Find more slides, ebooks, solution manual and testbank on www.downloadslide.com CHAPTER INTERCOMPANY DEBT, CONSOLIDATED STATEMENT OF CASH FLOWS AND OTHER ISSUES Chapter Outline I Variable interest entities (VIEs) A VIEs typically take the form of a trust, partnership, joint venture, or corporation In most cases a sponsoring firm creates these entities to engage in a limited and well-defined set of business activities For example, a business may create a VIE to finance the acquisition of a large asset The VIE purchases the asset using debt and equity financing, and then leases the asset back to the sponsoring firm If their activities are strictly limited and the asset is pledged as collateral, VIEs are often viewed by lenders as less risky than their sponsoring firms As a result, such arrangements can allow financing at lower interest rates than would otherwise be available to the sponsor B Control of VIEs, by design, often does not rest with its equity holders Instead, control is exercised through contractual arrangements with the sponsoring firm who becomes the "primary beneficiary" of the entity These contracts can take the form of leases, participation rights, guarantees, or other residual interests Through contracting, the primary beneficiary bears a majority of the risks and receives a majority of the rewards of the entity, often without owning any voting shares C An entity whose control rests a primary beneficiary is referred to by FASB Interpretation 46R "Consolidation of Variable Interest Entities," (FIN 46R) as a variable interest entity The following characteristics indicate a controlling financial interest in a variable interest entity The direct or indirect ability to make decisions about the entity's activities The obligation to absorb the expected losses of the entity if they occur, or The right to receive the expected residual returns of the entity if they occur The primary beneficiary bears the risks and receives the rewards of a variable interest entity and is considered to have a controlling financial interest D FIN 46R reasons that if a "business enterprise has a controlling financial interest in a variable interest entity, assets, liabilities, and results of the activities of the variable interest entity should be included with those of the business enterprise." Therefore, primary beneficiaries must include their variable interest entities in their consolidated financial statements consistent with the provisions of SFAS 141R II Intercompany debt transactions A No real consolidation problem is created when one member of a business combination loans money to another The resulting receivable/payable accounts as well as the interest McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 6-1 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com income expense balances are identical and can be directly offset in the consolidation process B The acquisition of an affiliate's debt instrument from an outside party does require special handling so that consolidated financial statements can be produced Because the acquisition price will usually differ from the book value of the liability, a gain or loss has been created which is not recorded within the individual records of either company Because of the amortization of any associated discounts and/or premiums, the interest income being reported by the buyer will not correspond with the interest expense of the debtor C In the year of acquisition, all intercompany accounts (the liability, the receivable, interest income, and interest expense) are eliminated within the consolidation process while the gain or loss (which produced all of the discrepancies because of the initial difference) is recognized Although several alternatives exist, this textbook assigns all income effects resulting from the retirement to the parent company, the party ultimately responsible for the decision to reacquire the debt Any noncontrolling interest is, therefore, not affected by the adjustments utilized to consolidate intercompany debt D Even after the year of retirement, all intercompany accounts must be eliminated again in each subsequent consolidation; however, the beginning retained earnings of the parent company is adjusted rather than a gain or loss account The change in retained earnings is needed because a gain or loss was created in a prior year by the retirement of the debt, but only interest income and interest expense were recognized by the two parties The amount of the change made to retained earnings at any point in time is the original gain or loss adjusted for the subsequent amortization of discounts or premiums III Subsidiary preferred stock A Subsidiary preferred shares not owned by the parent are a component of the noncontrolling interest B In an acquisition, the fair value of any subsidiary preferred shares not acquired by the parent is added to any consideration transferred along with the fair value of the noncontrolling interest in common shares to compute the acquisition-date fair value of the subsidiary IV Consolidated statement of cash flows A Statement is produced from consolidated balance sheet and income statement and not from the separate cash flow statements of the component companies B Intercompany cash transfers are omitted from this statement because they not occur with an outside, unrelated party C The "Noncontrolling Interest's Share of the Subsidiary's Income'' is not included as a cash flow although any dividends paid to these outside owners is reported as a financing activity McGraw-Hill/Irwin 6-2 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com V Consolidated earnings per share A This computation normally follows the pattern described in intermediate accounting