Accounting 311 Workbook PDF

Chapter 1
Important Definitions- Chapters 1 and 2
Affiliated Companies
Investor (equity method)
Investee (equity method)
Parent (consolidation)
Subsidiary (consolidation)
Book Value
Net Assets
Book Value of Net Assets Acquired (BVNAA)
Fair Value (of asset or liability)
Fair Value of Consideration Transferred (purchase price)
Fair Value of Net Assets Acquired (FVNAA)
Arms Length Transaction
Premium over Book Value (purchase premium)
Goodwill
lntercompany Transactions
Fair Value Allocations
Initial Value (cost) Method
Equity Method
Partial Equity Method
Consolidation
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Definitions---- Chapter 1----Class #2
Transferor---entity doing the selling (either

investor/investee or parent/sub)
Transferee---entity doing the buying (either

investor/investee or parent/sub)
Downstream transfer---from investor to investee

or from parent to sub
Upstream transfer---from investee to investor or

from sub to parent
Economic entity---ownership structure formed by

investor-investee or parent-sub
Arms length transaction---completed at price a

willing buyer and willing seller would agree to with
neither being under pressure to complete the
transaction
Unrealized gain on intercompany transfer---

amount earned (profit) on transactions done
inside the economic entity.
1b
Realized gain---amount earned (profit) on
transactions completed by one entity inside an
economic entity with another entity outside the
economic ·entity
Principle: lntercompany transactions (between

investor and investee or parent and sub) are not
arms length due to the relationship between the
parties. Any profits (or losses) recorded by an
investor/investee on an intercompany transaction
are considered unrealized and must be reversed
while the unsold inventory is still in the economic
entity, to the extent of the ownership percentage.
Once the transferee sells inventory outside the
economic entity, the unrealized gain is now
realized and is recognized in the income statement
(Dr. Investment Cr. Equity Income).
Formula to calculate equity income in year 2:
Net Income of Investee (year 2) x ownership

percentage
Plus: Unrealized gain from inventory transfer (Yl)
now realized in V2
Minus: Unrealized gain from inventory ~ransfer

year two.
The unrealized gain from each year is calculated

using the 4 step process described in class.
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Investor Ownership of
Investee Shares
0 utstanding
1
Equity Consolidated Financial

Method Statements
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20% -50~/o 100,
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..," In some cases, ~nfluence or control may
exist with less than 20% ownership.
M€G~a~t4:J.Jfli;l111rwin © The McGraw-Hill Companies, Inc., . 107
7e,
Representation o,n the investee's Board of
Directors.
Participation in the investee's policy-

making process
Material intercompany transactions.
© The McGraw-Hill Companies, Inc., : '07

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Accounting for Investments in Equity Securities---Journal (Worksheet) Entries
Event Eauitv Method Fair Value Method Initial Value Method Consolidation
Initial investment
Earnings of investee
Investee Dividends
Change in Fair Value
Sale of Investment
Permanent Impairment
,
Interco Inventory Transfe
Amortize Premium over E ook

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-; 3
In Class Exercises Using Equity Method
Example 1 : Assume B (the investee) has the following simplified balance sheet:
Assets $100,000 Liabilities $ 60,000
Equity $40,000
Prepare journal-entries for the INVESTOR (A) for the following events:
(a) A (the investor) pays $10,000 for a25% interest in B. A has significant influence.
Dr.
Cr.
(b) In the first year after the investment, the investee earns $20,000.
Dr.
Cr.
(c) At the end of the first year, B pays total dividends of $8,000 to its shareholders.
Dr.
Cr.
(d) At the end of the first year, A sells 30% of its investment for $9000.
Dr.
Cr.
Cr.
(e) Instead of (d), A decides to keep its investment. In year 2, B has a loss of$100,000.
Dr.
Cr.
(f) After recording entry (e), how much will the investee need to earn before the investor
can return to using equity method accounting.
Important points to note:

1. Under equity method accounting, the investor uses only 2 accounts, the
investment asset account and the equity earnings P&L account.
2. Positive earnings increase the investment account; dividend decrease it.
3. The required entries by the investor mirror what the investee is recording in
earnings and stockholders equity ..... for the % ownership by the investor.
4. On sale of a partial interest, use "T accounts" to update the investment balance to
date of sale and remove only the percentage sold.
5. The investor reflects its share of losses of the investee only until the balance· in the
Investment Account goes to zero.
Example 2: This example looks at how to handle an excess of investment cost over the
book value of net assets acquired when using the equity method.
Assume B (the investee) has the following book values and fair values.
Book Value(BV) Fair Value(FV) Difference
Assets 100 140

Liabilities 20 20
Equity 80 120
A (the investor) pays 30 for a 20% interest in B. Calculate goodwill.
Price paid
Minus: Book value of net assets acquired
Excess of price paid over BV
Allocation of Excess to Specific assets or

Liabilities whose FV>BV
Remainder= Goodwill
Shortcut method:
Price paid
Minus Fair value of net assets acquired (based on ownership%)
Equals Goodwill
Assume that the excess paid over book value is attributable to investee fixed assets
having a remaining useful life of 4 years. What journal entry is prepared by the investor
after the first year.
Dr.
Cr.
1. When comparing price paid to the book value of net assets acquired, remember to
apply the percentage ownership to the BV acquired.
2. While it may seem easier to use the "shortcut method" to solve for goodwill, it is
recommended that at this stage you follow the 2 step approach first shown.
3. Amortization of fair value adjustment under the equity method are always debited
to the equity earnings account, not a separate amortization account.
Example 3: Elimination of Unrealized Gains on Sales of Inventory Between Investor and
Investee (Downstream)
A owns 30% ofB. A has inventory on its books with a cost basis of $60,000 that it sells
to B for $100,000. B sells 80% of the goods it acquires from A to third parties. What
entries does A record to reflect the sale the elimination of the umealized gain on the
intercompany transaction.
Entry to record the sale (assume cash received):

Dr
Cr.
Cr.
Entry to record deferral of portion of intercompany gain related to unsold inventory

Dr.
Cr.
Supporting calculation using the 4 step approach
Step 1: Calculate gross profit percentage
Step 2: Determine ending inventory on the books of the transferee
Step 3: Determine the unrealized gain in the ending inventoy
Step 4 Apply ownership percentage to the result from step 3
Example 4 Same facts as above except it is B who sells the inventory to A (upstream).
Show the entries that A records to pick up the equity earnings of B as well as the
elimination of its share of the unrealized gain from the unsold ending inventory
Entry to reflect equity pick up :

Dr.
Cr.
Entry to reflect deferral of portion of unrealized gain related to unsold inventory
Dr.
Cr.

1. When using the equity method there is NO DIFFERENCE between upstream and
downstream inventory sales.
2. Remember to always follow the 4 step approach ......... .it is not recommended
that you combine steps.
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Change from Fair Value Method to Equity Method (retrospective treatment)
Example 4: Assume A owns 10% ofB on January 1, 2012. On July 1, 2012 A increases
ownership to 40% by purchasing additional shares in B. The following represent the
earnings and dividends ofB for 2012.
Income Dividends
January 1- June 30 50,000 30,000
July 1- December 31 70,000 40,000
1. How much equity income is recognized by A in 2012.
2. How much dividend income is recognized by A in 2012
3. What is the balance of A's Investment in B as of December 31, 2012
Change from Equity Method to Fair Value Method (prospective treatment)
Example 5: Assume A owns 40% ofB on January 1, 2012. On July 1, 2012 A decreases
its ownership to 10% by selling its shares in B to third parties. The following represent
the earnings and dividends ofB for 2012.
Income Dividends
January 1- June 30 50,000 30,000
July 1- December 31 70,000 40,000
4. How much equity income is recognized by A in 2012.
5. How much total income is recognized by A in 2012
6. What is the balance of A's Investment in B as of December 31, 2012

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February 08, 2010

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825 Financial Instruments

10 Overall
25 Recognition
General Note: Thie Recog1ni~tio1n Section provides g;u,i<Lfa,nce ori tfile requi,red cri,teda, bmi,ng, and
location (wiibhi,n the rina,filGia,I statements) for recording a p,articu1la,r iitem i,n th.e financial
statements. Disclosure is not recognition.
Fair Value Option
> Overall Guidance
825-10-25-1 This Subtopic perrrHts all entities to choose, at specified el,ection dates, to
measure eligibie items at fair value\the fair value option).
' '
825-10-25-2 '
The decision about whetber to el,ect the fair value optfon:
\
a. Shall be applied instrument by instn~ment, except as ctiscussed in pa,ra-graph 825-10 -25-

z
b. Shall be irrevocable (unless a new election date occurs, as discussed in paragraph 825-
10-25-4)
c. Shalf be applied only to an entire instrument and not to only specified risks, specific cash
flows, or portions of that ihstrument.
An entity may decide whether to elect the fair value option for each eligible item on its election
date. Alternatively, an entity may elect the fair value option according to a preexisting policy for
specified types of eligible items.
825-10-25-3 Upfront costs and fees related to items for which the fair value option is elected
shall be recognized in earnings as incurred and not deferred.
>> Election Dates
825-10-25-4 An entity may dhoose to eifect the fair value opti,on for an eligible item only on
the date that one of the following occurs:
a. The entity first recognizes the eHgible item.
b. The entity enters into an eligible firm commitment.
c. Financial assets that have been reported at fair vaiue with unrealized gains and losses
included in earnings because of specialized accounting principles cease to qualify for that
specialized accounting (for example, a trarisfer of assets from a subsidiary subject to
http :/lase. fasb .org/print&rendercmd=section&trid=~ 134558&nav_ type=section_rollover_pa... 2/8/2010

Financial Accounting Stam.dards Board Page 3 of 4
c. [ Si;gin,i!fi,ca;nt mocd1iificaitio,ns of de,bt, as olefined, i,n Subtopic 470-50. [FAS 159, paragraph 10,
sequence 41] ]
825-10-25-,fi [ A,ri a.cq,u,i,rnr, parent, or pri,rma,ry beneficiary decides whether to a,pply the fair
va Il ue opti,o,n to e11iii91i1bil1e iite,ms of a,n acq,ukee, su,bsidiiary, or consolidated VJ,E, bu,t that decision
appli,es o,nily i1n the conso11iiida1ted fi,na,ndail staitemen,ts. [FAS 159, paragraph 11, sequence 42.1] ] [ Fair
valu,e 0;pt,i10,o oh,o,i,ces m.a,d,e by a,n acq,u,i,red entity, su,bsidiary, or VIE conitinue to a,pply k1 separate
.fina,r;ida1l state,ments of those e:ntiiti,es if they issue separate financia,I statements. [FAS 159,
paragraph 11, sequence 42.2] ]
>> Unit of Accounting
825-10-25-7 [ The fair value option may be elected for a s.ing,le eH,gibl,e item wi bhout el,ecting 1
it for other identical items with the following four exceptions: [FAS 159, paragraph 12,
sequen·ce 43j ]
a. [ If multiple advances a,re .tnaole to one bo.rrower pursuant to a sing1l,e co,n,t:ra,ot (such as
a line o,f credit o,r a construct ion lqan) an,d tJ11,e indiviidua1l advances l,os,e their i,d,entiity and
1
become part of a larger loan balari:c;.e, the fa·i r valw,e op,No,ri siha11!1 be appM,ed only to the la,rg,er
balance and not to each advance in~M,olual;ly: [FAS 159, paragrapt1 ·tz,--seq\Jence 44] ]
- - ------- ·-·----- .... '"-
✓- -6 ~~ [ If the fair value

option is appHed to.an investment that woiwM otherwise be ac·coun ted -------
/ for under the equity method of accounting, it shaH be app,l.ied to a1M of the investor's fin.ancial
interests in the same entity (equity and debt, ine'luding guarantees) that are eUgible · ms.
[FAS 159, paragraph 12, sequence 45] ]
c. [ If the fair value opti~n is applied to an eligible insurance or reinsurance contract, it

shall be applied to all claims and obligations under the contract.' [FAS 159, paragraph 12,
sequence 46] ]
d. [ If the fair value option is elected for an insurance contract (base contract) for wniCih
integrated or nonintegrated contract features or coverages (some of whi,cih are cai,1,ed riders)
are issued either concurrently or subsequently, the fair va'lue option ailso must be appiHed to
those features or coverages. [FAS 159, paragraph 12, sequence 47.1] ] [ The fa:ir va lue opbon 1
cannot be elected for only the nonintegrated contract features or toverng,es, even though
those features or coverages are accounted for separate,l y under Subtop,;,c 944-30. {FAS 159,
paragraph 12, sequence 47.2] ] [ Paragraph 944-30-35-30 defines a noninte,grated contract
feature in an insurance contract. [FAS 159, paragraph 12, sequence 48,1] ] [ For purposes of
applying this Subtopic, neither an integrated contract feature or covernge nor a
nonintegrated contract feature or coverage quaHfiies as a separate instrument. [FAS 159,
paragraph 12, sequence 48.2] ]
825-10-25-8 [Paragraph not used]

Accounting 311 Chapter 1 Homework Problems
Instructions: Number your paper in the order of the problems. Do not recopy the problem. Show your
calculations supporting your answer. Circle the number that represents your answer.
1. On January 1, 2010 Harris pays $300,000 for 6,000 shares of Horton, representing a 25%
ownership. Harris has significant influence. During 2010, Horton earns $200,000 and pays
dividends of $2 per share. Harris has net income of $500,000 and pays dividends of $300,000 in
2010. Answer the following:
a. How much equity income is recorded by Harris in 2010.
b. What is the balance in the Investment in Horton found on Harris books at December 31,
2010.
2. On January 1, 2009, Davis acquires 30% of the outstanding common stock of Erdman for
$800,000 . Davis has significant influence. At that date Erdman had assets with a book value of
$5,000,000 and liabilities with a book value of $3,000,000. Any excess of the price paid by Davis
over the book value of net assets acquired is attributable to a trademark, which has a remaining
life of 5 years. In 2009 Erdman has net income of $200,000 and pays dividends of $80,000. In
2010, Erdman has net income of $150,000 and pays dividends of $60,000. What is the balance
of Davis Investment in Erdman at December 31, 2010?
3. On January 1, 2009, Davis acquires 30% of the outstanding common stock of Erdman for
$800,000. Davis has significant influence. At that date, Erdman had assets with a book value of
$5,000,000 and liabilities with a book value of $3,000,000. Erdman also had equipment with a
book value of $200,000 and a fair value of $500,000, with a remaining useful life of 5 years. In
2009 Erdman has net income of $200,000 and pays dividends of $80,000. What is amount of
equity income recorded by Davis in 2009 ?
4. Tolson Corp owns 40% of the voting common shares of Ramos Corp and has significant
influence. In 2010, Tolson buys inventory costing $100,000 from third parties and then sells it to
Ramos for $150,000. At the end of 2010, Ramos still has $60,000 inventory on hand. What
amount of unrealized gross profit must Tolson defer in 2010. S~ow the required entry and
amounts.
Dr._$ _ _ _ _ _ _ _ _ _ __
Cr$ _ _ _ _ _ _ _ _ _ __ _ _ __
II
5. Assume the same facts as in problem 4. Assume that the $60,000 ending inventory is sold by
Ramos by the end of 2011. Also assume that in 2011, Tolson purchases an additional $80,000 in
inventory from third parties and sells it to ~amos for $100,000. At the end of 2011, $40,000 of
this inventory is unsold. In 2011, Tolson earns $500,000 and pays dividends of $400,000. Ramos
earns $200,000 and pays dividends of $80,000. What is the amount of equity income recorded
by Tolson in 2011 ?
6. Rollins owns 40% of Sussex. On October 1, 2009 Rollins reduces its ownership percentage to
10%. For the first 9 months of 2009, Sussex earns $100,000 and for the last three months of
2009, Sussex earns $40,000. No dividends are paid. How much income is recorded by Rollins in
2009?
7. Same facts as number 6, except that Rollins ownership percentage goes from 10% to 40%. How
much income is recorded by Rollins in 2009?
8. Gimbel owns 10,000 shares, representing 50% ownership of Yelene. Its investment account at
the beginning of 2010 is at $200,000. In 2010, Yelene has net income of $100,000 and pays
dividends of $60,000. At December 31, 2010 Gimbel sells 8,000 shares to XYZ Corp for
$300,000.
a. What is the gain or loss to Gimbel on the sale of the shares
b. What is the balance in investment account at December 31, 2010 after the sale.
I J-
Chapter 2
Chapter 2----Consolidation Examples (Statutory Merger)
Example 1: Statutory Merger (Acquisition Method). Purchase price = FV NAA

Assume at date of acquisition, acquiree has:
Assets: BV: 100 FV:150

Liabilities: BV: 80 FV: 70
Net Assets (Equity)
Purchase price= 80
Entry on the books of acquirer:
Example 2: Statutory Merger (Acquisition Method). Purchase price> FV NAA

Same facts as example 1, except purchase price = 100
Entry on books of acquirer:
Example 3: Statutory Merger (Acquisition Method). Purchase price< FVNAA

Same facts as example 1, except purchase price= 60
Example 4: Statutory Merger (Purchase Method). Purchase price< FVNAA

Same facts as example 3. Assume all assets of acquiree are noncurrent assets.
Example 5: Same facts as #4, but assume all assets of acquiree are current assets.
Acqu isition (Subsidiary Survives) Acqu isition Method
BV Acquirer BV Acquiree Consolidation Entries Consolidated Totals
Dr Cr
Investment in B 100
Other Assets 1000 100
Goodwill
Total Assets 1100 100
Liabilities 200 80
Net Worth 900 20
Total Liabilities and Net Worth 1100 100
Facts: Acqu irer pays 100 to acquiree shareholders for 100% ownership. On date of acquisition, fj fair value
of acquiree Other Assets was 150 and fair value of acquiree Liabilities was 70. Prepare consolidated workshee.t •
Note: The purpose of the consolidation worksheet entries is to:
1. eliminate subsidary net worth against the parent company investment account (entry S)
2. record the fair val ue of net assets of the subsidiary and goodwiJ! (or gain from bargain purchase) with an •
(etttr'1
offsetting debit or credit to the investment account. A)
26. (oon,t ilwea) MERFULL, l,NC., ANiD H,APUiUSS CO.
b. Consolidation Work-sheet
Jan,u-ary 1, 2004
Entri,s Consolidated
AJ:._eaunts Merr-m_, Inc. Harriss Co. Debit Credit Totals
Dehi#s
Caet-r...•....... ......................•
_ $ 84,0-00 $ 40,000 $ 124,000
~ee-eivai~les ..................... . 180,000 90,000 (A) 10,000 240,000
IFl•V&Mr1!e,ry ...................... ;.. .. 220,000 130,000 350,000
IA.v~rtt i•fl 1=1-a,rri-ss ..... .. 390,000 -0- (S) 280,000
(A) 110,000 -0-
La-REI·································· 100,000 60,000 160,000
~LJ.i,lcel~,r,t,§1$ ......................... . 40,0,000 110,000 (A) 30,000 540,000
F=Et~•i,~Flt ...................... .. 120,000 S0,000 170,00.0
~a,ter,i,t ............................... . -0- -0- (A) 30,000 30,000
<3:e0Cilw,Fl1i .......................... . -0- -0- (A) 40,000 40.a.,.000
Te•ls ............................... . $1,414,000 $~10,9_00 $1.654t000 ··-·-·
Cr-edits
A0eeuf.)ts peyab~e ............ $ 160,000 - $ 30,0-00 $190,000
Lont~term li·abHithts ......... 380,000 , 170,000 , (A) 20,000 530,000
Cofflfl!H!)fl $tock................. 500,000 40,000 (S) 40,000 500,000
AdcM,titf),n,a,I paiid•in c-a,pital 74,000 -0- 74,000
lil&tai,n.e,d eafni-ng, ............ 360,000 240,000 ($) 240,000 360,000
'f&ta,le ................................ $1.474.000 $480.000 $1.654.000
He•'le-: 'f.ke aee0u11tt,s of M,ctrrtll have already been adjusted for the first. three journal entries indicated in the answer to Part a.
te r-eGE)•ra the JMH'chase price, the direct acquisition costs, and the stock issuance costs.
l'h~ e~,l,i~iefl entries are dQi,gned to:
-=i~Hililt. . . . 1!he fi~lth<(!>,i@jors' equfty accounts of the subsidiary
-=~"Ci>•Fcd a,l11 s,u,toekiUery •••• and liabilities at fair market value {including the patent)
-=litee09ni~e the 1f>0t\twU1I i,n,dtcated by the acquisition price
1
-itiminate th,e l1fl,VN,ffl'let'lt i·n Harriss account
~ I(,
Chapter 2 Exercises---Acquired Company survives as 100% owned subsidiary
For each of the following independent situations, prepare the journal entry( entries) on the books
of the parent company at date of acquisition.
1. A acquires B by issuing 10,000 shares of $1 par value common shares that have a fair
value of $80. A pays $10,000 to its lawyers to complete this transaction and pays $5,000
in underwriting commissions in conjunction with the issuance of shares.
a. Journal entries using acquisition method
b. Journal entries using purchase method
2. A acquires B for a payment of $5,000,000 cash. A will operate B as a separate

subsidiary. A agrees that it will pay an additional $2,000,000 to B's shareholders after
one year, ifB earns net income of $500,000 in the first year after the acquisition. At the
date of closing, there is 40% likelihood that B will achieve the $500,000 earnings target.
a. Journal entry using acquisition method
b. Journal entry using the purchase method
3. Assume A acquires B on December 31, 2008. In 2008, B expensed $300,000 on in

process research and development cost for a new product that had not yet reached
technological feasibility. The fair value at year end of this in process Rand Dis
$200,000
a. Using the acquisition method, what will be reflected in the consolidated balance
sheet
b. Under the purchase method, what will be reflected in the consolidated balance sheet
4. A acquires B. At acquisition date, A has fixed assets with a book value of $400,000 and a
fair value of $300,000. B has fixed assets with a book value of$500,000 and a fair value
of $600,000. How much is consolidated fixed assets at date of acquisition using:
a. Pooling of interest
b. Purchase method
c. Acquisition method
,1
Contrast of Acquisition Method with Purchase and Pooling of Interest Methods
Prior the effective dates of FASB Statements 141 R and 160, previously completed
acquisitions were previously accounted for under the purchase method or the pooling of
interest method. Since the new rules are "grandfathered", those acquisitions will
continue to be accounted for under the rules that were in place at the time the acquisitions
closed. The following discussion first summarizes the key points with each method.
Following that is a table contrasting the key differences between the acquisition and
purchase methods of accounting.
ACQUISITION METHOD(effective for new acquisitions with fiscal years beginning

after Dec 15, 2008)---Focus is on fair value of the entity acquired. Direct combination
costs are expensed. Stock issuance costs are treated as a reduction of Additional Paid in
Capital. A bargain purchase (FV of entity acquired is greater than consideration paid) is
treated as INCOME to the acquirer. The fair value of contingent consideration at
acquisition date is considered part of the fair value of the entity acquired. Subsequent
resolution of contingent consideration at a value different from that recorded at
acquisition date is run through the income statement. The fair value of acquiree in
process research and development costs is considered part of business fair value. Other
purchased intangibles are recorded at fair value at acquisition date. Preacquisition
contingencies that are resolved after the acquisition closing date are expensed. Assets and
liabilities of the acquiree are reported in the consolidated entity at fair value.
PURCHASE METHOD(effective for acquisitions closed prior to Dec 15,2008 that have
been accounted for under the purchase method; these acquisitions will continue to be
accounted for under the purchase method. The focus is on historical cost, i.e., the price
paid to acquire an entity. Direct combination costs are capitalized as part of the
Investment cost. Stock issuance costs are treated as a reduction of Additional Paid in
Capital. A bargain purchase results in a proportional reduction of noncurrent assets of the
acquiree with any excess treated as an extraordinary gain. Contingent consideration is not
recorded as part of acquisition cost until subsequently resolved. If the resolution of the
contingency requires an additional payment to be made by the acquirer, that payment will
either increase goodwill or reduce the reduction to noncurrent assets in the case of a
bargain purchase. Acquiree in process research and development costs are included in
acquisition cost only where considered either technologically feasible or subject to
alternative future use. Other purchased intangibles are included in investment cost only if
either contractual in nature, e.g. patents, copywrights, trademarks or separable (are
capable of alternative future use). Preacqusition contingencies resolved within one year
of the acquisition date result in an adjustment to original investment cost. Assets and
liabilities of the acquiree are reported at fair value, subject to any reduction in acquiree
noncurrent assets due to a bargain purchase. .
Pooling oflnterest Method (effective for acquisitions completed prior to June 30, 2001,
assuming they met all 12 of the specific criteria in existence at that time; these
acquisitions will continue to be consolidated under the pooling of interest method, until
the entities are sold, closed or otherwise disposed of).
Assets and liabilities are consolidated at their book values. There are no adjustments to
either the balance sheet (fair value allocations) or the income statement (amortization of
fair value adjustments). Income and expense of the acquiree are reported retrospectively,
i.e. they are retroactively restated for all periods presented.
Contrast of Acquisition Method vs the Purchase Method
New Rules (Acquisition Method) Old Rules (Purchase Method)

