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Chapter 10

Other ConsolidationReporting Issues

Copyright 2005 McGraw-Hill Ryerson Limited. All rights reserved.

Solutions Manual, Chapter 10 416


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DESCRIPTION OF CASES AND PROBLEMS

Case 1

In this case, the student must determine how to report two investments. One investment is

subject to joint control and should be accounted for as a joint venture. The other investment

is subject to control through means other than voting shares and should be accounted for as a

variable interest entity.

Case 2

In this case, the company plans to set up a variable interest entity (VIE) to renovate its

manufacturing plant and record a gain on the transfer to the VIE. The student is asked to

discuss the accounting issues for the proposed transactions.

Case 3 (prepared by Peter Secord, Saint Marys University)

This Case is a real life situation featuring the Coca-Cola Company and its less than 50%

ownership interests in its bottlers. Under U.S. GAAP, these are significant influence

investments. The student is asked to evaluate the accounting policies followed in light of

proposed changes that are being suggested, and to visit the companys Web site to obtain

current information on how these investments are being reported.

Problem 1 (25 min.)

This problem involves the preparation of a consolidated balance sheet at the date of acquisition

for a VIE under 3 different values attributed to the noncontrolling interest.

Problem 2 (15 min.)

A short case-like problem that requires determining whether pooling of interests can be used

after the formation of a joint venture.

Problem 3 (30 min.)

This problem involves the preparation of the consolidated financial statements of a venturer and

a joint venture and also involves unrealized inventory profits.




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Problem 4 (20 min.)

This problem requires the calculation of balance sheet amounts to be used to consolidate

a 100% owned subsidiary where the purchase has just occurred and there are future tax

complications.

Problem 5 (15 min.)

This problem asks students to discuss the shortcomings of consolidated statements and review

how segment disclosures overcome some of these concerns.

Problem 6 (35 min.)

This problem requires the calculation of the purchase price discrepancy (PPD) and subsequent

amortization for an 80% owned subsidiary when there is an unrecognized loss carryforward and

future income taxes on temporary differences. It also requires a calculation of noncontrolling

interest along with an explanation as to why the PPD gives rise to a future income tax liability.

Problem 7 (30 min.)

The student is asked to prepare a consolidated balance sheet immediately after acquisition for a

parent and its 100% owned subsidiary where there are future tax complications.

Problem 8 (45 min.)

This problem is the same as Problem 7, except the subsidiary is 80% owned. A consolidatedbalance sheet is required immediately after acquisition, and there are future tax complications.

The problem also requires an explanation as to how the definition of a liability supports the

recognition of a future tax liability.

Problem 9 (60 min.)

This is a complex problem involving the preparation of a consolidated balance sheet for a

primary beneficiary and a VIE five years after the date of acquisition. It involves negative

goodwill and amortization of the purchase price discrepancy. It also requires an explanationof how the definition of a liability supports the inclusion of the VIEs liability on the consolidated

balance sheet.

Problem 10 (20 min.)

The student is asked to identify which segments should be reported from a list. The revenue

test, operating profit test, and asset test must be performed.


418 Modern Advanced Accounting in Canada, Fourth Edition


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A consolidated balance sheet is required for an investor and its two investees, one of which is

a subsidiary, the other a joint venture. Preferred shares and unrealized profits in inventory are

also involved.


This problem requires the preparation of a company's income statement under the assumption

that its 40% investment in another company is either (a) a joint venture or (b) an equity

ownership that is not a control or portfolio investment.


This problem involves the preparation of the consolidated financial statements of a venturer and

a joint venture where intercompany sales have occurred during the year. It also requires an

explanation of how the gain recognition principle supports the elimination of only a portion of the

gain on intercompany transactions.


A year's equity method journal entries involving unrealized profits in opening and closing

inventory and equipment profits are required under the assumption that the investee is (a) a

subsidiary, and (b) a joint venture.


This problem involves the investment of nonmonetary assets in the formation of a joint venture.

The investor receives an equity interest plus cash.


The student is asked to discuss some aspects of the new Handbook Section 1701, and to

outline the quantitative guidelines used to establish reportable segments.


This problem requires the preparation of journal entries under the equity method for a venturer

who has contributed assets at a gain for an interest in a joint venture. As well, the student

must describe how the accounts will be shown on the consolidated statements. Finally equity




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method entries are required for the case where the venturer receives cash back from the assets

contributed for an interest in a joint venture.


This problem requires the preparation of a balance sheet for a company with a 40% interest

in another company under three assumptions: (a) control exists, (b) the investment is a joint

venture, and (c) it is a significantly influenced investment. The date is five years after acquisition

and there are intercompany profits and balances.

REVIEW QUESTIONS

1. Both the subsidiary and the variable interest entity (VIE) are controlled. The subsidiary is

controlled by the parent whereas the VIE is controlled by the primary beneficiary. The

parent typically controls the subsidiary by owning the majority of the voting shares of the

subsidiary. The primary beneficiary controls the VIE through governing agreements and

may even have this control without owning any of the voting shares of the VIE.

2. Both the majority shareholder and the primary beneficiary have control of their respective

investees. The majority shareholder controls the subsidiary wheras the primary

beneficiary controls the variable interest entity. The majority shareholder typically controls

the subsidiary by owning the majority of the voting shares of the subsidiary. The primary

beneficiary controls the VIE through governing agreements and may even have this

control without owning any of the voting shares of the VIE.

3. Assets and liabilities should be presented on a balance sheet if they meet the definition of

assets and liabilities. Assets are economic resources controlled by an entity as a result

of past transactions or events and from which future economic benefits may be obtained.

When the primary beneficiary controls the variable interest entity, it indirectly controls

the economic resources of the VIE and receives the future economic benefits. Liabilities

are obligations of an entity arising from past transactions or events, the settlement of

which may result in the transfer or use of assets, provision of services or other yielding

of economic benefits in the future. When the primary beneficiary controls the variable

interest entity, it indirectly takes responsibility for and assumes the risk related to the

obligations of the VIE.




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4. The full consolidation method combines 100% of the financial statement elements of

the parent and its subsidiaries and shows an amount for the noncontrolling interest

in the assets and liabilities and the revenue and expenses of these subsidiaries. The

proportionate consolidation method does not report an amount for noncontrolling interest.

Instead, it requires the combination of elements from the parent's financial statements with

the parent's proportionate share of the elements of the subsidiaries' financial statements.

5. Normally, a 62% interest in the voting shares of a company would be sufficient for control

to exist, and therefore Z would be a subsidiary. But if there were an agreement between Y

Company and the entities that hold the other 38% establishing joint control over Z

Company, then Z would not be a subsidiary; rather, it would be a joint venture.

6. In a parentsubsidiary affiliation, 100% of intercompany inventory profits are eliminated.

If the parent was the selling company, the elimination is entirely allocated to consolidated

retained earnings. If the subsidiary was the selling company, the elimination is allocated

to noncontrolling interest and consolidated retained earnings. In a venturerjoint venture

affiliation, only the venturer's share of the intercompany profit is eliminated, regardless

of which party was the selling company. If the joint venture was the selling company,

there is no noncontrolling interest to make an allocation to. If the venturer was the selling

company, the venturer realizes a portion of the profit equal to the interest of the other

venturers, provided that they are not related to the venturer.

