Solution manual advanced accounting 11th by beams chapter11

Chapter 11 CONSOLIDATION THEORIES, PUSH-DOWN ACCOUNTING, AND CORPORATE JOINT VENTURES Answers to Questions 1 Parent company theory views consolidated financial statements from the vi

Chapter 11

CONSOLIDATION THEORIES, PUSH-DOWN ACCOUNTING, AND

CORPORATE JOINT VENTURES

Answers to Questions

1 Parent company theory views consolidated financial statements from the viewpoint of the parent and entity

theory views consolidated financial statements from the viewpoint of the business entity under which all

resources are controlled by a single management team By contrast, traditional theory sometimes reflects

the parent viewpoint and at other times it reflects the viewpoint of the business entity A detailed

comparison of these theories is presented in Exhibit 11–1 of the text

2 Only contemporary theory is changed by current pronouncements of the Financial Accounting Standards

Board While such pronouncements can and do change the current accounting and reporting practices, they

do not change the logic or the consistency of either parent company or entity theory

3 The valuation of subsidiary assets on the basis of the price paid for the controlling interest seems justified

conceptually when substantially all of the subsidiary stock is acquired by the parent But the conceptual

support for this approach is less when only a slim majority of subsidiary stock is acquired In addition, the

valuation of the noncontrolling interest based on the price paid by the parent has practical limitations

because noncontrolling interest does not represent equity ownership in the usual sense The ability of

noncontrolling stockholders to participate in management is limited and noncontrolling shares do not

possess the usual marketability of equity securities

4 Consolidated assets are equal to their fair values under entity theory only when the book values of parent

assets are equal to their fair values Otherwise, consolidated assets are not equal to their fair values under

either parent company or entity theories

5 The valuation of the noncontrolling interest at book value might overstate the equity of noncontrolling

shareholders because of the limited marketability of shares held by noncontrolling stockholders and

because of the limited ability of noncontrolling stockholders to share in management through their voting

rights Valuation of the noncontrolling interest at book value also overstates or understates the

noncontrolling interest unless the subsidiary assets are recorded at fair values

6 Consolidated net income under parent company theory and income to the controlling stockholders under

entity theory should be the same This is illustrated in Exhibit 11–5, which shows different income

statement amounts for cost of sales, operating expenses, and income allocated to noncontrolling

stockholders, but the same income to controlling stockholders Note that consolidated net income under

parent company and traditional theories reflects income to controlling stockholders

7 Income to the parent stockholders under the equity method of accounting is the same as income to the

controlling stockholders under entity theory But income to controlling stockholders is not identified as

consolidated net income as it would be under parent company or traditional theories

8 Consolidated income statement amounts under entity theory are the same as under traditional theory when

subsidiary investments are made at book value because traditional theory follows entity theory in

eliminating the effects of intercompany transactions from consolidated financial statements

9 Traditional theory corresponds to entity theory in matters relating to unrealized and constructive gains and

losses from intercompany transactions In other words, unrealized and constructive gains and losses are

allocated between controlling and noncontrolling interests in the same manner under these two theories

10 Push-down accounting simplifies the consolidation process The push-down adjustments are recorded in

the subsidiary’s separate books at the time of the business combination; thus, it is not necessary to allocate

the unamortized fair values in the consolidation working papers

11 A joint venture is an entity that is owned, operated, and jointly controlled by a small group of

investor-venturers to operate a business for the mutual benefit of the investor-venturers Some joint ventures are organized as

corporations, while others are organized as partnerships or undivided interests Each venturer typically

participates in important decisions of a joint venture irrespective of ownership percentage

12 Investors in corporate joint ventures use the equity method of accounting and reporting for their investment

earnings and investment balances as required by GAAP The cost method would be used only if the

investor could not exercise significant influence over the corporate joint venture Alternatively, investors in

unincorporated joint ventures use the equity method of accounting and reporting or proportional

consolidation for undivided interests specified as a special industry practice

Only the parent’s percentage of unrealized profits from upstream sales

is eliminated under parent company theory

3 b

Subsidiary’s income of $400,000  10% noncontrolling

interest

$ 40,000 Less: Patent amortization ($140,000/10 years  10%)

Solution E11-3 (continued)

4 a

Implied fair value — $1,680,000 = patents at acquisition

5 b

Purchase price — ($1,680,000  80%) = patents at acquisition

Solution E11-4

1 Goodwill

Parent company theory

2 Noncontrolling interest

Parent company theory

3 Total assets

Parent company theory

1 Consolidated net income and noncontrolling interest share for 2011:

EntityTheory

Depreciation on excess allocated to

equipment:

