Chapter 3

Consolidated Financial Statements—Date of Acquisition

Multiple Choice

1. A majority-owned subsidiary that is in legal reorganization should normally be accounted for using
a. consolidated financial statements.
b. the equity method.
c. the market value method.
d. the cost method.

2. Under the acquisition method, indirect costs relating to acquisitions should be

a. included in the investment cost.
b. expensed as incurred.
c. deducted from other contributed capital.
d. none of these.

3. Eliminating entries are made to cancel the effects of intercompany transactions and are made on the
a. books of the parent company.
b. books of the subsidiary company.
c. workpaper only.
d. books of both the parent company and the subsidiary.

4. One reason a parent company may pay an amount less than the book value of the subsidiary's stock
acquired is
a. an undervaluation of the subsidiary's assets.
b. the existence of unrecorded goodwill.
c. an overvaluation of the subsidiary's liabilities.
d. none of these.

5. In a business combination accounted for as an acquisition, registration costs related to common

stock issued by the parent company are
a. expensed as incurred.
b. deducted from other contributed capital.
c. included in the investment cost.
d. deducted from the investment cost.

6. On the consolidated balance sheet, consolidated stockholders' equity is

a. equal to the sum of the parent and subsidiary stockholders' equity.
b. greater than the parent's stockholders' equity.
c. less than the parent's stockholders' equity.
d. equal to the parent's stockholders' equity.

7. Majority-owned subsidiaries should be excluded from the consolidated statements when

a. control does not rest with the majority owner.
b. the subsidiary operates under governmentally imposed uncertainty.
c. a foreign subsidiary is domiciled in a country with foreign exchange restrictions or controls.
d. any of these circumstances exist.
3-2 Test Bank to accompany Jeter and Chaney Advanced Accounting

8. Under the economic entity concept, consolidated financial statements are intended primarily for the
benefit of the
a. stockholders of the parent company.
b. creditors of the parent company.
c. minority stockholders.
d. all of the above.

9. Reasons a parent company may pay more than book value for the subsidiary company's stock
include all of the following except
a. the fair value of one of the subsidiary's assets may exceed its recorded value because of
appreciation.
b. the existence of unrecorded goodwill.
c. liabilities may be overvalued.
d. stockholders' equity may be undervalued.

10. What is the method of presentation required by SFAS 160 of “non-controlling interest” on a
consolidated balance sheet?
a. As a deduction from goodwill from consolidation.
b. As a separate item within the long-term liabilities section.
c. As a part of stockholders' equity.
d. As a separate item between liabilities and stockholders' equity.

11. Which of the following is a limitation of consolidated financial statements?

a. Consolidated statements provide no benefit for the stockholders and creditors of the parent
company.
b. Consolidated statements of highly diversified companies cannot be compared with industry
standards.
c. Consolidated statements are beneficial only when the consolidated companies operate within the
same industry.
d. Consolidated statements are beneficial only when the consolidated companies operate in
different industries.

12. Pine Corp. owns 60% of Sage Corp.'s outstanding common stock. On May 1, 2011, Pine advanced
Sage $90,000 in cash, which was still outstanding at December 31, 2011. What portion of this
advance should be eliminated in the preparation of the December 31, 2011 consolidated balance
sheet?
a. $90,000.
b. $54,000.
c. $36,000.
d. $-0-.
 Chapter 3 Consolidated Financial Statements—Date of Acquisition 3-3

Use the following information for questions 13-15.

On January 1, 2011, Polk Company and Sigler Company had condensed balance sheets as follows:
Polk Sigler
Current assets $ 280,000 $ 80,000
Noncurrent assets _360,000 __160,000
Total assets $ 640,000 $240,000
Current liabilities $ 120,000 $ 40,000
Long-term debt 200,000 -0-
Stockholders' equity __120,000 200,000
Total liabilities & stockholders' equity $ 640,000 $240,000
On January 2, 2011 Polk borrowed $240,000 and used the proceeds to purchase 90% of the outstanding
common stock of Sigler. This debt is payable in 10 equal annual principal payments, plus interest, starting
December 30, 2011. Any difference between book value and the value implied by the purchase price relates
to land.

On Polk's January 2, 2011 consolidated balance sheet,

13. Noncurrent assets should be

a. $520,000.
b. $536,000.
c. $544,000.
d. $586,667.

14. Current liabilities should be

a. $200,000.
b. $184,000.
c. $160,000.
d. $120,000.