FAs 141R; FAs 160 'Asc. 1 ,r, Bio FAS 141; ARB 51
focus Fair value of entity acquired, referred Histori!::al cost, i.e. price paid to acquire the entity
to as "business fair value"
Direct combination
Costs Expensed Treated as part of the cost of the acquisition
Bargain
purchase Recognize as income on transaction closing date Reduce noncurrent assets proportionately; any
e excess is extraordinary gain
Stock issuance costs Decrease (debit) to Additional Paid in Capital Same
Contingent Recorded at fair value at transaction closing date; Not recorded as part of acquisition cost until contingency
resolved : will result in either additional goodwill or less
r reduction to noncurrent assets (bargain purchase)
consideration Subsequent changes _in fair value recorded in income
statement
In process Capitalize at fair value as intangible assets, subject to Expensed

Research and impairment testing or amortization
Development
Costs
Preacquisition Recorded at fair value Not recorded unless FAS 5 criteria met, i.e. probable and
Contingencies reasonably estimable
Valuation of equity Fair value at transaction closing date Fair value at date that acquisition is announced
Issued
Other intangible Recorded at fair value Recorded as part of investment cost if meeting criteria of
Assets contractual, e.g. patents or separability, e.g. technology
Chapter 2---Consolidation Entries S & A
The following are the consolidation worksheet entries to be completed under the
acquisition method. These entries are placed in the consolidation entries column on the
worksheet. They are NOT posted to the general ledgers of either the parent or subsidiary
unless push down accounting is specified.
Entry S (at date of acquisition)

Dr. Common Stock----Subsidiary xxxx
Dr. Additional Paid In Capital ---Subsidiary xxxx
Dr. Retained Eamings---Subsidiary xxxx
Cr. Investment in Subsidiary xxxx
Purpose of entry is to eliminate the parent's investment account against the stockholders
equity of the subsidiary to allow the assets and liabilities of the subsidiary to flow
through in consolidation. In consolidation, the investment account goes away (balance of
zero after all entries).
Entry A (at date of acquisition)

Dr. Fixed Assets (fair value-book value) xxxx
Dr. Goodwill (purchase price-FY of net assets acquired) xxxx
Cr. Investment xxxx
To adjust the subsidiary assets in consolidation to fair value at date of acquisition (when
fair value exceeds book value) and record any goodwill
Alternative Entry A(at date of acquisition)

Dr. Investment xxxx
Cr. Fixed Assets (book value-fair value) xxxx
Cr. Gain on Bargain Purchase xxxx
To adjust subsidiary assets in consolidation to fair value at date of acquisition (when
book value exceeds fair value) and record a gain on bargain purchase, when the
consideration transferred is less than fair value of net assets acquired
Chapter 2 Homework----
Note: Unless otherwise stated, all problems assume that the acquisition method is to be used. Please
show all supporting calculations on your homework submission.
1. Rollins acquires 100% of the voting common shares of Baxter on January 1, 2010 in a transaction
structured as a statutory merger. The terms of the transaction are that Baxter's shareholders
will receive 1 share of Rollin's common stock for each 2 shares of Baxter stock outstanding. At
the date of acquisition, there are 300,000 shares of Baxter's stock outstanding and 2,000,000
shares of Rollin's stock outstanding. At date of acquisition, the par value of Rollin's stock is $1
and the fair value is $30 and the par value of Baxter stock is $2 and the fair value is $14.
a. Prepare the journal entry to be recorded by Rollins to reflect this acquisition.
b. Assume that in addition to the above, Rollins pays $500,000 to its attorneys to structure the
deal and $200,000 to its accountants to assist in preparing consolidated financial
statements. Prepare the journal entry on Rollins books to reflect this.
c. Same facts as in b. above except the acquisition was done on January 1, 2008. Prepare the
journal entry on Rollins books to reflect this.
d. Rollins pays $600,000 to underwriters and the stock exchange in consideration of the new
shares of stock to be issued in the transaction. Prepare the journal entry on Rollins books to
reflect this .
e. Same facts as in d. above except that the acquisition was done on January 1, 2008. Prepare
the journal entry on Rollins books to reflect this.
f. Do the answers to the above a, b, c., d and e above differ if the transaction was structured
as either a statutory consolidation or an acquisition ?
2. Chaney acquires 100% of the voting shares of Roberts on January 1, 2010 in a transaction
structured as an acquisition. Assume that using the acquisition method, goodwill of $2,000,000
resulted. In addition to the initial payment to Roberts shareholders, Chaney agrees that if in 2
years, Roberts earnings increase by 40%, Chaney will pay an additional $500,000 to Roberts
shareholders. At the date of acquisition, the probability of meeting this earnings target is
viewed as 70%.
a. Prepare the journal entry to be recorded by Chaney on January 1, 2010 (you may ignore the
time value of money).
b. Assume that at the end of 2012, Roberts earnings have increased by 50%. What entry is
recorded by Chaney at that time.
c. Assume that at the end of 2012, Roberts earnings have increased by 30%. What entry is
recorded by Chaney at that time.
Note: The text has a detailed discussion on contingent consideration in chapter 3 of the text on
pages l F ■ JI .
t1f"-1tb
3. On January 1, 2010 Hand acquires 100% of Finger in a statutory merger. At acquisition date the
following were the book values and fair values of fixed assets of these two companies:
Book Value Fair Value
Hand 900,000 800,000
Finger 200,000 300,000
a. What is consolidated fixed assets under the acquisition method

b. What is consolidated fixed assets under the purchase method
c. What is consolidated fixed assets under the pooling of interests method
4. Davis acquires 100% of Reynolds in an acquisition. At date of acquisition, Reynolds had in

process research and development costs they had spent $300,000 for 3 years ago and is now
recorded on its books at $100,000 This Rand D has not yet reached technological feasibility
and no alternative use has been identified. At acquisition date, Reynolds continues to work on
'
this project and the fair value is considered to be $200,000. How much will Davis recorded this
for at acquisition date using the:
a. Acquisition method
b. Purchase method
c. Pooling of interests method
d. Do either of answers a, b, c above differ is this transaction was structured as either a
statutory merger or statutory consolidation.
5. Holmes acquires 100% of Watson in a transaction structured as an acquisition at January 1, 2010

for a payment as follows: Payment to Watson shareholders of $6 million cash, notes payable of
$4 million due in 3 years at a market interest rate, and 100,000 shares of Holmes common stock
with a $5 par and a $20 fair value.
a. Under the acquisition method, how much is debited to Holmes Investment Account at
January 1, 2010.
b. Under the purchase method, how much is debited to Holmes Investment Account at January
1, 2010.
c. Under both methods how much is the consolidated Investment in Watson.
6. On January 1, 2010 Adams pays $4 million cash to acquire 100% of Baker in a transaction
structured as an acquisition. At date of acquisition, Baker has book value of assets of $7 million
and book value of liabilities of $4 million. In addition Baker has land on its books with a book
value of $800,000 and a fair value of $500,000.
a. How much is consolidated goodwill.
b. How does the answer to a. above differ if Adams paid$ 2 million
• c. Assume Adams pays$ 4 million cash and instead of Land, it is Note Payable that has the as
above fair value and book value. How much is consolidated goodwill
d. How does the answer to c. above differ if Adams paid$ 2 million.
Jo 31h 31b
Complete chapter 2 problems _)(and ~from the text. For Problem~, please
complete the worksheet in Excel.
13
Chapter 3
Chapter 3---Consolidations Subsequent to Acqusition Date
Investment Accounting by Acquiring Co.----choices
Cost Method----Dividend Income recognized when cash received ......... no

income accrual of subsidiary earnings
Equity Method----Income accrued by the acquiring company when earned.

Dividends reduce investment. Amortization of fair value adjustments made
on acquiror books. Unrealized gains on intercompany transactions deferred.
Partial Equity----Same as equity method except no fair value adjustment
Specific worksheet consolidation entries are impacted based on the choice

made above------------however, the consolidated totals will be IDENTICAL.
PARENT COMPANY JOURNAL ENTRIES USING THE EQUITY

METHOD
Dr. Investment in Sub

Cr. Cash/Debt/Stock
To record purchase, including direct acquisition costs.
Dr. Cash (or Dividends Received)

Cr. Investment in Sub
To record cash dividends received from the sub.
Dr. Investment in Sub

Cr. Equity Earnings from Sub
To accrue income earned by the sub
Dr. Equity Earnings from Sub

Cr. Investment in Sub
To recognize amortization of purchase accounting fair value adjustments
( fixed assets/intangibles)
The consolidation worksheet must reverse the impact of these intercompany

transactions. This is accomplished by consolidation entries SAIDEP.
Consolidation Entries "IDEP"
Parent (Equity Method) Consolidation Worksheet Entry
Dr. Investment in Sub Dr. Equity Income

Cr. Equity Income Cr. Investment in Sub (entry I)
Reason for consolidation entry: Remove ·subsidiary income accrued by

parent to allow underlying revenue. and expense of subsidiary to flow
through in consolidation. Without this entry the subsidiary's revenue and
expense would be counted twice (once by the parent and once by the sub).
Dr. Cash (Dividends Received) Dr. Investment in Sub

Cr. Investment in Sub Cr. Dividends Rec (entry D)
Reason for consolidation entry: To eliminate the impact of the intecompany

dividend payment made from the sub to the parent.
Excess depreciation originally Dr. Depreciation Expense

recorded by the parent and then Dr. Amortization Exp
reversed irt entry I Cr. Bldg/Equip
Cr. Intangibles (entry E)
Reason for consolidation entry: to record annual excess depreciation on fair

value adjustment that were part of entry A.
Dr. Assets (Due from Sub) Dr. Liabilities (due to parent)

Cr. Liabilities or Cash Cr. Assets (due from sub)
(entryP)
Reason for entry: To eliminate intercompany receivables and payables in

consolidation
').. (,
Consolidations Subsequent to the Year of Acquisition
Guidelines When Parent has Used the Equity Method
Update balance of Investment account to the end of the current period

i.e. add subsidiary income, subtract dividends, record excess
amortizations. The total balance in the investment account will be
eliminated in Entry S.
Eliminate entire subsidiary capital as of January 1 of the current

reporting year ........... this balance will reflect subsidiary earnings and
dividends subsequent to the date of acquisition, but not inclusive of
the current reporting year.
Entries IDEP all relate to the current reporting period.
Only the parent's capital balances get reported in the consolidated

totals Gust like chapter 2)
Parent company retained earnings are correct after application of the

equity method.
Entry A is made AFTER annual excess amortization
Intercompany transactions-------dividends paid by the sub to the

parent along with any intecompany receivable and payable are offset
in the consolidation entries
Study the chart on paget Tit ... as well as Exhibit 3 .14 ( f ,.Jc. 1ofl)
f 01
Push Down Accounting
While the FASB has given extensive guidance on how consolidated financial statements
should be prepared under the acquisition method, little attention has been paid to how an
acquired subsidiary should reflect assets and liabilities on its books. One view is that the
subsidiary should maintain its previous basis of recording, be that historical cost, market
value or other basis of accounting. Under that view, all fair value adjustments to prepare
consolidated financial statements would appear on a worksheet only, and not be posted to
the subsidiary's general ledger.
Under the alternative view, the change in ownership resulting from the acquisition of the
subsidiary results in a new measurement basis for that company. That measurement basis
is fair value and the balances on the subsidiary's general ledger are adjusted to fair value.
This eliminates the need for consolidation worksheet adjustments as these are now made
directly to the affected accounts on the subsidiary's books. This is referred to as push
down accounting. ·
The differences in the two views becomes important only if the subsidiary issues separate
GAAP financial statements, which could be required if the subsidiary issues stock or
needs to borrow. The Securities and Exchange Commission, which governs reporting by
publicly held companies has in its Staff Accounting Bulletins No. 54 and 73 indicated
that push down accounting should be used in separately issued financial statements of a
subsidiary when that subsidiary is "substantially wholly owned" (generally greater than
95% ownership). The rationale is that if the acquiree were merged into the parent (as
under a statutory merger), the accounting basis for the acquiree's net assets would be fair
value and therefore the basis of accounting should not be different when the parent
decides to maintain the existence of the subsidiary.
,..s
Goodwill impairment---example
Goodwill may be impaired when the FV of it related reporting unity< BV

Goodwill must be allocated to each business unit in firm
F,,,,.. ,,,-,.. (,,.,-

Consol BV w/out G.W G.W BVw/G.W F.V
1""~.>""" , 'l
Division A 60 20 80 90
Division B 220 30 250 > 200
Division C 180 20 200 300
Step 1: Is FV of Reporting Unit< BV(inc GW)?

Step 2: If yes to step 1, then is G.W's implied value< BV?
Comi;,are the fair value of Division B (as if it were the purchase price) to the fa;.- v"-l.1c.. e+- ,-fJ
G..S, e.~.s IA.~A
I.~•1 ,I ,-tj e .s
--
.
Fair value Division B (above)
FV Net Assets(given)
Implied Value of G.W
BV of Goodwill ••
Writeoff of Goodwill
•
Also: Sale of some or All of Sub - could result in Goodwill write-off
Q v~Lt~,JG l!,st
~.f-",.,.o...-e, J.J('el 1 -t1, ~/\ 11ot" Cf'--.~~/, 1.'f1 > u-n ?,) --rl..,,;f
If.._ II e.- ,,J... -f1-i e-- t- 0 ~-f;J v 'f ~ /3 V of //et q .I ,,;/s !
A
r~/
c;.,o 1o G?,o oJw./1 /~ ., ,/Y\f t ;r Ptfl'If ,
l~f41.1rN,1' Jt.s-r , -es ''AJ
I\ pr (l lc.eJj,f ,-j
(Ji'tf i)
Income Taxes
For business combinations occurring after the effective date of this statement, the
acquiring company shall recognize a deferred tax asset or liability associated with
temporary differences between the assigned value on the books versus the tax bases of
net asset assets acquired, in accordance with FASB Statement No. 109, Accounting for
Income Taxes. The acquirer shall also account for potential tax effects of temporary
differences, carryforwards and any income tax uncertainties of the acquiree in accordance
with Statement 109.
For business transactions occurring before the effective date of the Statement, the
acquirer shall not adjust the accounting for prior business combinations for previously
recognized changes in acquired tax uncertainties or previously recognized changes in the
valuation allowance for acquired deferred tax assets.
Disclosures
For each acquisition that occurs during the reporting period, the acquirer must disclose:
a. Name and description of the acquiree
b. Acquisition date
c. Percentage of voting interest acquired
d. Rationale for business combination and how acquirer obtained control of acquiree
e. Qualitative factors supporting any goodwill from the transaction, e.g. expected
synergies from combined operations; description of intangible assets not
qualifying for separate recognition
f. Fair value of total consideration transferred as well as the fair value of each
component
g. Amount and description of any contingent consideration as well as discussion of
under what circumstances will payment be made; include a range of possible
outcomes or, if a range cannot be estimated, discuss why.
h. Amounts recognized at acquisition date for each major class of assets acquired
and liabilities assumed.
1. Nature of recognized and unrecognized contingencies along with a range of
possible outcomes.
J. Total goodwill expected to be deducted for tax purposes
k. If acquirer is required to disclose segment information, the amount of goodwill by
reportable segment (this information will be used in the goodwill impairment test)
I. Where acquirer and acquiree have previously had a business relationship identify
any amounts that are not part of what the acquire and acquiree exchanged in the
business combinations
m. Any acquisition related costs and where reported, e.g. expense, reduction of paid
in capital or other category
n. For any bargain purchase, the amount of gain and reason why business
combination resulted in a gain.
o. Fair value of any noncontrolling interest and valuation techniques used to
measure fair value
p. For step acquisitions, the fair value of any equity interest held immediately prior
to acquisition date and the amount of gain or loss recognized as a result ~f ,
remeasuring to fair value.
q. For public companies, the amount of revenue and earnings subsequent to the
acquisition date, reported in the consolidated income statement.
r, Supplemental proforma information, showing revenue and earnings for any
comparative period for which financial statements are presented, including the as
of the beginning of the current reporting period.
,,
Chapter 03 - Consolidations-Subsequent to the Date of Acquisition
33·
lff. (continued) Palm and Subsidiary Consolidated Worksheet for year ended Decemb~r 31, 2013
'
,7....,.-Gonsolidation Entries Consolidated
Accounts Palm Co. Storm Co. ·: Debit Credit Totals "\
Income Statement ~'.
Revenues ....•.•.................................................. (485,000) (190,000)
Cost of goods sold .......................................... 160,000 70,000
pepreciation expense ..................................... . 130,000 52,000
Amortization expense ..................................... -0- -0-
Equity in subsidiary earnings ........................ . (66,000) -0-
Net incom~ ................................................. (261.000) (68.000)
Statement of Retained Earnings
Retained earnings 111 ..................................... (659,000) (98,000)
Net income (above) ......................................... (261,000) (68,000)
Dividends paid ................................................. 175,500 40,000
Retained earnings 12131 ........................... . (744.500) (126.000)
Balance Sheet
Current assets ................................................ . 268,000 75,000
Investment in Storm Co.................................. 216,000 -0-
Land ............................................................... 427,500 58,00.0

Buildings and equipment (net) ..................... .. 713,000 161,000
Formula ............................................................ -0- -0-
Total assets ...••........................................... 1.624.500 294,000
Current liabilities ............................................ . (110,000) (19,000)

