Chapter 4
Consolidated Financial Statements
and Outside Ownership
ANSWERS TO QUESTIONS
1."Noncontrolling interest" refers to an equity interest that is held in a member of a business combination by an unrelated (outside) party.
2.a.Economic unit concept = $220,000 (fair market value)
b.Proportionate consolidation concept = $176,000 (80 percent of fair market value)
c.Parent company concept = $208,000 (all of the book value plus 80 percent of the $60,000 difference between fair market value and book value)
3.Basic information derived from this question:
Book value of Small...... $200,000
Fair market value of Small'sassets and liabilities
(includes adjustment for building)...... $210,000
Implied value of Small ($224,000/70%)...... $320,000
a.Economic Unit Concept—Valuation of Subsidiary Accounts
Implied value of subsidiary (above) $320,000 Annual Excess
Book value of assets and liabilities (100%) {$200,000)LifeAmortizations
Excess to be allocated based on fair market value $120,000
Allocated to building 10,000 10 years $1,000
Allocated to copyright $110,000 20 years 5,500
Total 0 $6,500
Economic Unit Concept—Consolidated Net Income
Giant net income $ 60,000
Small net income (100 %) 30,000
Excess Amortization expenses (above) (6,500)
Total net income $ 83,500
Noncontrolling interest in subsidiary income
(30% of Small's income after reduction for
excess amortizations) (7,050)
CONSOLIDATED NET INCOME AFTER
NONCONTROLLING INTEREST ALLOCATION $ 76,450
b.Proportionate Consolidation Concept—Purchase Price Allocation
Purchase price $224,000
Book value equivalency—70% of total ( 140,000)
Excess cost over book value $ 84,000 Annual Excess
Allocated to building based on fair market valueLifeAmortizations
($10,000 x 70%) 7,000 10 years $ 700
Allocated to copyright 77,000 20 years 3,850
Total 0 $4,550
Proportionate Consolidation Concept—Consolidated Net Income
Giant net income $ 60,000
Small net income (70% of book value) 21,000
Excess Amortization expenses (above) (4,550)
CONSOLIDATED NET INCOME $ 76,450
No noncontrolling interest figures are recognized under the proportionate consolidation concept.
c.Parent Company Concept—Purchase Price Allocation
Purchase price $224,000
Book value 70% of total ( 140,000) Annual Excess
Excess cost over book value $ 84,000 LifeAmortizations
Allocated to building based on fair market value
($10,000 x 70%) 7,000 10 years $ 700
Allocated to copyright 77,000 20 years 3,850
Total 0 $4,550
Parent Company Concept—Consolidated Net Income
Giant net income $ 60,000
Small net income (100%) 30,000
Excess Amortization expenses (above) (4,550)
Total net income $ 85,450
Noncontrolling interest in subsidiary income (30% of book
value) (9,000)
CONSOLIDATED NET INCOME AFTER
NONCONTROLLING INTEREST ALLOCATION $ 76,450
4.The parent company concept is actually a hybrid approach to consolidations that blends aspects of the economic unit concept and proportionate consolidation. In a manner similar to that of proportionate consolidation, the parent company concept presumes that consolidated financial statements are primarily for the benefit of the parent company stockholders. Thus, the cost of making the purchase (and not the implied value of the subsidiary) is of central importance to the establishment of subsidiary account values. However, like the economic unit concept, the parent is viewed as having an indivisible interest in the subsidiary company. For this reason, the full book value of each subsidiary account is entered into the consolidation with no division being recorded based on the ownership percentage.
5.In practice, noncontrolling interest figures will appear in various locations within consolidated financial statements. The end of year balance can be found in the liability section, in the stockholders' equity section, or between these two. The noncontrolling interest's share of net income can be shown as a reduction on either the income statement or the statement of retained earnings. Based on current practice, this textbook reports the ending balance between consolidated liabilities and stockholders' equity with the income allocation shown as a reduction on the income statement.
6.The ending noncontrolling interest can always be determined on a consolidation worksheet by adding the components found in the noncontrolling interest column: the beginning balance plus allocation of current year net income less dividends paid to these outside owners. The ending balance can also be determined (at this point in the exploration of consolidated financial statements) by multiplying the outside ownership percentage by the subsidiary's ending book value. In subsequent chapters, this calculation must be altered because of various adjustments made within the consolidation process.
