Chapter 3
Introduction to Consolidation: The Balance Sheet
SUMMARY OF ASSIGNMENT MATERIAL
Item / Topic Covered / Level / TimeQ3.1 / Discussion of why consolidated statements are required for reporting following a business combination recorded as a stock acquisition. / Low / 5-10
Q3.2 / Understanding the nature of the consolidated entity. / Low / 5-10
Q3.3 / Explanation of why working paper eliminations are needed to eliminate double counting. / Low / 5-10
Q3.4 / Discussion of the concept of control in consolidation policy. / Mod / 10-15
Q3.5 / Reason for presence of both purchase premium and negative goodwill. / Low / 5-10
Q3.6 / Reconciliation of presence of positive goodwill when a purchase discount exists. / Mod / 5-10
Q3.7 / Procedure for valuation of individual assets and liabilities of S when neither a purchase premium nor a purchase discount exists. / Mod / 10-15
Q3.8 / Differences between consolidated statements and post-merger combined statements (as in Chapter 1). / Mod / 10-15
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SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item / Topic Covered / Level / TimeQ3.9 / Explanation of whether the wholly-owned versus partially owned subsidiary scenarios affect the total amount of reported consolidated assets. / Mod / 10-15
Q3.10 / Treatment of subsidiary's dividends unpaid at date of business combination. / Mod / 10-15
Q3.11 / Treatment of subsidiary's goodwill under purchase accounting. / Low / 5-10
Q3.12 / Explanation of assumptions underlying recognition of goodwill. / Mod / 5-10
E3.1 / Recording purchase combinations, investment eliminations, calculations of consolidated assets and retained earnings. / Low / 15-20
E3.2 / Investment eliminations under seven alternative stock purchase plans. / Mod / 15-20
E3.3 / Elimination entry and preparation of consolidated balance sheet for a pooling combination. / Mod / 15-20
E3.4 / Working paper entries to prepare consolidated balance sheet under purchase and pooling alternatives; purchase premium and fair value adjustments. / Mod / 20-25
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SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item / Topic Covered / Level / TimeE3.5 / Working paper entries to prepare consolidated balance sheet in purchase combination; purchase premium and negative goodwill. / Mod / 20-25
E3.6 / Completion of elimination entries and working backward to book values. / Mod / 15-20
E3.7 / Consolidated balance sheet purchase premium and goodwill. / Mod / 20-30
E3.8 / Allocation of purchase premium and purchase discount; negative goodwill. / Mod / 20-25
E3.9 / Reconstruct working paper eliminations from pre-acquisition and consolidated information and compute acquired company's total assets. / Mod / 20-25
E3.10 / Under the purchase method, reconstruct the entry to record the business combination, the subsidiary's balance sheet, and the consolidation elimination entry. / Low / 15-20
E3.11 / Working backwards from elimination entries. / Mod / 15-20
E3.12 / Application of SFAS 94 and FASB 1999 Exposure Draft. / High / 15-20
P3.1 / Schedule to allocate purchase premium, working paper eliminations and consolidated balance sheet. / Mod / 20-30
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SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item / Topic Covered / Level / TimeP3.2 / Consolidated balance sheet working paper and formal consolidated balance sheet; purchase premium. / Mod / 20-30
P3.3 / Consolidated balance sheet working paper; unpaid dividends at acquisition, goodwill recorded by subsidiary, purchase premium and consolidated goodwill; pooling of interests. / Mod / 50-60
P3.4 / Consolidated balance sheets under complete ownership and partial ownership assumptions; purchase premium, purchase discount, and negative goodwill. / High / 50-60
P3.5 / Consolidated balance sheet working paper; purchase discount, positive and negative goodwill, minority interest. / Mod / 50-60
P3.6 / Reconstruction of consolidation elimination entry and P's balance sheet given consolidated balance sheet and S's balance sheet. / High / 30-40
P3.7 / Consolidation of three subsidiaries including the preparation of the consolidated balance sheet at combination date and the preparation of elimination entries to consolidate each of the three subsidiaries. / Mod / 30-40
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SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item / Topic Covered / Level / TimeP3.8 / Reconstruct working paper eliminations and subsidiary's separate balance sheet from parent's separate balance sheet and consolidated balance sheet. / High / 30-40
P3.9 / Consolidated balance sheet under purchase and pooling of interests; effect on future income. / Mod / 40-50
P3.10 / Analysis of elimination entries for purchase and pooling; finding various data. / Mod / 30-40
P3.11 / Consolidated balance sheet working paper with both a purchased and a pooled subsidiary; no purchase premium or fair value adjustments. / Mod / 30-40
P3.12 / Consolidation policy; analysis using FASB 1999 Exposure Draft. / High / 30-40
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CARRYBACK TABLE
The carryback table identifies the assignment items which are new in this edition and those which are carried over from the seventh edition. For the latter, the problem number in the seventh edition is shown.
