Consolidated Cash Flows and Changes in Ownership: Solutions Manual, Chapter 8

Chapter 8
Consolidated Cash Flows and

Changes in Ownership
Copyright  2016 McGraw-Hill Education. All rights reserved.

Solutions Manual, Chapter 8 1
A brief description of the major points covered in each case and problem.
CASES
Case 8-1
One day after purchasing 100% of the shares of a company, the parent sells 40% of these
shares to an unrelated party and realizes a substantial profit. The parent wants to recognize
this gain on the date of acquisition rather than the date of sale.
Case 8-2
The company pays a premium to buy out a minority shareholder who has been very aggravating
to the controlling shareholder. You are asked to resolve a dispute over how to account for the
acquisition differential.
Case 8-3
This case, adapted from a CPA exam, involves a public company wishing to divest a wholly
owned subsidiary. You are asked to recommend accounting policies to maximize the selling
price and how the agreement should be changed to minimize disputes in the future.
Case 8-4
This case, adapted from a CPA exam, involves a manufacturing company. You are asked to
recommend accounting policies relating to revenue recognition and related selling expenses,
Inventory costing and business acquisition costs.
Case 8-5
This case, adapted from a CPA exam, involves a clothing store. You are asked to prepare a
report regarding cash flow problems and accounting and other issues excluding income tax and
assurance. The accounting issues include going concern, capitalize versus expense of various
expenditures and change in ownership percentage of significant-influence investment.
PROBLEMS
Problem 8-1 (20 min.)
A consolidated cash flow statement is presented and the student is required to answer a series
of questions with regard to the consolidation process.
2 Modern Advanced Accounting in Canada, Eighth Edition
This comprehensive problem requires the preparation of consolidated financial statements when
the subsidiary has preferred shares outstanding. Calculations involved with an ownership
reduction and unrealized profits in inventory and plant and equipment are also required.

This problem is concerned with a business combination in 3 steps of 25%, 20% and 10%. It
requires journal entries under the cost and equity methods, the calculation of the investment
account balance under the two methods and the calculation of select account balances for the
consolidated financial statements.

The preparation of a consolidated cash flow statement is required given that there has been a
reduction in the parent's investment during the year.

This problem requires the calculation of consolidated profit, other consolidation amounts and the
parent’s profit under the equity method when there is an indirect shareholding involved.

This problem requires the calculation of consolidated profit, retained earnings, and non-
controlling interest for the first year after acquisition when the subsidiary has cumulative
preferred shares outstanding.

The calculations of the gains and losses associated with ownership reductions are required
along with an explanation of whether the historical cost principle is used in accounting for the
acquisition differential.

This problem involves the sale of shares by the parent –first from 90% to 70% and then from
70% to 45%. It requires the calculation of the balance in the investment account under the
equity method and non-controlling interest on the consolidated balance sheet after the two
different sales of shares.
A journal entry and calculations of unamortized acquisition differential are required when there
has been a reduction in the parent's ownership.

This problem requires the calculation of patents, consolidated profit, retained earnings, and non-
controlling interest for the second year after acquisition when the parent increases its
percentage ownership from 75% to 95%.

This problem requires the calculation of consolidated profit attributable to the parent’s
shareholders and non-controlling interest when a parent has indirect holdings and an
explanation of how the revenue recognition principle supports adjustments for unrealized profits.

The preparation of a consolidated balance sheet is required immediately after the parent's
ownership decreases due to a new share issue by the subsidiary.

This problem requires the preparation of a consolidated balance sheet and a consolidated
retained earnings statement where indirect shareholdings are involved.

The preparation of a consolidated cash flow statement is required along with an explanation on
why 100% of the subsidiary’s dividends do not appear on the consolidated cash flow statement.

This problem is concerned with the calculations of the investment account, unamortized
acquisition differential and non-controlling interest when the parent sells and is deemed to sell
part of its investment.

This is a fairly comprehensive problem involving the step acquisitions of a subsidiary company
that has preferred shares in its capital structure. There are unrealized profits in inventory and
equipment. The problem also requires the calculation of goodwill impairment loss and NCI
under the parent company extension theory. Non-controlling interest is measured using the
market price of the subsidiary’s shares at the date of acquisition. A consolidation worksheet is
also required.
Problem 8-17 (90 min.) (prepared by Peter Secord, Saint Mary’s University)
The preparation of consolidated financial statements is required when the subsidiary has
convertible preferred shares and there have been unrealized intercompany profits from asset
transfers. Also required is a brief discussion on the reporting implications if the preferred shares
were converted to common shares. A consolidation worksheet is also required.
Problem 8-18 (60 min.) (prepared by Peter Secord, Saint Mary’s University)
The question requires the calculation of amounts for certain consolidated financial statement
items when step purchases have occurred and there are unrealized profits in inventory and
depreciable property, plant and equipment.
SOLUTIONS TO REVIEW QUESTIONS
1. Theoretically yes, since it could be prepared by consolidating the cash flow statements of
the parent and its subsidiaries, but this would be a complex process. Practically though, it
is much easier to prepare the statement by analyzing the yearly changes that have
occurred in the noncash items in the consolidated balance sheet.
2. $700,000 (minus any cash on the balance sheet of the subsidiary company) would appear
as an outflow in the investing activities section. Because the $300,000 share issue did not
affect cash, it would not appear as a separate item on the consolidated cash flow
statement. However, complete footnote disclosure would be required and would indicate
the total acquisition price, the consideration given (cash and common shares), and a
summary of the assets, liabilities, and equity interest acquired.
3. The amortization of the acquisition differential is similar to depreciation expense in that it is

deducted in the determination of net income but does not represent a cash outflow.
Therefore, as with depreciation expense, the amortization of the acquisition differential is

added back to consolidated net income to determine cash flow from operations in the
consolidated cash flow statement.
4. Dividend payments to non-controlling shareholders represent a flow of cash outside the

economic entity, and, as a result, they must be disclosed on the consolidated cash flow
statement. The only dividends that can be reported in the consolidated statement of
retained earnings are those that are paid to the parent's shareholders. From the
consolidated entity's point of view, dividends declared or paid to non-controlling
shareholders represent a reduction of the equity of the non-controlling interest in the
subsidiary's assets. If a statement of changes in non-controlling interest were presented, it
would show an increase from the allocation of entity net income, and a decrease from
dividends to non-controlling shareholders.
5. The change from the cost to the equity method should be accounted for retroactively under
the following circumstances:
- when the reason for the change is to correct an error in prior periods i.e., the entity should
have been using the equity method in the past, but was using the cost method, or
- when the entity could have been using either method in the past and is now changing
from one equally acceptable method to another. For example, the parent company can
use either the cost method or equity method for recording purposes when it controls the
subsidiary and prepares consolidated financial statements.
On the other hand, if the change is being made as a result of a change in circumstance,
the change should be accounted for prospectively. For example, if the investor company
increases its investment from 10% to 30% of the shares of the investee company and
thereby changes from having no influence to having significant influence, then the change
is made prospectively.
6. No, the subsidiary’s net assets are only measured at fair value at the date of acquisition
i.e., when the parent first obtains control of the subsidiary. When increasing the percentage
ownership from 60% to 75%, the parent’s portion of the unamortized acquisition differential
increases and the NCI’s portion decreases by the same amount, which is the carrying
amount of the portion sold by the NCI. Neither the parent’s portion nor the NCI’s portion is
remeasured at fair value as a result of this transaction. This transaction is treated as a
transaction among owners. Any difference between the amount paid by the parent and the
carrying amount sold by the NCI is treated as an equity transaction and is charged or
credited directly to shareholders’ equity.
7. The non-controlling interest is not remeasured at fair value because the parent’s interest is
not remeasured at fair value. Revaluation only occurs when the purchaser’s position
changes from not having control to having control or vice versa. Here, the parent had
control at 76% and still has control at 60%. The decrease in the parent’s carrying amount
is added to the non-controlling interest. This transaction is treated as a transaction among
owners. Any difference between the amount received by the parent and the carrying
amount sold to the NCI is treated as an equity transaction and is charged or credited
directly to shareholders’ equity.
8. When the parent's ownership declines because of a subsidiary share issue, a loss to the
parent occurs due to the reduction in the parent's investment account. However, a gain
occurs from the perspective of the parent due to the parent's new share of the proceeds
from the subsidiary share issue. The two are netted and produce a net loss or gain on the
transaction. This gain or loss is reported as an equity transaction i.e., a transaction
between shareholders. The gain or loss is reported as a direct credit or charge to
shareholders’ equity i.e., a credit to contributed surplus or a debit to retained earnings.
9. No, a gain or loss realized by a parent company on the sale of part of its investment in the
common shares of its subsidiary is not eliminated in the preparation of the consolidated
financial statements because it represents a transaction between the consolidated entity
and parties outside the entity.
10. Yes, assuming that the parent company does not own all of the preferred shares. The
consolidated income statement will show a non-controlling interest equal to the non-
controlling interest’s share of the subsidiary's net income applicable to the preferred
shares. The consolidated balance sheet will show an amount for non-controlling interest
equal to the non-controlling interest’s share of the total shareholders' equity of the
subsidiary that is applicable to that company's preferred shares.
11. Net income for the year 17,000)

Allocated to preferred shares (12,000)
Net income for common shares 5,000
The common shareholders have the right to income remaining after the claim of the
preferred shareholders. In this case, income of $5,000 “belongs” to the common
shareholders.
12. Because in most situations the market value of preferred shares is related to the general
level of interest rates, it does not make sense conceptually to use a preferred share
acquisition differential to revalue the net assets of the subsidiary when consolidated
financial statements are prepared. Therefore, a negative acquisition differential should be
added to consolidated contributed surplus and a positive acquisition differential should be
deducted from consolidated contributed surplus (if there is any) or from consolidated
retained earnings.
13. When a subsidiary has preferred shares, the subsidiary’s shareholders’ equity must be
split between common shareholders and preferred shareholders before determining the
amount belonging to the controlling shareholder versus the non-controlling interest.
Similarly, when a subsidiary has preferred shares, the subsidiary’s net income must be
split between common shareholders and preferred shareholders before determining the
amount belonging to the controlling shareholder versus the non-controlling interest. In both
cases, the preferred shareholder amount is determined first based on the terms of the
preferred shares. The common shareholders get the residual amount after determining the
amount belonging to the preferred shareholders. For cumulative preferred shares, the
preferred shareholders will eventually receive a dividend for each year regardless of
whether or not it is paid each year. After the net assets and income have been split
between preferred and common shareholders, it can then be allocated to the controlling
and non-controlling interests based on their ownership percentages. In this particular case,
the non-controlling interest consists of 70% of the preferred equity and 10% of the
common equity.
14. The subsidiary’s income is split between the preferred shareholders and common
shareholders prior to calculating the parent’s and NCI’s share of the subsidiary’s income. If
the preferred shares are cumulative, the preferred shareholders are entitled to a share of
the investee’s income each year regardless of whether dividends are actually paid in any
given year. However, if the preferred shares are noncumulative, the preferred
shareholders will only receive a portion of the investee’s income of a given year if
dividends are actually declared in that year. Similarly, when calculating consolidated
retained earnings, the change in the subsidiary’s retained earnings since acquisition must
be split between the preferred shareholders and the common shareholders prior to
calculating the parent’s share of the change in retained earnings. The preferred
shareholders will receive a portion of the investee’s income for all years for which they
were entitled to receive a portion of the income less the amount of dividends already
received for those years.
15. The major consolidation problem associated with indirect shareholdings is the iterative
nature of the calculations. One must start at the lowest level of the corporate hierarchy and
work up the corporate structure. At each level, the income of the subsidiary has to be
adjusted for amortization of the acquisition differential and unrealized profits. Then, the
income is attributed to the controlling and non-controlling shareholders. In the end, the
non-controlling interest incorporates its share of each of the different entities on a
cumulative basis.
SOLUTIONS TO CASES
Case 8-1
(a) A subsidiary is usually measured at fair value at the date of acquisition. Fair value is defined
as the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (i.e., an exit price). It
would reflect the highest and best use for non-financial asset.
Since Pepper and Salt were unrelated parties at the date of acquisition, one could argue
that $1,440, the amount paid by Pepper, represented the fair value of Salt. Using this same
logic, one could also argue that Salt was worth $2,250 on this date since an unrelated party
was willing to pay $900 for 40% of the shares of Salt one day after Pepper purchased Salt.
What is the fair value of Salt as a whole? That is the big question. Once we have
determined the fair value of Salt as a whole, we can determine the fair value of Salt’s
goodwill and whether Pepper can record a gain on purchase.
The following consolidated balance sheets were prepared at December 31, Year 7 under
three different valuation alternatives:

A. The fair value of Salt as a whole is $1,440 and Salt’s goodwill is valued at $900, the
excess of amount paid by Pepper ($1,440) over the fair value of Salt’s identifiable net
assets ($240 + $700 – $400)
B. The fair value of Salt as a whole is $2,250 and Salt’s goodwill is valued at the excess of
amount paid by Pepper over the fair value of Salt’s identifiable net assets
C. The fair value of Salt as a whole is $2,250 and Salt’s goodwill is valued as the difference
between the value of Salt as a whole ($2,250) and the fair value of Salt’s identifiable net
assets ($240 + $700 – $400)
A B C
Tangible assets (1,000 + 240) $ 1,240 $ 1,240 $ 1,240
Intangible assets (400 + 700) 1,100 1,100 1,100
Goodwill 900 900 1,710
$3,240 $3,240 $4,050
Liabilities (800 + 400) $ 1,200 $ 1,200 $ 1,200