15. Noncurrent liabilities should be

a. $440,000.
b. $416,000.
c. $240,000.
d. $216,000.

16. A newly acquired subsidiary has pre-existing goodwill on its books. The parent company’s
consolidated balance sheet will:
a. treat the goodwill the same as other intangible assets of the acquired company.
b. will always show the pre-existing goodwill of the subsidiary at its book value.
c. not show any value for the subsidiary’s pre-existing goodwill.
d. do an impairment test to see if any of it has been impaired.

17. The Difference between Implied and Book Value account is:
a. an account necessary for the preparation of consolidated working papers.
b. used in allocating the amounts paid for recorded balance sheet accounts that are different than
their fair values.
c. the excess implied value assigned to goodwill.
d. the unamortized excess that cannot be assigned to any related balance sheet accounts
3-4 Test Bank to accompany Jeter and Chaney Advanced Accounting

18. The main evidence of control for purposes of consolidated financial statements involves
a. possessing majority ownership
b. having decision-making ability that is not shared with others.
c. being the sole shareholder
d. having the parent company and the subsidiary participating in the same industry.

19.  In which of the following cases would consolidation be inappropriate? 

a. The subsidiary is in bankruptcy.
b. Subsidiary's operations are dissimilar from those of the parent.
c. The parent owns 90 percent of the subsidiary's common stock, but all of the subsidiary's
nonvoting preferred stock is held by a single investor.
d. Subsidiary is foreign.

20.  Princeton Company acquired 75 percent of the common stock of Sheffield Corporation on
December 31, 2011. On the date of acquisition, Princeton held land with a book value of $150,000
and a fair value of $300,000; Sheffield held land with a book value of $100,000 and fair value of
$500,000. What amount would land be reported in the consolidated balance sheet prepared
immediately after the combination? 
a. $650,000
b. $500,000
c. $550,000
d. $375,000
 Chapter 3 Consolidated Financial Statements—Date of Acquisition 3-5

Use the following information to answer questions 21 - 23.

On January 1, 2011, Pena Company and Shelby Company had condensed balanced sheets as follows:

Pena Shelby

Current assets $ 210,000 $ 60,000

Noncurrent assets 270,000 120,000
Total assets $480,000 $180,000

Current liabilities $ 90,000 $ 30,000

Long-term debt 150,000 -0-
Stock holders' equity 240,000 150,000
Total liabilities & stockholders' equity $ 480,000 $ 180,000

On January 2, 2011 Pena borrowed $180,000 and used the proceeds to purchase 90% of the outstanding
common stock of Shelby. This debt is payable in 10 equal annual principal payments, plus interest, starting
December 30, 2011. Any difference between book value and the value implied by the purchase price relates
to land.

On Pena's January 2, 2011 consolidated balance sheet,

21. Noncurrent assets should be

a. $390,000.
b. $402,000.
c. $408,000.
d. $440,000.

22. Current liabilities should be

a. $150,000.
b. $138,000.
c. $120,000.
d. $90,000.

23. Noncurrent liabilities should be

a. $330,000.
b. $312,000.
c. $180,000.
d. $162,000. 

24. On January 1, 2011, Primer Corporation acquired 80 percent of Sutter Corporation's voting common stock.
Sutters's buildings and equipment had a book value of $300,000 and a fair value of $350,000 at the time of
acquisition. At what amount will Sutter’s buildings and equipment will be reported in the consolidated
statements ? 
a. $350,000
b. $340,000
c. $280,000
d. $300,000
3-6 Test Bank to accompany Jeter and Chaney Advanced Accounting

Problems

3-1 On December 31, 2011, Page Company purchased 80% of the outstanding common stock of Snead
Company for cash. At the time of acquisition, Snead Company's balance sheet was as follows:

Current assets $ 1,680,000

Plant and equipment 1,580,000
Land 280,000
Total assets $3,540,000

Liabilities $ 1,320,000
Common stock, $10 par value 1,440,000
Other contributed capital 700,000
Retained earnings 240,000
Total $3,700,000
Treasury stock at cost, 5,000 shares 160,000
Total equities $3,540,000

Required:

Prepare the elimination entry(s) required for the preparation of a consolidated balance sheet
workpaper on December 31, 2011, assuming the purchase price of the stock was $1,670,000. Any
difference between the value implied by the purchase price of the investment and the book value of
net assets acquired relates to subsidiary land.

