Find more slides, ebooks, solution manual and testbank on www.downloadslide.com CHAPTER CONSOLIDATED FINANCIAL STATEMENTS - OWNERSHIP PATTERNS AND INCOME TAXES Chapter Outline I Indirect subsidiary control A Control of subsidiary companies within a business combination is often of an indirect nature; one subsidiary possesses the stock of another rather than the parent having direct ownership These ownership patterns may be developed specifically to enhance control or for organizational purposes Such ownership patterns may also result from the parent company's acquisition of a company that already possesses subsidiaries B One of the most common corporate structures is the father-son-grandson configuration where each subsidiary in turn owns one or more subsidiaries C The consolidation process is altered somewhat when indirect control is present The worksheet entries are effectively doubled by each corporate ownership layer but the concepts underlying the consolidation process are not changed Calculation of the accrual-based income of a subsidiary recognizing the consolidated relationships is an important step in an indirect ownership structure a The determination of accrual-based income figures is needed for equity income accruals as well as for the computation of noncontrolling interest balances b Any company within the business combination that is in both a parent and a subsidiary position must recognize the equity income accruing from its subsidiary before computing its own income II Indirect subsidiary control-connecting affiliation A A connecting affiliation exists whenever two or more companies within a business combination hold an equity interest in another member of that organization B Despite this variation in the standard ownership pattern, the consolidation process is essentially the same for a connecting affiliation as for a father-son-grandson organization C Once again, any company in both a parent and a subsidiary position must recognize an appropriate equity accrual in computing its own income III Mutual ownership A A mutual affiliation exists whenever a subsidiary owns shares of its parent company B Parent shares being held by a subsidiary are accounted for by the treasury stock approach The cost paid to acquire the parent's stock is reclassified within the consolidation process to a treasury stock account and no income is accrued McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 7-1 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com The treasury stock approach is popular in practice because of its simplicity and is now required by SFAS 160 IV Income tax accounting for a business combination—consolidated tax returns A A consolidated tax return can be prepared for all companies comprising an affiliated group Any other companies within the business combination file separate tax returns B A domestic corporation may be included in an affiliated group if the parent company (either directly or indirectly) owns at least 80 percent of the voting stock of the subsidiary as well as 80 percent of each class of its nonvoting stock C The filing of a consolidated tax return provides several potential advantages to the members of an affiliated group Intercompany profits are not taxed until realized Intercompany dividends are not taxed (although these distributions are nontaxable for all members of an affiliated group whether a consolidated return or a separate return is filed) Losses of one affiliate can be used to reduce the taxable income earned by other members of the group D Income tax expense—effect on noncontrolling interest valuation If a consolidated tax return is filed, an allocation of the total expense must be made to each of the component companies to arrive at the realized income figures that serve as a basis for noncontrolling interest computations Income tax expense is frequently assigned to each subsidiary based on the amounts that would have been paid on separate returns V Income tax accounting for a business combination—separate tax returns A Members of a business combination that are foreign companies or that not meet the 80 percent ownership rule (as described above) must file separate income tax returns B Companies in an affiliated group can elect to file separate tax returns Deferred income taxes are often recognized when separate returns are filed due to temporary differences stemming from unrealized gains and losses as well as intercompany dividends VI Temporary tax differences can stem from the creation of a business combination A The tax basis of a subsidiary's assets and liabilities may differ from their consolidated values (which is based on the fair market value on the date the combination is created) B If additional taxes will result in future years (for example, it the tax basis of an asset is lower than its consolidated value so that future depreciation expense for tax purposes will be less), a deferred tax liability is created by a combination C The deferred tax liability is then written off (creating a reduction in tax expense) in future years so that the net expense recognized (a lower number) matches the combination's book income (a lower number due to the extra depreciation of the