
Ad$)sted retained earnings
1(/6(916
8namorti+ed ac)isition di##erential 5600(000 J 10/(607
3E1(660 2(939(2!6
=C'
20
=C'( Fan. 1( Dear E
69(63
Calc/lation of consolidated non-controllin interests = Aan 1 ;ear ! ethod 2D
=on-c =on-cont ontrol rolliling ng int intere erest sts s at at date date o# ac ac)i )isi siti tion on 520 520 , 1(! 1(!00( 00(000 000 @ ./7 ./7 Least
00(00 00(000 0
939(2!6
=C'
19(63
=C'( Fan. 1( Dear E
69(63
aD
ost Company Consolidated $tatement of Chanes in */ity or ;ear *nded ecember 31? ;ear !
4alance( "eginning o# o# year
Common
Retained
%toc*
&arnings
otal
1(000(000 10(332(312 11(332(312
=C'
otal
69(63 11(/9E(9!6
AddB net income
1(1E9(!12
1(1E9(!12
/2(62/
1(2/0(10
LessB diidends
5360(0007
5360(0007
520(0007
5390(0007
4alance( end o# year
1(000(000 11(19E(E2 12(19E(E2
!0E(E/1 12(9/E(E06
Proof of consolidated retained earnins? end of ;ear !
Retained earnings o# Most( ?ec. 31( Dear E
10(00(000
LessB pro#it in ending inentory
5$7
Ad$)sted retained earnings
!0(000
10(30(000
Retained earnings o# Least( ?ec. 31( Dear E
2(300(000
Retained earnings o# Least at ac)isition
1(000(000
'ncrease
1(300(000
LessB pro#it in ending inentory
5*7 12/(690
amorti+ation o# ac)isition di##erential 55c7 10/(60 T 5d7 13(0967
121(626
Ad$)sted increase
1(0E(E06
Most;s ownership
5p7
/0
/3E(E2
Consolidated retained earnings( ?ec. 31( Dear E
11(19E(E2
Proof of non-controllin interest? end of ;ear ;ear ! ethod 1D
Retained earnings o# Least
2(300(000
Common shares o# Least
600(000
otal shareholders; e)ity
2(/00(000
LessB pro#it in ending inentory
5*7
Ad$)sted shareholders; sharehol ders; e)ity
12/(690 2(!91(30
AddB )namorti+ed ac)isition di##erential
39/(96 3(0E(E06
=on-controlling interest( ?ec. 31( Dear E
20 !0E(E/1
Calc/lation of consolidated non-controllin interests = end of ;ear ! ethod 2D
=on-c =on-cont ontrol rolliling ng int intere erest sts s at date date o# ac)i ac)isi siti tion on 520 520 , 1(! 1(!00( 00(000 000 @ ./7 ./7 Least
00(00 00(000 0
1(0E(E06 20E(E/1
=on-controlling interest( ?ec. 31( Dear E
bD
!0E(E/1
ost Company Consolidated :alance $heet ecember 31? ;ear !
Cash 5600(000 T 0(0007 Acco)nts receia"le 51(900(000 51( 900(000 T 600(000 600 (000 J 5m7 /0(0007 /0(000 7
60(000 2(120(000
'nentories 52(300(000 T 1(200(000 J 5l7 31(2/7
3(1/6(91!
lant an and e e)ipment 5n 5net7 5/(200(000 T (000(000 T 5a7 (3967
12(20(396
Land 5900(000 T 2!0(0007
E!0(000
Goodwill
5"7
39(100
?e#erred income ta,es
5n7
126(91
otal assets
1E(60E(E06
C)rrent lia"ilities 5!00(000 T 200(000 J 5m7 /0(0007
920(000
Long-term lia"ilities 53(000(000 T 3(000(0007
!(000(000
Common shares
1(000(000
Retained earnings
11(19E(E2
=on-controlling interest
!0E(E/1
otal lia"ilities K shareholders; e)ity
1E(60E(E06
cD he cost principle re)ires that certain assets s)ch as inentory "e reported at cost. >hen a pro#it is made on an intercompany sale( the inentory cost to the p)rchaser is higher than the cost inc)rred "y the seller. An ad$)stment is made on consolidation to remoe the pro#it #rom the inentory o# the p)rchaser to "ring the al)e o# the inentory down to the original cost to the consolidated entity.