textbooks For basic EPS, consolidated net income is divided by the weighted-average number of parent shares outstanding If convertibles (such as bonds or warrants) exist for the parent shares, their weight must be included in computing diluted EPS but only if earnings per share is reduced The subsidiary's diluted earnings per share are computed first to arrive at (1) an earnings figure and (2) a shares figure The portion of the shares figure belonging to the parent is computed That percentage of the subsidiary's diluted earnings is then added to the parent's income in order to complete the earnings per share computation VI Subsidiary stock transactions A If the subsidiary issues new shares of stock or reacquires its own shares as treasury stock, a change is created in the book value underlying the parent's investment account The increase or decrease should be reflected by the parent as an adjustment to this balance B The book value of the subsidiary that corresponds to the parent's ownership is measured before and after the transaction with any alteration recorded directly to the investment account The parent's additional paid-in capital (or retained earnings) account is normally adjusted although the recognition of a gain or loss is an alternate accounting treatment C Treasury stock acquired by the subsidiary may also necessitate a similar adjustment to the parent's investment account In addition, any subsidiary treasury stock is eliminated within the consolidation process Learning Objectives Having completed Chapter 6, students should have fulfilled each of the following learning objectives: Describe a variable interest entity and primary beneficiary Also should know when a variable interest entity is subject to consolidation Eliminate all intercompany debt accounts and recognize any associated gain or loss created whenever one company acquires an affiliate's debt instrument from an outside party Recognize that intercompany debt transactions require a constantly changing consolidation entry to be prepared for each subsequent period until the debt is formally retired Compute the appropriate amounts and make the worksheet entry needed in each subsequent consolidation when one company has purchased the debt of an affiliate directly from an outside parry Discuss the various theories as to the appropriate allocation of any income effect created by intercompany debt transactions and identify the assignment employed in this textbook (and the rationale for its use) Understand that subsidiary preferred stocks not owned by the parent are initially valued in consolidated financial reports as noncontrolling interest at acquisition-date fair value Prepare a consolidated statement of cash flows Compute basic and diluted earnings per share for a business combination in which the subsidiary has dilutive convertible securities McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 6-3 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Identify subsidiary stock transactions that can impact the underlying book value figure recorded within the parent's Investment account 10 Calculate the effect that a subsidiary stock transaction has on the parent's investment balance and make the required journal entry to record that impact Answer to Discussion Question Who Lost the $300,000? This case is designed to give life to a theoretical accounting issue discussed within the chapter: If a subsidiary's debt is retired, should the resulting gain or loss be assigned to the parent or to the subsidiary? The case attempts to illustrate that no clear-cut solution to this question can be found This lack of an absolute answer makes financial accounting both intriguing and frustrating Interesting class discussion can be generated from this issue Students should note that the decision as to assignment only becomes necessary because of the presence of the noncontrolling interest Regardless of the level of ownership all intercompany balances are simply eliminated on the worksheet with the gain or loss being recognized Not until the time that the noncontrolling interest computations are made does the identity of the specific party become important All financial and operating decisions are assumed to be made in the best interest of the business entity as a whole This debt would not have been retired unless corporate officials believed that Penston/Swansan would benefit from the decision Thus, a strong argument can be made against any assignment to either separate party Students should be required to pick one method and justify its use Discussion usually centers on the following issues:    Parent company officials made the actual choice that created the loss Therefore, assigning the $300,000 to the subsidiary directs the impact of their reasoned decision to the wrong party In effect, the subsidiary had nothing to with this transaction (as indicated in the case) so that its financial records should not be affected by the $300,000 loss The debt was that of the subsidiary Because the subsidiary's debt is being retired, all of the $300,000 should be attributed to that party Financial records measure the results of transactions and the retirement simply culminates an earlier transaction made by the subsidiary The parent is doing no more than acting as an agent for the subsidiary (as indicated in the case) If the subsidiary had acquired its own debt, for example, no question as to the assignment would have existed Thus, changing that assignment simply because the parent was forced to be the acquirer is not justified Both parties were involved in the transaction so that some allocation of the loss is required If, at the time of repurchase, a discount existed within the subsidiary's