Financial Reporting Financial Statement Analysis and Valuation 8th Edition Wahlen Solutions Manual

Financial Reporting Financial
Statement Analysis and Valuation 8th

Edition Wahlen Solutions Manual
Visit to Download in Full: https://testbankdeal.com/download/financial-reporting-financ
ial-statement-analysis-and-valuation-8th-edition-wahlen-solutions-manual/
CHAPTER 8
INVESTING ACTIVITIES
Solutions to Questions, Exercises, Problems, and Teaching Notes to Cases
8.1 Capitalization versus Expensing Decision.

a. The effect in the first year would be an equal decrease in both the numerator
(adjusted net income) and the denominator (average total assets) of ROA.
Because net income is substantially smaller than average total assets, the
percentage decrease in the numerator would be greater, and ROA would be
understated. However, in the next two years, net income would be overstated
because it is not burdened by a depreciation charge, average total assets would
remain understated, and ROA would be overstated.
b. This error does not affect cash flows, but it does affect classification within the
statement of cash flows. Expensing results in an operating cash outflow in year
one. Capitalization results in an investing cash outflow.
8.2 Self-Constructed Assets. The company should capitalize the full costs of
construction, including direct labor, direct materials, and an allocation of overhead
(both variable and fixed). Also, if interest is incurred during the project, interest
cost should be capitalized.
8.3 Natural Resources. All costs are capitalized except for exploration costs associated
with dry wells, which may be capitalized if the firm chooses the full costing
approach or expensed if the firm chooses the successful efforts approach. Capitali-
zation is justified because most of the costs are necessary to yield probable future
economic benefits. Proponents of expensing unsuccessful exploration efforts argue
that no product was discovered and, thus, that the probable future economic bene-
fits criterion is not met.
8.4 Research and Development Costs. Standard setters require R&D costs to be
expensed because of the uncertainty in judging their future revenue-generating
potential. Although it is debatable whether capitalization better serves investors,
clearly in-depth disclosure of firms’ R&D expenditures serves the investor well.
This is particularly true for firms with large R&D expenditures, such as biotechnol-
ogy firms. To date, standard setters have shown no interest in revisiting Statement
No. 2, the standard that addresses accounting for R&D costs. However, under IFRS,
the product development portion of R&D is capitalized.
8-1
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part.
Chapter 8
Investing Activities
8.5 Capitalization of Software Development Costs. Adobe capitalizes software

development costs once a graphics software program reaches the technological
feasibility stage of development. However, Adobe indicates that the amount of
software cost capitalized is immaterial to the financial statements. The firm states:
“Capitalization of software development costs begins upon the establishment of
technological feasibility, which is generally the completion of a working prototype
that has been certified as having no critical bugs and is a release candidate or when
alternative future use exists. To date, software development costs incurred between
completion of a working prototype and general availability of the related product
have not been material and have not been capitalized.” In essence, Adobe concludes
that the time between the prototype and product availability stage is so short that
the additional costs incurred at this stage are minor relative to the total costs
incurred to develop the software
8.6 Testing for Goodwill Impairment. The tests for goodwill impairment are similar
under U.S. GAAP and IFRS. Goodwill is not considered a separable asset; there-
fore, goodwill impairment is assessed at the reporting unit (U.S. GAAP) or cash-
generating unit (IFRS) level. If the fair value of a unit exceeds its carrying amount
(after impairment tests for tangible and intangible assets other than goodwill have
been performed and carrying amounts adjusted), goodwill is impaired. The amount
of goodwill impairment is obtained by comparing the carrying amount of goodwill
to the goodwill implied by the difference between the unit’s fair value and its carry-
ing value.
U.S. GAAP tests for the impairment of amortizable intangibles first require a
comparison of undiscounted future cash flows from the asset to the book value of
the asset. If undiscounted future cash flows are higher, the asset is not impaired.
IFRS follows the theoretically defensible approach of comparing the asset’s book
value to the larger of the asset’s value in use (discounted future cash flows) and the
asset’s value from sale (fair value – disposal costs) to ascertain whether goodwill is
impaired and what the amount of the impairment is.
Because of the difference between IFRS and U.S. GAAP rules on limited-life
assets, goodwill impairment charges may differ between the two sets of standards.
Recall that goodwill impairment tests depend on the carrying amounts of individual
assets and liabilities that may differ between the two sets of standards.
8.7 Earnings Management and Depreciation Measurement. Depreciation is a

process of allocating historical cost of depreciable assets to the periods of their use
in a rational and systematic manner. Three factors must be considered when mea-
suring depreciation expense: (1) acquisition cost, including subsequent expendi-
tures to add to or improve an existing depreciable asset; (2) expected useful life of
the depreciable asset; and (3) depreciation method. Many illustrations involve alter-
ing one or more of the factors to manage earnings. However, a key point to remem-
ber is that depreciation is a cost allocation process. This means that it affects the
8-2
Chapter 8
timing of expense recognition. For example, incorrectly expensing a cost to manage

earnings accelerates expense recognition relative to capitalization. Short useful
lives accelerate expenses relative to long useful lives. Transparency demands that
firms disclose a change in policy for any of these factors, and, as such, analysts can
judge whether the change makes sense from a business perspective or whether it
appears to be a means for managing earnings. For example, an airline that extends
the useful life of aircraft because of the implementation of more stringent mainten-
ance and inspection schedules might be understandable. On the other hand, a
change in the useful lives of aircraft that positions the firm as an outlier relative
to other airlines would appear to be a means of managing earnings. As another
example, a firm may change from one acceptable depreciation method to another.
Because more firms in the United States use the straight-line method, however, the
change would position the firm as an outlier and generate questions about the moti-
vation for the change.
8.8 Corporate Acquisitions and Goodwill. The acquirer records the intercorporate
investment in the common stock of the acquired company at the fair value of the
consideration given. If the fair value exceeds the book value of the net assets
acquired, the acquiring company allocates the excess to identifiable assets (includ-
ing specifically identifiable intangible assets) and liabilities to revalue them to fair
values. The acquiring firm allocates any remaining excess to goodwill. If the fair
value of identifiable acquired assets (including intangibles other than goodwill)
exactly equals the fair value of the consideration given to acquire, no goodwill is
recorded. If the fair value of identifiable acquired assets (including intangibles other
than goodwill) exceeds the fair value of the consideration given to acquire (a bar-
gain purchase), the difference is recorded as a gain on acquisition and no goodwill
is recorded.
8.9 Corporate Acquisitions and Acquisition Reserves. “Acquisition reserves” may

be recorded at the time one company acquires another company because the
acquiring company may not know the potential losses inherent in the acquired
assets or the potential liabilities of the acquired company. Acquisition reserve
accounts always have credit balances and represent estimates of future merger-
related expenditures or losses. Examples include estimated losses on long-term
contracts and estimated liabilities on unsettled lawsuits. An acquiring company has
up to one year after the date of acquisition to revalue these acquisition reserves as
new information becomes available. After that, the acquisition reserve amounts
remain in the accounts and absorb expenditures (that would otherwise be recorded
as period expenses) or losses as they occur. That is, the acquiring firm charges
actual expenditures or losses against the acquisition reserves instead of against
income for the period of the loss. Firms can misuse acquisition reserves by (1)
inappropriately valuing the reserves, (2) charging losses to the reserves that are not
related to acquisitions, or (3) a combination of (1) and (2).
8-3
Chapter 8
8.10 Accounting for Available-for-Sale and Trading Marketable Equity Securities.