dD
he de"t to e)ity ratio wo)ld increase "eca)se de"t remains the same ")t the noncontrolling interest within shareholders< e)ity decreases. =on-controlling interests decreases "eca)se it does not contain the incorporate the non-controlling interests< share o# the al)e o# the s)"sidiary
Problem 6- Intercompany profits :efore ta9
4"H ta9
.fter ta9
pening inentory J L selling
6(000
2(000
3(000 5a7
&nding inentory J selling
/(000
3(200
(/00 5"7
aD ?ecem"er 31 Cash
20(200
'nestment in L Co. 56(000 , E67
(960
'nestment in F Co. 53(000 , E07
2(900
'nestment in Co. 516(000 , /67
12(960
o record diidends receied #rom s)"sidiary companies. 'nestment in L Co. 520(000 , E67
1E(000
'nestment in Co. 530(000 , /67
26(600
'nestment in F Co. 56(000 , E07
(600
'nestment income
0(000
o record share o# s)"sidiaries; pro#it 'nestment 'ncome
1(230
'nestment in L Co. 53(000 , .E67
2(/60
'nestment in Co. 5(/00 , ./67
(0/0
o hold "ac* a#ter-ta, inentory pro#it in ending inentory 5 Co.7 and add "ac* a#ter-ta, inentory pro#it in "eginning inentory 5L. Co.7 'nestment 'ncome is 0(000 − 1(230 I 3/(990.
bD Calc/lation of consolidated profit attrib/table to shareholders of > Co = ;ear 5 ro#it o# L
20(000
AddB pro#it in opening o pening inentory inent ory
5a7
Ad$)sted pro#it
3(000 23(000
H Co.;s ownership
E6
ro#it o# F
21(/60
56(0007
H Co.;s ownership
E0
ro#it o#
5(6007
30(000
LessB pro#it in ending inentory
5"7
Ad$)sted pro#it
(/00 26(200
H Co.;s ownership
/6
Consolidated pr pro#it attri")ta"le to to shareholders o# H Co. J Dear 6
cD
21(20 3/(990
> Company Consolidated )etained *arnins $tatement for the ;ear *nded ecember 31? ;ear 5
Retained earnings( Fan)ary 1
12(000
AddB pro#it
3/(990 60(990
LessB diidends
10(000
Retained earnings( ?ecem"er 31
0(990
Problem 6-! Intercompany profits
pening inentoryU J )rple selling &nding inentory J )rple selling
:efore
4"H
.fter
ta9
ta9
ta9
E6(63/
3/(216
69(323
1E(000
99(!00
11!(00
6!(600
22(!00
33(E00
Land J )rple selling 52!0(000 J 203(6007 U
'nentory at selling price 5!E0(000 , !07
1(000
'nentory at cost 51(000 @ 1.307
31/(!2
ro#it
E6(63/
Calc/lation of consolidated net income attrib/table to P/rples shareholders = c/rrent year
=et income o# )rple
6!/(100
AddB opening openin g inentory pro#it
69(323 !26(23
LessB &n &nding inentory pro#it Land pro#it
11!(00 33(E00
Ad$)sted pro#it
96(123
=et income o# %and
2/(!90
)rple
90
Consol Consolidat idated ed net inco income me attri") attri")ta"l ta"le e to )rple< )rple
160(300
19(0!E !E(1E2 !E(1E2
he intercompany rentals and interest reen)e@e,pense cancel each other o)t when %and;s net income is added to )rple;s.
Problem 6-1" Intercompany reven/es and e9penses
%ales and p)rchases 5E0(000 T 199(0007
2!9(000 5a7
Rental reen)e and e,pense 52(/00 , 127
33(!00 5"7
'nterest reen)e and e,pense 53!0(000 , 0.067
1/(000 5c7
Intercompany profits :efore ta9
4"H ta9
.fter ta9
(260
1(900
2(660 5d7
3(300
1(320
1(E/0 5e7
9(660
3(020
(630 5#7
6(960
2(300
3(60 5g7
E00
3!0
60 5h7
!(!60
2(!!0
penin pening g in inent entory ory J &an &ans s sel selliling ng 521(260 J 21(260 @ 1.267 J alcon selling 511(000 , 0.37 &ndi &nding ng inen nento tory ry
J &an &ans s selli elling ng 52/(960 J 2/(960 @ 1.267 J alcon selling 53(000 , 0.37
3(EE0 5i7
Calc/lation of consolidated profit = c/rrent year
ro#it o# &ans
!1(E00
LessB 'ntercompany diidends 50(000 , /07 ro#it in ending inentory
32(000 5g7
3(60
36(60 2!(60
AddB pro#it in opening o pening inentory inent ory
5d7
Ad$)sted pro#it
2E(000
ro#it o# alcon LessB pro#it in ending inentory
2(660
96(600 5h7
60 9(E!0
AddB pro#it in opening o pening inentory inent ory
5e7
1(E/0 9!(E0
Consolidated pro#it Attri")ta"le toB
106(E0
%hareholders o# &ans
E0(662
=on-controlling interests 520 , 9!(E07
16(3// 106(E0
aD
*vans Company Consolidated Income $tatement for the C/rrent ;ear
%ales 560(000 T !00(000 J 5a72!9(0007
9/3(000
Raw materials K #inished goods p)rchased 52!/(000 T 32/(000 J 5a72!9(0007
32E(000
Changes in inentory 520(000 T 26(000 J 5#79(660 T 5i7!(!607
(100
ther e,penses 510(000 T 1!(000 J 5"733(!007
21!(00
'nterest e,pense 530(000 J 5c71/(0007
12(000
'ncome ta,es 531(900 T 3(600 T 5#73(020 J 5'72(!!07
96(6!0
otal e,penses
!99(0!0
ro#it
106(E0
Attri")ta"le toB %hareholders o# &ans
E0(662
=on-controlling interests 520 , 9!(E07
16(3// 106(E0
bD Calc/lation of consolidated retained earnins = beinnin of year
Retained earnings o# &ans( "eginning o# year
!32(000
LessB pro#it in opening inentory
5d7
Ad$)sted retained earnings
!2E(60
Retained earnings o# alcon( "eginning o# the year LessB pro#it in opening inentory Ad$)sted increase since ac)isition &ans; ownership Consolidated retained earnings( "eginning o# year
2(660
3/(000 5e7
1(E/0 3!(020 /0
29!(/1! E0!(2!!