consolidated value) Vll Operating loss carryforwards A Net operating losses recognized by a company can be used to reduce taxable income from the previous two years (a carryback) or for the future 20 years (a carryforward) McGraw-Hill/Irwin 7- © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com B If one company in a newly created combination has a tax carryforward, the future tax benefits are recognized as a deferred income tax asset C However, a valuation allowance must also be recorded to reduce the deferred tax asset to the amount that is more likely than not to be realized Learning Objectives Having completed Chapter 7, "Ownership Patterns and Income Taxes—Consolidated Financial Statements," students should be able to fulfill each of the following learning objectives: Differentiate between a father-son-grandson ownership configuration and a connecting affiliation Calculate realized income figures for all companies in a business combination when either a father-son-grandson or connecting affiliation is in existence Prepare a consolidation worksheet for both a father-son-grandson ownership pattern and a connecting affiliation Eliminate a subsidiary's ownership interest in its parent using the treasury stock approach Explain the rationale underlying the treasury stock approach to a mutual ownership List the criteria for being a member of an affiliated group for income tax filing purposes Discuss the advantages to a business combination of filing a consolidated tax return Allocate the income tax expense computed on a consolidated tax return to the various members of a business combination according to their separate taxable incomes Compute taxable income for an affiliated group based on information presented in a consolidated set of financial statements 10 Compute the deferred income tax expense to be recognized when separate tax returns are filed by any of the members of a business combination 11 Determine the deferred tax liability that is created when the tax bases of a subsidiary's assets and liabilities are below consolidated values 12 Explain the impact that a net operating loss of an acquired affiliate has on consolidated figures McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 7- Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions A father-son-grandson relationship is a specific type of ownership configuration often encountered in business combinations The parent possesses the stock of one or more companies At least one of these subsidiaries holds a majority of the voting stock of its own subsidiary Each subsidiary controls other subsidiaries with the chain of ownership going on indefinitely The parent actually holds control over all of the companies within the business combination despite having direct ownership in only its own subsidiaries In a business combination having an indirect ownership pattern, at least one company is in both a parent and a subsidiary position To calculate the accrual-based income earned by that company, a proper recognition of the equity income accruing from its own subsidiary must initially be made Structuring the income calculation in this manner is necessary to ensure that all earnings are properly included by each company Able—100% of income accrues to the consolidated entity (as parent company) Baker—70% (percentage of stock owned by Able) Carter—56% (80% of stock owned by Baker multiplied by the 70% of Baker controlled by Able) Dexter—33.6% (60% of stock owned by Carter multiplied by the 80% of Carter controlled by Baker multiplied by the 70% of Baker owned by Able) When an indirect ownership is present, the quantity of consolidation entries will increase, perhaps significantly An additional set of entries is included on the worksheet for each separate investment Furthermore, the determination of realized income figures for each subsidiary must be computed in a precise manner For any company in both a parent and a subsidiary position, equity income accruals are recognized prior to the calculation of that company's realized income This realized income total is significant because it serves as the basis for noncontrolling interest calculations as well as the equity accruals to be recognized by that company's parent In a connecting affiliation, two (or more) companies within a business combination own shares in a third member A mutual ownership, in contrast, exists whenever a subsidiary possesses an equity interest in its own parent In accounting for a mutual ownership, SFAS 160 requires the treasury stock approach The treasury stock approach presumes that the cost of the parent shares should be reclassified as treasury stock within the consolidation process The subsidiary is being viewed, under this method, as an agent of the parent Thus, the shares are accounted for as if the parent had actually made the acquisition According to present tax laws, an affiliated group can be comprised of all domestic corporations in which a parent holds 80 percent ownership More specifically, the parent must own (directly or indirectly) 80 percent of the voting stock of the corporation as well as at least 80 percent of each class of nonvoting stock Several basic advantages are available to combinations