Firms report both available-for-sale and trading marketable equity securities at fair
value at the end of each reporting period. The reporting of any unrealized holding
gain or loss depends on the firm’s purpose for investing in securities. Firms that
actively buy and sell securities to take advantage of short-term differences or
changes in market values classify the securities as trading securities, a current asset
on the balance sheet. Firms include unrealized holding gains and losses on trading
securities in the calculation of net income each reporting period. Firms classify
marketable equity securities that do not qualify as trading securities as securities
available for sale, including them as either current or noncurrent assets depending
on the expected holding period. Unrealized holding gains or losses on securities
available for sale are not included in net income each period; instead, they appear as
a component of other comprehensive income, labeled Unrealized Holding Gain or
Loss on Securities Available for Sale. The cumulative unrealized holding gain or
loss on securities available for sale appears in the shareholders’ equity section of
the balance sheet as part of Accumulated Other Comprehensive Income.
When a firm sells a trading security, it recognizes the difference between the
selling price and the book value (that is, the market value at the end of the most
recent accounting period prior to sale) as a gain or loss in measuring net income.
When a firm sells a security classified as available for sale, it recognizes the
difference between the selling price and the acquisition cost of the security as a
realized gain or loss. At the time of sale, the firm must eliminate any amount in the
shareholders’ equity account, Accumulated Other Comprehensive Income, for the
unrealized holding gain or loss related to that security.
8.11 Equity Method for Minority, Active Investments.

a. Equity income of $35.14 million (0.35 × $100.4 million) will be reported by
Ace Corporation for 2014.
b. The statement of cash flows for Ace Corporation will report a net reduction in
operating cash flows of $26.39 million due to undistributed earnings of the
investee. Recall that $35.14 million of equity income is already shown in the
operating cash flow section under the indirect method, but dividends received in
cash equals only $8.75 million.
c. The balance in Investment in Spear Corporation at the end of 2014 is $1,126.39

million ($1,100 million + $35.14 million – $8.75 million).
8.12 Consolidation of Variable-Interest Entities. Often the structure of a VIE is such

that effective control is not captured by simply applying the rule of greater than
50% of equity ownership. In addition, the structure of the entity may take a legal
form other than that of a corporation and thus does not have outstanding equity
securities.
8-4
Chapter 8
Determining whether an investing firm should consolidate the VIE is at the

heart of Interpretation No. 46R. An investing firm consolidates the VIE if it absorbs
the majority of the entity’s expected losses if they occur, receives a majority of the
entity’s expected residual returns if they occur, or both. The consolidating firm is
labeled the primary beneficiary. The firm considers the rights and obligations
conveyed by its variable interests and the relationship of its variable interests to
variable interests held by other firms to determine whether it will absorb a majority
of expected losses, receive a majority of expected residual returns, or both. If one
firm absorbs a majority of the expected losses and another firm receives a majority
of the expected residual returns, the firm absorbing a majority of the losses
consolidates the variable interest entity.
8.13 Choice of a Functional Currency. The following discussion applies the five criteria
of Statement No. 52 in determining the functional currency for Qing Corporation.
Cash Flows of Foreign Entity. No information is provided about cash flows,

which implies that Qing’s policy is to allow all of its foreign subsidiaries to retain
cash for growth rather than remit it to their U.S. parent. This suggests a foreign
currency (in this case, peso) rather than U.S. dollar perspective as the functional
currency.
Sales Prices. The fact that 50% of revenues are generated by sales to Qing Corpo-
ration is not unusual, given the subsidiary was formed primarily to serve the parent
company. The fact that third-party sales are denominated in the peso might suggest
the foreign currency as the functional currency, although this is not clear.
Cost Factors. All material contracts are denominated in the peso, also indicating
the peso as the functional currency.
Financing. Financing for manufacturing plants is denominated in U.S. dollars, with

some labor contracts denominated in U.S. dollars as well. These operational charac-
teristics point toward the U.S. dollar as the functional currency.
Relations between Parent and Foreign Unit. Senior management of the subsidi-
ary consists of employees of Qing Corporation transferred to Mexico for an interna-
tional tour of duty. Although this points toward the U.S. dollar as the functional
currency, this is not an uncommon arrangement for multinational corporations.
Overall, an argument can be made that the peso should be identified as the func-
tional currency. Mixed signals for choice of the functional currency are common,
and firms must weigh the various factors to determine which ones should dominate
in choosing a functional currency.
8-5
Chapter 8
8.14 Foreign Currency as Functional Currency. The text provides a description of the
exchange rates used when the foreign currency is the functional currency. The logic
is that the management of the foreign unit likely makes operating investing, and
financing decisions based primarily on economic conditions in that foreign country,
with minimal concern for economic conditions, exchange rates, and similar factors
in other countries.
8.15 Analyzing Disclosures Regarding Fixed Assets.

a. NewMarket Monsanto Olin
Corporation Company Corporation
Average depreciable assets at cost:
0.5($752 + $777) .............................. $765
0.5($4,611 + $4,604) ........................ $4,608
0.5($1,796 + $1,826) ........................ $1,811
Divide by depreciation expense ............ $27 $328 $72
Equals average depreciable life ............ 28.3 14.0 25.2
b.
Accumulated depreciation, Year-end ... $ 611 $ 2,517 $ 1,348
Divide by depreciation expense ............ $ 27 $ 328 $ 72
Equals average age................................ 22.6 7.7 18.7
Relative age (age divided by average
life) ................................................... 80% 55% 74%
c. Depreciation—straight-line method ..... $ 27 $ 328 $ 72

Difference between straight-line and
accelerated depreciation:
($9 – $13) ÷ 0.35 ................................ (11)
($256 – $267) ÷ 0.35 .......................... (31)
($96 – $83) ÷ 0.35 .............................. 37
Depreciation—Accelerated for tax ....... $ 16 $ 297 $ 109
d. Net income as reported ......................... $ 33 $ 267 $ 55

Add back depreciation expense on
straight-line method (net of taxes):
(1 – 0.35)($27) ............................... 18
(1 – 0.35)($328) ............................. 213
(1 – 0.35)($72) ............................... 47
Subtract depreciation expense for tax
reporting (net of taxes):
(1 – 0.35)($16) ............................... (10)
(1 – 0.35)($297) ............................. (193)
(1 – 0.35)($109) ............................. (71)
Net income as restated .......................... $ 41 $ 287 $ 31
8-6
Chapter 8
e. NewMarket Monsanto Olin

Corporation Company Corporation
Reported property, plant, and
equipment (net):
$777 – $611 ......................................... $ 166
$4,604 – $2,517 ................................... $ 2,087
$1,826 – $1,348 ................................... $ 478
Restatement to accelerated depreciation:
$9 ÷ 0.35 ................................................. (26)
$256 ÷ 0.35 ............................................. (731)
$96 ÷ 0.35 ............................................... (274)
Restated property, plant, and equipment .... $ 140 $ 1,356 $ 204
f. NewMarket Corporation and Olin Corporation might have a higher proportion

of their depreciable assets in longer-lived manufacturing plants and buildings
relative to Monsanto Corporation. Alternatively, NewMarket and Olin might
have chosen longer estimated lives for computing depreciation.
g. Note that the depreciable assets for NewMarket Corporation and Olin Corpora-
tion are close to 75% depreciated, where as Monsanto Corporation’s
assets are approximately 50% depreciated. This difference is consistent with
NewMarket and Olin having a higher proportion of long-live manufacturing
plants and buildings in the depreciable asset mixes relative to Monsanto. In ad-
dition, for some reason, NewMarket and Olin might have delayed the acquisi-
tion of new depreciable assets.
8.16 Asset Impairments.

a. U.S. GAAP Treatment: Because total undiscounted future cash flows of
$1,920,000 ($160,000 × 12) exceed the carrying value of $1,200,000, the paper
company reported no impairment loss. If the total estimated undiscounted future
cash flows were to fall below the carrying value, the paper company would
compute an impairment loss as the difference between the carrying value and
the fair market value of the press (in this case, $1,000,000). The company
would report the impairment loss of $200,000 in income from continuing
operations, and the press would be reduced to the “new” carrying value of
$1,000,000. Although the firm uses undiscounted future cash flows to decide
whether an impairment charge is necessary, fair value is used to measure the
actual impairment charge.
IFRS Treatment: Under IFRS, first identify the greater of the asset’s value in
use and fair value from sale. Value in use is $1,090,191, obtained by using the
10% discount rate to compute the present value of a 12-year annuity of
$160,000 cash inflow. The value from a sale is $950,000 (the $1,000,000 fair
value – $50,000 in disposal costs). Compare the larger of the two, $1,090,191,
to the carrying value of $1,200,000 to justify a $109,809 impairment charge.
8-7
Chapter 8
The company would report the impairment loss in income from continuing op-
erations, and the press would be reduced to the “new” carrying value of
$1,090,191.
b. Compare the carrying amount of the unit to the unit’s fair value:
Fair value of Vineyard unit at 12/31/14 ........................................ $1,800,000
Carrying value of Vineyard unit at 12/31/14:
Identifiable assets ............................................... $1,500,000
Goodwill ............................................................. 400,000 $1,900,000
If the fair value of the unit exceeds the carrying amount, goodwill is deemed not
to be impaired. However, in this case, the carrying value exceeds the fair value
of the unit, so Sterling must measure the amount of goodwill impairment by si-
mulating a reacquisition. The fair value of the unit is compared to the fair value
of the identifiable assets to yield an implied goodwill, as follows:
Fair value of Vineyard unit at 12/31/14 ............................................. $1,800,000