Consolidated diidends declared
30(000
Problem 6-11 Calc/lation? allocation? and amorti8ation of the ac/isition differential
Cost o# E0 inestment( Fan. 2( Dear 1
E0(000
'mplied al)e o# 100 inestment
100(000
Carrying amo)nts o# %;s net assetsB Common shares
!0(000
Retained earnings
20(000
otal shareholders; e)ity
/0(000
Ac)isition di##erential J patents
20(000
Amorti+ationB Dears 1 J
5a7
1! 1 !(000
Dear 6
5"7
( (000
4alance( ?ec. 31( Dear 6
20(000 J0J
Intercompany profits
:efore ta9
4"H ta9
.fter ta9
pen penin ing g ine inent ntor ory y J % sel selliling ng 59(000 , 0.07
2(/00
1(120
1(!/0 5c7
1(200
/0
920 5d7
( (000
1(!00
2(00 5e7
/(000
3(200
(/00 5#7
2(000
/00
1(200 5g7
10(000
(000
!(000 5h7
10(000
(000
!(000 5i7
J selling 53(000 , 0.07 &nding ding ine nentory tory J % selling 520(000 , 0.07 J selling 56(000 , 0.07
%ale o# land J Dear 3 % selling 560(000 J 0(0007
Calc/lation of consolidated net income = ;ear 5
=et income o# Company
!0(000
LessB ?iidends #rom % 510(000 , E07
E(000
ro#it in ending inentory
5g7
1(200
10(200 E(/00
AddB pro#it in opening o pening inentory inent ory
5d7
Ad$)sted net income
920 60(620
=et income o# % Company
/(000
LessB pro#it in ending inentory
5#7
(/00
patent amorti+ation
5"7
(000 3E(200
AddB pro#it in opening o pening inentory inent ory
5c7
1(!/0 0(//0
Consolidated net income
E1(00
Attri")ta"le toB %hareholders o# Co.
/9(312
=on-controlling interests 510 , 0(//07
(0// E1(00
Calc/lation of consolidated retained earnins = Aan 1? ;ear 5
Retained earnings o# ( Fan. 1( Dear 6 5101(000 T 12(0007
113(000
LessB pro#it in opening inentory
5d7
Ad$)sted retained earnings
112(2/0 112(2/0
Retained earnings o# % 53(000 T 10(0007
(000
Retained earnings o# % at ac)isition
20(000
'ncrease since ac)isition LessB Amorti+ation o# patents
920
2(000 5a7
1!(000
Land gain
5i7
!(000
ro#it in opening inentory
5c7
1(!/0
Ad$)sted increase ;s ownership Consolidated retained earnings( Fan. 1( Dear 6
23(!/0 320 E0
5$7 2// 112(6!/
Calc/lation of consolidated non-controllin interests? beinnin of ;ear 5 ethod 1D
Company % shareholders; e)ity Common shares
!0(000
Retained earnings
(000 10(000
LessB Land gain ro#it in "eginning inentory
5i7
!(000
5c7
1(!/0
9(!/0
Ad$)sted shareholders; sharehol ders; e)ity
E!(320
8namorti+ed ac)isition di##erential
(000
100(320 10 =on-controlling interest( Fan 1( Dear 6
10(032
Calc/lation of consolidated non-controllin interests = Aan 1 ;ear 5 ethod 2D
=on-controlling in interests at da date o# o# ac ac)isition 51 510 , E0(000 @ .E7 % Co.