7.Whenever the purchase of a subsidiary company is made within a fiscal period, the accountant faces a problem of establishing comparable figures between current and subsequent years. The subsidiary’s operational accounts could be included in the consolidation for only the portion of the year after the purchase but comparison with the full year figures reported in the future would be difficult if not impossible. Therefore, the subsidiary’s revenue and expense accounts are usually consolidated in total as if the purchase had taken place on the first day of the current period. Although this procedure helps to ensure comparability, some accounting must be made to remove the results of the subsidiary's operations prior to acquisition. A Preacquisition Income account serves this purpose by reducing consolidated net income by the amount earned by the previous ownership during this time. The figure reported is the subsidiary’s income for the period before the takeover multiplied by the percentage of shares acquired.
In this combination, Sandridge has apparently purchased a subsidiary during the year. The $55,000 preacquisition income being reported represents the current earnings of the acquired portion of the subsidiary generated during the period before the purchase.
8.In previous years, Tree has appropriately utilized the marketvalue method in accounting for its investment In Limb. Now, following a second acquisition, consolidation has become applicable. These two methods are not considered to be comparable. Therefore, at the point in time that Tree begins to produce consolidated statements, all previous financial reports must be restated as if the equity method had been applied since the date of the first acquisition. This handling presents the reader of the financial statements with figures that are more comparable from year to year.
9.When a company sells any portion of an investment, a gain or loss must be recognized. This income effect is the difference between the proceeds received from this transaction and the book value of the investment (or the portion of the investment being sold). The correct book value can only be determined based upon the consistent application of the equity method. Thus, if either the cost method or the partial equity method has been used, Duke must first restate the account to the equity method before recording the sales transaction. This same method is also applied to the operations of the current period occurring prior to the time of sale.
10.In selling a portion of a subsidiary, a gain or loss is recognized by the parent based on the difference in the proceeds received and the book value of that portion of the investment that is removed from the financial records (after being adjusted, if necessary, to the equity method).
11.Unless control is surrendered, the economic unit concept views the sale of subsidiary's stock as a treasury stock transaction. Thus, no gain or loss can be recognized.
12.The decision as to the method to be utilized in accounting for the remaining shares is totally dependent upon the relationship that now exists between the two companies. If Duke has retained control, consolidation is still required. However, if the parent now has only the ability to significantly influence the decisionmaking process, the equity method should be applied. A third possibility does exist: Duke may have lost the power, because of the sale, to exercise even significant influence. The marketvalue method then becomes appropriate.
ANSWERS TO PROBLEMS
1.DThe economic unit concept consolidates assets at fair market value. The proportionate consolidation concept uses the ownership percentage (60%, in this case) of fair market value. The parent company concept consolidates all of the asset's book value ($200,000) plus the ownership percentage of the difference between market value and book value (60% of $300,000 or $180,000).
2.DIf the subsidiary's figures are consolidated, all of any intercompany balance is intercompany and must be eliminated within the process of producing financial statements for external reporting purposes.
3.BPurchase Price ...... $692,000
Book Value of Net Assets
($760,000 x 80%) ...... (608,000)
Purchase Price in Excess of Book Value... $ 84,000 Annual Excess
Excess Purchase Price Assigned Based LifeAmortizations
on Market Value:
—Equipment ($60,000 x 80%) ...... 48,000 4 years $12,000
—Patent ($45,000 x 80%) ...... 36,000 10 years 3,600
Total...... 0 $15,600
Patent = $28,800 (allocation after two years of amortization)
4.AUndervaluation of Building ($310,000 $260,000) .... $ 50,000
Ownership Acquisition ...... 70%
Allocation to Building at January 1, 2001 ...... $ 35,000
Life of Building ...... 10 years
Annual Amortization ...... $ 3,500
Consolidated Building, 12/31/03 = $779,500 (add the two book values plus the initial allocation after three years of amortization)
5.DPurchase Price ...... $840,000
Book Value of Net Assets ($880,000 x 80%). (704,000)
Purchase Price in Excess of Book Value .. $136,000Annual Excess
Excess Purchase Price Assigned Based LifeAmortizations
on Market Value:
—Building ($70,000 x 80%) ...... 56,000 10 years $5,600
—Goodwill ...... 80,000 indefinite 0
Total ...... 0 $5,600
Consolidated Expenses = $1,340,600 (add the two book values plus the annual excess amortization of the building allocation)
6.BConsolidated Revenues = $1,100,000 (add the two book values)
Consolidated Expenses = $708,800 (add the two book values plus the annual excess amortization)
Consolidated Net Income = $351,200 (consolidated revenues less
consolidated expenses less non-controlling interest of $40,000)
7.C
8.B
9.AAllocation of First Purchase
Purchase price ...... $160,000
Book value of net assets ($400,000 x 30%) . 120,000
Goodwill ...... $ 40,000
Allocation of Second Purchase
Purchase price ...... $240,000
Book value of net assets ($550,000 x 40%) . 220,000
Goodwill ...... $ 20,000
Total Goodwill = $60,000
10.C
11.ASubsidiary’s reported income ...... $240,000
Outside ownership ...... 30%
Noncontrolling interest ...... $ 72,000
Preacquisition Income
Subsidiary's reported income ...... $240,000
Previous ownership ...... 70%
Period of previous ownership ...... 3/12 Yr.
