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Reading 16 Intercorporate Investment FinQuiz.

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CFA Level II Item-set - Question
Study Session 5
June 2017

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 15551


Questions 1(15552) through 6(15557) relate to Reading 16

Donald Sweeney Case Scenario

Donald Sweeney works as the chief investment officer at Exquisite Interiors (EI), a firm
that offers top quality home renovation services to its customers. As part of its expansion
strategy, EI acquired Home Decorators (HD), a large firm in Virginia. EI paid $1 billion
to acquire 35% of the company and the ability to exert influence on the firms financial
and operating decisions. Exhibit 1 displays information concerning Home Decorators
assets and liabilities on January 1, 2010.

Exhibit 1
Book Value Fair Value
Current Assets $198.50 million $198.50 million
Plant and Equipment $2,500 million $2,800 million
Liabilities $375.47 million 375.47 million

The plant and equipment are depreciated on a straight line basis with a useful life
estimate of 10 years. Exquisite Interiors share of the residual value of the P&E is
$500,000. During 2010, Home Decorators reported net income of $200 million and paid
dividends of $98 million.

Ethan Anderson is a close friend of Sweeney who works as a financial consultant for
firms with merger and acquisition motives. Sweeney invited Anderson for lunch to
discuss the various methods of reporting investments in financial assets. During their
conversation, Anderson mentioned that he is currently analyzing the financial statements
of Walter Company (WC). Walter Company owns 30% of Wood Company, and
Anderson has determined that the equity method would be appropriate to report this
acquisition. At the time of acquisition, the excess purchase price attributable to
identifiable assets equaled $65,000, which is amortized using straight line depreciation
and a useful life estimate of 8 years. During 2009, Walter sold Wood inventory for
$250,000, with a cost of $165,000. Wood resold $180,000 of this inventory during the
year to an outside party. Wood reported income from operations of $975,500 in 2009.

As the conversation continued, Sweeney talked about the acquisition method of


accounting for business combinations. He made the following comment:

Statement 1: On the acquisition date, the acquirer must recognize any contingent
liability assumed in the acquisition if it is a present obligation that arises

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Reading 16 Intercorporate Investment FinQuiz.com

from past events and its fair value can be reliably measured. This is true
for companies either following the IFRS or the U.S. GAAP.

Sweeney then mentioned that he is evaluating a business combination involving FLC


Enterprises and REM Enterprises that occurred a year ago on 1st of January 2010. The
price paid by FLC for REM was less than the fair value of REMs net assets. In addition,
Sweeney inquired about how non-controlling interests are presented on consolidated
balance sheets. To answer his query, Anderson made the following comment:

Statement 2: Under either IFRS or the U.S. GAAP, FLC would have reported the
difference between the fair value of REMs net assets and the purchase
price immediately at the time of acquisition as a gain in the profit or loss
statement. Also, both IFRS and the U.S. GAAP now require
noncontrolling interests to be presented on the consolidated balance
sheets as a separate component of stockholders equity.

Anderson has just been hired by the Red Corporation (Red-Corp) to analyze their
acquisition of the Blue Company (Blue-Co). Red-Corp acquired 85% of Blue-Co on
1stJan, 2009. The transaction was stock based with the fair value of Red-Corp common
stock offered equal to $85,500,000. The fair market value of Blue-Cos shares on the date
of the acquisition was $105,500,000. Anderson gathered the following information as of
1stJan, 2009.

Exhibit 2
Blue Company
Book Value Fair Value
Cash and receivables 5,350,000 5,350,000
Inventory 47,000,000 47,000,000
Property, plant and equipment 67,800,000 75,500,000
Payables and long term debt 45,200,000 45,200,000

Sweeney recently attended a seminar on The reporting of intercorporate investments


organized by Capital Specialists (CS) and Financial Strategists (FS), two of USAs
largest investment firms. Ethan Day, a financial expert with more than ten years of
experience in the field, was the guest speaker. During his lecture, Day made the
following comments:

Statement 3: Under IFRS, investments classified as available-for-sale are initially


measured at fair value plus transaction costs. At each subsequent
reporting date, the investments are remeasured, with any unrealized gains
or losses amount, before taxes, arising from changes in fair value
reported in equity as other comprehensive income.

Statement 4: Both U.S. GAAP and IFRS require that held-to-maturity securities be
initially recognized at fair value including transaction costs.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 15552


1. The amount that Exquisite Interiors would report as investment in Home Decorators
at the end of the year 2010 will be closest to:

A. $1,025,200,000.
B. $1,025,250,000.
C. $1,059,550,000.

FinQuiz Question ID: 15553


2. The equity income reported as a line item on Walter Companys income statement in
the year 2009 is closest to:

A. $283,072.
B. $260,725.
C. $277,385.

FinQuiz Question ID: 15554


3. Are Sweeney and Anderson most likely correct with respect to statements 1 and 2?

A. Only Sweeney is correct.


B. Only Anderson is correct.
C. Both Sweeney and Anderson are correct.

FinQuiz Question ID: 15555


4. For the Blue-Cos acquisition by Red-Corp, the value of goodwill and the value of the
noncontrolling interest at the acquisition date under the full goodwill method are
closest to:

A. $22,850,000 and $15,825,000 respectively.


B. $10,000,000 and $14,325,000 respectively.
C. $30,550,000 and $12,397,500 respectively.

FinQuiz Question ID: 15556


5. For the Blue-Co acquisition by Red-Corp, the value of goodwill and the value of the
noncontrolling interest at the acquisition date under the partial goodwill method are
closest to:

A. $35,247,500 and $14,325,000 respectively.


B. $15,247,500 and $12,397,500 respectively.
C. $24,325,000 and $1,927,500 respectively.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 15557


6. Day is most accurate with respect to:

A. Statement 3 only.
B. Statement 4 only.
C. neither Statement 3 nor Statement 4.

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Reading 16 Intercorporate Investment FinQuiz.com

15743
Questions 7(15744) to 12(15749) relate to Reading 16

Woodrow Foster Case Scenario

Woodrow Foster, CFA is an equity analyst working for Thuraiya. Foster routinely
engages in the financial statement analysis of the companies he covers. His recent
assignment is Rigor, a sound systems manufacturer. Rigor is situated in the U.K. and uses
the IFRS to compile its financial statements.

