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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
CHAPTER 4
ANSWERS TO QUESTIONS
Q4-1 An adjusting entry is recorded on the company's books and causes the balances
reported by the company to change. Eliminating entries, on the other hand, are not
recorded on the books of the companies. Instead, they are entered in the consolidation
workpaper so that when the amounts included in the eliminating entries are added to, or
deducted from, the balances reported by the individual companies, the appropriate
balances for the consolidated entity are reported.
Q4-2 The differential represents the difference between the acquisition-date fair value
of the acquiree and its book value.
Q4-3 A company must acquire a subsidiary at a price equal to the subsidiary’s fair
value, and that subsidiary must have a total acquisition-date fair value less than its book
value.
Q4-4 Each of the stockholders' equity accounts of the subsidiary is eliminated in the
consolidation process. Thus, none of the balances is included in the stockholders' equity
accounts of the consolidated entity. That portion of the stockholders' equity claim
assigned to the noncontrolling shareholders is reported indirectly in the balance
assigned to the noncontrolling shareholders.
Q4-5 Current consolidation standards require recognition of the fair value of the
subsidiary's individual assets and liabilities at the date of acquisition. At least some
portion of the book value would not be included if the fair value of a particular asset or
liability was less than book value.
Q4-6 One hundred percent of the fair value of the subsidiary’s assets and liabilities at
the date of acquisition should be included. The type of asset or liability will determine
whether a change in its value will be recognized following the date of acquisition.
Q4-7 Using a clearing account can reduce the chance of error in preparing
consolidated statements. The number of accounts requiring adjustment for the difference
between book value and fair value at the date of acquisition may be very large. Rather
than including all such adjustments along with other eliminations in a single eliminating
entry, it is often easier to place the unamortized balance in a differential clearing account
and then use one or more subsequent entries to assign the clearing account balance to
the appropriate individual accounts or account groups.
Q4-8 The differential account is a clearing account. Each time consolidated statements
are prepared, the balance in the investment account is eliminated and the unamortized
portion of the differential is entered in the clearing account. It then is assigned to the
appropriate asset and liability accounts. This same process is followed each time
consolidated statements are prepared. The eliminating entries do not actually remove
the balance in the investment account from the parent's books; thus, the differential
continues to be a part of the investment account balance until fully amortized.
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
Q4-9 The investment account in the financial statements of the parent company shows
its investment in the subsidiary as a single total and therefore does not provide
information on the individual assets and liabilities held by the subsidiary, nor their
relative values. The existence of a large differential indicates the parent paid well over
book value to acquire ownership of the subsidiary. When the differential is assigned to
identifiable assets or liabilities of the subsidiary, both the consolidated balance sheet and
consolidated income statement are likely to provide information not available in the
financial statements of the individual companies. The consolidated statements are likely
to provide a better picture of the assets actually being used and the resulting income
statement charges that should be reported.
Q4-10 Additional entries are needed to eliminate all income statement and retained
earnings statement effects of intercorporate ownership and any transfers of goods and
services between related companies.
Q4-11 Separate parts of the consolidation workpaper are used to develop the
consolidated income statement, retained earnings statement, and balance sheet. All
eliminating entries needed to complete the entire workpaper normally are entered before
any of the three statements are prepared. The income statement portion of the
workpaper is completed first so that net income can be carried forward to the retained
earnings statement portion of the workpaper. When the retained earnings portion is
completed, the ending balances are carried forward and entered in the consolidated
balance sheet portion of the workpaper.
Q4-12 None of the dividends declared by the subsidiary are included in the
consolidated retained earnings statement. Those which are paid to the parent have not
gone outside the consolidated entity and therefore must be eliminated in preparing the
consolidated statements. Those paid to noncontrolling shareholders are treated as a
reduction in the net assets assigned to noncontrolling interest and also must be
eliminated.
Q4-13 Consolidated net income is equal to the parent’s income from its own
operations, excluding any investment income from consolidated subsidiaries, plus the
income of each of the consolidated subsidiaries, adjusted for any differential write-off.