Less: Noncontrolling interest share

Controlling interest share of NI(Income

Attributable to controlling stockholders)

Company Theory

Depreciation on excess allocated to

equipment:

($75,000 excess x 80% acquired)/5 years (12,000)

Less: Noncontrolling interest share

Solution E11-6

Preliminary computation

Interest acquired in Sal: 72,000 shares  80,000 shares = 90%

1 Sal’s net assets under entity theory

Implied value from purchase price: $1,800,000/90% interest $2,000,000

3 Investment income from Sal

4 Noncontrolling interest under entity theory

2,040,000

Alternatively, $200,000 noncontrolling interest at July 1, plus $4,000

share of reported income = $204,000

Solution E11-7

Less: Pal’s share of unrealized profits from upstream

Less: Noncontrolling interest share ($300,000  20%) (60,000)

2 Entity theory

Income allocated to controlling stockholders ($500,000 +

Less: Unrealized inventory profits

from downstream sales

Allocated to noncontrolling

Stockholders

Solution E11-9 [Push-down accounting]

1 Push down under parent company theory

To record revaluation of 90% of the net assets and elimination of

retained earnings as a result of a business combination with Pin

Corporation Push down equity = ($600,000 fair value/book value

differential  90%) + $360,000 goodwill + $800,000 retained

To record revaluation of 100% of the net assets and elimination of

retained earnings as a result of a business combination with Pin

Push down equity = $600,000 fair value/book value differential +

$400,000 goodwill + $800,000 retained earnings

Solution E11-10

Each of the investments should be accounted for by the equity method as a

one-line consolidation because the joint venture agreement requires consent of

each venturer for important decisions Thus, each venturer is able to exercise

significant influence over its joint venture investment irrespective of

ownership interest

The 40 percent venturer:

The 15 percent venturer

Solution E11-11

In general, VIE accounting follows normal consolidation principles

Under that approach, the noncontrolling interest share would be 90% of VIE

earnings, or $900,000 However, the intercompany fees must be allocated to the

primary beneficiary, not to noncontrolling interests Therefore, in this case,

noncontrolling interest share would be 90% of $920,000, or $828,000

Field Code Changed

Solution E11-12

As primary beneficiary, Pal must include Pot in its consolidated

financial staements Additionally, Pal must make the following disclosures:

(a) the nature, purpose, size, and activities of the variable interest entity,

(b) the carrying amount and classification of consolidated assets that are

collateral for the variable interest entity’s obligations, and (c) lack of

recourse if creditors (or beneficial interest holders) of a consolidated

variable interest entity have no recourse to the general credit of the primary

beneficiary

Den will not consolidate Pot, since they are not the primary beneficiary As

in traditional consolidations, only one firm consolidates a subsidiary

However, since Den has a significant interest in Pot, they must disclose: (a)

the nature of its involvement with the variable interest entity and when that

involvement began, (b) the nature, purpose, size, and activities of the

variable interest entity, and (c) the enterprise’s maximum exposure to loss as

a result of its involvement with the variable interest entity Den accounts

for the investment using the equity method

Solution E11-13

According to GAAP, if an enterprise absorbs a majority of a variable

interest entity’s expected losses and another receives a majority of expected

residual returns, the enterprise absorbing the losses is the primary

beneficiary and if condition one is also met Laura meets condition one, since

as CEO, she had the power over economic decisions Laura must consolidate the

variable interest entity The contractual arrangement makes Laura the primary

beneficiary

Field Code Changed

Field Code Changed

SOLUTION TO PROBLEMS

Solution P11-1

Pin Corporation and Subsidiary

Comparative Consolidated Balance Sheets

at December 31, 2012 (in thousands) Parent

Total liabilities and

a Parent company theory: Combined plant assets of $1,950 + ($80  3/5 undepreciated

excess)

Entity theory: Combined plant assets of $1,950 + ($100  3/5 undepreciated excess)

b Parent company theory: $80 patents - $16 amortization

Entity theory: $100 patents - $20 amortization

c Parent company theory: Noncontrolling interest equals Son’s equity of $800  20%

d Entity theory: [Son’s equity of $800 + ($60 undepreciated plant assets + $80

unamortized patents)]  20%

Solution P11-2

Preliminary computation

Implied value of Sip based on purchase price ($320,000/.8) $400,000

1 Par Corporation and Subsidiary

Consolidated Income Statement for the year ended December 31, 2011

Allocation of income to:

a $150,000 depreciation - $1,000 piecemeal recognition of gain on equipment

through depreciation + ($60,000 excess  6 years) excess depreciation

b ($60,000 reported income - $10,000 unrealized gain on equipment + $1,000

piecemeal recognition of gain on equipment - $10,000 excess depreciation) 