Preacquisition income ...... $ 42,000
12.DPurchase Price Allocation and Amortization
Purchase price ...... $300,000
Book value equivalency (60%)...... (240,000)
Purchase price in excess of book value... $ 60,000 Annual Excess
Excess cost assigned to specific Life Amortizations
accounts based on fair market value
Equipment (60%) ...... 36,000 10 years $3,600
Buildings (60%)...... 24,000 20 years 1,200
Total ...... 0 $4,800
Consolidated Net Income
Consolidated revenues (book values added) ...... $1,300,000
Consolidated expenses (book values added) ...... (800,000)
Excess amortization expenses (above) ...... (4,800)
Consolidated net income ...... $ 495,200
13.B40% of the subsidiary's income ($100,000) and 40% of the subsidiary's ending book value ($530,000, as found by subtracting liabilities from assets): $40,000 and $212,000 respectively.
14.ADavid's book value ...... $260,000
Mark's book value ...... 200,000
Allocation from purchase price (see 12 above) ...... 36,000
Excess amortization for two years ...... (7,200)
Consolidated equipment account ...... $488,800
15.A Purchase price ...... $60,000
90% of Strass's book value ...... (45,000)
Price paid in excess of book value ...... $15,000
Excess assigned to Inventory (60%) ...... $ 9,000
Excess assigned to goodwill (40%) ...... $ 6,000
Consolidated current assets—$99,000 (add the two book values and include $9,000 allocation above)
16.CAdd the two book values and include $6,000 allocation to goodwill.
17.BAdd the two book values and include 10% (the current portion) of the loan taken out by Polk to acquire Strass.
18.BAdd the two book values and include 90% (the noncurrent portion) of the loan taken out by Polk to acquire Strass. in addition, because the problem so indicates, the 10% noncontrolling interest is included. These outside owners report a $5,000 balance or 10% of the book value of the subsidiary.
19.AAt the date of a purchase, only the parent's stockholders' equity accounts are included.
20.(8 Minutes) (Determine consolidated balances with a noncontrolling interest present)
a.Harrison's income 2002 ...... $220,000
Starr's income 2002 ...... 70,000
Amortization expense (given) ...... (8,000)
Noncontrolling interest in Starr's income (10%) ...... (7,000)
Consolidated net income 2002 ...... $275,000
Harrison's income 2003 ...... $260,000
Starr's income 2003 ...... 90,000
Amortization expense (given) ...... (8,000)
Noncontrolling interest in Starr's income (10%) ...... (9,000)
Consolidated net income 2003 ...... $333,000
b.Starr's book value January 1, 2002:
Common stock ...... $100,000
Retained earnings ...... 200,000 $300,000
Starr's income—2002 ...... $ 70,000
Dividends paid ...... (30,000) 40,000
Starr's income—2003 ...... $ 90,000
Dividends paid ...... (30,000) 60,000
Starr's book value December 31, 2003 .... $400,000
Outside ownership ...... 10%
Noncontrolling interest in Starr—December 31, 2003 $ 40,000
21.(20 Minutes) (Determine consolidation income balances, includes a preacquisition income figure)
a.Purchase Price ...... $406,000
Book Value of Net Assets
($400,000 x 70 %) ...... (280,000)
Purchase Price in Excess
of Book Value ...... $126,000 Annual Excess
Excess Purchase Price Assigned LifeAmortizations
Based on Market Value:
—Patent ($140,000 x 70%) ...... 98,000 5 years $19,600
—Land ($10,000 x 70%) ...... 7,000
—Buildings ($30,000 x 70%)...... 21,000 10 years 2,100
Total...... $ 0 $21,700
Consolidated Figures:
—Revenues = $1,500,000 (add book values)
—Expenses = $1,021,700 (add book values and add excess amortizations)
—Noncontrolling interest in Subsidiary’s net income = $60,000 (30% of Bytvl's income)
—Net income = $418,300 (revenues less expenses and noncontrolling interest)
b.Consolidated figures:
—Revenues = $1,350,000 (add book values)
—Expenses = $936,275 (add book values and add excess amortization for 9 months)