Long-term liabilities ........................................ (80,000) (84,000)
Common stock..........................................,...... • (600,000) (60,000)
Additional paid-in capital ........... ~ ................... . (90,000) (5,000)
Retained earnings 12/31 ................................ .. (744,500) (126,000)
Total liabilities and equity ....................... .. (1,624.500) (294.000)
Parentheses indicate a credit balance.
3-44
32.
Chapter 3 Homework
1. Davis acquires 100% of Ramos on January 1, 2009. Ramos will be operated as a separate
subsidiary. Davis will use the equity method to account for its investment in Ramos. In 2013,
Davis has net income of $400,000 and pays dividends of $100,000. Ramos has net income of
$200,000 and pays dividends of $75,000. At acquisition date, Davis has a building with a book
value of $3,000,000 and a fair value of $4,000,000. At that date, Ramos had a building with a
book value of $800,000 and fair value of $900,000. Both buildings have a remaining useful life
of 5 years (assume straight line depreciation).~-4- Pcc..Jl,J.0 13 D4.,,.> J,,.,J 8 r fJ~JJ ~ S,ooo,ot,J-rF_tl
• "o•~,ooo. p.-,,-.o-l }I"" at 8d9 1f ~,oo,:po-o _,.. r II
a. Prepare consolidation worksheet "D" to re lecithe necessary adjustment for i"1'dends· af- l .r~~'i>OO,
b. How much are consolidated dividends for 2013
c. Prepare worksheet entry "A" at December 31, 2013 (assume there is no goodwill).
d. How much is consolidated buildings at December 31, 2013
2. Harry acquires 100% of David on January 1, 2010 by issuing 10,000 shares with par value $1 and
fair value $70. In addition, Harry agrees to pay an additional $100,000 if David earns $50,000
net income in 4 years. David will be operated as a separate subsidiary of Harry. At acquisition
date, there is a 80% probability of this occurring. On January 1, 2010, Harry had net assets with
book value of $400,000 and fair value of $500,000. At that date, David had net assets with
book value of $200,000 and fair value of $150,000. At December 31, 2012, Harry has net assets
with book value of $600,000 and fair value of $800,000. At that date, David has net assets with
book value of $300,000 and fair value of $400,000. Assume that all differences between book
value and fair value relate to Land.
a. How much is goodwill at January 1, 2010 (show calculation).
b. How much is goodwill at December 31, 2012 (assume no impairment)
3. Wang acquires 100% of Chen on January 1, 2010 and will operate Chen as a separate subsidiary.
In the first year of operation, Chen has net income of $70,000 and pays dividends of $50,000
and that there is $3000 of excess annual amortization associated with Chen's equipment.
a. Assume Wang uses the equity method to account for its investment. What entries will
Wang record on its books on December 31, 2010 for Chen's income, dividends and excess
amortization.
b. Same as a.......... what consolidation worksheet entries will Wang record for Chen's income,
dividends and excess amortization.
c. Assume Wang uses the partial equity method to account for its investment. What entries
will Wang record on its books on December 31, 2010 for Chen's income, dividends and
excess amortization.
d. Same as c.......... what consolidation worksheet entries will Wang record for Chen's income,
e. Assume Wang uses the cost method to account for its investment. What entries will Wang
record on its books on December 31, 2010 for Chen's income, dividends and excess
amortization.
f. Same as e.......... what consolidation worksheet entries will Wang record for Chen's income,
4. Shoe owns 100% of Foot in an acquisition completed 3 years ago. It is now December 31, 2012.
Foot has borrowed $500,000 from Shoe, without interest.
a. Prepare the necessary consolidation worksheet entry on December 31, 2012.
b. Assume instead that Shoe had borrowed $500,000 from Foot. Prepare the necessary
consolidation worksheet entry on December 21, 2012.
c. In both parts a . and b., how much is consolidated Loans Receivable and Payable at
December 31, 2012.
d. In both parts a. and b. how much w,ill show up on the individual books of Shoe and Foot as
to Loans Receivable and Payable. Answer by identifying whose books, the name of the
account (specify part a. orb.) and the amount.
5. Haskins acquires 100% of Sells on January 1, 2011. Haskins uses the equity method. It is now
December 31, 2014. The following are the stockholders equity accounts of Sells on various
dates.
1/1/11 1/1/14 12/31/14
Common Stock 120,000 140,000 160,000
Additional Paid in Capital 2,000,000 2,300,000 2,500,000
Retained Earnings 100,000 130,000 150,000
a. Prepare consolidation worksheet Sat December 31, 2014
b. Assume total Stockholders Equity of Haskins at December 31, 2015 is $6,000,000. How
much is consolidated Stockholders equity.
c. How would this answer differ if Haskins were using the partial equity method and if there
was $10,000 of excess amortization.
Complete problems ~and~ and~- Please do the consolidation worksheet in Excel.
,~(A., -~ ~
3oR ;oc
Accounting 311 Midterm Review----Areas to Emphasize in Your Studying
it I iJ. Z,,
Chapter 1
Understand why companies acquire other companies and what makes them successful
Fair value method---know entry for recognition of dividends and changes in market value
Cost (initial value) method---when FV not available ......... know dividend entry
Equity method
1. be able to calculate ending investment balance (adding net income, subtracting
dividends, subtracting amortization of fair value adjustments ....... know when to
apply percentage to total dividends but not to per share dividends, apply
percentage of ownership to fair value adjustments).
2. understand what significant influence means and what happens if investor ll:lcks it.
3. know how to account for change from fair value method to equity method and
from the equity method to the fair value method; understand what the words
retroactive and prospective mean.
4. be able to deal with excess of cost (price paid) over book value of net assets
acquired ...... allocate to net assets with FV different than BV FOR THE
PERCENTAGE OF OWNERSHIP with the remainder to goodwill; understand
how to update equity earnings and investment balance for amortization of fair
value adjustments.
5. practice examples with upstream and downstream inventory transfers, re. how
much intercompany profit gets reversed ........ know 4 step approach .... KNOW
WHAT HAPPENS IN THE SUBSEQUENT YEAR----UNREALIZED GAIN
FROM YEAR ONE BECOME_S REALIZED IN YEAR TWO; IN YEAR TWO,
THE UNREALIZED GAIN FROM YEAR TWO IS DEDUCTED FROM
EQUITY EARNINGS.
6. know how to deal with investee losses, re how low can the investment account
balance go (ZERO---WHEN YOU REACH ZERO DISCONTINUE EQUITY
METHOD UNTIL FUTURE PROFITS ARE GREATER THAN LOSSES NOT
PREVIOUSLY RECORDED)
7. be comfortable calculating a gain or loss on a partial sale of
shares ...... CALCULATE COST OF SHARES SOLD BY APPLYING
NUMBER SHARES SOLD/TOTAL SHARES OWNED BY INVESTOR *
INVESTOR CARRYING VALUE OF INVESTMENT. Subtract result from the
proceeds from sale.
8. understand why investors like the equity method (off balance sheet financing) and
why the method is sometimes criticized.
9. know how extraordinary items are handled under the equity method.
Chapter 2
1. Understand difference between a statutory merger, a statutory consolidation and
an acquisition re. which company or companies survive. Be able to handle the
accounting entries for a simple statutory merger under the acquisition method.
2. Understand what a variable interest is and recognize that there are issues as to
whether to consolidate or not---to be further covered in chapter 6.
3. Know what pooling of interests means and understand it is banned for
acquisitions taking place after June 30, 2001.
4. Concentrate on the PURCHASE METHODS AND ACQUISITION METHODS.
KNOW HOW EACH METHOD TREATS A BARGAIN PURCHASE
(PURCHASE METHOD---REDUCE NONCURRENT ASSETS
PROPORTIONATELY ....... ACQUISITION METHOD---GAIN FROM
BARGAIN PURCHASE). KNOW THE CHART CONTRASTING
DIFFERENCES BETWEEN PURCHASE AND ACQUISITION METHODS,
RELATING TO DIRECT ACQUISITION COSTS, CONTINGENT
CONSIDERATION etc
5. Understand rules for recognition of intangible assets in a business
combination ....... contractual or separable ........ know what meets and does not
meet the criteria. EMPLOYEE WORKFORCE IS NOT AN INTANGIBLE
THAT CAN BE RECOGNIZED
6. Know rules for recognition purchased in process research and development
costs ... FAIR VALUE (ACQUISITION METHOD), technological feasibility
and alternative future use (PURCHASE METHOD), .
7. Unconsolidated majority owned subsidiaries ...... when do you not consolidate.---
IF YOU DO NOT CONTROL
8. Do not memorize pooling rules or pooling consolidations, but know why investors
preferred the pooling method over purchase accounting. EASIER AND HIGHER
NET INCOME (NO A AND E ENTRIES)
9. Understand the purpose of the consolidation worksheet and what happens with the
worksheet amounts subsequent to the financial statement date.
10. Know treatment of direct combination costs and stock issuance costs in a business
combination. ACQUISITION METHOD---EXPENSE .......... PURCHASE
METHOD---DIRECT COMBINATION COSTS ARE PART OF COST OF
INVESTMENT; STOCK ISSUANCE COSTS ARE A REDUCTION TO
ADDITIONAL PAID IN CAPITAL under both methods.
11. KNOW THAT IN AN ACQUISITION (ACQUIREE SURVIVES AS A SUB)
CONSOLIDATED TOTALS FOR ASSETS AT ACQUISITION DATE IS BV
OF PARENT PLUS FV OF SUB or book value of parent plus book value of
subsidiary plus 100% of fair value adjustment.
Chapter 3 .... always assume acquisition method is in use unless told otherwise.
1. Using the equity method by the parent, know the entries made by the parent
(acquirer) for earnings, dividends and amortization of fair value adjustments.
2. Know the corresponding entries made in consolidation to eliminate intercompany
transactions.
3. Understand the meaning of SAIDEP and be able to do each of these entries in
both journal entry and posting to a worksheet format. A and E are the tricky
entries ....... understand the correct methodology IF AN ASSET IS
UNDERVALUED (FV>BV, VERSUS IF AN ASSET IS OVERYALUED
FV<BV). If the asset is overvalued, the A entry will be a credit to asset for the
unamortized fair value adjustment.
4. Be comfortable in knowing what adjustments need to be made to SAIDEP entries
in periods after the date of acquisition (end of same year, several years in
future) ...... REMEMBER ENTRIES SAND A ARE AS OF JAN 1 OF THE
YEAR OF REPORTING
5. Study the Sun Company example and supporting worksheets on pages 88-98.
6. Broadly know that the parent can also choose to use the partial equity method and
cost method and what the difference are with the equity method as well as
similarities (consolidated totals are !he same under all 3 methods) .... BUT
PARTIAL EQUITY METHOD DOES NOT REFLECT AMORTIZATION OF
FAIR VALUE ALLOCATIONS on the parent's books. UNDERSTAND THAT
THE INVESTMENT BALANCES WILL BE DIFFERENT UNDER THE 3
METHODS. KNOW THAT THE PARENT CANNOT ACCOUNT FOR ITS
INVESTMENT IN ITS WHOLLY OWNED SUBSIDIARY UNDER THE FAIR
VALUE METHOD.
THE PARENT OFTEN CHOOSES THE EQUITY METHOD AS THEN THE
OPERATING RES UL TS OF THE PARENT EQUAL THE CONSOLIDATED
RESULTS (INCOME STATEMENT).
7. Understand the rules for when goodwill impairment needs to be recognized and
be comfortable with the example we reviewed in class .... THE TWO STEP
APPROACH ............ THE CRITERIA FROM BOTH STEPS NEEDS TO BE
MET. IT IS AN ANNUAL IMPAIRMENT TEST.
8. Know how contingent consideration is dealt with under the acquisition method
(probably weighted fair value) and under the purchase method (ignored until
contingency is resolved). Understand what happens under the acquisition method
when the contingency is resolved.
9. Understand what push down accounting means and why there are some that
advocate it (IT'S ABOUT PUTTING ENTRIES A AND EON THE
SUBSIDIARY FINANCIAL STATEMENTS)
10. UNDERSTAND THE PURPOSE OF THE CONSOLIDATION
ENTRIES ........... SAIDEP ......... A IS UNAMORTIZED FV ADJUSTMENTS
RE SUB AS OF JAN 1, OF YEAR OF REPORTING PLUS GOODWILL.
11. Do not study examples from bottom of page 98-through the middle of page 107.
12. You can study the comprehensive end of chapter problem through entry E in the
middle of page 120. Do not focus on the entries needed when the parent uses the
intial value method. ,
s--r Df he-~e- -to..- fh~J-rwr -t I (;o -to 3Jf +or
Chapter 4
r~c.e ~~""'
I .understand method to consolidate individual asset or net assets when given book value
and fair values using the economic unit method, the proportionate consolidation method,
and the parent company method.
2. be able to calculate goodwill using the economic unit method
3. understand consolidation worksheet (page 175) and what accounts are introduced
when dealing with consolidation of noncontrolling interests under the economic unit
method; know where the noncontrolling interest on the balance sheet and income
statement are shown under the economic unit method.
4. understand the chart we went through in class that contrasted how noncontrolling
interests were handled under the old rules (purchase accounting) as opposed to how
noncontrolling interests will be handled under the new rules (acquisition
accouting ... FAS 141 R and 160). Specifically understand the differences for
a. control premium---what is it and how is it used under the new rules to calculate
business fair value
b. preacquisition income --- what is it and how it is handled under the new FASB rules
c. step acquisitions---how under the new rules the accounting depends on whethe the
parent held control prior to the additional purchases
d. sale of subsidiary shares---under new rules, different accounting depending on
whether control is maintained after the sale; also understand how to calculate a gain
or loss and what are acceptable methods for determining book value of shares sold
Chapter 5
1. in general understand whether the question deals with which column in the
consolidation ......... parent, sub, consolidation worksheet entries or consolidated totals.
2. in general, you will only need information on noncontrolling interests when being
asked to solve for noncontrolling interest in subsidiary earnings for upstream inventory
transfers or when solving for preacquisition income (as in chapter 4).
3. refer to the previous handouts and examples, specifically ........... .
4. how to deal with intercompany sale of land and elimination entries---make sure you
know who the question is asking about
5. intercompany sale of depreciable assets and reversal of excess (extra) depreciation as
well as calculation of amounts that need to be reversed in year of sale and subsequent
years (study example previously handed out).
6. intercompany inventory transfers-----know the chart we went through in class which
shows the consolidation entry needed if ending inventory is over/understated and
beginning inventory is over/understated re impact on cost of goods sold; be able to
calculate the noncontrolling interest in subsidiary net income where there are upstream
inventory transfers and unsold inventoy over 2 years ......... .look at the examples we did
for homework and in class.
7. know how to deal with intercompany sales and purchases ......... what amounts get
eliminated from what accounts and do ownership percentages matter
8. understand what happens when a parent borrows money from a subsidiary (ownership
percentage doesn't matter).
9. Know the effective dates of FAS 141 R and 160 and how prior acquisitions are
"grandfathered" under the old rules.
Chapter 6
1. Understand definition of variable interest entities and the SPECIFIC criteria that if
met, will require consolidation. You do not have to know how to consolidate.
2. Know what went wrong at Enron and how it led to FIN46R
3. Know the manner in which variable interest entities are legally
organized ........ partnerships, trusts etc.
4. Understand treatment of subsidiary acquiring parent debt or visa versa ........ how to
calculate gain or loss on extingll;ishment (retirement) of debt , elimination of interest
revenue and expense over time and how amounts differ depending on amortization of
premiums and discounts.
Accounting 311 Practice Midterm # 1
Instructions: Complete the problems below on separate sheets of paper and bring them to
my desk before the start of the review class. A maximum of 3 points will be added to
your first midterm grade. It is not necessary to re-write the questions or to use excel.
Students arriving to class late will receive a maximum of 1 point added to their midterm
grade.if their work was done in excel.
Use the following information for problems 1-4.

On January 1, 2012, Adams acquires 100% of Baker in a transaction accounted for using
the acquisition method. Adams will use equity accounting for its investment in Baker.
Baker will remain a wholly owned subsidiary of Adams. The following is information
about this acquisition.
To pay for this purchase, Adams issues 20,000 shares of common stock with a $5 par and
$20 market value. Legal and accounting costs were $50,000. Stock issuance costs were
$20,000. If Baker has net income of $50,000 in 2012, Adams will pay an additional
$100,000. At acquisition date there is a 40% probability of this occurring.
The book value of net assets acquired of Baker was $200,000 at acquisition date. Adams
was willing to pay in excess of book value to acquire Baker because Baker had a building
(10 year life) with a book value of $300,000 and a fair value of $340,000.
Baker has $40,000 in net income in 2012 and pays a dividend of $30,000. Adams has
$100,000 of net income in 2012 and pays a dividend of $70,000.
1. Prepare an investment analysis at date of acquisition, including the following:

a. Calculate the amount debited to the investment
b. Calculate the premium over book value
c. Determine the amount of goodwill or if it is a bargain purchase.
d. How much is the excess depreciation that will be reflected as consolidation
entry E in 2012 ?
2. How much are consolidated dividends in 2012?
3. At December 31, 2014 assume Adams has Buildings with a book value of
$500,000 and fair value of $600,000 and Baker has Buildings with a book value
of $400,000 and a fair value of $450,000.
a. What is the CONSOLIDATED total for buildings at that date?
b. Prepare journal entry "A" that will show up on the consolidated worksheet as
of December 31, 2014.
4. How much is consolidated Equity Income in 2012.

5. Fred owns 25% of Eaton and at January 1, 2013 has a balance in its Investment
account of $40,000. In 2013 Eaton reports a net loss of $200,000.
a. What is balance of Fred's Investment in Eaton at December 31, 2013
b. How much will Eaton need to earn in 2014 before Fred can return to using the
equity method
6. Regency owns 5% of Marriott. On October 1, 2012 Regency acquires an

additional 25% of Marriott bringing its ownership percentage up to 30%. From
January I - September 30, 2012 Marriott earns $100,000. From October 1,
December 31 2012 Marriott earns $40,000. What is the total income reported by
Regency in 2012.
7. Roberts owns 40% of Simpson. On April 1, 2012 Roberts reduces its ownership
of Simpson to 10%. From January I-March 31 Simpson earns $80,000 and pays
dividends of $30,000. From April 1- December 31 Simpson earns $300,000 and
pays dividends of $100,000. What is the total income reported by Roberts in 2012
8. On January 1, 2012 Hand acquires 40% ownership of Foot. At acquisition date,

Foot had equipment with a book value of $100,000 and a fair value of $160,000.
The remaining useful life is 4 years. What is the amount of amortization (debit to
equity earnings) that will be recognized in 2012 ?
9. Pez owns 30% of Rollo. In 2012, Pez sells inventory costing $100,000 to Rollo
for $150,000. At December 31 , 2012 $60,000 of this inventory was still held by
Rollo and is sold in 2013. In 2013, Pez sells inventory costing $200,000 to Rollo
for $250,000. At December 31, 2013 $60,000 of this inventory is still held by
Rollo. In 2013, Rollo reports net income of $80,000.
How much equity income is reported by Pez in 2013 ?
10. Harry owns 25% of David. On January 1, 2012 Harry's investment account has a
balance of $500,000. On that date, Harry sells 30% of its investment for
$200,000.
a. What is the balance in the investment account after sale
b. What is the gain or loss on sale recorded by Harry.
11. On January 1, 2012 Roberts purchases 100% of Smith for $800,000 cash. At
acquisition date, Roberts had book value of net assets of $600,000 and Smith had
a book value of net assets of $700,000. Roberts owned a building with a book
value of $200 000 and a fair value of $300 000 and Smith ·owned a building with
a book value of$ 100,000 and a fair value of$3 00,000. How much is Co" Jo l, Jd"e./
(;,l)odi1.f( oi- Co/\sol,J ted 6 41/\ "'" {3c,..J 11.:I\ fvrcf..a.se.
Chapter 4
CONSOLIDATION OF NONCONTROLLING (MINORITY) INTERESTS
Noncontrolling interest (also refemed to as minority interest) represents the portion of a

subsidiary's equity that is not owned directly or indirectly by the parent. This has three
implications:
1. The noncontrolling shareholders have an interest in the equity (net assets) of the
subsidiary. That interest must be clearly identified and presented within
Stockholders Equity in the consolidated financial statements, but separate from
the parent's equity. Prior to the adoption of SFAS 160, the interest of the minority
shareholders was sometimes reflected in the "mezzanine section" of the balance
sheet, between liabilities and stockholders equity. That presentation is no longer
acceptable.
2. The noncontrolling shareholders have an interest in the net income of the
subsidiary. That interest is separately reported on the face of the income statement
apart from the earnings associated with the controlling interest (parent).
3. The noncontrolling shareholders have an interest in any dividends paid by the
subsidiary.
The following example illustrates the application of these concepts.
This consolidated income statement presentation is illustrated below for a 30%

noncontrolling interest in XYZ:
XYZ Consolidated Statement of Income

For the Year Ended December 31, 20x0
Revenues $5,000,000
Expenses (4,000,000)
Income From Continuing Operations, pre tax 1,000,000
Income Tax Expense (400,000)
Income From Continuing Operations, net of tax 600,000
Discontinued Operations, net of tax (100,000)
Net Income 500,000
Less: Net income attributable to noncontrolling interest (150,000)
Net Income attributable to XYZ 350,000
Earnings per share data follows after the above presentation.
Losses may be incurred by the subsidiary, with their concurrent negative financial effects
on noncontrolling interests. If the noncontrolling interest in subsidiary net assets has been
reduced to zero because of the losses, the noncontro_lling interest will continue to be
charged for its share of additional losses, even if that results in a deficit balance in the
noncontrolling interest account. That represents a change from prior practice and is now
mandated by FAS 160.
Notes for Chapter 4----Consolidated Statements and Outside Ownership
There are 3 methods to reflect outside ownership. Each is illustrated by an example,

following the descriptions.
Economic unit concept-------accounting emphasis placed on entire entity that results from
business combination. Valuation of subsidiary accounts based on implied value of the
company (as determined by purchase price). Subsidiary assets and liabilities
consolidated at fair market value. Noncontrolling interest balance calculated and reported
as part of stockholders equity.
Proportionate consolidation concept----objective is to serve as report to stockholders of

parent company. Valuation of subsidiary assets and liabilities are at fair value multiplied
by the ownership percentage.
Parent company concept-.,.--a hybrid approach of the previous two theories. Start with
book values of subsidiary assets and liabilities which are consolidated in total. The
difference between cost and fair value of the subsidiary assets and liabilities is included
in consolidated statements based on the ownership percentage. Noncontrolling interest
computed from subsidiary book value.
Examples ......... to be completed in class:

Example. On Jan 1 parent acquires 70% interest in subsidiary for $140,000.
Subsidiary earns $100,000 for the full year. Other information about the subsidiary:
Book value of net assets: $110,000

Fair value of net assets: $130,000
Example 1-----using the economic method, calculate a. goodwill b. noncontrolling

interest (balance sheet) c. income statement impact
a. Implied value of acquisition= purchase price/ownership percentage
Goodwill= Price paid (implied value) - fair value of net assets acquired
b. Noncontrolling interest=% of outside ownership x implied value of company
c. Revenue (at 100%)- noncontrolling interest share of net income
Example 2 -----using the proportionate concept, calculate a. goodwill b

noncontrolling interest on the balance sheet c. income statement impact
Purchase Price -a. Fair value of net assets acquired x ownership percentage results in
cost in excess of fair value, which is goodwill if there are no specific assets or
liabilities to allocate the difference to.
b. Noncontrolling interest on the balance sheet is _ _ __
c. How much revenue and expense are shown ?
How much revenue and expense is associated with the noncontrolling interest.
akvl.-..te
Example 3 Using the parent company method, alipcm goodwill.
Price paid - book value of acquiree (reduced by noncontrolling interest)= cost in

excess of book value.
If FMV of net assets = 130 and the book value of net assets = 110, mulitiply by
ownership percentage to get the amount deducted from above to compute goodwill
Other Important Concepts in Chapter 4