10(000 320
=C'
32
=on-controlling interest( Fan 1( Dear 6
10(032 P Co
Consolidated $tatement of Chanes in */ity or ;ear *nded ecember 31? ;ear 5
Common
Retained
%hares
&arnings
otal
=C'
otal
160(000
112(6!/
2!2(6!/
10(032
292(!00
AddB net income
/9(312
/9(312
(0//
E1(00
LessB diidends
512(0007
512(0007
51(0007
513(0007
1/9(//0
3/9(//0
13(120
361(000
4alance( "eginning o# year
Retained earnings( ?ec. 31
160(000
Proof:
Retained earnings o# ( ?ec. 31( Dear 6 Copyright !2
© 200/
McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, i#th &dition
5101(000 T !0(0007
1!1(000
LessB ro#it in ending inentory
5g7
Ad$)sted retained earnings
1(200 16E(/00
Retained earnings o# %( ?ec. 31( Dear 6 53(000 T /(0007
/2(000
Retained earnings o# % at ac)isition
20(000
'ncrease since ac)isition
!2(000
LessB LessB Amorti Amorti+at +ation ion o# the patents patents 55a71!(000 T 5"7(0007
20(000
Land gain
5i7
!(000
ro#it in ending inentory
5#7
(/00
30(/00
Ad$)sted increase
31(200
;s ownership
E0
Consolidated retained earnings( ?ec.( 31( Dear 6
5*7 2/(0/0 1/9(//0
Calc/lation of consolidated non-controllin interests = ec 31 ;ear 5 ethod 1D
Company % shareholders; e)ity Common shares
!0(000
Retained earnings
/2(000 12(000
LessB Land gain ro#it in ending inentory
5i7
!(000
5#7
(/00
Ad$)sted shareholders; sharehol ders; e)ity
10(/00 131(200
8namorti+ed ac)isition di##erential
0 131(200 10
=on-controlling interests( ?ec. 31( Dear 6
13(120
Calc/lation of consolidated non-controllin interests = ec 31 ;ear 5 ethod 2D
=on-controlling in interests at da date o# o# ac ac)isition 51 510 , E0(000 @ .E7 % Co.
10(000 31(200 3(120 13(120
Problem 6-12 .c/isition differential amorti8ation = ;ear 5
lant and e)ipment depreciation 5!0(000 @ 67
12(000 5a7
atent amorti+ation 50(000 @ /7
6(000 5"7
Goodwill impairment loss
3(000 5c7 20(000 5d7
Intercompany reven/es and e9penses
%ales J R)nner to Road
20(000 5e7
Rental J R)nner to Road
36(000 5#7
Intercompany profits
:efore ta9
4"H ta9
.fter ta9
pening inentory J R)nner selling
96(000
30(000
6(000 5g7
&nding inentory J R)nner selling
0(000
1!(000
2(000 5h7
aD
)oad Ltd Consolidated Income $tatement for the ;ear *nded ecember 31? ;ear 5
%ales 5(000(000 T 2(100(000 - 5e720(0007 Rental reen)e 590(000 - 5#736(0007 otal income
6(!/0(000 36(000 6(916(000
Materials )sed in man)#act)ring 52(000(000 T /00(000 - 5e720(0007
2(3/0(000
Change in wor*-in-progress K #inished goods inentory 56(000 - 20(000 - 5g796(000 T 5h70(0007 &mployee "ene#its 5660(000 T /0(0007 Copyright !
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510(0007 1(030(000
McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, i#th &dition
'nterest e,pense 5260(000 T 10(0007
3E0(000
?epreciation 506(000 T 26(000 T 5a712(0007
!!2(000
atent amorti+ation 526(000 T 5"76(0007
30(000
Goodwill impairment loss
5c7
'ncome ta, 5300(000 T 200(000 T 5g730(000 - 5h71!(0007
3(000 61(000
otal e,penses
(EEE(000
ro#it
91!(000
Attri")ta"le toB %hareholders o# Road
!26(900
=on-controlling interests 530 , 300(000 J 5d720(000 T 5g76(000 - 5h72(0007
E0(300 91!(000
bD %ince Road )ses the e)ity method o# acco)nting #or its inestment in R)nner( consolidated retained earnings at ?ecem"er 31( Dear 6 wo)ld "e 2(626(900( which is e)al to Road
cD he ret)rn on e)ity attri")ta"le to shareholders o# Road #or Dear 6 wo)ld not change. nly the =C'
Problem 6-13 Calc/lation? allocation? and amorti8ation of ac/isition differential
Cost o# 90 inestment( Fan)ary 1( Dear 1
!3(000
'mplied al)e o# 100 inestment
E0(000
Carrying amo)nts o# %age;s net assetsB rdinary shares
60(000
Retained earnings
16(000
otal shareholders; e)ity
!6(000
Ac)isition di##erential
26(000
AllocationB
N J CA
'nentory
-12(000
8n#ao)ra"le lease agreement
-1/(000
-30(000
4alance J goodwill
66(000 :alance
.morti8ation
Aan/ary 1 ;ear ;ear 1
'nentory
ecember 31 ;ears ;ears 1 M 2
;ear ;ear 3
;ear ;ear 3
- 12(000
- 12(000
-1/(000
-9(200
-3(!00
-9(200 5a7
66(000
3(0!0
1(630
60(10 5" 5 "7
26(000
- 1!(10 5c7
Lease agreement Goodwill
-2(090 5d7
3(210 66 66(000 5e7
Intercompany receivables and payables = notes
Intercompany reven/es and e9penses
Management #ee
2!(600 5#7
%ales and p)rchases ost selling
126(000
%age selling
E0(000
'nterest 512 , 1@2 , 66(0007
216(000 5g7 3(300 5h7
Intercompany profits :efore ta9
Land
J %age selling
4"H ta9
.fter ta9
30(000
12(000
1/(000 5i7
3(600
1(00
2(100 5$7
9(000
2(/00
(200 5*7
penin pening g ine inento ntory ry J %age %age sell selling ing 51(000 , 0.267 &ndi &nding ng inen nento tory ry
J %age %age sell elling ing 52/(000 , 0.267 J ost selling
Copyright !!