—Noncontrolling interest in subsidiary's net income = $63,000 (30% of Bytvl's income)
—Preacquisition income = $36,750 (70% of Bytvl's income for 3 months)
—Net income = $313,975 (revenues less expenses, noncontrolling interest,
and preacquisition income)
22.(30 Minutes) (Determine various balances using each of the concepts presented in this chapter)
a.Economic Unit Concept
Implied Value of Company $42,000/60% = ...... $70,000
Book Value ...... (10,000)
Implied Value in Excess of Book Value ...... $60,000
Allocation to invention Based on Difference in Fair Market Value
and Book Value ($50,000 $10,000) ...... 40,000
Goodwill ...... $20,000
Excess Amortizations:
Invention $40,000/10 years = $4,000
Goodwill indefinite life 0
Total $4,000
Consolidated Figures:
—Revenues = $50,000 (book value)
—Expenses = $24,000 (book value plus excess amortizations)
—Noncontrolling interest in subsidiary's income = $10,400 (40 percent of revenues less expenses)
—Goodwill = $20,000 (original allocation)
—Invention = $45,000 (1/1/02 book value less one year of amortization plus $40,000 allocation less one year of amortization on that figure)
b.Proportionate Consolidation
Purchase price ...... $42,000
Book Value ($10,000 x 60%) ...... (6,000)
Purchase Price in Excess of Book Value ...... $36,000
Allocation to Invention Based on Difference in Fair Market Value
and Book Value ($40,000 x 60%) ...... 24,000
Goodwill ...... $12,000
Excess Amortizations:
Invention $24,000/10 years = $2,400
Goodwill indefinite life 0
Total $2,400
Consolidated Figures:
—Revenues = $30,000 (60% of book value)
—Expenses = $14,400 (60% of book value plus amortization)
—Noncontrolling interest in subsidiary's income = 0 (not recognized in this approach)
—Goodwill = $12,000 (original allocation)
22. (continued)
—Invention = $27,000 (60% of 1/1/02 book value less one year of depreciation [$6,000 less $600] plus $24,000 allocation less one year of excess depreciation on that figure)
c.Parent Company Concept
Purchase price ...... $42,000
Book Value ($10,000 x 60%) ...... (6,000)
Purchase Price in Excess of Book Value ...... $36,000
Allocation to invention on Difference in Fair Market Value
and Book Value ($40,000 X 60%) ...... 24,000
Goodwill ...... $12,000
Excess Amortizations:
Invention $24,000/10 years = $2,400
Goodwill indefinite life 0
Total $2,400
Consolidated Figures:
—Revenues = $50,000 (book value)
—Expenses = $22,400 (book value plus amortization)
—Noncontrolling interest in subsidiary's income = $12,000 (40 percent of subsidiary revenues less expenses [amortization not included])
—Goodwill = $12,000 (original allocation)
—Invention = $30,600 (1/1/02 book value less one year of depreciation plus $24,000 allocation less one year of excess depreciation on that figure)
23.(20 Minutes) (Determine consolidated net income for a step purchase and the ending balance of the noncontrolling interest)
a.Mabry's income—2002 (given) ...... $360,000
Thompson's income 2002:
Revenues ...... $600,000
Expenses ...... (420,000) 180,000
Excess amortization expenses
First purchase (given) ...... (6,000)
second purchase ($10,000 x 3/12) (2,500)
Preacquisition income (second purchase)
($180,000 x 30% x 9/12) ...... (40,500)
Noncontrolling interest in Thompson's income (10%) (18,000)
Consolidated net income ...... $473,000
b.Thompson's book value—1/1/02
Common stock...... $310,000
Retained earnings, 1/1/02...... 540,000 $850,000*
Operations—2002
Net income (revenues minus expenses) $180,000*
Dividends paid ...... (70,000)* 110,000
Book value 12/31/02 ...... $960,000
Outside ownership ...... 10%
Noncontrolling interest in Thompson—12/31/02 $ 96,000
*Ending noncontrolling interest can also be computed by taking 10 percent of each of these three marked numbers and then totaling them as in the noncontrolling interest column on the worksheet.