1. Treatment of step acquisitions---under parent company concept each investment
viewed as separate purchase , with its own cost allocations and amortization.
2. Treatment of preacqusition income---income statement accounts consolidated as
if acquisition made at beginning of year and a preacquisition income account is
deducted for the parent's share of the sub income prior to the date of acquisition.
Study Exhibit ~ on pages 164 l 65 focusing particularly on the noncontrolling interest

column. t,,\-l, I S'1
CONTRAST OF ACQUISITION AND PURCHASE METHODS FOR
NONCONTROLLING INTERESTS
~S'- lo.I r 8/C)

The following is terminology mentioned in FAS 141 R and 160 as it relates to various
aspects of treatment of noncontrolling interest. The chart that follows contrasts the.new
acquisition method rules (FAS 141R and 160) "':'.~h the grandfathered "old rules" (FAS·
141 and ARB 51) Cft sc. B0f °'"J 11°,/
(fr S c Q o.5 -.-.J i810)
CONTROL PREMIUM (FAS 141R, 160): Repres~nts extra dollars paid to acquire
control; remainder of shares sell at a lower price.
Business fair value= Fair value (FV) of Controlling Interests+ FV ofNoncontrolling
Interest.
Goodwill= Total business FV - FV of Net Assets Acquired
CONTROL PREMIUM (FAS 141): Not discussed. Noncontrolling interest reported as a

percentage of subsidiary net assets (par~nt company method).
81
STEP ACQUISITION (FAS 141R, 160): (~JC 1°s r o)
a. If parent held a noncontrolling interest prior to obtaining control, remeasure the
noncontrolling interest at fair value and calculate a gain or loss that will appear on
the income statement.
b. If parent had control prior to the acquisition of additional shares, treat as an equity
transaction (debit or credit to Additional Paid in Capital)
STEP ACQUISITION (FAS 141, ARB 51): Each "step" requires separate fair value
allocations and amortization (cost accumulation), resulting in several layers of goodwill
O
SALE OF SUBSIDIARY SHARES (FAS 141R, 160) ( ~Jt:. 8°S' r 8 I )
a. establish cost basis of shares sold (FIFO, specific identification and weighted
average cost are acceptable cost flow assumptions)
b. if control maintained after sale, treat as a capital transaction (debit or credit to
Additional Paid in Capital)
c. if control is not maintained after sale, calculate gain or loss reported in earnings
SALE OF SUBSIDIARY SHARES (FAS 141,ARB 51)

a. establish cost basis of shares sold (FIFO, specific identification and weighted
average cost are acceptable cost flow assumptions)
b. gain or loss reported on the income statement; there is no distinction between
whether control is maintained after the sale
( As, 9or-ts,o) ·
PREACQUISITION INCOME (FAS 141R, 160): Only report revenue and expense
subsequent to the date of acquisition (separately show 100% ofrevenue and expense less
the noncontrolling interest share of net income)
PREACQUISITION INCOME (FAS 141): For acquisitions after January 1, report full
year revenue and expense and deduct "preacquisition net income" for the months not
owned.
PRESENTATION OF NONCONTROLLING INTEREST ON BALANCE SHEET (FAS

141R, 160): In Stockholders Equity
PRESENTATION OF NONCONTROLLING INTEREST ON BALANCE SHEET (FAS

141): Prior rules did not mandate presentation. Noncontrolling interest on the balance
sheet were reported in Liabilities, between Liabilities and Stockholders Equity (known as
the "mezzanine section"), or in Stockholders Equity.
The following summarizes the above rules in tabular form.
(insert chart "Contrast of Acquisition and Purchase Methods for Noncontrolling

Interests") ·
Chapter 4 Summary- Noncontrolling Interests
This document is intended to give you a summary of the key points in chapter 4 of
the Hoyle text, similar to what you would experience if you were in class and I was
lecturing on the chapter.
Let's start by having you go to page 167 of the text and looking at the worksheet
there. I'll wait.. .................. please get your text and open to that page ............ it's very
important to get the big picture. Looking at the worksheet you will see some
similarities with the worksheets from chapter 3. On the left are the accounts, income
statement first and then the balance sheet. The next column is the parent (King)
followed by the subsidiary (Pawn). Then come the consolidation worksheet
entries SAIDEP, as we have studied previously. This particular example does not
have a P entry.
Now for the differences: You see on the top right of the worksheet that King owns
80% of Pawn. The 2 0% of Pawn not owned by King is referred to as "the
noncontrolling interest". The noncontrolling interest has a right to 20% of the net
income of Pawn as well as ownership of 20% of the net assets of Pawn. Looking at
the account captions on the left, you see two lines. "net income attributable to
noncontrolling interest" and "net income attributable to King Company", which is
the controlling interest.. Similarly on the balance sheet, you see two lines,
noncontrolling interest in Pawn 1/1 and noncontrolling interest in pawn 12/31.
Those two lines represent the portion of the net assets of the subsidiary (Pawn) that
are owned by outside shareholders (not King).
Continuing across the worksheet you see a column called noncontrolling interest.
That column reflects all activities impacting the 20% shareholders in Pawn. For
instance the 16,000 reflects 20% of (net income of Pawn minus excess amortization
associated with Pawn assets having fair value greater than book value at date of
acquisition). The calculation is Pawn's net income of 90,000 - excess amortization
of 10,000 (see schedule on page 157) x 20%.
The next number you see in the noncontrolling interest column is Dividends 10,000.
Looking at the second column you can see that Pawn declared Dividends of 50,000.
40,000, or 80% of those dividends went to the controlling shareholders of Pawn.
The other 20% x 50,000 = 10,000 went to the nocontrolling interest shareholders.
As in chapter 3 we prepare worksheet entry D for the dividends paid by the
subsidiary to the parent (Dr. Investment in Pawn Cr. Dividends paid) ... however the
amount paid to the parent is 80% x 50,000 = 40,000, which is what you see for entry
D. That leaves the remaining 10,000 ( 50,000 - 40,000) going to the noncontrolling
interest shareholders. The 10,000 is entered in the noncontrolling interest column.
Notice that consolidated dividends still equals the dividends of the parent, just as it
did in chapter 3.
Finally you see (207,000) and (213,000) in the noncontrolling interest column. This
represents the portion of the stockholders equity of Pawn that is not owned by King
as of the beginning and end of the year. I'll tell you in a minute how to get the
numbers, but let me first focus on how to get from the starting to the ending
number. Starting with noncontrolling interest (which I will abbreviate NCI going
forward) of (207,000) as of January 1, I then add 16,000 for the NCI share of net
income and subtract 10,000 for the NCI share of dividends to get to the year end
total of 213,000. You can see that reconciliation on the bottom of page 160. At to
where the 207,000 number comes from, that is the 230,000 of Common Stock for
Pawn plus the beginning balance in Retained Earnings for Pawn of 580,000 (find
those numbers in the Pawn Company column), multiplied by 20%. (230,000 +
580,000) X 20%.
Also note that there is 25,000 of goodwill in this example and it is part of worksheet
entry A, as before. The calculation of goodwill is as it was in chapters 2 and 3 and
can be found on page 157. You will notice that the Goodwill in split between the
controlling and noncontrolling interest on that page. I will explain why and how this
is done subsequently.
Let's stay on page 161 and let me make a few more important observations about
the consolidated totals when there is over 50% but under 100% ownership.
1. Notice that while King owns 80% of Pawn, the consolidated totals for Revenues,
Cost of Goods Sold and other expenses equals 100% of the parent balance plus
100% of the subsidiary (Pawn) balance. How can this be when King owns 80% and
not 100% of Pawn. The answer is that Pawn's outside shareholders, who get 20% of
Pawn's net income after excess amortization, see the amount as a deduction from
consolidated net income on the bottom of the income statement ( the 16,000).
2. On the balance sheet, the consolidation of assets and liabilities is identical with
chapter. Because King owns a majority of the voting shares of Pawn, King is viewed
as controlling 100% of the company. This is known as the "economic unit method"
which is the same as the acquisition method and is applicable for business
combinations occurring beginning in 2009. Illustrating with a couple of the balance
sheet items, for consolidated current assets, take 100% of King Company plus 100%
of Pawn Company to get to the consolidated total. For Patented Technology, add the
parent balance plus the subsidiary balance (Pawn) plus the unamortized fair value
adjustment as of January 12015, minus the 2015 excess amortization. THIS IS
IDENTICAL TO WHAT WE DID IN CHAPTER 3. WORKSHEET ENTRIES A AND E ARE
UNAFFECTED BY OWNING LESS THAN 100% BUT OWNING MORE THAN 50%.
3. There are a couple of older grandfathered methods that were applicable for
periods before 2009. One is called the parent company (purchase) method and the
other was called the proportionate concept. I am not going to ask you either
computational or theory questions on either of these older methods. If you are
curious, the proportionate method is easier to explain in that you multiply the
percentage of ownership (say 80% in the earlier example) by the fair values of the
acquiree at date of acquisition, less any amortization. Under the parent company
concept the consolidated totals are determined by adding the ( book value of the
parent, plus the book value of the subsidiary plus or minus ( FV-BV) of the
subsidiary at acquisition date) multiplied by the percentage of ownership, less any
accumulated amortization. If this sound complicated, that's because it is. Be happy
you not responsible for it.
Now let's go to the workbook and complete the exercises and theory. We start on
page 35. As described previously, even though the parent does not control 100% of
the company, you are consolidating 100% of it and separately reflecting the
noncontrolling interest on the balance sheet and income statement as described on
the page. On the bottom of the page you see a typical consolidated income statement
under the acquisition method. The 150,000 is calculated as Net Income of 500,000
multiplied by the NCI percentage of 30% = 150,000.
Page 37 describes the 3 methods to consolidate. Only the Economic unit method
(acquisition method) is GAAP today (since 2009) and that is all you are responsible
for. In example 1 at the bottom of the page, we assume there is no control premium
(further described on page 41). Since in the example we acquire 70% and need to
consolidate 100% of the company, we need to calculate the implied value of the
subsidiary at the date of acquisition. Here are the steps (on the bottom of the page).
a. implied value= 140,000/.7 = 200,000
b. noncontrolling interest on the balance sheet (in equity) = 30% x 200,000= 60,000
c. revenue at 100% 100,000 - .3 (100,000) = 70,000. Net Income to controlling

interest.
We are skipping examples 2 and 3 which you are not responsible for.
Workbook pages 39 and 40 are very similar to page 19 which contrasted the special
rules for the acquisition method vs. the purchase method. Where it says Control
Premium (FAS 141R, 160) you can write (ASC 805 and 810---Acquisition method).
ASC stands for Accounting Standards Codification. For each topic, I explain the new
rules first and then the old rules which correspond to FAS 141, for which you can
write "old rules purchase method". Rather than walk through the theory of the rules
it is easier to do the workbook examples beginning on page 41 and then refer back
to the rules to figure out the solutions. This is identical to how we dealt with page 19
of the workbook ........ we did examples and then looked up the rules to solve them.
Let's start on page 41. I will show you the answer that you should insert for each
line on than page. Next to the answer is a supporting calculation. The technique in
this example is only applicable when there is a control premium, meaning the shares
of the subsidiary do not increase to the price that the parent was willing to pay for
them to acquire majority ownership.
1. 30 ( 100-70)
2. 2,400,000 (30x 80,000 shares)
3. FVCI 8,000,000 ( 80,000xl00)

FVNCI 1,400,000 ( 20,000 x 70)
Total 9,400,000
4. Goodwill = Business Fair Value (from #3) - 100% FVNAA

9,400,000 - 8,000,000 = 1,400,000
5. G to Cl: FV CI - 80% FVNAA

8,000,000 - .8 (8,000,000) = 1,600,000
Since total Goodwill from problem 4. Is only 1,400,000 100% of the goodwill is
allocated to the controlling interest. That leaves nothing left for the NCI. You will see
a problem later (in the homework) where there is something left in goodwill for the
NCI.
6. The rule with preacquisition income is simpler than the old rule (which I am not
covering). The new rule simply says we IGNORE ..... DO NOT COUNT ...... any income
of the acquired company before the date of acquisition. Here are the solutions to 6a
and 6b:
6a. Subsidiary revenue ( 3 months): 100x3 300

Subsiidary expense ( 3 months): 80x3 240
Subsidiary net income 60
Multiply by NCI percentage x40%
Equals NCI of subsidiary net income 24
6b. Net income to CI can be calculated in two ways:

6bl, Sub net income (above) 60
Multiply by CI percentage x60%
Net Income to CI 36
6b2. Sub net income (above) 60

Less net income to NCI (above) ( 24 )
Net income to CI 36
The series of examples on page 4 la are the application of the acquisition method
rules. Where applicable I cross reference the rules to pages 39 and 40 of the
workbook. I am showing the formulas to get to the answers for each.
1. BV of Parent+ BV sub+ 100% (FV-BV sub) at date of acquisition
2,000,000 + 3,000,000 + (1,500,000 - 3,000,000) = 3,500,000
The procedure here is identical to what we covered in chapter 3.
2. )Subsidiary net income - excess amortization) x NCI percentage ....... same as text
p. 161
( 150,000 - 10,000) X 20% = 28,000
The excess amortization is calculated: 200,000 divided by 20.
3. Dr. Cash 5,000,000

Cr. Investment 3,000,000
Cr. APIC 2,000,000
Explanation: Parent's ownership went from 90% to 60%, They started with control
and still have control. Per workbook page 39b 4b, the rule is that the difference
between the sales proceeds and cost of investment sold is either debited or credited
to APIC----treated as a capital transaction.
4. Dr. Cash 8,000,000

Cr. Investment 5,000,000
Cr. Gain on Sale 3,000,000
Explanation: Parent's ownership went from 90% (had control) to 40% (do not have
control). Per workbook page 39 4c the rule is that the difference between the sales
proceeds and cost of investment sold is either debited or credited to Gain on Sale. (if
debited it would be a loss).
5. This example is about "step acquisitions". In a step acquisition, the parent can
either go from not having control (50% or less ownership) to acquiring majority
ownership, or from already having control (owning more than 50%) to still having
control. The rules for step acquisitions are on workbook page 39.
The rule says you must first measure the investment on the books at fair value.
Since no control premium is indicated in this problem, you can use the price Alpha
paid to acquire an additional 20% ownership as indicative of the value of whole of
Alpha, using the implied value calculation.
Implied value= Price paid to acquire 20% divided by 20%

= 100,000/.2 = 500,000 representing the FV of the whole company
Therefore the fair value of NCI = 500,000 x 40% = 200,000
Compare that to the BV of the NCI (given) 150,000
Gain on revaluation of NCI 50,000
Reference: Workbook page 39 3a.
6. This problem is not in your workbook.

Assume you go from 60% to 80% ownership. The implied value is still 500,000
(above). The fair value of the 60% ownership is 60% of 500,000= 300,000
The book value of the 60% ownership is assumed to be............... 220,000
The difference is ( 300,000 - 220,000) equals 80,000 which is credited to APIC,
since you are going from having control to still having control. Refer to rule 3b for
Step Acquisitions on workbook page 39.
Workbook page 41a1 has another example of a worksheet where there is no control
premium. It is very similar in content to the textbook page 161. I will refer to
portions of the worksheet in class, but we will not spend the time to build it "from
scratch".
Chapter 4- Example of Control Premium and Business Fair Value- Acquisition
Method (FAS 160/ FAS 141R)
ABC acquires 80% of XYZ by paying $100 a share for 80,000 of XYZ. The remaining
20,000 shares of XYZ are held by minority shareholders and are worth $70 per
share both before and after the acquisition. Answer the following:
1. How much is the control premium per share

2. How much is the total control premium paid by ABC
3. Calculate business fair value=
Fair value of controlling interest+
Fair value of noncontrolling interest
~ 91 00<{ ~CJ,o,
4. Assume that the fair value of net assets acquired is C Calculate
goodwill.
5. Allocate goodwill (from #4) to the controlling and noncontrolling interest.

(Rule: First allocate goodwill to the controlling interest for the excess of the
fair value of the parent's controlling interest(above) over its share of the
fair value of net assets acquired; any remaining goodwill goes to the
noncontrolling interest.)
6. Example of Preacquisition Income (FAS 141R/160)

Assume parent acquires 60% of subsidiary on Oct 1, 2010 and that in each
month of 2010, the subsidiary has revenues of 100 and expenses of 80.
a. How much is the NCI share of net income in 2010.
b. Calculate the net income to the controlling interest relating to this sub in
2010.
Chapter 4- Additional Exercises
1. On Jan 1, 2010 parent acquires 60% of sub. At acquisition date, sub has Accounts
Receivable, book value 3,000,000 and fair value 1,500,000. Parent has Accounts
Receivable, book value 2,000,000 and fair value 4,000,000. How much is
Consolidated Accounts Receivable on Jan 1, 2010.
2. Assume parent acquires 80% of sub on Jan 1, 2010. At acquisition date BV=FV
for sub assets and liabilities, except that sub had building (20 year life) with
FV >BV by 200,000. Assume sub earns 150,000 net income in 2010. How much
is NCI of sub net income in 2010.
Formula: NCI (sub)= [ 100% of sub net income - 100% of excess amort] x NCI
percentage.
3. Assume parent owns 90% of sub. Parent sells shares reducing ownership to 60%.
If proceeds of sale equal 5,000,000 and cost of shares sold (FIFO) equals
3,000,000 what journal entry does parent make for sale.
4. Assume parent owns 90% of sub. Parent sells shares reducing ownership to 40%.
If proceeds of sale is 8,000,000 and cost of shares sold (FIFO) is 5,000,000 what
journal entry does the parent make for sale.
5. Alpha owns 40% of Beta and at December 31, 2010 the balance in Alpha's
investment account (equity method) equals 150,000. On January 1, 2011 Alpha
purchases an additional 20% of Beta for 100,000. Assuming no control premium,
what entry does Alpha make
Ch : 04 - Consolidated Financial Statements and Outside Ownership
37. (continued) Acquisition Method

Consolidation Entries Noncontrolling Consolidated
Account$_ Padre Sie_,ra Debit Credit Interest Totals
Revenues ............................................ _(1,394,980) (684,900) (2,079,880)
Cost of goods sold ........................... .. 774,000 432;000 1,206,000
Depreciation expense ...................... .. 274,000 11,600 (E) 2,400 283,200
Amortization expense ...................... .. -0- 6~100 (E) 4,700 10,800
Interest expense ................................ . 52,100 9,200 (E) 2,300 63,600
Equity in income of Sierra .............. .. (177,120) -0- (I) 177,120 -0-
Separate company net income .......... (472.000) (226.000)
Consolidated net income ................. .. (516,280)
NI to noncontrolling interest.......... .. (44,280) 44,280
NI to Padre Company .................... .. (472.000)
Retained earnings 1/1 ..................... .. (1,275,000) (530,000) (S) 530,000 (1,275,000)
Net income (above) .......................... . (472,000) (226,000) (472,000)
Dividends declared ......................... .. 260,000 65,000 (D) 52,000 13,000 260,000
Retained earnings 12/31 ............. . (1,487.000) (691.000) (1,487.000)
Current assets ................................... 856,160 764,700 1,620,860
Investment in Sierra ........................ .. 927,840 (D) 52,000 (S) 552,000
(I) 177,120
(A) 250,720 -0-
Land' ................................................... 360,000 65,000 (A) 225,000 650,000
Buildings and equipment (net) ......... . 909,000 275,400 (E) 2,400 (A) 24,000 1,162,800
Copyright .......................................... . -0- 115,900 (A) 94,000 (E) 4,700 205,200
Total assets ................................ .. 3.053.000 1.221.000 3.638.860
Accounts payable ............................. . (275,000) (194,000) (469,000)
Notes payable .................................... (541,000) (176,000) (A) 18,400 (E) 2,300 (700,900)
NCI in Sierra 1/1 ................................ .. (S) 138,000
NCI in Sierra 12/31 ............................. . (A) 62,680 (200,680)
........................................................ (231,960) (231,960)
Common stock .................................. (300,000) (100,000) (S) 100,000 (300,000)
Additional paid-in capital ................. .. (450,000) (60,000) (S) 60,000 (450,000)
Retained earnings 12/31 ... (above) ... (1,487,000) (691,000) (1,487,000)
Total liab. and stockholders' equity (3,053.000) (1,221.000) 1.265.920 1.265.920 (3,638.860)
4-32
Copyright 11:12015 McGraw-Hill Education. All rights'reserv;d. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
lf / q. ,
Chapter 4 Homework
1. Justin acquires 90% of the voting common shares of Stevens on January 1, 2010.
In 2010, Justin pays dividends of $350,000 and Stevens pays dividends of
$25,000.
a. How much is the noncontrolling interest in subsidary dividends.
b. How much is consolidated dividends
c. Prepare worksheet entry D for this situation.
2. Roland acquires 70% of Felix on January 1, 2011. The terms of purchase is that
Roland pays to Felix shareholders 70,000 shares of Roland common stock with a
market value of $20 per share. The remaining 30,000 shares of Felix were traded
at $15 both just before the acquisition date and right after the acquisition date.
a. How much is the control premium per share
b. How much is the total control premium paid by Roland
c. Calculate business fair value
d. Assume that 100% of the fair value of net assets acquired was $1 ,200,000. How
much is goodwill
e. How much goodwill is allocated to the controlling interest
f. How much goodwill is allocated to the noncontrolling interest
3. Tall acquires 80% of Short on May 1, 2010. For the first 4 months of 2010, Short
has total revenues of $1,000,000 and total expenses of $600,000. For the last 8
months of the year Short has total revenues of $1,800,000 and total expenses of
$800,000.
a. How much is the noncontrolling interest in Short net income in 2010
b. How much subsidiary net income is allocated to the controlling interest
4. a. Thompson owns 100% of Rollins and at December 31, 2012, its Investment in
Rollins account stands at $10,000,000. On that date Thompson sells 20% of its
ownership for $2,500,000 cash. Prepare the journal entry to.be recorded by
Thompson on December 31, 2012.
b. Same facts as above, except the sales price is $1,000,000 cash. Prepare the
journal entry to be recorded by Thompson on December 31, 2012.
5. a. Big owns 60% of Little and at December 31, 2012, its Investment in Little
account stands at $6,000,000. On that date Big sells half its ownership for
$4,000,000 cash. Prepare the journal entry to be recorded by Big on December 31,
2012.
c. Same facts as above, except the sales price is $2,500,000 cash. Prepare the
journal entry to be recorded by Big on December 31, 2012.
Chapter 4 Homework (continued)
5. Wang owns 30% of Chen and at December 31, 2015 the balance in Wang's investment account equals
$400,000. On January 1, 2016 Wang purchases an additional 40% ownership in Chen for $600,000,
bringing Wang's ownership up to 70%. Wang will Dr. Investment in Chen for $600,000 and credit cash
for $600,000. What additional entry will Wang be required to make to reflect the increase in ownership.
6. Roberts owns ~ of Smith at has a balance in the investment account of $200,000 at December 31,
2015. On January 1, 2016 Roberts purchases an additional 10% ownership in Smith for $70,000. Roberts
will Dr. Investment in Smith for $70,000 and credit Cash for $70,000. What additional entry will Roberts
be required to make to reflect the increase in ownership.
Textbook: Answer Questions 2,3,6
Problems 2,3
Chapter 5
ifl.
Chapter 5 Notes on Intercompany Transactions and Consolidations
We will be covering the impact that intercompany transactions have on the consolidation
process, both in the year of acquisition and in subsequent years. Specifically, we will
review intercompany transfers of land, depreciable assets and inventory ......... .in that
order. You will need to be familiar with the necessary worksheet adjustments to produce
correct consolidated statements which ELIMINATE THE IMP ACT OF THESE
INTERCOMPANY TRANSACTIONS. The goal is to bring the consolidated results to
what they would have been if the intercompany transactions had never taken place.
Remember, there are separate financial results for the parent, the subsidiary and for the
consolidated entity along with the worksheet entries. It is critical to understand where the
various entries and adjustments are recorded.
INTERCOMPANY TRANSFER OF LAND (between parent and subsidiary).