Fair values of Vineyard’s assets other than goodwill at
12/31/14 ......................................................................................... (1,500,000)
Implied goodwill at 12/31/14 ............................................................. $ 300,000
c. Goodwill is written down from $400,000 to $300,000 and a $100,000 impair-

ment loss is reflected in operating income.
8.17 Upward Revaluations under IFRS.

a. Fair value increases above original acquisition cost in 2013, causing a €10,000
upward revaluation of the land and an increase in other comprehensive income
(OCI) but not net income. The increase is accumulated in accumulated other
comprehensive income (AOCI) in the shareholders’ equity section. In 2014, the
land is revalued downward €5,000, causing a partial reversal in the unrealized
gains accumulated in AOCI. Downward revaluations are accumulated in AOCI
on the balance sheet as long as fair value is greater than original acquisition
cost. In 2015, fair value falls below original acquisition cost, causing a reversal
of the remaining €5,000 of accumulated unrealized gains in AOCI and the rec-
ognition in net income of €10,000 unrealized loss. The land recovers €5,000 of
its value in 2016, and this partial reversal of the prior year’s unrealized loss re-
ported in income is reported in 2016 income as an unrealized gain.
b. [Note: This concept was not covered in the text.] The company will record
$16,000 depreciation expense. At the same time, the company will remove
$1,000 of unrealized gain from AOCI and increase retained earnings by $1,000.
8-8
Chapter 8
8.18 Application of Statement No. 115 for Investments in Marketable Equity

Securities.
a. (1) The change in the market value of Suntrust’s investment in Coke’s com-
mon stock has no effect on the bank’s 2006 net income. Under Statement
No. 115, all unrealized holding “gains” and “losses” on securities classi-
fied as available for sale are not included in income; instead, they appear
as a component of accumulated other comprehensive income in the share-
holders’ equity section of the balance sheet.
(2) As described above, the 2006 unrealized holding “gain” of $379,204,000

($2,324,826,000 – $1,945,622,000) will appear as a component of other
comprehensive income, labeled “Unrealized Holding Gain on Securities
Available for Sale.” The cumulative holding gain appears in the share-
holders’ equity section of the balance sheet as part of accumulated other
comprehensive income.
b. The $379,204,000 unrealized holding gain would appear in net income and
increase retained earnings. Total shareholders’ equity would be the same as in
Solution a, but its components would differ.
c. No, Statement No. 115 states that all marketable equities securities, regardless
of how they are classified by management, appear at market value at the end of
each reporting period. Classification of the securities by management affects the
reporting of only unrealized holding gains or losses related to the securities.
8.19 Effect of an Acquisition on the Date of Acquisition Balance Sheet.

a. Fair value of Chalfont ......................................................................... $ 504
Book value of Chalfont ....................................................................... (300)
Excess ................................................................................................. $ 204
Allocation (Fair value/book value differences):

Fixed assets ......................................................................................... $ 80
Copyright ............................................................................................ 50
Reserve for lawsuit ............................................................................. (30)
Goodwill ............................................................................................. $ 104
b. Cash..................................................................................................... $ 130
Accounts receivable ............................................................................ 330
Fixed assets ($1,000 + $360 + $80) .................................................... 1,440
Copyright ............................................................................................ 50
Deferred tax asset................................................................................ 40
Goodwill ............................................................................................. 104
Total assets ..................................................................................... $2,094
8-9
Chapter 8
Accounts payable and accruals ($240 + $80 + $30) ........................... $ 350

Long-term debt.................................................................................... 580
Deferred tax liability ........................................................................... 160
Other noncurrent liabilities ................................................................. 120
Common stock ($320 + $504) ............................................................ 824
Retained earnings ................................................................................ 60
Total equities .................................................................................. $2,094
8.20 Effect on an Acquisition on the Postacquisition Balance Sheet Income Statement.

Fair value at date of acquisition ................................. $ 312 million
Book value at date of acquisition............................... (125 million)
Excess ........................................................................ $ 187 million
Allocated to:
Fixed assets...................................................... $50 million
Patent ............................................................... 40 million
Accounts payable and accruals........................ (25 million)
Post-employment benefits ............................... (20 million) (45 million)
Goodwill .............................................................. $ 142 million
a. Date of Acquisition Consolidated Ormond Daytona Elimina- Consoli-

Worksheet (January 1, 2014) Company Company tions dated
Balance Sheet
Cash........................................................... $ 25 $ 15 $ 40
Accounts receivable .................................. 60 40 100
Investment in Daytona Company.............. 312 0 $(312) 0
Fixed assets (net) ...................................... 250 170 50 470
Patent ........................................................ 0 0 40 40
Deferred tax asset...................................... 10 0 10
Goodwill ................................................... 0 0 142 142
Total assets ............................................. $657 $225 $ (80) $802
Accounts payable and accruals ................. $ (60) $ (40) $(25) $(125)

Long-term debt.......................................... (120) (60) (180)
Deferred tax liability ................................. (40) 0 (40)
Other noncurrent liabilities ....................... (30) 0 (20) (50)
Common stock .......................................... (392) (50) 50 (392)
Retained earnings ...................................... (15) (75) 75 (15)
Total liabilities and shareholders’
equity ................................................. $(657) $(225) $80 $(802)
Revenues, gains, and net income are in parentheses to indicate that their signs
are opposite those of expenses and losses; that is, they are credits for those in-
terpreting the worksheet from the accountant’s traditional debit/credit approach.
Liabilities and shareholders’ equity accounts are in parentheses to indicate that
8-10
Chapter 8
they are claims against assets; again, they are credits in the traditional debit/
credit framework.
b. Consolidation Worksheet for Ormond Company and Daytona Company 2014

(amounts in millions)
Ormond Daytona Elimina- Consoli-
Consolidated Worksheet Company Company tions dated
Income Statement (2014)
Sales .......................................................... $(600) $ (450) $ (1,050)
Equity in earnings of Daytona Company .. (30) $ 30 0
Operating expense..................................... 550 395 13 958
Interest expense......................................... 10 5 15
Loss (Gain) on lawsuit .............................. 0 20 (25) (5)
Income tax expense ................................... 28 12 40
Net income ................................................ $ (42) $ (18) $ 18 $ (42)
Balance Sheet (12/31/14)

Cash........................................................... $ 45 $ 25 $ 70
Accounts receivable .................................. 80 50 130
Investment in Daytona Company.............. 339 $(339) 0
Fixed assets ............................................... 280 195 40 515
Patent ........................................................ 0 36 36
Deferred tax asset...................................... 15 15
Goodwill ................................................... 0 142 142
Total assets ............................................. $759 $270 $(121) $908
Accounts payable and accruals ................. $(90) $(55) $ 0 $(145)

Long-term debt.......................................... (140) (75) (215)
Deferred tax liability ................................. (50) (50)
Other noncurrent liabilities ....................... (40) (19) (59)
Common stock .......................................... (392) (50) 50 (392)
Retained earnings ...................................... (47) (90) 90 (47)
Total liabilities and shareholders’
equity .................................................. $(759) $(270) $121 $(908)
Equity in Daytona Company earnings = $18 million Daytona Company earnings

