Solution manual advanced accounting 10e by beams ch08

The gain or loss on the sale of an equity interest is the difference between the proceeds from the sale the fair value andthe recorded book value of the interest sold, provided that the

CONSOLIDATIONS — CHANGES IN OWNERSHIP INTERESTS

Answers to Questions

1 Preacquisition earnings and dividends are the earnings and dividends applicable to an investment

interest prior to its acquisition during an accounting period Assume that P purchases an 80 percentinterest in S on July 1, 2009 and that S has earnings of $100,000 between January 1 and July 1, 2009 andpays $50,000 dividends on May 1, 2009 In this case, preacquisition earnings and dividends are $80,000and $40,000, respectively Historically, preacquisition earnings purchased were shown as a deduction on

the income statement to arrive at consolidated net income Under SFAS No 160, this is no longer the

case Instead, the consolidated income statement should only report revenues, expenses, gains andlosses subsequent to the combination date For example, in a Mmarch 31 acquisition, the consolidatedincome statement would only include income of the subsidiary from April 1 through December 31 TheFASB reasons that acquirers purchase assets and assume liabilities, based on their fair values Acquirers

do not “purchase” preacquisition earnings, although fair values of net assets should reflect earningpower of the acquired firm

2 Preacquisition earnings are not recorded by a parent company under the equity method because the

investor only recognizes income subsequent to acquisition on the interest acquired Historically,preacquisition earnings purchased were shown as a deduction on the income statement to arrive at

consolidated net income Under SFAS No 160, this is no longer the case Instead, the consolidated

income statement should only report revenues, expenses, gains and losses subsequent to the combinationdate For example, in a Mmarch 31 acquisition, the consolidated income statement would only includeincome of the subsidiary from April 1 through December 31

3 Noncontrolling stockholders of Sub Company held a 20 percent interest during the first half year and a

10 percent interest during the last half year and at year-end But noncontrolling interest share for theyear and total noncontrolling interest at year-end are computed for the 10 percent interest held bynoncontrolling stockholders throughout the year

4 Preacquisition income is similar to noncontrolling interest share because it represents the income of a

subsidiary attributable to stockholders outside the consolidated entity But preacquisition income is notincome of the noncontrolling stockholder group at the date of the financial statements In fact,preacquisition income relates to a previous controlling stockholder group when the interest acquiredexceeds 50 percent In such a case, it seems improper to report this as a deduction in the consolidatedincome statement Rather, the fair value of net assets acquired should reflect the acquiree’s earningshistory

5 Under FASB Statement No 160, a gain or loss is only recorded when the sold interest results in

deconsolidation of the subsidiary, i.e., the parent no longer holds a controlling interest The gain or loss

on the sale of an equity interest is the difference between the proceeds from the sale (the fair value) andthe recorded book value of the interest sold, provided that the investment is accounted for as a one-lineconsolidation If another method of accounting has been used, the investment account must be converted

to the equity method so that any gain or loss on sale is the same as if a one-line consolidation had beenused previously

When the parent maintains a controlling interest after the sale, the sale is treated as an equitytransaction, with no gain or loss recognition The parent debits cash or other consideration received inthe sale, credits the investment account based on percent of carrying value sold, and records thedifference as an adjustment to other paid-in capital

6 Conceptually, the income applicable to an equity interest sold during an accounting period should be

included in investment income and consolidated net income In this case, the gain or loss on sale iscomputed on the basis of the book value of the interest at the time of sale, and income is assigned to the

increased noncontrolling interest only after the date of sale As a practical expedient, a period sale date can be used such that no income is recognized on the interest sold up to the time of sale,and the gain or loss is computed on the book value at the beginning of the period When this expedient isused, income must be assigned to the increased noncontrolling interest for the entire year of sale Thecombined investment income and gain or loss on sale are the same under both approaches provided thatthe assumptions (beginning of the year and time of sale) are followed consistently As noted in question

beginning-of-the-5, gain or loss on the sale of the equity interest is only recognized when the subsidiary isdonconsolidated Other wise, the gain or loss is an adjustment to other paid-in capital

7 Assuming that no gain or loss is recognized, no adjustment of the parent’s investment account is

necessary when the subsidiary sells additional shares to outside parties at book value because theparent’s share of underlying book value does not change If additional shares are sold above book values,the parent’s share of the underlying equity of the subsidiary increases This increase is recorded by theparent company as follows:

If the subsidiary sells additional shares below book value, the parent’s interest is decreased andthe parent company records decreases in its investment and additional paid-in capital accounts In allthree cases (book value, above book value, or below book value), the parent company’s ownershippercentage decreases from 80 percent (8,000 of 10,000 shares) to 662

is to assume that the parent sold one-sixth of its interest for 662

3 percent of the proceeds, the differencebeing the amount of adkustment to additional paid-in capital

8 The acquisition of the 2,000 shares directly from the subsidiary increases the parent’s percentage

interest from 80 percent (8,000 of 10,000 shares) to 5/6 (10,000 of 12,000 shares, or 83 1/3%) Thechange in the interest held does not affect the way in which the parent company records its additionalinvestment The parent company in all cases increases its investment account by the amount of cash paid

or other consideration given for the additional investment It makes no difference if the purchase price isabove or below book value

9 Treasury stock transactions by a subsidiary change the parent company’s proportionate interest in the

subsidiary Any changes in the parent’s share of the underlying book value of the subsidiary requireadjustments in the parent company’s investment in subsidiary and additional paid-in capital accounts

10 Gains and losses to a parent company (or equity investor) do not result from the treasury stock

transactions of its subsidiaries (or equity investees) Although the parent’s investment interest mayincrease or decrease from such transactions, the predominate view is that such changes are of a capitalnature and should be accounted for by additional paid-in capital adjustments rather than by recordedgains and losses

11 Stock splits and stock dividends by a subsidiary do not affect the amounts that appear in the

consolidated financial statements But stock dividends by a subsidiary result in capitalization ofsubsidiary retained earnings and the amounts involved in eliminations for the subsidiary’s stockholders’equity accounts are affected

SOLUTIONS TO EXERCISES

Solution E8-1

Allocation of Sweet’s net income:

Controlling share of income

($100,000 × 70% × 1 year) + ($100,000 × 20% × 1/2 year) $ 80,000Noncontrolling interest share ($100,000 × 10% × 1 year) $ 10,000Preacquisition income ($100,000 × 20% × 1/2 year) $ 10,000Note: This does not appear on the consolidated income statement

Companies only include subsidiary earnings subsequent to the

acquisition date

Allocation of Sweet’s dividends:

Dividends to Pie ($30,000 × 70%) + ($30,000 × 90%) $ 48,000Noncontrolling interest ($60,000 × 10%) $ 6,000Preacquisition interests ($30,000 × 20%) $ 6,000

Solution E8-2

1 Income from Superstore for 2009:

60% interest × $240,000 × 1/3 year $ 48,000

2 Preacquisition income:

Under SFAS No 160, no preacquisition income appears on the

consolidated income statement The income statement only

includes income of the subsidiary earned after the parent

obtains its controlling interest Control was established on

September 1, when Pinnacle’s interest increased from 40% to

60%, so the consolidated income statement includes

Superstore income of $80,000 ($240,000 x 1/3 of year)

3 Noncontrolling interest share for 2009:

Solution E8-3 (amounts in thousands)

Entry to record sale of 15% interest:

To record sale of 15% interest in Swamp

No gain or loss on sale is recognized since Peat maintains an 85% controlling

interest.

Entry to record investment income for 2009:

Investment in Swamp($600 × 85%) 510

To record income from Swamp

Check:

* Note that implied total goodwill is $400 ($340 / 85%)

Solution E8-4 (amounts in thousands)

1 Gain on sale of 20% interest: No gain or loss is recognized since Pauley

maintains a 60% controlling interest

Beginning of the period sale assumption

Book value of interest ($436 investment

Actual sale date assumption

Book value of interest sold:

Beginning of the period balance $436

Add: Income ($150 × 1/3 year × 80%) 40

476

Adjustment to increase additional paid-in capital $ 11

2 Income from Savage

Beginning of the period sale assumption

Actual sale date assumption

January 1 to May 1:

Share of Savage’s income ($150 × 80% × 1/3 year) $ 40

May 1 to December 31:

Share of Savage’s income ($150 × 60% × 2/3 year) 60

Solution E8-4 (continued)

3 Investment in Savage December 31, 2009

Beginning of ActualPeriod Sale Sale DateAssumption Assumption

Implied fair value of Stork ($1,274 / 70%) $1,820

Book value ($1,480 January 1 balance

+ $100 income for 5 months - $60 dividends in

1b Income from Stork (Note: Only include earnings subsequent to the

acquisition date)

