Hilton6e SM08

Chapter 8
Consolidated Cash Flows and

Ownership Issues
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2010 McGraw-Hill Ryerson Limited. All rights reserved.

Modern Advanced Accounting in Canada, Sixth Edition
DESCRIPTION OF CASES AND PROBLEMS

CASES
Case 1
One day after purchasing 100% of the shares of a company, the parent sells 40% of these
shares to an unrelated party and realizes a substantial profit. The parent wants to recognize
this gain on the date of acquisition rather than the date of sale.
Case 2
The company pays a premium to buy out a minority shareholder who has been very
aggravating to the controlling shareholder. You are asked to resolve a dispute over how to
account for the acquisition differential.
Case 3
This case, adapted from a CA exam, involves a public company wishing to divest a wholly
owned subsidiary. You are asked to recommend accounting policies to maximize the selling
price and how the agreement should be changed to minimize disputes in the future.
Case 4
This case, adapted from a CA exam, involves a forestry company. You are asked to
recommend accounting policies relating to valuation of intangible assets, revenue recognition,
asset impairment and sale of a portion of a subsidiary.
PROBLEMS
Problem 1 (20 min.)
A consolidated cash flow statement is presented and the student is required to answer a series
of questions with regard to the consolidation process.
Problem 2 (40 min.)
This comprehensive problem requires the preparation of consolidated financial statements
when the subsidiary has preferred shares outstanding. Calculations involved with an
ownership reduction and unrealized profits in inventory and plant and equipment are also
required.
Problem 3 (40 min.)
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This problem is concerned with the calculations of the investment account and unamortized
acquisition differential when there has been an increase and decrease in a parents ownership
interest.
Problem 4 (30 min.)
The preparation of a consolidated cash flow statement is required given that there has been a
reduction in the parent's investment during the year.
Problem 5 (25 min.)
This problem requires the calculation of consolidated profit and other consolidation amounts
when there is an indirect shareholding involved.
Problem 6 (20 min.)
This problem requires the calculation of consolidated profit, retained earnings, and noncontrolling interest for the first year after acquisition when the subsidiary has cumulative
preferred shares outstanding.
Problem 7 (30 min.)
The calculations of the gains and losses associated with ownership reductions are required
along with an explanation of whether the historical cost principle is used in accounting for the
acquisition differential.
Problem 8 (25 min.)
The straightforward preparation of a consolidated cash flow statement is required from a list of
consolidated financial statement items.
Problem 9 (25 min.)
A journal entry and calculations of unamortized acquisition differential are required when there
has been a reduction in the parent's ownership.
Problem 10 (40 min.)
This problem requires the calculation of patents, consolidated profit, retained earnings, and
non-controlling interest for the second year after acquisition when the parent increases its
percentage ownership from 75% to 95%.
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This problem requires the calculation of consolidated profit attributable to the parents
shareholders and non-controlling interest when a parent has indirect holdings and an
explanation of how the revenue recognition principle supports adjustments for unrealized
profits.
The preparation of a consolidated balance sheet is required immediately after the parent's
ownership decreases due to a new share issue by the subsidiary.
This problem requires the preparation of a consolidated balance sheet and a consolidated
retained earnings statement where indirect shareholdings are involved.
The preparation of a consolidated cash flow statement is required along with an explanation on
why 100% of the subsidiarys dividends do not appear on the consolidated cash flow
statement.
This problem is concerned with the calculations of the investment account, unamortized
acquisition differential and non-controlling interest when the parent sells and is deemed to sell
part of its investment.
This is a fairly comprehensive problem involving the step acquisitions of a subsidiary company
that has preferred shares in its capital structure. There are unrealized profits in inventory and
equipment. The problem also requires the calculation of goodwill impairment loss and NCI
under the parent company extension theory. Non-controlling interest is valued using the market
price of the subsidiarys shares at the date of acquisition.
Problem 17 (60 min.) (prepared by Peter Secord, Saint Marys University)
The preparation of consolidated financial statements is required when the subsidiary has
convertible preferred shares and there have been unrealized intercompany profits from asset
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transfers. Also required is a brief discussion on the reporting implications if the preferred
shares were converted to common shares.
Problem 18 (60 min.) (prepared by Peter Secord, Saint Marys University)
The question requires the calculation of amounts for certain consolidated financial statement
items when step purchases have occurred and there are unrealized profits in inventory and
depreciable property, plant and equipment.
WEB-BASED PROBLEMS
Problem 1
The student answers a series of questions based on the most recent financial statements of
Vodafone, a British company. The questions involve an analysis of the cash flow statement
and changes in the parents percentage ownership.
Problem 2
The student answers a series of questions based on the most recent financial statements of
Siemens, a German company. The questions involve an analysis of the cash flow statement
and changes in the parents percentage ownership.
REVIEW QUESTIONS
1.
It could be prepared by consolidating the cash flow statements of the parent and its
subsidiaries, but this would be a complex process. It is much easier to prepare the
statement by analyzing the yearly changes that have occurred in the noncash items in the
consolidated balance sheet.
2.
$700,000 (minus any cash on the balance sheet of the subsidiary company) would
appear as an outflow in the investing activities section. Because the $300,000 share
issue did not affect cash, it would not appear as a separate item on the consolidated cash
flow statement. However, complete footnote disclosure would be required and would
indicate the total acquisition price, the consideration given (cash and common shares),
and a summary of the assets, liabilities, and equity interest acquired.
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3.
The amortization of the acquisition differential is similar to depreciation expense in that it

is deducted in the determination of net income but does not represent a cash outflow.
Therefore, similar to depreciation expense, the amortization of the acquisition differential
is added back to consolidated net income to determine cash flow from operations in the
consolidated cash flow statement.
4. Dividend payments to noncontrolling shareholders represent a flow ofcash outside the

economic entity, and, as a result, they must be disclosed on the consolidated cash flow
statement. The only dividends that can be reported in the consolidated statement of
retained earnings are those that are paid to the parent's shareholders. From the
consolidated entity's point of view, dividends declared or paid to noncontrolling
shareholders represent a reduction of the equity of the non-controlling interest in the
subsidiary's assets. If a statement of changes in non-controlling interest were presented,
it would show an increase from the allocation of entity net income, and a decrease from
dividends to noncontrolling shareholders.
5.
The change from the cost to the equity method should be accounted for retroactively
under the following circumstances:
- when the reason for the change is to correct an error in prior periods i.e., the entity
should have been using the equity method in the past but was using the cost method, or
- when the entity could have been using either method in the past and is now changing
from one equally acceptable method to another. For example, the parent company can
use either the cost method or equity method for recording purposes when it controls the
subsidiary and prepares consolidated financial statements.
On the other hand, if the change is being made as a result of a change in circumstance,
the change should be accounted for prospectively. For example, if the investor company
increases its investment from 10% to 30% of the shares of the investee company and
thereby changes from having no influence to having significant influence, then the
change is made prospectively.
6.
No, the subsidiarys net assets are only valued at fair value at the date of acquisition i.e.
when the parent first obtains control of the subsidiary. When increasing the percentage
ownership from 60% to 75%, the parents portion of the unamortized acquisition
differential increases and the NCIs portion decreases by the same amount, which is the
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carrying value of the portion sold by the NCI. Neither the parents portion nor the NCIs
portion is revalued to fair value as a result of this transaction.
7.
The non-controlling interest is not revalued to fair value because the parents interest is
not revalued at fair value. Revaluation only occurs when the purchasers position
changes from not having control to having control. In this situation, the parent had control
at 76% and still has control at 60%. The decrease in the parents carrying value is added
to the non-controlling interest.
8.
When the parent's ownership declines because of a subsidiary share issue, a loss to the
parent occurs due to the reduction in the parent's investment account. However, a gain
occurs from the perspective of the parent due to the parent's new share of the proceeds
from the subsidiary share issue. The two are netted and produce a net loss or gain on the
transaction. This gain or loss is reported as an equity transaction i.e. a transaction
between shareholders. The gain or loss is reported as a direct credit or charge to
shareholders equity i.e. a credit to contributed surplus or a debit to retained earnings.
9.
No, a gain or loss realized by a parent company on the sale of part of its investment in
the common shares of its subsidiary is not eliminated in the preparation of the
consolidated financial statements because it represents a transaction between the
consolidated entity and parties outside the entity.
10. Yes, assuming that the parent company does not own all of the preferred shares. The
consolidated income statement will show a non-controlling interest equal to the noncontrolling interests share of the subsidiary's net income applicable to the preferred
shares. The consolidated balance sheet will show an amount for non-controlling interest
equal to the non-controlling interests share of the total shareholders' equity of the
subsidiary that is applicable to that company's preferred shares.
11. Net income for the year
17,000)
Allocated to preferred shares
(12,000)
Net income for common shares
5,000
The common shareholders have the right to income remaining after the claim of the
preferred shareholders. In this case, income of $5,000 belongs to the common
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shareholders.
12. Because in most situations the market value of preferred shares is related to the general
level of interest rates, it does not make sense conceptually to use a preferred share
acquisition differential to revalue the net assets of the subsidiary when consolidated
financial statements are prepared. Therefore, a negative acquisition differential should be
added to consolidated contributed surplus and a positive acquisition differential should be
deducted from consolidated contributed surplus (if there is any) or from consolidated
retained earnings.
13. When a parent company acquires less than 100% of its subsidiary's preferred stock, the
preferences associated with this preferred stock must be considered in determining the
amounts of the shareholders equity (net assets) that is assignable to both preferred and
common non-controlling interests. For example, if the preferred shares are cumulative,
any preferred dividends in arrears must be included in the shareholders' equity allocated
to the preferred shares. In this particular case, the non-controlling interest consists of
70% of the preferred equity and 10% of the common equity, and income is allocated
accordingly.
14. The subsidiarys income is split between the preferred shareholders and common
shareholders prior to calculating the parents and NCIs share of the subsidiarys income.
If the preferred shares are cumulative, the preferred shareholders are entitled to a share
of the investees income each year regardless of whether dividends are actually paid in
any given year. However, if the preferred shares are noncumulative, the preferred
shareholders will only receive a portion of the investees income of a given year if
dividends are actually declared in that year. Similarly, when calculating consolidated
retained earnings, the change in the subsidiarys retained earnings since acquisition must
be split between the preferred shareholders and the common shareholders prior to
calculating the parents share of the change in retained earnings. The preferred
shareholders will receive a portion of the investees income for all years for which they
were entitled to receive a portion of the income less the amount of dividends already
received for those years.
15. The major consolidation problem associated with indirect shareholdings is the iterative
nature of the calculations. One must start at the lowest level of the corporate hierarchy
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and work up the corporate structure. At each level, the income of the subsidiary has to be
adjusted for amortization of the acquisition differential and unrealized profits. Then, the
income is attributed to the controlling and non-controlling shareholders. In the end, the
non-controlling interest incorporates its share of each of the different entities on a
cumulative basis.
MULTIPLE-CHOICE QUESTIONS
1.
2.
(900 440) 1,270 = 810
3.
200 x .25 = 50
4.
40 x .25 = 10
5.
6.
7.
8.
100 x 8% x 2.5 years = 20
9.
10 x $13 = 130
10.
.20 x (264 / .8) = 66
11.
100 + (10 x 13 - 100) + (8% x 100 x 2.5) = 150
12.
13.
(750 / .75) (500 + 240 + 90 x 8/12) 40 = 160