1. When there is a intercompany sale at a price that is either greater or less than book
value, there will be a gain or loss recorded ....... that will need to eliminated.
2. In subsequent years, the gain will have moved from the income statement of the seller
to Retained Earnings of the seller ......... that will need to 'reversed.
3. When land is transferred by the buyer (parent or subsidiary) to an unrelated third party,
the earnings process is complete and the full gain or loss can be recognized at that time.
Consolidation Entries ..... assuming a gain on sale (opposite assuming a loss on sale)
In year of sale: ENTRY TL
Dr. Gain on Sale of Land
Cr. Land
In subsequent years, before Land is sold to 3rd party: ENTRY GL

Dr. Retained Earnings
Cr Land
When Land is sold to a third party in either the same year or subsequent years.
1. Reverse the intercompany gain/loss (entry TL or GL)
2. Record the gain or loss on sale
Intercompany Land Transfer Example ......... to be completed in class

Parent purchases land on January 1, 2003 for $500,000.
On January 1, 2004 parent sells land to its 100% owned subsidiary for $700,000.
Subsidiary holds land for 3 years and then on December 31, 2006 sells to unrelated third
party for $800,000 .
Show entries for the parent, the subsidiary, and consolidation entries for 2003, 2004,
2005 and 2006.
Entries for the Intercompany Sale of Land Example
2003:
Parent
2004:
Parent
Subsidiary
Worksheet
2005
Worksheet
2006
Subsidiary
Consolidation
4- 4
Intercompany Depreciable Asset Transfer-----Rules
If a Parent sells asset to Subsidiary at a gain over book value, there is an intercompany
gain that must be eliminated in consolidation. To achieve that, the following must take
place.
In year of transfer:
Consolidation(worksheet) Entry TA
Dr. Gain on Sale of Asset

Dr. Asset
Cr. Accumulated Depreciation
To reverse the intecompany gain and restore the asset and accumulated depreciation
accounts. If there is loss on sale, the consolidation entry will be to _ ___ (debit or
credit) the loss on sale.
In subsequent years,
Consolidation (worksheet) entry *TA
Dr. Retained Earnings

Dr. Asset
Cr Accumulated Depreciation
To remove the intercompany unrealized gain and restore the asset and accumulated
depreciation to their historical cost, less accumulated depreciation.
The intercompany gain will continue to be deferred until either the sale to an unrelated
third party or through the subsequent use of the asset, through depreciation expense.
Depreciation will gradually offset the amount of unrealized gains that sits in retained
earnings and thus consolidation entry *TA will change every year, getting smaller,
assuming we had an intercompany gain on the original transaction. This will be
illustrated.
There is also an Income Statement Impact: If the parent sells to the subsidiary at a higher
price than the parent's carrying value, subsequent depreciation expense is overstated and
must be reversed.
In year of transfer:
Consolidation(worksheet) entry ED
Dr. Accumulated Depreciation
Cr. Depreciation Expense
In subsequent years: ......... this is the hard part. The methodology is to compare the
balances for the asset, accumulated depreciation and depreciation expense on the parent
and subsidiary's books (based on the inflated sales price) ........ to what the correct
balances should be in consolidation reflecting the original historical cost balances before
the intercompany sale. That difference is consolidation entry *TA and entry ED
Dr. Asset
Dr. Retained Earnings (beginning)
Cr. Accumulated Depreciation TA
Dr. Accumulated Depreciation

Cr. Depreciation Expense ED
Example (to be completed in class)
Parent buys building on January 1, 2000 for $500,000.

Useful life is 10 years. On January 1, 2005 parent sells building to 100% owned
subsidiary for $400,000. Subsidiary determines remaining useful life is 5 years.
Prepare consolidation entries for December 31, 2005
Steps:
1. Identify what the parent and subsidiary have recorded on their individual books.
2. Determine what the consolidated result should have looked like if no intecompany
transfer had taken place.
3. Prepare appropriate consolidation entries.
Step 1
Parent Entries (cumulative)
Subsidiary Entries (cumulative)
Step 2
Step 3
'f 7
tf i tL
Consolidated Statements-----Intercompany Transactions
Intercompany Transfers of Depreciable Assets----Final Thoughts

In the previous class we went through a detailed example of the consolidation entries that
are required when a parent sells a depreciable assets, such as a building, to its wholly
owned subsidiary; We focused on the worksheet entries required in the year of
acquisition to reverse the unrealized intercompany gain, reinstate the building at original
historical cost as well as bring depreciation expense and accumulated depreciation to the
amounts that should be reflected in consolidation------based on the original depreciation
schedule.
In subsequent years, until the building is sold, it will be necessary to continue to record
worksheet entries similar to the above. The two modifications are:
1. instead of debiting gain on sale of building, we will debit retained earnings as the
gain on sale from the previous year, would have been closed to retained earnings.
2. the amount that retained earnings is debited will be the original intercompany gain
on sale MINUS the extra depreciation that has been recorded by the subsidiary
based on its inflated purchase price. That "extra depreciation" flowed through
retained earnings of the subsidiary as a debit, reducing the amount that must be
debited in consolidation. There is a good example in the text on page 230
illustrating this ....... focus on entry *TA debit to retained earnings (in the year
subsequent to transfer) and see how it is less than the amount debited to Gain on
Sale in the year of transfer (page 229). The difference is due to the extra
depreciation taken by the subsidiary on the inflated asset price.
3.. you do not need to study the entries on page 231 where there is a downstream
intercompany transfer and the parent used the equity method .......... .it is
needlessly complicated.
Intercompany Sales/Transfers of Inventory

Similar to how we handled depreciable assets, the objective is to get the consolidated
books to be in the same position they would have been, had the intercompany transfer not
taken place. Complicating factors include:
1. the purchaser of the inventory may either hold or resell the inventory ........ as we saw
in chapter 1, we will need to make different entries in each of these cases.
2. when there is a noncontrolling interest, there will be a different treatment of the

income statement impact between an upstream vs. a downstream inventory transfer.
4. in years subsequent to the transfer, we need to determne where the overstated

profit is sitting (who's books, what accounts and what amounts) so that we can do
the appropriate consolidation entries.
The key to understanding the consolidation process is to be able to analyze each

problem and determine the impact that intecompany sales of inventory has on the
following accounts ............. Sales, purchases, beginning inventory, ending inventory
and how each of these( except sales) impacts Cost of Goods Sold. Remember that
purchases are closed out to Cost of Goods sold at each period end. In class, we will
go through a chart you may find helpful in analyzing the impacts and associated
consolidation entries.
Consolidation Worksheet Entries---- VfSf";-ea."" -rr-"',v ferJ

1. Entry TI: Dr. Sales xxx
Cr. Cost of Goods Sold (purchases) xxx
Purpose of entry: eliminate the intercompany sales and purchases on transferred
inventory. This entry is for 100% of the amount of the purchase and sale and is the same
for both upstream and downstream transfers.
2. Entry G (gain) Dr. Cost of Goods Sold (profit in ending inventory) xxx
Cr. Inventory xxx
Purpose of entry: to remove the unrealized gain recorded by the seller, in the year of sale
(either the parent or sub) as a result of the intercompany sale. This entry will be necessary
to the extent that the inventory is still on the books of the transferee, meaning it is unsold.
3. Entry G* Dr. Retained Earnings (beginning balance of seller) XXX

Cr. Cost of Goods Sold XXX
Purpose of entry: the profit that was overstated in the year of sale is now in the
BEGINNING inventory of the buyer. Since beginning inventory is a positive component
of cost of goods sold, it is therefore the case that cost of goods sold are overstated in the
subsequent accounting period. To correct this you need to credit cost of goods sold. The
debit to Retained Earnings is because the seller's individual books still reflects the profit
from the prior year (entry G was for worksheet purposes only). This is also explained
and illustrated on page 208. . 1 1, _.,.
5vDj,tl'"'r '
4. Treatment ofNoncontrolling Interest in,et Income ·
In a downstream transfer (parent sells inventory to subsidiary), the unrealized gain
belongs to the parent company and no adjustment is necessary to change the
noncontrolling interest.
In an upstream transfer, the income is recognized on the subsidiary's individual books,

even though it is unrealized from a consolidation perspective. Since the outside owners
have an interest in the subsidiary, the noncontrolling interest's share of consolidated net
income is calculated based on the reported income of the subsidiary after adjusting for
any unrealized upstream gains.
Study the upstream inventory transfer example (starts on page 216) including appropriate
consolidation worksheet entries. We will do a practice example in class along with the
homework in Chapter 5.
Chapter 5 Additional Exercises
1. Assume parent reports sales of $5,000,000 which includes $1,000,000 of sales to its 80% owned
subsidiary. Assume subsidiary has sales of $2,000,000, which includes sales of $400,000 to its
parent. How much is consolidated sales.
2. (Alternative wording to #1) Assume parent reports third party sales of $4,000,000 and
$1,000,000 of sales to its 80% owned subsidiary. Assume subsidiary reports third party sales of
$1,600,000 and $400,000 sales to its parent. How much is consolidated sales.
3. Assume parent reports purchases of $3,000,000 which includes $400,000 of purchases from its
80% owned subsidiary. Assume subsidiary reports purchases of $1,500,000 which includes
$1,000,000 of purchases from its parent. How much is consolidated purchases.
4. (Alternative wording to #2) Assume parent reports third party purchases of $2,600,000 and
$400,000 of purchases from its 80% owned subsidiary. Assume subsidiary reports purchases
from third parties of $500,000 and $1,000,000 of purchases from its parent. How much is
consolidated purchases.
5. Assume that in 2012 parent, who uses the equity method, sells inventory costing $60,000 to its
70% owned subsidiary for $100,000. Assume subsidiary sells 70% of this inventory to third
parties by the end of 2012.
a. What are the worksheet entries at the end of 2012. (Tl and G)
b. Asssume all the inventory subject to the intercompany transfer is sold by the subsidiary to
third parties by the end of 2013.
Bl. What is the journal entry recorded on the parent books in 2013
B2. What is worksheet entry prepared at the end of 2013. (*G)
6. Assume the same facts as in problem 5 except it is the subsidiary selling to the parent. How
would the answers to #5 above differ.
Class Problem------Upstream Inventory Transfer with Noncontrolling Interest
Parent acquires 70% interest in subsidiary on January 1, 2000.
In 2003, subsidiary sells inventory costing $80,000 to parent for $120,000. 20% of this
inventory was not sold to outsiders by the parent until 2004 (meaning that 80% of the
transferred inventory was sold by the parent in ___(year).
In 2004, subsidiary sells inventory costing $100,000 to parent for $150,000. 40% of this
inventory was not sold to outsiders until 2005.
In 2004, parent reported cost of goods sold of $500,000 and subsidiary reported cost of
goods sold of $300,000. Also, the parent net income in 2004 is $80,000 and the
subsidiary income in 2004 is $50,000.
(a)What is consolidated cost of goods sold in 2004?

(b) What is noncontrolling interest in net income of subsidiary
Solution:
(a) Unrealized gain in 2003:
Intercompany Gain
Inventory Remaining at Yearend 2003
Unrealized Intercompany Gain 2003
Unrealized Gain 2004

Intercompany Gain
Inventory Remaining at Yearend 2004
Unrealized Intercompany Gain 2004
Consolidated Cost of Goods Sold---2004

Parent
Subsidiary
Remove Intercompany Transfer
Recognize 2003 Deferred Gain (2003 inventory is sold in 2004)
Defer 2004 Unrealized Gain
Consolidated Cost of Goods Sold
so
(b) Reported Income in 2004 (subsidiary)
Realized Gain Previously Deferred in 2003
Deferral of 2004 Unrealized Gain
Realized Income of Subsidiary
Outside Interest Percentage
Noncontrolling interest in Net Income
51
Chapter 5 -----Formulas + Downstream Sales oflnventory
FORMULAS:
Although the classes have stressed procedures and worksheet entries to correctly
calculate consolidated totals, the following is presented as a recap that students may fi nd
useful. c., /\$41~ J~rul pv~ #\,SCJ ~ /<J ,.. p rlAf- P"'""'-. + ,~0111 S-vh f,/rr,,.4 . -
/Oo'i,# iA"f.e.re,b. fvrr., /...
Consolidated Sales= 100% parent sales + 100% of subsidiary sales - 100% of

intercompany sales
Consolidated Cost of Goods Sold= 100% of parent CGS + 100% of subsidiary CGS -
100% of intecompany purchases + intercompany unrealized gains on ending inventory
(current year) - intercompany unrealized gains on ending inventory (prior year)
Noncontrolling Interest in Subsidiary Net Income (upstream sales of inventory)=

(100% of subsidiary net income + realized intercompany inventory gains deferred from
previous year - deferral of current year intercompany unrealized gains) x % of outside
ownership
Noncontrolling Interest (balance sheet)= Subsidiary Net worth (after adjusting for
unrealized gains on intercompany transactions) x % of outside ownership.
Unrealized Gain on Ending Inventory= Ending inventory on books of transferee x GPP
Consolidated Expenses= Parent expenses + Subsidiary expenses - excess deprecation

(one year)+ annual amortization of fair value adjustments on fixed assets and intangibles.
Excess Depreciation= 100% of annual depreciation based on transfer price - 100% of

annual depreciation based on historical cost
DOWNSTREAM SALES OF INVENTORY
The following was discussed in class:

Ina downstream sale of inventory, when the parent uses the equity method, there is an
adjustment that needs to be made to the worksheet entries previously reviewed.
In the year of sale, the parent will have already deferred the intercompany unrealized gain
under the equity method (debit equity earnings and credit investment) and retained
earnings of the parent will be correct. However, we need to reclassify the debit to equity
earnings to a debit to cost of goods sold, which means the following worksheet entry is
necessary in the year of the intercompany sale:
Dr. Cost of Goods Sold

Cr. Equity Income (referred to as entry G)
In the subsequent year when the subsidiary is assumed to have sold the remaining
inventory, the parent will now treat the previous unrealized gain as realized (same as
chapter 1) by debiting the Investment and crediting Equity Income. Once again the
par~nt's retained earnings are correct; however the classification needs to change in the
consolidated income statement from equity income to a reduction of cost of goods sold in
the year the goods are sold by the subsidiary to 3rd parties. This is accomplished by the
following consolidation entry:
Dr,Equityincome (or lt\v'tJt""e."+)

Cr. Cost of Goods Sold (referred to as entry G*)
S3
Chapter 5 Homework
1. Parent purchases Land on January 1, 2009 for $100,000. On January 1, 2010 parent sells land to
100% owned subsidiary for $140,000. Subsidiary holds land until December 31, 2014 and then
sells it to third parties for $160,000.
a. . How much gain on sale does the parent record in 2010.
b. How much does the ,subsidiary record the land for on its books in 2010.
c. How much is consolidated gain on sale of land in 2010.
d. How much gain does the subsidiary record on its books in 2014.
e. How much is consolidated gain on sale of land in 2014.
f. How much is debited to retained earnings in 2014.
2. Rollins owns 100% of Felix. Rollins purchased equipment on January 1, 2002 for $100,000. The
equipment had a useful life of 10 years and straight line depreciation was used. On January 1,
2009 Rollins sells this equipment to Felix for $80,000. Felix uses a 5 year depreciable life for the
equipment and continues to l:lse the equipment through 2010.
a. How much gain on sale does Rollins record in 2009.
b. How much does Felix record the purchase for in 2009.
c. How much is the consolidated gain on sale of equipment in 2009.
d. How much is consolidated Equipment and Accumulated Depreciation at December 31, 2009
e. How much is consolidated Equipment and Accumulated Depreciation at December 31, 2010
f. What is the worksheet debit and credit entry to record excess depreciation in 2009?
g. What is the worksheet debit and credit entry to record excess depreciation in 2010?
h. What additional worksheet entry is needed in 2009?
i. What additional worksheet entry is needed in 2010?
Complete Chapter 5 problems 1,2,3,4,5,6 and 7 from the textbook

Chapter 6
Intercompany Debt (Chapter 6) Key Concepts
Direct Loans between parent and subsidiary are the easiest .......... they are eliminated in
entry P, which we discussed in Chapter 3. Additionally, any intercompany interest
expense and income is eliminated in the worksheet (debit interest income, credit interest
expense).
The purchase by a subsidiary of a parent's debt in the open market presents issues. The
debt remains outstanding on the parent's books (net of premium or discount), while the
subsidiary will likely have purchased the debt at a price different than the carrying value
of the parent. For the consolidated entity this will be accounted for as an early retirement
of debt.
The following is the required entry on the consolidation worksheet:
Dr Liabilities (the amount the parent has on its books for the debt)
Dr Interest Income
Dr. Loss on Retirement of Bonds or
Cr. Gain on Retirement of Bonds
Cr. Investment in Bonds ( the amount the subsidiary has on its books)
Cr. Interest Expense
Note that the above can be done either as a single entry or as a combined entry.
An additional issue arises when there is an noncontrolling interest: who does the gain or
loss on early retirement belong to ?
1. the company issuing the bonds
2. the company purchasing the bonds in the open market
3. split between the parent and the subsidiary
4. the parent company----they are the controlling party in the transaction . .... in which
case the noncontrolling interest does not receive any share of the gain or loss.
Chapter 6----Intercompany Debt Transactions
Key Learning Points:

1. Start by recalling the consolidation entry from chapter 3 when are
intercompany receivables and payables between parent and
subsidiary (debit payables; credit receivables).
2. If intercompany loans and borrowings result in recognition of
interest income and interest expense by the parent or subsidiary,
these too must be eliminated in consolidation (debit interest
revenue; credit interest expense), as they are within the same
economic entity.
3. If a subsidiary (or parent) borrows from outside party by issuing
bonds ......... normal bond accounting applies. Depending on the
coupon and prevailing interest rates, the bond may be issued at
either a premium or discount. Amortization of the premium or
discount will either reduce (premium) or increase (discount) the
cost of borrowing.
4. If the parent (or subsidiary) were to purchase the bonds in the
open market, the purchase is recorded as in investment by the
acquiring company ........ ... AND, the original bonds continue to
be a liability of the issuing subsidiary (or parent).
5. From a consoli<;lated viewpoint, the liability is retired at the date
of acquisition since both the investment and bonds payable are
within the same economic entity. A gain or loss on retirement of
bonds is calculated as the difference between the purchase price
by the parent (or sub) and the carrying (book) value of the debt
on the books of the sub (or parent), plus or minus any difference
between the interest expense and interest income accrued by
subsidiary/parent, respectively.
6. The gain or loss is recorded as a consolidation entry on the
worksheet:
Dr. Bonds Payable (net of unamortized premium or discount) xxx
Dr. Interest Income xxx
Dr. Loss on Retirement of Bonds or xxx
Cr. Gain on Retirement of Bonds xxx
Cr. Investment in Bonds XXX
Cr. Interest Expense XXX
Questions for Class Discussion
1. Why do subsidiaries borrow from parents?