New Problem Number / Source / New Problem Number / Source / New Problem Number / SourceQ3.1 / Q3.1 / E3.1 / E3.11 / P3.1 / P3.1
Q3.2 / Q3.2 / E3.2 / E3.2 / P3.2 / P3.2
Q3.3 / Q3.3 / E3.3 / new / P3.3 / P3.3
Q3.4 / Q3.4 / E3.4 / E3.4 / P3.4 / P3.9
Q3.5 / Q3.5 / E3.5 / E3.5 / P3.5 / P3.5
Q3.6 / Q3.6 / E3.6 / E3.6 / P3.6 / P3.6
Q3.7 / Q3.7 / E3.7 / E3.7 / P3.7 / P3.7
Q3.8 / Q3.8 / E3.8 / E3.8 / P3.8 / P3.8
Q3.9 / Q3.9 / E3.9 / E3.9 / P3.9 / P3.41
Q3.10 / Q3.10 / E3.10 / E3.101 / P3.10 / P3.10
Q3.11 / Q3.111 / E3.11 / E3.11 / P3.11 / P3.11
Q3.12 / Q3.12 / E3.12 / E3.12 / P3.12 / P3.12
1 Revised for requirements of SFAS 141 and SFAS 142.
Carryforward tables for all chapters, identifying the disposition of seventh edition assignment items, appear at the beginning of the solutions manual.
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ANSWERS TO QUESTIONS
Q3.1
In the case of a business combination recorded as a merger, the acquired company is absorbed into the acquiring company, resulting in a single entity. There is only one set of accounting records, and thus no consolidation is needed. In the case of a business combination recorded as a stock acquisition, both companies remain as separate entities, with their own accounting records. Consolidation is required to present one set of financial statements for this single economic entity.
Q3.2
While the parent company (P) is a legal entity and the subsidiary company (S) is a legal entity, the consolidated company (P+S) is not a legal entity in a strict sense. There is, however, considerable economic meaning to the consolidated entity. P controls the combined resources and operations of both companies. Investors and creditors would recognize this, and view P+S as the relevant entity for their investment or lending decisions. Under some circumstances, tax law recognizes P+S as the tax-paying entity. Thus, while P+S is an accounting creation, it is deemed to represent the economic reality of common ownership.
Q3.3
When two affiliated corporations engage in transactions with one another, double counting generally results. For example, an intercompany sale of merchandise will result in both companies recording Purchases (or Cost of Goods Manufactured) for the same merchandise. Similarly, the internal sale and the subsequent external sale mean that Sales of the same goods are recorded twice within the same reporting entity.
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Q3.3 (cont=d.)
The Investment in S duplicates the net assets of the subsidiary and the parents' stockholders' equity represents control over the subsidiary's stock as represented by the subsidiary's stockholders' equity. There are other examples.
Double counting is eliminated in consolidation so that consolidated assets, liabilities, revenues and expenses will not include internal transactions and, accordingly, will not be overstated.
Q3.4
Control involves unshared decision-making power over assets. An individual company possesses that unshared power over its own assets, enabling it to include them in its own balance sheet. Only when a parent has that same degree of control over a subsidiary=s assets is it appropriate to consolidate the subsidiary=s assets (and liabilities) and include them with those of the parent.
Legal control is the unconditional ability to direct decision-making and is indicated by direct or indirect ownership of a majority of another entity=s voting shares, enabling the parent to direct decision-making by dominating a subsidiary=s governing board. In contrast, effective control exists when a parent possesses that decision-making power without majority ownership. By its very nature effective control is somewhat more tentative than legal control and, as the text discussion indicates, is conditioned on the strength of the parent=s interest and the weakness of other interests in a subsidiary.