Shareholders’ equity (300 + 720) 2,040 2,040 2,850
$3,240 $3,240 $4,050
The shareholders’ equity in C includes a gain on purchase of $810, which is the difference
between the value of the subsidiary as a whole ($2,250) and the amount paid by Pepper
($1,440).
To answer which method best reflects economic reality, one needs to know what the fair
value of the subsidiary is. If it is $1,440, then column A best reflects economic reality and
would be required under GAAP. If the fair value of the subsidiary is really $2,250, then
column C best reflects economic reality. However, GAAP requires that goodwill of the
subsidiary be measured as the difference between the amount paid and the fair value of the
identifiable net assets. Therefore, Pepper could not report a gain on purchase in Year 7 and
would have to use column B.
(b) When a parent sells a portion of its interest in the subsidiary and retains control over the
subsidiary, the value of the subsidiary’s assets and liabilities on the consolidated balance
sheet do not change – they are retained at carrying amount. This transaction is treated as a
transaction among owners. The carrying amount of the portion sold is transferred from the
parent’s interest to the non-controlling interest. The parent will report a gain or loss for the
difference between the proceeds received from the sale and the carrying amount of
consideration sold. This gain will not be reported in net income but will be reported as a
direct adjustment to shareholders’ equity – either to retained earnings or contributed surplus.
The following consolidated balance sheets were prepared at January 1, Year 8 under the
same three valuation alternatives considered above.
A B C
Cash $ 900 $ 900 $ 900
Tangible assets (1,000 + 240) 1,240 1,240 1,240
Intangible assets (400 + 700) 1,100 1,100 1,100
Goodwill 900 900 1,710
$4,140 $4,140 $4,950
Liabilities (800 + 400) $ 1,200 $ 1,200 $ 1,200

Non-controlling interest (Note 1) 576 576 900
Shareholders’ equity (Note 1) 2,364 2,364 2,850
$4,140 $4,140 $4,950
Note 1: A B C
Carrying amount of Salt’s net assets
on consolidated balance sheet $ 1,440 $ 1,440 $ 2,250
Portion sold to non-controlling interest 40% 40% 40%
Value assigned to non-controlling interest 576 576 900
Proceeds received from non-controlling interest 900 900 900
Gain on sale of 40% interest 324 324 0
Shareholders’ equity prior to sale 12,040 12,040 2,850
Shareholders’ equity subsequent to sale $2,364 $2,364 $2,850
In scenarios A and B, a gain on sale is reported on January 1, Year 8 as a direct credit to

contributed surplus. In scenario C, no gain on sale is recorded on January 1, Year 8
because a gain of $810 was reported on December 31, Year 7. In all cases, non-controlling
interest is measured at 40% of the carrying amounts of the subsidiary’s assets and liabilities
on the consolidated balance sheet at the date of the sale.

Case 8-2
Both the CFO and controller are wrong. The transaction is an equity transaction between
shareholders of Stiff. Since Prince controlled Stiff both before and after this transaction, the
valuation of Stiff’s assets and liabilities for consolidation purposes will not change. Only the
parent’s and non-controlling interests’ share of the consolidated net assets will change. Any
difference between the amount paid by Prince and the carrying amount given up by the non-
controlling interest will not be reported in profit but will be reported as an adjustment to
shareholders’ equity. For this transaction, the difference is $330,000 calculated as follows:
Acquisition cost (54 x 100,000 x 20%) 1,080,000

Carrying amount of Stiff shares acquired (35 x 100,000 x 20%) 700,000
Carrying amount of acquisition differential acquired (250,000 x 20%) 50,000 750,000
Excess 330,000
The $330,000 will be reported as a reduction to contributed surplus, if any exists, or a reduction
to retained earnings.
Even if the acquisition differential were allocated to assets and liabilities, the entire amount
would not have been allocated to goodwill. $130,000 (20% x $650,000) should be allocated to
the patents in order to recognize the value of the patents. The remaining amount would be
allocated to goodwill. Then, the goodwill would have to be assessed for impairment at the end of
Year 13 and all subsequent years by determining the fair value of Stiff’s shares. The recent
trading price of $50 is not necessarily a true indication of the fair value of the shares. It
represents the exchange price for the parties exchanging shares on that particular date. To
acquire control of Stiff, investors typically pay a premium over the trading price for the shares..
An independent business valuation could determine the fair value of the shares. If the fair value
is less than $54 per share, the goodwill will have to be written down to reflect the impairment in
value. For example, if the fair value of the shares were only $52.50 per share, the purchase
price would have been inflated by $30,000 ($1.50 x 100,000 x 20%). In turn, goodwill would
have been overstated by $30,000 and would have to be written down by $30,000 in Year 13.
The $130,000 allocated to the patent would have to be amortized over the useful life of the patent
commencing in Year 14. Given a useful life of 4 years, the amortization expense would be
$32,500 ($130,000 / 4) per year and would cause a decrease in income of $32,500 for Year 14.
Case 8-3
Canada Transport Enterprises Inc. ("CTE")
Attention: Andrew Joel

DRAFT REPORT
Dear Andrew:
Sale of Traveller Bus Lines ("TBL")

As requested, we have reviewed the information provided. Our report:
 recommends ways in which the selling price can be maximized

 provides comments and recommendations on how the agreement should be changed to
minimize possible disputes in the future, and
 summarizes the accounting issues of significance to CTE that will arise on the sale of
TBL
Generally, the carrying amount (CA) of a company does not approximate its fair value (FV). This
is especially true of TBL. Many of its assets are worth significantly more than the CA recorded in
the financial statements, mainly because TBL's assets have increased in value over time. For
example, the bus routes are recorded at a fraction of what they are worth today; they are
discussed in more detail below.
Recommendations on ways to maximize the selling price

The sale of TBL will have a significant impact on CTE's share price. Therefore, by maximizing
the sale price, you will be maximizing the gain from the sale and maximizing the recorded equity
for CTE. However, the sale of TBL, one of CTE's profitable divisions, may adversely affect the
share price if the market feels that you did not get enough for the division. Management should
consider the impact of the sale on the share price.
Other alternatives are available for valuing a business and should be considered. Specifically, a
capitalized earnings approach would be a better way to value TBL. The reason is that future
earnings will reflect the value of assets that are not fully recorded on the balance sheet – for
example, intangible assets. This approach can also be justified on the grounds that earnings

have been stable and could be used to calculate the sale price.
Earnout clause
The new owners of TBL will be preparing the July 31, Year 8 financial statements, which will be
used to calculate the earnout amount. They will want to minimize the sale price. We should
specify in the agreement that the accounting policies cannot be changed in the year in which
the earnout is calculated. In addition, the new owners could make overly aggressive accruals to
further minimize the selling price. For example, they could pay unusually high salaries or
bonuses to reduce income. Restrictions should be placed in the agreement to prevent such
measures, and CTE should be allowed to independently verify the July 31, Year 8 results.
Possible adjustments to the selling price

The accounting policies chosen for TBL's financial statements will impact the calculation of the
selling price. Adjustments that increase the net value of TBL assets sold are more desirable
than adjustments that affect the earnout payment because CTE will receive all increases in the
CA and only 55% of increases that affect the July 31, Year 8 earnings.
We must determine whether we must use generally accepted accounting principles or whether
we can use a disclosed basis of accounting. If a disclosed basis of accounting is acceptable,
then FVs should be used. TBL is worth significantly more on a FV basis, and these adjustments
will result in an increased selling price. Therefore, we recommend using FV for accounting
purposes.
Bus routes
The bus routes obtained approximately 40 years ago currently have no carrying amount. This
situation does not reflect the value of these routes today. The value today is significant as
indicated by the amounts paid for similar routes in subsequent years. The FV of all bus routes
should be included in the selling price. Therefore, the CA of bus routes should be increased to
reflect FV. The FV can be estimated on the basis of the amount paid for similar bus routes
purchased.
However, the FV of the bus routes may be included in the value of the goodwill already
recorded. We must determine whether the goodwill represents the value of these routes. In
addition, the earnout may also compensate CTE for the underlying value of the bus routes.
Further information is needed.
School buses – useful life
The carrying amount of the school buses on TBL's balance sheet appears to be less than the
fair value of these buses, based on a recent report. The reason may be because we have
depreciated these assets over 10 years instead of 15 years. An adjustment should be made to
the financial statements and, as a result, the selling price will increase. The amount of the
adjustment will depend on the age of the buses
For accounting purposes, we must find out whether the value is understated as a result of a
change in an accounting estimate or as a result of an error. If it is the result of a change in an
accounting estimate, the adjustment will be made prospectively. If CTE can argue that it was
the result of an error, the adjustment will be made retroactively to the fixed asset account,
thereby increasing the selling price.
Non-refundable deposits
We must find out whether these deposits were recorded in income for the July 31, Year 7
period. The entire deposit relating to the cancelled contract should be included in the July 31,
Year 7 income because, at year-end, the amount has been earned and no future services must
be provided.
In addition, it may be possible to justify including all deposits received prior to July 31, Year 7, in
income as well. We could argue that the deposit is intended to guarantee service and does not
relate to the costs of providing the service. If this assumption can be successfully argued, CTE
will receive 100% of the income, rather than 55%, with no related costs. This approach will
increase the selling price. We must consider the wording of the contract to determine the proper
accounting treatment.
Travel the country

It appears that the liability for giving skis or skates to customers must be provided for. This will
decrease the selling price. In addition, the cash received for the passes could be reported as
revenue even though the three-month passes have not yet expired. The revenue could be
recorded in Year 7 since there is no incremental costs of having ticket-holders take the bus
thereby increasing the selling price.

Consolidation entries
Fair value increments (fixed assets and goodwill) are not currently included in the selling price.
However, these amounts should be included in the selling price since they probably represent
the FV of the assets being sold. Pushdown accounting treatment is recommended. It may be
preferable to revalue the company since the goodwill and fair value increments have likely
changed since they were first recorded.
Long-term receivables
We must determine whether this amount should be written down to fair value. If so, it will
decrease the selling price. Although the security does not cover the amount of the outstanding
balance, receivable is being collected. Therefore, we should argue that the loan is not impaired
and a write-down is not necessary.
Advertising
Plans call for an aggressive advertising campaign ($500,000), and the agreement states that
CTE will pay for these costs. However, the benefit is likely to be received in years subsequent
to the earnout. The payment of advertising costs should be considered further.
Bus retrofit
TBL is planning substantial costs to retrofit the fleet of buses. These costs will occur next year
yet will benefit TBL for many years to come. These costs should be capitalized or excluded
from the agreement.
Futures taxes
The deferred taxes should either not be considered in determining the selling price or should be
discounted if they are to be included. Otherwise, the selling price would be reduced.
Lease facility
We must determine whether a loss should be accrued for future lease payments. If so, the
selling price will decrease. TBL is receiving the benefit; therefore, CTE should not bear the cost
of moving. One possible alternative to providing for this amount is to account for these
payments on a cash basis, assuming that CTE will be able to sublet.
Significant accounting issues – CTE

There are various accounting issues that CTE must consider on the sale of TBL.
Reporting the sale of TBL
Although CTE can announce the sale and the potential profit that would result, it cannot report
the sale in its first quarter's income statement because of the timing of the sale. CTE may want
to change the timing of the sale accordingly. Otherwise, note disclosure can be provided. Under
the efficient market hypothesis, note disclosure would have the same impact on the share price.
In addition, the sale may have to be reported as a sale of discontinued operations. It depends
on whether TBL was the only company in an operating segment that was reported separately in
the segment-reporting note for CTE’s financial statements. If so, the gain in the financial
statements should be reported separately, net of applicable taxes.
Recognition of the gain on sale of TBL

Rather than recognize the gain right away, an argument could be made that the gain should not
be recognized until the full proceeds have been received because of the guarantee included in
the sale price. However, such an approach seems unduly conservative considering who the
purchasers are. Generally, the cost of future advertising, bus restoration, or environmental
liabilities should be accrued and applied against the gain on sale. Finally, the consulting income
should not be recognized until it is earned.
The earnout payment should be recognized in income in the year in which it is determinable. An
argument could be made to recognize the earnout payment in the current year since TBL's
income is static, but this approach may be too aggressive.
Comments on current agreement