Rigor maintains an investment portfolio comprising of debt and equity investments in


three firms (Exhibit 1). All three constituent investments have been acquired on January
1, 2010. So far, Rigor has classified two of the three investments. Foster would like to
explore the reporting implications of each of the three investments on the manufacturers
financial statements.

Exhibit 1
Rigors Investment Portfolio For the Year ending
31st December 2010 (in 000)
Monsieur
Jador Inc. LePelle
Vito
Acquisition cost (Par
3,000 2,875 2,825
value)
Fair value 1 January 4,500 2,875 2,825
Fair value 31
3,895 3,240 3,000
December
Stated rate* 8.0% 2.5% N/A
Held-to- Held for
Classification Unclassified
Maturity trading
Type of investment Debt Equity Equity
*The stated rate quoted for the Jador Inc. investment represents the annual rate of
interest paid on the investments par value. The stated rate quoted for the
LePelle investment represents its annual dividend rate. The market rate in effect
when the bonds were issued was 3.5%.

In a discussion with Rigors CEO, the CEO tells Foster that the acquisition cost paid for
the Monsieur Vito investment (Exhibit 1) represents the fair value of Rigors shares
which were exchanged with Vitos shares to acquire a 70% controlling interest in Vito.
The total market value of Vitos common stock at the time of acquisition was 2,080,000.
Following their discussion, Foster collects pre-acquisition selected balance sheet
information on the target (Exhibit 2).

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Reading 16 Intercorporate Investment FinQuiz.com

Exhibit 2
Monsieur Vitos Pre-Acquisition Selected Balance Sheet
Information Book Values and Fair Values (in 000)

Book Fair
Value Value
Current assets 2,325 2,455
PPE (net) 1,440 1,546
Total assets 3,765 4,001

Current payables 556 556


Long-term debt 1,255 1,255
Total liabilities 1,811 1,811

Shareholders
equity:
Capital stock (1 1,560
par)
Retained earnings 394

Next, Foster engages in a discussion with one of Vitos senior manager. The manager
informs him that the increase in net PPE was solely due to a revaluation of one of Vitos
machinery at the time of the firms acquisition. The machinery was purchased eight years
ago at a cost of 500,000. At the time of revaluation, it had a remaining useful life of five
years. The machine is depreciated using a straight line method and has an expected
salvage value of zero.

FinQuiz Question ID: 15744


7. Using the information in Exhibit 1, Rigor will record its investment in Jador Inc., at
the time of acquisition, at an amount (in 000) closest to:

A. 3,000.
B. 3,042.
C. 4,500.

FinQuiz Question ID: 15745


8. The value of the Jador Inc. investment account (in 000) in Rigors balance sheet at
December 31, 2010 is closest to:

A. 2,760.
B. 4,448.
C. 4,418

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 15746


9. The amount recorded by Rigor in its 2010 income statement (in 000), in relation to
the LePelle investment, is closest to:

A. 365.
B. 437.
C. 446.

FinQuiz Question ID: 15747


10. Using the partial goodwill method, the amount of goodwill arising on date of the Vito
acquisition is closest to:

A. 110,000.
B. + 547,000.
C. + 1,292,000.

FinQuiz Question ID: 15748


11. If Rigor had significant influence over Monsieur Vito, the method of accounting
which would have been used to record its investment in the acquire is the:

A. equity method.
B. proportionate consolidation method.
C. acquisition method.

FinQuiz Question ID: 15749


12. Assuming no further changes in value, the closing balance of Vitos revalued
machinery to be recorded on the consolidated balance sheet at December 31, 2010
will be closest to:

A. 304,800
B. 334,800
C. 356,000

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Reading 16 Intercorporate Investment FinQuiz.com

16067
Questions 13(16068) through 18(16073) relate to Reading 16

Abdul Ibrahim Case Scenario

Abdul Ibrahim, CFA, has been hired by Green Corp - a manufacturer of environmentally
safe detergents, to undertake an equity analysis of Green Corp Group. The group
comprises of two corporations - Ester Corp and Poly Corp, situated in France and the
U.K., respectively. Green Corp is headquartered in the U.S. and complies with U.S.
GAAP for financial reporting purposes. The reporting period for all three firms ends on
December 31.

Green Corp purchased a 25% stake (with voting rights) in Ester Corp for 150 million at
an exchange rate of US$0.6435 per 1 on March 15, 2007. Green Corp has classified this
investment as significant influence and accounts for it under the equity method of
accounting based on the following criteria:

Criteria 1: Green Corp heavily relies on key employees, serving Ester Corps
compliance department, to provide legal advice concerning relevant
French tax and income remittance laws. Compliance department
employees of the two corporations often relocate within the groups
corporations.

Criteria 2: Green Corps board members must hold a minimum of two executive
positions on Ester Corps board at any one time.

Criteria 3: Inter-corporate transactions between Green Corp and Ester Corp are
restricted to a maximum amount of 1 million per transaction to ensure
they remain immaterial.

On March 1, 2008, Ester Corp purchases 0.5 million worth of detergents from Green
Corp at a total cost of 5 million. By December 31, 2008, the subsidiary has sold 35% of
these detergents for 350,000. Ester Corps reported income for the year was 12 million.

For its 75% stake in Poly Corp, Green Corp paid 500 million in cash on January 1,
2009. The purchase granted the parent control over the target. For his analysis, Ibrahim
has collected relevant financial information on the subsidiary and parent immediately
prior to acquisition (Exhibit 1). The difference in fair value between the assets was solely
due to an item of machinery, which had a net book value of 15 million immediately
prior to the acquisition. The machinery has a total useful life of 15 years of which 8 years
have passed and is being depreciated on a straight line basis with a zero salvage value.