3-2 P Company purchased 80% of the outstanding common stock of S Company on January 2, 2011, for
$380,000. Balance sheets for P Company and S Company immediately after the stock acquisition
were as follows:

P Company S Company
Current assets $ 166,000 $ 96,000
Investment in S Company 380,000 -0-
Plant and equipment (net) 560,000 224,000
Land 40,000 120,000
$1,146,000 $440,000

Current liabilities $ 120,000 $ 44,000

Long-term notes payable -0- 36,000
Common stock 480,000 160,000
Other contributed capital 244,000 64,000
Retained earnings 302,000 136,000
$1,146,000 $440,000

S Company owed P Company $16,000 on open account on the date of acquisition.

 Chapter 3 Consolidated Financial Statements—Date of Acquisition 3-7

Required:

Prepare a consolidated balance sheet for P and S Companies on the date of acquisition. Any
difference between the value implied by the purchase price of the investment and the book value of
net assets acquired relates to subsidiary land. The book values of S Company's other assets and
liabilities are equal to their fair values.

3-3 P Company acquired 54,000 shares of the common stock of S Company on January 1, 2011, for
$950,000 cash. The stockholders' equity section of S Company's balance sheet on that date was as
follows:

Common stock, $10 par value $600,000

Other contributed capital 80,000
Retained earnings 320,000
Total $1,000,000

On the date of acquisition, S Company owed P Company $10,000 on open account.

Required:
Present, in general journal form, the elimination entries for the preparation of a consolidated balance
sheet workpaper on January 1, 2011. The difference between the value implied by the purchase
price of the investment and the book value of the net assets acquired relates to subsidiary land.

3-4 On January 2, 2011, Potter Company acquired 90% of the outstanding common stock of Smiley
Company for $480,000 cash. Just before the acquisition, the balance sheets of the two companies
were as follows:

Potter Smiley
Cash $ 650,000 $ 160,000
Accounts Receivable (net) 360,000 60,000
Inventory 290,000 140,000
Plant and Equipment (net) 970,000 240,000
Land 150,000 80,000
Total Assets $2,420,000 $680,000

Accounts Payable $ 260,000 $ 120,000

Mortgage Payable 180,000 100,000
Common Stock, $2 par value 1,000,000 170,000
Other Contributed Capital 520,000 50,000
Retained Earnings 460,000 240,000
Total Equities $2,420,000 $680,000

The fair values of Smiley's assets and liabilities are equal to their book values with the exception
of land.
3-8 Test Bank to accompany Jeter and Chaney Advanced Accounting

Required:

A. Prepare the journal entry necessary to record the purchase of Smiley's common stock.
B. Prepare a consolidated balance sheet at the date of acquisition.

3-5 P Corporation paid $420,000 for 70% of S Corporation’s $10 par common stock on December 31,
2011, when S Corporation’s stockholders’ equity was made up of $300,000 of Common Stock,
$90,000 of Other Contributed Capital and $60,000 of Retained Earnings. S’s identifiable assets and
liabilities reflected their fair values on December 31, 2011, except for S’s inventory which was
undervalued by $60,000 and their land which was undervalued by $25,000. Balance sheets for P
and S immediately after the business combination are presented in the partially completed work-
paper below.

Eliminations
P S Debit Credit Noncontrolling Consolidated
Interest Balances
ASSETS
Cash $40,000 $30,000
Accounts
receivable-net 30,000 45,000
Inventories 185,000 165,000
Land 45,000 120,000
Plant assets-
net 480,000 240,000
Investment in
S Corp. 420,000
Difference
between implied
and book value
Goodwill
Total Assets $1,200,000 $600,000
EQUITIES
Current
liabilities $170,000 $150,000
Capital stock 600,000 300,000
Additional paid-
in capital 150,000 90,000
Retained
earnings 280,000 60,000
Noncontrolling
interest
Total Equities $1,200,000 $600,000

Required:
Complete the consolidated balance sheet workpaper for P Corporation and Subsidiary.

3-6 Prepare in general journal form the workpaper entries to eliminate Porter Company's investment in
Sewell Company in the preparation of a consolidated balance sheet at the date of acquisition for
each of the following independent cases:
 Chapter 3 Consolidated Financial Statements—Date of Acquisition 3-9

Sewell Company Equity Balances

Percent of Investment Common Other Contributed Retained
Cash
Stock Owned Cost Stock Capital Earnings
a. 90 $675,000 $450,000 $180,000 $75,000
b. 80 318,000 620,000 140,000 20,000

Any difference between book value of net assets acquired and the value implied by the purchase
price relates to subsidiary property, plant, and equipment except for case (b). In case (b) assume that
all book values and fair values are the same.