The terminology used in the draft agreement is open to interpretation. The ambiguous wording
may create arguments in the future if one party disagrees with the other's interpretation or
earnings calculation. To minimize future disputes, we recommend the following changes to the
agreement:
1. Clause 1. The assets and liabilities included in the purchase and sale agreement should be
based on the audited financial statements rather than on the draft July 31, Year 7 financial
statements. The audited financial statements will provide you with greater assurance with
respect to the accuracy of the figures and accounts reported.
2. Clause 2. The environmental liabilities that are not included in the agreement should be
limited to those that are CTE's responsibility up to the date of sale. In addition, this
clause should be effective for only a limited period of time. In addition, you may want to
have an environmental assessment performed prior to the sale to determine what the
potential exposure is.
3. Clause 3. The term "net reported income" must be clearly defined to ensure that there is
no misunderstanding as to what is and what is not included in the calculation. In
addition, this calculation is based on TBL’s net income, and future profits may differ
from past results, especially if the new management is inefficient in the short term and
incurs significant "start-up" costs.
4. Clause 5. You should clarify what "compete" means and what is included in the
limitation. For example, does it mean that you cannot operate any bus line service
anywhere in the world?
5. Clause 6. The loan guarantee is for an unlimited period of time. Unless a specific expiry
date is used, CTE will be responsible for the loan until it is ultimately paid.
6. Clause 7. "Cost" must be explicitly defined. For example, defining cost as "fulI cost"
(including overhead allocations) or as "out-of-pocket cost" produces very different
results.
7. Clause 8. The phrase "restored to its original condition" must be defined. This clause
could result in a significant cost to CTE if it is not clarified. For example, it could mean a
complete reconstruction of the building.
8. Clause 9. You should place a limit on the dollar value of advertising that CTE is obliged
to provide under the agreement. As the clause is now worded, CTE could incur very
large costs.
9. Clause 12. The longer payment terms will lower the effective purchase price given the
present value of money. Either the purchase price can be increased or payment can be
made sooner.
10. Clause 14. You must determine the nature of the consulting agreement – what it does
and does not include.
We would be pleased to discuss our comments and recommendations with you at your
convenience.
Yours truly,
CPA
Case 8-4
To: Partner
From: CPA
Subject: Accounting issues related to Dry Quick (DQ)
Currently, Randy Wall, the CFO of DQ, has a wide range of responsibilities that give him a great
deal of autonomy and opportunities for manipulation. During our audit, we noted situations
where Randy has exerted control that may present him with an opportunity to manipulate the
records without anyone noticing. While there is no overt evidence of fraudulent behaviour at this
time, there is a consistent bias in the recording of transactions to positively affect earnings. As a
shareholder in the company, Randy stands to benefit from the sale of the company. In
particular, since the earnings results may be a key part of the determination of the purchase
price, he has an incentive to manipulate earnings positively. If he has been overly aggressive
and the end result is that the financial statements are misleading, DQ runs of the risk of being
sued by the purchaser of the company.
The following are accounting issues that we noted from the information we reviewed.
Early Order Program
The Early Order Program is a new program whereby deposits of 10% are received prior to year-
end for deliveries that would occur within four months. The total sales recognized prior to year-
end under this program were $1.5 million. Under Section 3400 of Part II of the CPA Canada
Handbook, revenue can be recognized when the following conditions have been fulfilled:
(a) the seller of the goods has transferred to the buyer the significant risks and rewards of
ownership, in that all significant acts have been completed and the seller retains no continuing
managerial involvement in, or effective control of, the goods transferred to a degree usually
associated with ownership.
In most cases, the above conditions are met when goods are delivered. In DQ’s case, delivery
of the goods has not occurred. In addition, DQ still maintains control of the goods, since they
are still in its possession. The buyer has not requested that the transaction be on a bill and hold
basis or that the goods be delivered. Based on our audit confirmations, even the customers
seem to be unclear as to whether a sale has occurred. As a result of the above deficiencies, the
bill and hold sales should not be recognized as revenue; revenue has been overstated by $1.5
million.
We will also need to understand how the related inventory and cost of sales were accounted for
to ensure the entries are appropriately reversed. Based on inventory count observations, it
appears that the bill and hold inventory items were not included in the original inventory count
listing, but since the sales should be reversed, these items must now be returned to inventory.
The 10% deposits that were received should be recorded as deferred revenue.
Demo Units
Demo sales also appear to be overstated. The CFO indicated that 80% of the $400,000 of demo
sales, or $320,000, has been recognized as revenue. It could be argued that the company’s
history of returns supports recording this amount of revenue. However, when the seller delivers
a product to a customer for trial or evaluation purposes that is subject to customer acceptance,
even if only by the passage of time (in this case six months), the revenue should not be
recognized until the earlier of when acceptance occurs or the acceptance provisions lapse.
Therefore, revenue can only be recognized for those demo units that have been outstanding for
more than six months as of year-end, unless earlier acceptance of the product has occurred or
a return provision can be reliably estimated. Revenue is, therefore, likely overstated for at least
a portion of the demo units, particularly given the confirmation response disputing a portion of
accounts receivable as relating to demo units. Further investigation will be required to determine
the appropriate amount to record. However, given that the demo units were delivered to
customers throughout the year, it is probably reasonable to recognize approximately half of the
demo sales, since those delivered in the first half of the year would have been outstanding for
more than six months.
Any demo units that are on customer premises but have not been outstanding for at least six
months should be recorded as inventory and disclosed as consignment inventory. DQ will need
to ensure that these demo units, as well as those that have already been returned by
customers, are properly valued at the lower of cost and net realizable value. The demo units
have been used, so their value has probably decreased. The issue with regards to these units is
whether their net realizable value (NRV) is lower than their cost and, therefore, whether a
writedown is necessary.
Overhead Allocation
In general, the costs of bringing the inventories to their present location and condition can be
capitalized. It is appropriate to include depreciation of the manufacturing facilities in inventory
overhead because these facilities are most likely used for the production of goods for sale to
customers. It is unlikely that the depreciation related to the administration building and the
administrative salaries could be allocated to inventory, unless it can be established that these
costs were related to bringing inventory to its present state and condition. Randy indicated that
he generally allocates 60% of administrative costs to inventory. These costs are also unlikely to
be able to be included as inventory overhead, unless it can be established that they are linked
to bringing inventories to their present state. However, it may be possible to allocate some of
the other salaries to inventory overhead to the extent that it can be argued the work performed
by those staff relates to inventories.
For example, given that the CEO’s role is actually related more to production and operations, it
may be appropriate to have 75% of his time allocated to inventory overhead. It may be more
difficult to argue the same for the CFO, given his high involvement in sales and accounting.
Selling costs, such as advertising, cannot be included in inventory overhead. As a result of
these adjustments, inventory is likely overstated and cost of sales understated. We will need to
investigate further to determine the appropriate amount to record.
Merger and Acquisition Costs
DQ has capitalized $350,000 of costs related to the first offer to purchase DQ by an outside
party. In order for these to be capitalized, they must meet both the definition of an asset and the
recognition criteria. According to paragraph 1000.25 of Part II of the CPA Canada Handbook —
Accounting, assets have three characteristics:
a) They embody a future benefit: DQ believes that these costs do embody a future benefit
because most of them were incurred to prepare the company to be sold. DQ is still
hoping to be purchased, and another potential buyer is currently performing due
diligence work. Therefore, it can be argued that the costs incurred have improved DQ’s
marketability and have improved its odds of being purchased.
b) The entity can control access to the benefit: While DQ does not have ultimate control
over whether it receives another purchase offer, it has already started negotiations with
another buyer, so it seems probable that it will eventually be purchased and stands to
benefit from these costs.
c) The transaction or event giving rise to the entity’s right to, or control of, the benefit has
already occurred: DQ has already incurred these costs, and they will not need to be
incurred again for future purchase offers.
Paragraph 1000.39 outlines the recognition criteria:
a) The item has an appropriate basis of measurement and a reasonable estimate can be
made of the amount involved: The costs have already been incurred, therefore the
amounts are known.
b) For items involving obtaining or giving up future economic benefits, it is probable that
such benefits will be obtained or given up: This issue is debatable. DQ will only receive a
future benefit from these amounts if the second purchase offer or an eventual purchase
offer is successful.
Therefore, we will have to perform additional work to determine just how probable it is that DQ
will obtain a future benefit from these costs. It may be that part or all of the $350,000 originally
deferred would need to be expensed.
Commissions Expense Accrual
Subsequent to year-end, a commission expense of $37,500 was paid related to $750,000 of

sales in the last quarter of the year. Because the commissions were paid after year-end, this
amount should be accrued at year-end. The payment reflects a rate of 5%, but the general
ledger only includes commissions at a rate of 3%. The year-end accrual should reflect the actual
rate paid. To the extent that any of the sales relate to the revenue recognition issues outlined
above, the commissions should also be adjusted accordingly.
Conclusion
There appears to be some early evidence of aggressive accounting practices. This includes the
recording of the Early Order Program and demo unit sales, the aggressive allocation of costs to
inventory, and the deferral of costs related to an inactive deal. While these may simply be due to
aggressive accounting, Randy has the autonomy in his various roles within the company to
manipulate the earnings, and there may be inadequate review to detect manipulation. This is
particularly true since he has the complete trust of the CEO, the bookkeeper relies on him, and
the Board has been relatively inactive in its oversight role. Before the situation develops into
something more significant, we thought it should be brought to your attention.
Case 8-5
To: Vision Clothing Inc. (VCI) management
From: CPA
Re: Issues Facing VCI
Our report regarding the issues facing your company is enclosed. The report deals first with
VCI's serious cash condition. If it is not taken care of immediately, it will have adverse
repercussions on your whole operation. Second, since the year-end has recently passed and
your statements need to be finalized, we have considered the relevant accounting issues and
suggested accounting treatments. The report also discusses other issues we consider important
for your company's situation.
If you have any concerns or questions, please contact us.
Yours truly,
CPA
REPORT TO VISION CLOTHING INC.

ACCOUNTING AND OTHER ISSUES
Financial concerns of the immediate future
Analysis of your preliminary financial statements and other information gathered regarding
future events shows that VCI may face a cash shortfall in the near future. The current portion of
long-term debt is $55 million at January 31. There is also a potential debenture payment in
March Year 3 of $50 million, which VCI has shown as a long-term liability. If the debentures that
are listed as long-term liabilities are reclassified as current liabilities, the current ratio will be 1:
1. It is questionable whether VCI will be able to repay its liabilities. VCI had a consolidated
accounting loss last year and has one in the preliminary Year 3 statements as well. VCI has
also indicated that tax losses are about to expire and future losses are expected. There is also a

$30 million debt coming due in May Year 3 that is recorded in other current liabilities. Thus,
even though accounting and tax losses do not equate to cash flows, it appears that cash is
being drained from VCL
The cash balance at January 31, Year 3, has decreased significantly since the prior year. While
the balance sheet reflects only a moment in time and could change considerably with a single
transaction, current assets are not much greater than in the prior year and liabilities have not
greatly decreased. Inventory has remained at roughly the same level as for the prior year;
however, payables have decreased. It would appear that payables are not financing inventory to
the same extent as last year. It is difficult to reach a conclusion on these findings since
information has not yet been obtained to explain some of the balances.
Sources of financing for VCI are dwindling. The share price is down considerably, making it
more difficult to raise funds. Funds generated (or used up) in operations also appear to be
dwindling (or increasing). Companies that sell clothes through retail outlets are usually cash
businesses (few accounts receivable). If VCI cannot fund itself through operations now, it is
unlikely to generate sufficient funds to do so in the next quarter- when sales are generally lower
than at Christmas.
It would appear that the way to raise money would be through the sale of non-strategic assets.
XYZ Ltd. is a prime candidate, since $3.7 million was considered the fair market value for 4% of
the shares. VCI's 29% interest would be worth $26.8 million. If there are buyers, the sale of XYZ
would raise much-needed funds. VCI could also try to renegotiate the terms of the debentures
and try to encourage holders to trade them in for equity instead of cash.
If one of the alternatives to generate cash is not used, VCI may face a severe cash shortage in
the next few months.
Financial accounting issues
VCI is a public company, and therefore a large number of users rely on the statements.
Management will seek to improve the appearance of VCI's financial situation with potential
creditors and shareholders in mind. Management will want to reduce its debt and improve its
equity. In addition, VCI is going to require more financing and will therefore be approaching
banks and potential investors who will also rely on the statements.