On January 1, 2011 Green Corp creates a trust with the aid of a legal firm. The trust has
been created to purchase and refurbish defunct factories which are later leased to Green

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Reading 16 Intercorporate Investment FinQuiz.com

Corp. The purchases are usually financed by long-term loan notes linked to long-term
treasury securities. These long-term notes are collateralized by the defunct factories
which are marketable after being refurbished.

Although Green Corp holds a 10% stake in the trust, which entitles it to voting rights
commensurate with its proportion of stockholding. The remainder of the trusts stock is
held by external corporations who retain the remainder of the voting rights over the trust,
commensurate with their stockholdings. Any defaults on principal and monthly interest
payments are to be covered by Green Corp.

Exhibit 1
Green Corps and Poly Corps Pre-Acquisition
Balance Sheet Information on January 1, 2009
(In US$ millions and millions, respectively)
Green Poly Corp Poly
Corp Book Book Corp
Value Value () Fair
($) Value
()
Cash and receivables 500 95 95
Inventory 450 125 125
Property plant and equipment 1,250 345 550
(net)
Total Assets 2,200 565 770

Total Liabilities 565 50 65


Stockholders equity:
Capital Stock 1,250 400*
Additional paid in capital 100 -
Retained Earnings 285 115

*At the date of acquisition, the fair value of Poly Corps shares was 650 million

FinQuiz Question ID: 16068


13. Which of the following criteria least likely justify the investment classification used
for Ester Corp?

A. 1
B. 2
C. 3

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 16069


14. Using the information in Exhibit 1, in relation to its acquisition of Poly Corp, on
January 1, 2009 Green Corp will (ignoring currency effects) recognize a gain in its
income statement closest to (in millions):

A. 29.
B. 78.
C. 205.

FinQuiz Question ID: 16070


15. The amount of net income to be reported by Green Corp in relation to Ester Corp for
the 2008 period (in millions) is closest to (ignoring currency effects):

A. 2.27.
B. 2.61.
C. 3.00.

FinQuiz Question ID: 16071


16. Based on the acquisition data gathered by Ibrahim on Poly Corp the amount of
goodwill arising on the date of acquisition, prior to its accounting treatment, is closest
to (in millions):

A. 55.
B. 95.
C. 271.

FinQuiz Question ID: 16072


17. The amount of consolidated assets to be reported in the consolidated balance sheet, in
relation to Poly Corp, on the date of acquisition is most likely (assuming an exchange
rate of US$1 per 1):

A. higher under the pooling of interest method.


B. higher under the acquisition method.
C. identical under the two methods.

FinQuiz Question ID: 16073


18. Green Corps trust is most likely to be:

A. held off-balance sheet.


B. consolidated on its financial statements.
C. consolidated on its financial statements only if Green Corps owns majority
voting rights in the trust.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 11613


Questions 19(11614) through 24(11619) relate to Reading 16

Fisher Corp. Case Scenario

Fisher Corp. is a U.S. based organization involved in coal extraction activities. To


diversify its organization base it is contemplating an investment in two local companies:
a tire manufacturer, Tire-Go, and a small scale steel manufacturer, C.S. Corp. It plans to
implement its investment decision on January 1, 2010.

For its investment in Tire-Go, the corporation is willing to offer $60 million in cash. The
book value of Tire-Gos assets and liabilities equal their fair values with the exception of
Tire-Gos manufacturing plant whose fair value is $15 million upon acquisition with a
book value of $8 million and a useful life of 10 years. The investment will enable Fisher
Corp. to gain 30% control of the target. Fisher Corp.s chief executive believes the level
of control acquired will help enable it to achieve a level of representation on the board of
directors to participate in the targets policy-making process. Pre-investment balance
sheet and income statements for both organizations are illustrated below (exhibit 1).

Exhibit 1
Fisher Corp. and Tire-Go Pre-Acquisition Balance Sheets and Income Statements
Fisher
Corp. Tire-Go
($ 000) ($ 000)
Income Statement
Sales $400,000 $250,000
Cost of Sales (225,000) (100,000)
Other Expenses (45,000) (20,0000)
Net Income $130,000 $130,000

Balance Sheet
Cash $35,000 $15,000
Inventory 110,000 85,000
Accounts Receivable 55,000 40,000
Other assets 15,000 10,000
$215,000 $150,000

Accounts Payable 75,000 60,000


Long-Term Debt 5,000 2,000
Shareholders Equity 80,000 60,000
Retained Earnings 55,000 28,000

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Reading 16 Intercorporate Investment FinQuiz.com

Total Liabilities and Shareholders Equity $215,000 $150,000

With respect to C.S. Corp. Fisher Corp. is planning to acquire 100% of the outstanding
shares of the former corporation by issuing 2 million of its own equity that has $1 par
value and a current market value of $10 million. The pre-acquisition balance sheet
information for C.S. Corp. using book values and fair values is illustrated below (exhibit
2). The shareholders equity figure included in Fisher Corps pre-acquisition balance
sheet (exhibit 1) includes $30 million additional paid in capital with the remainder
attributable to common stock with a $1 par value.

Exhibit 2
C.S. Corp. Pre-Acquisition Balance Sheet using Book Values and Fair Values

C.S. Corp. C.S. Corp. Fair


Book Value Value ($000)
($000)
Cash $4,000 $4,000
Inventory 2,500 3,500
Accounts Receivable 500 500
Other assets 8,000 10,500
15,000 18,500
Account Payables 2,000 2,000
Long-Term Debt 5,000 7,000
7,000 9,000
Net Assets 22,000 27,500

Shareholders Equity:
Common Stock ($1 par) 4,500
Additional paid in capital 2,000
Retained Earnings 1,500

One year following the investment in C.S. Corp., the carrying value of its steel
conversion unit is $1,500,000 and fair value is $1,250,000. An in-house analyst estimates
the units recoverable amount to be worth $900,000 and the fair value of its identifiable
net assets to be worth $1,180,000. The steel conversion unit is an independent reporting
unit.