3-7 On December 31, 2011, Pryor Company purchased a controlling interest in Shelby Company for
$1,060,000. The consolidated balance sheet on December 31, 2011 reported noncontrolling interest
in Shelby Company of $265,000.

On the date of acquisition, the stockholders' equity section of Shelby Company's balance sheet was
as follows:

Common stock $520,000

Other contributed capital 380,000
Retained earnings 280,000
Total 1,180,000

Required:

A. Compute the noncontrolling interest percentage on December 31, 2011.

B. Prepare the investment elimination entry made to prepare a consolidated balance sheet
workpaper. Any difference between book value and the value implied by the purchase price
relates to subsidiary land.

3-8 On January 1, 2011, Primer Company issued 1,500 of its $20 par value common shares with a fair
value of $50 per share in exchange for 2,000 outstanding common shares of Swartz Company in a
purchase transaction. Registration costs amounted to $1,700 paid in cash. Just prior to the
acquisition, the balance sheets of the two companies were as follows:

Primer Swartz

Cash $ 73,000 $13,000

Accounts Receivable (net) 95,000 19,000
Inventory 58,000 25,000
Plant and Equipment (net) 95,000 43,000
Land 26,000 20,000
Total Assets $ 347,000 $ 120,000

Accounts Payable $ 66,000 16,000

Notes Payable 82,000 21,000
3-10 Test Bank to accompany Jeter and Chaney Advanced Accounting

Common Stock, $20 par value 100,000 40,000

Other Contributed Capital 60,000 24,000
Retained Earnings 39,000 19,000
Total Liabilities and Equities $ 347,000 $ 120,000

Any differences between the book value of equity and the value implied by the purchase price relates to
Land.

Required:
A. Prepare the journal entry on Primer’s books to record the exchange of stock.
B. Prepare a Computation and Allocation Schedule for the Difference between book value and value
implied by the purchase price.
C. Calculate the consolidated balance for each of the following accounts as of December 31, 2011:
1. Cash
2. Land
3. Common Stock
4. Other Contributed Capital

Short Answer

1. There are several reasons why a company would acquire a subsidiary’s voting common stock
rather than its net assets. Identify at least two advantages to acquiring a controlling interest in
the voting stock of another company rather than its assets.

2. A useful first step in the consolidating process is to prepare a Computation and Allocation of
Difference (CAD) Schedule. Identify the steps involved in preparing the CAD schedule.

Short Answer Questions from the Textbook

1. What are the advantages of acquiring the majority of the voting stock of another company rather than
acquiring all its voting stock?

2. What is the justification for preparing consolidated financial statements when, in fact, it is ap-parent that
the consolidated group is not a legal entity?

3. Why is it often necessary to prepare separate financial statements for each legal entity in a consolidated
group even though consolidated statements provide a better economic picture of the combined
activities?

4. What aspects of control must exist before a subsidiary is consolidated?

5. Why are consolidated work papers used in pre-paring consolidated financial statements?

6. Define noncontrolling (minority) interest. List three methods that might be used for reporting the
noncontrolling interest in a consolidated balance sheet, and state which is preferred under the SFAS No.
160[topic 810].
 Chapter 3 Consolidated Financial Statements—Date of Acquisition 3-11

7. Give several reasons why a parent company would be willing to pay more than book value for
subsidiary stock acquired.

8. What effect do subsidiary treasury stock holdings have at the time the subsidiary is acquired? How
should the treasury stock be treated on consolidated work papers?

9. What effect does a noncontrolling interest have on the amount of intercompany receivables and payables
eliminated on a consolidated balance sheet?

10 A.SFAS No. 109and SFAS No. 141R[ASC 740 and805] require that a deferred tax asset or liability
be recognized for likely differences between the reported values and tax bases of assets and liabilities
recognized in business combinations (for example, in exchanges that are nontaxable to the selling
shareholders). Does this decision change the amount of consolidated net income reported in years
subsequent to the business combination? Explain.