accounts, this figure would have been amortized to interest expense (if the debt had not been retired) Thus, the $300,000 loss was accepted now in place of the later amortization This reasoning then assigns this portion of the loss to the subsidiary Because the parent was forced to pay more than face value, that remaining portion is assigned to the buyer Answers to Questions McGraw-Hill/Irwin 6-4 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com A variable interest entity (VIE) is a business structure that is designed to accomplish a specific purpose A VIE can take the form of a trust, partnership, joint venture, or corporation although typically it has neither independent management nor employees The entity is frequently sponsored by another firm to achieve favorable financing rates Variable interests are contractual, ownership, or other pecuniary interests in an entity that change with changes in the entity's net asset value Variable interests will absorb portions of a variable interest entity's expected losses if they occur or receive portions of the entity's expected residual returns if they occur Variable interests typically are accompanied by contractual arrangements that provide decision making power to the owner of the variable interests Examples of variable interests include debt guarantees, lease residual value guarantees, participation rights, and other financial interests The following characteristics are indicative of an enterprise qualifying as a primary beneficiary with a controlling financial interest in a VIE  The direct or indirect ability to make decisions about the entity's activities  The obligation to absorb the expected losses of the entity if they occur, or  The right to receive the expected residual returns of the entity if they occur Because the bonds were purchased from an outside party, the acquisition price is likely to differ from the book value of the debt as found on the subsidiary's records This difference creates accounting problems in handling the intercompany transaction From a consolidated perspective, the debt has been retired; a gain or loss should be reported with no further interest being recorded In reality, each company will continue to maintain these bonds on their individual financial records Also, because discounts and/or premiums are likely to be present, both of these account balances as well as the interest income/expense will change from period to period because of amortization For reporting purposes, all individual accounts must be eliminated with the gain or loss being reported so that the events are shown from the vantage point of the consolidated entity If the bonds are acquired directly from the affiliate company, all reciprocal accounts will be equal in amount The debt and the receivable will be in agreement so that no gain or loss is created Interest income and interest expense should also reflect identical amounts Therefore, the consolidation process for this type of intercompany debt requires no more than the offsetting of the various reciprocal balances The gain or loss to be reported is the difference between the price paid and the book value of the debt on the date of acquisition For consolidation purposes, this gain or loss should be recognized immediately on the date of acquisition Because the bonds are still legally outstanding, they will continue to be found on both sets of financial records Thus, each account (Bonds Payable, Investment in Bonds, Interest Expense, and Interest Income) must be eliminated within the consolidation process Any gain or loss on the retirement as well as later effects on interest caused by amortization are also included to arrive at an adjustment to the beginning retained earnings of the parent company The original gain is never recognized within the financial records of either company Thus, within the consolidation process for the year of acquisition, the gain is directly recorded whereas (for each subsequent year) it is entered as an adjustment to beginning retained earnings In addition, because the book value of the debt and the investment are not in agreement, the interest expense and interest income balances being recorded by the two McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 6-5 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com companies will differ each year because of the amortization process This amortization effectively reduces the difference between the individual retained earnings balances and the total that is appropriate for the consolidated entity Consequently, a smaller change is needed each period to arrive at the balance to be reported For this reason, the annual adjustment to beginning retained earnings gradually decreases over the life of the bond No set rule exists for assigning the income effects that result from intercompany debt transactions although several different theories have been put forth over the years which include: (1) assignment of the entire amount to the debtor, (2) assignment of the entire amount to the buyer, and (3) allocation of the gain or loss between the two parties in some manner This textbook attributes the entire income effect (the $45,000 gain in this case) to the parent company Assignment to the parent is justified because that party is ultimately responsible for the decision being made to retire the debt The answer to the discussion question included in this chapter analyzes this question in more detail 10 Subsidiary outstanding preferred shares are part of the noncontrolling interest and are included in the consolidated financial statements at acquisition-date fair value and subsequently adjusted for their share of subsidiary income and dividends 11 The consolidated statement