FinQuiz Question ID: 11614


19. The amount of goodwill reported on Fisher Corp.s balance sheet immediately
following the purchase of Tire-Go is closest to:

A. $0.
B. $15 million.
C. $32 million.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 11615


20. If the purchase price paid by Fisher Corp. for Tire-Go was $22 million, the most
probable adjustment would be:

A. increase Tire-Gos net profit by $6.5 million.


B. decrease the carrying amount of the cost of the investment by $6.5 million on
Fisher Corp.s balance sheet.
C. create a comprehensive income account worth $21.0 million on Fisher Corp.s
balance sheet.

FinQuiz Question ID: 11616


21. Assuming Fisher Corp.s chief executive would like the option to recognize its
investment in Tire-Go at fair value at the time it is initially recognized in its financial
statements. The use of the fair value method will result in all of the following effects
except for:

A. Fisher Corp. will not record its proportionate share in Tire-Gos profit as part of
the carrying value of the investment reported on its balance sheet.
B. Fisher Corp. will not amortize the excess of cost over the fair value of Tire-Gos
identifiable net assets.
C. Fisher Corp. will record any changes in the fair value of the investment in Tire-
Go as part of comprehensive income.

FinQuiz Question ID: 11617


22. One year following the investment in Tire-Go, Tire-Go reports an annual net profit of
$150 million while Fisher Corp. reports an annual net profit of $230 million (for the
year ending 2011). The net profit figure includes a $5.5 million sale of steel inventory
by Fisher Corp. to Tire-Go for $7.5 million. Tire-Go has resold $4.0 million of this
inventory by the year-end with the remainder to be sold over the next two years.
Using the intercompany sales transaction data, the proportionate equity income to be
reported on Fisher Corp.s income statement for the year ending 2011 is closest to
(ignore the amortization of the purchase price):

A. $43.88 million.
B. $43.95 million.
C. $44.72 million.

FinQuiz Question ID: 11618


23. With respect to the pooling of interest method and the acquisition method, the total
shareholders equity to be reported on the balance sheet of the consolidated
corporation (C.S. Corp. and Fisher Corp.) is:

A. higher under the pooling of interest method by $3.5 million.

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Reading 16 Intercorporate Investment FinQuiz.com

B. higher under the acquisition method by $6.5 million.


C. higher under the acquisition method by $10.5 million.

FinQuiz Question ID: 11619


24. Assuming the carrying value of goodwill for the steel conversion unit is $200,000
(one year following the investment in C.S. Corp.); the impairment loss incurred on
the unit is closest to:

A. $0.
B. $130,000.
C. $600,000.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 17325


Questions 25(17326) through 30(17331) relate to Reading 16

Brockdale Securities Case Scenario

Sam Anderson is a senior investment analyst at Brockdale Securities located in


Milwaukee, Wisconsin. Brockdale Securities is a corporate investment entity,
specializing in providing investment advice to institutional investors. Andersons team is
currently evaluating a long-term clients balance sheet which views DeltInd house as an
associate. The client, Hidden Solutions, invested in DeltInd ten years ago to take
advantage of their technologically innovative server base. The equity accounting method
applied is in accordance with the International Financial Reporting Standards.

Hidden Solutions acquired 25% of DeltInds stock that was trading at $15 per share at the
time of acquisition. The bulk purchase of a quarter of the associates stock required an
additional premium of $2 per share to be paid to the institutional investor Hidden
Solutions acquired the stock from. At the time of investment, DeltInd had 20 million
shares outstanding. Exhibit 1 provides summarized data on the fair values of the net
assets on the acquisition date.

FV of Noncurrent Assets $104 million FV of Noncurrent Liabilities $40 million


FV of Other Assets $20 million FV of Other Liabilities $18 million

Assumption: Book values of the assets and the liabilities are insignificantly different
from the fair values.

Four years after the original investment, the cost of investment was reduced to zero due
to heavy losses incurred by the associate. Subsequent to this null figure, further losses of
$12 million were not deducted from Hidden Solutions income statement. Following
major operational reconstruction, six years after the original investment, DeltInd reported
a profit of $50 million.

Andersons assistant found old files that had been compiled by Brockdale Securities
analysts at the time of acquisition. Anderson delegated the browsing of these files to his
assistant, to ensure that no important facts were overlooked. Some of the statements
highlighted in the files were:

Statement 1: Voting shares acquired are the sole determinant in calculating the
investors stock interest.

Statement 2: The impairment losses from associates charged to the income statement
may be reversed granted the associates meet certain criteria.

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Reading 16 Intercorporate Investment FinQuiz.com

Statement 3: As DeltInd is not a venture capital organization, a mutual fund, a unit trust
or an investment-related insurance fund, it cannot be reported at fair value
in Hidden Solutions balance sheet.

FinQuiz Question ID: 17326


25. The cost of investment in the equity is closest to:
A. $ 75 million.
B. $ 85 million.
C. $340 million.

FinQuiz Question ID: 17327


26. Ignoring question 1, assume the cost of investment (COI) in equity is $75 million.
The calculated goodwill is closest to:

A. $0.
B. $9 million.
C. $59 million.

FinQuiz Question ID: 17328


27. Six years after the investment, the profit recognized by Hidden Solutions in terms of
its holding of DeltInd is closest to:

A. $0.5 million.
B. $12.5 million.
C. $28.0 million.

FinQuiz Question ID: 17329


28. The first statement from the acquisition notes is most likely:
A. correct.
B. incorrect, exercisable and convertible warrants and securities also need to be
taken into consideration to determine voting power.
C. incorrect, voting shares and convertible options need to be included in the voting
interest calculation, but exercisable warrants do not.