7. The investment is recorded at the fair value of the nonmonetary assets transferred. The

gain is split between the amount represented by the interests of the other nonrelated

venturers (which is recognized in a systematic manner over the life of the assets), and the

amount represented by the venturer's own interest (which is deducted from the venturer's

share of the related asset when the consolidated statements are prepared).

8. The gain recognition principle states that gains should be recorded when they are realizedi.e. when a transaction has occurred with an outside entity and consideration is received.

For transactions between a venturer and the joint venture, the portion of the gain equal

to the outside interest in the joint venture is considered to be realized because the other

parties in the joint venture are not related to the venturer and are considered to be

outsiders.




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9. The fact that the fair values of Y's assets exceeded their tax bases on the date that X

Company acquired control over Y will have the following impact on the consolidated

balance sheet:

a. A future tax liability for the consolidated balance sheet will be determined for

the difference between the fair value excess plus Ys book values and the tax

bases of Y's net assets, and the purchase discrepancy will be allocated to this

amount before calculating goodwill.

b. As a result of (a), goodwill will be different than it would have been if Y's assets

had fair values equal to tax bases.

c. The future tax liability determined in (a) will be disclosed on the consolidated

balance sheet and will be reassessed each year.

d. Finally, as a result of (a), the noncontrolling interest on the consolidated balance

sheet will be different than it would have been if Y's assets had fair values equal

to their tax bases.

10. The parent company may be able to recognize its own unused income tax losses and

those of the acquired company at the date of acquisition if it can now meet the "more likely

than not" test for these losses. This test may now be met because of synergies created

by the combining of the two companies. If this is so, this will result in future tax assets

appearing on the consolidated statements that were not on the separate entity statements.

11. Temporary differences exist when the carrying value of an asset or liability is different

from its tax basis. A deductible temporary difference is one that can be deducted in

determining taxable income in the future when an asset or liability is recovered or settled

for its carrying amount. Deductible temporary differences exist when the carrying amount

of an asset is less than its tax basis, or when an amount related to a liability can be

deducted for tax purposes. Deductible temporary differences represent a future tax asset

to the company. A taxable temporary difference will result in a taxable amount in the futurewhen the carrying amount of an asset or liability is recovered or settled and represents a

future tax liability to the company. A taxable temporary difference arises mainly when the

carrying amount of an asset is greater than its tax basis.




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12. A future tax asset would exist on a subsidiary's balance sheet if the subsidiary carried an

asset on its books at less than its tax basis. If this same asset had a fair value that was

greater than the tax basis, a future tax liability would be reported on the consolidated

balance sheet. The reason for the change is that the carrying value of the asset on the

consolidated balance sheet has changed as a result of the acquisition transaction.

13. Since tax returns are filed for separate legal entities and not the consolidated entity, the fair

value excess in a business combination is not considered to be a deductible cost for tax

purposes. If the asset acquired in a business combination were subsequently sold at its

fair value, a gain would be reported for tax purposes even though no gain may be realized

from a consolidated point of view. This future tax obligation is reported as a future tax

liability on the consolidated financial statements at the date of acquisition.

14. A company should report information about an operating segment that meets any ONE of

the following:

a. The operating segment's reported revenue (intersegment sales plus transfers,

plus external sales) is 10% or more of the combined internal and external

revenue of the company.

b. The absolute amount of the segment's reported profit or loss is 10% or more of

the greater of:

i. the combined reported profit of all operating segments that did not reporta loss

ii.the combined reported loss of all operating segments that did report a

loss.

c. The segment's assets are 10% or more of the combined assets of the company.

15. The following information must be disclosed for each operating segment:

factors used to identify the reportable segments

types of products and services offered by reportable segments profit or loss

total assets

In addition, the following should also be disclosed if they are included in the measure of

profit or loss reviewed by the chief operating decision maker:

external and intersegment revenue




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interest revenue and expense (separately)

amortization and other significant noncash items

unusual items

equity in income of investees

income tax expense or benefit

extraordinary items

amount of investment in investees subject to significant influence

total expenditures for additions to capital assets and goodwill

16. In addition to segmented information based on operating segments, the financial

statements must also disclose segmented information on an enterprise-wide basis. In

other words, the financial statements must provide segmented information regardless

of whether there are operating segments to report. Unless it is impractical to do so, the

financial statements should disclose the following:

Information about external revenues, capital assets, and goodwill on the basis of

geographic areas.

Information about external revenues on a product-by-product basis, or by each

group of similar products.

If the company's revenue to a single external customer is 10% or more of total

revenue, the company must disclose this fact, the total amount of the revenue to

that customer, and the identity of the operating segment(s) reporting the revenue.

17. The following reconciliations are required for segment reporting:

The total of the reportable segments revenues reconciled to the enterprises total

revenues.

The total of the reportable segments measures of profit or loss to the

enterprises income before tax, discontinued operations, and extraordinary items,

or to income after these items if these items are allocated to the reportable

segments. The total of the reportable segments assets to the enterprises total assets.

The total of the reportable segments amounts for other significant amounts to

the total for the enterprise. Each significant item should be separately identified.




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MULTIPLE CHOICE

1. a

2. a

3. c

4. c 600 + .4(217) (80 x .5 x .7 x .4) = 675.6

5. a 1,560 + .4(580) (80 x .5 x .4) = 1,776

6. a

7. c 315.9 + 35 = 350.9 x .1 = 35.09, therefore E.

8. b 2,718 x .1 = 271.8, therefore B, D, and E; 2,415 x .1 = 241.5, therefore C, D, E.

9. a

10. c

11. a

12. c [(500,000 70,000) (500,000 75,000)] x 30% = 1,500

13. b

14. b 240,000 + .2(110,000 7,500) = 260,500

15. c 495,000 + .2(95,000 10,000) = 512,000

16. b 420,000 [400,000 .3(400,000 270,000)] = 59,000

17. d 98,000 + (600,000 375,000).4 = 188,000




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CASES

Case 1

Holdcos 30% interest in Elgin Company should be reported using proportionate consolidation

because Elgin Company is a joint venture. Although Mr. Richer owns 70% of the common

shares of Elgin, he does not control Elgin. The shareholders agreement indicates that the two

shareholders must agree on all major operating, investing and financing decisions. Therefore,

the two shareholders jointly control Elgin and Elgin should be accounted for as a joint venture.

Metcalfe Inc. should be consolidated with Holdco because Metcalfe is a variable interest entity

and Holdco is the primary beneficiary. Although Holdco only owns 40% of Metcalfe, it controlsMetcalfe because Mr. Landman, the sole owner of Holdco, has veto power on all key operating,

investing and financing decisions. Furthermore, Holdco has the obligation to absorb Metcalfes

expected losses and the right to receive Metcalfes expected residual returns if they occur.

Case 2

Memorandum

To: CFO

From: Consultant

Re: Accounting for Renovation of Manufacturing Facility

You have asked me to comment on the proposed accounting for the sale of the unrenovated

facility and subsequent repurchase of the renovated facility. My comments are presented below

along with supporting arguments.

First of all, I understand your frustration with historical cost accounting. It prevents you from

reporting the fair value of the manufacturing plant and makes your debt to equity ratio appear to

be very high at 4:1. If the fair value of the unrenovated plant is $600,000 and if you were able to

report the plant at fair value, the debt to equity ratio would be 1.14:1 prior to the renovation and

1.67:1 after the renovation.