of cash flows is developed from the information found in the consolidated balance sheet and income statement Thus, the cash flows generated by operating, investing, and financing activities are identified only after the consolidation of these other statements 12 The noncontrolling interest share of the subsidiary’s income is a component of consolidated net income Consolidated net income then is adjusted for noncash and other items to arrive at consolidated cash flows from operations Any dividends paid by the subsidiary to these outside owners are listed as a financing activity of the business combination because an actual cash outflow is created 13 An alternative to the normal diluted earnings per share calculation is required whenever the subsidiary has dilutive convertible securities such as bonds or warrants In this case, the potential impact of the conversion of subsidiary shares must be factored into the overall diluted earnings per share computation 14 Basic Earnings per Share The existence of subsidiary convertible securities does not affect consolidated basic EPS Consolidated basic earnings per share is computed by dividing consolidated net income by the weighted average number of parent shares outstanding Diluted Earnings per Share The subsidiary's diluted earnings per share is computed by including both convertible items The portion of the parent's controlled shares to the total shares used in this calculation is then determined Only this percentage (of the income figure used in the subsidiary's computation) is added to the parent's income in arriving at the diluted earnings per share for the business combination 15 Several reasons could exist for a subsidiary to issue new shares of stock to outside parties Clearly, additional financing is brought into the company by any such sale Also, stock issuance may be used to entice new individuals to join the organization Additional management personnel, as an example, might be attracted to the company in this manner The company could also be forced to sell shares because of government regulation Many countries require some degree of local ownership as a prerequisite for operating within that country McGraw-Hill/Irwin 6-6 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 16 Because the new stock was issued at a price above book value, the book value per share of Metcalf's stock has been increased Consequently, the book value of Washburn's investment should be increased to reflect this change To measure the effect, the underlying book value of Washburn's investment is calculated both before and after the new issuance Because the increment is the result of a stock transaction, an increase is made to additional paid-in capital although recording a gain or loss is currently allowed Although the subsidiary's shares (both new and old) are eliminated in the consolidation process, the increase in the parent's APIC (or gain or loss) does carry into the consolidated figures In addition, the percentage of the subsidiary attributed to the noncontrolling interest will have increased 17 A stock dividend does not alter the book value of the subsidiary company and, thus, creates no effect on Washburn's investment account or on the consolidated figures Hence, no entry is recorded at all by the parent company in connection with the subsidiary's stock dividend Answers to Problems D C A D A D Cash Flow from Operations: Net income Depreciation Trademark amortization Increase in accounts receivable Increase in inventory Increase in accounts payable Cash Flow from Operations C Cash Flow from Financing Activities: Dividends to parent’s interest Dividends to noncontrolling interest (20%  $5,000) Reduction in long-term notes payable Cash Flow from Financing Activities $45,000 10,000 15,000 (17,000) (40,000) 12,000 (20,000) $25,000 ($12,000) (1,000) (25,000) ($38,000) C C 10 C Rodgers' Reported Balance McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e $200,000 © The McGraw-Hill Companies, Inc., 2009 6-7 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Ferdinal's reported balance Eliminate interest expense—intercompany Eliminate interest income—intercompany Recognize gain on retirement of debt ($212,000 – $199,000) Consolidated net income 80,000 21,000 (22,000) 13,000 $292,000 11 B Eliminate interest expense—intercompany Eliminate interest income—intercompany Recognize loss on retirement of debt ($206,000 – $189,000) Reduction in retained earnings, 1/1/10 $21,000 (18,000) (17,000) $(14,000) 12 B Ace reported income Remove intercompany dividends (cost method) Byrd reported income Gain on extinguishment of debt ($48,300 – $46,600) Eliminate interest expense on "retired" debt ($48,300 x 10%) Eliminate interest income on "retired" debt ($46,600 x 12%) Consolidated net income $400,000 (7,000) $393,000 100,000 1,700 4,830 (5,592) $493,938 13 D 30% of Byrd's reported income of $100,000; the intercompany debt transaction is attributed solely to the parent company 14 A For 2010, the adjustment to beginning retained earnings should recognize the gain on the retirement of the debt, the elimination of the 2009 interest expense, and the elimination of the 2009 interest income Gain on Retirement of Bond Original book value 2006–2008 amortization ($600,000 ÷ 20 yrs x yrs.) Book value, January 1, 2009 Percentage of bonds retired Book value of retired bonds Cash received ($4,000,000 x 96.6%) Gain on retirement of bonds Interest Expense on Intercompany Debt—2009 Cash interest expense (9% x $4,000,000) Premium amortization ($30,000 per year total x 40% retired portion of bonds) Interest expense on intercompany debt Interest Income on Intercompany Debt—2009 Cash interest income (9% x $4,000,000) Discount amortization ($136,000 ÷ 17 yrs.) Interest income on intercompany debt McGraw-Hill/Irwin 6-8 $10,600,000 (90,000) $10,510,000 40% $4,204,000 3,864,000 $340,000 $360,000 (12,000) $348,000 $360,000 8,000 $368,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Adjustment to 1/1/10 Retained Earnings Recognition of 2009 gain on extinguishment of debt (above) Elimination of 2009 intercompany interest expense (above) Elimination of 2009 intercompany interest income (above) Increase in retained earnings, 1/1/10 $320,000 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e $340,000 348,000 (368,000) © The McGraw-Hill Companies, Inc., 2009 6-9 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 15 D Consideration transferred for preferred stock $424,000 Consideration transferred for common stock 3,960,000 Noncontrolling interest fair value for preferred 1,696,000 Noncontrolling interest fair value for common 400,000 Acquisition-date fair value 6,480,000 Acquisition-date book value (6,000,000) Goodwill $480,000 16 C Consideration transferred for preferred stock $106,000 Consideration transferred for common stock 916,400 Noncontrolling interest fair value for common 580,000 Acquisition-date fair value $1,602,400 Acquisition-date book value (1,500,000) Excess fair value $102,400 to building 50,000 to goodwill $52,400 17 A Parent’s reported sales Subsidiary's reported sales Less: intercompany transfers Sales to outsiders Eliminate increase in receivables (less cash collected) Cash generated by sales $300,000 200,000 (40,000) $460,000 (30,000) $430,000 18 B Book value of subsidiary prior to issuing new shares (12,000 x $40) Parent's ownership Book value acquired $480,000 100% $480,000 Book value of subsidiary after issuing new shares (above value plus 3,000 shares at $50 each) Parent's ownership (12,000 ÷ 15,000 shares) Book value acquired $630,000 80% $504,000 Investment in Nestlum increases by $24,000 ($504,000 less $480,000) 19 A Because the parent acquired 80 percent of the new shares, its proportion of ownership has remained the same Because the purchase price will necessarily equal 80 percent of the increase in the subsidiary's book value, no separate adjustment by the parent is required 20 C Adjusted book value of subsidiary ($795,000 + $150,000) Current parent ownership (32,000 shs ÷ 50,000 shs.) Book value acquired Book value acquired currently recorded in parent's investment account ($795,000 x 80%) McGraw-Hill/Irwin 6-10 $945,000 64% $604,800 636,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 43 (50 Minutes) (Prepare consolidation entries for intercompany preferred stock and bonds Determine specified account balances Preferred stock is a debt instrument.) a Consideration transferred for common stock Consideration transferred for preferred stock Noncontrolling interest in common stock Noncontrolling interest in preferred stock Lisa’s acquisition-date fair value Book value of Lisa Excess assigned to franchises $552,800 65,000 138,200 34,000 $790,000 750,000 $40,000 CONSOLIDATION ENTRIES 1/1/09 Entry S and A combined Preferred Stock (Lisa) Common Stock (Lisa) Retained Earnings, 1/1/09 (Lisa) Franchises Investment in Lisa-common stock Investment in Lisa-preferred stock Noncontrolling Interest in Lisa, Inc 100,000 200,000 450,000 40,000 552,800 65,000 172,200 (To eliminate subsidiary stockholders’ equity, record excess acquisition-date fair values, and record outside ownership of subsidiary's preferred and common stock at acquisition-date fair values.) b Acquisition price of bonds, 1/2/09 Book value of bonds payable (½ acquired) Loss on extinguishment of debt Interest income—Mona ($53,310 x 8%) Interest expense—Lisa ($44,175 x 14%) Investment in Lisa—bonds (book value) Book value—date of acquisition, 1/2/09 Cash interest ($50,000 x 10%) Effective interest (above) Investment in Lisa—bonds (book value as of 12/31/09) McGraw-Hill/Irwin 6-40 (rounded) (rounded) $53,310 (44,175) $9,135 $4,265 $6,185 $53,310 $5,000 4,265 735 $52,575 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 43 b (continued) Bonds payable (book value) Book value—date of acquisition, 1/2/09 Cash interest ($50,000 x 10%) Effective interest (above) Bonds payable (book value as of 12/31/09) CONSOLIDATION ENTRY B—December 31, 2009 (all figures computed above) Bonds Payable Interest Income (or Other Revenues) Extraordinary Loss on Retirement of Debt Discount on Bonds Payable ($50,000 – $45,360) Interest Expense Investment in Lisa—Bonds $44,175 $5,000 6,185 1,185 $45,360 50,000 4,265 9,135 4,640 6,185 52,575 c December 31, 2009 book values based on historical cost figures: Cost of fixed assets $100,000 Depreciation expense ($40,000 book value over a 10-year life) 4,000 Accumulated depreciation (including current expense) 64,000 December 31, 2009 book values based on transfer price: Cost of fixed assets $120,000 Depreciation expense (10-year life) 12,000 Accumulated depreciation 12,000 Gain on transfer of fixed assets ($120,000 – $40,000) book value 80,000 CONSOLIDATION ENTRY TA—December 31, 2009 Gain on Transfer of Fixed Assets (to remove) Accumulated Depreciation ($64,000 – $12,000) Depreciation Expense ($12,000 – $4,000) Fixed Assets ($120,000 – $100,000) McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e 80,000 52,000 8,000 20,000 © The McGraw-Hill Companies, Inc., 2009 6-41 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 43 (continued) d Original allocation to franchises (given) Amortization at $1,000/year (2009–2010) Consolidated franchises—12/31/10 Fixed assets (book values): Mona, Inc Lisa Co Reduction necessitated by intercompany sale ($120,000 transfer price reduced to $100,000 original cost) (see part c) Consolidated fixed assets—12/31/10 Accumulated depreciation (book values): Mona, Inc Lisa Co Increase needed to eliminate intercompany sale ($60,000 accumulated depreciation at time of transfer less excess depreciation expense [$12,000 - $4,000] for 2009 and 2010) Consolidated Acc Depr.