24.(10 Minutes) (Consolidated income statement figures for a step acquisition)
a.Revenues—Lamp...... $500,000
Expenses Lamp ...... 300,000
Net income Lamp ...... $200,000
Outside ownership (at end of year) ...... 20 %
Noncontrolling interest in subsidiary income ...... $ 40,000
b. Preacquisition Income ($200,000 [earned by Lamp]
x 30% x 3/12 year) ...... $ 15,000
c.Consolidated revenues ...... $1,100,000
Consolidated expenses ...... (680,000)
Amortization expense ($60,000 ÷ 20 years) ...... (3,000)
Preacquisition Income (above) ...... (15,000)
Noncontrolling interest in subsidiary income (above) .... (40,000)
Consolidated net income ...... $ 362,000
25.(30 Minutes) (Reporting the sale of a portion of an investment in a subsidiary)
a.The 1,000 shares that are sold are reported by means of the equity method for the period from January 1, 2002 until October 1, 2002. This stock represents 10 percent of the outstanding shares of Green. Consequently, an accrual of $9,000 is reported by Wilson (10% x $120,000 x 9/12 year). This figure is then reduced by $1,071 in amortization expense as computed below. Therefore, an "Equity Income from Sold Shares of Green" in the amount of $7,929 will appear in the 2001 consolidated income statement for this business combination. This figure appears although Green Company is actually being consolidated. The consolidation will now include all of Green's accounts with a 40 percent reduction for the noncontrolling interest.
Purchase price ...... $800,000
70% of subsidiary's book value ...... (700,000)
Patent ...... $100,000
Life of patent ...... 10 years
Annual amortization ...... $ 10,000
Amortization relating to 1,000 shares sold for period from January 1, 2002 until October 1, 2002:
Annual amortization ...... $10,000
Time period involved ...... 9/12years
Amortization for nine months ...... $ 7,500
Shares sold—1,000 out of 7,000 ...... 1/7
Amortization relating to sold shares ...... $ 1,071 (rounded)
b. Correct Investment Book Value 10/1/02
1/1/02 balance (given—partial equity method) ... $1,085,000
Amortization 19982001 (4 years) ...... (40,000)
Recognition of 1/1/0210/1/02 period:
Income accrual ($120,000 x 70% x 9/12) ...... 63,000
Dividends ($40,000 x 70% x 9/12) ...... (21,000)
Amortization ($10,000 x 9/12) ...... (7,500)
Correct investment book value—10/1/02...... $1,079,500
Computation of Income Effect—Sales Transaction
10/1/02 book value (above) ...... $1,079,500
Portion of investment being sold
(1,000 out of 7,000 shares) ...... 1/7
Book value of investment being sold ...... $ 154,214 (rounded)
Proceeds ...... 191,000
Gain on sale ...... $ 36,786
25. (continued)
c.Since Wilson continues to hold 6,000 shares of Green, control is still maintained and consolidated financial statements would be appropriate with a noncontrolling interest of 40 percent.
26.(20 Minutes) (Consolidated figures with both preacquisition income and a noncontrolling interest)
A.To provide figures that will be comparable with future time periods, the consolidated income statement would include all $400,000 in revenues generated by Quinn during the entire year of 2002.
B.The noncontrolling interest is Anita Blackwood who owned 30 percent of Quinn during the entire year. Therefore, the noncontrolling interest in Quinn’s income that will be reported in the consolidated income statement is $54,000 ($180,000 net income multiplied by 30 percent outside ownership).
C.The $3,500 per month (70%) paid in dividends to Palmer ($38,500 in total for 11 months) is eliminated entirely within the consolidation process (through Entry S). This money was distributed by Quinn to a person who is no longer an owner. Thus, no reporting in the consolidated statements is necessary.
D.Preacquisition income is the earnings that can be attributed to Palmer for the first 11 months of the year. Her share of income was $10,500 per month (70% of $15,000) for 11 months for a total $115,500. This amount is a reduction within the consolidated income statement to bring the final income figure in line with the amount actually accruing to Brown's ownership during the final month of the year.