2. Why might there be interest charged on intercompany loans ?
3. Why might a subsidiary choose to issue bonds to a 3 rd party
rather than borrow from its parent ?
4. Why would a parent purchase the subsidiary's bonds from a third
party?
5. Why would the purchase price of the bonds by the parent almost
always be different than the carrying value of the bonds on the
subsidiary's books?
6. Why would the parent not officially retire the bonds once
purchased ? (think Treasury stock analogy)
7. If a noncontrolling interest exists, under what circumstances, if
any, would you assign a portion of the gain or loss upon
retirement to the noncontrolling interest.
Class problems (to be worked out on the board in class)
1. On January 1, 2006, parent lends $100,000 to its 100% owned

subsidiary for one year at 8%. Prepare consolidation worksheet
for this transaction, reflecting the parent, subsidiary,
consolidation entries and consolidated totals.
2. On January 1, 2005 subsidiary issues $100,000 of 8%, coupon

bonds to third parties for $95,000. Interest is payable annually
and the bonds mature in 5 years. For simplicity, assume straight
line amortization of premium or discount. On January 1, 2006,
parent purchases all the outstanding bonds for $104,000. Show
journal entries for the subsidiary and parent for 2005 and 2006,
along with the consolidation worksheet as of December 31, 2006.
s8
lntercompany Debt---Example with Subsidiary Issuing Bonds and Parent Purchasing them in the Open
Market
Roberts owns 70% of Cisco. Cisco has a bond payable outstanding to third parties on January 1, 2018
with a book value (net of premium or discount) of $400,000. On that date Roberts purchases the bond in
the open market for $410,000.
Required :
a. Prepare a worksheet as of January 1, 2018 after the above transactions

b. Prepare consolidation worksheet entry "B" as o.f January 1, 2018
c. How much is the consolidated gain or loss on "retirement" of the bond.
Same facts as above except Roberts purchases the bond in the open market for $380,000.
Required :
d. Prepare a worksheet as of January 1, 2010 after the above transactions

e. Prepare consolidation worksheet entry "B" as of January 1, 2018
f. How much is the consolidated gain or loss on "retirement" of the bond.
Chapter 6
Variable Interest Entities
Traditional criteria for consolidation have required the parent to have a controlling
financial interest in its subsidiaries, typically in the form of voting common shares. In the
1990' s, companies began to sponsor the formation of so called special purpose entities to
isolate certain assets and liabilities into separate legal entities , so that investors and
creditors of those entities could better understand the risks and require a lower return on
that risk. FASB Interpretation 46(FIN 46, revised in 2003, was issued to close what was
viewed as the abusive practices of some companies, notably Enron, to not consolidate
special purpose entities that they clearly controlled, particularly when there was no
substantial outside equity investors and when the sponsor(the company creating the SPE)
guaranteed that the SPEs would not lose money.
The FASB utilizes the terminology, "variable interest entity"(VIE) which is defined as a
contractual, ownership, or other interest in an entity that changes as the entity's net assets
change. Examples of variable interests include guarantees, equity investment, written put
options and forward contracts. An "entity" is any legal structure used carry out operations
and can include corporations, partnerships, limited liability companies and trusts. that
requires consolidation by a primary beneficiary (typically the company that sponsors the
creation of the entity) where any one of the following circumstances are met:
1. the equity at risk by the outside investors is not sufficient to enable the entity to
finance its own activities without additional support; in practice, an outside equity
ownership percentage of less than 10% is viewed as insufficient equity at risk.
2. the equity investors lack the direct or indirect ability to make decisions regarding
the operations of the. entity; if that is the case, the sponsor company is probably in
control of key decisions and is the primary beneficiary of the entity.
3. the equity investors do not absorb the expected losses of the entity nor do they
have the right to receive residual returns of the entity; in that instance, the primary
beneficiary has the risks and rewards of ownership and must consolidate.
Assets, liabilities and noncontrolling interests of VIEs will be consolidated at the fair
value as of the date they meet the above criteria. The one significant exception is with
regard to assets or liabilities transferred at inception by the primary beneficiary to the
VIE. These are, in effect, intercompany transactions and will be measured in the
consolidated financial statements in the same manner as the intercompany transactions
previously described, i.e., any intercompany profit on transfer is eliminated m
consolidation through a worksheet adjustment.
The primary beneficiary of a VIE is required to disclose:

1. the nature, purpose, size and activities of the VIE
2. the book value and classification of any assets that serve as collateral to VIE
obligations.
3. whether creditors of the VIE have recourse to the assets of the primary
beneficiary.
4. maximum loss exposure as a result of its involvement with the activities of the
VIE
If a company holds significant variable interests but is not primary beneficiary, they are
required to disclose:
1. the nature of its involvement with the VIE and the date the involvement began
2. the nature, purpose, size and activities of the VIE
3. the maximum loss exposure
Chapter 6
1. On January 1, 2010, parent lends 70% owned subsidiary $5,000,000 at 6% annual interest for
two years. Subsidiary pays the accrued interest at the end of each year. Answer the following :
a. How much interest income is recorded on the Parent's books in 2010.
b. How much interest expense is recorded on the subsidiary's books in 2010.
c. What journal entry did the parent record on January 1, 2010
Dr._ _ _ _ _ _ _ _ $
Cr._ _ _ _ _ _ _ _ _ _ _ $
d. What journal entry did the subsidiary record on January 1, 2010
Dr._ _ _ _ _ _ _ _ _$
Cr._ _ _ _ _ _ _ _ _ _ _$
e. What consolidation worksheet entry is recorded at December 31, 2010 to eliminate the
intercompany receivable and payable.
Dr._ _ _ _ _ _ _ _ _ _$
Cr._ _ _ _ _ _ _ _ _ _ _ _$
f. What consolidation worksheet entry is recorded at December 31, 2010 to eliminate the
intercompany interest income and interest expense
Dr._ _ _ _ _ _ _ _ _$
Cr . _ _ _ _ _ _ _ _ _ _ _$
g. How much is consolidated loan receivable at December 31, 2010
h. How much is consolidated loan payable at December 31, 2010
i. How much is consolidated interest income at December 31, 2010
j. How much is consolidated interest expense at December 31, 2010
k. Assume the subsidiary had no other transactions in 2010. How much is noncontrolling
interest in subsidiary net income
2. Apple owns 80% of Pear. Apple had a bond payable outstanding on January 1, 2010 with a book
value of $212,000. Pear purchases the bond in the open market for $199,000. How much is the
gain or loss on retirement of the bond (show your calculation) .
3. Same facts as #2 with Pear reporting interest income of $22,000 and Apple reporting interest
expense of $21,000. How much is consolidated income in 2010.
4. Which special purpose entities must be consolidated
5. Who is required to consolidate a variable interest entity
6. What are the criteria to determine if a primary beneficiary exists

Chapter 8
Chapter 8 Segment and Interim Reporting---Summary of Rules
10% Tests to Determine Reportable Operating Segments

. In order for an operating segment to be reportable it must meet ONE of the following
three tests.
A. Asset Test----segment assets greater than or equal to 10% of combined assets of

all operating segments.
B. Revenue Test---- segment revenues, both external and intersegment, are greater
than or equal to 10% of combined revenues (both internal and external) of all
operating segments.
C. Profit and Loss Test--- segment Profit and Loss (P & L) greater than or equal to
I 0% of the higher of the absolute value of the combined profit of all profitable
segments or combined losses of all loss segments. Intersegment revenues and
expenses are included in the definition of P & L.
The 75% test is used to determine whether the Company has disclosed enough segments.
Must disclose enough segments so that the third party sales of the disclosed segments is
greater than or equal to 75% of total company third party (external) sales.
Major Customer Disclosure 10% test.

If greater than or equal to 10% of a Company's third party revenue comes from a major
customer, the Company must disclose information about that customer, specifically the
amount of revenue that the customer generated for the company and the identity of the
segment from which the revenue was generated.
Geographic Disclosure: Must disclose information about:

I. the domestic country (the United States for US based companies)
2. the total of all foreign countries from which the company earns revenue or holds
assets.
3. each "material" foreign country
Notes for Chapter 8---Segment Reporting
I. Understand "management approach" to running and reporting complex

businesses. Management evaluates business results along either product,
customer or geographic lines .............. NOT based on legal entity results.
2. Understand what an operating segment is
a. business activity with a income statement
b. income statement reviewed by the chief decision maker
c. for which discrete financial information is available (corporate cost
centers are not operating segments)
d. product is primary breakdown; geographic and customer is secondary.
e. can combine similar operating segments if in same business activity, e.g.
retail stores
3. Understand what a REPORTABLE operating segment is
· a. 10% test criteria ............ examples reviewed in class
b. understand the treatment of intersegment revenues, expenses and
assets .... covered in class (very important)
4. Know what must be disclosed for a reportable operating segment
5. Disclosure requirement under SFAS 131:
a. how segments are idel).tified
b. types of products/services offered by the segment
c. profit and loss data: revenues, interest revenue and interest expense,
depreciation , amortization and depletion, other noncash items,
discontinued operations and extraordinary items, income tax expense
d. total segment assets: separately disclose investment in equity affiliates and
'expenditures for long lived assets
6. Other Rules for Segment Reporting
a. non GAAP measures ok, but must reconcile to GAAP
b. reconcile segment totals to consolidated totals, e.g. intersegment
"doublecounts", corporate unallocated items.
c. for immaterial (nonreportable) operating segments (in the aggregate), must
disclose revenues, P & L and assets.
d. for nonoperating segments, disclose assets, revenues, expenses, gains,
losses, depreciation, amortization and depletion
e. if only one operating segment (like McDonalds), show revenues with
external customers by product.
f. must disclose enough segments such that the combined third party sales
are> or equal to 75% of total company sales.
g. geographic disclosure----for domestic country and the total 9f all foreign
countries where the company has revenue or assets+ EACH foreign
country where the company has material revenue or assets. Dislosure is:
I . revenue from external customers
2. long lived assets
;o
h. reliance on major customers (> or equal to 10% of third party revenue
from a single customer
1. disclose amount ofrevenue and state the operating segment of which
the customer is a part of (no names of customers)
2. note that the government can be a customer
1. no more than 10 segments to be disclosed
J. SFAS 131 drops the requirement for disclosure of export sale amounts
(had been a SPAS 14 requirement)
Notes for Chapter 8 --- ~nterim Reporting
1. Per APB 28---interim period is treated as an INTEGRAL part of an annual

period ............. not a 'DISCRETE period. Examples of this will be reviewed in
class.
2. Treatment of revenues under integral method essentially the same as under the
discrete method.
3. Inventory and CGS under the integral method----rules for LIFO liquidation
4. Inventory and Lower of Cost or Market under integral method
5. Treatment of other costs and expenses under integral method ............ accrued as
incurred, unless cost benefit future periods.
6. Extraordinary items.
7. Income taxes
8. Cumulative effect of accounting changes
9. Seasonal Items
10. Minimum disclosure
11. Treatment of Q4 "special items" disclosure: extraordinary items, disposal of
segment, cumulative change in accounting principles
12. Segment_ information in interim reports
Chapter 8 Exercises Applying the 10% Tests
Instructions: Consider examples 1, 2 and 3 individually and example 4 together with 1,2
and 3.
1. Adams Company has 4 operating segments and 2 nonoperating segments as

follows: ·
Segment Assets
1 (operating) 2000
2 (nonoperating) 900
3 (operating) 800
5 (operating) 300
6 (operating) 100
Using the 10% test applicable to Assets, which segment(s) are reportable?
Answer: Segments_ _ __ _ __ _ __ _ __ _ __ __
2. Adams Company has revenues in each of its six segments as follows
Segment External Revenue Intersegment Revenue

1 (operating) 1600 400
2 (nonoperating) 0 100
4 (nonoperating) 100 0
Using the 10% test applicable to Revenues, which segments are reportable?
Answer: Segments_ _ _ _ _ _ _ _ _ _ _ _ _ _ __
3. Adams Company has the revenues from example 2, above. It also has expenses
as indicated below
Segment Expenses
1 (operating) 800
3 (operating) 1600
4 (nonoperating) 50
5 (operating) 200
6 (operating) 400
Using the P & L test alone, which segments are reportable?
Answer: Segments _ _ __ _ __ _ _ __ _ _ __
4. Using the results of the asset test, revenue test and P and L tests together
(problems 1, 2,3) which segments are reportable?
Answer: Segments
- -- - - - -- - - - - - - -
5. Adams Company has five customers who have generated the following revenue
for the company.
Customer A 400
Customer B 300
Customer C 250
Customer D 200
Customer E 100
Using the major customer test, which customers will Adams be required to
disclose information about in the footnotes to its financial statements
c .,.,r~""' c..-..-.5
Answer: i1•111!MD►►q58,____________ _ _ __
6. Adams has determined it will provide geographic disclosure for the following
locations where it has significant revenue or assets:
United States and Canada, Europe, Japan and Australia, India, Brazil and all other
countries.
Using the rules for geographic disclosure what is wrong with the above breakdown.
7 'C.
Interim Reporting---Chapter 8
Introduction: Most of GAAP is based on accounting principles used to prepare

annual financial statements. Additionally, the CPA audit opinion is usually only given
on the fairness of the client's annual financial statements.
Much less is written about accounting during interim periods and one would think
that the same principles that are applicable to annual fina ncial statements are also
applicable to the preparation of monthly / quarterly financials. Approximately 98%
of the time this is true. However, the exceptions are what are dealt with in this
chapter.
Two views of how to accounting for interim periods have emerged:
View 1: Integral approach (GAAP----FASB): The interim period is an "integral" part

of the whole year and one must consider the whole year when lo oking at how to
account for transactions during interim periods.
View 2: Discrete approach ( IFRS-----IASB): The interim period stands on its own;
accounting is not influenced by what is expected to occur in the full year.
Example: In 201 2, Company paid $120,000 in bonuses based on full year income
before taxes and bonuses of $5 00,000. In 2013, Company anticipates it will have the
same income as 2012 and that it will pay bonuses of $12 0,000. In the first quarter
of 2013, Company earns zero income before taxes and bonuses but anticipates
earning $500,000 for the full year. How much is the bonus accrual under:
Integral method:
Discrete method:
Rules for LIFO liquidation: Under IFRS, liquidation of LIFO layers (meaning selling
more units of inventory than are purchased during the interim period) results in
additional gross profit Under GAAP, you must ask the question, "does the company
anticipate purchasing inventory to replace the LIFO layer that was d'isposed by the
end of the year". If yes, then gross profit can only be taken up the replacement cost
of the inventory. lf no, then the full profit (same as under IFRS) can be taken.
Example: Assume Company uses LIFO and has two sales taking place in the first
quarter of 2013:
Sell 100 units@ $100 (cost of $80)
Sell 10 units@ $100 (cost of $70): not expected to be replaced by year end.
Purchases in the first qu9-rter of 2013 were 100 units @ $80 . :I ·
A 5 ,.., 191 t- ,. tp !c..£-£-11'\ ~-r c. ~ cl-+- f't'\ q..yv{... 3 l 1 '7- I3 , :; q v .
What is amount of gross profit that is recognized under the discrete and integral
methods.
Invento and lower of cost or market: Under GAAP and IFRS inventory is
reported at the "lower of cost or market". If aggregate market is less than cost in an
interim period, it is handled in the following way: -
Assume at March 31, 2013, inventory@ cost is $800,000 and inventory@ market is
$700,000.
Under the discrete method (IFRS) a $100,000 write-down is recorded (Dr. Loss on
Inventory write-down Cr. Inventory)
Under the integral method, you must ask if the market value is anticipated to
recover to at least cost by the end of the fiscal year. If yes, then no write-down is
taken. If no, then the full (or partial ) write-down is taken, as above. Evidence of any
company assertion that the market price will recover must be provided.
Extraordinar Items: Must meet the criteria of unusual and infrequent The
treatment of material extraordinary items in interim periods is as follows:
Integral method: Must ask is the item expected to be material to the full year: If yes,
then it is treated as an extraordinary item in the quarter. If no, then it is treated as
an operating expense in the quarter (not extraordinary). Note that the full amount
of the extraordinary item is recorded in the quarter ........ no amortizing of losses.
Discrete method: Treat the full amount as an extraordinary item.
Example: In the first quarter of 2013, ABC Company suffers a $4 million loss from a
fire that destroyed its factory . The loss is material to first quarter results but is not
expected to be material to full year results. How is this loss handled under the:
Integral method:
Discrete method:
Same facts as above, but the loss is expected to be material to full year results.
Integral method:
Discrete method:
Income taxes in interim periods (income tax expense)
Integral method: Use estimated annual effective tax rate. This will take into account,
estimated income, deductions and tax credits.
Discrete method: Use effective tax rate for the interim period only
Accounting 311 Practice Midterm #2
Instructions: Complete the problems below on separate sheets of paper and bring them to
my desk before the start of the review class. A maximum of 3 points will be added to
your midterm grade. It is not necessary to re-write the questions o or to use Excel.
Students arriving to class l ate will receive a maximum of 1 point added to their midterm
grade if their work was done in excel.
1. Stevens owns 60% of David. In 2012, Stevens has net income of $80,000 and
David has net income of $60,000. There is also $4,000 of annual excess
amortization associated with David's acquisition date equipment plus David had a
$3,000 gain on an intercompany sale ofland to Stevens. Finally, Stevens had a
$5,000 gain on an intercompany sale of land to David. How much is the
noncontrolling interest in subsidiary net income.
2. Davis owns 70% of Free. In 201 2 Davis reports sales of $200,000 which includes
third party sales of $160,000 and intercompany sales of $40 000. Cost of goods
sold for Davis are $80,000. Free reports sales of $150,000 of which $50,000 are
intercompany. How much are consolidated sales.
3. Gulko owns 60% of Larsen. In 2012 Gulko reports Sales of $4,000,000, which
includes 3 rd party sales of $3,500,000 and intercompany sales of $500,000. Larsen
reports intercompany sales of $200,000 and total sales of $700,000. How much is
Consolidated Sales.
4. Hand owns 90% of Finger. In 2008, Hand purchased Land from third parties for
$500,000. On January 1, 2012 Hand sells Land to Finger for $800,000. Finger
holds the Land until December 31, 2015 and sells it for $2,000,000. ·
a. How much is consolidated gain on sale of Land for the year ended December 31,
2012
b. How much is consolidated Land at December 31, 2012
c. How much is consolidated gain on sale of Land at December 31, 2015
d. At December 31, 2015 how much is debited to Retained Earnings as part of the
necessary worksheet entry at that date
5. Parent buys building (useful life 10 years) for $3,000,000 on January 1, 2012. On
that same date, parent sells building to 80% owned subsidiary for $4,000,000.
Subsidiary will use the same 10 year depreciable life.
a. How much depreciation expense will the subsidiary record in 2012.
b. How much is consolidated depreciation expense in 2012.
c. How much is the worksheet entry to eliminate excess depreciation in 2012.
72.
6. In 2012, parent reports Cost of Goods Sold of $4,000,000. Its 90% owned
subsidiary reports Cost of Goods Sold of $1,000,000 in 2012. During 2011 the
subsidiary had $60,000 of unrealized gains on intercompany sales to its parent. In
2012, the subsidiary had sold $200,000 of goods to its parent and had $30,000 of
unrealized gains. How much is consolidated cost of goods sold in 2012.
7. Same facts as problem 19. Assume in 2012 the subsidiary had net income of
$150,000. What is the noncontrolling interest in subsidiary net income in 2012.
8. Adams owns 80% of Williams and the carrying value of the investment on January
1, 2012 is $600,000. On that date Adams sells half of its shares for $250,000. What
journal entry is recorded at that date.
9. Same facts as #21 except that Adams sells 20% of its investment for $150,000,
reducing its ownership to 60%. What journal entry is recorded by Williams at that
date.
10. Harry purchases 80% of David by paying $50 a share for 40,000 of David. The
remaining 10,000 shares of David are held by minority shareholders and are worth
$40 per share both before and after the acquisition. Assume that 100% of the
FVNAA of David at date of acquisition is $2,200,000.
a. Calculate goodwill
b. How much goodwill is allocated to the controlling interest and how much to the
noncontrolling interest
11. Felix pays $1,000,000 to acquire 80% of Unger. Assume there is no control
premium. At acquisition date the FVNAA of Unger is $1 ,100,000. Calculate any
goodwill or consolidated gain on bargain purchase that is to be recorded in
consolidation
12. On January 1, 2010 parent lends its 60% owned subsidiary $2,000,000 at 10%
annual interest.
a. How much interest income is recorded by the parent in 2010
b. How much interest expense is recorded by the subsidiary in 2010
c. How much is consolidated interest income
d. How much is consolidated interest expense
e. How much is consolidated loan receivable
f. How much is consolidated loan payable.
13. Willis owns 60% ofYonex. On January 1, 2011 Yonex has bonds payable
outstanding of $6,000,000 and a bond discount account with a debit balance of
$500,000. On that date Willis purchases all the outstanding bonds for a price of
$5,600,000. How much is the gain or loss on the in substance defeasance (early
"retirement") of the bonds?
Problems 14-19. Use the below table to answer the questions.
Segment Reporting Practice Exam

Segments
Red Blue Green Pink Black White
Sales to outsiders 1811 812 514 309 121 99
Intersegment revenues 16 91 109 0 16 302
Salary expense 614 379 402 312 317 62

Rept expense 139 166 81 92 42 31
Segment Profit and Loss
Segment Assets 100 300 600 200 300 500
Segment Liabilities 50 100 200 75 275 220
14. Under the revenue test alone which are the reportable operating segments
15. Under the asset test alone which are the reportable operating segments
16. Under the Profit and Loss test alone which are the reportable operating
segments
17. Using all three tests, which are the reportable operating segments.
18. Assume that only Red, Blue and Green are of sufficient size to require
separate disclosure. Is Steinitz disclosing enough segments?
19. What is the amount of revenues from a single customer in one year that will
cause it to be a major customer
20. Kirk owns 20% of McCoy and has a balance in its investment of $300,000 at
December 31, 2015. On January 1, 2016 Kirk purchases and additional 40%
ownership for $800,000. Kirk debits its investment in McCoy for $800,000
and credits Cash for $800,000. What additional entry is Kirk required to
make.
21. Stone owns 60% of Rock and has a balance in its investment of $800,000 at
December 31, 2015. On January 1, 2016 Stone purchases an additional 25%
ownership for $300,000. Stone debits its investment in Rock for $300,000.
What additional entry is Stone required to make.
72(;
22. Happy owns 80% of Sad, paying $500,000 on January 1, 2016. At that date, Sad
had Equipment (20 year life) with book value of 200,000 and fair value of 600,000.
In 2016 Sad had net income of 100,000. How much is noncontrolling interest in
subsidiary net income in 2016?
23. Head owns 80% of Shoulders. Head reports Dividends of $300,000. Shoulders
reports Dividends of $100,000.
a. How much is consolidated dividends
b. How much dividends were paid by Shoulders to Head
c. Prepare worksheet letter D to eliminate intercompany dividends
Dr. _ _ _ _ _ _ _ _ _ __ $
Cr. _ _ _ _ _ _ _ _ _ _ _ _ $
d. How much dividends go to the noncontrolling interest shareholders?
e. Are the dividends paid to the NCI shareholders an increase or reduction to NCI in
stockholders equity?
24. Carefully review LIFO liquidation problems in chapter 8 (problems 32, 33 as

well as in the workbook page 71d)
7l J
Chapter 9
Chapter 9 -Foreign Currency Transactions and Hedging Foreign Exchange Risk: Introduction/ Definitions
Foreign Currency
Foreign Currency Transactions
Direct Exchange Rate
Indirect Exchange Rate
Spot Rate
Forward Rate
FX Derivative Contracts: forwards, futures options
Option contracts: European, American, Semi American
How are notional amounts of FX derivative contracts accounted for
Hedging
Highly Effective
Explanation of FX Rate Sheet from Wall Street Journal
5 team mini case studies
Exercises with FX rates