© 200/
McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, i#th &dition
51/(000 , 0.267
(600
1(/00
2(900 5l7
11(600
(!00
!(E00 5m7
eferred income ta9es = ecember 31? ;ear 3
'nentory
(!00
Land
12(000 1!(!00 5n7
Acc)m)lated depreciation deprecia tion at date o# ac)isition #or # or %age
10(000 5o7
Calc/lation of consolidated profit
ro#it o# ost
109(E9E
LessB 'nestment 'nestment income income #rom %age1(9E ro#it in ending inentory
5l7
2(900
Ad$)sted pro#it
(19E 103(/00
ro#it o# %age
2(000
AddB pro#it in opening o pening inentory inent ory
5$7
2(100 2!(100
AddB Amorti+ation o# ac)isition di##erential LessB ro#it in ending inentory Land gain
5d7 5*7
(200
5i7
1/(000
2(090 -22(200
Ad$)sted pro#it
6(E90
ro#it
10E(990
Attri")ta"le toB %hareholders o# ost
109(E9E
=on-controlling interests 530 , 6(E907
1(9E1 10E(990
aD 5i7
Post Corporation Consolidated $tatement of Profit or the ;ear *nded? ecember 31? ;ear 3
%ales 5E00(000 T 20(000 J 5g7216(0007 'nterest reen)e 5!(/00 J 5h73(3007 otal reen)e
E26(000 3(600 E2/(600
Cost o# goods sold 560(000 T 1!2(000 J 5g7216(000 - 5$73(600 T 5m711(6007
E6(000
'nterest e,pense 520(000 J 5h73(3007
1!(900
ther e,pense 51/0(000 T 9(/00 J 5#72!(600 - 5a73(!007
22(900
Goodwill impairment loss
5"7
1(630
'ncome ta, e,pense 5/0(000 T 1!(000 T5$7 1(00 J 5m7 (!00 J 5i7 12(0007
/0(/00
otal e,penses
/1/(930
ro#it
10E(990
Attri")ta"le toB %hareholders o# ost
109(E9E
=on-controlling interests 530 , 6(E907
1(9E1 10E(990
Calc/lation of non-controllin interests = ecember 31? ;ear 3
rdinary shares
60(000
Retained earnings
/1(000
otal shareholders; e)ity
131(000
LessB r ro#it in ending inentory Land gain
5*7
(200
5i7
1/(000
- 22(200
AddB )namorti+ed ac)isition di##erential
3(210
Ad$)sted shareholders; sharehol ders; e)ity
162(010
=on-controlling interest
30
=on-controlling interest( ?ecem"er 31( Dear 3 aD 5ii7
6(!03
Post Corporation Consolidated $tatement of inancial Position ecember 31? ;ear 3
Land 5196(000 T 1E(000 J 5i730(0007
1!(000
lant and e)ipment 5620(000 T !6(000 J 5o7 10(0007
696(000
Acc)m)lated depreciation deprecia tion 522E(00 T 19(000 J 5o7 5 o7 10(0007 523!(007 Goodwill Copyright !/
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60(10
McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, i#th &dition
?e#erred income ta,es
5n7
1!(!00
'nentory 53(000 T 29(000 J 5m711(6007
E(600
Acco)nts receia"le 519(200 51 9(200 T E(1007
2!(300
Cash 512(200 T 12(E007
26(100
otal assets
!90(610
rdinary shares
100(000
Retained earnings
2!6(909
=on-controlling interests
6(!03 11(310
8n#ao)ra"le lease agreement Acco)nts paya"le 5212(000 T 0(0007 0(0007
9(200 262(000
otal shareholders< e)ity K lia"ilities
!90(610
Goodwill impairment loss J entity theory
1(630
bD LessB =C'
6E
Goodwill impairment loss J parent company e,tension theory
1(091
=C' J entity theory
1(9E1
=C'
6E
=C' J parent company e,tension theory
1(332
cD Goodwill J entity theory
60(10
LessB =C'
16(123
Goodwill J parent company e,tension theory
36(2/9
=C' J entity theory
6(!03
=C'
16(123
=C' J parent company e,tension theory
30(/0
Problem 6-14 aD
.c/isition cost .llocation
Ac)isition Fan)ary 1( Dear 1
Cost 5!0(000 , /07
(/00(000 'mplied al)e o# 100 inestment 5/0(000 shares , /07 !(00(000 CAB rdinary %hares