Q3.5
A purchase premium results when the investment cost is greater than the book value of the net assets required. Negative goodwill arises when the fair value of the net assets acquired exceeds the investment cost. The two are not mutually exclusive. While the more common case involves a purchase premium and positive goodwill, there is no inherent reason why negative goodwill could not have been present instead.
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Q3.6
A purchase discount results when the investment cost is less than the book value of the net assets required. (Positive) goodwill arises when the fair value of the net assets acquired is less than the investment cost. The two are not mutually exclusive. While the more common case involves a purchase premium and positive goodwill, there is no inherent reason why a purchase discount could not have been present instead.
Q3.7
The identifiable assets and liabilities of a purchased company must be stated at their fair values at date of business combination. This is done when consolidated statements are prepared in a stock acquisition; for other types of business combinations the allocation takes place on the books of the acquiring company. The need for establishing these fair values is independent of the existence of a purchase premium or discount. Without the need to allocate a purchase premium or discount, the fair value adjustments may be made directly on the consolidated working paper. Alternatively, the schedule used in the text to allocate a purchase premium or discount could also be used here. Some items would be above book value, others below. In sum, the net difference between book and fair value is zero. Equivalently, a redistribution has taken place as a way of allocating a zero purchase premium (discount).
Q3.8
In a stock acquisition, the combining companies continue as separate legal entities with their own separate financial statements. Consolidated statements which bring together these separate statements are prepared only for reporting purposes and the necessary allocation of any purchase premium or discount must be made at consolidation points. Since the companies acquired in a statutory merger or statutory consolidation lose their separate legal identities, the allocation is made by the acquiring company on its books at date of acquisition. Other things being equal, the financial statements following a merger would be no different from consolidated statements prepared after a stock acquisition.
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Q3.9
The total consolidated assets could be different in such a case. A difference would occur in the case where the purchase method is used and fair values of the subsidiary's net assets differ from book values. The reason for a difference is that fair value adjustments are recorded only to the extent of the parent's ownership interest. Thus 100 percent of the fair value adjustment would be recorded in the wholly-owned case, and less than 100 percent would be recorded in the partially-owned case.
Note that no difference would occur if (a) the pooling of interests method were used or (b) the purchase method were used and investment cost equaled book value of net assets acquired.
Q3.10
To compute the purchase premium, the dividends of $80,000 declared on the shares of S held by P must be offset against the investment account. S's stockholders' equity of $2,000,000 already has been reduced by the entire $100,000 dividend declaration. Thus the purchase premium is $20,000 (= $1,700,000 $80,000 .8($2,000,000)). P must explicitly recognize the $80,000 in dividends as follows.
Dividends Receivable / 80,000Investment in S / 80,000
To record P's share of dividends declared by S company.
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Q3.11
Goodwill recorded by a subsidiary is ignored when assigning fair values to S's identifiable assets and liabilities. At most, the subsidiary's goodwill would be reflected in any purchased goodwill implicit in the parent's purchase price. Only $720,000 is carried to consolidated assets.
Q3.12
The assumption underlying recording goodwill as an asset is that the investment cost represents a fair price for the interest in S that was acquired, and that the tangible and intangible items acquired have future value. It is assumed that the investment cost arises from a market process that fairly values these items.
In some cases, this assumption may not be warranted. An acquisition price could be too high, especially if the acquisition follows a bidding process where egos of the acquiring executives get involved. If an excessive price is paid, the excess should not be considered an asset.
Unfortunately, there is no good way to determine if an acquisition price is excessive. Much judgement is involved. Thus the assumption that a fair market price was reached typically prevails.
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SOLUTIONS TO EXERCISES
E3.1COMBINATION AND CONSOLIDATION
Investment in S / 150,000Common Stock / 15,000
Additional Paid-in Capital / 135,000
To record the acquisition of 90 percent of S Company=s outstanding stock through an exchange of 15,000 shares of P Company stock worth $150,000.