+ $12 million amortizations (see schedule below) = $30 million.
Investment in Daytona Company = $312 million original investment + $30 mil-

lion equity in Daytona Company earnings – $3 million dividends received =
$339 million.
The Eliminations column is further supported by the schedule below, which

shows amortizations of the excess amounts and remaining excess amounts at the
end of 2014.
8-11
Chapter 8
Revenues, gains, and net income are in parentheses to indicate that their signs are
opposite those of expenses and losses; that is, they are credits for those interpret-
ing the worksheet from the accountant’s traditional debit/credit approach. Lia-
bilities and shareholders’ equity accounts are in parentheses to indicate that they
are claims against assets; again, they are credits in the traditional debit/credit
framework.
Date of Acquisition
Differences Charged (Credited) to Expense or Loss Balance One Year Later
Fixed assets: $50 million $50 million/5 years = $10 million increase
in operating expense $40 million
Patent: $40 million $40 million/10 years = $4 million increase
in operating expense $36 million
Accounts payable and
accruals: $25 million ($25 million) to reduce loss on lawsuit $0
Post-employment benefits: $20 million/20 years = ($1 million)
$20 million decrease in operating expense $19 million
Goodwill: $142 Million $0 (not impaired) $142 million
Net effects: $50 + $40 + Increase income by ($10) + ($4) + $25 + Increase net assets by $40 +
($25) + ($20) + $142 = $187 $1 million = $12 million $36 + ($19) + $142 = $199
million million
The balance of adjustments to net assets (that is, assets minus liabilities) is greater one
year later because the liabilities have been satisfied faster than the assets have been
amortized.
8.21 Variable-Interest Entities.

a. RMBC is a joint venture with Owens-Brockway Glass Container, Inc. in which
Molson Coors holds a 50% interest. RMBC produces glass bottles at a glass
manufacturing facility for use at the Golden, Colorado brewery. Under this
agreement, RMBC supplies the firm’s bottle requirements and Owens-
Brockway has a contract to supply the majority of bottle requirements not met
by RMBC. RMMC is a joint venture with Ball Corporation in which Molson
Coors holds a 50% interest.
RMMC supplies the firm with substantially all of the cans for its Golden,
Colorado brewery. RMMC manufactures the can at the Molson Coors’ manu-
facturing facilities, which RMMC operates under a use and license agreement.
Grolsch is a joint venture between CBL and Royal Grolsch N.V. in which
Molson Coors holds a 49% interest. The Grolsch joint venture markets Grolsch
branded beer in the United Kingdom and the Republic of Ireland. The majority
of the Grolsch branded beer is produced by CBL under a contract brewing ar-
rangement with the joint venture. CBL and Royal Grolsch N.V. sell beer to the
joint venture, which sells the beer back to CBL (for onward sale to customers)
for a price equal to what it paid plus a marketing and overhead charge and a
profit margin.
8-12
Chapter 8
b. An investing firm consolidates the VIE when it absorbs the majority of the enti-
ty’s expected losses if they occur, receives a majority of the entity’s expected
residual returns if they occur, or both. The consolidating firm is labeled the pri-
mary beneficiary. The firm considers the rights and obligations conveyed by its
variable interests and the relationship of its variable interests to variable interest
held by other firms to determine whether it will absorb a majority of expected
losses, receive a majority of expected residual returns, or both. If one firm
absorbs a majority of the expected losses and another firm receives a majority
of the expected residual returns, the firm absorbing a majority of the losses con-
solidates the variable-interest entity.
c. Cost of goods sold for Molson Coors includes all costs that the firm incurred for
producing, bottling, and canning its beers. Although the firm performs most of
these services in-house, it does outsource some to the three consolidated VIEs.
However, the accounting that Molson Coors followed is not precise because the
amount credited to cost of goods sold for the VIEs is net of revenues and costs,
whereas the cost of goods sold incurred in-house only includes the costs of pro-
duction, bottling, and canning.
d. The parent does not always own 100% of the voting stock of a consolidated sub-
sidiary. Accountants refer to the owners of the remaining shares of voting stock
as the minority interest. These shareholders have a proportionate interest in the
net assets (total assets – total liabilities) of the subsidiary as shown in the subsid-
iary’s separate corporate records. The shareholders also have a proportionate in-
terest in the earnings of the subsidiary. The amount of the minority interest in the
subsidiary’s income results from multiplying the subsidiary’s net income by the
minority’s percentage of ownership. The consolidated income statement shows
the proportion of consolidated income applicable to the parent company (net in-
come before minority interest) and the proportion of the subsidiary’s income ap-
plicable to the minority interest (minority interest in earnings). Typically, the
minority interest in the subsidiary’s income appears as a subtraction in calculat-
ing consolidated net income.
e. If RMBC, RMMC, and Grolsch did not qualify as VIEs, GAAP would require
them to account for minority, active investments (generally those in which own-
ership is between 20% and 50%) using the equity method. Under the equity me-
thod, the firm owning shares in another firm recognizes as revenue (expense)
each period its share of the net income (loss) of the other firm. The line “Equity
Income from Affiliates” would include Molson Coors’ share of the earnings in
50%-owned affiliates. The firm would treat dividends received from the inves-
tee as a return of investment, not as income. The statement of cash flows would
report Equity Income from Affiliates as a deduction from operating cash flows,
net of any cash dividends received from the affiliates.
8-13
Chapter 8
f. Molson Coors consolidated the financial statements of RMBC, RMMC, and

Grolsch with the financial statements of the parent. Thus, the depreciation re-
ported by the VIEs increased the parent’s depreciation by $13.1 million for 2004.
8.22 Accounting for a Merger under the Acquisition Method (Noncontrolling

Interests).
Solution a Solution b
Fair value of Sanders (as evidenced by fair value of
cash given and liability incurred by Pace) ............ $3,150,000 $2,150,000
Fair value of Sanders’ net assets ................................ (2,400,000) (2,400,000)
Goodwill .................................................................... $ 750,000
Gain on bargain acquisition ....................................... $ 250,000
a. Financial Statement Effects of a Merger

Shareholders' Equity
Assets = Liabilities +
CC AOCI RE
Cash +3,000,000 Accounts Payable +400,000

Cash +400,000 Notes Payable +2,200,000
Receivables +500,000 Contingent Performance
Inventory +1,600,000 Obligation +150,000
PP&E +2,000,000
Unpatented Technology +300,000
In-Process R&D +200,000
Goodwill +750,000
Journal Entries
Cash............................................................................... 400,000
Receivables ................................................................... 500,000
Inventory ....................................................................... 1,600,000
PP&E............................................................................. 2,000,000
Unpatented Technology ................................................ 300,000
In-Process R&D ............................................................ 200,000
Goodwill ....................................................................... 750,000
Accounts Payable ..................................................... 400,000
Notes Payable ........................................................... 2,200,000
Contingent Performance Obligation ......................... 150,000
Cash .......................................................................... 3,000,000
To record fair value paid and received.
Legal and Management Costs

Shareholders' Equity
Assets = Liabilities +
CC AOCI RE
Cash –20,000 Operating Expenses –20,000
Operating Expenses ...................................................... 20,000

Cash .......................................................................... 20,000
To record legal fees and management time.
8-14
Chapter 8
b. If the cash consideration is only $2,000,000, Pace records a gain from a bargain
acquisition of $250,000, and no goodwill is reported.
8.23 Consolidation Subsequent to the Date of Acquisition (Noncontrolling Interests).
a. Exhibit 8.30
Allocations of Fair Value
(in millions)
Charged Balance
Allocation (Credited) on
of Fair Estimated to Expense Dec. 31,
Values Life Each Year 2015
Booking fair value at
acquisition date ........... $ 1,462.5
Booking book value at
acquisition date ........... (1,110)
Fair value in excess of
book value ............... 352.5
Land (not depreciated) ...... (90) NA $ 0 $ 90
Equipment ......................... 15 10 (1.5) (12)
Customer lists ................... (180) 20 9 162
Long-term liabilities
(lower fair value) ........ (60) 8 7.5 45
Goodwill ..................... $ 37.5 Indefinite 0 37.5
$ 15
b. Exhibit 8.31
Investor Interests in Booking, Inc.
(in millions)
Prestige Properties Noncontrolling