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Under current accounting rules, a manufacturing plant must be reported at historical cost less

accumulated amortization. Any appreciation in the value of the plant can only be reported in

income if the plant is sold to an outside entity. At first glance, it may appear that SPE is an

outside entity because Mr. Renovator who is not related to P Co. is the sole owner of SPE.

According to the new Handbook section on Variable Interest Entities, SPE is a variable interest

entity for the following reasons:

SPE is indirectly controlled by P Co because P Co. must approve all activities carried out

by SPE

P Co is paying $400,000 for the renovation of the plant. This price is expected to cover

SPEs cost and provide a reasonable return to SPE. P Co. is, in effect, guaranteeing a

return to SPE. Mr. Renovator has little or no risk of incurring any losses in this venture.

P Co retains the right to receive the expected residual returns on the use and/or sale of

the manufacturing plant.

Since SPE is a variable interest entity, it must be consolidated with P Co. for reporting

purposes. The $500,000 gain on the sale of the plant and the intercompany note receivable

and payable are considered to be intercompany transactions that must be eliminated on

consolidation. On December 31, Year 5, the consolidated balance sheet would appear as

follows (in 000s):

Manufacturing plant (960 500 or 100 + 360) $460

Other assets 900

$1,360

Other liabilities $800

Noncontrolling interest 360

Common shares 10

Retained earnings 190$1,360

If the noncontrolling interest were viewed as a part of P Co.s liabilities, the debt to equity ratio

would be 5.8:1 ([800 + 360] / [10+ 190]) on the consolidated financial statements on December

31, Year 5. Therefore, your proposed transaction would not circumvent the rules for historical

cost accounting and P Co.s debt to equity ratio would be even higher than it was before.




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If P Co. was to report its results on a nonconsolidated basis, the CICA Handbook rules on

related party transactions would have to be applied. Since SPE is a variable interest entity,

it is considered to be a related party. Under the rules for related party transactions in section

3840.26 of the Handbook, the proposed sale and repurchase would have to be measured at

carrying value for the following reasons:

The sale and repurchase of the manufacturing plant is not in the normal course of

operations

Since P Co. indirectly controls SPE and enjoys 100% of the benefits of the plant, the

change in the ownership interests in the plant is not substantive

The sale price of $600,000 is not supported by independent evidence

Therefore, the renovated manufacturing plant would be reported at its total cost of $500,000

($100,000 + $400,000). On January 1, Year 6, after P Co. repurchases the renovated plant

from SPE for $400,000 and SPE is wound up, the balance sheet for P Co. would appear as

follows (in 000s):

Manufacturing plant (100 + 400) $500

Other assets 900

$1,400

Bank loan payable $400

Other liabilities 800

Common shares 10

Retained earnings 190

$1,400

The debt to equity ratio would be 6:1 ([400+800] / [10+190]). Therefore, your proposedtransaction would not circumvent the rules for historical cost accounting and P Co.s debt to

equity ratio would be even higher than it was before.




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Case 3

A Case of Coca-Cola Teaching Note

It is suggested that the instructor review the recent annual reports of The Coca-Cola Company

and CocaCola Enterprises Inc. before assigning this case, and strongly encourage students

to do the same. These are dynamic companies in competitive markets, and financial reporting

rules and practices, as well as the underlying economic realities of the companies, are evolving.

The purpose of this case is to push students to examine financial reporting practices for

intercorporate investments critically, and, in particular, to consider the implications of de facto

control relative to de jure, as well as international differences in GAAP. This note considers only

a few of the potential issues that could be raised during class.

The relationship of The Coca-Cola Company ( with the anchor bottlers is extremely complex.

Many of these companies were initially founded by The Coca-Cola Company as bottlers of

their product, and have systematically been spun off. Others were founded on the initiative

of Coke, and /or received significant financial assistance from Coke during the early stages of

operations.

If these various companies were accounted for as subsidiaries of The Coca-Cola Company,

consolidated sales would increase by at least US$25 billion. Many of these companies do little

other than bottle and distribute products of the Coca-Cola Company; most are clearly subject

to at leastsignificant influence. Several were reported as subsidiaries in earlier annual reports.

Chief among these associated companies is CocaCola Enterprises.

CocaCola Enterprises Inc. (CCE, ) is the world's largest bottler and distributor of CocaCola

products, and accounts for almost 70% of all North American sales of bottled and canned

beverages sold by 44% owner The CocaCola Company. Coca

Cola products (such as

CocaCola classic, Diet Coke, Barq's, and Sprite) account for nearly 90% of its sales. CCE also

bottles and distributes other beverage brands, including Dr. Pepper, Canada Dry, and Nestea.

The CocaCola Company and other beverage companies supply concentrates and syrups for

Peter Secord, Saint Marys University.




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the drinks and share in advertising and promotional expenses. CCE bottles and distributes

CocaCola products through operations in Canada, Europe, and the U.S.A. (Hoovers Capsule

(see ), CocaCola Enterprises).

Coke uses the equity method to account for CCE and most of the other anchor bottlers. Coke

freely acknowledges that these investments are subject to significant influence. An important

question is raised: Are these investments (such as CCE) actually controlled? Are there other

accounting practices in use by Coke that do not provide the most meaningful presentation?

As noted in the case, U.S. GAAP (SFAS 94) does require consolidation of all majorityowned

subsidiaries unless control is temporary or does not rest with the majority owner. There are no

other exceptions to consolidation permitted. However, the concept of control is limited to that

of de jure control: only majorityowned subsidiaries are consolidated. Other situations, where

there could be control in substance, are not contemplated.

Canadian GAAP (as well as IAS 27), by contrast, uses what is best described as a de facto

standard of control. Arguments and definitions included in CICA Handbooks Section 1590

clearly are based on the underlying economic substance, not the legal form. For example,

control has a definite meaning, and leads to consolidation:

(a) A subsidiary is an enterprise controlled by another enterprise (the parent) that has the

right and ability to obtain future economic benefits from the resources of the enterprise

and is exposed to the related risks.

(b) Control of an enterprise is the continuing power to determine its strategic operating,

investing, and financing policies without the cooperation of others (1590.03).

Further sections expand on this argument, and make it clear that a narrow definition based on

majority ownership is not contemplated. The statement that the right and ability of the parentto obtain future economic benefits from the resources of an enterprise that it controls and the

parent's exposure to the related risks are necessary characteristics of a parentsubsidiary

relationship (1590.04) is key. If we were to evaluate the economic reality of the relationship

between Coke and CCE, would we find that control was in factpresent? Are Coke and CCE in

fact one economic entity? Under Canadian rules, would we consolidate the investment in CCE?

Would consolidation provide the most meaningful presentation of this relationship?




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Evidence, which suggests that there is control in fact, is bountiful: note the various factors,

which distinguish an anchor bottler:

A pursuit of the same strategic aims as The CocaCola Company in the development of

the non-alcoholic beverage business.

A commitment to longterm growth.

Commitment to the CocaCola System.

Service to a large, geographically diverse area.

Sufficient financial resources to make longterm investments.

Managerial expertise and depth.

Note also that:The Company provides certain administrative and other services to CocaCola

Enterprises under negotiated fee arrangements, as well as providing direct support for

certain marketing activities of CocaCola Enterprises and participating in cooperative

advertising and other marketing programs (amounting to $604 million in 1997). In

addition, during 1997 and 1996, the Company committed approximately $190 million to

CocaCola Enterprises under a Company program that encourages bottlers to invest in

building and supporting beverage infrastructure [from the case].