FinQuiz Question ID: 17330


29. The second statement from the acquisition notes is most likely:

A. correct.
B. incorrect, impairment losses from the associates charged to the income statement
cannot be reversed under any circumstances.
C. incorrect, impairment losses from the associates charged to the income statement
may be reversed without the application of any criteria.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 17331


30. The third statement from the acquisition notes is most likely:

A. correct.
B. incorrect, as DeltInd is not a venture capital organization, a mutual fund, a unit
trust or an investment-related insurance fund, it can be reported at fair values as
the equity method allows it.
C. incorrect, venture capital organizations, mutual funds, unit trusts and investment-
related insurance funds cannot be reported at fair value.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 17332


Questions 31(17333) through 36(17338) relate to Reading 16

CoverTech Case Scenario

CoverTech is a globally recognized software firm renowned for developing off-the-shelf


customized software for its clients. It has recently acquired 45% ownership interest in
Quantum Solutions and exercises control over all policy-making processes. The software
firm uses the U.S. GAAP method to compile its financial statements. CoverTech also
occupies 80% of the representation on Quantum Solutions board. Exhibit 1 portrays
some of the data available on the date of acquisition:

Fair value of net assets acquired $520 million


Purchase price of acquisition $470 million

The balance sheet of Quantum Solutions carries a contingent liability of $25 million in
anticipation of the outcome of a court case filed by a senior employee for wrongful
termination. Quantum Solutions lawyers hold the opinion that the company would most
probably lose the case to the prosecuting party. In light of this matter, Quantum
Solutions investors have assured CoverTech that any amount payable to the prosecutors
would be compensated by the formers shareholders.

CoverTech also holds 35% of the common equity of The Embilon Enterprise (TEE).
However, it has been unable to exert any significant impact on the policy making
processes of the entity.

Brian Course, a financial analyst at CoverTech recently read the following statement in a
published article:

Statement 1: Under U.S. GAAP, the voting interest component and the variable interest
component need to be jointly considered to ascertain viability of the
consolidation of the two entities.

FinQuiz Question ID: 17333


31. The excess of the fair value over the purchase price would most likely be:

A. charged immediately as an impairment loss to the income statement.


B. reported immediately as a gain in the income statement.
C. capitalized and amortized over the estimated life of the investment.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 17334


32. Under the U.S. GAAP, CoverTech would most likely allowed to calculate goodwill
through:

A. the full goodwill method.


B. the partial goodwill method.
C. either the full or the partial goodwill method.

FinQuiz Question ID: 17335


33. The wrongful dismissal case pending in the court should most likely be treated as:

A. an indemnification asset in the balance sheet of CoverTech.


B. a contingent liability in the balance sheet of CoverTech.
C. not be recorded in the balance sheet of CoverTech.

FinQuiz Question ID: 17336


34. CoverTechs ownership in TEE would most likely be classified as:

A. an investment in financial instruments.


B. an investment in associates.
C. a business combination.

FinQuiz Question ID: 17337


35. Quantum Solutions is least likely a:

A. variable interest entity for CoverTech.


B. cash generating unit for CoverTech.
C. special purpose vehicle for CoverTech.

FinQuiz Question ID: 17338


36. The statement read by Course is most likely:

A. correct.
B. incorrect, under the IFRS, the voting interest component and the variable interest
component need to be jointly considered to ascertain viability of the consolidation
of the two entities.
C. incorrect, under U.S. GAAP, the voting interest component ascertains the
consolidation of the two entities. The variable interest component is disregarded.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 17339


Questions 37(17340) through 42(17345) relate to Reading 16

Edward Gray Case Scenario

Edward Gray is the head of the financial instrument valuation team at ProLif Investments
located in Fresno, California. Gray and his team are currently evaluating the financial
instruments carried by Stowaway Inc. Stowaway is a cargo shipping giant with
headquarters in London, Great Britain. The entity uses the International Financial
Reporting Standards to draft its financial statements. Exhibit 1 outlines some of the
passive financial instruments carried by Stowaway Inc. All investments are accounted for
according to the current IAS 39 Financial Instruments standard.

Company Rottweiler Beagle Pitbull


Classification Held-to-Maturity Available-for-Sale Held-for-Trading
FV at Acquisition $52,000 $80,000 $18,000
Transaction Costs $3,500 $4,000 $800
MV (31st December, $55,000 $72,000 $22,000
2010)
MV (31st December, $49,000 $82,000 $25,000
2011)

Note:
During the last three years, Stowaway Inc. has reclassified 22% of its held-to-maturity
investments to available-for-sale, without meeting the required criteria.

Robert Wright, a junior member of the team, made the following statements during an
interim meeting held a week after the initiation of the analysis:

Statement 1: Any unrealized gains or losses reported to other comprehensive income


from Beagle should be net of tax.

Statement 2: Any unrealized gains or losses arising from the changes in the fair value
of Pitbull are to be charged to other comprehensive income.

FinQuiz Question ID: 17340


37. Taking into account the note provided in the vignette, Stowaway Inc. is most likely:

A. justified in maintaining the classification of Rottweiler as held-to-maturity.


B. justified in reclassifying Rottweiler as an available-for-sale security.
C. not permitted to hold held-to-maturity financial assets.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 17341


38. Assuming Stowaway Inc. is justified in maintaining the classification of Rottweiler as
held-to-maturity, the initial recognition amount of the security would be closest to:

A. $48,500.
B. $52,000.
C. $55,500.

FinQuiz Question ID: 17342


39. Pitbull was most likely initially recognized at an amount closest to:

A. $17,200.
B. $18,000.
C. $25,000.

FinQuiz Question ID: 17343


40. The first statement made by Wright is most likely:

A. correct.
B. incorrect, any unrealized gains or losses reported to other comprehensive income
from Beagle should be gross of tax.
C. incorrect, any unrealized gains or losses reported to the income statement from
Beagle should be gross of tax.

FinQuiz Question ID: 17344


41. The second statement made by Wright is most likely:

A. correct.
B. incorrect, any unrealized gains or losses arising from the changes in the fair value
of Pitbull are to be charged to the income statement.
C. incorrect, no unrealized gains or losses arise in held-for-trading securities as they
are constantly adjusted to fair value.

