Chapter 5,6,7
True or False
1. In a business combination that establishes a
parent company-subsidiary affiliation, the
subsidiary prepares journal entries on the
date of the combination to increase the
carrying amounts of its net assets to
current fair values.
Answer: False
2.Only the balance sheet is consolidated on
the date of a business combination of a
parent company and subsidiary.
Answer: True
3.A controlling financial interest
traditionally has been defined as the
investor corporation's ownership of more
than 50% of the investee corporation's
outstanding common stock.
Answer: True
4.All out-of-pocket costs of a business
combination reduce additional paid-in
capital of the combinor.
Answer: False
5.Consolidated financial statements
emphasize the legal form of the parent
company-subsidiary relationship.
Answer: False
6. A parent company's control of a subsidiary
may be achieved both directly and
indirectly, the latter through another
subsidiary of the parent.
Answer: True
7.A debit to GoodwillSubsidiary in a
working paper elimination (in journal
entry format) for a parent company and its
wholly owned subsidiary indicates that the
current fair values of the subsidiary's
identifiable net assets exceeded their
carrying amounts on the date of the
business combination.
Answer: False
8.Goodwill recognized in a business combination
of a parent company and a partially owned
subsidiary is attributable to the subsidiary.
Answer: False
9.In a business combination resulting in a parent
company-subsidiary affiliation, the parent
company's Investment in Subsidiary Common
Stock ledger account is not closed, as it is in
other types of business combinations.
Answer: True
10.Under the parent company concept of
consolidated financial statements, the minority
interest in net assets of a subsidiary is displayed
as a liability.
Answer: True
11.All out-of-pocket costs of a business
combination are recognized as expenses by the
combinor.
Answer: False
12.Contingent consideration that is determinable on
the date of a business combination is part of the
total cost of the combinor's investment in the
combinee.
Answer: True
13.In a statutory merger, all except one of the
constituent companies are liquidated.
Answer: True
14.A part of the cost of a combinee is allocated to
identifiable tangible and intangible assets that
resulted from research and development
activities of the combinee.
Answer: True
15.The issuer of common stock in a business
combination always is the combinor.
Answer: False
16.Goodwill acquired in a business combination is
amortized over its economic life.
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 Answer: False
17.Under the equity method of accounting, a
parent company credits the
Intercompany Investment Income
ledger account for dividends declared
by the subsidiary.
Answer: False
18. Under the equity method of
accounting, a parent company's journal
entry to record a dividend declared by
the subsidiary includes a debit to the
Retained Earnings of Subsidiary ledger
account and a credit to the Dividends
Revenue ledger account.
Answer: False
19. Proponents of the equity method of
accounting assert that dividends
declared by a subsidiary constitute
revenue to the parent company.
Answer: False
20. A wholly owned subsidiary credits the
Dividends Payable ledger account when its
board of directors declares a dividend.
Answer: False
22. Under the equity method of accounting, the
parent company debits the Intercompany
Investment Income ledger account for the
depreciation and amortization of differences
between the current fair values and carrying
amounts of a subsidiary's identifiable net
assets on the date of the business
combination.
Answer: True
23. The depreciation and amortization of
differences between current fair values and
carrying amounts of a subsidiary's
identifiable net assets is included in
consolidated financial statements by means
of a working paper elimination.
Answer: True

Multiple Choice Questions

1. In a business combination resulting in a parent company-subsidiary relationship,

differences between current fair values and carrying amounts of the subsidiary's
identifiable net assets on the date of the combination are:
A) Disregarded
B) Entered in the accounting records of the subsidiary
C) Accounted for in appropriately titled ledger accounts in the parent company's
accounting records
D) Provided in a working paper elimination
E) Accounted for in some other manner

Answer: D

2. Consolidated financial statements are prepared when a parent-subsidiary

relationship exists, in recognition of the accounting principle or concept of:
A) Materiality
B) Entity
C) Reliability
D) Going concern

Answer: B

3. Pangborn Corporation paid $840,000 (including direct out-of-pocket costs) for

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 70% of the outstanding common stock of Siddon Company on September 30,
2006, the end of Pangborn's fiscal year. Included in the working paper elimination
(in journal entry format) for Pangborn Corporation and subsidiary on that date
were the following:

GoodwillPangborn [$840,000 – ($1,100,000 x 0.70)] $ 70,000 dr

Minority Interest in Net Assets of Subsidiary ($1,100,000 x 0.30) 330,000 cr

If Pangborn had inferred a current fair value for 100% of Siddon's total net assets
from the $840,000 cost, Goodwill and Minority Interest in Net Assets of
Subsidiary in the September 30, 2006, working paper elimination would have
been, respectively:
A) $100,000 and $330,000
B) $70,000 and $360,000
C) $49,000 and $231,000
D) $100,000 and $360,000
E) Some other amounts

Answer: D
Rationale: [($840,000 ÷ 0.70) – $1,100,000 = $100,000]; ($1,200,000 x 0.30 =
$360,000)

4. On March 31, 2006, Preston Corporation acquired for cash at $25 a share all
300,000 shares of the outstanding common stock of Sexton Company. Out-of-
pocket costs of the business combination may be disregarded. Sexton's balance
sheet on March 31, 2006, had net assets of $6,000,000. Additionally, the current
fair value of Preston's plant assets on March 31, 2006, was $800,000 in excess of
carrying amount. The amount to be shown for the balance sheet caption
"Goodwill" in the March 31, 2006, consolidated balance sheet of Preston
Corporation and its wholly owned subsidiary, Sexton Company, is:
A) $0
B) $700,000
C) $800,000
D) $1,500,000
E) Some other amount

Answer: B
Rationale: [(300,000 x $25) – ($6,000,000 + $800,000) = $700,000]

5. Consolidated financial statements are not appropriate if:

A) The subsidiary is in the process of bankruptcy reorganization
B) There is a minority interest in the subsidiary
C) The subsidiary has a substantial amount of long-term debt payable to
outsiders
D) The parent company makes substantial purchases of material from the
subsidiary

Answer: A

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6. On March 1, 2006, Pride Corporation paid $400,000 for all the outstanding
common stock of Supra Company in a business combination, for which out-of-
pocket costs may be disregarded. The carrying amounts of Supra's identifiable
assets and liabilities on March 1, 2006, follow:

Cash $ 40,000
Inventories 120,000
Plant assets (net) 240,000
Liabilities (90,000)

On March 1, 2006, the inventories of Supra had a current fair value of $95,000,
and the plant assets (net) had a current fair value of $280,000.

The amount recognized as goodwill as a result of the business combination is:

A) $0
B) $25,000
C) $75,000
D) $90,000
E) Some other amount
Answer: C
Rationale: [$400,000 – ($310,000 – $25,000 + $40,000) = $75,000]

7. On October 31, 2006, Portugal Corporation acquired 80% of the outstanding

common stock of Spain Company in a business combination. Total cost of the
investment, including direct out-of-pocket costs, was $480,000. The working
paper elimination (in journal entry format, explanation omitted) for Portugal
Corporation and Subsidiary on October 31, 2006, was as follows:

Common StockSpain 100,000

Additional Paid-in CapitalSpain 120,000
Retained EarningsSpain 180,000
Plant Assets (net)Spain 50,000
GoodwillPortugal [$480,000 – ($450,000 x 0.80)] 120,000
Investment in Spain Company Common StockPortugal
480,000
Minority Interest in Net Assets of Subsidiary ($450,000 x
0.20) 90,000

If minority interest in net assets of subsidiary had been reflected at carrying

amount, rather than at current fair value, of the subsidiary's identifiable net assets,
the credit to Minority Interest in Net Assets of Subsidiary in the foregoing
elimination would have been:
A) $90,000
B) $120,000
C) $60,000
D) Some other amount

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 Answer: D
Rationale: ($400,000 x 0.20 = $80,000)

8. On October 31, 2006, Portugal Corporation acquired 80% of the outstanding

common stock of Spain Company in a business combination. Total cost of the
investment, including direct out-of-pocket costs, was $480,000. The working
paper elimination (in journal entry format, explanation omitted) for Portugal
Corporation and Subsidiary on October 31, 2006, was as follows:

Common StockSpain 100,000

Additional Paid-in CapitalSpain 120,000
Retained EarningsSpain 180,000
Plant Assets (net) Spain 50,000
GoodwillPortugal [$480,000 – ($450,000 x 0.80)] 120,000
Investment in Spain Company Common StockPortugal
480,000
Minority Interest in Net Assets of Subsidiary ($450,000 x
0.20) 90,000
If goodwill had been computed based on the implied current fair value of the
subsidiary's total net assets, the debit to GoodwillPortugal in the foregoing
working paper elimination would have been:
A) $120,000
B) $150,000
C) $180,000
D) Some other amount