These are clearly material amounts. Coke is involved in both the operating activities and the

capital expenditure program. As the only significant shareholder, does Coca-Cola have the

continuing power to determine the strategic operating, investing, and financing policies of

Coca-Cola Enterprises without the cooperation of others? Technically, perhaps not, as there

are 56% of the shares owned by other investors (this proportion has been increasing as CCE

has issued new shares). Yet there are no other significant individual shareholders among this

group, so is there truly a control risk to Coke? Who really sits on the board of CCE? Would an

important decision ever be reached that was opposed by Coke?

Look beyond the accounting policy choices made. Consider the underlying facts. The U.S.

position on legal control has been under review for some time, and presently is a minority

view internationally, with most major countries having adopted the potentially more meaningful

de factocontrol approach. However, as at December 31, 2001, FASB had not changed its




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requirement that a majority of shares must be owned in order for consolidation to take place.




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There are other issues of interest in this case. For example, under the heading Issuances of

Stock by Equity Investees, the 1997 Annual Report of The Coca-Cola Company notes that:

When one of our equity investees issues additional shares to third parties, our

percentage ownership interest in the investee decreases. In the event the issuance price

per share is more or less than our average carrying amount per share, we recognize a

noncash gain or loss on the issuance. This noncash gain or loss, net of any deferred

taxes, is recognized in our net income in the period the change of ownership interest

occurs.

This is one of the factors that has led to the carrying value of the investment in CCE being so

low relative to its market value (the multiple is about 30). Is this carrying value meaningful?

Is the note disclosure (which is provided) a substitute for a more meaningful value actually

reported on the balance sheet?

Additional issues included transactions with CocaCola Enterprises and with other associated

companies:

In February 1997, we sold our 49 percent interest in CocaCola & Schweppes

Beverages Ltd. to CocaCola Enterprises. This transaction resulted in proceeds for our

Company of approximately $1 billion and an aftertax gain of approximately $.08 per

share (basic and diluted). In August 1997, we sold our 48 percent interest in CocaCola

Beverages Ltd. of Canada and our 49 percent ownership interest in The CocaCola

Bottling Company of New York, Inc. to CocaCola Enterprises in exchange for aggregate

consideration valued at approximately $456 million. This sale resulted in an aftertax

gain of approximately $.04 per share (basic and diluted). (1997 Annual Report, The

Coca Cola Company)

In July 1996, we sold our interests in our French and Belgian bottling and canning

operations to CocaCola Enterprises in return for cash consideration of approximately

$936 million. Also in 1996, we contributed cash and our Venezuelan bottling interests

to a new joint venture, Embotelladora CocaCola y Hit de Venezuela, S.A. (CocaCola




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y Hit), in exchange for a 50 percent ownership interest. In 1997, we sold our interest in

CocaCola y Hit to Panamerican Beverages, Inc. (Panamco) in exchange for shares in

Panamco. (1997 Annual Report, the Coca Cola Company).

Among the questions, which these raise: If Coke and CCE are in fact parent and subsidiary,

are these gains reportable? Should gains of this nature and magnitude be recognized in what is

essentially a nonarms length transaction?




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PROBLEMS

Problem 1

A B CImplied Value (i.e., acquisition cost) of Pharmas net assets

Fair value of amount invested by Benefit 0 0 0

Fair value of NCI (= value of common shares) 25 15 30

Total implied value 25 15 30

Assessed Value of Pharmas assets

Carrying value of amount invested by Benefit 0 0 0

Fair value of Pharmas own assets 210 210 210

Less: Fair value of liabilities of Pharma (185) (185) (185)

Total assessed value 25 25 25

Difference between implied and assessed values 0 (10) 5

Assigned on consolidation to:

Loss on investment 5

Intangible assets . (10) .

Balance to assign 0 0 0

The consolidated balance sheets would appear as follows:

Current assets $300 $300 $300

Property, plant & equipment 490 490 490

Intangible assets 120 110 120

$910 $900 $910

Current liabilities $205 $205 $205

Long-term debt 450 450 450

Noncontrolling interest 25 15 30

Common shares 10 10 10

Retained earnings (220 5) 215

Retained earnings 220 220

$910 $900 $910




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Problem 2

The pooling of interests method used to be one possible method of accounting for a business

combination, but since June 30, 2001, its use is no longer permitted.

A business combination occurs when one company gains control over the net assets of another

company. In this particular case, Bayle Resources Inc. has just been formed by Exacto Ltd.

(and others) and as such this transaction is not a business combination. In order for a business

combination to exist, Exacto would have to gain control over a previously existing company, not

one that it has formed.

Furthermore, Bayle Resources is a joint venture because the three venturers have signed an

agreement establishing joint control and no one venturer can unilaterally control the venture.

An acquisition of an investment in a joint venture cannot be a business combination because it

does not provide for the control that is required.

Exacto will have to report its investment by consolidating Bayle Resources, using the

proportionate consolidation method according to the CICA Handbook.




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Problem 3

Intercompany eliminations

Sales and purchases (70,000 30%) 21,000

Receivables and payables (12,000 30%) 3,600

Inventory profits Before Tax After

tax 40% tax

Closing inventory 10,000

Considered realized 70%

Unrealized Able selling 30% 3,000 1,200 1,800

Able Ltd.

Consolidated Income Statement

for the Year Ended December 31, Year 6

Revenues (900,000 + [30% 100,000] 21,000) 909,000

Cost of sales and expenses

(812,000 + [30% 70,000] 21,000 + 3,000 1,200) 813,800

Net income 95,200




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Able Ltd.

Consolidated Retained Earnings Statement


Balance Jan. 1 (110,000 97,000) 13,000

Net income 95,200

Balance Dec. 31 (110,000 1,800) 108,200

Able Ltd.

Consolidated Balance Sheet

as at December 31, Year 6

Current assets (247,000 + [30% 40,000] 3,600 3,000) 252,400

Other assets (530,000 + [30% 70,000]) 551,000

Deferred charge - income taxes 1,200

804,600

Current liabilities (94,000 + [30% 20,000] 3,600) 96,400

Long-term debt 400,000

Capital stock 200,000Retained earnings (110,000 1,800) 108,200

804,600




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Problem 4

Future tax assets and liabilities

Fair value Tax basis Difference

Instalment accounts receivable 120,000)

)

120,000

Inventory 150,000) 150,000) 0

Land 100,000) 100,000) 0

Buildings 180,000) 110,000) 70,000

Equipment 200,000) 130,000) 70,000

Trade liabilities (240,000) (240,000) 0

510,000) 250,000) 260,000

Subsidiary's tax rate 45.00%

Future tax liability 117,000

Cost of 100% of Knightbridge 700,000

Fair value of Knightbridge:


Inventory 150,000)

Land 100,000)

Buildings 180,000)

Equipment 200,000)

Trade liabilities (240,000)

510,000)

Leighton's percentage ownership 100.00% 510,000

Purchase discrepancy 190,000

Allocated to future tax liability 117,000

Goodwill 307,000




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The following amounts would be used to prepare Leighton's consolidated balance sheet:


Inventory 150,000)

Land 100,000)

Buildings 180,000)

Equipment 200,000)

Goodwill 307,000)

Trade liabilities (240,000)

Future tax liabilities (117,000)

700,000)

Investment account 700,000)

This could be arranged as an investment elimination entry, as follows:

Instalment accounts receivable 120,000

Inventory 150,000

Land 100,000Buildings 180,000

Equipment 200,000

Goodwill 307,000

Trade liabilities 240,000

Future tax liabilities 117,000

Investment in Knightbridge 700,000




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Problem 5

When several companies' financial statements are consolidated, much of the detail about

any one specific company is lost. As a result, it is difficult to determine if any one company

or operation within the group is performing well, or is being carried by the others due to poor

returns. As well, it is impossible to know what types of businesses have been aggregated

into the one set of consolidated statements, or in which countries those businesses operate.