that file a consolidated tax return First, intercompany profits are not taxed until realized For companies with large amounts of McGraw-Hill/Irwin 7- © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com intercompany transactions, the deferral of unrealized gains causes a delay in the making of significant tax payments Second, losses incurred by one company can be used to reduce or offset taxable income earned by other members of the affiliated group In addition, intercompany dividends are not taxable but that exclusion applies to the members of an affiliated group regardless of whether a consolidated or separate tax return is filed Members of a business combination may be forced to file separate tax returns Foreign corporations, for example, must always file separately Domestic companies that not meet the 80 percent ownership rule are also required to file in this manner Furthermore, companies that are in an affiliated group may still elect to file separately If all companies within the combination are profitable and few intercompany transactions are carried out, little advantage may accrue from preparing a consolidated return With a separate filing, a subsidiary has more flexibility as to accounting methods as well as its choice of a fiscal year-end The allocation of income tax expense among the component companies of a business combination has a direct bearing on realized income totals and, therefore, noncontrolling interest calculations Obviously, the more expense that is assigned to a particular company the less realized income is attributed to that concern Income tax expense can be allocated based on the income totals that would have been reported by various companies if separate tax returns had been filed or on the portion of taxable income derived from each company 10 In filing a separate tax return (assuming that the two companies not qualify as members of an affiliated group), the parent must include as income the dividends received from the subsidiary For financial reporting purposes, however, income is accrued based on the ownership percentage of the realized income of the subsidiary Because income is frequently recognized by the parent prior to being received in the form of dividends (when it is subject to taxation), deferred income taxes must be recognized Either the parent or the subsidiary might also have to record deferred income taxes in connection with any unrealized intercompany gain On a separate tax return, such gains are reported at the time of transfer while for financial reporting purposes they are appropriately deferred until realized Once again, a temporary difference is created which necessitates the recognition of deferred income taxes 11 If the consolidated value of a subsidiary’s assets exceeds their tax basis, depreciation expense in the future will be less on the tax return than is shown for external reporting purposes The reduced expense creates higher taxable income and, thus, increases taxes Therefore, the difference in values dictates an anticipated increase in future tax payments This deferred liability is recognized at the time the combination is created Subsequently, when actual tax payments arise, the deferred liability is written off rather than recognizing expense based solely on the current liability In this manner, the expense is shown at a lower figure, one that is matched with reported income (which is also a lower balance because of the extra depreciation) Recognition of this deferred liability at date of acquisition also reduces the net amount attributed to the subsidiary's assets and liabilities in the initial allocation process Therefore, the residual asset (goodwill) is increased by the amount of any liability that must be recognized McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 7- Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 12 A net operating loss carryforward allows the company to reduce taxable income for up to 20 years into the future Thus, a benefit may possibly be derived from the carryforward but that benefit is based on Wilson (the subsidiary) being able to generate taxable income to be decreased by the carryforward To reflect the potential tax reduction, a deferred income tax asset is recorded for the total amount of anticipated benefit However, because of the uncertainty, unless the receipt of this benefit is more likely than not to be received, a valuation allowance must also be recorded as a contra account to the asset The valuation allowance may be for the entire amount or just for a portion of the asset 13 At the date of acquisition, the valuation allowance was $150,000 As a contra asset account, recognition of this amount reduced the net assets attributed to the subsidiary and, hence, increased the recording of goodwill (assuming that the price did not indicate a bargain purchase) If the valuation allowance is subsequently reduced to $110,000, the net assets have increased by $40,000 This change is reflected by a decrease in income tax expense McGraw-Hill/Irwin 7- © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Problems D B D C C C A Damson's accrual-based income: Operational income Defer unrealized gain Damson's accrual-based income $200,000 (40,000) $160,000 Crimson's accrual-based income: Operational income Investment Income (90% of Damson’s realized income) Crimson's accrual-based income $200,000 144,000 $344,000 Bassett's accrual-based income: Operational income Investment income (80% of Crimson's realized income) Bassett's accrual-based income $300,000 275,200 $575,200 C Icede's accrual-based income: Operational income Defer unrealized gain Icede's accrual-based income Outside ownership Noncontrolling interest $220,000 (60,000) $160,000 20% $32,000 Healthstone's accrual-based income: Operational income Defer unrealized gain Investment income (80% of Icede's accrual-based income) Healthstone's accrual-based income Outside ownership Noncontrolling interest $300,000 (30,000) 128,000 $398,000 20% $79,600 Total noncontrolling interest = $111,600 ($32,000 + $79,600) McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 7- Find more slides, ebooks, solution manual and testbank on www.downloadslide.com D Juvyn's Operational Income Dividend Income Juvyn's Income Outside Ownership Noncontrolling Interest $50,000 14,000 $64,000 10% $6,400 10 A Equity Income (60% of $200,000) Dividend Income (60% of $40,000) Tax Difference Dividend Deduction upon Eventual Distribution (80%) Temporary Portion of Tax Difference Tax Rate Deferred Income Tax Liability $120,000 24,000 $96,000 (76,800) $19,200 30% $5,760 11 C Unrealized Gain: Total Gain Portion Still Held Unrealized Gain Tax Rate Deferred Tax Asset $30,000 20% $6,000 25% $1,500 12 A Recognition of this gain is not required on a consolidated tax return 13 C Because fair value of the subsidiary's assets exceeds the tax basis by $100,000 a deferred tax liability of $30,000 (30%) must be recorded Goodwill is then computed as follows: Consideration transferred Fair Value Deferred Tax Liability Goodwill $420,000 $400,000 (30,000) 370,000 $50,000 14 (35 Minutes) (Series of reporting and consolidation questions pertaining to a father-son-grandson combination Includes unrealized inventory gains) a Consideration transferred (by Tree) Noncontrolling interest fair value Limb’s business fair value Book value Trade name Life Annual amortization McGraw-Hill/Irwin 7- $252,000 108,000 360,000 (300,000) $60,000 30 years $2,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 14 (continued) Consideration transferred for Leaf (by Limb) Noncontrolling interest fair value Leaf’s business fair value Book value Trade name Life Annual amortization a Investment in Limb Limb's reported income-2009 Amortization expense Accrual-based income Limb’s percentage ownership Equity accrual-2009 Dividends received 2009 Limb's reported income-2010 Amortization expense Income from Leaf Accrual-based income Limb’s percentage ownership Equity accrual-2010 Dividends received 2010 Investment in Limb 12-31-10 $252,000 $40,000 (2,000) $38,000 70% $26,600 (7,000) $60,000 (2,000) 6,300 $64,300 70% $45,010 (14,000) $302,610 b Leaf—2010 income (revenues minus expenses) Amortization Accrual-based income Limb's ownership percentage Equity Income accrual Income recognized ($2,000 dividends × 70%) Retained earnings increase (Limb), 1/1/11 $10,000 (1,000) $9,000 70% $6,300 (1,400) $4,900 Limb—2009 operating income Limb—2010 operating income Amortization (2 years at $2,000 per year) Equity income from ownership of Leaf (above) Total income for previous periods Tree's ownership percentage Equity Income accrual Income recognized ($10,000 [2009] + $20,000 [2010] dividends × 70% ownership) Retained earnings Increase (Tree), 1/1/11 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e $91,000 39,000 $130,000 (100,000) $30,000 30 years $1,000 $40,000 60,000 (4,000) 6,300 102,300 70% 71,610 (21,000) $50,610 © The McGraw-Hill Companies, Inc., 2009 7- Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 14 (continued) c Consolidated sales (total for the companies) Consolidated expenses (total for the companies) Total amortization expense (see a.) Consolidated net income for 2011 d Noncontrolling interest in income of Leaf Revenues less expenses Excess amortization Accrual-based income Noncontrolling interest percentage Noncontrolling interest in income of Leaf $1,260,000 (1,025,000) (3,000) $232,000 $30,000 (1,000) $29,000 30% $8,700 Noncontrolling interest in income of Limb: Revenues less expenses $65,000 Excess amortization (2,000) Equity in Leaf income [(30,000-1,000) × 70%] 20,300 Realized income of Limb—2011 $83,300 Outside ownership 30% NCI share of consolidated income $24,990 $33,690 e 2010 Realized income of Limb (prior to accounting for unrealized gains) (see a) 2009 Transfer-gain recognized in 2010 2010 Transfer-gain to be recognized in 2011 2010 Realized income Limb $64,300 10,000 (16,000) $58,300 2011 Realized Income of Limb (prior to accounting for unrealized gains) (see d.) 2010 Transfer-gain recognized in 2011 2011 Transfer-gain to be recognized in 2012 2011 Realized income—Limb $83,300 16,000 (25,000) $74,300 f In b., an adjustment of $50,610 was made to the beginning 2011 retained earnings Question e takes this same question and alters it by including unrealized gains The $10,000 gain does not affect the answer because the 2010 and 2011 effects cancel each other