160 160 / 10 x 4/12 = 154.667
14.
750 + .75(90 x 4/12) .75(10) [.75(40) /5 x 4/12] [.75(160)/10 x 4/12] = 759

160 .2(759) = 8.2
15.
16.
17.
18.
19.
75% (.2[75%]) = 60%
CASES
Case 1
(a) A subsidiary is usually valued at fair value at the date of acquisition. Fair value is defined
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as the amount of consideration that would be agreed upon in an arms-length transaction

between knowledgeable, willing parties who are under no compulsion to act. Since Pepper
and Salt were unrelated parties at the date of acquisition, one could argue that $720, the
amount paid by Pepper, represented the fair value of Salt. Using this same logic, one
could also argue that Salt was worth $1,250 on this date since an unrelated party was
willing to pay $500 for 40% of the shares of Salt one day after Pepper purchased Salt.
What is the fair value of Salt as a whole? That is the big question. Once we have
determined the fair value of Salt as a whole, we can determine the fair value of Salts
goodwill and whether Pepper can record a gain on purchase.
The following consolidated balance sheets were prepared at December 31, Year 7 under
three different valuation alternatives:
A.
The fair value of Salt as a whole is $720 and Salts goodwill is valued at $450,
the excess of amount paid by Pepper ($720) over the fair value of Salts identifiable net
assets ($120 + $350 $200)
B.
The fair value of Salt as a whole is $1,250 and Salts goodwill is valued at the
excess of amount paid by Pepper over the fair value of Salts identifiable net assets
C.
The fair value of Salt as a whole is $1,250 and Salts goodwill is valued as the
difference between the value of Salt as a whole ($1,250) and the fair value of Salts
identifiable net assets ($120 + $350 $200)
A
$ 620
$ 620
$ 620
Intangible assets (200 + 350)
550
550
550
Goodwill
450
450
980
$1,620
$1,620
$2,150
$ 600
$ 600
$ 600
1,020
1,020
1,550
$1,620
$1,620
$2,150
Tangible assets (500 + 120)
Liabilities (400 + 200)

Shareholders equity (300 + 720)
The shareholders equity in C includes a gain on purchase of $530, which is the difference
between the value of the subsidiary as a whole ($1,250) and the amount paid by Pepper
($720).
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To answer which method best reflects economic reality, one needs to know what the true
value of the subsidiary is. If it is $720, then column A best reflects economic reality and
would be required under GAAP. If the true value of the subsidiary is really $1,250, then
column C best reflects economic reality. However, GAAP requires that goodwill of the
subsidiary is valued as the difference between the amount paid and the fair value of the
identifiable net assets. Therefore, Pepper could not report a gain on purchase in Year 7
and would have to use column B.
(b) When a parent sells a portion of its interest in the subsidiary and retains control over the
subsidiary, the value of the subsidiarys assets and liabilities on the consolidated balance
sheet do not change they are retained at carrying value. The carrying value of the
portion sold is transferred from the parents interest to the non-controlling interest. The
parent will report a gain or loss for the difference between the proceeds received from the
sale and the carrying value of consideration sold. This gain will not be reported in net
income but will be reported as a direct adjustment to shareholders equity either to
retained earnings or contributed surplus.
The following consolidated balance sheets were prepared at January 1, Year 8 under the
same three valuation alternatives considered above.
A
$ 500
$ 500
$ 500
Tangible assets (500 + 120)
620
620
620
Intangible assets (200 + 350)
550
550
550
Goodwill
450
450
980
$2,120
$2,120
$2,650
$ 600
$ 600
$ 600
288
288
500
1,232
1,232
1,550
$2,120
$2,120
$2,650
$ 720
$ 720
$ 1,250
40%
40%
40%
Cash
Liabilities (400 + 200)

Non-controlling interest (Note 1)
Shareholders equity (Note 1)
Note 1:
Carrying value of Salts net assets
on consolidated balance sheet
Portion sold to non-controlling interest
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Value assigned to non-controlling interest
288
288
500
Proceeds received from non-controlling interest
500
500
500
Gain on sale of 40% interest
212
212
1,020
1,020
1,550
$1,232
$1,232
$1,550
Shareholders equity prior to sale

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

contributed surplus. In scenario C, no gain on sale is recorded on January 1, Year 8
because a gain of $530 was reported on December 31, Year 7. In all cases, noncontrolling interest is valued at 40% of the carrying values of the subsidiarys assets and
liabilities on the consolidated balance sheet at the date of the sale.
Case 2
Both the CFO and controller are wrong. The transaction is a capital transaction between
shareholders of Stiff. Since Prince controlled Stiff both before and after this transaction, the
valuation of Stiffs assets and liabilities for consolidation purposes will not change. Only the
parents and non-controlling interests share of the consolidated net assets will change. Any
difference between the amount paid by Prince and the carrying value given up by the noncontrolling interest will not be reported in profit but will be reported as an adjustment to
shareholders equity. For this transaction, the difference is $700,000 calculated as follows:
Purchase price (110 x 100,000 x 20%)
Book value of Stiff shares acquired (70 x 100,000 x 20%)
Book value of acquisition differential acquired (500,000 x 20%)
Excess
2,200,000
1,400,000
100,000
1,500,000
700,000
The $700,000 will be reported as a reduction to contributed surplus, if any exists, or a

reduction to retained earnings.
Even if the acquisition differential were allocated to assets and liabilities, the entire amount
would not have been allocated to goodwill. $260,000 (20% x $1,300,000) should be allocated
to the patents in order to recognize the value of the patents. The remaining amount would be
allocated to goodwill. Then, the goodwill would have to be assessed for impairment at the end
of Year 13 and all subsequent years by determining the fair value of Stiffs shares. The recent
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trading price of $100 is not necessarily a true indication of the fair value of the shares. It
represents the exchange price for the parties exchanging shares on that particular date. To
acquire control of Stiff, investors may be willing to pay more or less than $100 per share. An
independent business valuation could determine the fair value of the shares. If the fair value is
less than $110 per share, the goodwill will have to be written down to reflect the impairment in
value. For example, if the fair value of the shares were only $105 per share, the purchase
price would have been inflated by $100,000 ($5 x 100,000 x 20%). In turn, goodwill would
have been overstated by $100,000 and would have to be written down by $100,000 in Year 13.
The $260,000 allocated to the patent would have to be amortized over the useful life of the
patent commencing in Year 14. Given a useful life of 4 years, the amortization expense would
be $65,000 ($260,000 / 4) per year and would cause a decrease in income of $65,000 for Year
14.
Case 3
Canada Transport Enterprises Inc. ("CTE")
Attention: Andrew Joel
DRAFT REPORT
Dear Andrew:
Sale of Traveller Bus Lines ("TBL")

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

The sale of TBL will have a significant impact on CTE's share price. Therefore, by maximizing
the sale price, you will be maximizing the share value as well. However, the sale of TBL, one of
CTE's profitable divisions, may adversely affect the share price. Management should consider
the impact of the sale on the share price.
Other alternatives are available for valuing a business and should be considered. Specifically,
a capitalized earnings approach would be a better way to value TBL. The reason is that future
earnings will reflect the value of assets that are not fully recorded on the balance sheet for
example, intangible assets. This approach can also be justified on the grounds that earnings
have been stable and could be used to calculate the sale price.
Earnout clause
The new owners of TBL will be preparing the July 31, Year 8 financial statements, which will be
used to calculate the earnout amount. They will want to minimize the sale price. We should
specify in the agreement that the accounting policies cannot be changed in the year in which
the earnout is calculated. In addition, the new owners could make overly aggressive accruals
to further minimize the selling price. For example, they could pay unusually high salaries or
bonuses to reduce income. Restrictions should be placed in the agreement to prevent such
measures, and CTE should be allowed to independently verify the July 31, Year 8 results.
Possible adjustments to the selling price

The accounting policies chosen for TBL's financial statements will impact the calculation of the
selling price. Adjustments that increase the net value of TBL assets sold are more desirable
than adjustments that affect the earnout payment because CTE will receive all increases in the
NBV and only 55% of increases that affect the July 31, Year 8 earnings.
We must determine whether we must use generally accepted accounting principles or whether
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we can use a disclosed basis of accounting. If a disclosed basis of accounting is acceptable,

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

It appears that the liability for giving skis or skates to customers must be provided for. This will
decrease the selling price. In addition, the cash received for the passes could be reported as
revenue even though the three-month passes have not yet expired. The revenue could be
recorded in Year 7 since there is no incremental costs of having ticket-holders take the bus
thereby increasing the selling price.
Consolidation entries
Fair value increments (fixed assets and goodwill) are not currently included in the selling price.
However, these amounts should be included in the selling price since they probably represent
the FV of the assets being sold. Pushdown accounting treatment is recommended. It may be
preferable to revalue the company since the goodwill and fair value increments have likely
changed since they were first recorded.
Long-term receivables
We must determine whether this amount should be written down to fair value. If so, it will
decrease the selling price. Although the security does not cover the amount of the outstanding
balance, receivable is being collected. Therefore, we should argue that the loan is not
impaired and a write-down is not necessary.
Advertising
Plans call for an aggressive advertising campaign ($500,000), and the agreement states that
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CTE will pay for these costs. However, the benefit is likely to be received in years subsequent
to the earnout. The payment of advertising costs should be considered further.
Bus retrofit
TBL is planning substantial costs to retrofit the fleet of buses. These costs will occur next year
yet will benefit TBL for many years to come. These costs should be capitalized or excluded
from the agreement.
Futures taxes
The deferred taxes should either not be considered in determining the selling price or should
be discounted if they are to be included. Otherwise, the selling price would be reduced.
Lease facility
We must determine whether a loss should be accrued for future lease payments. If so, the
selling price will decrease. TBL is receiving the benefit; therefore, CTE should not bear the
cost of moving. One possible alternative to providing for this amount is to account for these
payments on a cash basis, assuming that CTE will be able to sublet.
Significant accounting issues CTE

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

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

The terminology used in the draft agreement is open to interpretation. The ambiguous wording
may create arguments in the future if one party disagrees with the other's interpretation or
earnings calculation. To minimize future disputes, we recommend the following changes to the
agreement:
1. Clause 1. The assets and liabilities included in the purchase and sale agreement should be
based on the audited financial statements rather than on the draft July 31, Year 7 financial
statements. The audited financial statements will provide you with greater assurance with
respect to the accuracy of the figures and accounts reported.
2. Clause 2. The environmental liabilities that are not included in the agreement should
be limited to those that are CTE's responsibility up to the date of sale. In addition, this
clause should be effective for only a limited period of time. In addition, you may want to
have an environmental assessment performed prior to the sale to determine what the
potential exposure is.
3. Clause 3. The term "net reported income" must be clearly defined to ensure that there
is no misunderstanding as to what is and what is not included in the calculation. In
addition, this calculation is based on TBLs net income, and future profits may differ
from past results, especially if the new management is inefficient in the short term and
incurs significant "start-up" costs.
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4. Clause 5. You should clarify what "compete" means and what is included in the
limitation. For example, does it mean that you cannot operate any bus line service
anywhere in the world?
5. Clause 6. The loan guarantee is for an unlimited period of time. Unless a specific
expiry date is used, CTE will be responsible for the loan until it is ultimately paid.
6. Clause 7. "Cost" must be explicitly defined. For example, defining cost as "fulI cost"
(including overhead allocations) or as "out-of-pocket cost" produces very different
results.
7. Clause 8. The phrase "restored to its original condition" must be defined. This clause
could result in a significant cost to CTE if it is not clarified. For example, it could mean
a complete reconstruction of the building.
8. Clause 9. You should place a limit on the dollar value of advertising that CTE is obliged
to provide under the agreement. As the clause is now worded, CTE could incur very
large costs.
9. Clause 12. The longer payment terms will lower the effective purchase price given the
present value of money. Either the purchase price can be increased or payment can
be made sooner.
10. Clause 14. You must determine the nature of the consulting agreement what it does
and does not include.