Q4-14 Consolidated net income includes 100 percent of the revenues and expenses of
the individual consolidating companies arising from transactions with unaffiliated
companies.
Q4-16 Consolidated retained earnings at the end of the period is equal to the beginning
consolidated retained earnings balance plus consolidated net income attributable to the
controlling interest, less consolidated dividends.
Q4-17 The retained earnings statement shows the increase or decrease in retained
earnings during the period. Thus, income for the period is added to the beginning
balance and dividends are deducted in deriving the ending balance in retained earnings.
Because the consolidation workpaper includes the retained earnings statement, the
beginning retained earnings balance must be entered in the workpaper.
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
Q4-19 The differential is simply a clearing account used in the consolidation process. If
the differential arises because the fair value of land held by the subsidiary is greater than
book value, the amount assigned to the differential will remain constant so long as the
subsidiary continues to hold the land. When the differential arises because the fair value
of depreciable or amortizable assets is greater than book value, the amount debited to
the differential account each period will decrease as the parent amortizes an appropriate
portion of the differential against investment income.
Q4-20 Push-down accounting occurs when the assets and liabilities of the subsidiary
are revalued on the subsidiary's books as a result of the purchase of shares by the
parent company. The basis of accountability that the parent company would use in
accounting for its investment in the various assets and liabilities is used to revalue the
subsidiary's assets and liabilities; thereby pushing down the parent's basis of
accountability onto the books of the subsidiary.
Q4-22 When the assets and liabilities of the subsidiary are revalued at the date of
acquisition there will no longer be a differential. The parent's portion of the revised
carrying value of the net assets on the books of the subsidiary will agree with the
balance in the investment account reported by the parent.
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
SOLUTIONS TO CASES
After the financial statements of each of the individual companies are prepared in
accordance with generally accepted accounting principles, consolidated financial
statements must be prepared for the economic entity as a whole. The individual
companies generally record transactions with other subsidiaries on the same basis as
transactions with unrelated enterprises. In preparing consolidated financial statements,
the effects of all transactions with related companies must be removed, just as all
transactions within a single company must be removed in preparing financial statements
for that individual company. It therefore is necessary to prepare a consolidation
workpaper and to enter a number of special journal entries in the workpaper to remove
the effects of the intercorporate transactions. The parent company also reports an
investment in each of the subsidiary companies and investment income or loss in its
financial statements. Each of these accounts must be eliminated as well as the
stockholders' equity accounts of the subsidiaries. The latter must be eliminated because
only the parent's ownership is held by parties outside the consolidated entity.
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
MEMO
Prime Company controls companies in very different industries and combining the
accounts of its subsidiaries may lead to confusion by some investors; however, it may be
equally confusing to provide detailed listings of assets and liabilities by industry or other
breakdowns in the consolidated balance sheet. The actual number of assets and
liabilities presented in the consolidated balance sheet must be carefully considered, but
is the decision of Prime’s management.
It is important to recognize that the notes to the consolidated financial statements are
regarded as an integral part of the financial statements and Prime Company is required
to include in its notes to the financial statements certain information on its reportable
segments [FASB 131]. Because of the diversity of its ownership, Prime may wish to
provide more than the minimum disclosures specified in FASB 131. Segment
information appears to be used quite broadly by investors and permits the company to
provide sufficient detail to assist the financial statement user in gaining a better
understanding of the various operating divisions of the company.
You have requested information on those situations in which it may not be appropriate to
combine similar appearing accounts of two or more subsidiaries. The following is a
partial listing of such situations: (a) the accounts of a subsidiary should not be included
along with other subsidiaries if control of the assets and liabilities does not rest with
Prime Company, as when a subsidiary is in receivership; (b) while the assets and liability
accounts of the subsidiary should be combined with the parent, the equity account
balances should not; (c) negative account balances in cash or accounts receivable
should be reclassified as liabilities rather than being added to the positive
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
C4-2 (continued)
balances of other affiliates, and (d) assets pledged for a specific purpose and not
available for other use by the consolidated entity generally should be separately
reported.