FinQuiz Question ID: 17345


42. Given that the accumulated premium on the Beagle investment was $4,800 at the time
of acquisition, the unrealized gains/losses on the security as of 31st December, 2010
are closest to:

A. $3,200 loss.
B. $12,000 gain.
C. $12,800 loss.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 17346

Questions 43(17347) through 48(17352) relate to Reading 16

GumDrop Inc. Case Scenario

GumDrop Inc. is a market leader in the sweets and confectionary industry with reputed
goodwill in most countries. It is headquartered in Lincoln, Nebraska. The entity has
recently purchased a 20% holding in one of its competitors stock for the purpose of
acquiring significant control over the associates supply chain network. Its associate,
Surprises Galore (SG), has issued fifty million shares to date. GumDrop Inc. paid $23 for
each share acquired.

Exhibit 1 displays the data relevant on the date of acquiring the holding in SG.

Exhibit 1
Book Value of Net Assets $900 million
Plant and Equipment-Fair Value $35 million
Plant and Equipment-Carrying Value $18 million
Plant and Equipment-Life 6 years
Land-Fair Value $15 million
Land-Carrying Value $12 million

In the first year of investment, SG sold partially processed direct material to GumDrop
Inc. Exhibit 2 displays the figures relevant to the inter-company transaction.

Exhibit 2
Manufacturing Costs for SG $2,000,000
Purchase Price for GumDrop Inc. $2,800,000

FinQuiz Question ID: 17347


43. The goodwill included in the carrying value of the investment is closest to:

A. $30 million.
B. $46 million.
C. $50 million.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 17348

44. If the fair value of the associates identifiable net assets exceeds the cost of initial
investment, the difference between the fair value and the investment cost would most
likely be:

A. recognized as income in profit or loss and excluded from cost of investment.


B. charged as expense in profit or loss and excluded from cost of investment.
C. recognized as income in other comprehensive income and excluded from cost of
investment.

FinQuiz Question ID: 17349


45. The amortization of the excess purchase price relevant to plant and equipment is
closest to:

A. $100,000 per year.


B. $570,000 per year.
C. $2,830,000 per year.

FinQuiz Question ID: 17350


46. Ernie Banks, the chief executive officer of GumDrop Inc. wants to report its
investment in SG at fair value. Relevant to the policies outlined by U.S. GAAP, he
would most likely:

A. be allowed to hold his investment at fair value.


B. not be allowed to hold his investment at fair value unless the associate is a
financial institution.
C. not be allowed to hold his investment at fair value under any circumstances.

FinQuiz Question ID: 17351


47. The profit from the inter-company transaction prior to adjustments for inter-company
transactions would most likely be recorded:

A. entirely in the associates income statement.


B. entirely in the investors income statement.
C. partially in the associates income statement and partially in the investors
income statement.

FinQuiz Question ID: 17352


48. Compared to the proportionate consolidation method, recording a subsidiary under
the equity method would most likely result in:
A. a higher debt ratio..
B. overstated margin ratios..
C. a lower return on assets ratio..

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 17353


Questions 49(17354) through 54(17359) relate to Reading 16

Hart and Harper Investments Case Scenario

Kim Bailey is a senior financial analyst at Hart and Harper Investments located in
Denver, Colorado. She is currently carrying out an analysis of a ten year held-for-
maturity debt security in the financial statements of MaiCoal Inc. All investments are
accounted for according to the current IAS 39 Financial Instruments standard.

MaiCoal is a chain of art studios internationally recognized for their modern and
contemporary exhibitions. The entity follows the International Financial Reporting
Standards for the preparation of its financial statements. The security was bought eight
years ago at a price of $960 (with par value of $1,000) and offers a stated return of 8% on
annual basis. One year after the purchase, the security was trading in the market at $970.
Three years after the purchase, the issuing company was declared bankrupt with only
50% of the par value recoverable at maturity. The recovery policy eliminated the
payments of any coupons till maturity.

Jessica Reid, one of Connors colleagues, is analyzing an available-for-sale equity


instrument held by Valex Industries. This stock was acquired at a value of $80 per share.
Since its acquisition, there have been no principal repayments on the stock. Valex
Industries also uses the International Financial Reporting Standards for the preparation of
its financial statements. Impairment losses previously recorded by Valex Industries on the
equity stock are $4 per share. This stock is currently trading in the market at $68 per
share.

Reid noticed the following excerpt in a summarized financial instrument manual


provided by her assistant:

Excerpt 1: The International Financial Reporting Standards allow the reversal of


impairment losses incurred on available-for-sale-securities to be adjusted
in the income statement.

FinQuiz Question ID: 17354


49. The income to be recognized in the income statement of MaiCoal Inc. one year
following the purchase is closest to:

A. $83.
B. $85.
C. $90.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 17355


50. The capital gain to be recognized in the income statement of Mail Coal Inc. one year
following the purchase of debt security is closest to:

A. $0.
B. $7.
C. $10.

FinQuiz Question ID: 17356


51. The impairment loss incurred in year three on the MaiCoal Inc. investment is closest
to:

A. $280.
B. $468.
C. $688.

FinQuiz Question ID: 17357


52. Ignoring your answer to Question 3, assume the calculated impairment loss on the
MaiCoal Inc. investment was $688. This loss would most likely be charged to:

A. the income statement.


B. other comprehensive income.
C. statement of changes in equity.

FinQuiz Question ID: 17358


53. The cumulative loss per share to be reclassified to the income statement from other
comprehensive income due to Valex Industries investment is most likely:

A. $0.
B. $8.
C. $12.

FinQuiz Question ID: 17359


54. The treatment suggested by the excerpt from the financial instrument document is
most likely:

A. correct.
B. incorrect, impairment loss reversal is only allowed by IFRS when there is a debt
security involved.
C. incorrect, had the company been following the policies outlined by U.S. GAAP,
the suggested treatment would have been correct.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 17360


Questions 55(17361) through 60(17366) relate to Reading 16

Index Solutions Case Scenario

Eric Gonzalez is a recently hired financial analyst at Index Solutions located in Dallas,
Texas. Five years ago, Index Solutions acquired a 25% ownership interest in a mutual
fund entity, BenSol Advisory. Index Solutions opted to report its investment under the
fair value method allowed by the International Financial Reporting Standards. Gonzalez,
while reviewing old investment notes, questions some of the techniques applied in the
treatment of different line-items. Tracy Morgan, Gonzalezs supervisor, made the
following statements as answers to his queries:

Statement 1: Following the reporting of the investment at fair value, any unrealized
gains/losses should be charged to the investors income statement.