Thus, only the $16,000 gain must be taken into consideration on January 1, 2011 Limb’s realized income in 2010 is reduced by $16,000 because of the deferred gain The parent's equity accrual would be reduced by $11,200 or 70% of that figure The adjustment as of January 1, 2011 is $39,410 ($50,610 – $11,200) McGraw-Hill/Irwin 7- 10 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 26 (20 Minutes) (Consolidation entries for a mutual holding business combination) a Acquisition Price Allocation and Amortization Mighty's Purchase of Lowly Consideration transferred $420,000 Noncontrolling interest fair value 280,000 Lowly’s business fair value 700,000 Book value acquired (600,000) Trademarks $100,000 Annual amortization (20-year life) $5,000 CONSOLIDATION ENTRIES Entry *C Investment in Lowly 117,000 Retained Earnings, 1/1/10 (Mighty) 117,000 (To record $180,000 income accruing to parent during the previous years as measured by increase in book value [$200,000 × 60%] and amortization expense of $3,000 [$5,000 × 60%] for the previous year.) Entry S1 Common Stock (Lowly) 300,000 Retained Earnings, 1/1/10 (Lowly) 500,000 Investment in Lowly (60%) 480,000 Noncontrolling Interest in Lowly 1/1/10 (40%) 320,000 (To eliminate subsidiary stockholders' equity accounts against investment account and to recognize noncontrolling interest ownership.) Entry S2 Treasury Stock 240,000 Investment in Mighty (To reclassify cost of parent shares as treasury stock.) 240,000 Entry A Trademarks 95,000 Investment in Lowly 57,000 Noncontrolling Interest in Lowly 1/1/10 (40%) 38,000 (To recognize unamortized portion of acquisition-date excess fair value.) Entry E Amortization Expense Trademarks (To record trademarks amortization expense for 2010.) 5,000 5,000 Noncontrolling interest in subsidiary income = 40% × ($40,000 - $5,000) = $14,000 McGraw-Hill/Irwin 7- 26 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 27 (80 Minutes) (Prepare consolidation worksheet for a father-son-grandson combination Also asks about income taxes paid on both a separate and a consolidated return) a Acquisition-Date Allocation and Amortization The January 1, 2009 book values are determined by removing the 2009 income from the January 1, 2010 book values (based on equity accounts) Consideration transferred for Stookey Noncontrolling interest fair value Stookey business fair value Stookey book value Customer List Life Annual amortization $344,000 86,000 $430,000 (380,000) $50,000 10 Years $5,000 Consideration transferred for Yarrow Noncontrolling interest fair value Yarrow business fair value Yarrow book value Copyright Life Annual amortization $720,000 80,000 $800,000 740,000 $60,000 15 Years $4,000 CONSOLIDATION ENTRIES Entry *G Retained Earnings, 1/1/10 (Stookey) 7,680 Cost of Goods Sold 7,680 (To give effect to unrealized gain from 2009 Amount is calculated based on normal 48% markup [found from Income Statement] multiplied by $16,000 retained inventory [20% of $80,000]) Entry *C1 Investment in Stookey 85,856 Retained Earnings, 1/1/10 (Yarrow) 85,856 (To recognize equity income accruing from Yarrow's investment in Stookey during 2009 Because the initial value method is applied and no dividends paid, no income has been recognized in connection with the 2009 ownership of Stookey Reported income of $120,000 [2009] less unrealized gain of $7,680 deferred above indicates income of $112,320 Based on 80% ownership, an $89,856 accrual is needed, which is reduced by the $4,000 amortization (80% × $5,000) for that year McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 7- 27 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 27 (continued) Entry *C2 Investment in Yarrow 217,670 Retained Earnings, 1/1/10 (Travers) 217,670 (To recognize equity income accruing from Travers' investment in Yarrow during 2009 Because the initial method is applied and no dividends paid, income has not been recognized in connection with the 2009 ownership of Yarrow Income of $245,856 is calculated based on reported income of $160,000 [2009] plus the $85,856 accrual recognized in Entry *C1 Ownership of 90% dictates a $221,270 accrual that is then reduced to $217,670 by the $3,600 [90% × $4,000] amortization applicable to 2009.) Entry S1 Common Stock (Stookey) 200,000 Retained Earnings, 1/1/10 (Stookey, as adjusted by Entry *G) 292,320 Investment in Stookey (80%) 393,856 Noncontrolling Interest in Stookey (20%) 98,464 (To eliminate stockholders' equity accounts of subsidiary [Stookey] against corresponding balance in investment account and to recognize noncontrolling interest ownership.) Entry S2 Common Stock (Yarrow) 300,000 Retained Earnings, 1/1/10 (Yarrow, as adjusted by Entry *C1) 685,856 Investment in Yarrow (90%) 887,270 Noncontrolling Interest in Yarrow (10%) 98,586 (To eliminate stockholders’ equity accounts of subsidiary Yarrow against corresponding balance in investment account and to recognize noncontrolling interest ownership.) Entry A1 Customer List Investment in Stookey Noncontrolling Interest in Stookey (20%) 45,000 36,000 9,000 (To recognize January 1, 2010 unamortized portion of acquisition price assigned to Stookey’s customer list.) McGraw-Hill/Irwin 7- 28 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 