Business Ethics Question from the Textbook

Part I. You are working on the valuation of accounts receivable, and bad debt reserves for the
current year’s annual report. The CFO stops by and asks you to reduce the reserve by enough to
increase the current year’s EPS by 2 cents a share. The company’s policy has always been to use the
previous year’s actual bad debt percentage adjusted for a specific economic index. The CFO’s
suggested change would still be within acceptable GAAP. However, later, you learn that with the
increased EPS, the CFO would qualify for a significant bonus. What do you do and why?

Part II. Consider the following: Accounting firm KPMG created tax shelters called BLIPS, FLIP,
OPIS, and SOS that were based largely in the Cayman Islands and allowed wealthy clients (there
were 186) to create $5 billion in losses, which were then deducted from their income for IRS tax
purposes. BLIPS (Bond Linked Issue Premium Structures) had clients borrow from an offshore
bank for purposes of purchasing currency. The client would then sell the currency back to the lender
for a loss. However, the IRS contends the losses were phony and that there was never any risk to the
client in the deals. The IRS has indicted eight former KPMG partners and an outside lawyer alleging
that the transactions were shams, illegal methods for avoiding taxes. KPMG has agreed to pay
a$456 million fine, no longer to do tax shelters, and to cooperate with the government in its
prosecution of the nine individuals involved in the tax shelter scheme. Many argue that the courts
have not always held that such tax avoidance schemes show criminal intent because the tax laws
permit individuals to minimize taxes. However, the IRS argues that these shelters evidence intent
because of the lack of risk.

Question
In this case, the IRS contends that the losses generated by the tax shelters were phony and that the
clients never incurred any risk. Do tax avoidance schemes indicate criminal intent if the tax laws
permit individuals to minimize taxes? Justify your answer.
3-12 Test Bank to accompany Jeter and Chaney Advanced Accounting

ANSWER KEY

Multiple Choice

1. d 8. d 15. b 22. b
2. b 9. d 16. c 23. b
3. c 10. c 17. b 24. a
4. d 11. b 18. b
5. b 12. a 19. a
6. d 13. d 20. a
7. d 14. b 21. d
Problems

3-1 Common Stock – Snead 1,440,000

Other Contributed Capital – Snead 700,000
Retained Earnings – Snead 240,000
Investment in Snead Company 1,670,000
Treasury Stock - Snead 160,000
Difference Between Implied and Book Value 106,000
Noncontrolling Interest 444,000

Difference Between Implied and Book Value 106,000

Land 106,000

3-2 P COMPANY AND SUBSIDIARY

Consolidated Balance Sheet
January 2, 2011

Current assets $246,000

Plant and equipment (net) 784,000
Land ($160,000 + $115,000 excess cost) 275,000
Total $1,305,000

Current liabilities $ 148,000

Long-term notes payable 36,000
Common stock 480,000
Noncontrolling interest 95,000
Other contributed capital 244,000
Retained earnings 302,000
Total $1,305,000

3-3 Accounts Payable (to P) 10,000

Accounts Receivable (from S) 10,000

Common Stock - S 600,000

Other Contributed Capital - S 80,000
Retained Earnings - S 320,000
 Chapter 3 Consolidated Financial Statements—Date of Acquisition 3-13

Difference Between Implied and Book Value 50,000

Investment in S Company 950,000
Noncontrolling Interest 100,000

Land 50,000
Difference Between Implied and Book Value 50,000

3-4
A. Investment in Smiley Company 480,000
Cash 480,000

B. POTTER COMPANY AND SUBSIDIARY

Consolidated Balance Sheet
January 2, 2011

Assets
Cash (650,000 + 160,000 - $480,000) $330,000
Accounts Receivable 420,000
Inventory 430,000
Plant and Equipment (net) 1,210,000
Land ($150,000 + $80,000 + $73,333*) 303,333
Total Assets $2,693,333

Liabilities and Stockholders’ Equity

Accounts Payable $380,000
Mortgage Payable 280,000
Total liabilities $660,000

Noncontrolling Interest
($170,000 + $50,000 + $240,000 + 73,333) × .10 $ 53,333

Common Stock $1,000,000

Other Contributed Capital 520,000
Retained Earnings 460,000
Total Stockholders’ Equity 1,980,000
Total Liabilities and Stockholders’ Equity $2,693,333

* $480,000/.9 - ($170,000 + $50,000 + $240,000)