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Exchange Rates: New York Closing Snapshot
Tuesday, July 15, 2014 Find Historical Data I□ I WHAT'S THIS?
VIEW AS SPREADSHEET
U S.-dollar foreign-exchange rates in late New York trading
IN USS US$VS.% CHG PER US$

Country /currency Tues Mon 1-Day YTD Tues Mon
Americas
Argentina peso 01227 0.1227 unch 250 8. 1482 81477
Brazil real 04505 0.4523 o.~o -6.0 22200 22110
Canada dollar 0 9295 09336 0 44 13 1 0759 1 0711

Chile peso 0.001796 0.001805 0,54 59 556 90 553 90
Colombia peso 0.0005352 0,0005375 0.43 .3,2 1868 60 1860.60
Ecuador US dollar unch unch

Mexico peso 0,0772 0 0772 unch -0,7 12.9461 12 9521
Peru new sol 0,3594 0.3595 unch -07 2.7825 2 7815
Uruguay peso 0 04366 0.04358 --0.18 RI 22,9045 22.9450
Venezuela b. fuerte 0 15748031 0, 15748031 unch unch 6,3500 6.3500
Asia-Pacific
Australian dollar 0.9371 0.9393 0.23 -4 9 1 0671 1 0646
1-mos forward 0.9350 0 9371 0.22 -51 1 0695 1 0671
3-mos forward 09311 0 9332 0.23 -5 1 1.0740 1 0715
6-mos forward 0 9251 09275 0.26 -5 0 1 0810 1 0782
China yuan 0 1611 01611 unch 25 6,2080 6.2062
Hong Kong dollar 0.1290 01290 unch -0 1 7.7500 7 7501
India rupee 0 01662 0 01665 0.18 -2 T 6017995 60.06995
Indonesia rupiah 0,0000853 0 0000856 0,38 -3 5 11730 11686
Japan yen 0 00983 0 00985 0.15 -3 4 101 .69 101 54
1-mos forward 0 00984 0 00985 015 -3 6 101 67 101 52
3-mos forward 0 009B4 0 00985 0 15 -36 10163 10148
6-mos forward 0.00985 0.00986 0.14 -3 6 101 .54 101 39
Malaysia ringglt 0.3136 03143 0.23 -2 9 31893 31820
New Zealand dollar 0 8768 0 8805 0 42 -6 2 11405 11357
Pakistan rupee 001013 0.01013 unch -6 3 98,745 98.745
Philippines peso 0 0229 0 0230 0.25 -1 8 43,601 43.491
Singapore dollar 0.8042 0.8056 017 -1 5 1.2435 1 2414
South Korea won 0 0009739 0 0009810 0.72 -2 7 1026 77 1019.40
Taiwan dollar 0 03329 0,03337 0.24 03 30.036 29965
Thailand baht 0.03111 0.03112 unch -1 .8 32141 32134
Vietnam dong 0.00005 0 00005 unch 03 21198 21195
Europe
Czech Rep. koruna 0.04946 0.04965 0.39 17 20,220 20.142
Donmark krone 01820 0,1826 0.37 13 54956 5 4754
Euro area euro 1 3569 1 3619 0.37 13 07370 07343
Hungary forlnt 0,00438396 0 00440544 0.49 55 228.10 226 99
Norway krone 01610 01617 0.43 23 6.2103 61837
Poland zloty 03280 0,3291 0.33 09 30488 3 0388
I of3 7/16/2014 11:57 AM

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Romania leu 0.3069 o 3083 0.47 02 3.2588 3.2436

Russia ruble 0.02907 0.02912 0.17 45 34.396 34.339
Sweden krona 0.1466 0.1472 0.42 6.0 6.8220 6.7937
-·------ -- -- -- -----·--- -- -·
Switzerland franc 1.1165 1.1213 0.43 03 0.8957 0,8918
1-mos forward 11167 1.1215 0.43 o... 0.8955 08916
3-mos forward 11173 1.1221 0.43 03 0.8950 0.8912
6-mos forward 1 1184 1.1232 0.42 03 08941 0.8903
Turkey llra 0.4709 0.4725 0.34 -1.2 2.1236 2.1165
UK pound 1.7143 1.7085 --0.34 -34 0.5833 0.5853
1-mos forward 1.7139 1.7080 --0.34 -3.5 0.5835 0.5855
3-mos forward 1.7130 1.7071 --0.34 -3 5 0.5838 0.5858
6-mos forward 1.7109 1.7053 --0.33 -3.5 0.5845 0.5864
Middle East/Africa
Bahrain dinar 2.6519 2.6527 unch unch 0.3771 0.3770

Egypt pound 0.1399 0.1398 unch 2.8 7.1499 7.1508
Israel shekel 0.2935 02926 --0.29 -1 8 3.4076 3.4175
Jordan dinar 1.4119 1.4119 unch 0.1 0.7083 0.7083
Kenya shilllng 0.01140 0.01140 unch 15 87.752 87.746
Kuwait dinar 3.5461 35456 unch -02 0.2820 0.2820
0,0006612 0 0006610 unch 0.5 1512.45 1512.95 I
I
Lebanon pound
Saudi Arabia riyal 02666 0,2667 unch unch 3.7503 3.7500
South Africa rand 0.0934 0,0937 0.30 21 10-7100 10.6776
UAE dirham 02723 0.2723 unch unch 36730 3.6729 I
Source: ICAP pie: historical data prior to 6.IQ/11: Thomson Reuters
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2 of3 7/16/2014 11:57 AM

ife,a1r,m,s 11. ii11l'il1dl 1
You are pl.annfrilg a famijy vai,ca1ibi1oil'il fail !Pamirs @

11Tudl w1iilil lb>ie sta11yi~l'iljg ,i1m tilnie l10cal nlii1l~o111
hotel. You hav1e dedd,edl y,01u w1illll 1111,ee,c:il to !h1iive imo el.ll1rr@s cii11SIA a1V;alill,aili>1l1e as
1s y,Gl!w ·cafli1 ~fir01il11 wln1i1oln y,ou
spending mQney wihj~,e !1111'1 1fle1.nis. 11NJ,c1m,e a,s m1il1P1,y ,p1l1a,oes @
can obtain the ,eoros for yio,u1r t111i,p>. 1tRalim1k e.clldil .si0wiroe f.rmm ,li)es,t ra,te (rfior y,ot1,11) vs.
worst rate (for yo,u~.
___________________{,ra,rn1ld111ig~---------
___________________(ran1ld111lig~-- - - - - - - -
I
____________--.--_____,{ranlk~n,g)__________
(
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ (nmtdng) _ _ _ _ _ _ _ __
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _(ranking) _ _ _ _ _ _ __
Teams 3 and 4
You are working for JPMorgan Chase and hai,ve beieirn aslk1ed to
transfer for 4 years to londorn to wonk iin the ba11nlk's UIK
operations. You are g1iven a choq,ce of 1l'.Dte1in1g il)alliidl 1i111111..JJ!S .ciliG>1lll1@1rs Dir
.pound sterling. Name at teast 4 tlh1i1n,gs yi011J1 w1illll c101rniS1i,eil1e1r 1blietfiore
making your decision (hint: think about the ity1pie,s of ,eXj~r11,ses yoiw
will have while in London)
1.
-------------------------
2 --------------------------
'·
3_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __
4
-------------------------
IM ~• .aif!S 1l!Jila1rntr, • ..-s Jts ·~ 1t:.ill• ai& tfi>i ~ a·-ri@iicft currency
• ~ .s11i.f~~! tu•r:N ~ ~ wt . ~ @Irr ~em Olieo$e Jm 'Mal-.) against ibhe US
,~KlJjijiiijr,.
Ex~liM!il0ffl1: tf a for~ian curreocv sttire~me1fi)s iNm ~i/~l!K! 1ilt 1h>i1i11ys more US do~ilio11rs. If
a; te,~roJ: ,€tlillf4feocy weaken~. in vallue 1it ih>il!lliyiS ihess 1{JJ;$ .o11o1m1iil!rS.
l!. ___________ ________________ __,;. ____,;
.
\
2·----,-------------------~-------- ·'
I .
3 .
I
f
;
r
/
4 .
____________________________
5
__.____
I 7 3E
•
Teams 7 a~ I
\
You work in Tokyo and are the president of a whoilllw 0MJ11ledl J;ciltp>ld!r111t€•5 e Sll4ib,sii,cdli,ci11ry
of a US Corporation. The Japanese subs1idiany Js s,e~llii1ni,g ~o al.llisil:om,eirs 10,o~l'il ,i,m J,iilJ~cB,n
as well as throughout the As,ia region. The p1ne,s1i,dlte1rilt m1l!l1st 1c:d1eiaiidlle w1kl,eltlklt~1r i1t wiillil
1
bill its sales to its customers ,iilil ye,n, !US d,0111l,cilirs oir ,i,n itlhl1e Olillnr,e,miey i'fir,0ir.m wime,r,e ,tihe
•· buyer.is doing business. O.es,c1nibe as ,mam-y fei,oto,rs at;s ;fO,w ,ccil,l'il t!hidlit: w1illil ,g1L11i1Cilte yow to
making the correct decision
1
--------------------------------
2________________________________
I
3_ _ _ _ _ _ _ _ _ _ _ _ _...;.__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __
\
4________________________________
5
--------------------------------
ABC Corp has just completed a major sate to its SiW1i.ss ,customeir and
now has a one million swiss franc accounts rece~valb~e due ~none ve,a,r.
ABC is concerned that the swjss franc wm weaken a;g.aii,n~t tlhl,e OS di0illli@1r
and by the time the receivable matures,· the o,111e 1m1Ulltii0irn sw1i1s,s frai,rn,cs
will be worth less in US doUars than it is today. Na,mie ,dfii:ffie,ne,nt wa·ys 1hn
which ABC can protect itself from th~s risk
1.
-------------------------
I
2.
'
'
'·,
3. \
4.
-------------------------
5
-------------------------
Chapter 9 Class Exercises
Instructions: Using the July 15, 2014 foreign exchange rates, calculate:
1. How much is 10 million Japanese yen worth in US Dollars.
2. How much is 100 million South Korean won worth in US dollars
3. How many UK pound sterling will US 500,000 purchase
4. How many Russian rubles will US 300,000 purchase
5. Assume the indirect rate for the New Zealand dollar is 1.1405. Derive the direct
rate (to 4 decimal places)
6. Assume the direct rate for the Canadian dollar is .9295. Derive the indirect rate (
to 4 decimal places)
7. A company owes 100,000 in swiss francs that it will need to pay its vendor in 6
months. If the company wishes to "lock in" today the amount of US dollars it will
have to pay in 6 months to receive swiss francs 100,000, how many US dollars
will be required
8. Using the July 14 direct rate for the Euro and assuming the Company held 1
million of euro denominated accounts receivable, what is the FX transaction gain
or loss that will be recorded on July 15
9. Same facts as problem 8, except the company had 1 million euro denominated
Accounts Payable, what is the FX transaction gain or loss that will be recorded on
July 15
10. ABC holds 10 million Mexican pesos of debt securities (bonds). On July 16, 2014
assume the indirect quote for the Mexican peso against the US dollar moved to
13.0000. What is the FX transaction gain or loss to recorded on July 16.
11. XYZ Co has Accounts Payable of UK sterling 10 million due in 6 months.
Answer the following:
a. Is XYZ concerned that the sterling will strengthen or weaken
b. Structure a qualifying hedge that meets the criteria of a fair value hedge
c. Under a fair value hedge, where will the impact ofrevaluation of the hedge and
the sterling payable be recorded.
d. Assume the hedge meets the criteria for a cash flow hedge. Describe where the
impact of revaluation of both the hedge and the sterling payable will be recorded.
e. How can an PX option be used to structure a qualifying hedge and describe the
accounting
12. Describe how a qualifying hedge of a forecasted transaction (such as budgeted

monthly salary expense) can a structured using either a forward contract or
option.
13. Describe the criteria for there to be an effective hedge. For each of the following
examples of a hedge of a foreign currency accounts receivable, say whether or not
it is an effective fair value hedge.
a. PX gain on revaluation of receivable 60,000. FX gain on hedge 60,000
b. PX gain on revaluation ofreceivable 50,000. FX loss on hedge 45,000
c. FX loss on revaluation ofreceivable 40,000. PX gain on hedge 25,000
11ta
FX Hedge Accounting Under FASB Statement #133
Chapter 9
Hedge Accounting----recognize FX gain or loss on the hedge in the same

accounting period as the FX gain or loss on the hedged item.
Hedge Accounting can be used if 3 criteria are met:

1. there is a real exposure to adverse movements of foreign exchange
rates .... . .. this may either a fair value or cash flow exposure to FX
risk.
2. the derivative (like an FX forward) is highly effective in offsetting the
change in fore ign currency e posure (80% effective). - f 2s-"io t. t+-e H vc.,
3. proper documentation as a hedge is made at the inception of the
transaction.
Accounting Treatment:
Fair Value Hedge:
1. the hedged asset or liability is adjusted based on changes in spot
exchange rates ........ results in FX gain or loss.
2. the derivative hedge is adjusted to fair value ...... results in a FX gain
or loss on the hedge.
Cash Flow Hedge:

Requirements: the hedging instrument must completely offset the variability
of cash flows of the hedged asset or liability ....... this is referred to as a
"perfect hedge" with 100% correlation.
1. the hedged asset or liability is adjusted based on changes in spot
exchange rates ....... results in FX gain or loss (same as fair value
hedge).
2. the derivative is adjusted to fair value (same computation as step 2
above) ........ results in a debit or credit to Accumulated Other
Comprehensive Income (part of stockholders' equity).
3. Transfer amount from AOCI to FULLY OFFSET (zero out) the FX
gain or loss ( calculated in step 1) on the hedged asset or liability. This
may leave a residual balance in AOCI, which is appropriate.
Example of Fair Value Hedge
Assume ABC Company, a US based corporation, sells Ll00,000 of goods

on December 31,2005. Terms are settlement in 3 months (March 31, 2006).
ABC Company wishes to "lock in" today the amount of US dollars it will
receive in 3 months.
The spot rate at December 31, 2005 is 1 L= US 1. 74

The forward rate for settlement in 3 months is 1L = US 1. 7/,
At March 31, the spot rate moves to 1 L= US 1.80
Questions:
1. Is ABC concerned that the L will appreciate or depreciate vs the US
dollar between December 31 and March 31.
2. Is the L selling at a forward premium or discount versus the dollar.
3. If ABC wishes to reduce their FX transaction risk, will they buy or
sell an FX spot contract or buy or sell an FX forward contract (4
choices).
4. Prepare journal entries to reflect the sale, the hedge taken and the
settlement of the hedge.
5. Would ABC have been better off if they did not enter into the hedge
transaction.
Assuming ABC decides to hedge its transaction exposure, the company will
enter into an FX _ _ _ _ contract at December 31, 2005 with a Bank or
other counterparty to ( sell or buy how much L ??) and to (sell or buy how
much US dollars ??) for delivery on (December 31 or March 31 ??).
To receive hedge accounting treatment, ABC must designate this FX

transaction as a fair value hedge on December 31, 2005.
Assuming, as above, that the spot rate at March 31, 2006 moves to 1 L= US
$1.80, show the accounting entries required as of December 31 and March
31.
December 31 (to record the sale in US ·dollar equivalents)
December 31 (to record the FX contract)

March 31 ( to revalue the L Accounts Receivable to its current value)
March 31 (to settle the FX contract): Accting Entry:

Deliver L 100,000@ 1.80= $ Dr.
Receive $ Cr.
FX (is it gain or loss ?) $
Result: If no hedge, ABC Company would have collected L 100,000=
$180,000 on March 31, 2006.
With the hedge, ABC Company receives $176,000------the

contractual forward rate. However, ABC avoids the FX TRANSACTION
RISK associated with the possibility that the L might have significantly
weakened in value against the dollar between December 31 and March 31.
For instance, if the L had dropped to US 1.60 by March 31, ABC would
have suffered an FX loss of _ _ _ ( $174,000- $_ _ _ ).
SAME EXAMPLE AS ABOVE-----EXCEPT TREAT AS A CASH FLOW

HEDGE (perfect hedge). The following are the accounting entries:
Dec 31 (same entry to record the sale as in the fair value hedge)
March 31: Dr. Accounts Receivable 6,000

Cr. FX Gain 6,000
To revalue the L 100,000 at the March 31 spot rate ofL 1 = US $1.80
Original receivable at Dec 31 (L 100,000 x 1.74) $174,000
Amount of$ received on March 31 ( L 100,000 x 1.80) $180,000
Difference (foreign exchange gain) $ 6,000
March 31: Dr. Accumulated Other Comprehensive Income 4,000

Cr. Accrued Liabilities 4,000
Loss on settlement ofFX contract ( 1.80-1.76 x 100,000). In order to settle
the FX forward contract that matures on March 31, ABC must deliver the L
7<,
100,000 it receives on that date (which is worth 180,000) and receive
$176,000 (the amount specified in the forward contract)
March 31: Dr. FX Loss 6,000

Cr. Accumulated Other Comprehensive Income 6,000
Since this transaction qualifies as a cash flow hedge, an amount equal to the
FX gain recorded on the FX contract is transferred out of Accumulated
Other Comprehensive Income and used to fully offset ("zero out") the FX
gain recorded above.
Note: To qualify as a cash flow hedge, the hedging instrument must

completely offset the variability in the cash flows associated with the foreign
currency receivable or payable.
Hedging FX Transaction Risk Using FX Options
Example: Fair Value Hedge of a Firm Commitment
Assume ABC Company has an noncancelable lease commitment to pay

Euro 10,000 one month from today. ABC is concerned that the euro will
(strengthen or weaken?) against the dollar and that it will cost (more or less
?) in US dollar terms to make the lease payment next month.
ABC decides to (purchase or sell?) an FX option giving it the right, but not
the obligation to (purchase or sell ?) euros and (purchase or sell ?) dollars at
a rate of 1 euro = US 1.20, one month from today.
Today's spot rate is 1 euro = US 1.18 and assume the spot rate in one month
moves to 1 euro = US $1.25. Assuming that it costs ABC $300 to purchase
the option, show all the entries that are required:
Today: Dr. Foreign Currency Option (Asset) 300

Cr. Cash 300
One month from today:

Dr. Rental Expense ( euro 10,000 x ? )
Cr. Cash or Accrued Liabilities
Should the option be exercised ?
If it is exercised, what is the required accounting entry
Dr. Cash (euro 10,000 x 1.25) 12,500

Cr. Cash ( euro 10,000 x 1.20 ) 12,000
Cr. FX Gain 500
The FX option contract is exercised by ABC since the euro has appreciated
above the option exercise price and therefore a gain will result. It costs ABC
only US 12,000 to exercise the option at the exercise price .......... and they
receive 10,000 euros worth 12,500 that will be used to satisfy the rental
payment.
Rental expense effectively comes to 12,500- 500 FX gain+ 300 option cost=
12,300
,C~l\t1iPll,lfEU, s.<i>tl!JiP OC!»WANY
Cansdlidat,ed Stateme~ ootComil'J!:dumsive Income
6miHio»sO
~Oil:3 2,012 2011
'if~ Tax Tax
Pre-ti,x ~eXjl).en e~ Ai(ter-,~1:1.x P•re~tax (expense) After-tax Pr.e-.tax (expense) After-tax
am0J1.Rt -eiit ~~o,111D(t a®JiOlffit benefit a:mouQt ruJil(i),\!ijJ][ benefit amount
Net earnings $ 449 $ 7•64 $ 802
-Other comprekemsiive ,ii111t10me
(loss):
Foreign currency tranSJl!ait,iiQR
adjustments $ ('->5) $ 3 ('2) $ (127) $ (8) (D5) $ 269 $ (5) 264
Cash-flow hedges:
Unrealized gains (losses)
arising during the period M) (8) 12 15 (5) 10 {!2) 4 (8)
Reclassification
adjustment for (gains) losses
~eluded in net earnings 4 (I) 3 9 (3) 6
P~nsion and other
postretirement benefits: ',
Net actuarial gain (loss)
arising during the period 322 (H3) \ 21, (428) 151 (277)
Reclassification of prior
service credit included in
net earnings (2) '(7) (1) (I)
Reclassification qf net
actuarial loss included in net
earnirlgs 124 (54) 70 83 (29) 54 77 (30) 47
Other comprehensive income
(loss) $ 373 $ (163) $ 210 $ (458) $ 109 $ (349) $ 343 $ (34) $ 309
Total comprehensive income
(loss) 659 415 1,111
(loss) attributable to
noncontrolling interests (10) (10) (3)
(loss) attributable to Campbell
Soup Company $ 66, $ 425 $ l,H4
See accompanying Notes to Consolidated Financial Statements.
32
Chapter 9 Homework
1. ABC Corp has Accounts Receivable of FC 400,000 and Accounts Payable of FC 300,000 on both
March 31 and April 30, 2010. The applicable exchange rates at that date were as follows:
March 30 April 30
Spot rate lFC= .35 US lFC= .37 US
Forward rate (1 month) lFC=.36 US lFC= .39 US
a. What is the FX transaction gain or loss on Accounts Receivable on April 30, 2010?
b. What is the FX transaction gain or loss on Accounts Payable on April 30, 2010?
c. If on March 31, ABC wishes to hedge its exposure to changing exchange rates what is the
appropriate action it will take. Answer by saying whether ABC will enter a spot contract or
forward contract and say whether the contract will involve purchasing FC and selling US
dollars, or purchasing US dollars and selling FC and specify the appropriate exchange rate.
2. XYZ has cash of FC 100,000 on both April 30 and May 31, 2010. The applicable spot rates for
April 30 and May 31 are as follows:
April 30: 1 US= 5FC
May 31: 1 US= 4FC
How much is the FX transaction gain or loss on May 31, 2010.
3. Jones Corp has been doing business in Spain for the last year. In 2009, Jones sold inventory on
credit for US 480,000 with payment not due until January 2011. Jones billed its clients in US
dollars. On January 1, 2009 one US dollar purchased .75 euro. On December 31, 2009 one US
dollar purchased .76 euro. What is the FX transaction gain or loss for Jones Corp in 2010.
4. Masters Corp has a 100,000 foreign currency denominated accounts receivable on its books that
is due to be collected in on June 30, 2011. The following are the US dollar equivalents for this
receivable at various dates:
January 1, 2010 $35,000 December 31, 2010 $32,000
· March 31, 2010 $38,000 June 30, 2011 $40,000
April 30, 2010 $34,000
What is the FX transaction gain or loss as of the following dates:
a. Quarter ending March 31, 2010
b. Month ending April 30, 2010
c. Year ending December 31, 2010
d. Six months ended June 30, 2011
Textbook: Questions 7, 8,10 Problems 1,3,4,5,6, .
7'i
Chapter 10
Notes for Chapter 10
Translation of Foreign Currency Financial Statements to Reporting Currency