In light of the cash shortage, VCI’s status as a going concern may be doubtful. Unless VCI can
explain how it will meet its obligations as debts come due, its viability will be questionable. If VCI
is not a going concern, then this fact will have to be disclosed in a note and the statements may
have to be restated to liquidation values.
The rest of this report assumes that VCI will resolve the cash concerns. The analysis has been
made with GAAP as a constraint since VCI is a public company. Users of the statements
include present and future creditors, vendors, suppliers, current and potential shareholders, and
Canada Revenue Agency. Management may also be using the statements to evaluate the
operations or departments. Given the cash shortfall and the potential going-concern problem,
the most important users will be creditors and investors. These users will want information on
cash flow (ability to service debt) and asset values.
Specific issues
Underwriter fees and share-offering costs
It is unclear how the costs related to issuing shares ($5 million) have been treated since they
have not been deducted from share capital. Because VCI's objective is to present a strong
balance sheet and minimize losses, these expenses may have been capitalized as some form
of asset. If so, the transaction will need to be reversed (debit equity and reduce the asset). The
$5 million was used to raise capital (a capital transaction), and the total amount should be
netted against the capital stock. Alternatively, the amount could be deducted from retained
earnings directly.
The $1 million related to the deferred stock issue should be reported as a reduction in net
proceeds from the share issue if another issue is expected. If another share issue is unlikely,
then the costs should be expensed. In either case, shareholders’ equity is reduced.
Debentures
The redemption of the debentures should be properly disclosed since the amount is material.
Disclosure of the terms will be useful for creditors since the terms have a bearing on cash flows.
More important, at year-end, the debenture holders still maintained the right to redeem a further
$50 million for cash in March. If it is expected that debentures will be redeemed in March Year
3, then a current liability should be set up. Since the amount redeemed in March Year 2 was the
maximum allowed, a current liability of $50 million may be warranted.
XYZ Ltd. gain
VCI’s percentage ownership in XYZ did increase from 25% to 29%. However, XYZ’s net assets
decreased because it used assets or increased its debt to redeem some of its shares.
Therefore, VCI owned a big percentage of a smaller company after the share redemption.
With a 25% interest in XYZ, VCI likely had significant influence over XYZ and would have been
using the equity method. With a 29% interest, it would continue to use the equity method. Under
the equity method, VCI would accrue its share of XYZ’s income as it is earned by XYZ. The
income should be reported in income from continuing operations and not in the bottom portion
of the income statement. VCI would not report its investment at fair value. Therefore, it was
inappropriate to recognize a gain of $3.7 million on the increase in percentage ownership. The
gain should be reversed. From the date of the increase, 29% of XYZ's income will be reported in
VCI’s statements as equity method income.
Discontinued operations
The TTT division was operated as a separate division. VCI has plans to sell the assets of this
division. It may now be necessary to report the TTT division as part of discontinued operations
for the current and prior years. However, to be considered a discontinued operation, certain
conditions must be met. There must be a formal plan to dispose of the assets. Further, the
operations disposed of must constitute a different business segment. Children's shoes may be
considered a different business segment from retail clothes since the operations of a shoe store
and those of a clothing store are different. The customers of TTT are children, even though
adults actually purchase the shoes. Shoes are also different from clothes in the way they are
shipped, packed, displayed and sold. Separate financial information must also be available if it
is to be considered a business segment.
Since the shoe store operations appear to be a different business segment, operations of the
discontinued chain should be disclosed separately on both the income statement and balance
sheet for the current and prior year. VCI will benefit because investors and other potential
creditors will have the details necessary to assess continuing operations. The losses net of tax
that will be separately disclosed on the income statement will substantially reduce losses from
continuing operations, which will reflect well on VCI’s future prospects.
The assets of the TTT division should be reported at the lower of cost and fair value. Any
adjustments to fair value should be included as part of income from discontinued operations.
The assets should not be depreciated.
New technology
In order to capitalize the costs of the new consolidation and reporting package (technology)
developed internally, certain conditions must be met. It appears that VCI has met the criteria for
capitalization since the product is clearly defined and the costs are known within reason.
Technical feasibility is not a concern since the technology has already been implemented and is
being used as an advanced analysis and reporting tool. Likewise, the costs of labour and the
other costs relate to the product development and therefore can be included in the capitalized
amount. In line with VCI’s objectives, a reasonable amount for overhead can be allocated to the
project if it can be estimated. The amount would probably be immaterial; therefore we do not
recommend investing a lot of time in allocating such costs.
If the new inventory system at Style Co. has been internally produced, then the same approach
can be applied if VCI can clearly demonstrate that any problems it is having with the system can
and will be corrected. If the product was purchased, VCI should capitalize the implementation
costs necessary to get the product up and running. This treatment would serve to meet VCI’s
objective of reducing expenses.
The capitalized value should not exceed the net recoverable amount. The costs should be
segregated between hardware and software, given the different useful lives. Since new
technology is being developed very quickly, we recommend that VCI amortize these costs on a
simple straight-line basis over no more than five years. A longer period would suit VCI's
objectives but would be difficult to justify.
Style Co. issues
The adjustment to inventory should be reflected in the year-end statements. The interim
statements may have been misstated but, if best estimates were used at the time, the interim
statements should not be adjusted.
Landlord inducements
Guidance is available that states that lease inducements should be accounted for as a reduction
of rental expenses over the term of the related lease. Accordingly, the $20 million should be set
up as deferred revenue and the amount amortized over seven years since VCI’s leases are
usually for seven years. The amortization should be straight line if the lease payments are made
evenly. Alternatively, the lease inducements could be reported as a reduction of the cost of the
leasehold improvements.
Deferred tax debits
To carry a deferred tax debit on the balance sheet, VCI must be virtually certain of realizing the
deferred tax debit through future income, which could include decreasing discretionary
expenses such as capital cost allowance. VCI does not appear to have virtual certainty since
the loss is not from a non-recurring cause. Also, VCI does not have a proven record of
profitability since there have been losses in past years. Since future losses are expected, the
loss carry-forward period may expire before it can be used. Therefore, the deferred tax debit will
have to be removed from the books, thus increasing VCI’s loss.
SOLUTIONS TO PROBLEMS
Problem 8-1
(a) Since the cash flow statement is based on consolidated net income, the loss on sale of
equipment shown must have resulted from a sale to a non-affiliate. A loss on sale to an
affiliate would be eliminated from consolidated net income, and any amount of amortized
loss from a previous sale would be included in the adjustment for depreciation expense.
(b) Bonds issued at a premium reflect a market rate that is lower than the bond's stated rate,
and as a result investors are willing to pay more to purchase the bond. When this
excess payment is amortized, it decreases the interest expense so that it reflects the
market rate when the bonds were issued. Therefore, the bond premium amortization
represents a noncash amount that decreases interest expense and increases income.
In this case, consolidated net income is higher as a result of a noncash item and that
item must be deducted to calculate cash flow from operations.
(c) Non-controlling interest in subsidiary's income = 9,800
Non-controlling interest's percentage 40%
9,800 / 40% 24,500
Goodwill impairment loss 1,000
Subsidiary's net income 25,500
(d) Dividend payments to non-controlling shareholders do represent a flow of cash outside
the economic entity, and as a result they must be presented on the consolidated cash
flow statement. However, from the consolidated entity's point of view, these dividends
are reported as a reduction of the non-controlling interest on the consolidated balance
sheet. The only dividends that can be reported in the consolidated statement of retained
earnings are those that are paid to the parent's shareholders.
(e) Non-controlling interest's share of dividends = 6,000
Non-controlling interest's percentage 40%
Subsidiary's total dividends declared – 6,000 / 40% 15,000
Problem 8-2
PART A
Cost of 70% (1,400  2,000) of Star $232,400
Implied value of 100% 332,000
Shareholders' equity Total Preferred Common
Preferred stock $67,000) $67,000)
Common shares 180,000) 180,000) Dr
Retained earnings (97,000) 8,000* (105,000) Dr
$150,000 $75,000) 75,000
Acquisition differential $257,000
Allocated: FV – CA
Accounts receivable (2,000)
Inventory 7,000
Plant 50,000
Long-term liabilities (20,000) 35,000
Goodwill $222,000
* Dividends in arrears: 500 shares  $8  2 years = $8,000

Acquisition Differential Amortization Schedule
Balance Amortization Balance
Jan. 1, YR 5 YR 5 to 11 YR 12 Dec. 31, YR 12
Accounts receivable $(2,000) $(2,000) – –
Inventory 7,000) 7,000) – –
Plant 50,000) 50,000) – –
Long-term liabilities (20,000)) (17,500)) $(2,500) –
Goodwill 222,000) 134,570) 20,560 $66,870
$257,000) $172,070) $18,060 $66,870
Intercompany receivables and payables

December management fee $2,000
Intercompany profits Before tax Tax 40% After tax

Opening inventory – Star selling $31,000 $12,400 $18,600
– Par selling 30,000 12,000 18,000
$61,000 $24,400 $36,600
Closing inventory – Star selling $52,000 $20,800 $31,200

– Par selling 54,000 21,600 32,400
$106,000 $42,400 $63,600
Equipment – Star selling

July 1, Year 7 $20,000
Depreciation to Dec. 31, Year 11
($4,000  4½ years) 18,000
Balance December 31, Year 11 2,000 800 1,200
Depreciation Year 12 2,000 800 1,200
Balance December 31, Year 12 $–0– $–0- $–0–
Star Year 12 dividends $37,000

Preferred 500  $8 4,000
Common 33,000

70%
Intercompany dividends $23,100
Deferred income tax, December 31, Year 12

Closing inventory profit $42,400
Calculation of Year 12 consolidated net income

Par net income (loss) $31,000)
Less: Dividends from Star $23,100)
Closing inventory profit 32,400) 55,500)
(24,500)
Add: Opening inventory profit 18,000
(6,500)
Star net income (loss) (28,000)
Less: Acquisition differential amortization (18,060))
Preferred claim on net income (4,000))
Common net income (loss) (50,060)
Less: closing inventory profit (31,200))
(81,260)
Add: Opening inventory profit 18,600)
Equipment profit 1,200)
(61,460)
Preferred claim on net income 4,000)
Consolidated net income $(63,960)
Attributable to:
Par’s shareholders $(49,522)
Non-controlling interests ([100% x 4,000] + [30% x -61,460]) (14,438)
$(63,960)
Calculation of consolidated retained earnings – Jan. 1, Year 12
Par opening retained earnings $297,260

Less: Opening inventory profit (18,000)
279,260
Star retained earnings, Jan. 1, Year 12 $417,300)
Acquisition (105,000)
Increase 522,300)
Less: Acquisition differential amortization $172,070
Opening inventory profit 18,600
Equipment profit 1,200 191,870)
Adjusted increase 330,430)
70% 231,301
Consolidated opening retained earnings $510,561
(a)
Par Corp.
Consolidated Retained Earnings Statement
Year Ended December 31, Year 12
Balance January 1 $510,561

Net loss (49,522)
461,039
Dividends 26,000
Balance December 31 $435,039
Calculation of non-controlling interest – December 31, Year 12

Preferred Common Total
Preferred stock $67,000
Common shares $180,000)
Retained earnings 352,300)
532,300)
Closing inventory profit (31,200)
67,000 501,100
Unamortized acquisition differential . 66,870
67,000 567,970
100% 30%
$67,000 $170,391) $237,391
(b)
Par Corp.
Consolidated Balance Sheet
as at December 31, Year 12
Cash (57,000 + 2,700) $59,700

Accounts receivable (117,000 + 102,000 - 2,000) 217,000
Inventory (84,360 + 65,000 - 106,000) 43,360
Land (47,000 + 87,000) 134,000
Plant and equipment (net) (323,000 + 553,000) 876,000
Deferred income tax 42,400
Goodwill 66,870
$1,439,330
Accounts payable (98,800 + 197,000 - 2,000) 293,800

Accrued liabilities (9,700 + 13,400) 23,100
Common shares 450,000
Retained earnings 435,039
Non-controlling interest 237,391
$1,439,330
PART B
Since dividends paid by Star in Year 12 exceeded the annual minimum of $4,000 (500 x $8 per
share), the income attributed to the preferred shareholders would be the same regardless of
whether the preferred shares were cumulative or noncumulative. Therefore, consolidated net
income attributable to Par’s shareholders would not change.
PART C
Investment account – cost basis, Dec. 31, Year 12 $232,400)
Retained earnings – Par – equity basis $435,039
Retained earnings – Par – cost basis 302,260
132,779
Investment account – equity basis – Dec. 31, Year 12 $365,179
January 1, Year 13
Ownership reduction 70% – 56% = 14%
14%  70% = 20%
Reduction in investment account
20%  $365,179 $73,036)
New assets of Star 100,000
56% 56,000)
Loss $(17,036)
This loss will be debited to contributed surplus, if any exists, or to retained earnings in
shareholders’ equity. If Par were using the equity method, the following entry would be made:
Retained earnings $17,036

Investment in Star $17,036
Problem 8-3
Jan. 1, Year 4 Jan. 1, Year 5 Jan. 1, Year 6
Percentage acquired 25% 20% 10%
Percentage owned 25% 45% 55%
Cost of purchase 142,400 121,600 63,000
Previous equity interest remeasured at fair value
(63,000 / 10 x 45) 283,500 (A)
Total value of 55% 346,500
Carrying amount of Jovano’s net assets
Ordinary shares 200,000 200,000 200,000
Retained earnings 300,000 330,000 361,000
500,000 530,000 561,000
25% 20% 100%
125,000 106,000 561,000
Acquisition differential = customer lists (3-year life) 17,400 15,600 69,000
Amortization – Year 4 (5,800)
Amortization – Year 5 (5,800) (5,200)
Amortization – Year 6 n/a n/a (23,000)
Unamortized, end of Year 6 46,000

(a) Cost method Equity method
Year 4
Investment in Jovano 142,400 142,400
Cash 142,400 142,400
Investment in Jovano (50,000 x 25%) 12,500

Equity method income 12,500

Investment in Jovano 5,800
Cash (20,000 x 25%) 5,000 5,000

Dividend income 5,000
Year 5
Cash 121,600 121,600

Equity method income (5,800 + 5,200) 11,000

Cash (21,000 x 45%) 9,450 9,450

Year 6
Cash 63,000 63,000
Investment in Jovano ((per A above) 283,500 – (per B below) 268,650) 14,850

Remeasurement gain 14,850
Equity method income (23,000 x 55%) 12,650

Cash (22,000 x 55%) 12,100 12,100

(b) Cost method Equity method

Investment in Jovano (based on entries above)
- end of Year 4 142,400 144,100
- end of Year 5 264,000 268,650 (B)
- end of Year 6 327,000 352,550
(c)
Jovano’s shareholders’ equity, end of Year 6 (200,000 + 395,000) 595,000
Unamortized customer lists 46,000
641,000
Hidden’s percentage ownership 55%
Hidden’s $ interest 352,550
(d)
(i) customer lists 46,000
(ii) non-controlling interest on the statement of financial position
Jovano’s shareholders’ equity, end of Year 6 (200,000 + 395,000) 595,000
Unamortized customer lists 46,000
641,000
NCI’s percentage ownership 45%
NCI’s $ interest 288,450
(iii) consolidated net income attributable to the non-controlling interest
Jovano’s net income for Year 6 56,000
Amortization of acquisition differential (23,000)
33,000
NCI’s percentage ownership 45%
NCI’s $ interest 14,850
Problem 8-4
Shareholders' equity of Sub Dec. 31, Year 1: 1,135,000
Parent's investment account Dec. 31, Year 1:

(1,135,000 + 610,000) 1,745,000
Parent's journal entry Jan. 1, Year 2:

Cash 644,000
Investment (30%  1,745,000) 523,500
Retained earnings - gain on sale 120,500
Effect on consolidated statements:

Cash 644,000
Non-controlling interest (30%  1,745,000) 523,500
Retained earnings - gain on sale 120,500
* Calculation of dividends paid to non-controlling shareholders:
Opening balance of non-controlling interest 0

Carrying amount of shares purchased from parent (30%  1,745,000) 523,500
Add non-controlling interest’s share of sub's income 39,900
563,400
Less: Ending balance of non-controlling interest 534,500
Non-controlling interest in sub's dividends 28,900
Parent Ltd.
Consolidated Cash Flow Statement
For the Year Ended December 31, Year 2
Operating cash flow:

Profit 583,900)
Add (deduct):
Depreciation 370,000)
Goodwill impairment loss 49,500)
Increase in inventory (535,500)
Decrease in current liabilities (748,600)
Decrease in accounts receivable 89,600)
Cash used in operations (191,100)
Investing cash flow:

Proceeds from sale of investment in Sub 644,000)
Acquisition of plant and equipment (250,000)
Cash from investing 394,000)
Financing cash flow:

Issuance of long-term debt 295,400)
Dividends – to Parent Ltd. shareholders (108,500)
– to non-controlling shareholders (28,900)*
Cash from financing 158,000)
Net increase in cash 360,900)

