Download In Millions

CHAPTER 11
11-1 Marketable securities may be either short-term or long-term
investments. Short-term refers to intention, not to salability.
11-2 Trading securities are debt or equity securities that a company
buys only with the intent to resell them shortly. Held-to-maturity
securities are debt securities that the company purchases with
the intent to hold them until they mature. Available-for-sale
securities include all short-term investments that are not trading
or held-to-maturity securities.
11-3 The market method is now routinely applied to investments in
short-term securities classified as “available for sale” or
“trading securities”. The cost method applies only to “held-tomaturity” debt securities.
11-4 No. This statement is true for trading securities, but not for
available-for-sale securities (where the gain or loss is taken
directly to an account in stockholders’ equity) or for held-tomaturity securities (where changes in market price are not
reported).
11-5 Amortization of bond discount increases an investor's interest
income. The payment of $1,000 at maturity includes return of
the $950 invested plus $50 of interest. Amortization spreads
this extra interest income over the life of the bond.
11-6 Investments of 20 to 50 percent of the shares of unconsolidated
subsidiaries over which significant influence, but not control, is
exercised are carried in the balance sheet at original cost plus
the consolidated group's share of accumulated income since
acquisition reduced by dividends received. This is called the
equity method.
566
11-7 The equity method is usually appropriate for long-term
investments where the investor has an ownership interest of 20
to 50 percent, because the owner would usually have the ability
to exert significant influence over the investee. This method is
also often used by the parent to account for majority-owned
subsidiaries between financial statement preparation dates.
11-8 Under the equity method the investor recognizes income as it is
earned by the investee and accounts for dividends as a
reduction of the investment. Under the market method the
investor recognizes income when cash dividends are paid by
the investee. In addition, the market method adjusts carrying
values to market.
11-9 A parent-subsidiary relationship exists when one corporation
owns more than 50% of the outstanding voting shares of
another corporation.
11-10 The reasons for establishing subsidiaries include limiting the
liabilities in a risky venture, saving income taxes, conforming
with government regulations with respect to a part of the
business, doing business in a foreign country, and expanding
in an orderly way. It is also often easier to sell or spin-off a
subsidiary than an integrated part of the firm.
11-11 The answer depends upon who sells Company A the shares. If
Company A purchases the shares of B from the shareholders
of B, not from the company itself, the company’s books are
unaffected. If Company A purchases the shares from
Company B when Company B is created, Company B debits
cash and credits common stock and additional-paid-in-capital.
Chapter 11 Intercorporate Investments and Consolidations
567
11-12 Eliminating entries remove double-counting. Adding together
the books of the parent and subsidiary includes both the net
assets of the subsidiary and also the parent's ownership
interest in those assets (the investment in subsidiary account).
The consolidated statements should not show both amounts.
The investment in subsidiary account is deleted by the
eliminating entry along with the subsidiary’s owners’ equity.
Consolidation also requires adjustment for intercompany
transactions: purchases and sales, receivables and payables
between parent and subsidiary.
11-13 No. The consolidated statement and the parent-only statement
will show the same amount of net income. The difference is in
the format of reporting, not in the amount of income that is
reported. The parent reports subsidiaries’ results using the
equity method.
11-14 If the parent owns, say, 90% of the subsidiary stock, then
outsiders to the consolidated group own the other 10%. The
account Minority Interest in Subsidiaries is a measure of this
outside interest. Note that this minority interest is in the
subsidiary, not in the parent company. The financial statement
of the consolidated company will show the minority interest.
11-15 According to the FASB, control cannot exist unless an
ownership interest exceeds 50 percent. Significant influence is
presumed if the ownership interest is between 20 and 50
percent.
11-16 Goodwill is measured by the excess of purchase price over the
fair value, not the book value, of the net identifiable assets
(identifiable assets less liabilities) acquired. Goodwill is an
intangible asset related to the whole entity.
568
11-17 In the U.S. GAAP used to require that goodwill be amortized
over no more than 40 years, assuming it does not have an
infinite life. The rule was recently changed so that goodwill is
written off only when its value is impaired. In some countries it
is treated as having an infinite life and in other countries
immediate write-off against equity is permitted.
11-18 Twenty percent is the common cut-off between the use of the
market and equity method. Particularly when affiliates are
incurring losses, parents might prefer the market method so
they do not have to record their proportionate share of the
losses on their income statement. Note that many start up
companies may report losses while having steady or rising
market values.
11-19 Historically, subsidiaries whose business is totally different
from the parent and other subsidiaries were not consolidated.
Examples were finance companies and insurance companies
that are subsidiaries of parent companies with entirely different
activities such as manufacturing, merchandising, mining, and
transportation. Under current GAAP, all subsidiaries that are
more than 50% owned are consolidated, unless the control is
temporary.
11-20 Under the direct method the body of the statement of cash
flows would show the $20,000 dividends as part of cash flows
from operating activities. The reconciliation schedule would
adjust net income as follows:
Deduct: Pro-rata share of affiliated
company net income
$(32,000)
Add:
Dividends received
20,000
Alternatively, the reconciliation schedule might have the single
line:
Deduct: Undistributed earnings in affiliated company $ 12,000
Chapter 11 Intercorporate Investments and Consolidations
569
11-21 In consolidated statements, all the assets and liabilities of the
parent and subsidiary are added together in the statements.
But the shareholders of the parent do not own all of the
combined assets and liabilities, so the interests of the minority
owner’s must be subtracted. In contrast, with an affiliated
company, only the parent’s proportional interest in the affiliated
companies is added into the financial statements. Therefore,
the owners of the parent own 100% of all the items in the
financial statements.
11-22 Usually the parent uses the equity method to account for its
ownership interest in subsidiaries and then consolidates all
subsidiaries at the end of the year for reporting to the SEC and
investors. Since the parent’s separate income statement
includes the parent’s share of the subsidiaries earnings, net
income is identical on the parent’s separate income statement
and on consolidated statements.
11-23 Next year the income statement will include the 100% gain on
the portfolio because upon selling the securities the gains
become realized. In the first year, the portfolio was treated as
available-for-sale securities and therefore, gains were included
in comprehensive income but not in net income. Savvy
investors and analysts will already understand this, so the real
issue from a performance standpoint will be about how the
additional investment in the operating assets of the company
translates into ongoing operating profit.
570
11-24 Most acquisitions fail. The current importing business
demands expertise in style, consumer needs, and import and
export practices. The nature of the business is selling to
existing stores and the decision processes and staffing needs
for such a wholesale business are very different than for a retail
business. Thus, the approach faces many challenges along the
lines discussed in the text. You are not an expert in this area
and branching into retailing will raise many business practice
and cultural issues. Ideas of this sort can work. This is called
vertical integration, which means that a company supplies itself
by, in this case, importing the goods that will be most useful for
its retail establishments. However, most small businesses
would be better advised to extend their business by adding
product lines or adding countries to their importing activity.
11-25 The CFO is likely to point out that increasing your ownership
position will alter the accounting from use of the market
method to use of the equity method. Under the equity method
you would need to report your share of the losses that the
company is generating for financial reporting purposes. You
may not want to do this.