27 (continued) Entry A2 Copyright 56,000 Investment in Yarrow 50,400 Noncontrolling interest in Yarrow 5,600 (To recognize January 1, 2010 unamortized portion of acquisition price assigned to copyright.) Entry E Operating Expenses 9,000 Customer List 5,000 Copyright 4,000 (To recognize amortization expense for 2010—$5,000 in connection with Travers' investment and $3,000 in connection with Yarrow's investment.) Entry Tl Sales 100,000 Cost of Goods Sold 100,000 (To eliminate intercompany inventory transfers made during 2010.) Entry G Cost of Goods Sold 9,600 Inventory (current assets) 9,600 (To defer unrealized gain on ending inventory—$20,000 × 48% markup.) Noncontrolling Interest in Stookey's Net Income 2010 Reported net income Customer list amortization Realization of 2009 deferred income (*G) Deferral of 2010 unrealized gain (G) Realized income 2010 Outside ownership Noncontrolling interest in Stookey's net income Noncontrolling Interest in Yarrow's Net Income 2010 Reported net income Copyright amortization Accrual of Stookey's income (80% of $93,080 realized income [computed above]) Realized Income—2010 Outside ownership Noncontrolling interest in Yarrow's net income McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e $100,000 (5,000) 7,680 (9,600) $93,080 20% $18,616 $200,000 (4,000) 74,464 $270,464 10% $27,046 © The McGraw-Hill Companies, Inc., 2009 7- 29 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 27 (continued) Accounts TRAVERS COMPANY AND CONSOLIDATED SUBSIDIARIES Consolidation Worksheet December 31, 2010 Travers Yarrow Stookey Consolidation EntriesNoncontrollingConsolidated Company Company Company Debit Credit Interest Balances Sales and other revenues Cost of goods sold (900,000) 480,000 (600,000) 320,000 (500,000) 260,000 (Tl) (G) 100,000 9,600 Operating expenses Separate company net income Consolidated net income NCI in Yarrow's net income NCI in Stookey's net income To controlling interest Retained earnings, 1/1/10: Travers Company Yarrow Company Stookey Company 100,000 (320,000) 80,000 (200,000) 140,000 (100,000) (E) 9,000 Net Income (above) Dividends paid Retained earnings, 12/31/10 (320,000) 128,000 (892,000) (200,000) 444,000 720,000 380,000 Current assets Investment in Yarrow Company (700,000) (600,000) (300,000) (800,000) (*C2) 836,000 (*C1) 1,560,000 (200,000) (200,000) Retained earnings, 12/31/10 (above) NCI interest in Stookey, 1/1/10 (892,000) (800,000) (400,000) (1,560,000) (917,670) -0-0- (G) 217,670 (S2) (A2) 85,856 (S1) (A1) 9,600 887,270 50,400 393,856 36,000 1,094,400 -0-0- 45,000 (E) 56,000 (E) 2,305,000 40,000 52,000 3,491,400 5,000 4,000 800,000 (460,000) (300,000) (2,113,000) 217,670 85,856 520,000 (A1) (A2) 2,113,000 (*C2) 685,856 (*C1) 7,680 292,320 (800,000) (609,080) 27,046 18,616 (563,418) (563,418) 128,000 (1,353,088) 280,000 344,000 949,000 (S2) (*G) (S1) (400,000) (721,000) (500,000) McGraw-Hill/Irwin 7- 30 329,000 (100,000) Liabilities Common stock Noncontrolling interest in Yarrow, 1/1/10 Noncontrolling interests in subsidiaries Total liabilities and equities (1,900,000) 961,920 7,680 100,000 (27,046) (18,616) Investment in Stookey Company Land, buildings, & equipment (net) Customer List Copyright Total assets (*G) (TI) (1,381,000) (S1) (S2) 200,000 300,000 (S1) (A1) (S2) (A2) 2,008,982 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual 98,464 9,000 98,586 5,600 2,008,982 (500,000) (1,353,088) (107,464) (104,186) (257,312) (257,312) (3,491,400) Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 27 (continued) b Travers' reported income Yarrow's reported income Dividend income (none collected) Intercompany gains (no transfers) Amortization expense Taxable income Tax rate Income tax payable $320,000 200,000 -0-0(9,000) $511,000 45% $229,950 c Stookey's reported income (Unrealized gains are not deferred on a separate tax return.) Tax rate Income tax payable $100,000 45% $45,000 d (1) Because 80% of Stookey's stock is owned by Yarrow, intercompany dividends would be nontaxable Consequently, no temporary difference is created by Stookey's failure to pay a dividend (2) Stookey's unrealized gains are recognized in one time period for financial reporting purposes and in a different time period for tax purposes A temporary difference is created The net effect is an increase in taxable income by $1,920 over reported income: 2010 Unrealized gain taxed in 2010 2009 Unrealized gain taxed previously in 2009 Increase in taxable income Tax rate Deterred income tax asset $9,600 (7,680) $1,920 45% $864 Income Tax Expense: Travers and Yarrow—payable (part b) Stookey—payable (part c) Total taxes to be paid—2010 Prepayment (Asset) (above) Income tax expense 2010 $229,950 45,000 $274,950 (864) $274,086 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 7- 31 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 27 d (continued) Because a single rate is used, income tax expense can also be computed by taking consolidated net income (prior to noncontrolling interest reduction) of $609,080 (part a.) and multiplying by the 45% tax rate to obtain $274,086 Income Tax Expense—Current Deferred Income Tax—Asset Income Tax Payable 274,086 864 274,950 28 (40 Minutes) (Series