3-14 Test Bank to accompany Jeter and Chaney Advanced Accounting

3.5

Eliminations
P S Debit Credit Noncontrolling Consolidated
Interest Balances
ASSETS
Cash $40,000 $30,000 $70,000
Accounts
receivable-net 30,000 45,000 75,000
Inventories 185,000 165,000 (b) 60,000 410,000
Land 45,000 120,000 (b) 25,000 190,000
Plant assets-
net 480,000 240,000 720,000
Investment in
S Corp. 420,000 (a) 420,000
Difference
between
implied and
book value (a) 150,000 (b) 150,000
Goodwill (b) 65,000 65,000
Total Assets $1,200,000 $600,000 $1,530,000
EQUITIES
Current
liabilities $170,000 $150,000 $320,000
Capital stock 600,000 300,000 (a) 300,000 600,000
Additional
paid-in capital 150,000 90,000 (a) 90,000 150,000
Retained
earnings 280,000 60,000 (a) 60,000 280,000
Noncontrolling
interest (a) 180,000 180,000 180,000
Total Equities $1,200,000 $600,000 $750,000 $750,000 $1,530,000

3-6 A. Common Stock – Sewell 450,000

Other Contributed Capital – Sewell 180,000
Difference between Implied and Book Values 45,000
Retained Earnings – Sewell 75,000
Investment in Sewell 675,000
Noncontrolling Interest in Equity 75,000

B. Common Stock – Sewell 620,000

Other Contributed Capital – Sewell 140,000
Retained Earnings – Sewell 20,000
Investment in Sewell 318,000
Gain on Purchase of Business - Porter 306,000
Noncontrolling Interest in Equity 156,000
 Chapter 3 Consolidated Financial Statements—Date of Acquisition 3-15

3-7 A. 265,000/(1,060,000 +265,000) = 20% Noncontrolling interest

B. Common Stock – Shelby 520,000

Other Contributed Capital – Shelby 380,000
Retained Earnings – Shelby 280,000
Difference between Implied and Book Values 145,000
Investment in Shelby Company 1,060,000
Noncontrolling Interest in Equity 265,000

3-8
A. Investment in Swartz Company ($50  1,500) 75,000
Common Stock ($20  1,500) 30,000
Other Contributed Capital ($30  1,500) 45,000

Other Contributed Capital 1,700

Cash 1,700

B. Computation and Allocation of Difference

Non-
Parent Controlling Entire
Share Share Value
Purchase price and implied value $75,000 0 75,000
Less: Book value of equity acquired 83,000* 0 83,000
Difference between implied and book value 7,000 0 7,000
Land (7,000) (0) (7,000)
Balance -0- -0- -0-
* $40,000 + $24,000 + $19,000 = $83,000

C.
Cash balance: 73,000 + 13,000 –1,700 = $84,300
Land balance: 26,000 + 20,000 + 7,000= $ 53,000
Common Stock balance: 100,000 + 30,000 = $130,000
Other Contributed Capital: 60,000 + 45,000 – 1,700 = $ 103,300

Short Answer

1. Reasons why a company would acquire a subsidiary rather than its net assets include the following:
a. Stock acquisition is relatively simple and avoids the often lengthy and difficult negotiations that
are required in a complete takeover.
b. Control of the subsidiary's operations can be accomplished with a much smaller investment.
c. The separate legal existence of the individual affiliates provides an element of protection of the
parent's assets from attachment by subsidiary creditors.
3-16 Test Bank to accompany Jeter and Chaney Advanced Accounting

2. Preparation of the Computation and Allocation of Difference Schedule involves the following
process:
a. Determine the percentage of stock acquired in the subsidiary.
b. Compute the implied value of the subsidiary by dividing the purchase price by the percentage
acquired.
c. Allocate any difference between the implied value and the book value of the subsidiary's equity
to adjust the underlying assets and/or liabilities of the acquired company.

Short Answer Questions from the Textbook Solutions

1. (1) Stock acquisition is greatly simplified by avoiding the lengthy negotiations required in an
exchange of stock for stock in a complete takeover.
(2) Effective control can be accomplished with more than 50% but less than all of the voting
stock of a subsidiary; thus the necessary investment is smaller.
(3) An individual affiliate’s legal existence provides a measure of protection of the parent’s
assets from attachment by creditors of the subsidiary.

2. The purpose of consolidated financial statements is to present, primarily for the benefit of the
shareholders and creditors of the parent company, the results of operations and the financial
position of a parent company and its subsidiaries essentially as if the group were a single
company with one or more branches or divisions. The presumption is that these consolidated
statements are more meaningful than separate statements and necessary for fair presentation.
Emphasis then is on substance rather than legal form, and the legal aspects of the separate
entities are therefore ignored in light of economic aspects.