(80% Controlling Interest) Interest (20%)
Acquisition date fair value (1/1/14) =
$292.5
$1,462.5 $1,170
2014 Net income of Booking = $105 $ 84 $ 21
Annual excess amortizations = $15 (12) (3)
Equity in Booking’s earnings for 2014 72 18
Investment in Booking, Inc. (12/31/14) $1,242 $310.5
2015 Net income of Booking = $135 $108 $ 27
Annual excess amortizations = $15 (12) (3)
Equity in Booking’s earnings for 2015 96 24
Dividends paid by Booking in 2015 = $75 (60) (15)
Investment in Booking, Inc. (12/31/15) $1,278 $319.5
8-15
Chapter 8
c. Consolidation worksheet at December 31, 2015:

A = elimination of the Investment in Booking account
B = elimination of the Booking’s shareholders’ equity accounts
C = allocation of the fair value excesses at the date of acquisition to expenses
and to the balance sheet from Solution a
D = elimination of the Equity in Booking’s earnings account
E = recognition of a $24 noncontrolling claim on consolidated net income and
recognition of noncontrolling equity of $319.5 that should be reported as a
component of shareholders’ equity.
Consolidation Worksheet at December 31, 2015

(amounts in millions)
Prestige Booking,
Resorts Inc. Eliminations Consolidated
Revenues $ (1,365) $ (645) $ (2,010)
Cost of goods sold 516 300 816
Depreciation expense 90 30 C (1.5) 118.5
Amortization expense 150 112.5 C 9 271.5
Interest expense 105 67.5 C 7.5 180
Equity in Booking’s earnings (96) 0 D 96 0
Net income $ (600) $ (135)
Consolidated net income $ (624)
Noncontrolling interest in net income E 24 24
Net income to controlling interest $ (600)
Cash $ 780 $ 600 $ 1,380

Short-term investments 309 67.5 376.5
Land 456 442.5 C 90 988.5
Equipment (net) 585 240 C (12) 813
Investment in Booking, Inc. 1,278 0 A (1,278) 0
Customer lists 1,320 810 C 162 2,292
Goodwill C 37.5 37.5
Total assets $ 4,728 $ 2,160 $ 5,887.5
Long-term liabilities $ (1,623) $ (885) 45 $ (2,463)

Common stock (1,305) (345) B 345 (1,305)
Noncontrolling interests 0 0 E (319.5) (319.5)
Retained earnings (1,800) (930) B 930 (1,800)
Total liabilities and shareholders’ equity $ (4,728) $(2,160) 0 $(5,887.5)
Revenues, gains, and net income are in parentheses to indicate that their signs are
opposite those of expenses and losses; that is, they are credits for those interpreting the
worksheet from the accountant’s traditional debit/credit approach. Liabilities and
shareholders’ equity accounts are in parentheses to indicate that they are claims against
assets; again, they are credits in the traditional debit/credit framework.
8-16
Chapter 8
8.24 Calculating the Translation Adjustment under the All-Current Method and the
Monetary/Nonmonetary Method.
a. Net assets, January 1 .................. FC 900 $10:1FC $ 9,000

Common stock issued ................ 100 $10:1FC 1,000
Net income ................................. 240 $8:1FC 1,920
Dividends ................................... (190) $6:1FC (1,140)
Net assets, Dec. 31 (in dollars) ....................................................... $ 10,780
Net assets, Dec. 31 (in FC) ........ FC 1,050 $6:1FC 6,300
Translation adjustment .................................................................... $ 4,480
The $4,480 translation adjustment decreases shareholders’ equity. The U.S. dol-
lar increased in value during the year. The firm is worse off having had its capi-
tal invested in the foreign currency instead of U.S. dollars.
b. Net Monetary asset (liability)

position, January 1 .................. FC 50 $10:1FC $ 500
Increase in net monetary assets:
Sales for cash or on account ... 4,000 $8:1FC 32,000
Decrease in net monetary
assets:
Issue of long-term debt for
land....................................... (100) $10:1FC (1,000)
Purchase of merchandise......... (3,250) $8:1FC (26,000)
S&A expenses ......................... (400) $8:1FC (3,200)
Income taxes ........................... (160) $8:1FC (1,280)
Dividends ................................ (190) $6:1FC (1,140)
Net monetary asset (liability)
position, Dec. 31 (in dollars) ....................................................... $ (120)
Net monetary asset (liability)
position, Dec. 31 (in FC) ........ FC (50) $6:1FC (300)
Foreign exchange loss ..................................................................... $ 180
The actual net liability at year-end is $300. If converted into U.S. dollars at the
time of the transaction, the liability would have been only $120. Thus, a foreign
exchange loss arises.
8-17
Chapter 8
8.25 Translating the Financial Statements of a Foreign Subsidiary; Comparison of

Translation Methods.
a. Translation of the Accounts of Canadian Subsidiary

for Year 1 (All-Current Translation Method)
Canadian Exchange U.S.

Dollars Rate Dollars
Balance Sheet:
Assets
Cash..................................... C$ 77,555 0.80 US$ 62,044
Rent receivable ................... 25,000 0.80 20,000
Building (Net) ..................... 475,000 0.80 380,000
C$ 577,555 US$ 462,044
Liabilities and Equity
Accounts payable ................ 6,000 0.80 4,800
Salaries payable .................. 4,000 0.80 3,200
Common stock .................... 555,555 0.90 500,000
Translation adjustment ........ See below (59,156)
Retained earnings ................ 12,000 See below 13,200
C$ 577,555 US$ 462,044
Income Statement:
Rent revenue ....................... C$ 125,000 0.85 US$ 106,250
Operating expenses ............. (28,000) 0.85 (23,800)
Depreciation expense .......... (25,000) 0.85 (21,250)
Net income .......................... C$ 72,000 US$ 61,200
Retained Earnings Statement:

Balance, January 1, Year 1 . C$ — US$ —
Net income .......................... 72,000 See above 61,200
Dividends ............................ (60,000) 0.80 (48,000)
Balance, December 31,
Year 1 ............................ C$ 12,000 US$ 13,200
8-18
Chapter 8
Computation of Translation Adjustment for Year 1

Net asset position,
January 1, Year 1 ............ C$ — US$ —
Plus:
Capital contributed
by P ............................ 555,555 0.90 500,000
Net income .......................... 72,000 0.85 61,200
Less:
Dividends........................ (60,000) 0.80 (48,000)
Subtotal ...................................................................................... US$ 513,200
Net asset position,
December 31, Year 1 ...... C$ 567,555 0.80 454,044
Translation adjustment ............................................................... US$ 59,156
b. Translation of the Accounts of Canadian Subsidiary

for Year 1 (Monetary/Nonmonetary Translation Method)

Balance Sheet:
Assets
Cash..................................... C$ 77,555 0.80 US$ 62,044
Rent receivable ................... 25,000 0.80 20,000
Building (net) ...................... 475,000 0.90 427,500
C$ 577,555 US$ 509,544
Common stock .................... 555,555 0.90 500,000
C$ 577,555 US$ 509,544
Income Statement:
Rent revenue ....................... C$ 125,000 0.85 US$ 106,250
Translation exchange loss ... — See below (10,406)
Net income .......................... C$ 72,000 US$ 49,544
8-19
Chapter 8

Balance, January 1, Year 1 . CS$ — US$ —
Dividends ............................ (60,000) 0.80 (48,000)
Year 1 ............................ C$ 12,000 US$ 1,544
Computation of Translation Loss for Year 1