Answer: B
Rationale: [($480,000 ÷ 0.80) – $450,000 = $150,000]

9. Which of the following is the best theoretical justification for consolidated

financial statements?
A) In form the constituent companies are one economic entity; in substance they
are separate
B) In form the constituent companies are separate; in substance they are one
economic entity
C) In form and substance the constituent companies are one economic entity
D) In form and substance the constituent companies are separate

Answer: B

10. In a business combination resulting in a parent company-subsidiary relationship,

the parent company's Investment in Subsidiary Common Stock ledger account
balance is:
A) Allocated to individual asset and liability ledger accounts in a parent company
journal entry

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 B) Eliminated with a working paper elimination for the working paper for
consolidated balance sheet
C) Displayed among noncurrent assets in the consolidated balance sheet
D) Used as a basis for adjusting the subsidiary's asset and liability account
balances in the subsidiary's ledger to current fair values

Answer: B

11. Working paper eliminations are entered in:

A) Both the parent company's and the subsidiary's accounting records
B) Neither the parent company's nor the subsidiary's accounting records
C) The parent company's accounting records only
D) The subsidiary's accounting records only
Answer: B

12. On the date of a business combination resulting in a parent-subsidiary

relationship, the differences between current fair values and carrying amounts of
the subsidiary's identifiable net assets are:
A) Included in a working paper elimination
B) Recognized in the applicable asset and liability ledger accounts of the
subsidiary
C) Recognized in the applicable asset and liability ledger accounts of the parent
company
D) Accounted for in some other manner
Answer: A

13. Consolidated financial statements are intended primarily for the use of:
A) Stockholders of the parent company
B) Taxing authorities
C) Management of the parent company
D) Creditors of the parent company
Answer: A

14. On November 30, 2006, Pegler Corporation paid $500,000 cash and issued
100,000 shares of $1 par common stock with a current fair value of $10 a share
for all 50,000 outstanding shares of $5 par common stock (carrying amount $20 a
share) of Stadler Company, which became a subsidiary of Pegler. Also on
November 30, 2006, Pegler paid $50,000 for finder's, accounting, and legal fees
related to the business combination and $80,000 for costs associated with the SEC
registration statement for the common stock issued in the combination. The net
result of Pegler's journal entries to record the combination is to:
A) Debit Investment in Stadler Company Common stock for $1,000,000
B) Credit Paid-In Capital in Excess of Par for $900,000
C) Debit Expenses of Business Combination for $130,000
D) Credit Cash for $630,000

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 Answer: D

15. Minority interest in net assets of subsidiary is displayed in the consolidated

balance sheet as:
A) A part of consolidated stockholders' equity under the parent company concept
of consolidated financial statements
B) A liability under the parent company concept of consolidated financial
statements
C) An offset to investment in subsidiary common stock under the parent
company concept of consolidated financial statements
D) An item between liabilities and stockholders' equity under the economic unit
concept of consolidated financial statements
Answer: B

16. Before the computation of goodwill, the debits in the date-of-business-

combination working paper elimination for the consolidated balance sheet of
Promo Corporation and its 80%-owned subsidiary subtotaled $640,000, compared
with a $540,000 credit to Investment in Sindow Company Common Stock
Promo. The working paper elimination should be completed with:
A) An allocation of the $100,000 bargain-purchase excess to reduce the amounts
initially assigned to specified assets of Sindow.
B) A $100,000 credit to Minority Interest in Net Assets of Subsidiary
C) A $28,000 debit to GoodwillPromo and a $128,000 credit to Minority
Interest in Net Assets of Subsidiary
D) A $35,000 debit to GoodwillPromo and a $135,000 credit to Minority
Interest in Net Assets of Subsidiary
Answer: C

17.Two methods for arranging business combinations that begin with similar transactions
by the combinor are:
A) Statutory merger and statutory consolidation
B) Statutory merger and acquisition of common stock
C) Acquisition of common stock and acquisition of net assets
D) Statutory consolidation and acquisition of common stock
Answer: B

18. Direct out-of-pocket costs of a business combination that are part of the cost of
the combinee do not include:
A) Legal fees for registration of securities issued by the combinor
B) Finder's fee
C) Legal fees for the contract of combination
D) CPA firm fees for pre-combination investigation of the combinee
Answer: A