We would be pleased to discuss our comments and recommendations with you at your
convenience.
Yours truly,
CA
Case 4
Memo to:
From:
Subject:
Engagement Partner
CA
Analysis of Accounting Issues Concerning Capilano Forest Company Limited
(CFCL or the Company)
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Overview
For the current year, the newly hired controller intends to make changes to some of the
existing financial accounting policies of CFCL. His rationale for these changes is to maximize
the value of the Company because it may be sold to a large Japanese lumber importer.
It should be noted at the outset that financial statements might be of very limited usefulness in
the valuation of this company. Although the purchasers may use the statements to assess
logging costs or management performance, they will probably focus on timber reserves, since
that is the primary value of a forestry company. Therefore, as auditors working for Don Strom,
we must ensure that the controller is not changing the financial statements simply for his own
benefit, given that his bonus is based on net income. Such changes would clearly not be in the
best interests of Mr. Strom. In fact, Mr. Strom's primary concern may be to minimize income
thereby reducing bonus and tax costs. As mentioned, the buyers may not be too concerned
with the financial statements in valuing CFCL, so Mr. Strom may not be well served by the
controllers efforts to increase income.
(Most candidates failed to evaluate the objectives and needs of the preparers and users.)
The controller has identified several areas where he would like to change the accounting
policy. I have analyzed these proposals with reference to generally accepted accounting
principles, and have provided alternatives where appropriate.
(Most candidates failed to present alternative accounting treatments for the issues presented in the
question.)
Rights granted for Crown land
An argument could be made for recording the fair value of the rights, as the controller has
suggested in the financial statements. Future value will be associated with the rights because
revenues from logging will probably exceed the payments to the government for logs
harvested and the costs of reforestation. In addition, one could argue that fair value is
appropriate since this is essentially a non-monetary transaction - obtaining logging rights may
be considered the culmination of an earnings process in the forestry industry. This viewpoint is,
however difficult to defend.
If CFCL adopts this alternative, it will be very difficult to estimate the fair value of these rights.
Many assumptions would have to be made, and gathering the relevant information would take
considerable time.
We will also have to consider the basis of amortization of these rights. Alternatives include
expensing as trees are sold or amortizing the cost evenly over the life of the right.
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There are strong arguments against recording the rights in the financial statements. The
historical cost principle as well as the conservatism concept support no recognition in the
accounts; essentially, no asset was given up to obtain these rights. In addition, it is unlikely
that this transaction could be accepted as a culmination of an earnings process. It should
therefore be recorded at the amount of the asset that was given up, which is nil in this case.
The controller's proposal to reflect the fair value of the timber rights on the financial statements
may be intended solely to generate a windfall profit and is thus self serving. Disclosure of
these rights in a note may be sufficient for the purposes of the purchasers in valuing the
Company.
(Candidates failed to present valid arguments that supported recording the rights at fair value or at a nil
amount. Candidates did not make use of basic accounting concepts in their analysis.)
The rights granted in the prior periods should be accounted for in a manner consistent with
that of the current rights. If it were decided to record them at fair value, then it would be
necessary to restate prior years' amounts retroactively since recording them at fair value
represents a change in accounting policy.
Logging fees
Fees paid to the government for logs cut could be recognized as a period expense, instead of
being expensed when the trees are sold. We would have to view the logging records and the
agreement with the government to gain assurance that year-end accruals are done properly.
There is unlikely to be a lot of inventory on hand at any given time, so it is likely that expenses
will be reasonably well matched to revenues.
Reforestation costs
The current year's financial statements for CFCL must show an accrual for the reforestation
costs associated with trees logged under the Ministry rights. Depending on the degree of
reforestation currently done by CFCL, this amount may be difficult to estimate.
It will also be necessary to accrue costs for the reforestation of the rights granted in prior
years. This cost would be expensed in the current year since it is a result of actions taken by
the Ministry of Forests in the current year. CFCL may want to consider separate line disclosure
of this cost, as it is not tied to the current year's operations and would not be relevant for the
buyers in trying to estimate logging costs.
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If CFCL were able to log the reforested trees in the future, then an alternative would be to
capitalize the reforestation costs since a future benefit will be derived.
Purchased rights at mine site
There is a serious valuation problem with regard to the five-year timber rights acquired at a
future mine site. Due to insect infestation, a write-down in the value of the purchase rights may
be appropriate given that a net future benefit may no longer be associated with these timber
rights. The fact that the controller may not agree is not surprising given his bonus arrangement.
Assuming that a future net benefit is associated with the timber rights, the cost of the timber
rights must be amortized in a manner that matches the income from the logs. The alternatives
are as follows:
1.
Amortize the cost of the rights based on the total number of trees cut, or
2.
Allocate the cost based only on good trees cut during the time period, or
3.
Expense the cost evenly over five periods.
The first two alternatives will be difficult to implement because it will be difficult to ascertain
how many trees can be logged in five years, let alone how many good logs as opposed to
insect-infested logs can be logged. Assuming it is likely that the same number of logs can be
logged in most seasons and given that the Company has a demonstrated ability to sell all logs
cut, it may be simpler to amortize the rights equally over the five years.
(Candidates could have arrived at a different conclusion as long as it was supported by the facts of
the case and by their analysis.)
Tree costing
It seems illogical to suggest that little or no cost is associated with the trees that are harvested.
The purchase price of forest property is based on the trees on the property rather than on the
land. If the Company had purchased the lands with no timber on it some time ago and had
regenerated the timber, the controller's argument would have some merit. However, since it
takes 60 to 80 years to grow trees to maturity for logging, trees that will be grown through
reforestation have no present value.
Ongoing maintenance costs of timber properties could be expensed because the cost of
replanting and spraying pesticides is not large in comparison to other expenditures of the
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company. An argument can be made that they should be capitalized as the expenditures relate
to revenues that will be earned in the future. Similarly, a case could be made to capitalize other
carrying costs such as property taxes.
Pacific tract acquisition
In order to assess whether the $25,000 allocated to the sold parcel is an appropriate amount, it
is necessary to determine the value of this tract to CFCL upon its purchase. The $25,000
allocation may be considered reasonable considering its limited usefulness to CFCL at the time
of purchase. However, it is important to note that any allocation is arbitrary and will be difficult
to substantiate. The gain or loss on the sale of this land to developers should be disclosed
separately in the income statement since it is not part of recurring operations. Again, this
information may be useful to the purchasers in assessing ongoing costs.
(Candidates did not provide relevant arguments as to whether the allocation was appropriate.)
A write-down of the remaining timber property may be warranted. Value may be impaired since
the environmentalists may have permanently halted the generation of revenue. If it is found
that the question of logging on the property has not been settled and a write-down is
inappropriate, a potential contingent loss exists and should be disclosed in the financial
statements, if material.
(Again, candidates failed to consider the significant valuation issue.)
The controller's interest in capitalizing costs for legal fees, public relations and idle time
appears to be motivated by furthering his own objectives of maximizing current income. These
costs cannot be capitalized as goodwill since goodwill can arise only upon the purchase of a
business. However, these costs may be capitalized as part of the costs of the trees since the
costs were necessary to obtain a future benefit - the ability to log the trees in the future.
However, this future benefit is highly questionable in light of the significant uncertainty
involved, and conservatism would suggest expensing these costs.
(Candidates did not provide support for capitalization in accounts other than goodwill.)
Forest fires
The costs of the forest fires cannot be capitalized as goodwill since, as mentioned previously,
goodwill arises only upon the purchase of a business. However, they can be capitalized as part
of the protected trees. These costs were incurred to ensure a future benefit from these trees.
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However, this treatment may not be appropriate given the uncertainty of this future benefit. In
fact, we must investigate whether these fires still present a threat to CFCL's forests, since
there may be a significant impairment in value of these sites. It will be very difficult for us to
obtain assurance, as predicting the course and outcome of fires is probably impossible.
The $300,000 commitment should be disclosed in the notes to the financial statements. There
is very little justification for including a liability in the financial statements for this amount since
it may not relate to past fire fighting efforts, and is probably not a legally enforceable
commitment.
(Most candidates recognized the valuation implications of these forest fires.)
Revenue recognition from sales of pine and wood chips
The strong demand for the pine produced by the Company is not sufficient to support the
recognition of revenue when the logs are cut, as suggested by the controller. Many
uncertainties still exist at that time, with the result that the risks and rewards of ownership have
not transferred and that revenues and costs cannot be measured within a reasonable degree
of accuracy. Specifically:
CFCL retains the risks associated with the wood until it is accepted by the purchasers
(i.e., title to the wood is not transferred until delivery in Japan). The risk also exists that
CFCL may become unable to provide satisfactory delivery to the purchasers.
The price can change by up to 5%, depending on the grade. This may be a material
amount on large orders.
The price can change due to foreign currency fluctuations.
(Candidates did not consider the relevant facts in deciding whether to recognize revenue.)
It is also not appropriate to recognize the revenue on the wood chips as they are produced.
Again, significant uncertainties still exist at that time. CFCL retains the risks associated with
these chips until they are in the hands of the buyer. Furthermore, delivery may be difficult, as
the current strike may last a long time, despite the controller's probably optimistic assumption
to the contrary. Furthermore, the strike settlement may increase the costs associated with
these sales, thereby decreasing the estimated profit.
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It is necessary for us to examine this contract with Remul Ltd. to ensure that CFCL does not
face any liabilities as a result of late or non-delivery.
Sale of 25% interest in subsidiary
The pending sale of a 25% interest in NAN is a capital transaction since Capilano controlled
NAN both before and after this transaction. Therefore, the valuation of NANs assets and
liabilities on the consolidated financial statements will not change. Only the parents and noncontrolling interests share of the consolidated net assets will change. Any difference between
the selling price of the shares and the carrying value given up by Capilano will not be reported
in net income but will be reported as an adjustment to shareholders equity. The carrying value
of the investment will need to be updated to the date of the sale by accruing the income
earned by NAN and amortizing the acquisition differential pertaining to the timber rights.
The sale should be reported on the closing date of the sale because that is when the benefits
and risks of the net assets being sold are transferred to the new shareholders.
(Most candidates appropriately did not spend much time on these relatively minor issues.)
(Candidates failed to analyze the issues in adequate depth. Alternatives were often not provided, or the
validity of the alternatives was not adequately analyzed. Furthermore, candidates failed to incorporate
the users' needs into their analysis.)
PROBLEMS
Problem 1
(a)
Since the cash flow statement is based on consolidated net income, the loss on sale of
equipment shown must have resulted from a sale to a nonaffiliate. A loss on sale to an
affiliate would be eliminated from consolidated net income, and any amount of
amortized loss from a previous sale would be included in the adjustment for
depreciation expense.
(b)
Bonds issued at a premium reflect a market rate that is lower than the bond's stated
rate, and as a result investors are willing to pay more to purchase the bond. When this
excess payment is amortized, it decreases the interest expense so that it reflects the
market rate when the bonds were issued. Therefore, the bond premium amortization
represents a noncash amount that decreases interest expense and increases income.
In this case, consolidated net income is higher as a result of a noncash item and that
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128
item must be deducted to calculate cash flow from operations.
(c)
Non-controlling interest in subsidiary's income =
9,800
Non-controlling interest's percentage
40%
9,800 / 40%
(d)
24,500
Goodwill impairment loss
1,000
Subsidiary's net income
25,500
Dividend payments to noncontrolling shareholders do represent a flow of cash outside