Common Stock-S / 30,000
Additional Paid-in Capital-S / 70,000
Retained Earnings-S / 40,000
Purchase Premium (Goodwill) / 24,000
Investment in S / 150,000
Minority Interest in S / 14,000
To eliminate the investment in S against the stockholders= equity of S Company and establish the purchase premium (attributable to goodwill) and the minority interest.
Consolidated Assets: $1,224,000 (=$1,000,000 + $200,000 + $24,000)
Consolidated Retained Earnings: $300,000 (P Company's retained earnings
only.)
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E3.2ELIMINATION ENTRY: VARIOUS CASES
Working Paper Eliminations
(000 Eliminated)
Dr. (Cr.)
1. (100%) / 2. (100%) / 3. (100%) / 4. (80%) / 5. (80%) / 6. (80%) / 7. (80%)Common Stock / 1,000 / 1,000 / 1,000 / 1,000 / 1,000 / 1,000 / (1) 5,000
Additional Paid-In Capital / 300 / 300 / 300 / 300 / 300 / 300 / (2) 4,300
Donated Capital / 100 / 100 / 100 / 100 / 100 / 100 / 100
Appropriated Retained Earnings / 150 / 150 / 150 / 150 / 150 / 150 / 150
Retained Earnings / 350 / 350 / 350 / 350 / 350 / 350 / 350
Purchase Premium (Discount) / 100 / - / (300) / 80 / (240) / 80
Minority Interest in Saturn / - / - / (380) / (380) / (380) / (1,980)
Investment in Saturn / (2,000) / (1,900) / (1,600) / (1,600) / (1,520) / (1,280) / (8,000)
(1) $1,000,000 + (400,000 x $10) (2) $300,000 + 400,000 ($20 $10)
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E3.3CONSOLIDATING A POOLING OF INTERESTS
Requirement 1:
Consolidated Financial Statement Working Paper
Common Stock - S / 100,000Additional Paid-In Capital - S / 700,000
Retained Earnings - S / 800,000
Investment in S / 1,600,000
Requirement 2:
Consolidated Financial Statement Working Paper
Common Stock - S / 100,000Additional Paid-In Capital - S / 700,000
Retained Earnings - S / 800,000
Investment in S / 1,440,000
Minority Interest in S / 160,000
Requirements 3 and 4:
P and S Companies
Consolidated Balance Sheets
Requirement 3 (100%) / Requirement 4 (90%)Assets / $8,000,000 / $8,000,000
Liabilities / $3,400,000 / $3,400,000
Minority Interest in S / C / 160,000
Common Stock, Par Value $1 / 700,000 / 680,000
Additional Paid-In Capital / 1,600,000 / 1,540,000
Retained Earnings / 2,300,000 / 2,220,000
$8,000,000 / $8,000,000
NOTE: Common stock includes the par value of the new shares issued by P and retained earnings includes P=s share of S=s retained earnings. Additional paid-in capital includes P=s precombination amount plus P=s share of S=s total paid-in capital - par value of P shares issued; e.g., $2,220,000 = $1,500,000 + .9($100,000 + $700,000) - $180,000.
E3.4ELIMINATION ENTRIES: PURCHASE vs POOLING
Requirement 1:
Consolidated Financial Statement Working Paper
Purchase Premium / 300,000Investment in Small / 300,000
To reclassify the purchase premium. $300,000 = $2,000,000 + $100,000 .9($2,000,000)
Inventories [.9 ($1,140,000 $1,040,000)] / 90,000
Plant Assets (net) [.9 ($1,800,000 $1,600,000)] / 180,000
LongTerm Investments in Debt Securities [.9($80,000$60,000)] / 18,000
Goodwill / 102,000
LongTerm Debt [.9 ($500,000 $600,000)] / 90,000
Purchase Premium / 300,000
To allocate the purchase premium to Small's assets and liabilities and to Goodwill.
Capital Stock Small / 400,000
Retained Earnings Small / 1,600,000
Investment in Small / 1,800,000
Minority Interest in Small / 200,000
To eliminate the Investment in Small against the stockholders' equity of Small and establish the minority interest.
E3.4 (cont=d.)