Chapter 11 Intercorporate Investments and Consolidations
571
11-26There are a couple of critical issues. Sales would not rise by 25%
because half of the sales from the target to us would be
eliminated as intercompany transactions. For the consolidated
entity, only sales to real outsiders would count. The increase in
profit would depend on what proportion of the purchases we
make from this supplier are resold to our customers during the
year. Assuming instantaneous sales to our customers, our
profit might rise by the full $5 million. However, that assumes
that the purchase occurred at the current book values of the
target. If the market values of existing assets exceeded their
current book values and depreciation and other costs
increased as a result, the increase in profit for the combined
company could be much less than $5 million. Finally, much
would depend on when the purchase occurred. The operating
results for the target would only be included with the parent’s
results from the moment of acquisition forward.
11-27 (15-25 min.) Amounts are in millions.
1.
Original cost on January 1, $160.
Market values
1
150
Balance Sheet Presentation:
Trading securities (at market)
150
1
Income Statement Presentation:
Unrealized gain (loss) on portfolio
of trading securities
572
(10)
End of Period
2
3
4
140 152 160
140
152
160
For Period
2
3
4
(10)
8
12
11-27 (continued)
Current accounting rules require that changes in the market
values of trading securities must affect income in the period
when the market value changes.
2.
Journal entries for Periods 1, 2, 3, and 4 follow:
Unrealized loss in trading portfolio
Trading portfolio
To record unrealized loss in portfolio.
10
Unrealized loss in trading portfolio
Trading portfolio
To record unrealized loss in portfolio.
10
Trading portfolio
Unrealized gain on trading portfolio
To record unrealized gain.
12
Trading portfolio
Unrealized gain on trading portfolio
To record unrealized gain.
8
Chapter 11 Intercorporate Investments and Consolidations
10
10
12
8
573
11-28 (15-25 min.) Amounts are in millions.
1.
Original cost on January 1, $160.
End of Period
2
3
4
140 152 160
Market values
1
150
Balance sheet presentation:
Available-for-sale securities (at market)
150
140
152
160
Stockholders' Equity:
Unrealized loss on available-for-sale securities*
(10)
* Part of Accumulated other comprehensive income.
(20)
(8)
0
Income Statement Presentation:
No effect
Current accounting rules require that changes in the market
values of available-for-sale securities do not affect income.
Increases in market value are added to and decreases in market
value are deducted from an account in stockholders’ equity.
This might be called something like “Unrealized gain (loss) on
available-for-sale securities” and is part of comprehensive
income.
2.
Journal entries for Periods 1, 2, 3, and 4 follow:
Unrealized loss on available-for-sale securities
Available-for-sale securities
To record unrealized loss in portfolio.
574
10
10
11-28 (continued)
10
Unrealized loss on available-for-sale securities
Available-for-sale securities
To record unrealized loss in portfolio.
10
Available-for-sale securities
12
12
Unrealized gain on available-for-sale securities
To record unrealized gain.
Available-for-sale securities
8
8
Unrealized gain on available-for-sale securities
To record unrealized gain.
11-29 (15-20 min.)
1.
Cash interest payment: .10 x $1,000,000 x 1/2
Semi-annual interest income, 6/30/X2,
.12 x $926,400 x 1/2
Amortization of discount:
$50,000
55,584
$ 5,584
Analysis of Bond Transactions
A
Cash
a.
Purchase
b.
Semi-annual
interest,
6/30/X2
+ 50,000
Maturity value
c.
=
Investment
+ in bonds =
– 926,400
+926,400
=
+ 5,584
=
+1,000,000 −1,000,000
=
Chapter 11 Intercorporate Investments and Consolidations
L+
SE
Retained Earnings
+ 55,584
⎡Increase ⎤
⎢ Interest ⎥
⎢⎣Revenue⎥⎦
575
11-29 (continued)
2.
a.
b.
c.
Investment in bonds
Cash
To record the acquisition of $1
million face value 10% bonds
maturing on December 31, 20X6,
for $926,400
Cash
Investment in bonds
Interest revenue
To record receipt of interest
and amortization of discount
Cash
Investment in bonds
To record collection of bonds
at maturity date
3.
926,400
926,400
50,000
5,584
55,584
1,000,000
1,000,000
December 31, 20X1
Investor' s Balance Sheets
Investment in bonds, 10% due
December 31, 20X6
926,400
June 30, 20X2
931,984*
* $926,400 + $5,584 = $ 931,984
While the issuer typically keeps a separate account for
unamortized discounts and premiums, the investors do not
(though they could if desired).
576
11-30 (15-20 min.)
1.
Cash interest payment, .10 x $2,000,000 x 1/2
Semi-annual interest income, 6/30/X2,
.08 x $2,271,830 x 1/2
Amortization of premium
$100,000
90,873
$ 9,127
Analysis of Bond Transactions
= L+
A
Investment
Cash
in bonds =
a.
Purchase
b.
Semi-annual interest
c.
Maturity value
2.
a.
b.
c.
SE
Retained Earnings
–2,271,830 +2,271,830 =
+ 100,000 –
9,127 =
⎡Increase ⎤
+90,873 ⎢ Interest ⎥
⎢⎣Revenue ⎥⎦
+2,000,000 –2,000,000 =
Investment in bonds
Cash
To record the acquisition of $2
million face value 10% bonds
maturing on December 31, 20Y1
for $2,271,830
Cash
Interest revenue
Investment in bonds
To record receipt of interest
and amortization of premium
Cash
Investment in bonds
To record collection of
bonds at maturity date
Chapter 11 Intercorporate Investments and Consolidations
2,271,830
2,271,830
100,000
90,873
9,127
2,000,000
2,000,000
577
11-30 (continued)
3.
December 31, 20X1 June 30, 20X2
Investor' s Balance Sheets
Investment in bonds, 10% due
December 31, 20Y1
2,271,830
2,262,703*
* $2,271,830 – $9,127 = $2,262,703
While the issuer typically keeps a separate account for
unamortized discounts and premiums, the investors do not
(though they could if desired).
11-31 (15-20 min.)
1.
Answers are in millions of dollars.
Equity Method
Market Method
Liabilities &
Liabilities &
Assets
= Stock Equity
Assets
= Stock Equity
InvestLiabil Stock.
InvestLiabil- Stock.
Cash ments
-ities Equity Cash ments
ities Equity
a.
b.
c.
Acquisition
–50
Net income of
Bearpaw
Dividends from + 3
Bearpaw
Effects for year –47
+50
+7
–3
+54
=
=
–50
=
+7
=
=
+50
+3
+7
–47
+50
=
+3
=
+3
The journal entries that would accompany this table are:
578
11-31 (continued)
Market Method
Equity Method
a.
b.
c.
Investment in Bearpaw
Cash
50
Investment in Bearpaw
Investment revenue*
7
a.
50
Cash
3
Investment in Bearpaw
Investment in Bearpaw 50
Cash
50
b. No entry
7
c.
3
Cash
Dividend revenue**
3
3
* More frequently called "Equity in earnings of affiliates"
** Frequently called "dividend income"
Under the equity method, income is recognized by Yukon as it is
earned by Bearpaw rather than when dividends are received.