Net monetary asset
position, January 1,
Year 1 ............................. C$ — US$ —
Plus:
Cash invested by P ......... 555,555 0.90 500,000
Cash and receivable
from rents .................... 125,000 0.85 106,250
Less:
Cash disbursed for
building ........................ (500,000) 0.90 (450,000)
Cash disbursed and
liabilities incurred for
operating expenses ...... (28,000) 0.85 (23,800)
Cash disbursed for
dividends ..................... (60,000) 0.80 (48,000)
Subtotal ...................................................................................... US$ 84,450
Net monetary position,
December 31, Year 1 ... C$ 92,555 0.80 74,044
Translation loss .......................................................................... US$ 10,406
c. The all-current translation method assumes that the subsidiary’s net asset posi-
tion (assets minus liabilities) is at risk to exchange rate changes. The Canadian
dollar decreased in value relative to the U.S. dollar during Year 1. Maintaining
a net asset position in Canada during a period when the Canadian dollar de-
creased in value gives rise to a negative translation adjustment. The monetary/
nonmonetary translation method assumes that the subsidiary’s net monetary
position (monetary assets minus monetary liabilities) is at risk to exchange rate
changes. The subsidiary has no monetary assets or liabilities at the beginning of
the year but had a net monetary asset position at the end of the year. The net
monetary asset position coupled with a declining Canadian dollar gives rise to a
translation loss. The amounts for the negative translation adjustment and the
translation loss differ because the base for computing the loss differs (net assets
versus net monetary assets).
8-20
Chapter 8
d. Management would likely prefer the all-current method. This method provides
larger earnings for two reasons: (1) depreciation expense translates at the aver-
age exchange rate during the current period instead of the higher exchange rate
when the subsidiary acquired the building, and (2) earnings exclude the nega-
tive translation adjustment. The all-current method also yields lower asset
amounts because the balance sheet translates at the lower year-end exchange
rate. It also results in a smaller shareholders’ equity because of inclusion of the
translation adjustment. Therefore, the all-current method produces higher rates
of return on both assets and shareholders’ equity.
8.26 Translating the Financial Statements of a Foreign Subsidiary; Second Year of

Operations.
a. Translation of the Accounts of Canadian Subsidiary

for Year 2 (All-Current Translation Method)

Balance Sheet:
Assets
Cash..................................... C$ 116,555 0.84 US$ 97,906
Rent receivable ................... 30,000 0.84 25,200
Building (net) ...................... 450,000 0.84 378,000
C$ 596,555 US$ 501,106
Common stock .................... 555,555 0.90 500,000
Translation adjustment ........ See below (34,634)
C$ 596,555 US$ 501,106
Income Statement:
Rent revenue ....................... C$ 150,000 0.82 US$ 123,000
Net income .......................... C$ 91,000 US$ 74,620

Balance, January 1, Year 2 . C$ 12,000 See Prob. 8.25 US$ 13,200
Dividends ............................ (75,000) 0.84 (63,000)
Year 2 ............................ C$ 28,000 US$ 24,820
8-21
Chapter 8
Computation of Translation Adjustment for Year 2

Net asset position,
January 1, Year 2 ............ C$ 567,555 0.80 US$ 454,044
Plus net income ................... 91,000 0.82 74,620
Less dividends..................... (75,000) 0.84 (63,000)
Subtotal ...................................................................................... US$ 465,664
Net asset position,
December 31, Year 2 ...... C$ 583,555 0.84 490,186
Translation adjustment for
Year 2 ................................................................................... US$ 24,522
Change in Translation Adjustment during Year 2
Balance, January 1, Year 2 ........................................................ US$ (59,156)

Plus translation adjustment for Year 2 ....................................... 24,522
Balance, December 31, Year 2 .................................................. US$ (34,634)
b. Translation of the Accounts of Canadian Subsidiary

for Year 2 (Monetary/Nonmonetary Translation Method)

Balance Sheet:
Assets
Cash..................................... C$ 116,555 0.84 US$ 97,906
Rent receivable ................... 30,000 0.84 25,200
Building (net) ...................... 450,000 0.90 405,000
C$ 596,555 US$ 528,106
Common stock .................... 555,555 0.90 500,000
C$ 596,555 US$ 528,106
Income Statement:
Rent revenue ....................... C$ 150,000 0.82 US$ 123,000
Translation exchange gain .. — See below 6,022
Net income .......................... C$ 91,000 US$ 78,642
8-22
Chapter 8

Balance, January 1, Year 2 . CS$ 12,000 See Prob. 8.25 US$ 1,544
Dividends ............................ (75,000) 0.80 (63,000)
Year 2 ............................ C$ 28,000 US$ 17,186
Computation of Translation Gain for Year 2

Net monetary asset
position, January 1,
Year 2 ............................. C$ 92,555 0.80 US$ 74,044
Plus cash and receivables
from rents .................... 150,000 0.82 123,000
Less:
Cash disbursed and
liabilities assumed
for operating
expenses....................... (34,000) 0.82 (27,880)
Cash disbursed for
dividends ..................... (75,000) 0.84 (63,000)
Subtotal ...................................................................................... US$ 106,164
Net monetary position,
December 31, Year 2 ... C$ 133,555 0.84 112,186
Translation gain ......................................................................... US$ 6,022
c. The net asset position in Canada coupled with an increase in the value of the
Canadian dollar gives rise to a positive exchange adjustment for Year 2. Note
that the cumulative adjustment for Year 1 and Year 2 is negative. The net mone-
tary asset position coupled with the increase in the value of the Canadian dollar
gives rise to a translation gain. The base for computing the translation adjust-
ment (net asset position) and the translation gain (net monetary asset position)
differ, causing the dollar amounts to differ.
d. The monetary/nonmonetary translation method results in larger earnings than

for the all-current method. Two offsetting factors explain this result: (1)
depreciation expense is higher under the monetary/nonmonetary translation
method because this method uses the higher historical exchange rate, but (2) net
income includes the translation gain. Assets and shareholders’ equity are also
higher under the monetary/nonmonetary method because it uses the higher
historical exchange rates. The signal is not as clear in this case as to
management’s preference.
8-23
Chapter 8
8.27 Identifying the Functional Currency. The following discussion applies the five
criteria in determining the functional currency for ECS.
Cash Flows of Foreign Entity. The use of forward exchange contracts suggests
that ECS and its subsidiaries make currency conversions upon settlement of
receivables and payables. These contracts coupled with ECS’s policy of allowing
foreign subsidiaries to retain earnings for growth rather than remitting it to the U.S.
parent suggests a foreign currency rather than U.S. dollar perspective.
Sales Prices. ECS sets transfer prices to mirror free market prices. Given the signif-
icant amount of intersegment transfer, this suggests a worldwide influence on pric-
ing. The use of foreign exchange contracts indicates that exchange rate changes
likely affect pricing. These facts point to the U.S. dollar as the functional currency.
Cost Factors. The significant assets in Europe and the manufacturing plants
located around the world suggest a worldwide sourcing of material and labor. The
problem states that ECS transfers partially finished products through other
geographical segments, again indicating a non-U.S. dollar perspective.
Financing. Computer firms experience significant technological risks (short

product life cycles, high research and development costs) and tend not to assume
major financing risks as well. Thus, the foreign subsidiaries probably do not engage
in heavy borrowing. The financing for those foreign subsidiaries appears to come
from the retention of earnings, suggesting the foreign currency as the functional
currency.
Relations between Parent and Foreign Unit. The segment data indicate a high
volume of intercompany operations, particularly from the United States Although
the path is not fully evident, it appears that ECS sources components in the Canada,
Far East, and Americas segment, assembles them in the United States, and exports
finished products to sales subsidiaries abroad. This flow suggests the U.S. dollar as
the functional currency.
Mixed signals emerge regarding ECS’s functional currency. Three characteristics
(cash flows, cost factors, and financing) suggest the foreign currency as the func-
tional currency and two characteristics (sales prices and relations between parent
and foreign unit) suggest the U.S. dollar as the functional currency.
8-24
Chapter 8
The application of these criteria to ECS demonstrates a possible flaw in Statement

No. 52’s functional currency concept. Firms like ECS that are truly global in all
aspects of their operations often do not have an identifiable functional currency. The
characteristics for selecting the U.S. dollar as the functional currency include three
factors with a distinct U.S. orientation (cash flows, cost factors, and financing) and
two factors with a multinational orientation (sales prices and relation between parent
and foreign unit). The implication presumably is that firms with no clearly
identifiable functional currency use the U.S. dollar as the functional currency.
The solution attempts to identify the functional currency for all of ECS’s opera-
tions. It is likely that ECS will use the local currency for some activities and the
U.S. dollar for others. This problem uses data from Digital Equipment Corporation
which uses the U.S. dollar for all of its foreign operations.
Integrative Case 8.1: Starbucks