3(600(000
Retained &arnings
2(100(000 6(!00(000
Ac)isition di##erential
/00(000
Allocati onB
Li#e
Copyright 90
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McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, i#th &dition
'nentory
100(0 00
Cr
1 Land
200(0 00
?r
&)ipment
200(0 00 10
Cr
atents
00(0 00
?r
6 L.. Lia"ility
100(0 00
Cr
%)"total 200(000 ?r 4alanceB Goodwill !00(000 ?r /00(000 ?r =on-controlling interest 520(000 shares W /07
1(!00(000
.morti8ation 'ableE
Allocation
Li#e Amorti+ation 4alance DR 1 J DR
'ne 'nento ntory ry Copyright 92
© 200/
DR 6
?ec. 3( DR 6 100(00 100(000 0 Cr
1
McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, i#th &dition
100(000Cr 0
0 Land
200(000 ?r
200(000 ?r &)ipment
200(000 Cr
10
/0(000Cr 20(000 000
Cr
100(000 Cr atents
00(000 ?r
6
320(000?r
/0(000?r 0
L.. Lia"ility
100(000 Cr
100(000Cr 0
Goodwill
!00(000 ?r !00(000 ?r /00(000 ?r
0(000 ?r !0(000 (000
?r
900(000 ?r ?ei eine< ne
600( 600(00 000 0
Intercompany .mo/ntsE
?iidendsB 600(000 , 96 396(000 %alesB
Nine 5DR 67 2 M T ?eine 5DR 67 1.2M 3(200(000
Adances #rom Nine to ?eineB 200(000
4 LandB
a,
A
8pstream Gain %ept 1( DR 6
00(000 1!0(000 20(000
8nreali+ed ro#itsB 4 a, a, A
pening 100
8pstream W 0 0(000 1!(000 2(000
?ownstream 300 W 33 1@3 100(000 0(000 !0(000 &n & nding
8pstream 600 W 0 200(000 /0(000 120(000 ?ownstream
Copyright 9
© 200/
!00 W 33 1@3 200(000 /0(000
McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, i#th &dition
120(000
bD
Consolidated Income $tatement for the year endin ecember 31? ;ear 5
%ales 511.! M T 3 M J 3.2 M7 11(00(000 ?iidend( 'nestment 'ncome( and Gains 500 T 1(000 J 396 J 007 !26(000 12(026(000 Cost o# Goods %old 5/M T 1.6 M J 3.2 M - 0 J 100 T 200 T 2007
!(6!0(000
the therr &,pe &,pens nses es 5600 5600 T 300 300 J 20 20 5&) 5&)ip ip77 T /0 5at 5aten ent7 t7
/!0( /!0(00 000 0
a,es 5600 T 200 J 1!0 T 1! T 0 J/0 J /07
3!(000
otal e,penses
9(/6!(000
ro#it
(1!E(000
Attri")ta"le toB %hareholders o# Nine
3(9!/(000
=on-controlling interests 52M J 20 J120 T 2 J !07 , .26
01(000
(1!E(000 )econciliationE
Nine ro#itB 3(000(000 ?iidends #rom ?eine 'ncl)ded 5396(0007 &)ity in &arnings o# ?eine 1(13(000 Consolidated ro#it Attri")ta"le to Nine
cD
Consolidated )etained *arninsE Proof
3(9!/(000
arent retained earnings at ?ecem"er 31( Dear 6 12(000(000 %)" retained earnings at ?ecem"er 31( Dear 6
9(000(000
Retained earnings at ac)isition
2(100(000
'ncrease since ac)isition
(E00(000
LessB )nreali+ed pro#its( ending inentory
5120(0007
Land LessB c)m)latie amorti+ation o# ac)isition di##erential
520(0007 5100(0007
Reali+ed retained earnings since ac)isition
(0(000 5a7
arent 96 LessB )nreali+ed pro#its( ending inentory
3(330(000 5120(0007
Consolidated retained earnings 16(210(000
dD Consolidated $tatement of inancial Position ecember 31? ;ear 5 .ssets
Land 5!M T 2.6 M T 200 J 007
/(300(000
lant and &)ipment 51/./M T 11./M J 200 J 6007
2E(E00(000
Acc)m)lated depreciation depr eciation 56./M T 6.0M J 100 J 6007
510(200(0007
Goodwill
!00(000
320(000
?e#erred 'ncome a, 51!0 T /0 T /07 'nentories 5.! M T 2. M J 200 J 200 !(!00(000 Cash and C)rrent Receia"les 5E00 T 3007 1(200(000 3!(920(000 Copyright 9!