Income from Stork ($240,000 × 7/12 year × 70%) $ 98

1c Investment in Stork at December 31

Deduct: Dividends ($60,000 × 70%) (42)Investment in Stork December 31, 2009 $1,330

2 Consolidation working paper entries:

To eliminate income and dividends from Stork and adjust investment account to its cost on June 1

b Common stock, $10 par — Stork 1,000

Retained earnings — Stork 580

Solution E8-6

1 Investment in Sower (in thousands)

Investment balance December 31, 2009 ($9,000 × 80%) $ 7,200

Cost of new shares ($25 × 60,000 shares) 1,500

Investment in Sower after new investment $ 8,700

2 Goodwill from new investment

Sower’s stockholders’ equity after issuance

Petal’s ownership percentage

(480,000 + 60,000 shares)/660,000 shares .8182

Less: Petal’s book value before issuance (7,200)

Increase in book value from purchase

Goodwill from acquisition of new shares* $ 108.9

* This implies total goodwill is equal to $136,125

Solution E8-7

1 Sod issues 30,000 shares to Pod at $20 per share

Pod’s ownership interest before issuance: 176,000/220,000 shares = 80%Pod’s ownership interest after issuance: 206,000/250,000 shares = 82.4%

2 Sod sells 30,000 shares to the public at $20 per share

Pod’s ownership interest after issuance: 176,000/250,000 shares = 70.4%

3 Sod sells 30,000 shares to the public; no gain or loss recognized:

To record increase in investment in Sod computed as follows:

Book value before issuance ($3,200,000 × 80%) $2,560,000Book value after issuance ($3,800,000 × 70.4%) 2,675,200

Solution E8-8

Primetime buys shares

1a Percentage ownership after additional investment:

700,000/1,000,000 = 70%

1b Goodwill from additional investment (in thousands):

Book value of interest after sale

* This implies total goodwill is now equal to $114,286

Outsiders buy shares

2a Percentage ownership after sale:

600,000/1,000,000 = 60%

2b Change in underlying book value of investment in Satellite:

Satellite’s underlying equity after sale $2,600,000

Book value of Primetime’s investment in Satellite

Increase in book value of investment $ 160,000

2c Entry to adjust investment account:

Solution E8-9

Preliminary computations of fair value — book value differentials:

April 1, 2009 acquisition

Implied total fair value of Sum ($64,000 / 20%) $320,000Book value of Sum on april 1 acquisition date:

Beginning stockholders’ equity $280,000

Add: Income for 3 months ($80,000 × ¼ year) 20,000

July 1, 2010 acquisition

Implied total fair value of Sum ($164,000 / 40%) $410,000Book value on July 1 acquisition date:

Beginning stockholders’ equity $360,000

Add: Income for 6 months ($80,000 × 1/2 year) 40,000

Goodwill (amount is unchanged by this transaction) $ 20,000

1 Income from Sum

2009

Income from Sum for 2009 ($80,000 × 20% × 3/4 year) $ 12,000

2010 Income from Sum for 2010

20% share of reported income ($80,000 × 20%) $ 16,00040% share of reported income ($80,000 × 40% × 1/2 year) 16,000

2 Noncontrolling interest December 31, 2010

(($420,000 book value + $20,000 goodwill)× 40%) $176,000

3 Preacquisition income (does not appear in come statement)

Investment in Sum $264,000

Solution E8-10

Preliminary computations

Implied total fair value of Sandridge ($675,000 / 90%) $750,000Less: Book value of Sandridge at acquisition:

Equity of Sandridge Mines December 31, 2009 $700,000

Equity of Sandridge Mines July 1, 2010 750,000Excess (book value = underlying equity) 0

Income from Sandridge — 2010 ($100,000 × 1/2 year × 90%) $ 45,000Income from Sandridge — 2011:

January 1 to July 1 ($80,000 × 1/2 year × 90%) $ 36,000July 1 to December 31 ($80,000 × 1/2 year × 80%) 32,000

$ 68,000Investment in Sandridge Mines

Less: Dividends paid in December ($50,000 × 90%) (45,000)

Investment balance December 31, 2010 675,000Less: Book value of 1/9 interest sold on July 1, 2011a (79,000)

Less: Dividends paid in December ($30,000 × 80%) (24,000)

Investment balance December 31, 2011 $640,000

a Sale of 10% interest July 1, 2011:

Equity of Sandridge Mines December 31, 2009 $700,000 Add: Income less dividends — 2010 50,000 Add: Income for 1/2 year — 2011 40,000 Equity of Sandridge Mines July 1, 2011 790,000

Underlying equity of interest sold $ 79,000 Gain on sale of 1/9 interest ($85,000 proceeds - $79,000)

Since Piccolo maintains a controlling interest, the gain is

not recorded, but shown as an adjustment to additional

paid-in capital.