Statement 2: If the price paid for the target exceeds the fair value of the associate's net
assets, the excess purchase price is amortized over the remaining life of
the asset.

A sharp decrease in the fair value of BenSol Advisory in the third year was due to the
lossof a major client by the associate because of which estimates of the entitys future
cash flows had dropped dramatically to $80 million per year and were expected to remain
so in the foreseeable future. Exhibit 1 displays the data relevant to the third year of
investment:

Carrying Value of Investment $1,800,000,000


Fair Value of Investment $1,500,000,000
Costs to Sell $8,000,000
Prevailing Market Interest Rate 9%

FinQuiz Question ID: 17361


55. The first statement made by Morgan is most likely:

A. correct.
B. incorrect, following the reporting of the investment at fair value, any unrealized
gains/losses should be charged to the investors other comprehensive income.
C. incorrect, following the reporting of the investment at fair value, any unrealized
gains/losses should not be reported.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 17362

56. The second statement made by Morgan is most likely:

A. correct.
B. incorrect, if the price paid for the target exceeds the fair value of identifiable net
assets, no amortization takes place.
C. incorrect, if the price paid for the target exceeds the fair value of identifiable net
assets, the excess amount is recognized as goodwill.

FinQuiz Question ID: 17363


57. In light of the sharp decrease in fair value of the associate, Index Solutions would
most likely have:

A. charged an impairment loss as the decrease in future cash flows qualifies as a loss
event.
B. not charged an impairment loss as the decrease in future cash flows does not
qualify as a loss event.
C. not charged an impairment loss, as the fair value option does not allow
impairment loss charges.

FinQuiz Question ID: 17364


58. Assuming Index Solutions is allowed to charge an impairment loss and takes
advantage of this option, subsequent year increases in fair value would most likely
lead to:

A. reversal of the impairment loss being recognized in the income statement.


B. reversal of the impairment loss being recognized in equity.
C. no reversal of impairment loss.

FinQuiz Question ID: 17365


59. Assuming Index Solutions is allowed to charge an impairment loss and takes
advantage of this option, the value in use of the associate is closest to:

A. $800 million.
B. $889 million.
C. $969 million.

FinQuiz Question ID: 17366


60. Assuming Index Solutions is allowed to charge an impairment loss and takes
advantage of this option, the impairment loss to be recognized is closest to:

A. $300 million.
B. $308 million.
C. $911 million.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 17367

Questions 61(17368) through 66(17373) relate to Reading 16

Jim Connor Case Scenario

Jim Connor is a financial analyst at HRM Securities located in Memphis, Tennessee. He


is currently analyzing the financial statements of Alkal Inc., which consists of a number
of passive investments in various financial instruments. Alkal Inc. uses the International
Financial Reporting Standards to prepare its financial statements. Connors assistant,
Tom Creshaw, has carried out a preliminary classification of the securities carried by
Alkal Inc. and has also prepared a brief on acceptable treatments to be used in analyzing
these instruments. The stated treatments are in accordance with current IAS 39 Financial
Instruments standard. The brief included the following statements:

Statement 1: Securities designated at fair value can only be reclassified under U.S.
GAAP.

Statement 2: Reclassification of securities out of the held-for-trading category is


allowed only under the International Financial Reporting Standards.

Statement 3: When an available-for-sale security is reclassified as held-to-maturity,


any previous unrealized gains are charged to the income statement as a
one-off expense.

One of the securities Connor is valuing has been recorded at historical cost as no reliable
fair value was available at the time of acquisition. This debt instrument was bought by
Alkal Inc. with the intention to sell but no formal plan was made for its sale. Three years
after acquisition, the listing of the underlying company led to the possibility of a reliable
fair value to be measured for the instrument.

FinQuiz Question ID: 17368


61. The first statement made by Creshaw is most likely:

A. correct.
B. incorrect, securities designated at fair value can only be reclassified under the
International Financial Reporting Standards.
C. incorrect, securities designated at fair value can be reclassified under neither the
U.S. GAAP nor the International Financial Reporting Standards.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 17369

62. The second statement made by Creshaw is most likely:

A. correct.
B. incorrect, reclassification of securities out of the held-for-trading category can be
accomplished more easily under U.S. GAAP.
C. incorrect, reclassification of securities out of the held-for-trading category is
allowed under both the International Financial Reporting Standards and U.S.
GAAP.

FinQuiz Question ID: 17370


63. The third statement made by Creshaw is most likely:

A. correct.
B. incorrect, when an available-for-sale security is reclassified as held-to-maturity,
any previous unrealized gains are amortized to the income statement over the
remaining life of the security.
C. incorrect, when an available-for-sale security is reclassified as held-to-maturity,
any previous unrealized gains remain a part of other comprehensive income until
the security is sold.

FinQuiz Question ID: 17371


64. The debt security mentioned in the vignette should most likely be:

A. reclassified as available-for-sale.
B. reclassified as held-to-maturity.
C. maintained at historical cost.

FinQuiz Question ID: 17372


65. The dissolution of an active market for the debt instrument most likely:

A. is an extraordinary loss to be charged to other comprehensive income.


B. is an indication of impairment loss to be charged to the income statement.
C. does not call for any treatment and the debt security should be maintained at
current value.

FinQuiz Question ID: 17373


66. The downgrade of Alkal Inc.s credit rating would most likely:

A. be charged to other comprehensive income as an extraordinary loss.


B. be considered an indicator of impairment to be charged to the income statement.
C. not call for any treatment and the debt security would be maintained at current
value.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 17374

Questions 67(17375) through 72(17380) relate to Reading 16

Larry Hill Case Scenario

Larry Hill is a senior financial analyst at Beaver Inc. located in Madison, Wisconsin. He
is assessing the classification procedure of a debt security issued by Apparel Inc. which
has twenty years remaining to maturity. Apparel Inc. is a globally recognized clothing
line specializing in denim wear. The management of Beaver Inc. intends to hold this
security till its maturity date and is using the International Financial Reporting Standards
(IAS 39 Financial Instruments) for classification of all financial instruments. Exhibit 1
displays the data which has been compiled relevant to this security.