the economic entity, and as a result they must be presented on the consolidated cash
flow statement. However, from the consolidated entity's point of view, these dividends
are reported as a reduction of the non-controlling interest on the consolidated balance
sheet. The only dividends that can be reported in the consolidated statement of
retained earnings are those that are paid to the parent's shareholders.
(e)
Non-controlling interest's share of dividends =
6,000
Non-controlling interest's percentage
40%
Subsidiary's total dividends declared 6,000 / 40% 15,000
Problem 2
PART A
Cost of 70% (1400 2000) of Star
280,000
Implied value of 100%
400,000
Shareholders' equity
Total
Preferred
Preferred stock
50,000)
50,000)
Common shares
200,000)
Retained earnings
(80,000)
8,000*
170,000
58,000)
200,000) Dr
Acquisition differential
Allocated:
Common
(88,000) Dr
112,000
288,000
FV BV
Accounts receivable
Inventory
Plant
(2,000)
7,000
50,000
Long-term liabilities
(20,000)
Goodwill
35,000
253,000
* Dividends in arrears: 500 shares $8 2 years = 8,000

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Acquisition Differential Amortization Schedule

Balance
Amortization
Balance
Jan. 1, YR 5
YR 5 to 11
(2,000)
(2,000)
7,000)
7,000)
50,000)
50,000)
(20,000))
(17,500))
(2,500)
Goodwill
253,000)
138,970)
19,710
94,320
288,000)
176,470)
17,210
94,320
Before tax
Tax 40%
After tax
Opening inventory Star selling
30,000
12,000
18,000
Par selling
21,000
8,400
12,600
51,000
20,400
30,600
Closing inventory Star selling
35,000
14,000
21,000
Par selling
37,000
14,800
22,200
72,000
28,800
43,200
Accounts receivable
Inventory
Plant
YR 12
Dec. 31, YR 12
Intercompany receivables and payables

December management fee
2,000
Intercompany profits
Equipment Star selling

July 1, Year 7
22,000
Depreciation to Dec. 31, Year 11

(4,400 4 years)
19,800
Balance December 31, Year 11
2,200
880
1,320
Depreciation Year 12
2,200
880
1,320
0-

Star Year 12 dividends
20,000
Preferred 500 $8
4,000
Common
16,000
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130
70%
Intercompany dividends
11,200
Deferred income tax, December 31, Year 12

Closing inventory profit
28,800
Calculation of Year 12 consolidated net income

Par net income (loss)
Less: Dividends
30,000)
11,200)
22,200)
33,400)
(3,400)
Add: Opening inventory profit
12,600
9,200
Star net income (loss)

Less: Acquisition differential amortization
(24,000)
17,210)
Preferred claim on net income

Common net income (loss)
Less: closing inventory profit
4,000)
(45,210)
21,000)
(66,210)
Add: Opening inventory profit
18,000)
Equipment profit
1,320)
(46,890)
Preferred claim on net income

Consolidated net income
4,000)
(33,690)
Attributable to:
Pars shareholders
(23,623)
Non-controlling interests (100% x 4,000 + 30% x -46,890)
(10,067)
(33,690)
Calculation of consolidated retained earnings Jan. 1, Year 12
Par opening retained earnings
Less: Opening inventory profit
180,000
12,600
167,400
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Star retained earnings, Jan. 1, Year 12
208,000)
Acquisition
(88,000)
Increase
296,000)
176,470
Opening inventory profit
18,000
Unrealized equipment profit
1,320
Adjusted increase
195,790)
100,210)
70%
Consolidated opening retained earnings
70,147
237,547
(a)
Par Corp.
Consolidated Retained Earnings Statement
Year Ended December 31, Year 12
Balance January 1
$237,547
Net loss
23,623
213,924
Dividends
35,000
Balance December 31
$178,924
Calculation of non-controlling interest December 31, Year 12

Preferred
Preferred stock
Common
Total
50,000
Common shares
200,000)
Retained earnings
164,000)
364,000)
(21,000)
50,000
343,000
94,320
50,000
437,320
100%
30% )
50,000
131,196)
Unamortized acquisition differential
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181,196

132
(b)
Par Corp.
Consolidated Balance Sheet
as at December 31, Year 12
Cash (40,000 + 1,000)
41,000
Accounts receivable (100,000 + 85,000 2,000)
183,000
Inventory (55,000 + 48,000 72,000)
31,000
Land (30,000 + 70,000)
100,000
Plant and equipment (net) (220,000 + 400,000)
620,000
Deferred income tax
28,800
Goodwill
94,320
1,098,120
Accounts payable (92,000 + 180,000 2,000)
270,000
Accrued liabilities (8,000 + 10,000)
18,000
Common shares
450,000
Retained earnings
178,924
Non-controlling interest
181,196
1,098,120
PART B
Since dividends paid by Star in Year 12 exceeded the annual minimum of $4,000 (500 x $8 per
share), the income attributed to the preferred shareholders would be the same regardless of
whether the preferred shares were cumulative or noncumulative. Therefore, consolidated net
income attributable to Pars shareholders would not change.
PART C
Investment account cost basis, Dec. 31, Year 12
280,000)
Retained earnings Par equity basis
178,924
Retained earnings Par cost basis
175,000
3,924
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133

Investment account equity basis Dec. 31, Year 12
283,924
January 1, Year 13
Ownership reduction 70% 56% = 14%
14% 70% = 20%
Reduction in investment account
20% 283,924
56,785)
New assets of Star
100,000
56%
Loss
56,000)
785
This loss will be debited to contributed surplus, if any exists, or to retained earnings in
shareholders equity. If Par were using the equity method, the following entry would be made:
Retained earnings
785
Investment in Star
785
Problem 3
Dec. 31, Year 5 Regent owns 90% 8,000 shares = 7,200 shares
April 1, Year 6 2000 shares issued by Argyle
Regents % =
7,200
=
(8,000 + 2,000)
7,200
10,000
= 72%
Regent
Ownership before share issue
90%
Ownership after share issue
72%
Change
18%
Percentage of investment reduction: 18% / 90% = 20%

Oct. 1, Year 6 Regent acquires 1,300 shares
Regents % =
7,200 + 1,300
8,500
=
= 85%
10,000
10,000
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134
Therefore a step purchase of 13% has occurred.

(a)
Land
Equipment Trademarks
Total
Parent
NCI
Dec. 31, Year 5 (90/10)
28,333
44,444
52,223
125,000
112,500
12,500
Amort to April 1
(1,389)
(1,305)
(2,694)
(2,425)
(269)
April 1
43,055
50,918
122,306
110,075
12,231
28,333
20% sold to NCI

Amort April to Oct. 1 (72/28)
Oct. 1
28,333
22,015
(1,509)
(2,778)
(2,611)
(5,389)
(3,880)
40,277
48,307
116,917
84,180
32,737
13/28 sold to parent

Amort Oct. to Dec. 31 (85/15)
Dec. 31, Year 6
(22,015)
15,200
(15,200)
(1,389)
(1,305)
(2,694)
(2,290)
(404)
28,333
38,888
47,002
114,223
97,090
17,133
(b)
Parent
NCI
315,000
35,000
Net income to April 1 (50,000 3/12 90%)
11,250
1,250
Acquisition differential amortization to April 1
(2,425)
(269)
Investment account Dec. 31, Year 5
323,825
35,981
Result of Argyle share issue
20% 323,825
(64,765)
64,765
108,000
42,000
Net income April to Oct. (50,000 6/12 72%)
18,000
7,000
Acquisition differential amortization April 1 to Oct. 1
(3,880)
(1,509)
New shares (2,000 $75)
150,000
72%
381,180
148,237
Oct. 1 acquisition from NCI (13/28 x 148,237)
68,825
(68,825)
Net income Oct. to Dec. (50,000 3/12 85%)
10,625
1,875
(2,290)
(404)
(17,000)
(3,000)
Acquisition differential amortization Oct. to Dec.