Cash – January 1 350,000)
Cash – December 31 710,900)
Problem 8-5
Cost of 70% of Simon 910,000
Implied value of 100% of Simon 1,300,000
Carrying amount of Simon
Ordinary shares 550,000
Retained earnings Jan. 1 400,000
Profit to April 1 (¼  200,000) 50,000
1,000,000
Acquisition differential 300,000
Allocated: FV – CA –0–

Balance – broadcast rights 300,000
Cost of 60% of Fraser 600,000

Implied value of 100% of Fraser 1,000,000
Carrying amount of Fraser
Ordinary shares 300,000
Profit to April 1 (¼  150,000) 37,500
637,500
Allocated FV – CA –0–
Balance – broadcast rights 362,500
Closing inventory profits Before Tax After

tax 40% tax
Simon selling 32,000 12,800 19,200
Princeton selling 18,000 7,200 10,800
(a)
Princeton Corp.
Calculation of Consolidated Profit
for the Year Ended December 31, Year 7
Income of Princeton 100,000

Less: Dividends from Simon (70%  30,000) 21,000
Closing inventory profit 10,800 31,800
68,200
Income of Simon (¾  200,000) 150,000
Less: Broadcast rights amortization – see part (c) 22,500
Dividend from Fraser
(60%  70,000) 42,000
Closing inventory profit 19,200 83,700

66,300
Income of Fraser (¾  150,000) 112,500

Less: Broadcast rights amortization – see part (c) 27,188
85,312
Consolidated profit 219,812
Attributable to:
Princeton’s shareholders (68,200 + 70% x [66,300 + 60% x 85,312]) 150,441
Non-controlling interests (30% x [66,300 + 60% x 85,312] + 40% x 85,312) 69,371
219,812
(b) Calculation of non-controlling interest – Dec. 31, Year 7
Fraser shareholders' equity – Dec. 31 680,000

Unamortized broadcast rights – Fraser (see part c) 335,312
1,015,312
Non-controlling interest’s share 40% 406,125
Simon shareholders' equity – Dec. 31 1,120,000

Retained earnings Fraser – Dec. 31 380,000
Acquisition 337,500
Increase 42,500
Less: Broadcast rights amortization 27,188
15,312
60%
9,187
1,129,187
Unamortized broadcast rights – Simon (see part c) 277,500
1,406,687
Less: Closing inventory profit 19,200
1,387,487
Non-controlling interest’s share 30% 416,246

(c) Calculation of consolidated broadcast rights – Dec. 31, Year 7
Broadcast rights – Simon 300,000

Less: amortization – Year 7
(300,000  10 × ¾) 22,500 277,500
Broadcast rights – Fraser 362,500

Less: amortization – Year 7
(362,500  10 × ¾) 27,188 335,312
612,812
(d) Calculation of net income under equity method for Year 7
If Princeton’s uses the equity method to report its investments in subsidiaries, its profit on its
separate entity income statement would be $150,441, which is equal to consolidated profit
attributable to the shareholders of Princeton as calculated in (a) above.
Problem 8-6
Cost of 90% (900  1,000) of SET 63,000
Implied value of 100% of SET 70,000
Shareholders' equity Total Preferred Ordinary
1
Preferred stock 40,000 42,000 (2,000)
Ordinary shares 20,000 20,000
Retained earnings 30,000 8,0002 22,000
90,000 50,000) 40,000
Acquisition differential (all allocated to patents) 30,000
Patent amortization – Year 5 (six-year life) (5,000)
Unamortized patent, December 31, Year 5 25,000
NCI, date of acquisition
- interest in common shares (10% x 70,000) 7,000
- interest in preferred stock (100% x 50,000) 50,000
Total 57,000 (a)
Calculation of consolidated profit

PET profit 30,000
Less: Dividends from SET3 (2,700)

27,300
SET profit 22,000
Less: Patent amortization (5,000) 17,000
Attributable to:
PET’s shareholders 39,000
NCI (4,0004 + 10% x [17,000 – 4,0004]) 5,300
44,300
Notes:
1. Liquidation value of 40,000 x 1.05 = 42,000
2. Dividends in arrears: 4,000 shares x $1/year x 2 years = 8,000
3. Dividends on ordinary shares: (15,000 – 4,000 x $1/year x 3 years) x 90% = 2,700
4. Income for preferred: 4,000 x $1/year x 1 year = 4,000
(a)
PET Company
Statement of Retained Earnings
For the year ended December 31, Year 5
Retained earnings, beginning of year $50,000
Profit 39,000
Dividends (25,000)
Retained earnings, end of year $64,000
(b)
PET’s retained earnings 55,000
Total Preferred Ordinary
SET’s retained earnings,
End of Year 5 37,000 37,000
At acquisition 30,000 8,000 22,000
Change since acquisition 7,000 (8,000) 15,000
Amortization of patents (5,000) 0 (5,000)
2,000 (8,000) 10,000
PET’s share 90% 9,000
Consolidated retained earnings, December 31, Year 5 64,000
(c)
Calculation of non-controlling interest – income statement
Interest in preferred shares (100% x 4,000) 4,000
Interest in ordinary shares (10% x 13,000 as per above) 1,300
Total 5,300
Calculation of non-controlling interest – statement of financial position (Method 1)

Preferred Ordinary Total
Preferred stock 42,000 (2,000) 40,000
Retained earnings . 37,000 37,000
42,000 55,000 97,000
Unamortized acquisition differential . 25,000
42,000 80,000
100% 10% )
42,000 8,000) 50,000
Calculation of non-controlling interest – statement of financial position (Method 2)

Non-controlling interests at date of acquisition (a) 57,000
NCI’s share of Set’s adjusted increase in retained earnings
- on common shares (10% x 10,000) 1,000
- on preferred stock (100% x –8,000) (8,000) (7,000)
Non-controlling interest, Dec. 31, Year 5 50,000
Problem 8-7
(a)
July 1, Year 8
Proceeds from sale 720  $30 21,600

Carrying amount sold (see * in part (c) below for calculation) 26,550
Loss on sale Year 8 4,950

Dec. 29, Year 9
Reduction in investment account
** 118,800  ***1/9 (see ** and *** in part (c) below for calculation
of investment account and new percentage ownership) 13,200
Gain due to new assets
500  $46 23,000
Plumber’s % 64% 14,720
Gain on share issue, Year 9 1,520
(b) The parent, using the equity method, would not report the gain (loss) on its income
statement. These two transactions resulting from the ownership change are viewed as
capital transactions between shareholders of the same consolidated entity. For capital
transactions, gains are reported in contributed surplus and losses are shown first as a
reduction in contributed surplus, if any exists, and then as a reduction to retained earnings.
The gain or loss from the capital transactions would not be eliminated in the consolidation
process and therefore would appear in shareholder’s equity on the consolidated balance
sheet in the same manner as it appears on Plumber’s separate entity balance sheet.
(c) Total Parent’s NCI’s

Investment account Jan. 1, Year 8 (90%) 126,000
Implied value of 100% 140,000 126,000 14,000
Common shares (4,000 shares) 20,000
90,000 81,000 9,000
Trademarks Jan. 1, Year 8 50,000 45,000 5,000
Amortization to July 1, Year 8
(50,000  10 = 5,000  ½ year) (2,500) (2,250) (250)
Balance July 1, Year 8, before sale 47,500 42,750 4,750
Sale (720 / 3,600 = 20%) (8,550) 8,550
Balance after sale July 1, Year 8 (72% & 28%) 47,500 34,200 13,300)
Amortization to Dec. 31, Year 8 (2,500) (1,800) (700)
Amortization Year 9 (5,000) (3,600) (1,400)
Balance Dec. 29, Year 9 before ownership change 40,000 28,800 11,200
*** Disposal due to share issue (1/9) (3,200) 3,200

Plumber’s share of trademarks Dec. 31, Year 9 (64%) 40,000 25,600 14,400
Ownership before share issue 2,880/4,000 = 72%

Ownership after share issue 2,880/4,500 = 64%
8% 8%  72% = 1/9 reduction***
Calculation of investment account balances
Investment account Jan. 1, Year 8 126,000

Trademark amortization to July 1, Year 8 (2,250)
Net income to July 1 (10,000  90%) 9,000
Balance before sale 132,750
Sale (720 / 3,600 = 20%) (26,550)*
Balance after sale July 1, Year 8 106,200
Net income July to Dec. (10,000  [2,880 / 4,000]) 7,200
Dividend Year 8 (5,000  72%) (3,600)
Trademark amortization to Dec. 31, Year 8 (1,800)
Balance Dec. 31, Year 8 108,000
Net income Year 9 (28,000  72%) 20,160
Dividend Year 9 (8,000  72%) (5,760)
Trademark amortization Year 9 (3,600)
Balance before share issue 118,800**
Gain on share issue (see part (a)) 1,520
Balance after share issue 120,320
Proof of Investment Account Components

Carrying amount of sub’s net assets
(64% x [90,000 + 20,000 – 5,000 + 28,000 – 8,000 + 23,000]) 94,720
Unamortized fair value excess of trademarks 25,600
Total investment account 120,320
(d) Yes, the trademarks are recorded at historical cost less accumulated amortization on the
consolidated balance sheet. On the date of acquisition, the trademarks were recorded at
$50,000 on the consolidated balance sheet. This was the fair value at that time but is

viewed as the historical cost from that point on. Since the date of acquisition, the cost of
the trademarks has been amortized and reduced for the portion deemed to be sold.
Problem 8-8
(a)
Jensen’s shareholders’ equity $900,000
Unamortized acquisition differential 210,000
Total value of subsidiary for consolidation purposes 1,110,000
Hein’s percentage ownership 90%
Balance in investment in Jensen account under equity method 999,000 (a)
Non-controlling interest on consolidated balance sheet (10% x 1,110,000) 111,000
(b)
Cash 250,000
Investment in Jensen (20 / 90 x (a) 999,000) 222,000
Contributed surplus 28,000
Record sale of 20,000 ordinary shares of Jensen
Investment in Jensen (70% x 105,000) 73,500

Record Hein’s share of Jensen’s net income
Equity method income (90,000 / 9 years x 70%) 7,000

Investment in Jensen 7,000
Record Hein’s share of amortization of acquisition differential
Cash (70% x 50,000) 35,000

Investment in Jensen 35,000
Record dividend received from Jensen
(c)
Jensen’s shareholders’ equity (400,000 + 555,000) $955,000
Unamortized acquisition differential (210,000 – 90,000 / 9) 200,000

Total value of subsidiary for consolidation purposes 1,155,000 (b)
Hein’s percentage ownership 70%
Balance in investment in Jensen account under equity method 808,500 (c)
Non-controlling interest on consolidated balance sheet (30% x (b) 1,155,000) 346,500
(d)
Cash (25,000 x 13) 325,000
Investment in Jensen (25 / 70 x (c) 808,500) 288,750 (d)
Gain on sale of shares in Jensen 36,250
Record sale of 25,000 ordinary shares
Investment in Jensen (45,000 x 13 – [(c) 808,500 – (d) 288,750]) 65,250

Remeasurement gain on investment in Jensen 65,250
Record remeasurement gain on 45,000 shares retained in Jensen
Problem 8-9
Part A
Investment account (9,500 shares) – January 1, Year 6 320,000
Carrying amount of Sub 270,000
95% 256,500
Parent’s share of acquisition differential 63,500
Allocated: Land 45% 28,575
Equipment 30% 19,050
Patents 25% 15,875
63,500
Implied value of 100% of acquisition differential

Land (28,575 / 95%) 30,079
Equipment (19,050 / 95%) 20,053
Patents (15,875 / 95%) 16,711
Total 66,843
1,900
P sold = 20%
shares

9,500
shares
7,600
New ownership = 76%
shares
10,000
shares
(i)
Cash 66,500
Investment in Sub (20%  320,000) 64,000
Contribution surplus 2,500
(ii) Land Equipment Patents Total

Balance Jan. 1, Year 6 30,079 20,053 16,711 66,843
Amortization Year 6 – 5,013 1,671 6,684
Balance Dec. 31, Year 6 30,079 15,040 15,040 60,159
(iii)
Investment account Jan. 1, Year 6 320,000
20% sold (64,000)
Acquisition differential amortization (6,684 x 76%) (5,080)
Net income (76%  150,000) 114,000
Dividends (76%  70,000) (53,200)
Balance Dec. 31, Year 6 – equity method 311,720
Shareholders' equity Sub (270,000 + 150,000 – 70,000) 350,000
76% 266,000
Balance – Parent’s share of unamortized acquisition differential 45,720
100% of unamortized acquisition differential (45,720 / 76%) 60,158
Part b
Cash 66,500
Contribution surplus 2,500
Non-controlling interest [19%  (270,000 + 66,843)] 64,000
Change in non-controlling interest

After sale (100% – 76%) 24%
Before sale (100% – 95%) 5%
Change 19%
or,
Change in non-controlling interest
1,900
Shares sold by P: = 19%
10,000
Problem 8-10
1st 2nd
Cost of 75% purchase 600,000
Cost of 20% purchase 166,000
Carrying amount of Sic’s net assets
Retained earnings 300,000 310,000
500,000 510,000
100 % 500,000 20% 102,000
Acquisition differential 300,000 64,000
Allocated to:
Customer contracts 300,000 40,0001
Direct charge to retained earnings for excess of cost over
Carrying amount transferred from NCI 24,000
Total 300,000 64,000

Allocation and amortization of acquisition differential allocated to customer contracts
Total Parent NCI
Purchase on Jan 1, Year 5 300,000 225,000 75,000
Amort. for Year 5 (3 years) (100,000) (75,000) (25,000)
Dec 31, Year 5 200,000 150,000 50,000
1
NCI sold 2,000 / 2,500 x 50,000 40,0001 (40,000)
200,000 190,000 10,000
Amort. for Year 6 (2 years) (100,000) (95,000) (5,000)