—12/31/10 Expenses (book values): Mona, Inc Lisa Co Recognition of amortization on Franchises Elimination of interest expense on intercompany debt ($45,360 [see part b] x 14%) (rounded) Elimination of excess depreciation from intercompany transfer of fixed assets ($12,000– $4,000) Consolidated expenses McGraw-Hill/Irwin 6-42 $40,000 (2,000) $38,000 $1,100,000 800,000 (20,000) $1,880,000 $300,000 200,000 44,000 $544,000 $220,000 120,000 1,000 (6,350) (8,000) $326,650 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 44 (35 Minutes) (Prepare statement of cash flows for a business combination.) (Note: before working this problem, students may wish to review the statement of cash flows in an intermediate accounting textbook.) Development of Cash Flow Balances OPERATING ACTIVITIES—2009 Revenues (the consolidated balance plus the decrease in accounts receivable) Cost of goods sold (cash purchases) (the consolidated balance plus the increase in inventory plus the decrease in accounts payable) Depreciation and amortization (not cash expenses) Gain on sale of building (sales price is shown below as an investing activity) Interest expense (the consolidated balance) Noncontrolling interest in subsidiary's income (does not represent a cash flow although dividends paid to these outside owners is shown below as a financing activity) INVESTING ACTIVITIES—2009 Sale of building ($30,000 book value sold at a $20,000 gain) Purchase of equipment (Buildings and Equipment account increased by $50,000 Building with a $30,000 book value was sold [a decrease] Depreciation [without Databases amortization] was $95,000 [a decrease] Only a purchase of $175,000 would turn these two decreases of $125,000 into an increase of $50,000) FINANCING ACTIVITIES—2009 Dividends paid by parent (the consolidated balance) Dividends paid by subsidiary (amount paid to noncontrolling interest—20%) Issuance of bonds Issuance of common stock by the parent (increase in common stock and additional paid-in capital) McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e $890,000 720,000 -0-030,000 -0- $50,000 175,000 $100,000 2,000 100,000 47,000 © The McGraw-Hill Companies, Inc., 2009 6-43 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 44 (continued) ROGERS COMPANY AND CONSOLIDATED SUBSIDIARY Statement of Cash Flows Year Ending December 31, 2009 CASH FROM OPERATIONS Revenues Purchases Expenses Cash from operations CASH FLOWS—INVESTING ACTIVITIES Sale of building Purchase of equipment Cash from investing activities CASH FLOWS—FINANCING ACTIVITIES Dividends paid Issuance of bonds Issuance of common stock Cash from financing activities Net increase in cash during 2009 Cash, January 1, 2009 Cash, December 31, 2009 $890,000 (720,000) (30,000) 140,000 $50,000 (175,000) (125,000) $(102,000) 100,000 47,000 45,000 60,000 80,000 $140,000 The above statement uses the direct approach for computing cash flows from operations If the indirect approach were to be used, the following computation would be appropriate CASH FROM OPERATIONS Consolidated net income Adjustment from accrual to cash: Depreciation and amortization Gain on sale of building Decrease in accounts receivable Increase in inventory Decrease in accounts payable Cash from operations McGraw-Hill/Irwin 6-44 $230,000 100,000 (20,000) 10,000 (140,000) (40,000) $140,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 45 (40 Minutes) (Compute basic and diluted earnings per share Subsidiary has stock warrants outstanding and convertible debt.) (Note: This question may require students to review earnings per share fundamentals analyzed in intermediate accounting.) The subsidiary has two convertibles: warrants and bonds Thus the subsidiary’s diluted earnings per share must be computed as a preliminary step to the calculations made for the business combination as a whole Based on the amount of the "noncontrolling interest in Raleigh's income," outside ownership must be 20 percent so that the parent, Alexander, holds an 80 percent interest in Raleigh (or 24,000 shares) BASIC EARNINGS PER SHARE—BUSINESS COMBINATION Reported income (partial equity)—Alexander $304,000 Adjust for impact of intercompany transfers (consolidated gross profit is $5,000 higher than the individual figures; thus, deferred figure being recognized is that much higher than the amount being deferred) 5,000 Amortization expense (increase in consolidated expenses × parent’s 80% ownership) (20,000) Preferred stock dividends (40,000) Earnings applicable to basic EPS $249,000 Alexander's outstanding common shares Basic earnings per share ($249,000 ÷ 50,000) 50,000 $4.98 DILUTED EARNINGS PER SHARE—SUBSIDIARY (RALEIGH) Net income $130,000 Interest saved assuming conversion of bonds (net of taxes) 22,000 Income applicable to diluted EPS $152,000 Shares outstanding 30,000 Assumed conversion of warrants 5,000 Assumed acquisition of treasury stock with proceeds of conversion ([5,000 x $10] ÷ $20) (2,500) Assumed conversion of bonds 10,000 Shares applicable to diluted EPS 42,500 Diluted earnings per share—subsidiary ($152,000 ÷ 42,500) $3.58 (rounded) McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 6-45 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 45 (continued) INCOME APPLICABLE TO PARENT—DILUTED EARNINGS PER SHARE Shares used in diluted EPS computation Shares controlled by parent (24,000 plus 50% of increment created by warrants [or 1,250]) 42,500 Portion owned by parent (25,250 ÷ 42,500) Income applicable to parent—diluted EPS (59.4% of $152,000) 