Part I.
a. Leasehold improvements meet the definition of an asset. The improvements
enhance the quality of the stores and expected revenue inflows. The improve-
ments are controlled by the company over the term of the lease, and the costs to
improve the stores have been incurred (and thus are reliably measured). Because
the benefits of the leasehold improvements exist over several periods, the costs of
the improvements are assigned to the periods benefited through the amortization
process.
Starbucks’ useful life policy appears to be one that will generate high-quality
accounting numbers (assuming that the underlying assets used to improve the
leased property will have a useful life that is at least as long as the lease). At the
time the lease is signed, Starbucks equates the useful life with the lease term un-
less failure to renew the lease would involve a substantial penalty for Starbucks.
In that case, Starbucks forecasts that it will renew the lease to avoid the penalty
and, appropriately, equates the useful life with the extended lease term. The only
possible improvement in this policy would be to consider other factors that would
likely cause Starbucks to renew lease terms and incorporate those factors into the
forecast of the lease term. For example, bargain lease renewal options, slow pay-
back periods for leasehold improvements, and other moving costs might cause
Starbucks to expect to lease the properties for longer periods than the original
lease term. [Also, if leasehold improvement assets are likely to need replacement
before the end of the lease (for example, carpeting that will be replaced every
three years), Starbucks should use the shorter life of the underlying asset rather
than the lease life.] Another factor is likely at play here. Starbucks has many
properties under operating leases. It is highly likely that the assumed leasehold
improvement useful life estimates dovetail with the lease term estimates that orig-
inally caused the lease to be treated as an operating lease rather than a capital
lease. (It is useful at this point to pause and consider why it makes sense to show
an asset for capitalized leasehold improvements while showing no leased asset
under an operating lease.)
8-25
Chapter 8
If Starbucks estimates that it will renew a lease and does not, it will have an
unamortized balance in the leasehold improvements asset account that it must
remove when it abandons the property. This decrease in an asset will be recog-
nized as a loss on the income statement.
b. Starbucks estimates how much cost it will incur to remove the leasehold improve-
ments at the end of the lease and records an ARO at its fair value. It is unlikely that
AROs are traded in organized markets to the extent that Starbucks could use a
Level 1 or Level 2 valuation. Thus, Starbucks takes the Level 3 approach to fair
value and uses “a number of assumptions requiring management’s judgment” and
a present value of future cash outflows approach to measure the ARO’s fair value.
Starbucks recognizes this fair value as a noncurrent liability in the balance sheet.
The ARO-related asset is part of the costs included in leasehold improvements.
Starbucks accounts for the evolution of the ARO-related asset and ARO
liability through time. The note reports that the ARO-related asset is much lower
than the ARO liability. This situation occurs because the ARO-related asset is
amortized with the leasehold improvements asset and reported as amortization
expense on each year’s income statement. The ARO liability, on the other hand,
accretes (that is, becomes larger) over time. Recall that the ARO liability is
initially recorded at present value, which is the manager’s estimate of reclamation
costs discounted to the present time. The present value is lower than the gross
expected reclamation costs because the discounting process removes interest. As
time passes and the reclamation costs are not paid, the ARO liability grows
because the interest is added back to the liability. The interest expense reduces
income and causes the liability to grow to the expected future cost to retire the
ARO liability.
Income is not affected by the act of reclaiming the property to satisfy the
ARO liability. Cash is decreased, and the ARO liability is decreased. However, if
the cash paid to satisfy the ARO liability is different than expected, a loss is
reported in the period if cash outflow was higher than expected and a gain is
recorded if cash flow is lower than expected.
c. If Starbucks used IFRS, the carrying value of the asset would be compared to the
larger of its fair value in use (discounted future cash flows) and fair value from
sale (fair value in the market – disposal costs). IFRS impairment testing appears
to better estimate the economic decline in the fair value of the asset.
d. The analyst is concerned primarily with how often restructuring and impairment
charges occur and what their amounts are because he or she wants to assess the
likelihood of the charges recurring in the future. It is best when material amounts
of these charges are reported in separate line items or the amounts and their loca-
tion in the financial statements are clearly disclosed in the notes to the financial
statements. The downside of encouraging separate categorization of such charges
is that managers might be inclined to over-allocate expenses to line items they an-
ticipate might be ignored or underweighted by investors.
8-26
Chapter 8
Part II.
a. Recent business combination standards from both the FASB and IASB make it
clear that fair value will be the basis for recording all business combinations. The
fair value of the acquired firm’s individual assets and liabilities must be estab-
lished at the date of combination under the newly promulgated acquisitions
method. (Some exceptions exist, but they are few.) A number of intangible assets
(including in-process R&D) with little or no book value in the acquired firm’s
records are reported at fair value in the consolidated statements. Goodwill also is
reported at fair value. Finally, as required under U.S. GAAP and an option under
IFRS, the full fair value of the acquisition is allocated on a pro rata basis to non-
controlling interests. Recording noncontrolling interests at fair value is a major
departure from the purchase method, which is no longer allowable.
b. Starbucks states that international operations generally use their local currency as
their functional currency. Therefore, Starbucks uses the all current translation
method. Under the all current translation method, Starbucks translates revenues
and expenses at the average exchange rate during the period and balance sheet
items at the end-of-the-period exchange rate. The resulting “translation
adjustment” (the amount needed to balance the balance sheet) is reported as a
component of other comprehensive income rather than net income.
c. Bay Bread continues to produce its own financial statements using pre-acquisition
book values. Therefore, its own financial statements continue to report all three
items at or near $0. When preparing consolidated financial statements, Starbucks
will add on the differences between book value and fair value for these three
items so that they are reflected on the consolidated balance sheet at fair value. At
the date of acquisition, the amounts would be:
Trade name: $9.7 million
Proprietary recipes and processes: $14.6 million
Goodwill: $58.7 million
One year later, the amounts would be:
Trade name: $9.7 million
Proprietary recipes and processes: $14.6 million – ($14.6 million ÷ 10
years) = $13.14 million
Goodwill: $58.7 million
The values reported a year later for trade name and goodwill will be the same as
of the date of acquisition unless impairment tests indicate that they should be
written down to a lower fair value. These intangibles have indefinite lives and
thus are not amortized. Proprietary recipes and processes have been judged to
have a 10 year life and are thus amortized. These limited life intangibles may also
be written down further if they are judged to be impaired. One year later,
Starbucks will also be preparing a consolidated income statement. Bay Bread
reports no amortization for proprietary recipes and processes. In consolidation,
Starbucks will add the $1.46 million of amortization expense.
8-27
Chapter 8
Part III.
a. Average Total Estimated Useful Life of Depreciable PP&E:
Sept. 30, Oct. 2,

2012 2011
PP&E acquisition cost ............................................ $6,903.1 $6,163.1
Less land and WIP .................................................. (310.3) (172.2)
Depreciable assets acquisition cost ......................... $6,592.8 $5,990.9
Average depreciable assets acquisition cost = 0.5($6,592.8 + $5,990.9) = $6,291.8

Average total estimated useful life = $6,192.8 ÷ Depreciation expense
= $6,192.8 ÷ ($580.6 – $4.5)
= 10.92 Years
The largest portion of Starbucks’ depreciable PP&E is in leasehold improve-

ments and equipment. Starbucks’ accounting policy states that it amortizes lease-
hold improvements over 10 years and equipment over 2–15 years. Thus, a 10.92
year average appears in line with accounting policy.
b. Analysts can track this number over time to see if companies are changing esti-
mated useful lives (for strategic or earnings management purposes) or changing
the mix of PP&E. Analysts also can explain differences in earnings and asset
book values among competitors by comparing useful life estimates. The differ-
ences across firms may be due to different operating strategies or differences in
accounting quality.
c. Because the amount of accumulated depreciation depends on the number of years

for which depreciation has been taken, the average age of depreciable assets
equals the amount of accumulated depreciation divided by depreciation expense,
as follows:
$4,244.2 ÷ $576.1 = 7.37 years average age
The proportion of depreciable assets consumed equals total accumulated

depreciation divided by acquisition cost, as follows:
$4,244.1 ÷ $6,903.1 = 61.5%
The remaining useful life can be obtained by dividing net depreciable PP&E by
annual depreciation expense, as follows:
($6,903.1 – $4,244.2) ÷ $576.1 = 4.61 years average age
Forecasting future financial statements requires expectations of future tangible