Cash dividends do not affect net income; they increase Cash and
decrease the Investment balance. In a sense, the dividend is a
partial liquidation of the investor's "claim" against the investee.
The receipt of a dividend is similar to the collection of an account
receivable. The revenue from a sale of merchandise on account
is recognized when the receivable is created; to include the
collection also as revenue would be double-counting. Similarly,
it would be double-counting to include the $3 million of dividends
as income after the $7 million of income is already recognized as
it is earned.
2.
Yukon should account for the investment in Bearpaw
Snowshoes using the equity method. The market method is
generally not used for ownership interests in excess of 20%.
Chapter 11 Intercorporate Investments and Consolidations
579
11-32 (15 min.)
The year-end balance in Investment in Y is $102 million under the
equity method:
Assets
= Liabilities and Stockholders' Equity
Cash + Investment = Liabilities + Stockholders' Equity
Equity Method
1.
Acquisition
– 90
2.
Net income of Y
3.
Dividends from Y + 8
Effects for year
– 82
+
+
90
20
– 8
+ 102
=
=
=
=
+
20
+
20
11-33 (10-15 min.) Amounts are in thousands.
1 and 2.
Assets:
Cash
Net plant
Investment in Baker
Total assets
Liabilities and stockholders’ equity:
Accounts payable
Long-term debt
Stockholders’ equity
Total liabilities and stockholders’ equity
3.
Able
Baker
Consolidated
$ 300
1,700
200
$2,200
$100
400
$ 400
2,100
$500
$2,500
175
425
1,600
$2,200
$ 80
220
200
$500
$ 255
645
1,600
$2,500
Consolidated net income = $250 + 50 = $300.
11-34(5-10 min.)
Minority interest on P’s consolidated income statement is the unowned 5% times $200,000 = $10,000. From S
Company’s perspective there is no minority interest. Company P and the “minority” shareholders are all just shareholders
in S.
580
11-35 (10 - 15 min.)
1. Goodwill = $470,000 − $70,000 = $400,000. This would appear
with the noncurrent assets on Megasoft’s consolidated balance sheet.
2.
Income before effect of Zenatel
$150,000
Loss on Zenatel operations
(10,000)
Consolidated net income *
$140,000
* This assumes no sales between the two companies.
3.
Income before effect of Zenatel
Loss on Zenatel operations
Write-off of goodwill due to impairment
Consolidated net income
4.
Goodwill = $400,000 – $25,000 = $375,000
$150,000
(10,000)
(25,000)
$115,000
11-36 (10 min.)
Company P would use the equity method and claim equity in
earnings of Company S equal to 30% x $200,000 = $60,000. This
would also increase the investment account by $60,000. When
Company P receives 30% of $50,000 or $15,000, in dividends, the
investment account is reduced by the $15,000. The net change in the
investment account would be an increase of $60,000 − $15,000 =
$45,000.
Chapter 11 Intercorporate Investments and Consolidations
581
11-37 (5-10 min.)
The parent company could not achieve the window-dressing of
income under the equity method. For example, if the subsidiary were
wholly owned, each inflated profit to the parent would be offset by a
loss at the subsidiary. The parent's share of subsidiary losses would
be 100% and would be completely reflected in the parent's accounts.
That is why the equity method is often called a "one-line
consolidation."
11-38 (15-25 min.) Amounts are in thousands of dollars.
1.
The balance sheet value of January 1 is the market value,
955,182.
Market values
End of Period
January February March
940,000 960,000
980,160
Balance Sheet Presentation:
Net trading portfolio
980,160
940,000
960,000
January
February
March
Income Statement Presentation:
Unrealized gain (loss) on trading portfolio
* 955,182
** 980,160
*** 940,000
24,978*
(40,160)** 20,000***
– 980,160
– 940,000
– 960,000
Current accounting rules require the recognition of changes in
the market value of trading securities as gains or losses in the
income statement.
582
11-38 (continued)
2.
3.
Journal entries for January, February, and March follow:
Trading portfolio
Unrealized gain on trading portfolio
To record change in market value.
24,978
Unrealized loss in trading portfolio
Trading portfolio
To record unrealized loss in trading portfolio.
40,160
Trading portfolio
Unrealized gain on trading portfolio
To record unrealized gain.
20,000
24,978
40,160
20,000
If the securities were available-for-sale, the asset on the balance
sheet would not be any different but the unrealized gains and
losses would not appear in the income statement. Instead, they
would be added to a separate Stockholders' equity account and
included in other comprehensive income.
11-39 (15 min.)
1.
2.
Trading securities (at market):
U.S. Government Bonds
Held-to-maturity securities (at cost):
Bonds issued by Beta Corporation
Available-for-sale securities (at market):
Common shares of Gamma Corporation
Total short-term investments
$ 660,000
540,000
770,000
$1,970,000
Unrealized loss on trading securities
25,000
Trading securities
Available-for-sale securities
60,000
Unrealized gain on available-for-sale securities
Chapter 11 Intercorporate Investments and Consolidations
25,000
60,000
583
11-40 (15-20 min.)
1.
Carrying amount:
Face or par value
$10,000,000
Deduct: Initial discount on bonds
($10,000,000 - $8,852,950)
(1,147,050)
Add:
Amortization, 6/30/X3
31,177*
Amortization, 12/31/X3
33,048**
Cash received
Difference, gain on sale
$8,917,175
9,100,000
$ 182,825
* [.06 x 8,852,950] – 500,000 = 31,177
** [.06 x (8,852,950 + 31,177)] – 500,000 = 33,048
2.
Cash
Investment in bonds
Gain on disposal of bonds
To record the sale of bonds on the
open market
9,100,000
8,917,175
182,825
11-41 (20 min.)
CHOW COMPANY
Consolidated Income Statement
For the Year Ended December 31, 20X8
Sales
$1,420,000*
Operating expenses
1,312,000
Income before minority interests
$ 108,000
Outside stockholders' interest in consolidated
subsidiary's net income, 30% x $40,000
12,000
Net income, Chow Company
(consolidated net income)
$ 96,000
* This assumes that neither Chow nor its subsidiary had sales
to the other.
584
11-41 (continued)
A more detailed analysis follows:
Parent
Sales
Operating expenses
Operating income
Parent's share (70%) of
subsidiary net income
of $40,000
Net income–Parent
Minority's share (30%) of
subsidiary net income
Net income to consolidated entity
Subsidiary Consolidated
$870,000
802,000
$ 68,000
$550,000
510,000
$ 40,000
$1,420,000
1,312,000
$ 108,000
28,000
$ 96,000
12,000
$ 96,000
CHOW COMPANY
Consolidated Balance Sheet
As of December 31, 20X8
Assets
$916,000(a)
Liabilities to creditors
Minority interests
Total liabilities
Stockholders' equity
Total liab. & Stk. Eq.