20% interest

2 Par Corporation and Subsidiary

Consolidated Balance Sheet

a Sip beginning retained earnings $327,200 + Sip net income $112,800 - Sip

dividends of $100,000

b ($380,000 stockholders’ equity + $50,000 excess - $9,000 unrealized gain on

equipment)  20%

Check: $80,000 beginning noncontrolling interest + $8,200 noncontrolling

interest share - $4,000 noncontrolling interest dividends = $84,200

Solution P11-3

Parent company theory

($595,000 cost - $525,000 fair value)

1c Consolidated net income for 2011

1d Noncontrolling interest share for 2011

1e Noncontrolling interest December 31, 2011

2c Total consolidated income for 2011

Income to controlling stockholders ($300,000 + $63,000) $363,000

2e Noncontrolling interest at December 31, 2011

Pit used an incomplete equity method in accounting for its investment in Sam

It ignored the intercompany upstream sales of inventory Income from Sam on an

equity basis would be:

Less: Unrealized profits in ending inventory from

Pit Corporation and Subsidiary

Comparative Consolidated Income Statements for the year ended December 31, 2012

Less: Unrealized profit on

upstream sale of inventory

Solution P11-4 (continued)

Pit Corporation and Subsidiary

Comparative Statements of Retained Earnings for the year ended December 31, 2012

Traditional Company Entity Theory Theory Theory

Add: Net income to controlling

Pit Corporation and Subsidiary

Comparative Consolidated Balance Sheets

Solution P11-5

Pad Corporation and Subsidiary

Comparative Balance Sheets

Solution P11-6 [AICPA adapted]

1 P carries its investment in S on a cost basis This is evidenced by the

appearance of dividend revenue in P Company’s income statement and by

the absence of income from subsidiary

2 P holds 1,400 shares of S P Company’s percentage ownership is 70%, as

determined by the relationship of P Company’s dividend revenues and S

Company’s dividends paid ($11,200/$16,000) S has 2,000 outstanding

shares ($200,000/$100) and P holds 70% of these, or 1,400 shares

3 S Company’s retained earnings at acquisition were $100,000

Book value and fair value of S’s identifiable net assets 300,000

4 The nonrecurring loss is a constructive loss on the purchase of P bonds

by S Company

Working paper entry:

To eliminate intercompany bond investment and bonds payable and to

recognize a loss on the constructive retirement of P bonds

5 Intercompany sales P to S are $240,000 computed as follows:

S Company owes P Company $40,000 on intercompany purchases and P Company

owes S Company $5,600 dividends

Solution P11-6 (continued)

7 Adjustment to determine consolidated cost of goods sold:

Consolidated Cost of Goods Sold Combined cost of goods

9 Noncontrolling interest of $117,000 at the balance sheet date is

computed:

10 Consolidated retained earnings

Add: P’s share of increase in S’s retained earnings since

Less: P’s patent amortization since acquisition

Total liabilities and stockholders’

3 If Sap reports net income of $90,000 under the new push-down system for

the calendar year 2012, Pay’s income from Sap will also be $90,000 under

a one-line consolidation

Solution P11-8

1 Parent company theory

Excess allocated to:

Entry on Son’s books to reflect 80% push down:

3 Noncontrolling interest (Parent company theory)

4 Noncontrolling interest (Entity theory)

To record revaluation of 90% of net assets and elimination of

retained earnings as a result of a business combination with Paw

To record revaluation of net assets imputed from purchase price of

90% interest acquired by Paw Corporation and eliminate retained

earnings

Comparative Balance Sheets

at January 1, 2012 Parent Company Theory Entity Theory

Solution P11-10

a Paw Corporation and Subsidiary

Consolidation Working Papersfor the year ended December 31, 2012

Push down 90% — parent company theory

Power

90%

Sun

Adjustments andEliminations

ConsolidatedStatements

Retained earnings — Paw $ 147,000 $ 147,000

Retained earnings — Sun $ 0

* Deduct

Solution P11-10 (continued)

b Paw Corporation and Subsidiary

Consolidation Working Papers for the year ended December 31, 2012

Push down 100% — entity theory

Paw

90%

Sun

Adjustments andEliminations

ConsolidatedStatements

Retained earnings — Paw $ 147,000 $ 147,000

Retained earnings — Sun $ 0