Dividends (20,000 85%)
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135

441,340
77,883)
Proof:
Investment account Dec. 31, Year 6
441,340)
Shareholders' equity Jan. 1
225,000
New shares issued (2,000 x 75)
150,000
Net income
50,000
Dividends Dec. 31
(20,000)
Shareholders' equity Dec. 31, Year 6
405,000
85% )
Parents share of unamortized acquisition differential
344,250)
97,090)
Problem 4
Shareholders' equity of Sub Dec. 31, Year 1:
1,120,000
Parent's investment account Dec. 31, Year 1:

(1,120,000 + 565,000)
1,685,000
Parent's journal entry Jan. 1, Year 2:

Cash
629,000
Investment (30% 1,685,000)
505,500
Retained earnings - gain on sale
123,500
Effect on consolidated statements:

Cash
629,000
Non-controlling interest (30% 1,685,000)
505,500
Retained earnings - gain on sale
123,500
* Calculation of dividends paid to noncontrolling shareholders:

Opening balance of non-controlling interest
Carrying value of shares purchased from parent (30% 1,685,000)

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505,500

136
Add non-controlling interests share of sub's income
38,400
543,900
Less: Ending balance of non-controlling interest

Non-controlling interest in sub's dividends
515,000
28,900
Parent Ltd.
Consolidated Cash Flow Statement
For the Year Ended December 31, Year 6
Operating cash flow:
Profit
414,900)
Add (deduct):
Depreciation
370,000)
35,000)
Increase in inventory
(499,500)
Decrease in current liabilities
(701,500)
Decrease in accounts receivable

Cash used in operations
110,000)
(271,100)
Investing cash flow:

Proceeds from sale of investment in Sub
Acquisition of plant and equipment
Cash from investing
629,000)
(250,000)
379,000)
Financing cash flow:

Issuance of long-term debt
Dividends to Parent Ltd. shareholders
to noncontrolling shareholders
Cash from financing
500,000)
(104,000)
(28,900)*
367,100)
Net increase in cash
475,000)
Cash January 1
335,000)
Cash December 31
810,000)
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137

Problem 5
Cost of 70% of Simon
910,000
Implied value of 100% of Simon
1,300,000
Book value of Simon

Common shares
550,000
Retained earnings Jan. 1
400,000
Profit to April 1 ( 200,000)
50,000
1,000,000
300,000
Allocated: FV BV
Balance broadcast rights
300,000
Cost of 60% of Fraser
600,000
Implied value of 100% of Fraser
1,000,000
Book value of Fraser

Common shares
300,000
300,000
Profit to April 1 ( 150,000)
37,500
637,500
362,500
Allocated FV BV
Balance broadcast rights
362,500
Closing inventory profits
Before
Tax
After
tax
40%
tax
Simon selling
32,000
12,800
19,200
Princeton selling
18,000
7,200
10,800
(a)
Princeton Corp.
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138
Calculation of Consolidated Profit

for the Year Ended December 31, Year 7
Income of Princeton
100,000
Less: Dividends from Simon (70% 30,000)
21,000
Closing inventory profit after tax
10,800
31,800
68,200
Income of Simon ( 200,000)
150,000
Less: Broadcast rights amortization see part (c) 22,500

Dividend from Fraser
(60% 70,000)
42,000
19,200
83,700
66,300
Income of Fraser ( 150,000)
112,500
Less: Broadcast rights amortization see part (c)
27,188
85,312
219,812
Consolidated profit
Attributable to:
Princetons shareholders (68,200 + 70% x [66,300 + 60% x 85,312])
150,441
Non-controlling interests (30% x [66,300 + 60% x 85,312] + 40% x 85,312) 69,371
219,812
(b) Calculation of non-controlling interest Dec. 31, Year 7
Fraser shareholders' equity Dec. 31
680,000
Unamortized broadcast rights Fraser (see part c)
335,312
1,015,312
Non-controlling interests share
40%
Simon shareholders' equity Dec. 31
1,120,000
Retained earnings Fraser Dec. 31
380,000
Acquisition
337,500
Increase
42,500
Less: Broadcast rights amortization
27,188
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139
406,125

15,312
60%
9,187
1,129,187
Unamortized broadcast rights Simon (see part c)
277,500
1,406,687
Less: Closing inventory profit after tax
19,200
1,387,487
Non-controlling interests share
30%
416,246
822,371
(c) Calculation of consolidated broadcast rights Dec. 31, Year 7

Broadcast rights Simon
300,000
Less: amortization Year 7

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

(362,500 10 )
27,188
335,312
612,812
Problem 6
Cost of 80% (800 1000) of SET
56,000
Implied value of 100% of SET
70,000
Shareholders' equity
Total
Preferred
Preferred stock
40,000
Common shares
20,000
Retained earnings
30,000
8,0002
90,000
50,000)
42,000
Common
(2,000)
20,000
22,000
40,000
Acquisition differential (all allocated to patents)
30,000
Patent amortization Year 5 (six year life)
(5,000)
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140
Unamortized patent, December 31, Year 5
25,000
Calculation of consolidated profit

PET profit
30,000
Less: Dividends from SET3
(2,400)
27,600
SET profit
20,000
Less: Patent amortization
(5,000)
Consolidated profit
15,000
42,600
Attributable to:
PETs shareholders
36,400
NCI (4,0004 + 20% x [15,000 3 4,000 4])
6,200
42,600
Notes:
1. Liquidation value of 40,000 x 1.05 = 42,000
2. Dividends in arrears: 4,000 shares x $1/year x 2 years = 8,000
3. Dividends on common shares: (15,000 4,000 x $1/year x 3 years) x 80% = 2,400
4. Income for preferred: 4,000 x $1/year x 1 year = 4,000
(a)
PET Company
Statement of Retained Earnings
For the year ended December 31, Year 5
Retained earnings, beginning of year
$50,000
Profit
36,400
Dividends
(25,000)
Retained earnings, end of year
$61,400
(b)
PETs retained earnings
55,000
Total
Preferred
Common
SETs retained earnings,

End of Year 5
35,000
At acquisition
30,000
8,000
22,000
5,000
(8,000)
13,000
Change since acquisition

Copyright
141
35,000

Amortization of patents
(5,000)
(5,000)
(000)
(8,000)
8,000
PETs share
80%
Consolidated retained earnings, December 31, Year 5
6,400
61,400
(c)
Calculation of non-controlling interest income statement
Interest in preferred shares (100% x 4,000)
4,000
Interest in common shares (20% x 11,000 as per above)
2,200
Total
6,200
Calculation of non-controlling interest statement of financial position

Preferred
Preferred stock
42,000
Common shares
Retained earnings
Common
Total
(2,000)
40,000
20,000
20,000
35,000
35,000
42,000
53,000
95,000
25,000
42,000
78,000
100%
20% )
42,000
15,600)
57,600
Problem 7
(a)
July 1, Year 8
Proceeds from sale 720 $30
21,600
Book value sold (see * in part (c) below for calculation)
26,550
Loss on sale Year 8
4,950
Copyright

142
Dec. 29, Year 9

Reduction in investment account
** 118,800 ***1/9 (see ** and *** in part (c) below for calculation
of investment account and new percentage ownership)
13,200
Gain due to new assets

500 $46
23,000
Plumbers %
64%
Gain on share issue, Year 9
14,720
1,520
(b) The parent, using the equity method, would not report the gain (loss) on its income
statement. These two transactions resulting from the ownership change are viewed as
capital transactions between shareholders of the same consolidated entity. For capital
transactions, gains are reported in contributed surplus and losses are shown first as a
reduction in contributed surplus, if any exists, and then as a reduction to retained
earnings. The gain or loss from the capital transactions would not be eliminated in the
consolidation process and therefore would appear in shareholders equity on the
consolidated balance sheet in the same manner as it appears on Plumbers separate
entity balance sheet.
(c)
Total Parents
Investment account Jan. 1, Year 8 (90%)

NCIs
126,000
140,000
126,000
14,000
90,000
81,000
9,000
50,000
45,000
5,000
(50,000 10 = 5,000 1/2 year)
(2,500)
(2,250)
(250)
Balance July 1, Year 8, before sale
47,500
42,750
4,750
(8,550)
8,550
Common shares (4,000 shares)
20,000
Retained earnings
70,000
Trademarks Jan. 1, Year 8

Amortization to July 1, Year 8
Sale (720 / 3,600 = 20%)

Balance after sale July 1, Year 8 (72% & 28%)
47,500
34,200
13,300)
Amortization to Dec. 31, Year 8
(2,500)
(1,800)
(700)
Amortization Year 9
(5,000)
(3,600)
(1,400)
Balance Dec. 29, Year 9 before ownership change
40,000
28,800
11,200
(3,200)
3,200
*** Disposal due to share issue (1/9)

Copyright
143

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

Ownership after share issue 2,880/4,500 =
64%
8%
8% 72% = 1/9 reduction***
Calculation of investment account balances

Investment account Jan. 1, Year 8
Trademark amortization to July 1, Year 8
Net income to July 1 (10,000 90%)
Balance before sale
Sale (720 / 3,600 = 20%)
Balance after sale July 1, Year 8
Net income July to Dec. (10,000 [2,880 / 4,000])
Dividend Year 8 (5,000 72%)
Trademark amortization to Dec. 31, Year 8
Balance Dec. 31, Year 8
Net income Year 9 (28,000 72%)
Dividend Year 9 (8,000 72%)
Trademark amortization Year 9
Balance before share issue
Gain on share issue (see part (a))
Balance after share issue
126,000
(2,250)
9,000
132,750
(26,550)*
106,200
7,200
(3,600)
(1,800)
108,000
20,160
(5,760 )
(3,600)
118,800 **
1,520
120,320
Proof of Investment Account Components

Book value of subs net assets
(64% x [90 + 20 5 + 28 8 + 23])
94,720
Unamortized fair value excess of trademarks
25,600
Total investment account

(d)
120,320
Yes, the trademarks are recorded at historical cost less accumulated amortization on the
consolidated balance sheet. On the date of acquisition, the trademarks were recorded at
$45,000 which was the amount paid by Plumber when it purchased a 90% interest in
Summer. Since the date of acquisition, the cost of the trademarks has been amortized
and reduced for the portion deemed to be sold.
Problem 8
Consolidated Enterprises
Copyright

144

Operations
Net income (450,000 + 14,000)
464,000)
Add (deduct):
3,000)
Depreciation
73,000)
Gain on sale of equipment
(8,000)
Equity earnings Pacific Finance

Dividends from Pacific Finance
Increase in accounts payable
(90,000)
25,000)
(15,000)
5,000)
23,000)
Total cash from operations
480,000)
Investing
Purchase of building
Sale of equipment (8 + 37)
Total cash from investing
(580,000)
45,000)
(535,000)
Financing
Bond issue
120,000)
Dividends to parent's shareholders
(60,000)
Total cash from financing
(6,000)
54,000)
Total decrease in cash
(1,000)
Cash January 1
42,000)
Cash December 31
41,000)
Problem 9
Part A
Investment account (9,500 sh) January 1, Year 6
Copyright
145
320,000

Book value of Sub
270,000
95%
256,500
Parents share of acquisition differential
63,500
Allocated: Land 35%
22,225
Equipment 40%
25,400
Patents 25%
15,875
63,500
Implied value of 100% of acquisition differential

Land (22,225 / 95%)
23,395
Equipment (25,400 / 95%)
26,737
Patents (15,875 / 95%)
16,710
Total
66,842
1,900 sh
= 20%
9,500 sh
P sold
New ownership
7,600 sh
= 76%
10,000 sh
(a)
Cash
66,500
Investment in Sub (20% 320,000)
64,000
Contributed surplus gain on sale
2,500
(b)
Balance Jan. 1, Year 6
Land
Equipment
Patents
Total
23,395
26,737
16,710
66,842
6,684
1,671
8,355
23,395
20,053
15,039
58,487
Amortization Year 6
(c)
Investment account Jan. 1, Year 6
320,000
Copyright