$380,000
36,000 (b)
$416,000
500,000
$916,000
(a) $800,000 + $200,000 – $84,000
(b) $120,000 x .30
The balance sheet is based on the following analysis:
A
Investment
Other
in S
+ Assets
Parent accounts
84,000
+ 716,000
Subsidiary accounts
200,000
Eliminations
–84,000
Consolidated
0
+ 916,000
Chapter 11 Intercorporate Investments and Consolidations
=
=
=
=
=
Liabilities + Stockholders' Equity
Minority
Stockholders'
Liabilities + Interest +
Equity
300,000
+
500,000
80,000
+
120,000
+36,000
–120,000
380,000 + 36,000 +
500,000
585
11-42 (20-25 min.)
Although this problem deals with two subsidiaries, it is not
difficult. Amounts are in millions of dollars.
Assets
Investment in
Subsidiaries
Parent's accounts
S1 accounts
S2 accounts
Intercompany eliminations
Regarding S1
Regarding S2
Consolidated
65
Other
+ Assets
= Liabilities+ Stockholders' Equity
Liabilities
to
Minority Stockholders'
= Creditors + Interests + Equity
+ 135
90
20
=
=
=
–56a
=
– 9b
___
=
0 + 245 =
100
20
5
+ 100
+ 70
+ 15
+ 14a
– 70
___
+ 6b
– 15
125 + 20 + 100
a (.8 x 70) and (.2 x 70)
b (.6 x 15) and (.4 x 15)
Consolidated Balance Sheet
December 31, 20X4
(in millions)
Assets:
Other assets
Total assets
586
Liabilities & Stockholders’ Equity
$245,000 Liabilities:
Liabilities to creditors $125,000
$245,000
Minority interests
20,000
Total liabilities
145,000
Stockholders’ equity
100,000
Total liabilities & stk. Eq. $245,000
11-42 (continued)
Consolidated Income Statement
For the Year Ending December 31, 20X4
(In Millions of Dollars)
Sales
Expenses
Income before equity and
minority interests
Earnings (losses) from subsidiaries
Net income
Minority interests
Net income to consolidated entity
Parent
300
280
S1
80
90
S2
100
90
Consolidated
480
460
20
(2)
18**
(10)
10
20
(2)*
18
* 20% of (10) + 40% of 10 = (2) + 4 = 2
** 20 +80% of (10) + 60% of 10 = 20 + (8) + 6 = 18
The parent would record equity interest in subsidiaries net income of (2) on its
parent only financial statements. On the consolidated statements, the minority
interest reduces consolidated net income.
Chapter 11 Intercorporate Investments and Consolidations
587
11-43 (25-35 min.)
1.
A common mistake is to think that the $120 is additional money
flowing into the S Corporation rather than into the pockets of the
S shareholders as individuals.
Liabilities +
Assets
= Stockholders' Equity
InvestCash and Accounts
Stockment
Other
Payable, holders'
in S
+ Assets =
etc. + Equity
P's accounts, January 1
Before acquisition
Acquisition of S
S's accounts, January 1
Intercompany eliminations
Consolidated, January 1
2.
588
+120
–120
0
500
–120
160
____
+ 540
=
=
=
=
=
200
+
40
____
240
+
300
120
–120
+ 300
Sales
Expenses
Operating income
P
$600
450
$150
S
Consolidated
$180
$780
170
620
$ 10
$160
Pro-rata share
(100%) of unconsolidated
subsidiary net income
Net income
10
$160
–
$ 10
11-43 (continued)
3.
P's parent-company-only income statement would show its own
sales and expenses plus its pro-rata share of S's net income, as
the equity method requires. Reflect on the changes in P's
balance sheet equation (in millions):
Assets
= Liabilities + Stockholders' Equity
Invest- Cash and Accounts
ment
Other
Payable,
In S + Assets = etc. + Stockholders' Equity
P's accounts:
Beginning of year
Operating income
Share of S income
End of year
S's accounts:
Beginning of year
Net income
End of year
Intercompany
eliminations
Consolidated, end of year
120 +
+
+ 10
130 +
+
–130
0 +
380
150
530
= 200 +
=
+
=
+
= 200 +
300
150 retained earnings
10 retained earnings
460
160
10
170
=
=
=
120
10 retained earnings
130
700
=
–130
= 240 + 460
40 +
+
40 +
S's balance sheet accounts would have increased by $10 million,
$170 million versus $160 million.
At this point review to see that consolidated statements are the
summation of the individual accounts of two or more separate
legal entities. These statements are prepared periodically via
worksheets. A consolidated entity does not have a separate
continuous set of books like its legal entities. Moreover, a
consolidated income statement is merely the summation of the
revenues and expenses of the separate legal entities being
consolidated after the elimination of double-counting.
Chapter 11 Intercorporate Investments and Consolidations
589
11-43 (continued)
4.
Consolidated accounts would be unaffected. S's cash and
stockholders' equity would decline by $10 million.
P's
investment in S would decline by $10 million, but P's cash would
rise by $10 million.
Special note: Some instructors may wish to formulate
eliminating entries to show how the accounts are consolidated:
Stockholders' equity (on S books)
Investment in S (on P books)
For
Requirement
1
120
120
For
Requirement
3
130
130
11-44 (30-45 min.) Amounts are in millions.
A common error is to think that the $84 million is additional
money flowing into the S Corporation rather than into the pockets of
the S shareholders.
1.
Assets
= Liabilities + Stockholders' Equity
Invest- Cash and Accounts
ment
Other
Payable Minority Stockholders'
in S
+ Assets = etc. + Interest + Equity
P's accounts, January 1
Before acquisition
Acquisition of 80% of S
S's accounts, January 1
Intercompany eliminations
Consolidated, January 1
590
84
–84
0
500 =
+ – 84 =
160 =
=
+ 576 =
200
+
40
___
240
+ 120
+ –120
+ 300
+
+
36
36
300
11-44 (continued)
2.
The same basic procedures are followed by P and S regardless
of whether S is 100 percent owned or 70 percent owned.
However, the presence of a minority interest changes the
consolidated statements slightly. The income statements would
include:
Sales
Expenses
Operating income
Pro-rata share (70%) of Company S
net income
Net income
Minority interest (30%) in
consolidated subsidiaries' net income
Net income to consolidated entity
3.
(In Millions)
P's accounts:
Beginning of year
Operating income
Share of S income
End of year
S's accounts:
Beginning of year
Net income
End of year
Intercompany eliminations
Consolidated, end of year
P
$600
450
$150
S
Consolidated
$180
$780
170
620
$ 10
$160
7
$157
$ 10
3
$157
Assets
Liabilities + Stockholders' Equity
Invest
Cash &
Accounts
Stock-ment
Other
Payable + Minority + holder's
in S + Assets =
etc.
Interest
Equity
84
7
91
+ 416a
+ 150
+ 566
160
+ 10
170
–91
0
+ 736
=
=
=
=
200
=
=
=
=
=
40
200
40
240
+
+
39b
39
+
+
+
+
300
150
7
457
+
+
+
+
+
120
10
130
–130
457
a 500 beginning of year –84 for acquisition = 416
b 36 beginning of year + .30 x 10 = 36 + 3 = 39
Chapter 11 Intercorporate Investments and Consolidations
591
11-44 (continued)
Special Note: Some instructors may wish to formulate
eliminating entries to show how the accounts are consolidated:
For
For
Requirement Requirement
1
3
Stockholders' equity (on S books)
Investment in S (on P books)
Minority interest (in
consolidated statements)
4.