Primary citations:
FASB 94
FASB 131
FASB 160
Secondary sources:
ARB 51
FASB 14
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MEMO
Prior to the issuance of FASB 94, Amazing Chemical may have justified excluding the
boatyard from consolidation based on the differences in operating characteristics
between the subsidiary and the parent company; however, FASB 94 specifically deleted
the nonhomogeneity exclusion [FASB 94, Par. 9]. Thus, Amazing Chemical appears to
be following generally accepted accounting procedures in fully consolidating the
boatyard in its financial statements and should continue to do so.
The operations of the boatyard appear to be distinct from the other operations of the
parent company and its losses appear to be sufficient to establish it as a reportable
segment [FASB 131, Par. 10 and 18]. While the operating losses of the boatyard may
not be evident in analyzing the consolidated income statement, a review of the notes to
the consolidated statements should provide adequate disclosure of its operations as a
reportable segment. The financial statements for the current period should contain these
disclosures and if prior period statements have not included the boatyard as a reportable
segment it may be necessary to restate those statements.
Primary citations:
ARB 51, Par. 1
FASB 94, Par. 9
FASB 131, Par. 10 and 18
FASB 160
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Net assets of the subsidiary increase when positive earnings results occur and decrease
when negative results occur. A negative retained earnings balance indicates that the
other stockholders' equity balances of the subsidiary exceed the reported net assets of
the subsidiary.
b. The consolidation process does not change in any substantive manner. Rather than
debiting retained earnings in the entry to eliminate the stockholders' equity balances of
the subsidiary in the consolidation workpaper, the account must be credited.
c. Goodwill is recorded whenever the fair value of the acquired company as a whole, as
evidenced by the fair value of the consideration given in the acquisition and the fair value
of the noncontrolling interest, exceeds the fair value of the net identifiable assets
acquired. In this case it is not known whether the fair value is above or below book
value. Sloan Company recorded losses in prior periods and may have written down all
assets that had decreased in value. On the other hand, management may have been
reluctant to recognize such losses in order to avoid reducing earnings even further. In
the extreme, it may even have sold all assets that had appreciated in value. Many
factors, including the future earning power of the company, will affect the purchase price
and it is therefore difficult to determine whether goodwill will be recorded in a situation
such as this.
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
a. Under the first two alternatives, the cars and associated debt would appear on
Crumple's consolidated balance sheet. In the first case the debt is recorded directly by
Crumple. In the second case, the leasing subsidiary should be fully consolidated.
Although in economic substance there may be little difference between creating a
leasing subsidiary and creating a trust to accomplish the same goals, consolidation of a
trust generally has not been required under generally accepted accounting procedures.
However, the recent issuance of FASB 160 changes the definition of a subsidiary to
include trusts. Although the FASB is still grappling with specifically what entities to
include in consolidation, it now seems unlikely that a trust in which another company has
a controlling financial interest can escape being included in the consolidated financial
statements. If Crumple has the capability to name the directors of the trust and to
administer its activities, the activities of the trust may be carried out to benefit Crumple in
virtually the same manner as an operating corporate affiliate. The situation presented
provides an opportunity to think about the concept of control and the use of
nontraditional organization structures in carrying out the business activities of a
company.
c. Some individuals may focus on the fact that Crumple will not get any residual
amounts if the trust is dissolved. However, through management charges and selection
of lease rates, Crumple is likely to be able to leave as large or small a balance in the
trust as it wishes. Students may wish to look at the financial statements of one or more
leasing companies in arriving at their recommendation(s).
From a financial reporting perspective, all three alternatives now should be reported in
essentially the same manner in the consolidated financial statements. Thus, the financial
reporting aspects of the three alternatives have become irrelevant. However, even when
different alternatives lead to different reporting treatments, the choice of an alternative
should be based on economic considerations rather than on the financial reporting
effects. Even though the three financing alternatives Crumple is considering are reported
in the same manner, they each may have different legal, tax, and economic aspects that
should be considered by Crumple’s management.