59.4% 25,250 (rounded) $90,288 DILUTED EARNINGS PER SHARE—BUSINESS COMBINATION Reported income Alexander $304,000 Eliminate equity in earnings of Raleigh (104,000) Adjust for impact of intercompany transfers (consolidated gross profit is $5,000 higher than the individual figures; thus, the deferred figure being recognized is that much higher than the amount being deferred) 5,000 Amortization expense (increase in consolidated expenses × parent’s 80% ownership) (20,000) Income of Raleigh (computed above) 90,288 Because of assumed conversion, preferred stock dividends would not be paid -0Earnings applicable to diluted EPS $275,288 Alexander's outstanding common shares Assumed conversion of preferred stock (10,000 x shares) Shares applicable to diluted EPS Diluted earnings per share ($275,288 ÷ 70,000) McGraw-Hill/Irwin 6-46 50,000 20,000 70,000 $3.93 (rounded) © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 46 (50 Minutes) (Determine consolidated totals Subsidiary has preferred shares outstanding that are equity instruments.) Consideration transferred for common and preferred stock Skyler’s book value Excess fair value assigned to intangible asset (10-year life) Annual amortization $11,000 Ending Unrealized Gain Ending inventory (at transfer price) Markup ($30,000 ÷ $90,000) Ending unrealized gain (increase made to cost of goods sold to defer gain) McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e $560,000 450,000 $110,000 $18,000 33⅓% $6,000 © The McGraw-Hill Companies, Inc., 2009 6-47 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 46 (continued) Accounts Sales Cost of goods sold Expenses Gain on sale of equipment Net income Paisley, Inc and Skyler Corp Consolidation Worksheet Year Ending December 31, 2009 Consolidation Entries Paisley, Inc Skyler Corp Debit Credit $(800,000) $(400,000) (TI) 90,000 528,000 260,000 (G) 6,000 (TI) 90,000 180,000 130,000 (E) 11,000 (ED) 2,000 (8,000) -0(TA) 8,000 $(100,000) $(10,000) Retained earnings, 1/1/09 Net income Dividends paid Retained earnings, 12/31/09 $(400,000) (100,000) 60,000 $(440,000) $(150,000) (10,000) -0$(160,000) Cash Accounts receivable Inventory Investment in Skyler Corp $30,000 300,000 260,000 560,000 $40,000 100,000 180,000 -0- Land, buildings, and equipment Accumulated depreciation Intangible Asset Total assets 680,000 (180,000) -0$1,650,000 500,000 (90,000) -0$730,000 $(140,000) (240,000) -0(620,000) (210,000) (440,000) Total liabilities and stockholders’ equity $(1,650,000) $(90,000) (180,000) (100,000) (200,000) -0(160,000) $(730,000) Accounts payable Long-term liabilities Preferred stock Common stock Additional paid-in capital Retained earnings, 12/31/09 McGraw-Hill/Irwin 6-48 (S) 150,000 $(400,000) (87,000) 60,000 $(427,000) (P) 28,000 (G) 6,000 (S) 450,000 (A) 110,000 (TA) 10,000 (ED) 2,000 (A) 110,000 (P) Consolidated Totals $(1,110,000) 704,000 319,000 -0$(87,000) (TA) 18,000 (E) 11,000 28,000 (S) 100,000 (S) 200,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual $70,000 372,000 434,000 -01,190,000 (286,000) 99,000 $1,879,000 $(202,000) (420,000) -0(620,000) (210,000) (427,000) $(1,879,000) Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 46 (continued) Effect of Intercompany Equipment Transfer Transfer price Recorded value Depreciation expense ($20,000 ÷ 4) Accumulated depreciation Gain on sale ($20,000 – $12,000) Historical cost Recorded value Depreciation expense ($12,000 ÷ 4) Accumulated depreciation ($18,000 + $3,000) $20,000 5,000 5,000 8,000 $30,000 3,000 21,000 CONSOLIDATED TOTALS                    Sales = $1,110,000 (add book values and eliminate intercompany transfers) Cost of Goods Sold = $704,000 (add book values, eliminate intercompany transfers, and eliminate ending unrealized gain [computed above]) Expenses = $319,000 (add book values and include amortization of intangibles and eliminate $2,000 excess equipment depreciation) Gain on Sale of Equipment = $0 (intercompany balance is eliminated) Net Income = $87,000 (consolidated revenues less consolidated expenses) Retained Earnings, 1/1/09 = $400,000 (parent company figure only because subsidiary was not acquired until current year) Dividends Paid = $60,000 (parent balance only) Retained Earnings, 12/31/09 = $427,000 (consolidated beginning retained earnings plus net income less dividends paid) Cash = $70,000 (add book values) Accounts Receivable = $372,000 (add book values after eliminating intercompany balance) Inventory = $434,000 (add book values after eliminating unrealized gain) Investment in Skyler Corporation = $0 (intercompany account is eliminated so that individual asset and liability accounts of subsidiary can be included) Land, Buildings, and Equipment = $1,190,000 (add book values and increase transferred asset from transfer price to historical cost [see above]) Accumulated Depreciation = $286,000 (add book values and adjust balance for transferred asset from transfer price figure to historical cost (see above]) Intangible Asset = $99,000 (original allocations less one year amortization) Total Assets = $1,879,000 (summation of consolidated accounts) Accounts Payable = $202,000 (add book values and remove intercompany balance) Long-Term Liabilities = $420,000 (add book values) Preferred Stock = $0 (subsidiary outstanding shares are eliminated) McGraw-Hill/Irwin 6-46 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 46 (continued) Common Stock = $620,000 (parent balance only) Additional Paid-in Capital = $210,000 (parent balance only) Retained Earnings, 12/31/09 = $427,000 (computed above) Total Liabilities and Equities = $1,879,000 (summation of consolidated accounts) Many students may choose to prepare a worksheet for this problem Thus, the following is an explanation of that approach CONSOLIDATED ENTRIES Entry S Preferred Stock (Skyler) 100,000 Common Stock (Skyler) 200,000 Retained Earnings, 1/1/09 150,000 Investment in Skyler Corp 450,000 (To eliminate stockholder’s equity of subsidiary allocable to common and preferred stockholdings.) Entry A Intangible Asset 110,000 Investment in Skyler Corp 110,000 (To recognize amounts paid within acquisition prices that are attributed to Intangible Asset.) Entry E Amortization Expense 11,000 Intangible Asset (To record current year’s amortization of intangible asset.) 