120
130
84
91
36
39
Consolidated accounts would be affected because the minority
interest's claim would be partially liquidated in the amount of
30% of $10 million, or $3 million. S's cash would decline by $10
million, P's investment in S would decline by .70 x $10 million =
$7 million, but P's cash would rise by $7 million.
Assets
= Liabilities + Stockholders' Equity
InvestCash and
Accounts
ment
Other
Payable,
Minority Stockholders'
in S + Assets =
etc.
+ Interest + Equity
End of year balances:
P's accounts (from 3)
Effect of S dividend
Balance
592
91
– 7
84
+ 566
+
7
+ 573
=
=
=
S's accounts (from 3)
Effect of S dividend
Balance
170
– 10
160
=
=
=
Consolidated accounts
(from 3)
Effect of S dividend
Balance
736
– 3
733
=
=
=
200
+
457
200
+
457
40
+
40
+
130
–10
120
+
457
+
457
240
240
+
39
–3
+ 36
11-45 (25-35 min.)
Assets
Investment
in S
(In Millions)
P's accounts, January 1
Before acquisition
Acquisition of 100% of S
S's accounts, January 1
Intercompany eliminations
Consolidated, January 1
+150
–120
30*
= Liabilities + Stock. Equity
Cash and
Other
+ Assets
+
+
500
–150
160
510
Accounts
Payable, Stockholders'
=
etc.
+
Equity
=
=
=
=
=
200
+
300
40
___
240
+
120
–120
300
+
* The $30 million "goodwill" would appear in the consolidated balance sheet
as a separate intangible asset account. It often is the final item in a listing of
assets. It is usually written off when it is determined that its value has
decreased.
2.
a.
If the book values of the S individual assets are not equal to
their fair market values, the usual procedures are:
(1)
(2)
(3)
S continues as a going concern and keeps its
accounts on the same basis as before.
P records its investment at its acquisition cost (the
agreed purchase price).
For consolidated reporting purposes, the excess of
the acquisition cost over the book values of S is
identified with the individual assets, item by item. (In
effect, they are revalued at the current market prices
prevailing when P acquired S.) Any remaining excess
that cannot be identified is labeled as purchased
goodwill.
Chapter 11 Intercorporate Investments and Consolidations
593
11-45 (continued)
The balance sheet accounts immediately after acquisition would
be the same as in Requirement 1, except that Goodwill would be
$20 million instead of $30 million, and Other Assets would be
higher by $10 million. The $10 million would appear in the
consolidated balance sheet as an integral part of the asset
whose fair market value exceeded its book value. That is, the S
equipment would be shown at $10 million higher in the
consolidated balance sheet than the carrying amount on the S
books. Similarly, the depreciation expense on the consolidated
income statement would be higher. For instance, if the
equipment had five years of useful life remaining, the straight-line
depreciation would be $10 ÷ 5 = $2 million higher per year. As in
the preceding tabulation, the $20 million "goodwill" would appear
in the consolidated balance sheet as a separate intangible asset
account.
b. Thus, consolidated income will be lower each year by the
extra depreciation of $2 million. The assets are subject to
depreciation, but goodwill is not.
$10,000,000 ÷ 5 years
$2,000,000
The assigning of a "basket purchase price" to the various assets
can have a dramatic effect on income taxes. For example, not
only is income lower for corporate reporting purposes in part 2b,
but also income tax cash outflows would be less during the next
four years. Depreciation is deductible for Federal income tax
purposes, but the write-off of goodwill frequently is not.
594
11-46 (20-25 min.)
1.
(in millions)
A’s accounts:
Before acquisition
After acquiring B
B’s accounts
Intercompany
eliminations
Consolidated
Cash
Assets
Plant
Assets,
Net
Inventories
150
−100
15
+60
+
+25
+
30
65
+ 85
+
20*
110*
Goodwill
=
Stockholders’ Equity
InvestCommon
ment
Stock Etc.
Retained
in B =
+ Earnings
60
100
+10
+10
−100
0
=
=
=
70
+
200
30
+
40
=
=
−30
70
+
−40
200
* The $20 million would appear as an integral part of the plant assets
because they would be carried at $20 million higher in the consolidated
balance sheet than the carrying amount on the B books. Therefore, plant
assets would appear on the consolidated balance sheet as ($60 + $30) +
$20 = $110.
2.
The B plant assets would be carried in the consolidated balance
sheet at $60 million instead of $50 million, and no goodwill would
appear as a separate intangible asset.
3.
Consolidated cash would be $20 million less, and a goodwill
account of $20 million would be created. Note in requirement 2
that all of the cost in excess of book value was linked to specific
plant assets. The balance in the Investment in B account would
be $120 million instead of $100 million on A’s books before
consolidation.
Chapter 11 Intercorporate Investments and Consolidations
595
11-47 (15 min.)
596
1.
Goodwill = $5.6 billion - $1.7 billion = $3.9 billion
2.
Goodwill amortization was not tax deductible therefore the
entire difference in amortization would affect net earnings.
Amortization dropped by $1,097 so earnings would have been
$11,102 - $1,097 = $10,005 if amortization had continued at
prior levels and earnings would have increased by ($10,005 $8,500) ÷ $8,500 or 18%. This is still a very strong increase, but
only 60% as large as it first appeared.
3.
The after tax effect of the Miller transaction would be $2,631
less $900 of taxes or $1,731 so we estimate net earnings to be
$10,005 - $1,731 or $8,274 on a comparable basis to 2001. This
changes the apparent 30% increase to a decline of ($8,274 $8,500) ÷ $8,500 = (2.7%). Note that prior to the sale of Miller,
Miller’s net earnings were included in Altria’s income via
consolidation. Post-sale a similar net earnings contribution
can be expected via the equity interest in SAB, so it is only the
one-time recognition of gain on the sale that needs to be taken
into account.
11-48 (30 min.)
This problem is based on the acquisition of Paramount Pictures
by Gulf & Western, although Gulf & Western accounted for the
purchase as a pooling, which was then permissible. Note that this
transaction differs from examples in the text in that Cinemon issued
new shares of Cinemon stock in the transaction, and this increases
Cinemon’s stockholders’ equity.
1.