Shareholders must find out this information from other sources, or do without.

Section 1701 was drafted to overcome some of the shortcomings of consolidation. This section

requires that companies disclose information regarding operating segments that meet certain

size thresholds (generally, those which represent 10% of the entity's total revenues, profits or

assets). Detailed information is disclosed for each operating segment, including a description of

the segment, and financial information including total assets, revenues, amortization, and other

items. Further disclosure includes revenues from each product or service or each group of

similar products or services, and external revenues, capital assets, and goodwill for each foreign

country in which the parent operates. Finally, if revenue to a single customer is greater than

10% of total revenue, this fact and the amount of that customer's revenue must be disclosed.

The consolidated financial statements provide the reader with an overview of all assets and

liabilities controlled by the parent's shareholder group. The disclosure required by Section 1701

complements consolidated statements by providing information about the entity's significant

operating segments, sales in foreign countries, and major customers. Segment disclosures

should be organized in the same manner as the information management uses internally

to assess performance and make strategic decisions. Thus not only does the expanded

disclosure provide information that is useful to shareholders, but the format provides further

insights into management's strategic direction for the company.

Problem 6

Cost of investment, January 1, Year 5 8,000

Total shareholders' equity of Dandy 7,000

AB's ownership % 80% 5,600




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Allocation:

Equipment (950 700) 80% 200

Future tax asset on loss carryforward (800 x 40%) x 80% 256

Future tax liability on equipment (950 700) x 40% 80% (80) 376

Balance goodwill 2,024

(b) Noncontrolling interest on consolidated balance sheet at January 1, Year 5:

20 % x (1,000 + 6,000) = 1,400

(c) Amortization

Balance Year 5 Year 6 Year 7 Balance

Jan 1/5 Dec. 31/7

Equipment 200 20 20 20 140

FTA on loss carryforward 256 321 642 160

FTL on equipment (80) (8) (8) (8) (56)

Goodwill 2,024 - 300 - 1,724

Total 2,400 12 344 76 1,968

Notes:

1. 100 x 40% x 80%

2. 200 x 40% x 80%

(d) Since tax returns are filed for separate legal entities and not the consolidated entity, the fair

value excess in a business combination is not considered to be a deductible cost for tax

purposes. If the asset acquired in a business combination were subsequently sold at its

fair value, a gain would be reported for tax purposes even though no gain would be

realized from a consolidated point of view. This future tax obligation is reported as a future

tax liability on the consolidated financial statements at the date of acquisition.




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Problem 7

Future tax assets and liabilities

Fair value Tax basis Difference

Inventory 134,000) 110,000) 24,000)

Land 210,000) 75,000) 135,000)

Buildings 24,000) 15,000) 9,000)

Equipment 16,000) 12,000) 4,000)

Noncurrent liabilities (155,000) (150,000) (5,000)

229,000) 62,000) 167,000)

Subsidiary's tax rate 40 %)

Future tax liability

in total on consolidation 66,800

- already reported by Mansford 4,400

- adjustment required on consolidation 62,400

Cost of 100% of Mansford Corp. 335,000

Book value of Mansford Corp.

Common stock 100,000)

Retained earnings 41,435)

141,435)

Green Inc.'s percentage ownership 100.00%) 141,435


Allocated: FV BV

Inventory 24,000)

Land 135,000)

Buildings 3,000)

Equipment (1,000)

161,000)

Future tax liability 62,400)

Noncurrent liabilities 5,000) 93,600

Goodwill 99,965




30/60

Green Inc.


at January 1, Year 1

Cash (340,000 335,000 + 52,500) 57,500

Accounts receivable (167,200 + 61,450) 228,650

Inventory (274,120 + 110,000 + 24,000) 408,120

Land (325,000 + 75,000 + 135,000) 535,000

Buildings (250,000 + 21,000 + 3,000) 274,000

Equipment (79,000 + 17,000 1,000) 95,000

Goodwill 99,965

1,698,235

Current liabilities (133,000 + 41,115) 174,115

Future tax liabilities (120,000 + 4,400 + 62,400) 186,800

Noncurrent liabilities (0 + 150,000 + 5,000) 155,000

Common stock 380,000

Retained earnings 802,320

1,698,235




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Problem 8

(a)

Value used for

Book value FVI at 60% consolidation Tax basis Difference

Inventory 110,000) 14,400) 124,400) 110,000) 14,400)

Land 75,000) 81,000) 156,000) 75,000) 81,000)

Buildings 21,000) 1,800) 22,800) 15,000) 7,800)

Equipment 17,000) (600) 16,400) 12,000) 4,400)

Noncurrent liabilities (150,000) (3,000) (153,000) (150,000) (3,000)

104,600)

Subsidiary's tax rate 40 %

Future tax liability- - consolidated balance sheet 41,840

Future tax liability - Mansford balance sheet 4,400

Future tax liability - adjustment required on consolidation 37,440

Cost of 60% of Mansford Corp. 201,000)

Book value of Mansford Corp.



141,435)

Green Inc.'s percentage ownership 60%) 84,861)

Purchase discrepancy 116,139)

Allocated: FV - BV

Inventory 24,000) x 60% 14,400)

Land 135,000) x 60% 81,000)

Buildings 3,000) x 60% 1,800)

Equipment (1,000) x 60% (600)

161,000) 96,600)

Future tax liability (37,440)

Noncurrent liabilities 5,000) x 60% (3,000) 56,160)

Goodwill 59,979)




32/60

Green Inc.


January 1, Year 1

Cash (340,000 201,000 + 52,500) 191,500


Inventory (274,120 + 110,000 + 14,400) 398,520

Land (325,000 + 75,000 + 81,000) 481,000

Buildings (250,000 + 21,000 + 1,800) 272,800

Equipment (79,000 + 17,000 600) 95,400

Goodwill 59,979

1,727,849

Current liabilities (133,000 + 41,115) 174,115

Future tax liabilities (120,000+ 4,400 + 37,440) 161,840

Noncurrent liabilities (0 + 150,000 + 3,000) 153,000

Noncontrolling interest (141,435 x 40%) 56,574

Common stock 380,000


1,727,849

(d) Since tax returns are filed for separate legal entities and not the consolidated entity, the

fair value excess in a business combination is not recognized for tax purposes. If the net

assets acquired in a business combination were sold at their fair value, a gain would be

reported for tax purposes because the fair value is greater than the cost base for tax

purposes. This future tax obligation is reported as a future tax liability on the consolidated

financial statements at the date of acquisition.