Dec 31, Year 6 100,000 95,000 5,000
(a) Calculation of consolidated profit for Year 6

Pic profit 140,000
Less: Dividends from Sic (95% x 90,000) (85,500)
54,500
Sic profit 110,000
Less: amortization of customer contracts 100,000 10,000
Attributable to:
Pic’s shareholders 64,000
NCI (5% x 10,000) 500
64,500
(b)
(i) Customer contracts (see amortization schedule above) 100,000
(ii) Sic’s ordinary shares 200,000
Sic’s retained earnings 330,000
530,000
NCI’s ownership 5%
26,500
NCI’s share of unamortized patent 5,000
Total NCI on statement of financial position 31,500
(iii) Pic’s retained earnings 550,000
1st 2nd
Sic’s retained earnings 310,000 330,000
Sic’s retained earnings, at acquisition 300,000 310,000
Change since acquisition 10,000 20,000
Cumulative amort. of patents (100,000) (100,000)
(90,000) (80,000)
Pic’s ownership 75% 95%
(67,500) (76,000) (143,500)
nd
Excess of acquisition cost over carrying amount for 2 purchase (24,000)
Consolidated retained earnings 382,500
Problem 8-11
(a & b)
York Queens McGill Carleton Trent Total
Profit 54,000) 22,000) 26,700) 15,400) 11,600) 129,700)
Less – inventory profits (6,000) ) (600) (1,440) ) (8,040)
Consolidated profit 48,000) 22,000) 26,100) 13,960) 11,600) 121,660
Allocate Trent
60% to McGill 6,960) (6,960)
Allocate Carleton
70% to Queens 9,772) ) (9,772)
McGill’s profit – equity method 33,060)
Allocate McGill
10% to Queens 3,306) (3,306)
80% to York 26,448) ) (26,448)
Queen’s profit – equity method 35,078)
Allocate Queens
90% to York 31,570) (31,570) ) ) )
Unallocated 3,508) 3,306) 4,188) 4,640) 15,642 *
Consolidated profit – attributable to York’s shareholders (part a) 106,018
York’s profit – equity method 106,018
* Consolidated profit – attributable to non-controlling interest (part b)

(c) It makes no difference whether McGill sells to York, its parent, or to Carleton, another
subsidiary. In both cases, the entire amount of the unrealized profits is eliminated on
consolidation because the sales were within the consolidated entity. Therefore, the profit
has not been realized with an entity outside of the consolidated entity and should be
eliminated on consolidation. The unrealized profit will be deducted from McGill’s income
and 10% of the unrealized profit will be absorbed by the non-controlling interest in McGill
regardless of whether McGill sold to Carleton or York.
Problem 8-12
Investment in Delta 490,000
Carrying amount of Delta (250,000 + 350,000) 600,000
80% 480,000
Craft’s share of unamortized patent Dec. 31, Year 12 10,000
Value of 100% of unamortized patent Dec. 31, Year 12 12,500
Before share issue, Craft's holdings (80%  49,000) = 39,200 shares
After share issue, Delta's shares outstanding (49,000 + 12,250) = 61,250 shares
Craft's ownership before 80%

Craft's ownership after (39,200  61,250) 64%
Change 16%
Reduction in ownership 16%  80 = 20%
Analysis
Reduction in investment (20%  490,000) 98,000
New shares (12,250 shares  $15) 183,750
64% 117,600
Net gain from share issue 19,600
Non-controlling interest – Dec. 31, Year 12

Previous ordinary shares 250,000
New shares issued 183,750
783,750
Add: Unamortized patent 12,500
796,250
36%
286,650
(a)
Craft Ltd.
Consolidated Statement of Financial Position
Buildings and equipment (600,000 + 400,000) 1,000,000)

Patent 12,500)
Inventory (180,000 + 200,000) 380,000)
Accounts receivable (90,000 + 120,000) 210,000)
Cash (50,000 + 65,000 + 183,750) 298,750)
1,901,250)
Ordinary shares 480,000)

Retained earnings 610,000)
Contributed surplus 19,600
Non-controlling interest 286,650)
Mortgage payable 250,000)
Accrued liabilities 85,000)
Accounts payable (70,000 + 100,000) 170,000)
1,901,250)
(b)
Since the acquisition differential at the date of acquisition did not contain any goodwill, there
would be no difference between the parent company extension and entity theories. Therefore,
the return-on-equity under the parent company extension would be the same as the entity
theory.
Problem 8-13

A's 40% of C
Acquisition differential – equipment Jan. 1, Year 4 (42,500)
Amortization, Years 4–6 12,750)
Balance, Dec. 31, Year 6 (29,750)
Proof:
Investment in C, Jan. 1, Year 7 69,570)
Shareholders' equity, C Jan. 1, Year 7 248,300
40% 99,320)
Unamortized acquisition differential – as above (29,750)
Note:
A business combination occurred on January 1, Year 7 when B Company purchased its 40%
interest in C Company because A Company now controls C Company. A Company will be able
to control 80% of the votes in C Company because it owns 40% of C Company directly and
controls B Company, which owns another 40% of C Company.
On the date of the business combination, C Company will be measured at 100% of its fair value.
Therefore, A Company revalues its existing investment in C Company to fair value of $99,320.
A Company will record a gain of $29,750 ($99,300 – $69,570). Accordingly, the $29,750
negative acquisition differential related to equipment will disappear and there will be no
acquisition differential related to C Company.
A's 75% of B
Bal. Amort. Bal. Amort. Bal.
Jan. 1/6 Year 6 Dec. 31/6 Year 7 Dec. 31/7
Buildings (20 yrs) 40,000 2,000 38,000 2,000 36,000
Patents (8 yrs) 89,600 11,200 78,400 11,200 67,200
129,600 13,200 116,400 13,200 103,200
A’s share (75%) 97,200 9,900 87,300 9,900 77,400
Proof:
Investment in B, Jan. 1, Year 7 1,068,990
Shareholders' equity B, Jan. 1, Year 7 1,308,920
75% 981,690
Unamortized acquisition differential – as above 87,300
B Company’s accumulated depreciation on January 1, Year 6 450,000
B's 40% of C
Investment in C, Jan. 1, Year 7 99,320
Shareholders' equity C, Jan. 1, Year 7 248,300
40% 99,320
Acquisition differential –0–
C Company’s accumulated depreciation on January 1, Year 7 52,700
Intercompany receivables and payables 37,000
Unrealized profits Before Tax After

tax 40% tax
Closing inventory – A selling 7,600 3,040 4,560
– C selling 6,900 2,760 4,140
14,500 5,800 8,700
A Company
Calculation of Consolidated Net Income
A B C Total
Net income 131,800) 68,000) 33,000) 232,800
Gain on revaluation of C 29,750 29,750
Amortization – acq. diff. (13,200) (13,200)
Inventory profits (4,560) ) (4,140) (8,700)
Consolidated net income 156,990) 54,800) 28,600) 240,650)
Allocate C – 40% to B 11,544) (11,544)
– 40% to A 11,544) ) (11,544)
B’s net income 66,344)
Allocate B – 75% to A 49,748) (49,758) )
Attributable to NCI 16,586) 5,772) 22,358) *
Attributable to A’s shareholders ) 218,292)
A’s net income – equity 218,292)

(a) Non-controlling interest’s share of consolidated net income 22,358*
(b)
A Company
Balance Jan. 1 1,601,860

Net income 218,292
1,820,152
Dividends 57,000
Balance Dec. 31 1,763,152
Calculation of non-controlling interest – Dec. 31, Year 7
Shareholders' equity C 281,300

Less: closing inventory profit 4,140
277,160
20% 55,432
Shareholders' equity B
Net income (68,000 + 11,544) 79,544
1,388,464
1,491,664
25%
372,916
Preferred shares 50,000 422,916
478,348
(c)
A Company
Cash (119,100 + 50,600 + 21,300) 191,000)

Accounts receivable (226,000 + 126,000 + 57,000 – 37,000) 372,000)
Inventory (303,000 + 232,000 + 71,000 – 14,500) 591,500)
Property, plant and equipment (3,000K+2,300K+240K+40K-450K-52.7K) 5,077,300)
Accumulated depreciation (990K+580K+101K+4K-450K-52.7K) (1,172,300)
Patents 67,200)
Deferred income tax 5,800)
5,132,500)
Accounts payable (120,000 + 101,000 + 7,000 – 37,000) 191,000)

Bonds payable (800,000 + 700,000) 1,500,000)
Common shares 1,200,000)
Retained earnings 1,763,152)
Non-controlling interest 478,348)
5,132,500)
Problem 8-14
(a) Parento Inc.
Consolidated Cash Flow Statement
Operating
Net Income 54,200)
Add (deduct): )
Database amortization 2,400)
Depreciation 37,500)
Bond premium amortization (1,200)
Loss on sale of land 2,500)
Decrease in accounts receivable 21,000)
Increase in inventory (38,000)
Increase in accounts payable 24,200)
Increase in accrued liabilities 200
102,800)

Investing
Proceeds from sale of land 25,500)
Purchase of buildings and equipment (98,000)
(72,500)
Financing
Issue of bonds payable 60,000)
Dividends – to shareholders of Parento (17,000)
– to non-controlling shareholders (2,000)
41,000)
Increase in cash during the year 71,300)

Cash at beginning of year 49,800)
Cash at end of year 121,100)
(b) Santana paid dividends of $8,000 of which 20% went to the non-controlling interest and
80% went to Parento. Only the 20% paid to the non-controlling interest shows up on the
consolidated cash flow statement because the non-controlling interest is an outside entity
wheras Parento is within the consolidated entity.
Problem 8-15
Wellington owns 90% of Sussex, therefore: 90%  7,200 = 6,480 shares
Sussex issues 1,800 additional shares: 7,200 + 1,800 = 9,000 shares outstanding
6,480
Wellington's new ownership percentage = 72%
9,000
Ownership before share issue 90%

Ownership after share issue 72%
Change 18%
Percentage of investment reduction: 18% / 90% = 20%
Wellington sells 648 shares = 10% reduction

(6,480 – 648)
Ownership after sale = 64.8%
9,000
(a) Investment account Jan. 1, Year 5 for 90% interest 244,800
Total Parent NCI

Shareholders' equity – Sussex 152,000
Unamortized acquisition differential – land 120,000 108,000 12,000
Less: 20% sale to NCI (share issue) (21,600) 21,600
120,000 86,400 33,600
Less: 40% of land sold to outsiders (48,000) (34,560) (13,440)
72,000 51,840 20,160
Less: 10% sale to NCI (5,184) 5,184
Unamortized acquisition differential – land
Balance Dec. 31, Year 5 72,000 46,656 25,344
(b) Investment account Jan. 1, Year 5 244,800)

Net income to April 1 (3/12  48,000  90%) 10,800)
255,600)
Sussex share issue – April 1
Carrying amount deemed sold (20%  255,600) 51,120)
New shares (1,800  35) 63,000
Parent’s share 72% 45,360)
Loss due to share issue (5,760)
June 30 dividend (24,000  72%) (17,280)
Sept. 15: 30% of land sold (34,560)
Net income April to Dec. (9/12  48,000  72%) 25,920)
223,920)
Dec. 31 sale of 10% of shares (22,392)
Balance Dec. 31, Year 5 201,528)
(c) Calculation of non-controlling interest Dec. 31, Year 5

Common shares 28,000)
Retained earnings Jan. 1 124,000)
Net income 48,000)
Dividends (24,000)
Issue of new shares (1,800  $35) 63,000) 211,000
239,000
Unamortized acquisition differential – land 72,000
311,000
Non-controlling interest share (100% – 64.8%) 35.2%
Proof of Investment Account Components

Carrying amount of sub’s net assets (64.8% x 239,000) 154,872
Unamortized acquisition differential – land 72,000
Parent’s share 64.8% 46,656
Total investment account 201,528
Problem 8-16
It is assumed that Panet’s first purchase of 8% does not provide significant influence or control.
Panet will account for its 8% investment at fair value through profit/loss. Therefore, it is not
necessary to allocate the acquisition cost. It is assumed that Panet’s second purchase of 27%,
which brings the percentage ownership to 35%, does result in significant influence. Panet will
use the equity method. Therefore, it is necessary to allocate the acquisition cost. When Panet
acquires an additional 45%, it would gain control. A business combination has occurred. The
subsidiary is measured at fair value and a gain or loss is recognized when adjusting the
previous investments to fair value.
Panet’s 80% interest will be valued at $6,400,000 calculated as follows:
Cost of 225,000 common shares (45%) 3,600,000
Implied value of 80% (3,600,000 x 80 / 45) 6,400,000
The acquisition differential is then calculated as follows:
Panet NCI
80% 20%
Implied value of 80% (3,600,000 x 80 / 45) 6,400,000

Fair value of NCI’s interest in Saffer (15 x 100,000) 1,500,000
Carrying amount of Saffer’s shareholders’ equity
Common shares 3,000,000
Retained earnings 3,200,000
6,200,000 4,960,000 1,240,000
Acquisition differential Jan. 1, Year 11 1,700,000 1,440,000 260,000
Allocated:
Accounts receivable – 63,600 -50,880 -12,720
Plant and equipment 900,000 720,000 180,000
Long-term liabilities - 200,000 -160,000 -40,000
Balance – goodwill 1,063,600 930,880 132,720

Jan. 1, YR 11 to Dec. 31, YR 11 YR 12 Dec. 31, YR 12
Accounts receivable – 63,600 – 63,600
Plant and equipment 900,000 45,000 45,000 810,000
Long-term liabilities - 200,000 - 20,000 - 20,000 - 160,000
636,400 - 38,600 25,000 650,000
Goodwill – Panet’s purchase 930,880 82,400 55,200 793,280
– NCI’s purchase 132,720 20,600 13,800 98,320
1,700,000 64,400 94,000 1,541,600
Panet’s share
(80% x subtotal + Goodwill) 1,440,000 51,520 75,200 1,313,280 (d)
NCI’s share
(20% x subtotal + Goodwill) 260,000 12,880 18,800 228,320 (e)
For details of the change in the investment account over the 5-year period ending December 31,
Year 12, see the continuity schedule at the end of this problem.
Intercompany sales – Saffer 3,200,000