Note that the purchase price ($180 million) is equal to the net
assets of Bradley ($120 million – $20 million = $100 million) plus
the $80 million value of the film inventory. The combined
company would have the following balance sheet accounts
immediately after the acquisition (in million of dollars):
Cash and receivables
Inventories
Plant assets, net
Total assets
30
120
150
+ 22
+ 3
+ 95
Current liabilities
Common stock
Retained earnings
Total liabilities and
stockholders' equity
50
100
150
+ 20
+ 180*
+ 80
= 52
= 203
= 245
500
= 70
= 280
= 150
500
* New equity issued by Cinemon in acquisition
Chapter 11 Intercorporate Investments and Consolidations
597
11-48 (continued)
An alternative format follows:
Cash &
Investment Other
Stockholders'
in Bradley Assets = Liabilities +
Equity
Cinemon Accounts:
Before acquisition
Acquisition
Bradley accounts:
Intercompany
eliminations
Consolidated
300
+180
120
–100
80*
=
=
=
50
+
20
+
=
420
250
+180
100
–100
430
70
* The 80 would appear in the consolidated balance sheet as an addition to
inventory. An alternate format for the last two lines here would be
equally acceptable:
Intercompany eliminations
Consolidated
•
•
•
–180
0*
•
•
•
+ 80**
500
=
=
70
•
•
•
–100
430
** As already stated, the 80 would appear in the consolidated balance sheet
as an addition to inventory. The consolidating journal entry (on a
working paper only) would be:
Inventory
Stockholders' equity
Investment in Bradley
or
Inventory
Common stock
Retained earnings
Investment in Bradley
598
80
100
180
80
10
90
180
11-48 (continued)
2.
Net income for 20X7
Net income for 20X8:
20 + [21 – (.25 x 80)]
$19 million
$21 million
If the $80 million were assigned to goodwill and was not
amortized, net income for 20X8 would be:
20 + 21
$41 million
The chairman of Cinemon would prefer to assign as much as
possible to goodwill because Cinemon could generate net
income almost "on demand" by the timing of rentals or sales of
its films. This avoids revelation of the cost of the library of films
acquired. The immense size of this impact on income is vividly
demonstrated by the fact that net income could jump to $41
million in just one year. This could take place because Cinemon
would carry the film library at zero rather than the $80 million
actual cost.
The point of this example is to stress that assigning the purchase
costs to goodwill, which need not be amortized, or other assets,
which are depreciated or amortized, possibly over short periods,
can significantly affect income. If management wants to show
higher immediate net income, there will be a general pressure
toward assigning as much of the total purchase price as possible
to goodwill rather than to other assets.
An alternate format that emphasizes how the accounts are
affected is:
Chapter 11 Intercorporate Investments and Consolidations
599
11-48 (continued)
Sales
Expenses
Operating income
Equity in unconsolidated subsidiary net
income (21 – 20 amort.)
Net income
Amortization of the $80 increase in inventory
of films implicit in the purchase price of
$180 paid for the investment (.25 x 80)
Net income to consolidated entity
Cinemon
−
−
20
Bradley Consolidated
−
−
−
−
21
41
1
21
20
21
Entries in parent's books to record the year’s operations of Bradley:
a.
b.
Investment in Bradley
Equity in earnings of Bradley
To record pro-rata share of earnings
as recorded by Bradley (100% x 21).
21
Equity in earnings of Bradley
Investment in Bradley
To amortize ($80 x 25% or $80 ÷ 4)
the $80 increase in inventory of
films implicit in the purchase
price of $180 paid for the investment.
20
The T-account:
Note that net effect on
Cinemon’s earnings is a.
21-20 because, in a
sense, Cinemon had to
pay 20 to obtain the 21
in equity earnings.
600
21
Investment in Bradley
Acquire
180 b. Amortize
Equity in 20X8
the 80 (80 ÷ 4)
earnings
21
increase in
inventory
20
20
11-49 (35-45 min.)
This is a worthwhile problem because it provides an overall view
of relationships. Students should reflect on the diagram in the
chapter, and you might want to place a similar diagram on the board:
Consolidated
Parent
S
1
S
2
S
3
S
4
Minority Interests
20-50%
owned
company
20-50%
owned
company
Investments in
Affiliated Companies
On balance sheets, the minority interest typically appears just
above the stockholders' equity section; however, some accountants
place it as a subpart of the stockholders' equity section. On income
statements, the minority interest in net income is deducted as if it were
an expense of the consolidated entity.
Chapter 11 Intercorporate Investments and Consolidations
601
11-49 (continued)
MIDLANDS DATA CORPORATION
Consolidated Income Statement
For the Year Ended December 31, 20X2
(In Millions)
Net sales and other operating revenue
Cost of goods sold and operating expenses,
exclusive of depreciation and amortization
Depreciation and amortization
Total operating expenses
Operating income before share of net income
of affiliated companies
Equity in earnings of affiliated companies
Total income before interest expense and income taxes
Interest expense
Income before income taxes
Income taxes
Income before minority interest
Minority interest in subsidiaries' net income
Net consolidated income to Midlands Data Corporation
Preferred dividends
Net income to Midlands Data Corporation common stock
Earnings per share of common stock:
On shares outstanding (10,000,000 shares)
Assuming full dilution, reflecting conversion
of all convertible securities (12,000,000 shares)
$960
710
20
730
230
20
250
25
225
90
135
20
115*
10
$105
$ 10.50**
9.58***
* This is the total figure in dollars that the accountant traditionally labels net income. It
is reported accordingly in the financial press.
** This is the figure most widely quoted by the investment community.
*** $115,000,000 ÷ 12,000,000 = $9.58. This is significant potential dilution. Note that
$115,000,000 is used rather than $105,000,000, because no preferred dividends
would exist. Total common shares would be 10,000,000 + 2,000,000 = 12,000,000.
See Exhibit 11-49 on the following page for the balance sheet.
602
EXHIBIT 11-49
MIDLANDS DATA CORPORATION
Consolidated Balance Sheet
As of December 31, 20X2
(In Millions of Dollars)
Liabilities and Stockholders’ Equity
Assets
Current assets
Cash
Short-term investments at cost
(which approximates market value)
Accounts receivable
Inventories at average cost
Total current assets
Investments in affiliated companies
Property, plant, and equipment, net
Other assets:
Goodwill
Total assets
$ 55
35
110
390
590
100
120
100
____
$910
Current liabilities
Account payable
Accrued income taxes payable
Total current liabilities
Long-term liabilities
First mortgage bonds, 10% interest,
due Dec. 31, 20X8
Subordinated debentures, 11%
interest, due Dec. 31, 20X9
Total long-term liabilities
Minority interest in subsidiaries
Total liabilities
Stockholders' equity:
Preferred stock, 2,000,000
shares, $50 par*
Common stock, 10,000,000 shares, $1 par
Paid-in capital in excess of par
Retained earnings
Total stockholders' equity
Total liabilities and stockholders’ equity
$200
30
$230
80
100
180
90
500
100
10
82
218
410
$910
* Dividend rate is $5 per share; each share is convertible into one share of common stock.
Chapter 11 Intercorporate Investments and Consolidations
603
11-50 (15 min.)
1.
2.
3.
4.
604
(100% – 80%) x Colorado Grande
net income minority interest
Colorado Grande’s net income
= $310,607
= $310,607 ÷ .20
= $1,553,035
Colorado Grande’s portion of Anchor Gaming’s net income:
(.80 x $1,553,035) ÷ $35,676,428 = $1,242,428 ÷ $35,676,428
= 3.5%
Minority Interest in Consolidated Subsidiary
Dividends
0 Balance
672,955
Minority interest in
earnings
310,607
Balance
983,562
Anchor Gaming has control over Colorado Grande. Therefore,
we combine (or consolidate) the financial statements. However,
the stockholders of Anchor Gaming do not have a claim on all
the assets or net income of the consolidated entity. In a
statement for Anchor Gaming shareholders, we deduct the
claims of the minority shareholders. For example, shareholders
of Anchor Gaming have claim on only 80% of the net income of
Colorado Grande, but the consolidated statement includes 100%
of the net income. After deducting the minority interest, the
remaining net income represents the claim of the shareholders
of Anchor Gaming.