146
20% sold
(64,000)
Acquisition differential amortization (8,355 x 76%)
(6,350)
Net income (76% 150,000)
114,000
Dividends (76% 70,000)
(53,200)
Balance Dec. 31, Year 6 equity method
310,450
Shareholders' equity Sub (270,000 + 150,000 70,000)
350,000
76%
266,000
Balance Parents share of unamortized acquisition differential
44,450
100% of unamortized acquisition differential (44,450 / 76%)
58,487
Part B
Cash
66,500
Contributed surplus - gain on sale
2,500
Non-controlling interest [19% (270,000 + 66,842)]
64,000
Change in non-controlling interest

After sale (100 76)
24%
Before sale (100 95)
5%
Change
19%
or,
Change in non-controlling interest
Shares sold by P:
1,900
= 19%
10,000
Problem 10
1st
2nd
Cost of purchase
600,000
166,000
800,000
Book value of Sics net assets

Common shares
200,000
200,000
Retained earnings
300,000
310,000
Copyright
147

500,000
510,000
100 %
500,000
20%
102,000
300,000
64,000
300,000
48,000 1
Allocated to:
Patents
Direct charge to retained earnings for excess of cost over

Carrying value transferred from NCI
16,000
Total
300,000
64,000
Allocation and amortization of acquisition differential allocated to patents

Total
Parent
NCI
Purchase on Jan 1, Year 5
300,000
225,000
75,000
Amort. for Year 5 (5 years)
(60,000)
(45,000)
(15,000)
Dec 31, Year 5
240,000
180,000
60,000
48,000 1
(48,000)
NCI sold 2,000/2,500 x 60,000

240,000
228,000
12,000
Amort. for Year 6 (4 years)
(60,000)
(57,000)
(3,000)
Dec 31, Year 6
180,000
171,000
9,000
(a) Calculation of consolidated profit for Year 6

Pic profit
140,000
Less: Dividends from Sic (95% x 90,000)
(85,500)
54,500
Sic profit
110,000
Less: patent amortization
60,000
Consolidated profit
50,000
104,500
Attributable to:
Pics shareholders
102,000
NCI (5% x 50,000])
2,500
104,500
(b)
(i) Patents (see patent amortization schedule above)
180,000
(ii) Sics common shares
200,000
Sics retained earnings
330,000
Copyright

148
530,000
NCIs ownership
5%
26,500
NCIs share of unamortized patent
9,000
Total NCI on statement of financial position
35,500
(iii) Pics retained earnings
550,000
1st
2nd
Sics retained earnings
310,000
330,000
Sics retained earnings, at acquisition
300,000
310,000
10,000
20,000
(60,000)
(60,000)
(50,000)
(40,000)
75%
95%
(37,500)
(38,000)
Change since acquisition

Cumulative amort. of patents
Pics ownership
(75,500)
Excess of purchase price over carrying value for 2 nd purchase
(16,000)
458,500
Consolidated retained earnings
Problem 11
(a & b)
York
Queens
McGill
Carleton
Trent
Total
Profit
54,000)
22,000)
26,700)
15,400)
Less inventory profits
(6,000)
(600)
(1,440)
(8,040)
Consolidated profit
48,000)
22,000)
26,100)
13,960)
11,600)
121,660
11,600) 129,700)
Allocate Trent
60% to McGill
6,960)
(6,960)
Allocate Carleton
70% to Queens
9,772)
McGills profit equity method
(9,772)
33,060)
Allocate McGill
10% to Queens
80% to York
26,448)
Queens profit equity method
3,306)
(3,306)
(26,448)
35,078)
Allocate Queens
90% to York
Copyright
149
31,570)
(31,570)

Unallocated
3,508)
3,306)
4,188)
4,640)
Consolidated profit attributable to Yorks shareholders (part a)

Yorkss profit equity
*
(c)
15,642 *
106,018 **
106,018
Consolidated profit attributable to non-controlling interest (part b)

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

After share issue, Delta's shares outstanding (49,000 + 12,250) = 61,250 sh
Craft's ownership before
80%
Craft's ownership after (39,200 61,250)
64%
Change
16%
Reduction in ownership 16% 80 = 20%

Analysis
Reduction in investment (20% 490,000)
Copyright
98,000
150
New shares (12,250 sh $15)
183,750
64%
Net gain from share issue
117,600
19,600
Non-controlling interest Dec. 31, Year 12

Previous common shares
250,000
New shares issued
183,750
Retained earnings
350,000
783,750
Add: Unamortized patent
12,500
796,250
36%
286,650
Craft Ltd.
Consolidated Statement of Financial Position
Buildings and equipment (600,000 + 400,000)
Patent
1,000,000)
12,500)
Inventory (180,000 + 200,000)
380,000)
Accounts receivable (90,000 + 120,000)
210,000)
Cash (50,000 + 65,000 + 183,750)
298,750 )
1,901,250)
Common shares
480,000)
Retained earnings
610,000)
Contributed surplus
19,600
286,650)
Mortgage payable
250,000)
Accrued liabilities
85,000)
Accounts payable (70,000 + 100,000)
170,000)
1,901,250)
Copyright
151

Problem 13
A's 40% of C
Acquisition differential equipment Jan. 1, Year 4
(10,000)
Amortization, Years 46
3,000)
Balance, Dec. 31, Year 6
(7,000)
Proof:
Investment in C, Jan. 1, Year 7
85,000)
Shareholders' equity, C Jan. 1, Year 7
230,000
40%
92,000)
Unamortized acquisition differential as above
(7,000)
Note:
A business combination occurred on January 1, Year 7 when B Company purchased its 40%
interest in C Company because A Company now controls C Company. A Company will be able
to control 80% of the votes in C Company because it owns 40% of C Company directly and
controls B Company, which owns another 40% of C Company.
On the date of the business combination, C Company will be valued at 100% of its fair value.
Therefore, A Company revalues its existing investment in C Company to fair value of $92,000.
A Company will record a gain of $7,000 ($92,000 $85,000). Accordingly, the $7,000 negative
acquisition differential related to equipment will disappear and there will be no acquisition
differential related to C Company.
A's 75% of B
Bal.
Jan. 1/6
Amort.
Bal.
Amort.
Bal.
Year 6 Dec. 31/6
Year 7 Dec. 31/7
Buildings (20 yrs)
40,000
2,000
38,000
2,000
36,000
Patents (8 yrs)
53,333
6,667
46,666
6,667
39,999
93,333
8,667
84,666
8,667
75,999
70,000
6,500
63,500
6,500
57,000
As share (75%)
Proof:
Copyright

152
Investment in B, Jan. 1, Year 7
409,250
Shareholders' equity B, Jan. 1, Year 7
461,000
75%
Unamortized acquisition differential as above
345,750
63,500
B's 40% of C
Investment in C, Jan. 1, Year 7
92,000
Shareholders' equity C, Jan. 1, Year 7
230,000
40%
92,000
0
22,000
Unrealized profits
Before
Tax
After
tax
40%
tax
Closing inventory A selling
2,400
960
1,440
C selling
3,000
1,200
1,800
5,400
2,160
3,240
A Company
Calculation of Consolidated Net Income
A
Net income
Gain on revaluation of C
118,800)
Copyright
153
20,000)
194,100
7,000
(8,667)
(1,800)
(3,240)
124,360)
46,633)
18,200)
189,193)
7,280)
(7,280)
(7,280)
7,280)
53,913)
40,435)
Attributable to NCI
Attributable to As shareholders
55,300)
(1,440)
Bs net income
Allocate B 75% to A
Total
(8,667)
Allocate C 40% to B
40% to A
7,000
Amortization purch. discr.

Inventory profits
(40,435)
13,478)
3,640)
17,118) *
172,075)

As net income equity
172,075)
(a) Non-controlling interests share of consolidated net income
17,118*
(b)
A Company
Balance Jan. 1
314,250
Net income
172,075
486,325
Dividends
70,000
Balance Dec. 31
416,325
Calculation of non-controlling interest Dec. 31, Year 7

Shareholders' equity C
250,000
1,800
248,200
20%
49,640
Shareholders' equity B
Common shares
400,000
61,000
Net income (55,300 + 7,280)
62,580
523,580
75,999
599,579
25%
149,894
Preferred shares
50,000
199,894
249,534
Copyright

154
(c)
A Company
Cash (117.8 + 49.3 + 20)
187,100)
Accounts receivable (200 + 100 + 44 22)
322,000)
Inventory (277 + 206 + 58 5.4)
535,600)
Property, plant and equipment (2,800 + 1,500 + 220 + 40)

Accumulated depreciation (1,120 + 593 + 90 + 4)
Patents
4,560,000)
(1,807,000)
39,999)
Deferred income tax
2,160)
3,839,859)
Accounts payable (206 + 88 + 2 22)
274,000)
Bonds payable (1000 + 700)
1,700,000)
Common shares
1,200,000)
Retained earnings
416,325)
249,534 )
3,839,859)
Problem 14
(a)
Parento Inc.
Operating
Net Income
Add (deduct):
Database amortization
Depreciation
Bond premium amortization
Loss on sale of land
Increase in accounts payable
Decrease in accrued liabilities
Investing
Proceeds from sale of land
Copyright
155
52,200)
)
2,400)
37,000)
(1,200)
2,000)
11,000)
(40,000)
23,200)
(19,800)
66,800)
26,000)

Purchase of buildings and equipment
(88,000)
(62,000)
Financing
Issue of bonds payable
Dividends to shareholders of Parento
80,000)
(14,400)
(1,600)
64,000)
Increase in cash during the year

Cash at beginning of year
Cash at end of year
(b)
68,800)
49,800)
118,600)
Santana paid dividends of $8,000 of which 20% went to the non-controlling interest and
80% went to Parento. Only the 20% paid to the non-controlling interest shows up on the
consolidated cash flow statement because the non-controlling interest is an outside entity
wheras Parento is within the consolidated entity.
Problem 15
Wellington owns 90% of Sussex, therefore: 90% 7,200 = 6,480 shares
Sussex issues 1,800 additional shares: 7,200 + 1,800 = 9,000 shares outstanding
6,480
9,000
Wellington's new ownership percentage
Ownership before share issue
90%
Ownership after share issue
72%
Change
= 72%
18%
Percentage of investment reduction: 18% / 90% = 20%

Wellington sells 648 shares = 10% reduction
Ownership
sale
after
(6,480 648)
9,000
= 64.8%
Copyright

156
(a) Investment account Jan. 1, Year 5 for 90% interest

Total
Parent
NCI
90,000
10,000
(18,000)
18,000
100,000
72,000
28,000
30,000
(21,600)
(8,400)
70,000
50,400
19,600
(5,040)
5,040
45,360
24,640
262,000
Shareholders' equity Sussex
162,000
Unamortized acquisition differential land
100,000
Less: 20% sale to NCI (share issue)