– Panet 2,800,000
6,000,000
Intercompany receivables and payables

30%  560,000 = 168,000
Unrealized profits Before tax Tax 40% After tax

Opening inventory
Saffer selling 107,000 42,800 64,200
Panet selling 157,000 62,800 94,200
264,000 105,600 158,400
Closing inventory
Saffer selling (400,000  35%) 140,000 56,000 84,000
Panet selling (250,000  45%) 112,500 45,000 67,500
252,500 101,000 151,500
Equipment – Saffer selling
July 1, Year 12 210,000 84,000 126,000
Depreciation Year 12
(210,000 ÷ 10½  ½) 10,000 4,000 6,000
Balance Dec. 31, Year 12 200,000 80,000 120,000
Calculation of consolidated net income – Year 12
Panet’s net income under the equity method 4,012,660

Less: Investment income from Saffer 1,627,660
Closing inventory profit 67,500 1,695,160
2,317,500
Add: opening inventory profit 94,200
2,411,700
Saffer 2,285,000
Less: Acquisition differential amort. 94,000
Closing inventory profit 84,000
Equipment profit 120,000 298,000
1,987,000
2,051,200
Consolidated net income 4,462,900
Attributable to:

Panet’s shareholders (2,411,700 + 80% x (2,051,200 – 50,000) 4,012,660
NCI (20% x 2,001,200 + 100% x 50,000) 450,240
4,462,900
(a) (i)
Panet Company
Consolidated Income Statement
for the Year Ended Dec. 31, Year 12
Sales (16,100,000 + 10,100,000 – 6,000,000) $20,200,000
Cost of sales (9,660,000 + 6,060,000 – 6,000,000 – 264,000 + 252,500) 9,708,500
Selling and admin (2,522,000 + 552,000 + 45,000 – 10,000) 3,109,000
Other (479,000 + 451,000 – 20,000 + 69,000 + 210,000)* 1,189,000
Income tax (1,054,000 + 752,000 + 105,600 – 101,000 – 84,000 + 4,000) 1,730,600
Total expenses 15,737,100
Attributable to:
Panet’s shareholders 4,012,660
NCI (20% x 2,001,200 + 100% x 50,000) 450,240
4,462,900
* Gain on sale of equipment was not shown as a separate income statement item, therefore
must have been netted against other expenses. Upon consolidation it must be added back, as
it is unrealized.
Calculation of non-controlling interest – Dec. 31, Year 12
Preferred Common
Share capital 500,000 3,000,000
7,911,000
Less: Closing inventory profits (84,000)
Gain on equipment (120,000)
500,000 7,707,000
100% 20%
1,541,400
NCI’s share of unamortized acquisition differential
(650,000 x 20% + 98,320) 228,320
500,000 1,769,720 2,269,720
(a) (ii)
Panet Company
Cash (522,000 + 178,000) 700,000

Accounts receivable (2,455,000 + 333,000 – 168,000) 2,620,000
Inventory (500,000 + 400,000 – 252,500) 647,500
Plant and equipment (10,720,000 + 9,110,000 + 810,000 – 200,000) 20,440,000
Land (5,390,000 + 1,000,000) 6,390,000
Goodwill 891,600
Deferred income taxes (101,000 + 80,000) 181,000
31,870,100
Current liabilities (3,055,000 + 555,000 – 168,000) 3,442,000

Long-term liabilities (4,055,000 + 2,055,000 + 160,000) 6,270,000
Non-controlling interest 2,269,720
31,870,100
(b) Goodwill impairment loss under entity theory 69,000

Less: NCI’s share (20%) 13,800
Goodwill impairment loss under parent company extension theory 55,200
NCI on income statement under entity theory 450,240

Add: NCI’s share of goodwill impairment (20%) 13,800
NCI on income statement under parent company extension theory 464,040
(c) The debt to equity ratio would increase because debt would remain the same while equity
would decrease under the parent company extension theory.
Continuity Schedule for Panet’s Investment in Saffer:
Cost of 40,000 common shares (8%) 500,000
Unrealized gain in Years 8 and 9 60,000
Fair value of 8% interest on January 1, Year 10 560,000
Fair value of 175,000 common shares (35%) on January 1, Year 10 2,450,000
Carrying amount of Saffer’s shareholders’ equity
5,700,000
Panet's %: 175,000 / 500,000 = 35% 1,995,000
Acquisition differential Jan. 1, Year 10 455,000
Allocated:
Inventory 120,000  35% 42,000
Land 1,000,000  35% 350,000 392,000
Balance – goodwill 63,000

Jan. 1, YR 10 YR 10 Dec. 31, YR 10
Inventory 42,000 42,000
Land 350,000 – 350,000
Goodwill 63,000 63,000
455,000 42,000 413,000
Investment in Saffer, Jan 1, Year 10 2,450,000

Share of change in retained earnings during Year 10
(3,200,000 – 2,700,000) x 35% 175,000
Amortization of acquisition differential for Year 10 (42,000)
Carrying amount of investment in Saffer, Dec 31, Year 10 2,583,000
Gain in value of investment 217,000
Fair value of investment using value paid for Jan 1, Year 11 purchase
3,600,000 / 225,000 x 175,000 2,800,000
Retained earnings Saffer

Dec. 31, Year 12 4,911,000
Jan. 1, Year 11 3,200,000
Increase 1,711,000
Less: Acquisition differential amort. for Years 11 and 12
(64,400 + 94,000) 158,400
Closing inventory profit 84,000
Equipment profit 120,000 362,400
1,348,600
80% 1,078,880
Less: Closing inventory profit (67,500)
Balance on Dec. 31, Year 12 $7,411,380

(d) See journal entries below.
CONSOLIDATED FINANCIAL STATEMENT WORKING PAPER
PANET COMPANY
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, YEAR 12
Eliminations
Panet Saffer Dr. Cr. Consolidated
Income Statements - Year 12
Sales $ 16,100,000 $ 10,100,000 5 6,000,000 $ 20,200,000
Investment income from
1,627,660
Saffer 1 1,627,660
17,727,660 10,100,000 20,200,000
Cost of goods sold 9,660,000 6,060,000 7 252,500 5 6,000,000 9,708,500
6 264,000
Selling and administrative
2,522,000 552,000 3,109,000
expense 4 45,000 11 10,000
Income tax 1,054,000 752,000 6 105,600 7 101,000 1,730,600
8 80,000
Other expenses 479,000 451,000 4 69,000 4 20,000 1,189,000
11 210,000
13,715,000 7,815,000 15,737,100
Net Income $ 4,012,660 $ 2,285,000 $ 4,462,900
Attributable to:
Non-controlling interest 8 450,240 $ 450,240
Shareholders of Panet 4,012,660
Total 8,760,000 6,475,000
Retained Earnings Statements - Year 12
Balance, January 1 $ 7,375,720 $ 2,876,000 3 2,876,000 $ 7,375,720
Profit 4,012,660 2,285,000 Above 8,760,000 6,475,000 4,012,660
11,388,380 5,161,000 11,388,380
Dividends 500,000 250,000 1 160,000 500,000
9 90,000
Balance, December 31 $ 10,888,380 $ 4,911,000 $ 10,888,380
Total 11,636,000 6,725,000

Balance Sheet, December 31, Year 12
Assets:
Cash $ 522,000 $ 178,000 $ 700,000
Accounts receivable 2,455,000 333,000 10 168,000 2,620,000
Inventories 500,000 400,000 7 252,500 647,500
Plant and equipment (net) 10,720,000 9,110,000 3 855,000 4 45,000 20,440,000
11 200,000
Investment in Saffer 7,411,380 2 1,909,480 1 1,467,660
6 158,400 3 8,011,600
Land 5,390,000 1,000,000 6,390,000
Goodwill 3 960,600 4 69,000 891,600
Deferred tax asset 7 101,000 181,000
11 80,000
Total assets $ 26,998,380 $ 11,021,000 $ 31,870,100
Liabilities:
Current liabilities $ 3,055,000 $ 555,000 10 168,000 $ 3,442,000
Long-term liabilities 4,055,000 2,055,000 4 20,000 3 180,000 6,270,000
7,110,000 2,610,000 9,712,000
Shareholders’ equity:
10% non-cumulative
500,000
preferred shares 3 500,000
Common shares 9,000,000 3,000,000 3 3,000,000 9,000,000
Retained earnings 10,888,380 4,911,000 Above 11,636,000 6,725,000 10,888,380
Non-controlling interest 9 90,000 2 1,909,480 2,269,720
8 450,240
19,888,380 8,411,000 22,158,100
Total liabilities and
shareholders’ equity $ 26,998,380 $ 11,021,000 $ 31,870,100
$19,478,480 $ 19,478,480 0

Journal Entries
1 Investment income $ 1,627,660
Investment in Saffer $1,467,660
Dividends paid (80% x (250,000 - 50,000) 160,000
To adjust investment account under equity method to balance at beginning of year
2 Investment in Saffer 1,909,480

Non-controlling interest (note b) 1,909,480
To establish non-controlling interest at beginning of year
3 Common shares 3,000,000

Preferred shares 500,000
Plant and equipment 855,000
Long-term liabilities 180,000
Goodwill 960,600
Investment in Saffer 8,011,600
To eliminate subsidiary's shareholders' equity and
establish acquisition differential at beginning of Year 12
4 Other expense 20,000

Long-term liabilities 20,000
expense 45,000
Other expense 69,000
Goodwill 69,000
To amortize the acquisition differential for Year 12
5 Sales 6,000,000
Cost of goods sold 6,000,000
To eliminate intercompany sales
6 Investment in Saffer 158,400

Cost of goods sold 264,000
Income tax expense 105,600
To eliminate unrealized profits in beginning inventory
7 Cost of goods sold 252,500

Inventory 252,500
Deferred income tax asset 101,000
Income tax expenses 101,000
To eliminate unrealized profits in ending inventory
8 Non-controlling interest-P&L 450,240

Non-controlling interest-SFP 450,240
To record NCI's share of income for the year
9 Non-controlling interest-SFP 90,000

Dividends paid (50k + 20% x (250k-50k) 90,000
To record NCI's share of dividends paid

10 Current liabilities 168,000
Accounts receivable 168,000
Eliminate intercompany receivables and payables
11 Other expenses (gain on sale) 210,000

expense 10,000
Deferred tax asset 80,000
Eliminate unrealized profit in depreciable assets
Total of debits and credits $ 19,478,480 $19,478,480
Notes
a NCI, end of Year 12 $ 2,269,720
Less: NCI's share of consolidated net income for Year 12 -450,240
Add: NCI's share of PPC's dividends for Year 12 90,000
NCI, beginning of Year 12 $ 1,909,480
Problem 8-17
Cost of 70% of common (70,000 x $30) 2,100,000
Implied value of 100% 3,000,000
Carrying amount of net assets 1,525,000
Less: preferred shares 1,400,000
Carrying amount of common shares 125,000
Acquisition differential 2,875,000
Allocated:
Patents 300,000
Inventory 105,000
Brand name 2,375,000
Supply contract (500,000)
2,280,000
Balance: goodwill 595,000
Balance Amort. Amort. Patent Balance

12/31/YR 6 YR 7 YR 8 Sold 12/31/YR 8
Patent 300,000 60,000 58,000* 14,000* 168,000
Inventory 105,000 105,000
Brand name (40 years) 2,375,000 59,375 59,375 2,256,250
Sales supply contract (500,000) (250,000) (250,000) 0
Goodwill 595,000 595,000
2,875,000 (25,625) (132,625) 14,000 3,019,250
* Patents (12/31/YR 6) 300,000

Amort. Year 7 60,000
st
Amort. 1 half Year 8 30,000 90,000
Balance June 30, Year 8 210,000
Portion sold (20,000/300,000 x 210,000) 14,000
196,000
Amort. 2nd half Year 8
30,000 – (20,000/300,000 x 30,000) 28,000
168,000
Intercompany profits PPC selling Before Tax After

tax 40% tax
Opening inventory (15,000 x 60%) 9,000 3,600 5,400
Closing inventory (22K/60K x [60,000 – 42,000]) 6,600 2,640 3,960
The intercompany loss on the transfer of computer hardware is allowed to stand because it is
indicative of a permanent decline in value.
Intercompany sales 60,000

Annual dividends to preferred shareholders (12 x 12,500 shares) 150,000
Calculation of consolidated net income, Year 8

Ultra net income 220,000
PPC net income 1,135,000
1,140,400
Less: closing inventory profit 3,960
1,136,440
Add: Acquisition differential amortization 132,625
Less: Acquisition differential, sold patents 14,000 1,255,065

Attributable to:
Shareholders of Ultra 993,545
NCI (100% x 150,000 + 30% x [1,255,065 – 150,000]) 481,520
1,475,065
(i) Consolidated Income Statement

Sales (6,200,000 + 4,530,000 – 60,000 + 250,000) 10,920,000

Other income (120,000 + 7,000) 127,000
Gain on patent sale (50,000 – 14,000) 36,000
11,083,000
Cost of purchases (4,035,000 + 2,590,000 – 60,000) 6,565,000
Change in inventory (15,000 + 10,000 – 9,000 + 6,600) 22,600
Loss on write-down of computer equipment 1,080,000
Other expenses (850,000 + 675,000 + 3,600 – 2,640) 1,525,960
Depreciation and amortization (75,000 + 142,000 + 117,375) 334,375
Interest (45,000 + 35,000) 80,000
9,607,935
Net income 1,475,065
Attributable to:
NCI 481,520
1,475,065
(ii) Calculation of consolidated retained earnings – Jan. 1, Year 8

Ultra retained earnings 1,300,000
PPC retained earnings 117,000
Acquisition * 25,000
Increase since acquisition 92,000
Less: Opening inventory profit 5,400
86,600
Add: acquisition differential amort. 25,625
112,225

70% 78,558
1,378,558
* Net assets 1,525,000

Preferred shares 1,400,000
Carrying amount of common shares 125,000

Balance January 1 1,378,558

Net income 993,545
Balance December 31 2,372,103
(iii) (1) Software patents and copyrights (350,000 + 450,000 + 168,000) 968,000
(2) Inventory – software (350,000 + 380,000 – 6,600) 723,400
(3) Non-controlling interest December 31, Year 8

Total Preferred Common
R/E Jan. 1 117,000 — 117,000
Net income 1,135,000 150,000 985,000
1,252,000 150,000 1,102,000
Dividends 150,000 150,000 —
R/E Dec. 31 1,102,000 — 1,102,000
Preferred shares 1,400,000 1,400,000 —
Common shares 100,000 — 100,000
Bal. Dec. 31 2,602,000 1,400,000 1,202,000
Shareholders’ equity
Preferred 1,400,000
Common 1,202,000
Add: unamortized acquisition differential 3,019,250
Less: closing inventory profit (3,960)
4,217,290
30% 1,265,187
Non-controlling interest 2,665,187
(b)
Conversion of the preferred would result in no change in the dollar amount of shareholders’
equity of PPC but all net income earned in the future would belong to the common shares.
Twenty-five thousand new common shares would be issued. The parent’s ownership would
change from 70% to 56% (70,000/125,000), a 20% reduction while the non-controlling interest
would increase to 44%. The unamortized acquisition differential would remain the same in total
but the split between the parent and non-controlling interest would change to their new
percentage ownership. The parent’s investment account would be reduced by 20% for the
deemed sale of 20% of its previous holdings and then would be increased by 56% of the value
attributed to the new common shares, which would normally be the carrying amount of the
preferred shares prior to their conversion to common shares.