Requirement 2:
Consolidated Financial Statement Working Paper
Capital Stock Small / 400,000Retained Earnings Small / 1,600,000
Investment in Small / 1,800,000
Minority Interest in Small / 200,000
To eliminate the Investment in Small against the stockholders' equity of Small and establish the minority interest.
E3.5ELIMINATION ENTRIES
Consolidated Financial Statement Working Paper
Purchase Premium / 240,000Investment in S [$240,000 = $2,200,000 +$40,000 .8 ($2,500,000)] / 240,000
To reclassify the purchase premium.
Inventories [.8($1,600,000$1,500,000)] / 80,000
Land / 67,200 (1)
Other Plant Assets / 108,800 (2)
LongTerm Investment in Debt Securities [.8 ($250,000 $200,000)] / 40,000
Longterm Debt [.8($470,000$400,000)] / 56,000
Purchase Premium / 240,000
To allocate the purchase premium among the assets and liabilities of S Company.
Negative Goodwill =$240,000 .8 ($100,000 + $100,000 + $200,000 + $50,000 - $70,000)
=$240,000 $304,000
=($64,000)
(1) $ 67,200 = .8($100,000-[($200,000/$1,000,000)x$64,000]
= $80,000 - $12,800
(2) $108,800 = .8($200,000)-[($800,000/$1,000,000)x$64,000]
= $160,000 $51,200
Stockholders' Equity S / 2,500,000Investment in S / 2,000,000
Minority Interest in S / 500,000
To eliminate the investment account
against the stockholders' equity of S and establish the minority interest.
E3.6INTERPRETING ELIMINATION ENTRIES
Requirement 1:
The missing values in the two entries are as follows:
(a)$15,000 ($750 minority interest/.05 minority ownership)
(b) $33,750 ($48,000 + $750 - $15,000)
(c) $4,300 (after solving for (d), $3,800 + $4,750 + $33,750 - $38,000)
(d) $33,750 (must be same as (b))
Requirement 2:
The book value of S's assets and liabilities at time of acquisition are as follows:
Current assets / $30,000 / In the purchase premium allocation, current assets are reduced by $3,800. Thus, the given fair value of $26,000 must be $4,000 (=$3,800/.95) less than book value.Noncurrent assets / 55,000 / In the purchase premium allocation, noncurrent assets are increased by $38,000. Thus the given fair value of $95,000 must be $40,000 (=$38,000/.95) more than book value.
Current liabilities / 20,000 / Same as fair value, since there is no adjustment in the purchase premium allocation.
Noncurrent liabilities / 50,000 / In the purchase premium allocation, noncurrent liabilities are increased by $4,750. Thus the given fair value of $55,000 must be $5,000 (=$4,750/.95) more than book value.
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E3.7CONSOLIDATED BALANCE SHEET
Bates, Inc. and Wilkens Corp.
Consolidated Balance Sheet
January 31, 20X0
ASSETSCurrent Assets / $ 945,000(1)
Plant and Equipment, net / 4,740,000(2)
Goodwill / 910,000(3)
Total Assets / $6,595,000
LIABILITIES AND STOCKHOLDERS= EQUITY
Current Liabilities / $ 650,000
Long-Term Liabilities / 2,300,000
Total Liabilities / $2,950,000
Minority Interest in Wilkins Corp. / $ 45,000(4)
Common Stock ($10 par value) / 500,000(5)
Additional Paid-in Capital / 2,000,000(6)
Retained Earnings / 1,100,000
Total Stockholders= Equity / $3,645,000
Total Liabilities and Stockholders= Equity / $6,595,000
(1) $945,000 = $1,000,000 $300,000 + $200,000 + .9($50,000).
(2) $4,740,000 = $3,500,000 + $700,000 + .9($600,000).
(3) $910,000 = $1,900,000 - .9($50,000 + $600,000 + $450,000).
(4) $45,000 = .1($450,000).
(5) $500,000 = $300,000 + 20,000($10).
(6) $2,000,000 = $600,000 + 20,000 ($80 $10).