$ 6,000

Solution E8-10 (continued)

Noncontrolling interest share — 2010:

Noncontrolling interest share — 2011:

($80,000 × 1/2 year × 10%) + ($80,000 × 1/2 year × 20%) $ 12,000

Noncontrolling interest December 31, 2010

Add: Income less dividends for 2010 50,000Equity of Sandridge Mines December 31 750,000Noncontrolling interest percentage 10%

Noncontrolling interest December 31 $ 75,000

Noncontrolling interest December 31, 2011

Add: Income less dividends for 2011 50,000Equity of Sandridge Mines December 31 800,000Noncontrolling interest percentage 20%

Noncontrolling interest December 31 $160,000

Solution E8-11

Preliminary computations:

Implied total fair value of Sanyo ($690,000 / 75%) $ 920,000

Excess fair value over book value = Goodwill $ 120,000

2 Percentage ownership before purchase of additional shares

30,000 shares owned/40,000 shares outstanding = 75% interest

Percentage ownership after purchase of additional shares

40,000 shares owned/50,000 shares outstanding = 80% interest

Add: Share of Sanyo’s income less dividends

Investment in Sanyo December 31, 2009 840,000Add: Additional investment — January 3, 2011

(10,000 shares × $30) 300,000

Investment in Sanyo balance January 3, 2011 $1,140,000

4 Percentage ownership if shares sold to outside entities

30,000 shares owned/50,000 shares outstanding = 60% interest

Investment in Sanyo December 31, 2009

Add: Increase in book value from change in

ownership interest:

Book value after additional 10,000 shares

were issued ($1,300,000 equity × 60%) $780,000Book value before additional 10,000 shares

were issued ($1,000,000 equity × 75%) (750,000) 30,000Investment in Sanyo balance - January 3, 2011 $ 870,000

Less: Book value of Saton after issuance 710,000

To record income from Saton($90,000 × 10,000/12,000)

Solution E8-13

Add: 90% of $300 increase in equity since 2009 270

Investment in Striper January 1, 2011 $2,070

2 Entry on Patrick’s books (no gain or loss recognized)

To recognize change in book value of investment from Striper’s sale of additional shares, computed as follows:

Underlying equity after issuance ($2,400 × 75%) $1,800Underlying equity before issuance ($1,800 × 90%) (1,620)

$ 180

SOLUTIONS TO PROBLEMS

Solution P8-1

Preliminary computations (in thousands):

Implied total fair value of Spindle ($620 / 80%) $775

Book value of Spindle ($550 + $50 income) (600)

Book value after issuance ($762 × 5/6) $635

Book value before issuance ($600 × 80%) (480) (155)

Excess fair value over book value of 10,000 shares

Investment in Spindle December 31, 2009 $620

Share of Spindle’s income ($150 × 5/6) $125

3 Investment in Spindle — December 31, 2010

Less: Dividends for 2010 ($60 × 5/6) (50)

Investment in Spindle December 31, 2010 $857Check:

Share of Spindle’s equity ($852 × 5/6) $710

Goodwill [ ($175 x 80%) + ($210 x (5/6 – 80%) ] 147

Investment in Spindle December 31, 2010 $857

Solution P8-2

Investment in Smithtown January 1, 2011 $22,800

Shares owned 960,000/1,600,000 outstanding shares = 60% interest

3 No gain or loss recognized on issuance of additional shares

To recognize change in ownership interest computed as: Underlying equity after sale ($38,000 × 60%) less underlying equity before sale of additional shares ($26,000 × 80%)

2 Journal entry to record sale as of January 1, 2009

Investment in ShawneeBeginning of Year Sale Date Balance January 1, 2009 $1,039,500 $1,039,500Add: Income from Shawnee

January 1 — July 1 126,000 112,000July 1 — December 31 112,000 1l2,000Less: Dividends