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McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, i#th &dition
*/ities and Liabilities
rdinary shares 10(000(000 Retained &arnings
5%ee part c7 16(210(000
=on-controlling interests 5%ee 4elow7
2(910(000
Long erm erm Lia"ilities 5!.! M T 1.1 M7 9(900(000 ?e#erred 'ncome a,es 5200T1007
300(000
C)rrent Lia"ilities 5900 T 300 J 200 adances7
/00(000 3!(920(000
(on-controllin InterestsE ethod 1D
?eine J Carrying amo)nt ?ecem"er 31( Dear 6
10(600(000
8nreali+ed ro#its J 8pstreamB Land
520(0007
'nentory
5120(0007
8namorti+ed ac)isition di##erential
900(000 10(/0(000 26
=on-controlling interest
2(910(000
Calc/lation of non-controllin interests = ecember 31? ;ear 5 ethod 2D
=on=on-co cont ntro rollllin ing g int inter eres ests ts at date date o# o# ac) ac)is isit itio ion n 526 526 , ( (/0 /00( 0(00 000 0 @ .96 .9677 ?eine
1(!0 1(!00( 0(00 000 0
(0(000
=C'
1(110(000
=on-controlling interest( ?ecem"er 31( Dear 6
2(910(000
5e7 =on-controlling interest J at date o# ac)isition - )nder implied al)e approach 526 , !(00(0007 - )sing )sing mar mar*e *ett al)e al)e o# o# ?eine ?eine
1(!00(000 1(600 1(600(00 (000 0
?ecrease in non-controlling interest =on-controlling interest( ?ecem"er 31( Dear 3 - as preio)sly calc)lated - as per new calc)lation
100(000 2(910(000
2(!10(000
Goodwill at ?ecem"er 31( Dear 3 - as preio)sly calc)lated - decrease d)e to change in non-controlling interest - as per new calc)lation
!00(000 100(000
600(000
Problem 6-15 aD Cost o# 90 inestment( Fan)ary 1( Dear Dear 2
/(000
'mplied al)e o# 100 inestment
120(000
Carrying amo)nt o# %and
60(000
Retained earnings
30(000
otal otal shareholders< e)ity
/0(000
Ac)isition di##erential
0(000
AllocationB
N J CA
'nentory
- E(000
&)ipment
2(000
Goodwill as at Fan)ary 1( Dear 2 :alance
16(000 26(000
.morti8ationJImpairment
:alance
Aan/ary 1? ;ear ;ear 2
;ear ;ear 2-4
;ear 5
ec 31? ;ear ;ear 5
5E(0007
5E(0007
S
S
&)ip &)ipmen mentt
2(000 2(000
12(00 12(000 0
(000 (000
/(000 /(000 5a7 5a7
Goodw Goodwililll
26(000 26(000
S
21(600 21(600
3(600 3(600 5"7 5"7
0(000 0(000
3(000 3(000
26(600 26(600
11(600 (600 5c7 5c7
'nentory
bD
P.P*) C%)P Consolidated Income $tatement for the year ended ecember 31? ;ear 5
Copyright 9/
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McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, i#th &dition
%ales 59E/(000 T 300(000 J 100(00027
EE/(000
'nestment and interest income 51(600 T 3(!00 J 1600 J 2(00 37
1(200
otal otal reen)e
EEE(200
Cost o# goods sold 5/0(000 T 200(000 J 100(0002 T 10(600 !7
6E0(600
'nterest e,pense 510(000 J 2(0037
9(!00
Research K deelopment e,penses 50(000 T 12(000 T 5a7 (0007
6!(000
Miscellaneo)s e,pense 510!(000 T 31(!00 T 5"7 21(600 J 2(000 17
136(100
'ncome ta,es 5/0(000 T 32(000 J (200 ! J /(000 67
EE(/00
otal otal e,penses
//E(000
=et income
110(200
Attri")ta"le toB %hareholders o# aper
109(060
=on-controlling interest 5/(000 J 12(000 J 26(6007 5307
3(160 110(200
(otesE 1
Management Management #ee 52(000 X 127
2(000
2
?ownstream sales
100(000
3
'nterest 50(000 X / X E@127
2(00
'nestment income #rom %and
1600
Intercompany profits :efore ta9
4"H ta9
.fter ta9
6
Land S )pstream )pstream
20(000
/(000
12(000
!
&nding inentory S downstream530(000 X 367
10(600
(200
!(300
cD i7 'nentory 5!!(000 T (000 J 10(600 !7 ii7 Land 5160(000 T 30(000 J 20(00067
EE(600 1!0(000
iii7 =otes paya"leB he notes paya"le wo)ld not "e shown on the consolidated "alance sheet. i7 =on-controlling interest 560(000T120(000J 560(000T12 0(000J12(000T5c711(6007 12(000T5c711(6007 5307 7 Common shares
60(/60 160(000
dD =on-controlling interest J at date o# ac)isition - )nder implied al)e approach 530 , 120(0007 - )sing independent appraisal ?ecrease in non-controlling interest and goodwill
3!(000 30(000 !(000
Goodwill impairment loss #or the year ended ?ecem"er 31( Dear 6 - as preio)sly calc)lated 21(600 - decrease d)e to change in goodwill at ac)isition !(000 - as per new calc)lation 16(600 ro#it attri")ta"le to non-controlling interest #or the year ended ?ecem"er 31( Dear 3 - as preio)sly calc)lated 3(160 - increase d)e to red)ced goodwill impairment loss !(000 - as per new calc)lation E(160
$%L&'I%($ '% #*:-:.$* P)%:L*$ #eb Problem 6-1 he #ollowing answers are "ased on the 2011 consolidated #inancial statements #or R=A 'nc.B 5a7
R=A R=A )ses )ses the the weig weighte hted d aera aerage ge cost cost met method hod to to cost cost its its in inent entor ory y. his his is disclosed in the inentory al)ation acco)nting policy as descri"ed in note 35d7 to the consolidated #inancial statements.