of questions about a business combination and its income tax reporting) a Partial equity method "Income of Soludan" is 80% of Soludan's reported total b $12,000 Reduction is evidenced by a $338,000 figure reported for consolidated inventory rather than the $350,000 total for the two companies c $37,500 Consolidated operating expenses have increased by $2,500, evidently the annual amortization Because a 15-year life is assumed by the combination, the amount originally allocated to trademarks must have been $37,500 d $120,000 Decrease shown in consolidated sales account e Upstream "Noncontrolling interest in Soludan Company's income" is $18,700 Because this amount is not equal to 20% of Soludan's reported income less excess amortization ($100,000 – $2,500), realized income must have been adjusted for unrealized gains Subsidiary income is only adjusted to show the effects of upstream transfers f $20,000 For both receivables and liabilities, the consolidated total is $20,000 less than the sum of the two companies g $8,000 Consolidated cost of goods sold is decreased by $120,000 (to $780,000) in eliminating intercompany sales The increase of $12,000 created by the ending unrealized gain (see part b.) would then leave a $792,000 balance Because $784,000 is the ending balance reported for consolidated cost of goods sold, an $8,000 unrealized gain must have been deferred from the previous year McGraw-Hill/Irwin 7- 32 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 28 (continued) h Because the trademarks balance now stands at $32,500, amortization expense of $2,500 has been recognized, $2,500 in the previous year In addition, an $8,000 unrealized gain from the prior year (see part g.) is recognized Amortization expense—prior years × 80% Unrealized gain—upstream effect on parent's retained earnings is $8,000 × 80% Adjustment to parent’s beginning retained earnings i This figure is computed as follows: Book value of subsidiary—1/1 Unrealized gain in beginning inventory (see above) Realized book value Excess allocation Total to noncontrolling interest Outside ownership Noncontrolling interest in Soludan's income (as reported) Noncontrolling interest in Soludan's dividends ($20,000 × 20%) Ending noncontrolling interest $2,000 6,400 $8,400 $370,000 (8,000) $362,000 35,000 397,000 20% $79,400 18,700 (4,000) $94,100 j For a consolidated return, unrealized gains are deferred as in the consolidated statements At a 40% rate, both the expense and payable would be $117,400 Income Tax Expense Income Tax Payable 117,400 117,400 Consolidated Taxable Income: Sales $1,280,000 Cost of goods sold (784,000) Operating expenses (202,500) Taxable income $293,500 k On a separate return, Politan would report its operating income of $200,000 leading to a tax expense and payable of $80,000 Because of the level of ownership, intercompany dividend (or investment) income is omitted Income Tax Expense Income Tax Payable McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e 80,000 80,000 © The McGraw-Hill Companies, Inc., 2009 7- 33 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 28 k (continued) On a separate return, Soludan would report $100,000 operating income for a payable of $40,000 The unrealized gains are accounted for in different time periods in the financial statements, thus, a temporary difference is created The beginning gain of $8,000 was taxed in the previous year rather than currently The current gain of $12,000 is taxed now rather than next year; the tax paid this year on the net $4,000 ($1,600) is a prepayment Income Tax Expense Deferred Income Tax - Asset Income Tax Payable 38,400 1,600 Soludan's entry can also be computed as follows: Reported Income Unrealized gain from previous period realized currently Deferral of current unrealized gain Realized Income Tax rate Income tax expense Taxes payable Deferred tax asset 40,000 $100,000 8,000 (12,000) $96,000 40% $38,400 40,000 $1,600 29 (45 Minutes) Develop worksheet entries that were used to consolidate the financial statements of a father-son-grandson combination Entry *G Retained Earnings, 1/1/11 (Delta) 15,000 Cost of Goods Sold 15,000 (To recognize gain that was unrealized in 2010 [amount provided].) Entry *C1 Retained Earnings, 1/1/11 (Delta) 7,000 Investment in Omega Company 7,000 (To recognize amortization expense from Delta’s acquisition for 2010.) McGraw-Hill/Irwin 7- 34 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 29 (continued) Entry *C2 Retained Earnings, 1/1/11 (Alpha) 27,600 Investment in Delta Company 27,600 To recognize accrual adjustments for excess amortization and inventory deferral as follows: Excess amortization from Delta acquisition (80% × $6,250 × years) $10,000 Deltas’ share of excess amortization from Omega acquisition (80% × [70% × $10,000] × year) 5,600 Inventory profit deferral at 1/1/11 (80% × $15,000) (12,000) *C2 adjustment $27,600 Entry S1 Common Stock (Omega) 100,000 Retained Earnings, 1/1/11 (Omega) 100,000 Investment in Omega (70%) 140,000 Noncontrolling Interest in Omega (30%) 60,000 (To eliminate stockholders' equity accounts of Omega against parent's Investment account and to recognize outside ownership.) Entry S2 Common Stock (Delta) 120,000 