Exhibit 1
Fair Value @ Acquisition $250,000
Transaction Costs $2,200
Expected Market Value @ Maturity $350,000
Unamortized Discount @ 31st December, 2012 $2,500
Carrying Value @ 31st December, 2011 $275,000
Carrying Value @ 31st December, 2012 $282,000

Exhibit 2 displays the prevailing market interest rates for the relevant dates:

Exhibit 2
Market Rate
At the time of Security Purchase 10.8%
On 31st December, 2011 10.5%
On 31st December, 2012 11.2%

In the beginning of 2013, IGeniX, one of the primary competitors of Apparel Inc,
approached Beaver Inc. with the intention to buy the debt security for $297,500. IGeniX
applies US GAAP policies to compile its financial statements.

IGeniX intends to hold this security as available-for-sale. Stacy Meyers, a junior analyst
at IGeniX, made the following statement regarding the prospective transaction and its
subsequent classification at an analyst meeting in the company:

Statement 1: Any realized gains from changes in fair value will be reported in the
income statement, while any unrealized gains will be recognized in equity
through other comprehensive income.

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Reading 16 Intercorporate Investment FinQuiz.com

IGeniX plans to sell the debt security in five years. Meyers and her colleagues have
compiled the following hypothetical data for the prospective sale:

Exhibit 3
Sale Proceeds $310,000
Fair Value @ 31st December, 2017 $302,000
Unrealized Gain $15,000
Discount $1,500

FinQuiz Question ID: 17375


67. Assuming Beaver Inc. had applied U.S. GAAP instead of the IFRS, the effective
interest rate would most likely have been calculated based on the:

A. contractual cash flows over the assets contractual life.


B. estimated cash flows over the expected life of the asset.
C. prevailing market interest rate.

FinQuiz Question ID: 17376


68. The interest revenue recognized in the income statement of Beaver Inc. for the year
ended 31 December, 2012 would be closest to:

A. $28,875.
B. $29,700.
C. $31,584.

FinQuiz Question ID: 17377


69. Assuming Beaver Inc. agrees to sell the security to IGeniX for the price offered, the
entitys realized gain on the transaction would be closest to:

A. $13,300.
B. $15,500.
C. $18,000.

FinQuiz Question ID: 17378


70. The statement made by Meyers is most likely:

A. correct.
B. incorrect, all changes in fair value will be reported to the income statement.
C. incorrect, all changes in fair value will be recognized in other comprehensive
income.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 17379


71. If, in subsequent years, IGeniX needs to reverse an impairment loss on the available-
for sale security, it would most likely:

A. recognize the reversed amount in the income statement.


B. not be able to reverse the impairment loss charged, as available-for-sale debt
security amounts cannot be reversed.
C. recognize the reversed amount in other comprehensive income, as it is unrealized
till sold.

FinQuiz Question ID: 17380


72. The realized gain reported by IGeniX on the prospective sale of the debt security is
closest to:

A. $8,000.
B. $9,500.
C. $23,000.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Item-set ID: 17381

Questions 73(17382) through 78(17387) relate to Reading 16

Petroleum Pipes Inc. Case Scenario

Petroleum Pipes Inc. (PPI) is a private oil and gas exploration entity with headquarters in
Dallas, Texas. PPI has recently installed a pipeline, which runs from Mexico to the U.S.
The portion of the pipeline in Mexico is controlled by another private entity with
headquarters in Mexico City, Mexico. The two private parties, jointly controlling the
pipeline operations present their financial statements under the International Financial
Reporting Standards framework.

Francis Stewart, the chief financial officer of PPI is signing off the finalized contracts of
an acquisition to be made in Texas Petroleum Technicians (TPT). This acquisition would
give PPI significant control over TPT and give the parent firsthand access to the highly
specialized workforce of the subsidiary. A day ago, Stewart had attended an analyst
meeting which took place at the companys headquarters. At the meeting, Mariah
Hawthorne, a junior accountant at PPI, made the following statements:

Statement 1: Direct costs of business combinations are included in the cost of


investment calculated by the investor.

Statement 2: In the previously acceptable pooling of interests method, goodwill was


calculated using the book values of assets and liabilities.

FinQuiz Question ID: 17382


73. Which of the following characteristic is most likely identified by IFRS as being
common to joint ventures?

A. The parties have interlinked directorship boards.


B. The parties have significant influence over the operations.
C. There is a contractual arrangement in effect between the parties.

FinQuiz Question ID: 17383


74. PPI would most likely present the accounts from the joint operations under the:

A. proportionate consolidation method.


B. equity method.
C. either the proportionate consolidation or the equity method.

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Reading 16 Intercorporate Investment FinQuiz.com

FinQuiz Question ID: 17384


75. Assuming that PPI decides to use the proportionate consolidation method to account
for its investment, the most likely result would be:

A. a higher debt to equity ratio as compared to the equity method.


B. higher total net assets as compared to the equity method.
C. a higher operating margin as compared to the equity method.

FinQuiz Question ID: 17385


76. The first statement made by Hawthorne is most likely:

A. correct.
B. incorrect, direct costs of business combinations are expensed in the investors
income statement as they are incurred.
C. incorrect, direct costs of business combinations are capitalized as miscellaneous
items and amortized over the life of the services rendered.

FinQuiz Question ID: 17386


77. The second statement made by Hawthorne is most likely:

A. correct.
B. incorrect, in the previously acceptable pooling of interests method, goodwill was
calculated using the fair values of the assets and the liabilities.
C. incorrect, in the previously acceptable pooling of interests method, goodwill was
not calculated.

FinQuiz Question ID: 17387


78. Compared to the pooling of interests method, the acquisition method would most
likely report:

A. higher cost of goods sold.


B. lower depreciation.
C. lower goodwill.

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