3. Each legal entity must prepare financial statements for use by those who look to the legal entity
for analysis. Creditors of the subsidiary will use the separate statements in assessing the degree
of protection related to their claims. Noncontrolling shareholders, too, use these individual
statements in determining risk and the amounts available for dividends. Regulatory agencies are
concerned with the net resources and results of operations of the individual legal entities.

4. (1) Control should exist in fact, through ownership of more than 50% of the voting stock of the
subsidiary.
(2) The intent of control should be permanent. If there are current plans to dispose of a
subsidiary, then the entity should not be consolidated.
(3) Majority owners must have control. Such would not be the case if the subsidiary were in
bankruptcy or legal reorganization, or if the subsidiary were in a foreign country where
political forces were such that control by majority owners was significantly curtailed.

5. Consolidated workpapers are used as a tool to facilitate the preparation of consolidated

financial statements. Adjusting and eliminating entries are entered on the workpaper so that the
resulting consolidated data reflect the operations and financial position of two or more
companies under common control.
 Chapter 3 Consolidated Financial Statements—Date of Acquisition 3-17

6. Noncontrolling interest represents the equity in a partially owned subsidiary by those

shareholders who are not members in the affiliation and should be accounted and presented in
equity, separately from the parents’ shareholders equity. Alternative views have included:
presenting the noncontrolling interest as a liability from the perspective of the controlling
shareholders; presenting the noncontrolling interest between liabilities and shareholders’ equity
to acknowledge its hybrid status; presenting it as a contra-asset so that total assets reflect only
the parent’s share; and presenting it as a component of owners’ equity (the choice approved by
FASB in its most recent exposure drafts).

7. The fair, or current, value of one or more specific subsidiary assets may exceed its recorded
value, or specific liabilities may be overvalued. In either case, an acquiring company might be
willing to pay more than book value. Also, goodwill might exist in the form of above normal
earnings. Finally, the parent may be willing to pay a premium for the right to acquire control
and the related economic advantages gained.

8. The determination of the percentage interest acquired, as well as the total equity acquired, is
based on shares outstanding; thus, treasury shares must be excluded. The treasury stock account
should be eliminated by offsetting it against subsidiary stockholder equity accounts. The
accounts affected as well as the amounts involved will depend upon whether the cost or par
method is used to account for the treasury stock.

9. None. The full amount of all intercompany receivables and payables is eliminated without
regard to the percentage of control held by the parent.

10 A. The decision in SFAS No. 109 and SFAS No. 141R [topics 740 and 805] is primarily a
display issue and would only affect the calculation of consolidated net income if there were
changes in expected future tax rates that resulted in an adjustment to the balance of deferred tax
assets or deferred tax liabilities. Prior to SFAS No. 109 and SFAS No. 141R, purchased assets
and liabilities were displayed at their net of tax amounts and related figures for amortization
and depreciation were based on the net of tax amounts. With the adoption of SFAS No. 109
and SFAS No. 141R, assets and liabilities are displayed at fair values and the tax consequences
for differences between their assigned values and their tax bases are displayed separately as
deferred tax assets or deferred tax liabilities. Although the amounts shown for depreciation,
amortization and income tax expense are different under SFAS No. 109 and SFAS No. 141R,
absent a change in expected future tax rates, the amount of consolidated net income will be the
same.

ANSWERS TO BUSINESS ETHICS CASE

Part 1
Even though the suggested changes by the CFO lie within GAAP, the proposed changes will
unfairly increase the EPS of the company, misleading the common investors and other users. It
is evident that the CFO is doing it for his or her personal gain rather than for the transparency
of financial reporting. Thus, manipulating the reserve in this case comes under the heading of
3-18 Test Bank to accompany Jeter and Chaney Advanced Accounting

unethical behavior. Taking a stand in such a situation is a difficult and challenging test for an
employee who reports to the CFO.

Part 2
The tax laws permit individuals to minimize taxes by means that are within the law like using
tax deductions, changing one's tax status through incorporation, or setting up a charitable trust
or foundation. In the given case the losses reported were phony and the whole scheme was
fabricated to illegally benefit certain individuals; hence there appears to be a criminal intent in
the scheme. Although there is no reason to pay more tax than necessary, the lack of risk in these
types of shelters makes participation in such schemes of questionable ethics, at the best.