11-51 (15-20 min.)
1. The idea behind discontinued operations is to segregate income
that will not be ongoing so that predictions about the future do
not incorporate elements that are known to not be part of the
future. In this instance, IGT acquired Anchor Gaming in 2002 and
only 2002 income statements for IGT included Anchor Gaming’s
results and, therefore, the results of Anchor Gaming’s casino
subsidiary. Thus no adjustment for discontinued operations is
appropriate for IGT’s previously reported earnings in 2001 or
2000.
2. There are two consequences. Assets and liabilities of the
subsidiary to be discontinued should be segregated and they
should be shown at expected liquidation value. Any expected
gain or loss on sale of the activity should be shown in the
income statement and the balance sheet values should be fair
values, i.e. expected amounts to be realized at sale. In this
instance, the subsidiary is just being acquired, so book values
and liquidation values should be similar, hence, there was no
gain or loss on discontinuance. IGT showed assets held for sale
in the current assets section of the balance sheet of $147 million
and current liabilities of discontinued companies of $11 million.
3. The distinction between identifiable intangibles and goodwill is
important because the former are generally amortized and the
latter is only subject to an impairment test. IGT indicates that
identifiable intangibles are amortized over the following periods:
i. Patents
14.6 years
ii. Contracts
9.7 years
iii. Technology
12.7 years
iv. Trademarks
9.4 years
Chapter 11 Intercorporate Investments and Consolidations
605
11-52 (5-10 min.)
1.
Moscow Resources would recognize 40% x R 100 million = R 40
million as its pro-rata share of Siberia’s net income, and Moscow
Resources received 40% x R 60 million = R 24 million in cash
dividends from Siberia. The R 40 million share of Siberia’s
income is included in the net income of Moscow Resources, but
it is not a cash flow from operations. The R 24 million is a cash
flow. Therefore, net income must be adjusted by deducting R 16
million (R 40million – R 24 million).
2.
The amount of cash dividends received, R 24 million, is shown
as a cash inflow under operating activities. This question is
about Moscow, the owner, not about the company that is paying
the dividend. Some students may talk about transactions with
owners not affecting the income statement, but that is true only
from the issuer’s side, not the investor’s side.
606
11-53 (15 min.)
1.
If there are no new investments or sales of existing investments
then we would expect the asset account to change as follows:
Beginning Balance + Equity in Earnings – Dividends = Ending Balance
To isolate any additional items we can rearrange this equation:
Other items = Beg. Bal. + Equity in Earn. – Divs. – End. Bal. or
$5,128 + $384 - $128 - $4,737 = $647.
The T-account would show:
Equity-Method Investments
Beg. Bal.
5,128 Dividends received
128
Equity in income 384 Other decreases
647
End. Bal.
4,737
The ending balance is smaller than expected by $647 million.
This suggests that Coca-Cola disposed of some equity investees
that had a cost of $647 million. If true, there would be a gain or
loss on the transaction included in the income statement and
explained in the notes. Alternatively, Coca-Cola might have
purchased additional amounts of an equity investee sufficient to
change it to a consolidated company. The actual notes to CocaCola’s 2002 report reveal a complex combination of such
transactions.
2.
Net earnings includes $384 million but only $128 million was
received in dividends. Thus there should be an amount
subtracted from net earnings labeled Equity in earnings in
excess of dividends received equal to $256 million. Coca-Cola
actually labels this number “Equity income or loss, net of
dividends” and subtracts it from net income in its indirectmethod cash flow statement.
Chapter 11 Intercorporate Investments and Consolidations
607
11-54 (20-30 min.)
1.
Investment in SCC
Cash
To record the purchase of 40% of
SCC for $2.0 million.
2,000,000
2,000,000
Investment in SCC
Equity in earnings of SCC
To record a 40% share in the
earnings of SCC.
160,000
160,000
Cash
Investment in SCC
To record the receipt of dividends from SCC.
40,000
40,000
2.
JORDAN SHOE COMPANY
Income Statement
For the Year Ended December 31, 20X6
Sales
Expenses
Operating income
Equity in earnings of SCC
Net income
$12,500,000
11,100,000
1,400,000
160,000
$ 1,560,000
Investment in SCC = $2,000,000 + $160,000 – $40,000 = $2,120,000
608
11-54 (continued)
3.
Numbers are in thousands of dollars.
Assets
= Liabilities + Stockholders' Equity
Invest- Cash and
Stockment
Other
Minority holders’
in SCC + Assets = Liabilities + Interests + Equity
Jordan accounts,
before acquisition
Acquisition of 80% of SCC
SCC accounts
Intercompany eliminations
Consolidated
+4,000
10,000
– 4,000
6,000
–4,000
0 + 12,000
=
=
=
=
=
Jordan Shoe journal entry:
Investment in SCC
Cash
2,000
8,000
1,000
5,000
+1,000 – 5,000
+1,000 + 8,000
3,000
4,000,000
4,000,000
SCC has no journal entry
4.
Jordan Shoe Company
Consolidated Income Statement
Fiscal year 20X6
Sales
Expenses
Operating income
Equity in SCC income (.80 x 400,000)
Net income
Less minority interest (.20 x 400,000)
Net income to consolidated entity
Jordan
$12,500,000
11,100,000
$ 1,400,000
320,000
$ 1,720,000
SCC
Consolidated
$4,400,000 $16,900,000
4,000,000
15,100,000
$ 400,000 $ 1,800,000
80,000
$ 1,720,000
Note:Part four illustrates effectively that the equity method provides
parent-only results equivalent to the consolidated results. The equity
method is a "one-line consolidation."
Chapter 11 Intercorporate Investments and Consolidations
609
11-55 (30-40 min.)
One issue is to determine the sign of these items. Normally, if the
equity investees are profitable, the equity in earnings will increase
income or decrease a loss. Normally, if the consolidated but less-thanwholly-owned firms have a profit, the minority interests will represent a
claim on part of that profit and will reduce the consolidated profit. Here
the loss from continuing operations before minority interests and
equity in earnings is reduced by both items. Thus the equity investees
are reflecting a profit, but the consolidated subsidiaries are generating
losses. Some of the losses are being allocated to the minority
shareholders and therefore reducing the consolidated loss.
1.
If $116 million is Corning’s 40% interest in the profit of the
equity investees, the total earnings of these companies is $116
million ÷ .40 = $290 million.
2.
If $98 million is the minority investees’ 20% interest in the
consolidated companies, the consolidated companies were
generating $98 million ÷ .20 = $490 million in total. As
indicated above, this is a loss of $490 million.
3.
Net earnings increased by $116 million for equity in earnings.