20. On October 1, 2006, Poon Corporation acquired for cash all the outstanding common
stock of Soong Company, which was not liquidated. Consolidated net income for
the fiscal year ended December 31, 2006, includes net income of:
A) Poon for three months and Soong for three months

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 B) Poon for twelve months and Soong for three months
C) Poon for twelve months and Soong for twelve months
D) Poon for twelve months, but no income from Soong until it declares a cash
dividend

Answer: B

22. The Retained Earnings of Subsidiary ledger account is:

A) An account of the parent company that at all times in any business
combination shows the amount of the subsidiary's retained earnings
B) An account of the subsidiary
C) An account that appears only in the working paper for consolidated financial
statements
D) None of the foregoing

Answer: D

23. Under the equity method of accounting, depreciation and amortization of the date-
of-business-combination differences between current fair values and carrying
amounts of a subsidiary's identifiable net assets is debited in a journal entry to the:
A) Subsidiary's expense ledger accounts
B) Parent company's expense ledger accounts
C) Subsidiary's Retained Earnings ledger account
D) Parent company's Intercompany Investment Income ledger account

Answer: D

24. To recognize the impairment of goodwill arising from a business combination

involving a partially owned subsidiary:
A) The subsidiary debits the Impairment Loss ledger account and credits the
Goodwill account in its accounting records.
B) The parent company debits the Impairment Loss ledger account and credits
the Goodwill account in its accounting records.
C) The parent company debits the Intercompany Investment Income ledger
account and credits the Investment in Subsidiary Common Stock account in
its accounting records.
D) The parent company prepares some other journal entry.

Answer: D
Rationale: (Debit Impairment Loss, credit the Investment account)

25. Skeene Company, the 70%-owned subsidiary of Probert Corporation, had a net
income of $80,000 and declared dividends of $30,000 during the fiscal year ended
February 28, 2006. Fiscal Year 2006 depreciation and amortization of differences
between current fair values and carrying amounts of Skeene's identifiable net
assets on the date of the business combination was $15,000; and Fiscal Year 2006
impairment of goodwill recognized in the Probert-Skeene business combination
was $500. The minority interest in net income of Skeene for Fiscal Year 2006
was:
A) $24,000

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 B) $19,500
C) $19,350
D) $9,000
E) Some other amount

Answer: B
Rationale: [($80,000 – $15,000) x .30 = $19,500]

26. Which of the following does not affect the computation of the minority interest in
the net assets of a partially owned subsidiary?
A) Impairment of goodwill recognized in the business combination
B) Dividends declared by the subsidiary
C) Depreciation and amortization of differences between current fair values and
carrying amounts of the subsidiary's identifiable net assets on the date of the
business combination
D) None of the foregoing

Answer: A

27. Plover Corporation accounts for its 80%-owned purchased subsidiary, Swallow
Company, under the equity method of accounting. For the fiscal year ended
March 31, 2006, Swallow had a net income of $100,000, but declared no
dividends. Depreciation and amortization of differences between current fair
values and carrying amounts of Swallow's identifiable net assets for the year
ended March 31, 2006, totaled $40,000. Plover's closing entry for the year ended
March 31, 2006, includes a:
A) Credit of $48,000 to Intercompany Investment Income
B) Credit of $60,000 to Retained Earnings of Subsidiary
C) Debit of $60,000 to Intercompany Investment Income
D) Credit of $48,000 to Retained Earnings of Subsidiary

Answer: D
Rationale: [($100,000 – $40,000) x 0.80 = $48,000]

29. The minority interest in net assets of a partially owned subsidiary is:
A) Decreased by the minority's share of subsidiary dividends and increased by
the minority's share of subsidiary adjusted net income
B) Increased by the minority's share of subsidiary dividends and decreased by the
minority's share of subsidiary adjusted net income
C) Decreased by the minority's share of both subsidiary dividends and subsidiary
adjusted net income
D) Increased by the minority's share of both subsidiary dividends and subsidiary
adjusted net income

Answer: A

30. If a wholly owned subsidiary's net income was $150,000, the subsidiary declared
dividends of $80,000, and the depreciation and amortization of current fair value
excess was $20,000, the parent company's intercompany investment income under
the equity method of accounting is:

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A) $60,000
B) $70,000
C) $100,000
D) $130,000
E) Some other amount

Answer: D
Rationale: ($150,000 – $20,000 = $130,000)

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