E3.8ALLOCATION OF PURCHASE PREMIUM AND PURCHASE DISCOUNT
Requirement 1:
Cost of acquisition / $3,075,000Book value acquired (.8 x $1,600,000) / 1,280,000
Purchase premium / $1,795,000
FV / BV / FV-BV / Alloc (80%)
Cash and receivables / $ 100,000 / $ 100,000 / B / B
Inventories / 500,000 / 400,000 / $ 100,000 / $ 80,000
Land / 600,000 / 300,000 / 300,000 / 240,000
Buildings, net / 2,400,000 / 1,500,000 / 900,000 / 720,000
Equipment, net / 1,800,000 / 1,200,000 / 600,000 / 480,000
Long-term investments / 850,000 / 600,000 / 250,000 / 200,000
Current liabilities / (700,000) / (700,000) / B / B
Long-term liabilities / (2,100,000) / (1,800,000) / (300,000) / (240,000)
$3,450,000 / $1,600,000 / $1,850,000 / 1,480,000
Goodwill / 315,000
Total purchase premium / $1,795,000
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E3.8 (cont=d.)
Requirement 2:
Cost of acquisition / $2,305,000Book value acquired (.9 x $1,600,000) / 1,440,000
Purchase premium / $ 865,000
FV / BV / FV-BV / Alloc (90%)
Cash and receivables / $ 100,000 / $ 100,000 / B / B
Inventories / 500,000 / 400,000 / $ 100,000 / $ 90,000
Land / 600,000 / 300,000 / 300,000 / 270,000
Buildings, net / 2,400,000 / 1,500,000 / 900,000 / 810,000
Equipment, net / 1,800,000 / 1,200,000 / 600,000 / 540,000
Long-term investments / 850,000 / 600,000 / 250,000 / 225,000
Current liabilities / (700,000) / (700,000) / B / B
Long-term liabilities / (2,100,000) / (1,800,000) / (300,000) / (270,000)
$3,450,000 / $1,600,000 / $1,850,000 / 1,665,000
Negative Goodwill / (800,000)
Total purchase premium / $ 865,000
The second stage of the allocation process involves the allocation of $800,000 in negative goodwill among land, and buildings and equipment.
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E3.8 (cont'd.)
Allocation
(1) / (2) / (3)[(2)x$800,000] / (4) / (5)
[(4)-(3)]
Noncurrent Asset / Fair Value / Percent of Fair Value / Allocation of Negative Goodwill / Initial Allocation / Final Allocation
Land / $ 600,000 / 12.5% / $100,000 / $ 270,000 / $170,000
Buildings / 2,400,000 / 50.0% / 400,000 / 810,000 / 410,000
Equipment / 1,800,000 / 37.5% / 300,000 / 540,000 / 240,000
$4,800,000 / 100.0% / $800,000 / $1,620,000 / $820,000
Inventories / 90,000
Long-term investments / 225,000
Long-term liabilities / (270,000)
Total purchase premium / $865,000
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E3.9RECONSTRUCTION OF ELIMINATION ENTRIES AND BOOK VALUE
Requirement 1:
Since all of Bay's identifiable assets and liabilities were fairly stated, the purchase premium must equal the Goodwill of $340,000. Therefore, the book value of 90 percent of Bay's stock was $1,260,000 (=$1,600,000 $340,000). Bay's total stockholder's equity was $1,400,000 (=$1,260,000/.9) and the minority interest amounts to $140,000. The following working paper entries were made in consolidation.
Consolidated Financial Statement Working Paper
Goodwill / 340,000Investment in Bay / 340,000
To reclassify the purchase premium as Goodwill.
Stockholder's Equity Bay / 1,400,000
Investment in Bay / 1,260,000
Minority Interest in Bay / 140,000
To eliminate the investment account against the stockholders' equity of Bay and establish the Minority Interest.
Requirement 2:
Before the acquisition, Cove's total assets amounted to $9,000,000 (=$5,200,000 + $3,800,000). Recording the acquisition of Bay left this total unchanged since the cash spent of $1,600,000 was replaced by the investment account with the same balance. Since consolidated total assets were $13,000,000, and Cove's total assets were $9,000,000, Bay's total assets appear to have been $4,000,000 (=$13,000,000 $9,000,000). Because $1,260,000 of Cove's Investment in Bay was eliminated (the goodwill of $340,000 remains), however, Bay's total assets actually amounted to $5,260,000 [=$13,000,000 ($9,000,000 $1,260,000)].