If dividends were exactly $116 million, no adjustment would
have been required in the cash flow statement. An adjustment
of $25 million suggests that $116 - $25 = $91 million was
received from equity investees as dividends.
4. Net earnings fell by $98 million due to minority interests in the
consolidated companies. Since the adjustment was exactly equal to
the original minority interest, it appears that no dividends were paid by
these companies. Since they were generating losses, this seems
quite likely.
610
11-56 (10 – 15 min.)
1.
Goodwill comprises $8.8 billion ÷ $13.7 billion = 64% of assets,
which implies an aggressive campaign of growth by acquisition.
Goodwill only arises when one firm purchases another.
2.
Comparing reported earnings, Gannett’s earnings grew by
approximately ($1,160 million - $831 million) ÷ $831 million = 40%.
However, if goodwill amortization had been eliminated in the
prior year earnings would have been $234 million greater ($241
million - $7 million) or approximately $1,065 million. This makes
the year-to-year comparison more modest; a growth of about
($1,160 million - $1,065 million) ÷ $1,065 million = 9%. While the
data are not presented in the problem, another key contributor to
increased earnings was the drop in interest expense of about $70
million.
11-57 (10 – 15 min.)
When a purchase is expressed in terms of the number of shares
the buyer will be give for each share of the target, the selling
shareholders are subject to significant uncertainty. Markets react
quickly and share prices tend to move a lot around these
announcements. FleetBoston had been trading around $32 per share.
Thus the potential price of $45 represented a huge premium. At the
exchange rate, it was based on a price for Bank of America of $45 /
.5553 = $81 per share. But the market felt the premium was quite high
($45 - $32 = $13 or 40%), and Bank of America’s stock dropped about
10%. At that price, .5553 shares would be worth about $40.53. Thus it
is not surprising that the cash price for FleetBoston shares rose
immediately to only about $38 per share and drifted up to just over $40
by the end of November. In addition to the uncertainly about how
investors will value the transaction, there are also regulatory concerns.
Sometimes regulators will refuse to allow the transaction to happen,
other times they require that either the buyer or seller divest of certain
assets, exit some markets or respond in other ways.
Chapter 11 Intercorporate Investments and Consolidations
611
11-58 (10-20 min.)
Net income
Depreciation
Increase in noncash working capital
Deduct pro-rata share of income of
affiliated companies:
Alberta Mining Company
Sutter Gold Company
Add: Dividends received from Alberta
Mining Company
Net cash provided by operating activities
$696,000
130,000
(15,000)
(120,000)
(100,000)
40,000
$631,000
The two entries relating to the Alberta Mining Company could
have been combined:
Deduct: Equity in undistributed earnings of
Alberta Mining Company
(80,000)
Note that the $14,000 interest on the debt securities is part of
both net income and net cash provided by operating activities.
Because these debt securities have been owned for several years and
were acquired at par, any accrued interest receivable would be
unchanged year to year and cash received would equal interest
income regardless of interest payment dates. In contrast, the $120,000
pro-rata share of Alberta Mining Company income is in Global’s net
income but only the $40,000 dividends should be included in net cash
provided by operations. None of the Sutter Gold equity in earnings
was received in cash.
612
11-59 (15-20 min.)
1.
Because Medusa Electronics accounts for its 19% investment in
Rasmussen Transport using the market method, and because
the securities are available-for-sale securities, changes in the
market value of Rasmussen are entered directly into
stockholders’ equity. They are not included in the income
statement. In contrast, the amount of dividends paid by
Rasmussen is part of the income of Medusa Electronics. Thus
regardless of what happens to the market value of Rasmussen,
Medusa will include only Rasmussen’s dividends in income. By
increasing the Rasmussen dividends, Medusa will increase its
net income.
This opportunity for Medusa to increase its income by
influencing the dividend policy of Rasmussen does not seem
desirable.
2.
At least two ethical issues arise. First is the investment by
Medusa in Rasmussen. If Alex Renalda made his decision based
only on his friendship with Hans Rasmussen, and if it was not in
the best interests of the shareholders of Medusa, Renalda was
not appropriately carrying out his duties as an officer of Medusa.
Presently this may not be of much concern because the
investment appears to have turned out to be profitable to the
Medusa shareholders. Nevertheless, if the decision had been
based on personal benefits rather than corporate benefits, it was
not appropriate.
Chapter 11 Intercorporate Investments and Consolidations
613
11-59 (continued)
Second is the influence of Renalda on Rasmussen’s dividend
policy. Not only does this manipulation of Rasmussen’s policy
violate the intent of the accounting principles, it may not be in the
best interests of Rasmussen’s other shareholders (i.e., those
shareholders other than Medusa). If Rasmusssen pays out $4
million in dividends and then borrows to meet its capital needs,
future profitability of Rasmussen may be diminished. The
personal obligation of Rasmussen to Renalda should not
influence the corporate decisions.
On the other hand, Rasmussen and Medusa may be essentially
forming an implicit strategic alliance. When one company needs
special help, the other is willing to provide it. Companies in
Japan have had such alliances for years, and they have worked
well. Often it is hard to judge the ethical implications of actions
without being able to assess intent. Still, this situation at least
possesses the appearance of possible ethical violations.
614
11-60 (60 min. or more)
The purpose of this exercise is to show students the possible
different treatments of consolidation internationally. There is a great
variety in the way consolidated statements are prepared in different
countries. By having each student learn about a different country and
then share this knowledge with the other students, the international
diversity in practices can be seen without each student researching
each country.
Another purpose is to teach students to find information that is
not readily available in the textbook. If you want to provide some help
in finding this, you can advise the students that most of the major
public accounting firms have reference books on international
accounting standards.
11-61 (40-50 min.)
Each solution will be unique and will change each year. The
purpose of this problem is to identify the information generally
reported about the acquisition of another company.
11-62 (15 min.) Amounts are in millions.
1.
Unrealized gain or loss:
Short-term – available-for-sale
Short-term – trading
$88.4
9.8
2.
No effect. Changes in available-for-sale security prices do not
affect earnings.
3.
A gain of $9.8 million recognized on the income statement.
4. Starbucks must have purchased a company for more than the
fair value of its assets. Indeed, it purchased Seattle Best Coffee in the
year ended September 28, 2003.
Chapter 11 Intercorporate Investments and Consolidations
615
11-63 (30-60 min.)
NOTE TO INSTRUCTOR. This solution is based on the web site
as it was in late 2004. Be sure to examine the current web site before
assigning this problem, as the information there may have changed.
Many of these questions can be answered from the coverage of Ford
in the text for 2002. This solution is based on the 2003 annual report.
Results will change each year.
1. Ford reports for its automotive and financial services sectors as
separate business segments. Consumers can purchase a Ford
car using credit from Ford Credit, a subsidiary of Ford Motor
Company.
2. Footnote 4 provides substantial detail on marketable securities,
including classification as trading or available-for-sale.
3. $7,389 million appears as goodwill in 2003. Much of this goodwill
has arisen from purchases of prominent brands such as Jaguar and
Volvo. These brands provide the ability to earn higher profits than if
the same physical plant and raw materials were used to produce an
unbranded or unknown automobile.
616