(c) See journal entries below.
CONSOLIDATED FINANCIAL STATEMENT WORKING PAPER
ULTRA SOFTWARE LTD.
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, YEAR 8
Eliminations
Ultra PPC Dr. Cr. Consolidated
Income Statements - Year 8
Sales $ 6,200,000 $4,530,000 5 $ 60,000 4 $ 250,000 $10,920,000
Other income 120,000 7,000 127,000
Gain on patent sale 50,000 5 14,000 36,000
Total income 6,320,000 4,587,000 11,083,000
Cost of purchases 4,035,000 2,590,000 5 60,000 6,565,000

Change in inventory 15,000 10,000 7 6,600 6 9,000 22,600
Loss on write-down of computer
equipment 1,080,000 0 0 1,080,000
Other expenses 850,000 675,000 6 3,600 7 2,640 1,525,960
Depreciation and amortization 75,000 142,000 5 117,375 334,375

Interest 45,000 35,000 80,000
Total expenses 6,100,000 3,452,000 9,607,935
Profit $ 220,000 $1,135,000 $ 1,475,065
Attributable to:
Non-controlling interest 8 481,520 $ 481,520
Total $683,095 $ 321,640
Retained Earnings Statements - Year 8
Balance, January 1 $ 1,300,000 $ 117,000 3 $117,000 1 $ 78,558 $ 1,378,558
Profit 220,000 1,135,000 683,095 321,640 993,545
1,520,000 1,252,000 2,372,103
Dividends 0 150,000 9 150,000 0
Balance, December 31 $ 1,520,000 $1,102,000 $ 2,372,103
Total $800,095 $ 550,198

Balance Sheet, December 31, Year 8
Cash $ 320,000 $ 150,000 $ - $ - $ 470,000
Accounts receivable 300,000 280,000 580,000
Inventory 350,000 380,000 7 6,600 723,400
Deferred income tax asset 7 2640 2,640
Furniture and equipment (net) 540,000 675,000 1,215,000
Building (net) 800,000 925,000 1,725,000
Land 450,000 200,000 650,000
Patents and copyrights 350,000 450,000 3 240,000 4 72,000 968,000
Brand name 3 2,315,625 4 59,375 2,256,250
Goodwill 3 595,000 595,000
Investment in PPC 2,100,000 1 78,558 3 4,517,625 0
2 2,333,667
6 5,400
Total $ 5,210,000 $3,060,000 $ 9,185,290

Accounts payable $ 340,000 $ 138,000 $ 478,000
Mortgage payable 350,000 350,000
Bank loan payable 320,000 320,000
Sales supply contract 4 250,000 3 250,000 0
Preferred shares (12,500 outstanding) 1,400,000 3 1,400,000 0
Common shares (300,000 outstanding) 3,000,000 3,000,000
Common shares (100,000 outstanding) 100,000 3 100,000 0

Retained earnings 1,520,000 1,102,000 Above 800,095 Above 550,198 2,372,103
Non-controlling interests 9 150,000 2 2,333,667 2,665,187
8 481,520
Total $ 5,210,000 $3,060,000 $ 9,185,290

$8,270,985 $8,270,985

Journal Entries
1 Investment in PPC 78,558
Retained earnings (note a) 78,558
To adjust retained earnings to equity method at beginning of year
2 Investment in PPC 2,333,667

Non-controlling interest (note b) 2,333,667
To establish non-controlling interest at beginning of year
3 Common shares 100,000

Preferred shares 1,400,000
Patent 240,000
Brand name 2,315,625
Goodwill 595,000
Sales supply contract 250,000
Investment in PPC 4,517,625
To eliminate subsidiary's shareholders' equity and
establish acquisition differential at beginning of Year 8
4 Sales supply contract 250,000

Sales revenue 250,000
Depreciation expense 117,375
Gain on sale of patent 14,000
Patent 72,000
Brand name 59,375
To amortize the acquisition differential for Year 8
5 Sales 60,000
Cost of purchases 60,000
To eliminate intercompany sales
6 Investment in PPC 5,400

Change in inventory 9,000
To eliminate unrealized profits in beginning inventory
7 Change in inventory 6,600

Inventory 6,600
Deferred income tax asset 2,640
Income tax expenses 2,640
To eliminate unrealized profits in ending inventory
8 Non-controlling interest-P&L 481,520

Non-controlling interest-SFP 481,520
To record NCI's share of income for the year
9 Non-controlling interest-SFP 150,000

Dividends paid (100% x 150,000) 150,000
To record NCI's share of dividends paid
Total of debits and credits $ 8,270,985 $ 8,270,985

Notes
a Consolidated retained earnings, beginning of Year 8
(= Ulta's retained earnings, beginning of Year 8 under equity method) $1,378,558
Ulta's retained earnings, beginning of Year 8 under cost method 1,300,000
Difference between cost and equity method, beginning of Year 8 $ 78,558
b NCI, end of Year 8 $2,665,187

Less: NCI's share of consolidated net income for Year 8 -481,520
Add: NCI's share of PPC's dividends for Year 8 150,000
NCI, beginning of Year 8 $2,333,667
Problem 8-18
Acquisition cost Allocation Schedule for first two steps
Jan 1/YR 2 Jan 1/YR 4
Cost 50,700 98,300
CA – OS 200,000 200,000
RE 28,000 69,000
228,000 269,000
% Acquired 20% 45,600 30% 80,700
Acquisition differential 5,100 17,600
Land 2,550 8,800
Patents 2,550 8,800
Amortization Year 2 255
Year 3 255
Year 4 255 1,100
Value Dec. 31, Year 4 1,785 7,700
Acquisition cost Allocation Schedule for third step when Phase obtains control
Jan 1/YR 5
Cost of 30% investment 108,000
Implied value of 100% investment 360,000
CA – OS 200,000
RE 104,000
304,000
Land 28,000

Patents 28,000
Amortization Year 5 (4,000)
Value Dec. 31, Year 5 24,000
Intercompany profits Step selling Before Tax After

tax 40% tax
Opening inventory (10,000 x 20%) 2,000 800 1,200
Closing inventory (5,000 x 20%) 1,000 400 600
Sale of depreciable assets (Phase selling) 60,000 24,000 36,000

Realized in Year 5 (1/6 x ½) 5,000 2,000 3,000
Unrealized end of Year 5 55,000 22,000 33,000
Calculation of gain on revaluation of investment account when Phase obtains control

The investment account would show the following activity under the equity method:
Phase’s share of change in Step’s retained earnings during Years 2 & 3
(69,000 – 28,000) x 20% 8,200
Amortization of patent during Years 2 and 3 (255 + 255) (510)
Phase’s share of change in Step’s retained earnings during Year 4
(104,000 – 69,000) x 50% 17,500
Amortization of patent during Year 4(255 + 1,100) (1,355)
Phase’s share of unrealized profit in inventory at end of Year 4
(50% x 1,200) (600)
Investment account balance, January 1, Year 5 before revaluation 172,235
Value of 10,000 shares (108,000 / 6,000 x 10,000) 180,000
Gain on revaluation to fair value on January 1, Year 5 7,765
Note: When the investment account is adjusted to fair value of $180,000, the unrealized profit in
ending inventory is brought into income. It is akin to the profit being realized.
(a) Patents total 24,000
(b) Property, plant, and equipment (540,000 + 298,000 + 28,000 – 55,000) 811,000

(c) Current assets (173,000 + 89,000 – [80,000 +10,000] x 50% -1,000) 216,000
(d) Non-controlling interest on statement of financial position

Step’s ordinary shares 200,000
Step’s retained earnings (104,000 + 400,000 – 260,000 – 55,000 – 40,000)
149,000
Profit in ending inventory (600)
400,400
NCI’s ownership 20%
NCI on statement of financial position 80,080
(e) Retained Earnings, beginning

Phase’s retained earnings, beginning 360,000
Phase’s share of change in Step’s retained earnings during Years 2 and 3
(69,000 – 28,000) x 20% 8,200
Amortization of patent during Years 2 and 3 (255 + 255) (510)
Phase’s share of change in Step’s retained earnings during Year 4
(104,000 – 69,000) x 50% 17,500
Amortization of patent during Year 4(255 + 1,100) (1,355)
Phase’s share of profit in beginning inventory (50% x 1,200) (600)
Consolidated retained earnings, beginning 383,235
(f) Cost of goods sold (610,000 + 260,000 – 80,000 – 10,000 + 1,000)

781,000
Note: No adjustment is made for the profit in beginning inventory. Since the adjustment to fair
value at the beginning of Year 5 brought the intercompany profit from beginning inventory into
income, the typical adjustment to realize the profit in beginning inventory is not required for this
question.
(g) Phase profit (1,002,000 – 610,000 – 190,000) 202,000

Less: dividends (80% x 40,000) (32,000)
unrealized gain on sale (33,000)
Step profit (400,000 – 260,000 – 55,000) 85,000
Profit in ending inventory (600)
Amortization of acquisition differential (4,000)
80,400
Gain on revaluation 7,765
Attributable to:
Shareholders of Phase 209,085
NCI (20% x 80,400) 16,080
225,165
Note: No adjustment is made for the profit in beginning inventory. Since the adjustment to fair
value at the beginning of Year 5 brought the intercompany profit from beginning inventory into
income, the typical adjustment to realize the profit in beginning inventory is not required for this
question.


Consolidated Cash Flows and Changes in Ownership: Solutions Manual, Chapter 8

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Chapter 8

Consolidated Cash Flows and

Copyright  2016 McGraw-Hill Education. All rights reserved.

Problem 8-3 (40 min.)

Problem 8-4 (30 min.)

Problem 8-5 (30 min.)

Problem 8-6 (20 min.)

Problem 8-7 (30 min.)

Problem 8-8 (30 min.)

Problem 8-10 (40 min.)

Problem 8-11 (25 min.)

Problem 8-12 (20 min.)

Problem 8-13 (30 min.)

Problem 8-14 (30 min.)

Problem 8-15 (40 min.)

Problem 8-16 (100 min.)

SOLUTIONS TO REVIEW QUESTIONS

3. The amortization of the acquisition differential is similar to depreciation expense in that it is

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4. Dividend payments to non-controlling shareholders represent a flow of cash outside the

11. Net income for the year 17,000)

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Liabilities (800 + 400) $ 1,200 $ 1,200 $ 1,200

Liabilities (800 + 400) $ 1,200 $ 1,200 $ 1,200

In scenarios A and B, a gain on sale is reported on January 1, Year 8 as a direct credit to

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Acquisition cost (54 x 100,000 x 20%) 1,080,000

Attention: Andrew Joel

Sale of Traveller Bus Lines ("TBL")

 recommends ways in which the selling price can be maximized

Recommendations on ways to maximize the selling price

Copyright  2016 McGraw-Hill Education. All rights reserved.

Possible adjustments to the selling price

Travel the country

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Significant accounting issues – CTE

Recognition of the gain on sale of TBL

Comments on current agreement

Early Order Program

Merger and Acquisition Costs

Commissions Expense Accrual

Subsequent to year-end, a commission expense of $37,500 was paid related to $750,000 of

If you have any concerns or questions, please contact us.

REPORT TO VISION CLOTHING INC.

Financial concerns of the immediate future

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Financial accounting issues

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Underwriter fees and share-offering costs

XYZ Ltd. gain

Style Co. issues

Deferred tax debits

* Dividends in arrears: 500 shares  $8  2 years = $8,000

Intercompany receivables and payables

Intercompany profits Before tax Tax 40% After tax

Closing inventory – Star selling $52,000 $20,800 $31,200

Equipment – Star selling

Star Year 12 dividends $37,000

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Deferred income tax, December 31, Year 12

Calculation of Year 12 consolidated net income

Calculation of consolidated retained earnings – Jan. 1, Year 12

Par opening retained earnings $297,260