33/60

Problem 9

(a) Consolidated retained earnings at December 31, Year 6

Primes retained earnings $660,000

Cumulative amortization of fair value excess (Note 1) 14,000

Variables cumulative income since date of acquisition 200,000

Allocated to noncontrolling interest (180,000 x 8% x 5) (72,000)

Balance attributed to Prime 128,000

Consolidated retained earnings at December 31, Year 6 $802,000

Note 1:

Implied Value (i.e. acquisition cost) of Variables net assets

Fair value of amount invested by Prime 0

Fair value of NCI (= value of common shares) 180,000

Total implied value 180,000

Assessed Value of Variables net assets

Carrying value of amount invested by Prime 0

Fair value of Variables own assets 550,000

Less: Fair value of liabilities of Variable (340,000)

Total assessed value 210,000

Difference between implied and assessed values (30,000)

Assigned on consolidation to:

Land 200/500 x 30,000 (12,000)

Manufacturing plant 300/500 x 30,000 (18,000)

Balance to assign 0

The above calculation assumes that all assets and liabilities would be originally valued at fair

value. This caused a negative purchase price discrepancy of $30,000, which was assigned to

land, and manufacturing plant. Therefore, the total fair value excess at the date of acquisition is

as follows:

Preliminary Reassigned Total

Land 120,000 (12,000) 108,000

Manufacturing plant (20,000) (18,000) (38,000)

Long-term debt 10,000 10,000




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The amortization of the fair value excess from January 1, Year 12 to December 31, Year 16

would be as follows:

Jan 1/Yr 12 Cumulative Unamortized

Balance Amortization Balance

Land 108,000 108,000

Manufacturing plant (38,000) (19,000) (19,000)

Long-term debt 10,000 5,000 5,000

80,000 (14,000) 94,000

(b)

Prime Inc.


December 31, Year 16

Cash (20,000 + 180,000) $ 200,000


Land (400,000 + 80,000 + 108,000) 588,000

Manufacturing facility (650,00 + 260,000 19,000) 891,000

$2,024,000

Current liabilities (185,000 + 50,000) $235,000

Long-term debt (450,000 + 290,000 5,000) 735,000

Noncontrolling interest (180,000 + 72,000 50,000) 202,000

Common stock 50,000


$2,024,000

(c) Liabilities are obligations of an entity arising from past transactions or events, thesettlement of which may result in the transfer or use of assets, provision of services or

other yielding of economic benefits in the future. When the primary beneficiary controls

the variable interest entity, it indirectly takes responsibility for and assumes the risk related

to the obligations of the VIE.




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Problem 10

Revenues Profit Assets

A 12,000 2,100 24,000

B 9,600 1,680 21,000

C 7,200 1,440 15,000

D 3,600 660 9,000

E 5,100 810 8,400

F 1,800 270 3,600

39,300 6,960 81,000

Revenue test

Percentage

Revenues of total

A 12,000 31%

B 9,600 24%

C 7,200 18%

D 3,600 9%

E 5,100 13%

F 1,800 5%

39,300 100%

From the revenue test, segments A, B, C, and E are reportable.




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Percentage

Profit of total

A 2,100 30%

B 1,680 24%

C 1,440 21%

D 660 9%

E 810 12%

F 270 4%

6,960 100%

From the operating profit test, segments A, B, C, and E are reportable.

Asset test

Percentage of

Assets total

A 24,000 30%

B 21,000 26%

C 15,000 19%

D 9,000 11%

E 8,400 10%F 3,600 4%

81,000 100%

From the asset test, only segment F is not reportable. Since each other segment must be

reported separately, segment F will be reported separately by default.




37/60

Problem 11

Note to instructor: The tax allocation considerations outlined in this solution do not include those

arising from the two steps of the intercorporate investment, as this is beyond the scope of the

discussion in the text. Students should be advised to consider the tax effects of the unrealized

profits only.

Cost of 40% of Forma January 1, 2001 116,000

Shareholders' equity Forma 180,000

40% 72,000

Purchase discrepancy Jan. 1, 2001 44,000

Allocated:

Inventory 20,000 40% 8,000

Land 40,000 40% 16,000

Plant and equip. 50,000 40% 20,000 44,000

Balance 0

Amortization Schedule

Balance Amort. Balance

Jan. 1, 2001 to Dec. 31, 2005 Dec. 31, 2005

Inventory 8,000 8,000

Land 16,000 16,000

Plant and equip. 20,000 5,000 15,000

44,000 13,000 31,000

Cost of 60% of Forma Sept. 30, 2003 210,000

Shareholders' equity Forma 210,000

60% 126,000


Allocated:

Inventory 10,000 60% 6,000

Plant and equip. 70,000 60% 42,000 48,000

Balance goodwill 36,000




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Amortization Schedule

Balance Amort. Balance

Sept. 30, 2003 to Dec. 31, 2005 Dec. 31, 2005

Inventory 6,000 6,000))

Plant and equip. 42,000 4,725*) 37,275

Goodwill 36,000 2,025 33,975

84,000 12,750*) 71,250

* 42,000 / 20 2 = 4,725

Intercompany receivable and payable

Pro receivable from Forma 13,000

Pro receivable from Apex 40,000

30% 12,000

25,000

Unrealized profits Before Tax After

tax 40% tax

Pro selling to Apex 12,000

Less: 70% realized 8,400 3,600 1,440 2,160

Closing inventory Forma selling 45,000 18,000 27,000

Calculation of noncontrolling interestDec. 31, 2005

Preferred shares 200,000

Dividends in arrears 24,000224,000




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Calculation of consolidated retained earningsDec. 31, 2005

Pro Retained earnings Dec. 31, 2005 210,000)

Less: Purchase discrepancy amortization

First purchase 13,000

Second purchase 12,750

Inventory profit selling to Apex 2,160 27,910)

182,090)

Forma retained earnings Sept. 30, 2003 110,000

Jan. 1, 2001 80,000

Increase 30,000

40% 12,000)

Forma retained earnings Dec. 31, 2005 95,000

Less: preferred dividends in arrears 24,000

Available to Pro 71,000

Forma retained earnings Sept. 30, 2003 110,000

Decrease from 2003 to 2005 39,000

Less: Closing inventory profit after tax 27,000

Adjusted decrease 66,000 100% (66,000)

Apex retained earnings 40,000

30% 12,000)

140,090)




40/60

Pro Ltd.


as at December 31, 2005

Cash (70,000 + 1,500 + [.3 200,000]) $ 131,500)

Accounts receivable (210,000 + 90,000 + [.3 110,000] 25,000) 308,000)

Inventory (100,000 + 62,500 + [.3 70,000] 45,000 3,600) 134,900)

Land (100,000 + 110,000 + [.3 60,000] + 16,000) 244,000)

Plant & equipment (726,000 + 550,000 + [.3 290,000] + 20,000 + 42,000) 1,425,000)

Accum. depreciation (185,000 + 329,000 + [.3 60,000] + 5,000 + 4,725) (541,725)

Goodwill 33,975)

Deferred charge - income taxes (1,440 + 18,000) 19,440)

$1,755,090)

Accounts payable (175,000 + 90,000 + [.3 130,000] 25,000) $ 279,000)

Bonds payable 312,000)

Noncontrolling interest 224,000)



$1,755,090)




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Problem 12

(a)

