Solution manual advanced accounting 11e by BEAMS 08 chapter

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

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Chapter 8

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 percent interest in S on July 1, 2011 and that S has earnings of $100,000 between January 1 and July 1, 2011 and pays $50,000 dividends on May 1, 2011 In this case, preacquisition earnings and dividends are $100,000 and $40,000, respectively Historically, preacquisition earnings purchased were shown as a deduction on the income statement to arrive at consolidated net income Under current GAAP, this is no longer the case Instead, the consolidated income statement should only report revenues, expenses, gains and losses subsequent to the acquisition For example, in a March 31 acquisition, the consolidated income statement would only include income of the subsidiary from April 1 through December 31 GAAP 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 earning power of the acquired firm

2 Preacquisition earnings are not recorded by a parent 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 current GAAP, this is no longer the case Instead, the consolidated income statement should only report revenues, expenses, gains and losses subsequent to the combination date For example, in a March 31 acquisition, the consolidated income statement would only include income 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 at year-end is computed for the 10 percent interest held by noncontrolling stockholders at the end of the year Noncontrolling interest share for the year has two parts: (1) annual income x 50% x 10% plus (2) annual income x 50% x 20%

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 not income of the noncontrolling stockholders at the date of the financial statements In fact, preacquisition income relates to a previous controlling stockholder group when the interest acquired exceeds 50 percent

In such a case, it seems improper to report this as a deduction in the consolidated income statement Rather, the fair value of net assets acquired should reflect the acquiree’s earnings history

5 Under GAAP, 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) and the recorded book value of the interest sold, provided that the investment is accounted for as a one-line consolidation 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 been used previously

When the parent maintains a controlling interest after the sale, the sale is treated as an equity transaction, with no gain or loss recognition The parent debits cash or other consideration received in the sale, credits the investment account based on percent of carrying value sold, and records the difference 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 is computed 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 beginning-of-the-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 is used, income must be assigned to the increased noncontrolling interest for the entire year of sale The combined investment income and gain or loss on sale are the same under both approaches provided that the assumptions (beginning of the year and time of sale) are followed consistently As noted in question 5, gain

or loss on the sale of the equity interest is only recognized when the subsidiary is deconsolidated 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 the parent’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 the parent as follows:

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

3 percent of the proceeds, the difference being the amount of adjustment 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%) The change in the interest held does not affect the way in which the parent records its additional investment The parent 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 is above or below book value But, if the purchase price is above the book value of equity acquired, then the excess is assigned to undervalued assets or goodwill If the purchase price is below the book value of equity acquired, then the excess should

be assigned to reduce overvalued identifiable assets or goodwill

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

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

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

SOLUTIONS TO EXERCISES

Solution E8-1

Allocation of Set’s net income:

Controlling share of income

($100,000  70%  1/2 year) + ($100,000  90%  1/2 year) $ 80,000 Noncontrolling interest share

(30% x $100,000 x ½ year) + (10% x $100,000 x ½) $20,000

Note: This does not appear on the consolidated income statement

Allocation of Set’s dividends:

Dividends to Pie ($30,000  70%) + ($30,000  90%) $ 48,000 Noncontrolling interest ($30,000 x 30%) + ($30,000 x 10%) $ 12,000

Solution E8-2

1 Income from Sip for 2011:

40% interest x $240,000 x 8/12 year $64,000 60% interest  $240,000  1/3 year $ 48,000

2 Preacquisition income:

Under GAAP, 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 Pin’s interest increased from 40% to 60%,

so the consolidated income statement includes Sip income of

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

3 Noncontrolling interest share for 2011:

Solution E8-3 (amounts in thousands)

Entry to record sale of 15% interest:

To record sale of 15% interest in Sap

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

interest

Entry to record investment income for 2011:

Investment in Sap($600  85%) 510

To record income from Sap

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 Pal

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

Adjustment to increase additional paid-in capital $ 11

2 Income from Sag

Beginning of the period sale assumption

Actual sale date assumption

Solution E8-4 (continued)

3 Investment in Sag December 31, 2011

Period Sale Sale Date

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

Book value ($1,480 January 1 balance

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

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

acquisition date)

Income from Set ($240,000  7/12 year  70%) $ 98

1c Investment in Set at December 31

Investment in Set December 31, 2011 $1,330

2 Consolidation working paper entries:

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

b Common stock, $10 par — Set 1,000

Retained earnings — Set 580

c Noncontrolling interest share 240,000 x 7/12 x 30% 42,000

Noncontrolling interest 6,000

Solution E8-6

1 Investment in Sow (in thousands)

Investment balance December 31, 2011 ($9,000  80%) $ 7,200 Cost of new shares ($25  60,000 shares) 1,500

Investment in Sow after new investment $ 8,700

2 Goodwill from new investment

Sow’s stockholders’ equity after issuance

Pal’s ownership percentage

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

Less: Pal’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:

Additional paid-in capital 115,200

To record increase in investment in Sod computed as follows: Book value before issuance ($3,200,000  80%) $2,560,000 Book value after issuance ($3,800,000  70.4%) 2,675,200