Retained Earnings, 1/1/11 (Delta, as adjusted) 378,000 Investment in Delta (80%) 398,400 Noncontrolling Interest in Delta (20%) 99,600 (To eliminate stockholders' equity accounts of Delta [as adjusted as Entry *G and Entry *C1] against corresponding balance in Investment account and to recognize outside ownership.) Entry A Copyrights 222,500 Investment in Delta 90,000 Investment in Omega 77,000 Noncontrolling interest in Delta 22,500 Noncontrolling interest in Omega 33,000 (To recognize January 1, 2011 unamortized copyrights, years amortization recorded on first investment but only one year for second.) Entry I1 Income of Subsidiary 144,000 Investment in Delta 144,000 (To eliminate intercompany income accrual found on Alpha's records.) McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 7- 35 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 29 (continued) Entry I2 Income of Subsidiary 49,000 Investment in Omega 49,000 (To eliminate intercompany income accrual found on Delta's records.) Entry D1 Investment in Delta 32,000 Dividends Paid (Delta) 32,000 (To eliminate intercompany dividend payments, 80% of Delta's payment.) Entry D2 Investment in Omega 35,000 Dividends Paid (Omega) 35,000 (To eliminate intercompany dividend payments, 70% of Omega's payment.) Entry E Operating Expenses 16,250 Copyrights 16,250 (Current year amortization, $6,250 on first acquisition and $10,000 on second.) Entry Tl Sales Cost of Goods Sold (To eliminate intercompany inventory transfer.) 200,000 200,000 Entry G Cost of Goods Sold 22,000 Inventory (To defer ending unrealized gain on intercompany transfers.) Noncontrolling Interest in Omega's Income: Reported income Excess fair value amortization Accrual-based income Outside ownership Noncontrolling interest in Omega’s income McGraw-Hill/Irwin 7- 36 $70,000 (10,000) 60,000 30% $18,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual 22,000 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 29 (continued) Noncontrolling Interest in Delta's Income: Reported operating income Equity income investment in Omega (70% × $60,000) Amortization expense 2010 Unrealized income realized in 2011 2011 Unrealized income realized in 2011 Accrual-based income—Delta (2011) Outside ownership Noncontrolling interest in Delta's income (2011) Noncontrolling interest in Delta Company Noncontrolling interest, 1/01/11 (Entry S2) Noncontrolling interest, 1/01/11 (Entry A) Noncontrolling interest in Delta’s income (above) Dividends paid to noncontrolling interest ($40,000 × 20%) Noncontrolling interest in Delta, 12/31/11 Noncontrolling interest in Omega Company Noncontrolling interest, 1/01/11 (Entry S1) Noncontrolling interest in Omega’s income (above) Noncontrolling interest, 1/01/11 (Entry A) Dividends paid to noncontrolling interest ($50,000 × 30%) Noncontrolling interest in Omega, 12/31/11 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e $131,000 42,000 (6,250) 15,000 (22,000) $159,750 20% $31,950 $99,600 22,500 31,950 (8,000) $146,050 $60,000 18,000 33,000 (15,000) $96,000 © The McGraw-Hill Companies, Inc., 2009 7- 37 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter Excel Case Solution Summit Treeline Basecamp Operating income $345,000 $280,000 $175,000 Ownership percentages Summit >Treeline Treeline >Basecamp Dividends paid $150,000 $100,000 $40,000 Excess amortizations $20,000 $25,000 90% 70% Treeline's share of Basecamp income: Basecamp operating income Excess amortization Accrual based income Treeline ownership percentage Equity income from Basecamp $175,000 (25,000) $150,000 70% $105,000 Summit's share of Treeline income: Treeline operating income Equity income from Basecamp Excess amortization Treeline adjusted income Summit ownership percentage Summit's share of reported income $280,000 105,000 (20,000) $365,000 90% $328,500 Controlling interest in net income Summit's operating income Equity earnings in Treeline and Basecamp Summit’s net income $345,000 328,500 $673,500 Comparison Consolidated net income (operating incomes less amortizations) Noncontrolling interest in consolidated net income (30% × $150,000 plus 10% × $365,000) Controlling interest in consolidated net income $755,000 $81,500 $673,500 Difference between Summit’s net income and controlling interest in consolidated net income = -0- McGraw-Hill/Irwin 7- 38 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com RESEARCH CASE: CONSOLIDATED TAX EXPENSE At www.thecoca-colacompany.com the annual financial statements and 10-K provide an excellent set of statements and footnotes to review disclosures for consolidated income tax issues In particular Note 17 provides details of the consolidated tax expense in CocaCola’s 2006 annual report The excerpt below shows the portion of the footnote relating to components of deferred tax assets and liabilities and carryforwards McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 7- 39 ... Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The... Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The... the 70% of Baker controlled by Able) Dexter—33.6% (60% of stock owned by Carter multiplied by the 80% of Carter controlled by Baker multiplied by the 70% of Baker owned by Able) When an indirect