Intercompany eliminations

Rent (125,000 x 40%) 50,000

Intercompany profits Before Tax After

tax 40% tax

Land Kent Selling in 2002 75,000


45,000

Considered unrealized in 2002 40%

30,000

Realized in 2005 (50%) 15,000 6,000 9,000

Unrealized at end of

2005 (50%) 15,000 6,000 9,000

Calculation of consolidated net income 2005

Net income, Kent 800,000

Less: dividends 40% x 80,000 32,000

Purchase discrepancy amortization 9,500 41,500

758,500

Add: land gain 9,000

767,500

Net income, Laurier 230,000

40% 92,000

859,500




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Kent Corp.


for the Year Ended December 31, 2005

Sales (3,000,000 + [40% x 1,200,000]) 3,480,000

Other income (200,000 [40% x 80,000] + [40% x 70,000] 50,000) 146,000

Gain on sale of land (15,000 + [40% x 100,000]) 55,000

Total 3,681,000

Cost of sales (1,400,000 + [40% x 560,000]) 1,624,000

Operating expenses (500,000 + [40% x 300,000] 50,000 12,500) 557,500Depreciation expense (100,000 + [40% x 130,000] + 9,000) 161,000

Goodwill impairment loss 13,000

Income tax (400,000 + 6,000 + [40% x 150,000]) 466,000

2,821,500

Net income 859.500




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(b) Significant influence

Kent Corp.

Income Statement

for the Year Ended December 31, 2005

Sales 3,000,000

Other income (200,000 [40% x 80,000]) 168,000

Investment income (Note 1) 105,000

3,273,000

Cost of sales 1,400,000

Operating expenses 500,000

Depreciation expense 100,000

Income tax 400,000

2,400,000

Net income 873,000

Note 1:

Investment income

Lauriers income 230,000

Kents percentage 40%

92,000

Less: purchase discrepancy amortization 9,500

82,500

Add: Realized gain on sale of land

Kent selling (75,000 x 50% x [1 40%]) 22,500

105,000




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Problem 13

(a) Intercompany eliminations

Sales and purchases (6,000 60%) $3,600

Unrealized profits Before Tax After

tax 40% tax

Connor selling to Banff 6,000

25%

On-hand inventory 1,500

Gross profit (1,800 6,000) 30%

Profit in inventory 450

Considered unrealized 60% 270 108 162

Calculation of consolidated net income Year 3

Connor net income 40,000

Less: closing inventory profit after tax 162

39,838

Banff net income 2,500

60% 1,500

41,338

Connor Company



Sales (150,000 + [60% 20,000] 3,600) 158,400)

Cost of sales (90,000 + [60% 11,000] 3,600 + 270) 94,270)

Expenses (20,000 + [60% 6,500] 108) 23,792)

117,062)

Net income 41,338)




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Connor Company

Consolidated Retained Earnings Statement


Balance Jan. 1 30,000)

Net income 41,338)

Balance Dec. 31 71,338)

Connor Company


as at December 31, Year 3

Current assets (75,000 + [60% 6,000] 270) 78,330

Fixed assets (190,000 + [60% 72,000]) 233,200

Accumulated depreciation (60,000 + [60% 5,000]) (63,000)

Other assets (16,000 + [60% 8,000]) 20,800

Deferred charge - income taxes 108

269,438

Current liabilities (33,000 + [60% 18,500]) 44,100Long-term debt (45,000 + [60% 40,000]) 69,000

Capital stock 85,000


269,438

(b) The gain recognition principle states that gains should be recorded when they are realized

i.e. when a transaction has occurred with an outside entity and consideration is received.

When Connor sold inventory to Banff, sixty percent of the gain is considered to beunrealized because Connor is considered to be selling to itself since it owns 60% of Banff.




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Problem 14

Unrealized profits After tax

Closing inventory Prince selling 40,000

Albert selling 72,000

Equipment Jan. 1, 2004 Albert selling 120,000

Amount realized annually through depreciation

(120,000 / 5 years) 24,000

1) Albert owns 64% of Prince (a subsidiary)

Investment in Prince (64% 860,000) 550,400

Intercompany investment income 550,400

2005 net income

Dividends receivable (64% 200,000) 128,000

Investment in Prince 128,000

2005 dividends declared but not received

Intercompany investment income (64% 40,000) 25,600


Unrealized closing inventory profit Prince selling



Unrealized closing inventory profit Albert selling



Equipment profit realized in 2005 Albert selling




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2) Albert owns 30% of Prince (a joint venture)



2005 net income

Dividends receivable (30% 200,000) 60,000


2005 dividends declared but not received



Unrealized closing inventory profit Prince selling



Unrealized closing inventory profit Albert selling

(Note: 70% is realized selling to the other venturers)


Intercompany investment income 7,200Equipment profit realized in 2005 Albert selling

(70% is realized selling to other venturers)




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Problem 15

Part A

Fair value of plant and equipment transferred 1,000,000

Carrying value on Amco's books 300,000

Gain on transfer to joint venture (Bearcat) 700,000

Amco's portion 40% (unrealized) 280,000

Newstar's portion 60% 420,000

Immediate gain from selling to Newstar

Sale proceeds cash received 500,000

Carrying value sold (500 / 1,000 300,000) 150,000 350,000

Deferred gain from selling to Newstar 70,000

(a)

Jan. 1, Year 1

Cash 500,000

Investment in Bearcat (1,000,000 500,000) 500,000

Plant and equipment 300,000

Deferred (contra) gain Amco 280,000

Gain on transfer to Newstar 350,000

Deferred gain Newstar 70,000

Dec 31, Year 1

Investment in Bearcat 72,000

Equity earnings 72,000

(40% 180,000)

Dividend receivable 30,000


(40% 75,000)



(70,000 / 20 years)




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Part B

If Newstar did not invest cash, the cash received by Amco had to come from the borrowings of

the joint venture.

Cash received by Amco 500,000

From Amco's share of the borrowing 40% 200,000

From Newstar's share 60% 300,000

Sale proceeds 300,000

Carrying value sold (300 / 1000 300,000) 90,000


(a)

Jan. 1, Year 1

Cash 500,000


Plant and equipment 300,000

Deferred (contra) gain Amco 280,000

Gain on transfer to Newstar 210,000Deferred gain Newstar (420,000 210,000) 210,000

Dec. 31, Year 1


Equity earnings 72,000

Dividend receivable 30,000




(210,000 / 20 years)




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(b) The accounts Investment in Bearcat, Dividends receivable, and Equity earnings would

be eliminated in the preparation of the consolidated financial statements.

Deferred (contra) gain Amco would be deducted from plant and equipment in the

preparation of the consolidated balance sheet as follows:

Plant and equipment (40% 1,000,000) 400,000

Less: deferred (contra) gain 280,000

120,000

The balance left is Amco's share of the carrying value of the asset transferred to venture

40% 300,000 = 120,000

Gain on transfer to Newstar would appear in the consolidated income statement.

Deferred gain Newstar would appear as a deferred credit in the consolidated balance

sheet.




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Problem 16

(a) The purpose of segmented reporting is to provide information to users of financial

statements about the different types of business activities in which an enterprise

engages and the different foreign economic environments in which it operates. This will

help users to better understand the enterprise's performance, better assess its

prospects for future cash flows, and make more informed decisions about the

organization as a whole.

The principal reason segmented information is needed is that companies consolidate

their subsidiaries. There are many benefits to preparing consolidated statements for

readers of financial information, including:

Providing a broader view of the entire economic entity controlled by the parent

corporation.