Less: 30% of land sold to outsiders
235,800
Less: 10% sale to NCI

70,000
(b) Investment account Jan. 1, Year 5
235,800)
Net income to April 1 (3/12 36,000 90%)
8,100)
243,900)
Sussex share issue April 1

Net book value deemed sold (20% 243,900)
New shares (1,800 $25)
48,780)
45,000
Parents share
72%
32,400)
Loss due to share issue
(16,380)
June 30 dividend (12,000 72%)
(8,640)
Sept. 15: 30% of land sold
(21,600)
Net income April to Dec. (9/12 36,000 72%)
19,440)
216,720)
Dec. 31 sale of 10% of shares
(21,672)
195,048)
(c) Calculation of non-controlling interest Dec. 31, Year 5

Common shares
Copyright
157
28,000)
134,000)

Net income
36,000)
Dividends
(12,000)
Issue of new shares (1,800 $25)
45,000)
203,000
231,000
70,000
301,000
Non-controlling interest share (100% 64.8%)
35.2%
105,952
Proof of Investment Account Components

Book value of subs net assets (64.8% x 231,000)
149,688
70,000
Parents share
64.8%
Total investment account
45,360
195,048
Problem 16
It is assumed that Panets first purchase of 8% does not provide significant influence or control.
Therefore, it is not necessary to allocate the purchase price. It is assumed that Panets second
purchase of 27%, which brings the percentage ownership to 35%, does result in significant
influence. Therefore, it is necessary to allocate the purchase price. When Panet acquires an
additional 45%, it would gain control. A business combination has occurred. The subsidiary is
valued at fair value and a gain or loss is recognized when adjusting the previous investments
to fair value.
Panets investment:
Cost of
40,000 common shares (8%)
500,000
Cost of 135,000 common shares (27%)
1,890,000
175,000 common shares (35%)
2,390,000
Book value
Common shares
3,000,000
Retained earnings
2,700,000
5,700,000
Panet's %: 175,000 / 500,000 =
35%
Copyright
1,995,000

158
Acquisition differential Jan. 1, Year 10
395,000
Allocated:
120,000 35%
42,000
1,000,000 35%
350,000
Inventory
Land
392,000
Balance goodwill
3,000
Balance
Amortization
Balance
Jan. 1, YR 10
YR 10
Dec. 31, YR 10
42,000
42,000
350,000
Inventory
Land
Goodwill
3,000
350,000
3,000
.395,000
42,000
353,000
Investment in Saffer, Jan 1, Year 10
2,390,000
Share of change in retained earnings during Year 10

(3,200,000 2,700,000) x 35%
175,000
Amortization of acquisition differential for Year 10
(42,000)
Carrying value of investment in Saffer, Dec 31, Year 10
2,523,000
Fair value of investment using value paid for Jan 1, Year 11 purchase
3,600,000 / 225,000 x 175,000
2,800,000
Gain in value of investment
277,000
Panet
NCI
80%
20%
Cost of 225,000 common shares (45%)
3,600,000
Implied value of 80% (3,600,000 x 80 / 45)
6,400,000
Fair value of NCIs interest in Saffer (15 x 100,000)
1,500,000
Book value of Saffers shareholders equity

Common shares
3,000,000
Retained earnings
3,200,000
6,200,000
4,960,000
1,240,000
1,700,000
1,440,000
260,000
Accounts receivable
60,000
-48,000
-12,000
Plant and equipment
900,000
720,000
180,000
Acquisition differential Jan. 1, Year 11

Allocated:
Copyright
159

- 200,000
-160,000
-40,000
Balance goodwill
1,060,000
928,000
132,000
Balance
Amortization
Jan. 1, YR 11to Dec. 31, YR 11
YR 12
Balance
Dec. 31, YR 12
Accounts receivable
60,000
60,000
Plant and equipment
900,000
45,000
45,000
810,000
- 200,000
- 20,000
- 20,000
- 160,000
640,000
- 35,000
25,000
650,000
928,000
73,600
46,400
808,000
132,000
18,400
11,600
102,000
1,700,000
57,000
83,000
1,560,000
1,440,000
45,600
66,400
1,328,000 (d)
260,000
11,400
16,600
232,000 (e)
Goodwill Panets purchase
NCIs purchase
Panets share
(80% x subtotal + Goodwill)
NCIs share
(20% x subtotal + Goodwill)
Total dividends paid by Saffer
200,000
Preferred
50,000
Common
150,000
Panet's %: 400,000 / 500,000
80%
Dividend revenue
120,000
Intercompany sales Saffer
2,600,000
Panet
3,900,000
6,500,000

30% 450,000 =
Unrealized profits
135,000
Before tax
Tax 40%
After tax
Saffer selling
85,000
34,000
51,000
Panet selling
190,000
76,000
114,000
Opening inventory
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160
275,000
110,000
165,000
Saffer selling (400,000 35%)
140,000
56,000
84,000
Panet selling (250,000 45%)
112,500
45,000
67,500
252,500
101,000
151,500
210,000
84,000
126,000
10,000
4,000
6,000
200,000
80,000
120,000
Closing inventory
Equipment Saffer selling

July 1, Year 12
Depreciation Year 12
(210,000 10 )
Calculation of consolidated net income Year 12

Panet
1,620,000
Less: Dividends from Saffer
120,000
67,500
187,500
1,432,500
Add: opening inventory profit after tax
114,000
1,546,500
Saffer
1,100,000
Less: Acquisition differential amort.

Equipment profit after tax
83,000
84,000
120,000
287,000
813,000
Add: opening inventory profit after tax
51,000
864,000
2,410,500
Attributable to:
Panets shareholders (1,546,500 + 80% x (864,000 50,000)
NCI (20% x 814,000 + 100% x 50,000)
2,197,700
212,800
2,410,500
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161

(a) (i)
Panet Company
Consolidated Income Statement
for the Year Ended Dec. 31, Year 12
Sales (15,000 + 9,000 6,500)
$17,500,000
Cost of sales (9,500 + 6,200 6,500 275 + 252.5)
9,177,500
Selling and admin (2,500 + 530 + 45 10)
3,065,000
Other (468 + 440 20 + 58 + 210)*
1,156,000
Income tax (1,032 + 730 + 110 101 84 + 4)
1,691,000
Total expenses
15,089,500
2,410,500
Attributable to:
Panets shareholders
2,197,700
NCI (20% x 814,000 + 100% x 50,000)
212,800
2,410,500
* Gain on sale of equipment was not shown as a separate income statement item, therefore
must have been netted against other expenses. Upon consolidation it must be added back,
as it is unrealized.
Calculation of consolidated retained earnings Dec. 31, Year 12
Panet retained earnings
9,500,000
Less: Closing inventory profit
67,500
9,432,500
Retained earnings Saffer

Jan. 1, Year 11
3,200,000
Jan. 1, Year 10
2,700,000
Increase
500,000
35%
175,000
Acquisition differential amort. for Year 10
(42,000)
Gain on revaluation of investment at date of business combination
277,000
Dec. 31, Year 12
4,900,000
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162
Jan. 1, Year 11
3,200,000
Increase
1,700,000
Less: Acquisition differential amort. for Years 11 and 12

(57,000 + 83,000)
140,000
84,000
Equipment profit
120,000
344,000
1,356,000
80%
1,084,800
10,927,300
Calculation of non-controlling interest Dec. 31, Year 12

Preferred
Common
500,000
3,000,000
Share capital
Retained earnings
4,900,000
7,900,000
Less: unrealized profits
204,000
500,000
7,696,000
100%
20%
1,539,200
NCIs share of unamortized acquisition differential

(650 x 20% + 102)
232,000
500,000
1,771,200
2,271,200
(a) (ii)
Panet Company
Cash (500 + 200)
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163
700,000

Accounts receivable (2,400 + 300 135)
2,565,000
Inventory (500 + 400 252.5)
647,500
Plant and equipment (10,610 + 9,000 + 810 200)
20,220,000
Land (5,500 + 1,000)
6,500,000
Goodwill
910,000
Deferred income taxes (101 + 80)
181,000
31,723,500
Current liabilities (3,000 + 500 135)
3,365,000
Long-term liabilities (4,000 + 2,000 + 160)
6,160,000
Common shares
9,000,000
Retained earnings
10,927,300
2,271,200
31,723,500
(b)
Goodwill impairment loss under entity theory
58,000
Less: NCIs share (20%)
11,600
Goodwill impairment loss under parent company extension theory
46,400
NCI on income statement under entity theory
212,800
Add: NCIs share of goodwill impairment (20%)
11,600
NCI on income statement under parent company extension theory

(c)
224,400
The debt to equity ratio would increase because debt would remain the same while
equity would decrease under the parent company extension ratio.
Problem 17
Part A
Cost of 70% of common (70,000 x $30)
2,100,000
3,000,000
Book value of net assets
1,525,000
Less: preferred shares
1,400,000
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164
Book value of common shares
125,000
2,875,000
Allocated:
Land
95,000
Patents
300,000
Inventory
105,000
Brand name
2,375,000
2,875,000
Balance: goodwill
Land
Balance
Amort.
Amort.
12/31/YR 6
YR 7
YR 8
95,000
Patent Balance
Sold
12/31/YR 8
95,000
Patent
300,000
60,000
Inventory
105,000
105,000
2,375,000
59,375
59,375
2,256,250
2,875,000
224,375
117,375
14,000 2,519,250
Brand name (40 years)
58,000* 14,000* 168,000
Patents (12/31/YR 6)
300,000
Amort. Year 7
60,000
Amort. 1st half Year 8
30,000
Balance June 30, Year 8
90,000
210,000
Portion sold (20/300 x 210,000)
14,000
196,000
Amort. 2nd half Year 8

30,000 (20/300 x 30,000)
28,000
168,000
Intercompany profits PPC selling
Before
tax
Tax
40%
After
tax
Opening inventory (15,000 x 60%)
9,000
3,600
5,400
Closing inventory (22,000 x [60 42] / 60)
6,600
2,640
3,960
The intercompany loss on the transfer of computer hardware is allowed to stand because it is
indicative of a permanent decline in value.
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165

Intercompany sales
60,000
Annual dividends to preferred shareholders (12 x 12,500 shares)
150,000
Calculation of consolidated net income, Year 8

Ultra net income
220,000
PPC net income
1,135,000
Add: opening inventory profit
5,400
1,140,400
3,960
1,136,440
117,375
Acquisition differential, sold patents
14,000
1,005,065
1,225,065

Attributable to:
Shareholders of Ultra
818,546
NCI (100% x 150,000 + 30% x [1,005,065 150,000])
406,519
1,225,065
(a)
Consolidated Income Statement