5"7
At the the end end o# 2011( 2011( in inent entory ory rep repres resent ented ed 30.2 30.2 5/0 5/0(2/ (2/9 9 @ 2(9/0(3 2(9/0(39/7 9/7 o# R= R=A A
5c7 5c7
R=A R=A does does elimi eliminat nate e interc intercomp ompany any tra trans nsac actio tions ns and and )nrea )nrealili+e +ed d pro#it pro#its s when when preparing its consolidated #inancial statements as per note 35a75iii7 to the consolidated #inancial statements.
5d7
he n)mera n)merator tor(( cos costt o# good goods s sold sold(( wil willl incr increas ease e "y the the sale sales s amo) amo)nt nt o# the the intercompany sale and decrease "y the )nreali+ed pro#it in ending inentory. he denominator( aerage inentory( will decrease "y one-hal# o# the )nreali+ed pro#it in ending inentory "eca)se o# the )se o# aerage inentory rather rather than year-end year-end inentory. 4y )sing one-hal# o# the )nreali+ed pro#it in the denominator and the #)ll )nreali+ed pro#it in the n)merator( the inentory t)rnoer a#ter the eliminating entries will "e lower than the original inentory t)rnoer. &arnings per share will decrease
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d)e to the elimination o# the )nreali+ed pro#it in ending inentory. 5e7
Land Land is al) al)ed ed at cost cost as as per per the the acco acco)nt )nting ing pol polic icy y #or #or prop propert erty y( plan plantt and e)ipment descri"ed in note 35g7 to the consolidated #inancial statements.
5#7 5#7
he de"tde"t- toto- e)i e)ity ty rati ratio o wo)l wo)ld d decr decreas ease e "eca) "eca)se se de"t de"t wo)ld wo)ld not chang change e ")t ")t e)ity wo)ld increase. he ret)rn on aerage e)ity wo)ld also decrease "eca)se net income wo)ld stay the same and e)ity wo)ld increase.
#eb Problem 6-2 he #ollowing answers are "ased on the %eptem"er 30( 2011 consolidated #inancial statements #or Ceno)s &nergy 'nc. which are aaila"le on the company
Ceno Ceno)s )s )ses )ses the the #irs #irstt-in in(( #irst #irst-o) -o)tt or weig weight hted ed aerag aerage e cost cost method methods s to cost cost its its prod)ct inentory as per the acco)nting policy #or inentories in note 35l7 to the consolidated #inancial statements.
5"7
At the the end end o# 201 2011( in inent entori ories es rep repres resent ented ed 6./ 6./ 51(2 51(2E1 E1 @ !22(1 !22(1E7 E7 o# o# Ceno Ceno)s )s<< total assets( which is higher than the 2010 portion( which was . 5//0 @ 1E(/07.
5c7 5c7
As per per the prin princi cipl ples es o# cons consoli olida datio tion n acco)n acco)ntin ting g polic policy y as desc descri" ri"ed ed in not note e 35a7 35a7 to the consolidated #inancial statements( Ceno)s does eliminate intercompany transactions and )nreali+ed pro#its when preparing its consolidated #inancial statements.
5d7
he n)mera n)merator tor(( cos costt o# good goods s sold sold(( wil willl incr increas ease e "y the the sale sales s amo) amo)nt nt o# the the intercompany sale and decrease "y the )nreali+ed pro#it in ending inentory. he denominator( aerage inentory( will decrease "y one-hal# o# the )nreali+ed pro#it in ending inentory "eca)se o# the )se o# aerage inentory rather rather than year-end year-end inentory. 4y )sing one-hal# o# the )nreali+ed pro#it in the denominator and the #)ll )nreali+ed pro#it in the n)merator( the inentory t)rnoer a#ter the eliminating entries will "e lower than the original inentory t)rnoer. &arnings per share will decrease d)e to the elimination o# the )nreali+ed pro#it in ending inentory.
5e7
Land Land is al al)ed )ed at at per per the the acco)n acco)nti ting ng poli policy cy #or #or prop propert erty y( plant plant and and e)ip e)ipmen mentt descri"ed in note 35o7 to the consolidated #inancial statements.
5#7 5#7
he de"tde"t- toto- e)i e)ity ty rati ratio o wo)l wo)ld d decr decreas ease e "eca) "eca)se se de"t de"t wo)ld wo)ld not chang change e ")t ")t e)ity wo)ld increase. he ret)rn on aerage e)ity wo)ld also decrease "eca)se
net income wo)ld stay the same and e)ity wo)ld increase.
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McGraw-Hill Ryerson Limited. All rights resered. Modern Advanced Accounting in Canada, i#th &dition