Eliminating transactions between affiliated companies that do not increase the total

wealth of the group, but if not eliminated, may mislead readers.

However, as in many situations where data are accumulated, combined, and

summarized, consolidation can result in compromises. For example, information about

one specific company within the group, or one segment of the group's operations, is

impossible to determine from consolidated financial statements. Segmented reporting is

an attempt to provide readers with the information they require to understand the risks

and rewards of investing in the enterprise.

(b) An operating segment should be reported if it meets any oneof the following criteria:

Its reported revenue (including intersegment and external sales) is 10% or more of

the total of the combined intersegment and external revenue of all reported operating

segments.

The absolute amount of its reported profit or loss is 10% or more of the absolute

amount of the greater of the combined reported profits of all operating segments

reporting a profit or the combined reported losses of all operating segments reporting

a loss.

Its assets are 10% or more of the combined assets of all operating segments.




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Information about segments that do not meet any of these thresholds may be disclosed

if desired. As well, if two or more segments exhibit similar economic characteristics, they

can be aggregated into one operating segment.

At least 75% of a firms external revenues must be reported by segment disclosures. If

this does not occur as a result of applying the above criteria, additional operating

segments should be identified until at least 75% of the external revenue is reported by

segments.

There are no quantitative thresholds associated with geographic area disclosure.

Revenues, capital assets, and goodwill must be disclosed by country if they are material.




53/60

Problem 17

Fair value of land 2,000,000

Carrying value of land on Clifford's books 600,000

Gain on transfer of land 1,400,000

Cliffords portion to be netted against land (40%) 560,000

Portion related to other venturers (60%) 840,000

(a)

Equity method journal entries on Clifford's books:

January 1, Year 3

Investment in Jager Ltd. 2,000,000

Land 600,000

Deferred (contra) gain Clifford 560,000

Deferred gain other venturers 840,000

To record initial investment in Jager Ltd.

December 31, Year 3

Equity in loss of Jager Ltd. 40,000

Investment in Jager Ltd. (40% x 100,000) 40,000

To record 40% of loss of Jager Ltd.


Gain on transfer of land to Jager Ltd. 105,000

To recognize a portion of the gain on transfer of land to joint venture

(840,000 / 8 years expected useful life = 105,000)




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(b)

Investment in Jager Ltd. would not be reported on Cliffords consolidated financial

statements

would be replaced with 40% of the joint venture's assets and

liabilities

Deferred (contra) gain

Clifford

would be netted against the land account on Cliffords

consolidated financial statements to present only 40% of the

original cost of the land.

Value for consolidation purposes

2,000,000 x .4 = 800,000


Land at original cost (600,000 x 40%) 240,000

Deferred gain other venturers would be disclosed along with other long-term credits, such

as future income taxes, in Cliffords consolidated financial

statements

Equity in loss of Jager Ltd. would not be reported on Cliffords consolidatedfinancial statements

would be replaced with 40% of the joint venture's revenue

and expenses

Gain on transfer of land to Jager would be reported on Cliffords consolidated income

statement each year for the next 8 years

(c)

The cash is considered to be from the partial sale of the land to the other venturers.

Clifford could recognize a portion of the gain equal to the percentage that the cash received

is to the total fair market value (in this example, 50% x $1,400,000 = $700,000).

The amount recognized is then deducted from the original amount of the gain allocated to the

other venturers ($840,000 $700,000 = $140,000).




55/60

The following entry would record the example above:

Cash 1,000,000

Investment in Jager Ltd. 1,000,000

Land 600,000


Gain on sale of land to Jager Ltd 700,000


December 31, Year 3

Equity in loss of Jager Ltd. 40,000

Investment in Jager Ltd. 40,000

To record 40% of 100,000 loss of Jager.


Gain on transfer of land to Jager Ltd. 17,500

To recognize a portion of the gain on transfer of land to

joint venture (140,000 / 8 years = 17,500).




56/60

Problem 18

Cost of investment in Adams Company Ltd. 352,000

Book value of Adams Company Ltd.



620,000

Kay Corp's percentage 40% 248,000


(a)

Control investment full consolidation

Intercompany profit

Before Tax

After

tax 40% tax

Land

Kay Corp selling 60,000 24,000 36,000

Inventory

Adams selling 35,000 14,000 21,000

Intercompany receivable/payable 29,000

Noncontrolling interest:

Book value of Adams Company Ltd.



750,000

Less: unrealized profit Adams selling 21,000

729,000

Noncontrolling interest's percentage 60%

437,400




57/60

Consolidated retained earnings

Kay Corp's retained earnings

December 31, Year 5 700,000

Less: Unrealized profit Kay Corp selling

Purchase discrepancy amortization

36,000

104,000 140,000

560,000

Adams' retained earnings:


At acquisition 170,000

Increase 130,000


109,000


Kay Corp's consolidated retained earnings,


Kay Corp. Ltd


at December 31, Year 5

Cash (68,000 + 30,000) 98,000

Accounts receivable (80,000 + 170,000 29,000) 221,000

Inventory (600,000 + 400,000 35,000) 965,000

Property and plant (1,400,000 + 900,000 60,000) 2,240,000

Deferred charge - income tax (24,000 + 14,000) 38,000

3,562,000

Current liabilities (400,000 + 150,000 29,000) 521,000Bonds payable (500,000 + 600,000) 1,100,000

Noncontrolling interest 437,400



3,562,000




58/60

(b)

Joint venture investment proportionate consolidation

Intercompany profit

Before Tax After

tax 40% tax

Land

Kay Corp selling 60,000


Unrealized 40% 24,000 9,600 14,400)

Inventory

Adams selling 35,000

Kay Corp percentage 40% 14,000 5,600 8,400)

Intercompany receivable/payable (29,000 x 40%) 11,600)

.

Consolidated retained earnings:

Kay Corp's retained earnings:


Less: Unrealized profit Kay Corp selling

Purchase discrepancy amortization

(14,400)

(104,000) 581,600

Adams' retained earnings:



Increase 130,000

Kay Corp's percentage 40% 52,000)633,600)

Less: unrealized profit Adams selling 8,400)

Kay Corp's consolidated retained earnings )

December 31, Year 5 625,200)




59/60

Kay Corp. Ltd.



Cash (68,000 + [40% x 30,000]) 80,000

Accounts receivable (80,000 + [40% x 170,000] 11,600) 136,400

Inventory (600,000 + [40% x 400,000] 14,000) 746,000

Property and plant (1,400,000 + [40% x 900,000] 24,000) 1,736,000

Deferred charge - income tax (9,600 + 5,600) 15,200

2,713,600

Current liabilities (400,000 + [40% x 150,000] 11,600) 448,400

Bonds payable (500,000 + [40% x 600,000]) 740,000



2,713,600

(c)

Significantly influenced investment equity method

Refer to calculations under part (a)

Investment in Adams Corp.

January 1, Year 3 352,000

Less: unrealized profit on land Kay Corp selling 36,000

316,000

Adams retained earnings:



Increase 130,000


109,000


Less: purchase discrepancy amortization (104,000)

Balance December 31, Year 5 255,600




60/60

Kay Corp. Ltd



Cash 68,000

Accounts receivable 80,000

Inventory 600,000

Investment in Adams Corp. 255,600

Property and plant 1,400,000

2,403,600

Current liabilities 400,000

Bonds payable 500,000



2,403,600

hilton4e sm10.doc

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