Sales (6,200 + 4,530 60)
10,670,000
Other income (120 + 7)
127,000
Gain on patent sale (50 14)
36,000
10,833,000
Cost of purchases (4,035 + 2,590 60)
6,565,000
Change in inventory (15 + 10 9 + 6.6)
22,600
Loss on write-down of computer equipment
1,080,000
Other expenses (850 + 675 + 3.6 2.64)
1,525,960
Depreciation and amortization (75 + 142 + 117.375)

Interest (45 + 35)
334,375
80,000
9,607,935
1,225,065
Net income
Attributable to:
Shareholders of Ultra
818,546
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166
NCI
406,519
1,225,065
(b) Calculation of consolidated retained earnings Jan. 1, Year 8
Ultra retained earnings
1,300,000
PPC retained earnings
117,000
Acquisition *
25,000
Increase since acquisition
92,000
Less: Inventory profit
5,400
86,600
Less: acquisition differential amort
224,375
(137,775)
70%
(96,442)
1,203,558
Net assets
Preferred shares
Net book value of common shares
Common shares
Retained earnings
1,525,000
1,400,000
125,000
100,000
25,000

Balance January 1
1,203,558
Net income
818,546
Balance December 31
(c)
2,022,104
(i) Software patents and copyrights (350 + 450 + 168)
968,000
(ii) Inventory software (350 + 380 6.6)
723,400
(iii) Non-controlling interest December 31, Year 8

Total
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167
Preferred
Common
R/E Jan. 1
117,000
117,000
Net income
1,135,000
150,000
985,000
1,252,000
150,000
1,102,000

Dividends
150,000
R/E Dec.31
150,000
1,102,000
Preferred shares 1,400,000

Common shares
Bal. Dec. 31
1,102,000
1,400,000
100,000
2,602,000
100,000
1,400,000
1,202,000
Shareholders equity
Preferred
1,400,000
Common
1,202,000
Add: unamortized acquisition differential
2,519,250
Less: inventory profit
(3,960)
3,717,290
30%
1,115,187
2,515,187
Part B
Conversion of the preferred would result in no change in the dollar amount of shareholders
equity of PPC but all net income earned in the future would belong to the common shares.
Twenty-five thousand new common shares would be issued. The parents ownership would
change from 70% to 56% (70,000/125,000), a 20% reduction while the non-controlling interest
would increase to 44%. The unamortized acquisition differential would remain the same in
total but the split between the parent and non-controlling interest would change to their new
percentage ownership. The parents investment account would be reduced by 20% for the
deemed sale of 20% of its previous holdings and then would be increased by 56% of the value
attributed to the new common shares, which would normally be the net book value of the
preferred shares prior to their conversion to common shares.
Problem 18
Purchase Price Allocation Schedule for first two steps
Jan 1/YR 2
Jan 1/YR 4
50,700
98,300
Cost
BV
CS
200,000
200,000
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168
RE
% Acquired
28,000
69,000
228,000
269,000
20%
45,600
30%
80,700
5,100
17,600
Land
2,550
8,800
Patents
2,550
8,800
Amortization Year 2
255
Year 3
255
Year 4
255
1,100
Value Dec. 31, Year 4
1,785
7,700
Purchase Price Allocation Schedule for third step when Phase obtains control
Jan 1/YR 5
Cost of 30% investment
108,000
Implied value of 100% investment
360,000
BV
CS
200,000
RE
104,000
304,000
56,000
Land
28,000
Patents
28,000
Amortization Year 5
(4,000)
Value Dec. 31, Year 5
24,000
Intercompany profits Step selling
Before
tax
Tax
40%
After
tax
Opening inventory (10,000 x 20%)
2,000
800
1,200
Closing inventory (5,000 x 20%)
1,000
400
600
Sale of depreciable assets (Phase selling) 60,000
24,000
36,000
5,000
2,000
3,000
55,000
22,000
33,000
Realized in Year 5 (1/6 x )

Unrealized end of Year 5
Calculation of gain on revaluation of investment account when Phase obtains control

The investment account would show the following activity under the equity method:
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169

50,700
Phases share of change in Steps retained earnings during Years 2 & 3

(69,000 28,000) x 20%
8,200
Amortization of patent during Years 2 and 3 (255 + 255)

(510)
98,300
Phases share of change in Steps retained earnings during Year 4

(104,000 69,000) x 50%
17,500
Amortization of patent during Year 4(255 + 1,100)
(1,355)
Phases share of unrealized profit in inventory at end of Year 4

(50% x 1,200)
(600)
Investment account balance, January 1, Year 5 before revaluation
172,235
Value of 10,000 shares (108,000 / 6,000 x 10,000)
180,000
Gain on revaluation to fair value on January 1, Year 5
7,765
(a)
Patents total
24,000
(b)
Property, plant, and equipment (540,000 + 298,000 + 28,000 55,000) 811,000
(c)
Current assets (173,000 + 89,000 [80,000 +10,000] x 50% -1,000)
(d)
Non-controlling interest on statement of financial position
216,000
Steps common shares
200,000
Steps retained earnings (104 + 400 260 55 40)
149,000
Unrealized profit in ending inventory
(600)
52,000
400,400
NCIs ownership
20%
NCI on statement of financial position

(e)
80,080
Retained Earnings, beginning

Phases retained earnings, beginning
360,000
Phases share of change in Steps retained earnings during Years 2 and 3

(69,000 28,000) x 20%
8,200
Amortization of patent during Years 2 and 3 (255 + 255)
(510)
Phases share of change in Steps retained earnings during Year 4

(104,000 69,000) x 50%
17,500
Amortization of patent during Year 4(255 + 1,100)

Phases share of unrealized profit in beginning inventory (50% x 1,200)
Consolidated retained earnings, beginning
Copyright
(1,355)
(600)
383,235

170
(f)
Cost of goods sold (610 + 260 80 10 2 + 1)
779,000
(g)
Phase profit (1,002 610 190)
202,000
Less: dividends (80% x 40)
(32,000)
unrealized gain on sale

Step profit (400 260 55)
(33,000)
85,000
Unrealized profit in ending inventory

Amortization of acquisition differential
(600)
(4,000)
80,400
Gain on revaluation
Consolidated profit
7,765
225,165
Attributable to:
Shareholders of Phase
NCI (20% x 80,400)
209,085
16,080
225,165
WEB-BASED PROBLEMS
Problem 1
The following answers are based on Vodafones March 31, 2009 consolidated financial
statements:
(a)
Vodafone uses the indirect method as per note 31.
(b)
Purchase of property, plant and equipment of 5,204 as per the cash flow statement.
(c)
The cost of purchase of interests in subsidiary undertakings and joint ventures, net of
cash acquired was 1,389 as per the investing activities section of the cash flow
statement. The details of the acquisition are provided in note 29, which includes the
following:
breakdown of cash consideration paid by major acquisition
allocation of purchase price for the major acquisition
proforma information assuming that acquisition had occurred at the beginning of

the fiscal year
(d)
There were not any transactions during the year that resulted in a loss of control of
any subsidiaries as per note 30 on disposals and as per note 9 on intangible assets.
(e)
There were not any transactions during the year with respect to a subsidiary that did
not result in gaining or losing control as per note 30 on disposals.
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171

(f)
Gains or losses reported in continuing operations generally have a more profound

impact on share prices than gains or losses reported in discontinued operations.
Activities reported in continuing operations are expected to reoccur in the future
wheras activities reported in discontinued operations may not be expected to reoccur.
The share price generally reflects future expectations i.e. what is expected to occur in
the future.
Problem 2
The following answers are based on Siemens September 30, 2009 consolidated financial
statements:
(a)
Siemens uses the indirect method as per the statement of cash flows.
(b)
Additions to intangible assets and property, plant and equipment of 2,923 as per the
cash flow statement.
(c)
The cost of acquisitions was 208 as per the investing activities section of the
statement of cash flows. While none of the fiscal 2009 acquisitions were material,
either individually or in aggregate, details of the fiscal 2008 acquisitions are provided
in note 4, which includes the following:
(d)
cash consideration paid by major acquisition
allocation of purchase price for the major acquisition
There were no transations in fiscal 2009 between the Siemens and non-controlling
shareholders that resulted in a loss of control of a subsidiary. However, in fiscal 2008,
Siemens sold two major operating segments Siemens VDO Automotive and the
Communications operating segment as per note 4. Income earned from these
subsidiaries and gains or losses on sale of these segments were reported on the
income statement under discontinued operations for the current and all prior years.
The assets and liabilities for these divisions were reported as held for disposal for the
prior years comparative amounts. Siemens also sold its Global Tungsten & Powders
unit and its Wireless Modules Business. The gains on these transactions were
included in other operating income. Goodwill declined by 107 in the current year, and
630 in fiscal 2008 as a result of these sales or reclassifications.
(e)
There were not any transactions during the year with respect to a subsidiary that did
not result in gaining or losing control as per note 4 on disposals.
(f)
Gains or losses reported in continuing operations generally have a more profound

impact on share prices than gains or losses reported in discontinued operations.
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172
Activities reported in continuing operations are expected to reoccur in the future

whereas activities reported in discontinued operations may not be expected to
reoccur. The share price generally reflects future expectations i.e. what is expected to
occur in the future.
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173


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Chapter 8

Consolidated Cash Flows and

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DESCRIPTION OF CASES AND PROBLEMS

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Problem 11 (25 min.)

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

4. Dividend payments to noncontrolling shareholders represent a flow ofcash outside the

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11. Net income for the year

Allocated to preferred shares

Net income for common shares

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(900 440) 1,270 = 810

100 x 8% x 2.5 years = 20

.20 x (264 / .8) = 66

100 + (10 x 13 - 100) + (8% x 100 x 2.5) = 150

(750 / .75) (500 + 240 + 90 x 8/12) 40 = 160

750 + .75(90 x 4/12) .75(10) [.75(40) /5 x 4/12] [.75(160)/10 x 4/12] = 759

75% (.2[75%]) = 60%

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as the amount of consideration that would be agreed upon in an arms-length transaction

Intangible assets (200 + 350)

Tangible assets (500 + 120)

Liabilities (400 + 200)

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Tangible assets (500 + 120)

Intangible assets (200 + 350)

Liabilities (400 + 200)

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Value assigned to non-controlling interest

Proceeds received from non-controlling interest

Gain on sale of 40% interest

Shareholders equity prior to sale

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

The $700,000 will be reported as a reduction to contributed surplus, if any exists, or a

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Sale of Traveller Bus Lines ("TBL")

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Recommendations on ways to maximize the selling price

Possible adjustments to the selling price

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we can use a disclosed basis of accounting. If a disclosed basis of accounting is acceptable,

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Travel the country

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Significant accounting issues CTE

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Recognition of the gain on sale of TBL

Comments on current agreement

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and does not include.

Solutions Manual, Chapter 8

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Expense the cost evenly over five periods.

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2010 McGraw-Hill Ryerson Limited. All rights reserved.