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
SOLUTIONS TO EXERCISES
1. c
2. d [AICPA Adapted]
3. d
4. b
5. a
1. c
2. a
3. d
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
a. Eliminating entries:
Computation of differential
Fair value of consideration given $100,000
Book value of Brown's assets $85,000
Book value of Brown's liabilities (28,000)
Net book value (57,000)
Differential $ 43,000
b. Journal entries used to record transactions, adjust account balances, and close
income and revenue accounts at the end of the period are recorded in the
company's books and change the reported balances. On the other hand,
eliminating entries are entered only in the consolidation workpaper to facilitate the
preparation of consolidated financial statements. As a result, they do not change
the balances recorded in the company's accounts and must be reentered each time
a consolidation workpaper is prepared.
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
Eliminating entries:
Computation of differential
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a. Eliminating entry:
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a. Eliminating entries:
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a. Eliminating entry:
Gold
Enter- Premium Eliminations Consol-
Item prises Builders Debit Credit idated
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
a. Inventory $ 140,000
b. Land $ 60,000
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b. Eliminating entries:
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b. Eliminating entries:
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a. Eliminating entries:
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
E4-15 (continued)
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a. Eliminating entries:
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E4-16 (continued)
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a. Eliminating entries:
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E4-17 (continued)
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a. Eliminating entries:
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E4-18 (continued)
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Land 15,000
Buildings 50,000
Equipment 20,000
Revaluation Capital 85,000
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SOLUTIONS TO PROBLEMS
Sally
Teresa Enter- Eliminations Consol-
Item Corp. prises Debit Credit idated
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a. Eliminating entries:
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b. Eliminating entries:
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P4-24 (continued)
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a. Eliminating entries:
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P4-26 (continued)
Cash $105,000
Accounts Receivable 145,000
Inventory 164,000
Buildings and Equipment $700,000
Less: Accumulated Depreciation (235,000) 465,000
Goodwill 20,000
Total Assets $899,000
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
Note: The bonds go directly to the stockholders of Street and are not
recorded on the books of Street.
b. Eliminating entries:
The FASB now requires that no allowance accounts be carried forward from the
acquiree in a business combination. However, because of immateriality and the short-
lived nature of the carry forward subsequent to the date of combination, the allowance in
this problem has not been offset against the receivable. If such an offset is desired, the
following elimination entry would be made:
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P4-27 (continued)
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P4-27 (continued)
Cash $ 21,000
Receivables $ 65,500
Less: Allowance for Bad Debts (3,000) 62,500
Inventory 158,000
Land 125,000
Buildings and Equipment $1,680,000
Less: Accumulated Depreciation (631,000) 1,049,000
Patent 40,000
Goodwill 48,000
Total Assets $1,503,500
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a. Eliminating entries:
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P4-28 (continued)
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P4-28 (continued)
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a. Eliminating entries:
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P4-29 (continued)
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P4-29 (continued)
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P4-29 (continued)
Cash $ 77,500
Accounts Receivable 99,000
Inventory 121,000
Land 75,000
Buildings and Equipment $520,000
Less: Accumulated Depreciation (224,000) 296,000
Goodwill 2,500
Total Assets $671,000
Sales $490,000
Cost of Goods Sold $259,000
Wage Expense 55,000
Depreciation Expense 37,000
Interest Expense 16,000
Other Expenses 39,000
Total Expenses (406,000)
Consolidated Net Income $ 84,000
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b. Eliminating entries:
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P4-30 (continued)
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P4-31 (continued)
b. Eliminating entries:
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P4-31 (continued)
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Inventory 5,000
Land 85,000
Buildings 100,000
Equipment 70,000
Revaluation Capital 260,000
Revalue assets to reflect fair
values at date of combination.
Cash 50,000
Investment in Lindy Company Stock 50,000
Record dividend from Lindy Company.
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Chapter 04 - Consolidation of Wholly Owned Subsidiaries
P4-32A (continued)
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