Solution E8-8

Pam 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 Sat:

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

Book value of Pam’s investment in Sat

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, 2011 acquisition

Implied total fair value of Sum ($64,000 / 20%) $320,000

Book 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, 2012 acquisition

Implied total fair value of Sum ($164,000 / 40%) $410,000

Book 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

2011

Income from Sum for 2011 ($80,000  20%  3/4 year) $ 12,000

2012 Income from Sum

20% share of reported income ($80,000  20%) $ 16,000

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

2 Noncontrolling interest December 31, 2012

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

3 Preacquisition income does not appear in income statement

4 Investment balance at December 31, 2012

Gain on revaluation of investment

Less: Dividends ($2,000 + $6,000)

18,000 (8,000)

Implied fair value of Sum ($164,000/0.4) $410,000

Fair value of original investment($410,000 x 20%)

Less: Cost of original investment

82,000 (64,000)

Solution E8-10

Preliminary computations

Implied total fair value of Sad ($675,000 / 90%) $750,000

Less: Book value of Sad at acquisition:

Equity of Sad December 31, 2011 $700,000

Excess (book value = underlying equity) 0

1 Investment income from Sad

Income from Sad — 2012 ($100,000  1/2 year  90%) $ 45,000

Income from Sad — 2013:

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

$ 68,000 Investment in Sad

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

Investment balance December 31, 2012 675,000 Less: Book value of 1/9 interest sold on July 1, 2013a (79,000)

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

Investment balance December 31, 2013 $640,000

a Sale of 10% interest July 1, 2013:

Add: Income less dividends — 2012 50,000

Underlying equity of interest sold $ 79,000

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

Since Pit 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)

2 Noncontrolling interest share

Noncontrolling interest share — 2012:

($100,000 income  10% interest x 1/2 year) $ 5,000

Noncontrolling interest share — 2013:

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

Noncontrolling interest December 31, 2012

Add: Income less dividends for 2012 50,000

Noncontrolling interest percentage 10%

Noncontrolling interest December 31 $ 75,000

Noncontrolling interest December 31, 2013

Add: Income less dividends for 2013 50,000

Noncontrolling interest percentage 20%

Noncontrolling interest December 31 $160,000

Solution E8-11

Preliminary computations:

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

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

1 Underlying book value December 31, 2012

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

3 Investment in Soy balance January 3, 2013

Add: Share of Soy’s income less dividends

4 Percentage ownership if shares sold to outside entities

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

5 Investment in Soy balance January 3, 2013

Investment in Soy December 31, 2012

Add: Increase in book value from change in

ownership interest:

Book value after additional 10,000 shares

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

were issued ($1,000,000 equity  75%) (750,000) 30,000 Investment in Soy balance - January 3, 2013 $ 870,000

Less: Book value of Son after issuance 710,000

To record income from Son($90,000  10,000/12,000)

Solution E8-13

1 Investment in Sir (in thousands)

Add: 90% of $300 increase in equity since 2011 270

Investment in Sir January 1, 2013 $2,070

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

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

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

$ 180

SOLUTIONS TO PROBLEMS

Solution P8-1

Preliminary computations (in thousands):

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

Implied fair value of Sin [$162/(10/60)] $972

Fair value of original investment:

Less: Carrying value of original investment:

Gain on revaluation of investment

620 $28

1 Investment in Sin — December 31, 2011

Add: Income from Sin- $100  1/2 year  80% 40

Investment in Sin December 31, 2011 $620

2 Income from Sin — 2012

3 Investment in Sin — December 31, 2012

Investment balance December 31, 2011 $620

Add: Revaluation of original investment

Less: Dividends for 2012 ($60  5/6)

28 (50) Investment in Sin December 31, 2012 $885

Solution P8-2

1 Investment in Sit (in thousands)

Investment in Sit January 1, 2013 $22,800

2 Percentage interest after stock issuance

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, 2011

Actual Sale Date

Investment in Saw

Beginning of Year Sale Date Balance January 1, 2011 $1,039,500 $1,039,500 Add: Income from Saw

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

First half-year (72,000) (72,000) Last half-year (64,000) (64,000) Less: Book value of interest sold (121,500) (107,500)

Balance December 31, 2011 $1,020,000 $1,020,000

Solution P8-4

(in thousands)

Entries on Pan’s books to reflect the change in ownership interest:

Option 1 Pan sells 30,000 shares of Son

To record sale of 30,000 shares at $50 per share No gain or loss is

recognized since Pan maintains a controlling interest

Option 2 Son issues and sells 40,000 shares to the public

To record adjustment in ownership computed as follows:

Book value after sale of 40,000 shares

Book value before sale of 40,000 shares

Increase in book value of investment from sale $ 630

Option 3 Son reissues 40,000 shares of treasury stock

To record adjustment in ownership computed the same as 2 above

Consolidated Stockholders’ Equity

Total stockholders’ equity $23,240 $23,740 $23,740

a Noncontrolling interest under option 1: $10,440  25%

Noncontrolling interest under options 2 and 3: $12,440  25%