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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