asset acquisitions for replacement of existing production or service capacity and
8-28
Chapter 8
for growth in capacity. Although the analyst must rely on knowledge of industry
conditions and firm strategy to estimate capital expenditure growth, the analyst
can make these computations to gain a better understanding of when existing
long-lived assets must be replaced. The analyst can track average age and propor-
tion consumed through time and compare them to those of competitors to ascer-
tain whether assets are getting older, on average, and whether they are at a point
where large capital expenditures are necessary to replace them. Also, older assets
and high proportion consumed provides an indication that the firm is in a later
stage of average product life-cycle.
Case 8.2: Disney Acquisition of Marvel Entertainment

a. A September 1, 2009, article in The Wall Street Journal by Ethan Smith and
Lauren A. E. Schuker, entitled “Disney Nabs Marvel Heroes,” summarizes the
business reasons for this acquisition in the following quotes.
“As DVD sales sink, Hollywood has been scrambling for new sources of ancillary
revenue, such as toys, videogames, clothing and roller coasters. Marvel, with its
roster of 5,000 characters, could provide several years of fodder for Disney’s en-
tertainment and marketing empire.”
“By bringing in the macho types such as Iron Man, Thor, and Captain America,
the Marvel deal significantly expands Disney’s audience, adding properties that
appeal to boys from their preteen years into young adulthood and beyond. That
demographic group hasn’t been swept up by Disney’s recent hot properties such
as ‘High School Musical’ and the ‘Jonas Brothers’.”
b. Fair value of acquisition ........................................................... $ 4,000,000,000

Book value of Marvel (Total shareholders’ equity).................. (454,759,000)
Goodwill ................................................................................... $ 3,545,241,000
c. All else held equal, goodwill is larger for a higher acquisition fair value. There-
fore, the premium paid by Disney increases goodwill. However, the market price
existing at the time of the acquisition does not affect the computation of goodwill
in a 100% acquisition. That is, if the market price were $1 higher or lower, good-
will would not be different. The only fair value that matters is what Disney paid
to acquire Marvel Entertainment.
In a less than 100% acquisition, the premium does matter. Disney’s willingness
to pay the premium indicates its belief that Marvel is worth more under Disney’s
control (and not under the control of a competitor such as Paramount). In a less
than 100% acquisition, the noncontrolling shares of Marvel trade at prices that are
likely to differ from the per-share consideration given by Disney. Total goodwill
allocated to the acquirer and the noncontrolling interest are based on the implied
fair value of Marvel, which is measured as the fair value given by Disney and the
fair value of the noncontrolling shares.
8-29
Chapter 8
d. If Marvel is dissolved (a merger), Disney will record goodwill and Marvel’s

identifiable assets and liabilities at fair value in its own financial records. The
consolidation process is not necessary because there would be no records of
Marvel to consolidate. If Marvel continues to exist as a separate legal entity (an
acquisition), then Disney will record an “Investment in Marvel” in its own
records. During the consolidation process, the investment account will be
eliminated, and Disney will replace the account by adding goodwill and Marvel’s
identifiable assets and liabilities at fair value to the consolidated totals. The
financial statements issued by Disney will be exactly the same regardless of
whether the business combination is a merger or an acquisition.
e. Most current assets and liabilities have book values that do not materially differ
from fair values. An exception is the nonmonetary asset “Inventories” which is
likely to have a fair value greater than its book value (which is based on the lower
of cost or market). Long-lived assets such as Fixed assets, net; Film inventory,
net; and Goodwill are also likely to have fair values greater than their book values
(which are based on historical cost or historical cost adjusted for depreciation un-
less reduced for impairment). Also, Marvel likely has a number of identifiable in-
tangible assets such as the artistic-related intangible assets: video and audiovisual
material, including motion pictures, music videos, and television programs, and
character brand names, and the contract-based intangible assets: licensing, royal-
ty, standstill agreements. Book values of these intangibles are probably small, but
the fair values are large. Finally, Marvel has a number of noncurrent receivables
and payables. Long-term contractual agreements involving future cash receipt and
payment have fair values that depend on current market interest rates. If the cur-
rent market interest rates differ from contractual rates on the receivables and
payables, then differences between book and fair values will exist. Before alloca-
tion of the large excess consideration given to goodwill, Disney will allocate
amounts to the aforementioned differences between fair and book values. The re-
mainder will be classified as goodwill.
8-30

Financial Reporting Financial Statement Analysis and Valuation 8th Edition Wahlen Solutions Manual

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Financial Reporting Financial Statement Analysis and Valuation 8th Edition Wahlen Solutions Manual

Uploaded by

Copyright:

Available Formats

Financial Reporting Financial

Statement Analysis and Valuation 8th

8.1 Capitalization versus Expensing Decision.

8.5 Capitalization of Software Development Costs. Adobe capitalizes software

8.7 Earnings Management and Depreciation Measurement. Depreciation is a

timing of expense recognition. For example, incorrectly expensing a cost to manage

8.9 Corporate Acquisitions and Acquisition Reserves. “Acquisition reserves” may

8.10 Accounting for Available-for-Sale and Trading Marketable Equity Securities.

8.11 Equity Method for Minority, Active Investments.

c. The balance in Investment in Spear Corporation at the end of 2014 is $1,126.39

8.12 Consolidation of Variable-Interest Entities. Often the structure of a VIE is such

Determining whether an investing firm should consolidate the VIE is at the

Cash Flows of Foreign Entity. No information is provided about cash flows,

Financing. Financing for manufacturing plants is denominated in U.S. dollars, with

8.15 Analyzing Disclosures Regarding Fixed Assets.

c. Depreciation—straight-line method ..... $ 27 $ 328 $ 72

d. Net income as reported ......................... $ 33 $ 267 $ 55

e. NewMarket Monsanto Olin

f. NewMarket Corporation and Olin Corporation might have a higher proportion

8.16 Asset Impairments.

Fair value of Vineyard unit at 12/31/14 ............................................. $1,800,000

c. Goodwill is written down from $400,000 to $300,000 and a $100,000 impair-

8.17 Upward Revaluations under IFRS.

8.18 Application of Statement No. 115 for Investments in Marketable Equity

(2) As described above, the 2006 unrealized holding “gain” of $379,204,000

8.19 Effect of an Acquisition on the Date of Acquisition Balance Sheet.

Allocation (Fair value/book value differences):

Accounts payable and accruals ($240 + $80 + $30) ........................... $ 350

8.20 Effect on an Acquisition on the Postacquisition Balance Sheet Income Statement.

a. Date of Acquisition Consolidated Ormond Daytona Elimina- Consoli-

Accounts payable and accruals ................. $ (60) $ (40) $(25) $(125)

b. Consolidation Worksheet for Ormond Company and Daytona Company 2014

Balance Sheet (12/31/14)

Accounts payable and accruals ................. $(90) $(55) $ 0 $(145)

Equity in Daytona Company earnings = $18 million Daytona Company earnings

Investment in Daytona Company = $312 million original investment + $30 mil-

The Eliminations column is further supported by the schedule below, which

8.21 Variable-Interest Entities.

f. Molson Coors consolidated the financial statements of RMBC, RMMC, and

8.22 Accounting for a Merger under the Acquisition Method (Noncontrolling

a. Financial Statement Effects of a Merger

Cash +3,000,000 Accounts Payable +400,000

Legal and Management Costs

Operating Expenses ...................................................... 20,000

8.23 Consolidation Subsequent to the Date of Acquisition (Noncontrolling Interests).

Prestige Properties Noncontrolling

c. Consolidation worksheet at December 31, 2015:

Consolidation Worksheet at December 31, 2015

Cash $ 780 $ 600 $ 1,380

Long-term liabilities $ (1,623) $ (885) 45 $ (2,463)

a. Net assets, January 1 .................. FC 900 $10:1FC $ 9,000

b. Net Monetary asset (liability)

8.25 Translating the Financial Statements of a Foreign Subsidiary; Comparison of

a. Translation of the Accounts of Canadian Subsidiary

Canadian Exchange U.S.

Retained Earnings Statement:

Computation of Translation Adjustment for Year 1

Canadian Exchange U.S.

b. Translation of the Accounts of Canadian Subsidiary

Canadian Exchange U.S.

Retained Earnings Statement:

Computation of Translation Loss for Year 1

Canadian Exchange U.S.

8.26 Translating the Financial Statements of a Foreign Subsidiary; Second Year of