11,000 Entry P Accounts Payable Accounts Receivable (To eliminate intercompany debt.) 28,000 28,000 Entry TA Equipment 10,000 Gain on Sale of Equipment 8,000 Accumulated Depreciation 18,000 (To eliminate financial effects as of 1/1/09 created by intercompany transfer of equipment.) Entry TI Sales McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e 90,000 © The McGraw-Hill Companies, Inc., 2009 6-47 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Cost of Goods Sold 90,000 (To eliminate intercompany inventory transfers for the current year.) 46 (continued) Entry G Cost of Goods Sold 6,000 Inventory 6,000 (To defer unrealized intercompany gain remaining at the end of the current year Markup is 33⅓% [$30,000 gross profit ÷ $90,000 transfer price] indicating that the ending inventory of $18,000 contains an unrealized profit of $6,000 [$18,000 x 33⅓%].) Entry ED Accumulated Depreciation 2,000 Depreciation Expense 2,000 (To eliminate excess depreciation resulting from intercompany gain of $8,000 on transfer of equipment [see Entry TA] Equipment is being depreciated over a remaining life of four years.) 47 (30 minutes) (Consolidated Cash Flow Statement with current year business combination) Plaster Inc and Subsidiary Stucco Company Consolidated Statement of Cash Flows For the year ended 12/31/09 Consolidated net income Depreciation expense Amortization expense Decrease in accounts receivable (net of acquisition) Increase in inventory (net of acquisition) Decrease in accounts payable (net of acquisition) Net cash provided by operations $274,000 $187,500 8,750 3,600 (102,000) (8,000) Purchase of Stucco Company assets (net of cash acquired) Net cash used in investing activities Issue long-term debt Dividends Net cash provided by financing activities Increase in cash 1/1/09 to 12/31/09 Beginning Cash, 1/1/09 Ending cash, 12/31/09 McGraw-Hill/Irwin 6-48 89,850 $363,850 (856,000) $800,000 (108,000) 692,000 199,850 43,000 $242,850 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Excel Case–Intercompany Bonds Bonds with a stated rate of 11% sold to yield 12% Eff Yield 12% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1,000,000.00 110,000.00 943,497.77 946,717.50 950,323.60 954,362.43 958,885.93 963,952.24 969,626.51 975,981.69 983,099.49 991,071.43 1,000,000.00 0.32197 5.65022 321,973.24 621,524.53 943,497.77 113,219.73 113,606.10 114,038.83 114,523.49 115,066.31 115,674.27 116,355.18 117,117.80 117,971.94 118,928.57 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 Consolidated Worksheet Entry 12/31/10 Bonds Payable 954,362.43 Interest Revenue 117,523.20 Loss on retirement 0.00 Gain on retirement Investment in Bonds Interest Expense 46,299.01 911,547.79 114,038.83 Bonds retired by affiliate on 1/1/10 at Eff Yield 13% 1,000,000.00 0.37616 110,000.00 4.79877 2010 2011 2012 2013 2014 2015 2016 2017 904,024.59 911,547.79 920,049.00 929,655.37 940,510.57 952,776.95 966,637.95 982,300.88 1,000,000.00 117,523.20 118,501.21 119,606.37 120,855.20 122,266.37 123,861.00 125,662.93 127,699.12 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e 56,502.23 3,219.73 3,606.10 4,038.83 4,523.49 5,066.31 5,674.27 6,355.18 7,117.80 7,971.94 8,928.57 56,502.23 904,024.59 376,159.86 527,864.73 904,024.59 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 95,975.41 7,523.20 8,501.21 9,606.37 10,855.20 12,266.37 13,861.00 15,662.93 17,699.12 95,975.41 © The McGraw-Hill Companies, Inc., 2009 6-49 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Financial Reporting Research and Analysis Case The number of potential solutions is large Searches in Lexis-Nexis, Edgar, etc will produce numerous examples of consolidations of VIEs For example, Walt Disney Company prepares a before and after disclosure of its newly consolidated VIEs Euro Disney and Hong Kong Disneyland as follows (12-31-04): Cash and cash equivalents Other current assets Total current assets Investments Fixed assets Intangible assets Goodwill Other assets Total assets Before Euro Disney and Hong Kong Disneyland Consolidation $1,730 7,103 8,833 Euro Disney, Hong Kong Disneyland and Adjustments $312 224 536 Total $2,042 7,327 9,369 1,991 12,529 2,815 16,966 6,843 $49,977 (699) 3,953 135 $3,925 1,292 16,482 2,815 16,966 6,978 $53,902 $1,872 6,349 8,221 $2,221 617 2,838 $4,093 6,966 11,059 Borrowings 8,850 Deferred income taxes 2,950 Other long term liabilities 3,394 Minority interests 487 Shareholders' equity 26,075 Total liabilities and shareholders' equity $49,977 545 -225 311 $3,925 9,395 2,950 3,619 798 26,081 $53,902 Current portion of borrowings Other current liabilities Total current liabilities McGraw-Hill/Irwin 6-50 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual ... balances being recorded by the two McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 6-5 Find more slides, ebooks, solution manual and testbank... convertible securities McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 6-3 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com... Balance McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e $200,000 © The McGraw-Hill Companies, Inc., 2009 6-7 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com