Steps
I .Start with foreign currency financial statements and make any necessary adjustments
from foreign country accounting principles to US GAAP.
2. Determine the functional currency of the foreign operation---generally either the local
currency of the country or the US dollar.
3. If the functional currency is the US dollar, use the temporal method for
"remeasurement" from FC to US dollars.
a. assets and liabilities that are carried at historical cost are translated at the historic
exchange rate in effect when the asset of liability was created ........ e.g., fixed assets,
inventory, borrowings, capital stock, additional paid in capital.
b. assets and liabilities carried at current or future values are translated at current
(spot) exchange rates ........... e.g., cash, marketable securities.
c. revenue and expenses are translated using either the FX spot rate in effect on the
transaction date or the weighted average rate in effect over the reporting period.
4. If the functional currency is the local currency of the foreign location, use the current
rate method
a. assets and liabilities are translated at the current (spot) exchange rate.
b. revenues and expense---same as temporal method
c. stockholders equity is translated at historic rates under both the temporal and
current rate methods.
5. The translation adjustment is the "plug" to get the balance sheet to balance, after
having translated foreign currency balance sheet and income statement amounts at the
correct rates.
a. under the temporal method the translation adjustment is a component of Net
Income.
b. under the current rate method, the translation adjustment is reported on the balance
sheet in the Other Comprehensive Income (OCI) component of Stockholders Equity.
When the foreign operation is sold or liquidated, the cumulative translation adjustment is
removed from OCI and included as a component of the gain or loss on sale of the
investment
6. For foreign entities in "highly inflationary economies", use the temporal method.
Definition of highly inflationary=cumulative 3 year inflation rate of greater than 100%
Avoids the "disappearing fixed asset problem" of the current rate method.
gt
Determination of the Functional Currency
Consider the following factors .......... none has greater weighting than the other.
1. currency of the cash flows of the foreign operation.

2. sales prices ........ .is company billed in local currency or in US dollars.
3. sales market----where are the customers located ........ . in the local market or are
they international.
4. expenses ...... .in what currency are expenses paid and are accounts payable
denominated in the same currency. ·
5. financings ........ where and in what currency is the foreign operation receiving
money to operate; will repayment be in the same currency as the originating
transaction.
6. intercompany transactions ...... what is the transaction volume between the foreign
operation and head office (in the US); is there financing support coming from a
US parent; in what currency is the borrowing denominated in.
The functional currency can be either

----the local currency of the foreign unit
----the US dollar
----another foreign currency (rarely)
Hedging of a Net Investment in a Foreign Operation
Definition of Net Investment: Assets-Liabilities that are subject to translation

adjustments from exchange rate fluctuations.
Some companies choose to hedge their balance sheet exposure to avoid adverse effect on
net income (temporal method) or equity (current rate method) from translation of foreign
currency financial statements.
Steps:
1. identify the net investment in foreign currency of the foreign operation.
2. enter into an FX forward contract to deliver foreign currency and receive US
dollars, equal to the net investment (net asset position) .... this contract must be
designated as a hedge at the date it is entered into.
3. will need to "roll forward" the FX forward, that is, enter into new contracts when
the old contracts mature; note that FX options can be used as well.
4. unrealized gains and losses on revaluation of the FX forward hedge contracts will
be accounted for in the same manner as the translation adjustment or
remeasurement gain or loss being hedged (in OCI or Net Income, respectively).
5. can also hedge "on balance sheet" with additional FC assets or liabilities.
Translation of Fore ign Currency Financial Statements 479
operation's cash, marketable securities, receivables, and payables, as if those items were
actually carried on the parent's books.
Again, the major difference between the translation adjustment resulting from the use of
the temporal method and a foreign exchange gain or loss is that the translation adjustment
is not necessarily realized through inflows or outflows of cash. The U.S. dollar translation
adjustment in this case is realized only if (1) the parent sends U.S. dollars to the Japanese
subsidiary to pay all of its yen liabilities and (2) the subsidiary converts its yen receivables
and marketable securities into yen cash and then sends this amount plus the amount in its yen
cash account to the U.S. parent, which converts it into U.S. dollars.
The temporal method translates income statement items at exchange rates that exist when
the revenue is generated or the expense is incurred. For most items, an assumption can be
made that the revenue or expense is incurred evenly throughout the accounting period and an
average-for-the-period exchange rate can be used for translation. However, some expenses
are related to assets carried at historical cost-for example, cost of goods sold, depreciation
of property, plant, and equipment, and amortization of intangibles. Because the related assets
are translated at historical exchange rates, these expenses must be translated at historical
rates as well.
The current rate method and temporal method are the two methods currently used in the
United States and in all countries that have adopted International Financial Reporting Stan-
dards as their local GAAP. A summary of the appropriate exchange rates for selected finan-
cial statement items under these two methods is presented in Exhibit 10.1.
Translation of Retained Earnings

Stockholders' equity items are translated at historical exchange rates under both the cur-
rent rate and temporal methods. This creates somewhat of a problem in translating retained
EXHIBIT 10.1
Current Rate Method
Exchange Rates for
Exchange Rate
Selected Financial
Statement Items Balance Sheet
Assets
'Cash and r,ecelvables ,, ~•;.current Current
Marketable securlUes ".,, :';,,Curreri~ Current
Inventory ~ n'et reellzabie value ,.;, r ·>,:c
rrerit Current
lnventoJY,, et c,osJ . · .. _Hlstbr!c~I ;. , ! . Current
Prep111d' ~ pe.nses . . .'..:::-_, · · 'Historical · •-· · · Current
Property, plant. end ·equlpmeht · ,. -; : ,;" 0Hlstorlcal Current
·Intangible assets. . _,,,,, ,;, ,.H~orlcal: :- Current
Llebllltles
Current liabilities Current Current
Deferred Income ;/Historical: Current
Long-term _ d ebt Current
Stockholders' equity
Capital stock . Hlstorl_cal . Historical
.Adgltlonel pald-ln _capita!. _. Hlstprlcal . Historical
R_etelned earnings -C:omposlt~ Composite
DMden s, ' · Hlstorfcal _ 1
Historical
'. l~com~ Stcit~irient Income Statement

Revenues Av~r~ge Average
Most expenses Average Average
Cost of goods sold Historical Average
Depreciation of property, plant, and
equipment Historical· Average
Amortization of Intangibles Historical Average
*t,,farkccablc debt securities classified as held to maturity are carried at amortized cost and translated at the historical exchange rate under the
temporal method.
Translation of FC Financial Statements to US dollars
Canadian Dollars US Dollars

Temporal Method Current Rate Method
12-04 12-05 12-04 12-05 12-04 12-05
Cash 100 100

Accts Rec. 400 400
Inventory 300 300
Fixed Assets 200 200
Tot. Assets 1000 1000
Accts Pay 600 600

Tot Liab 600 600
Equity
-CS 100 100
-APIC 100 100
-RE 200 200
Tot Equity 400 400
L+E 1000 1000
Foreign Exchange Spot rates:

12-31-04 1 C$ = .8 US
12-31-05 1 C$ = .9 US
Historic 1 C$ = .6 US
Questions:
1. what is the net asset or net liability exposure under the a. temporal method b.
current rate method. How can the parent company hedge this exposure
2. translate the Canadian dollar balance sheet to US dollars at 12-31-04 and 12-31-
05 using the temporal method and the current rate method.
3. calculate the remeasurement gain or loss under the temporal method; where will
this be·reported.
4. calculate the translation adjustment using the current rate method; where will this
be reported.
5. under what circumstances will the temporal method be used; under what
circumstances will the current rate method be used.
6. which method would be utilized in a "highly inflationary economy"
7. calculate the cumulative inflation rate if inflation over each of the 3 years is (a)
25% (b) 30% ....... which accounting method would be used for
remeasurement/translation of the foreign currency financial statements in each of
these circumstances.
Chapter 14
B'f
LEGAL FORMS OF OWNERSHIP
1. SOLE PROPRIETORSHIPS
2. GENERAL PARTNERSHIPS
3. CORPORATIONS
4. SUBCHAPTER S CORPORATIONS
5. LIMITED PARTNERSHIPS
6. LIMITED LIABILITY PARTNERSHIPS (LLP)
7. LIMITED LIABILITY COMPANIES (LLC)
8. ADVANTAGES OF A GENERAL PARTNERSHIP

A. ease of formation
B. combine expertise/reduce expenses
C. expand services
D.no separate entity taxation
1. no double taxation of dividends
2. operating losses of partnership reduce taxable
income of owners
9. DISADVANTAGES OF A GENERAL
PARTNERSHIP
a. unlimited personal liability
b. mutual agency to contract
,-
Partnerships---Formation and Operation-----Chapter 14
1. Initial Capital Contributions

a. bonus method
b. goodwill method
2. Drawings---contra account deducted from partner's

capital
3. Allocation of Income to Partners Capital Accounts
4. Admit new partner---purchase interest from existing

partner
a. book value method
b. goodwill method
'
5. Admit new partner---new partner contributes to. the
business
a. bonus method
b. goodwill method
6. Withdrawal of partner
a. bonus method
b. goodwill method
Note: You are not responsible for the hybrid method.·

Partnerships---Initial Capital Contributions
All items contributed to partnership initially recorded at fair

value.
Initial capital account balances subject to negotiation in

Articles of Partnership
Value of intangible contributions (like business expertise)

must be agreed.
Example: A and B decide to start a partnership with equal

capital balances. A contributes inventory (fair value of
$30,000). B contributes fixed assets (fair value of $10,000)
and her expertise. The two methods to account for this are:
1. Bonus method (recognize only what is physically

transferred .... no goodwill).
Dr. Inventory (from A)

Dr. Fixed Assets (from B)
Cr. A Capital
Cr. B Capital
2. Goodwill method: (calculate implied value of
intangible contribution)
B contributed $20,000 less value than A, but receives an
equal starting capital balance. This implies a goodwill
amount of
Dr. Inventory (from A)
Dr. Fixed Assets (from B)
Dr. Goodwill (from B)
Cr. A Capital
Cr. B Capital
Note that goodwill is recorded even though there is no
expenditure.
Capital Withdrawals
Drawings----Reward for ownership or compensation for
work done in the business. Record initially in the drawings
account and then close to individual partner accounts at
year end.
Example: (continuation from previous example)

During the first year of operating the partnership, A
withdraws $3000 and B withdraws $5000.
Entry to record drawings:

Dr.
Dr.
Cr.
Entry to close drawings to partner capital accounts

Dr.
Dr.
Cr.
Cr.
87
Allocation of Income to Partners Capital Accounts
Rule: Income (or loss) is closed out to the partners' capital

accounts based on the partnership agreement.
Example: After several years of operation, the following

are the capital accounts of A and B
A Capital 140,000 (60% of profits)
B Capital 60,000 (40% of profits)
Each partner is entitled to 10% interest on their beginning
capital balances and each gets an annual compensation
allowance of $10,000. Any remain-ing profit is split in
accordance with _ _ ____ . Assume the partnership _
has net income of $80,000, before considering the above
distributions.
Questions: I
1. what is the balanced of A and B's capital account after

all the distributions
2. what journal entry is made by the partnership
Solution: A B
Capital Balance Beginning of Year
Interest on Capital
Compensation Allowance
Distribution of Net Income
Ending Capital Balance

Journal Entry:
88
Partnership Dissolution---Admittance of New Partner
NEW PARTNER PURCHASE AN INTEREST
DIRECTLY FROM ANOTHER PARTNER (privately
negotiated transaction).
Example (continuation of previous example from beginning

of year).
C buys a 10% interest in the partnership for a payment

directly to the partners of $30,000.
Capital before transfer:

A 140,000 (60%)
B 60,000 (40%)
What entries are made using the· book value

approach .......... using the goodwill approach.
Book Value Approach
Goodwill Approach
This page intentionally left blank
8 4 ev
Partnership Dissolution---Admittance .o f a New Partner
New partner contributes to the partnership
Example: Same facts as previous example re capital

account and profit and loss sharing percentages. Here C
contributes $30,000 TO THE PARTNERSHIP for a 10%
interest
Bonus Method:
Goodwill Method:
'f O
Partnership Dissolution---Withdrawal of a Partner
Reasons: Death, retirement, lack of involvement.
Can sell interest to another partner or to outside owner.
Cash or assets are distributes from partnership to settle

departing partner's rights.
Articles of Partnership specify how ·a payment is

made ............ Payment will not necessarily equal the book
value of the departing partner's capital account. Often an
appraisal is used to determing fair value of the business;
Accounting Alternatives:
1. bonus method: excess paid comes out of capital
accounts of remaining partners
2. goodwill method: recognize fair value of assets and
goodwill allocated to all partners before accounting
for the withdrawal.
3. hybrid method (not covered in class)-recognize fair
value of assets but no goodwill. Allocate fair value to
all partners before accounting for the withdrawal.
Example ---Withdrawal of a Partner
A, Band Care partners with the following capital balances

and profit and loss sharing percentages:
Capital Balance P&L Percentage

A 140,000 70
B 60,000 20
C 30,000 10
B wishes to withdraw from the business and it is agreed

that B will receive back her original capital balance plus (or
minus) any fair value adjustments where the FV of the
partnership differs from book value ..
Assume a fair value adjustment of $100,000
B is therefore entitled to receive
Bonus Method:
Goodwill Method:
Chapter 15
Chapter Partnership Liquidation
What we will cover:

1. why do partnerships liquidate
2. what groups have claims against the partnership and
the individual partners.
3. what are the steps for liquidation of a partnership
4. how are deficit capital balances handed under the UPA
5. what is a schedule of liquidation
6. what is the concept of a "safe payment"
7. what is a predistribution plan
8. in what order are the claims of the following groups
satisfied:
a. partnership creditors
b. personal creditors of insolvent partners
9. what is the marshaling of assets rule
1o.examples of liquidation schedule, predistribution plan,
marshaling of assets.
tpf
Claims of Partnership Creditors
1. look to partnership assets
2. look to personal assets of ALL partners (unlimited
personal liability)
Marshaling of Assets Rule: Priority of Claims Against an

Insolvent Partner
1. separate personal creditors of insolvent partner
2. partnership creditors
3. debts owed by insolvent partner to other partners
Personal Creditors of Insolvent Partner may claim against

partnership assets after:
1. partnership creditors are paid first
2. only to extent of the insolvent partners positive capital
balances
Example #1: Partner A is insolvent and owes $50,000 to
her personal creditors (after using all available cash). A is a
partner with B and C and the partnership balance sheet is as
follows:
ABC Partnership
Cash 120 Liabilities 100

A Capital 5
B Capital 10
C Capital 10
How much can A's personal creditors claim against the
partnership ?
a. 5
b.20
C. 25
d. 50
Solution:
#2
Partner A has: Personal Assets 80,000(cash)
Personal Liabilities 60,000
Partner A Deficit Capital Balance (10,000)
Partnership Debts 15,000
Assume there are three partners A, B and C that share
profits and losses equally
What claims do the other partners have against A.

Hint: Use the marshaling of assets rules
Available Cash
First Paid:
Next Paid:
Next Paid:
After personal and partnership creditors have been

satisfied, other partners can go after A's deficit capital
balance based on P & L percentage.
Partnership Liquidation- Example
ABC Partnership begins the liquidation process with the

following balance sheet:
Cash 10,000 Liabilities 200,000

N oncash Assets 500,000 A Capital 70,000
B Capital 80,000
C Capital 160,000
Total Assets 510,000 Liab + Cap 510,000
A, Band C share P&L in a 4:3:3 ratio. Assume noncash

assets are sold for 300,000 and that liquidation expenses are
10,000. Show the final distributions made to the partners.
Capital
Cash Noncash Liab A B C
Beg balance
Sell noncash assets
Subtotal
Settle liabilities
Subtotal
Liquidation Expenses
Subtotal
- /'JS:,v~ A ,s --r -i,.J /aJJ
0
~ S -.fe., '7'\ 1~ et1+

Final Capital Balances
Predistribution Plan
Purpose: To reduce the need for multiple schedules of

liquidation over long periods of time.
Shows: How available cash will be applied:

First to partnership creditors
Second to pay liquidation expenses
Third to pay partners based on their safe capital
balances
Methodology: Determine what loses will be of sufficient
size to eliminate the capital accounts of each partner. Then
determine the distributions if the assumed losses do not
occur:
Example: Partnership has 100,000 assets, no liabilities and

partner capital accounts of:
Partner 1 40,000 (25%)
Partner 2 60,000 (75%)
Determine the predistribution plan
Maximum losses that each partner can absorb:
Partner 1
Partner 2
4 'i
Additional Notes and Exercises- Chapter 15
As covered on page 9 5 of the workbook, personal creditors of an insolvent partner

may claim against partnership assets to the lesser of partnership cash or the
insolvent partner's positive capital balance ,after all partnership creditors have been
paid.
Additional example: Assume partnership has the following balance sheet.
Cash 200 Liabilities 190

A Capital 20
B Capital 10
C Capital (20)
Partner A is personally insolvent and owes $50,000 to creditors. How much can C's
creditors claim against partnership cash.
Solution:
Safe payment: Introduction: In a partnership liquidation, the partners do not

want to wait until the end of the liquidation to take money out of business. However
if they take money out before they are legally entitled it will cause future problems.
Partnership creditors have first claim against partnership assets and in addition,
there will likely be liquidation expenses paid to lawyers, accountants and perhaps
auctioneers who sell partnership property. There needs to be enough cash left to
pay all of them before partners can take money out the business. For that reason the
concept of a "safe payment" developed.
What is a safe payment? It is the amount that can be paid to each partner, while
leaving enough capital (cash) to absorb estimated liquidation expenses, pay
partnership liabilities at 100% and cover maximum losses on sale of non-cash
assets, as well as an assumption that deficit capital balances of any partner( s) will
not be repaid. Determination of a safe payment requires the preparation of a
"Proposed Schedule of Liquidation", which is in your textbook (pages 680-682).
The principal difference between the Schedule of Liquidation (workbook page 98)
and a Proposed Schedule of Liquidation is that in the proposed schedule, many of
the events of liquidation have not yet occurred. For example, assets may not have
been sold, liabilities and liquidation expenses have not have been paid etc. We will
prepare a proposed schedule of liquidation in class and calculate a safe balance by
completing textbook problem 7 at the end of chapter 15.
For your convenience, that problem is reproduced on the reverse side of this page.
Problem
A partnership has the following balance sheet just before final liquidation is to
begin:
Cash $26,000 Liabilities $50,000

Inventory 31,000 Art Cap. (40%) 18,000
Other Assets 62.000 Raymond (30%) 25.000
Darby (30%) 26.000
Total $119,000 $119,000
Liquidation expenses are estimated at $12,000. The Other Assets are sold for
$40,000. What distribution can be made to the partners before the liquidation
begins ?..... meaning what is "safe payment" or "safe balance" that can be distributed.
THE PRACTICE MIDTERM AND FINAL WILL BE
POSTED IN BLACKBOARD ASSIGNMENTS
APPROXIMATELY ONE WEEK PRIOR TO THE
EXAMS
CONSULT THE SYLLABUS AS TO EXTRA CREDIT

AVAILABLE FOR COMPLETION AND SUBMISSION
OF THE PRACTICE EXAM IN THE CLASS BEFORE
THE EXAM
I 00
Accounting 311 Review for Final
Segment and Interim Reporting (Chapter 8)

1. BE AN EXPERT ON THE 10% TEST. Study the homework and what we did in class.
2. know how to do the test re. assets (straightforward)
3. know how to do the test on revenues and treatment of intersegment revenues
4. know how to do the test on P & L ........ know what P&L means (how to calculate) and
whether intersegment sales should be included ........ know how to deal with multiple
segments where some segments have positive earnings and other segments have negative
earnings.
5. know how many segments that need to be disclosed, the percentage and whether based
on external revenues or combined external and intersegment revenues.
6. know definition of an operating segment and what makes an operating segment
reportable.
7. understand requirements for disclosure of major customers ........ % of sales (to
outsiders or in total including intersegment sales )
8. know how to deal with accounting changes that take place during the year ...... .like
changing from FIFO to LIFO re cumulative effect ( on which quarter earnings )
9. know treatment of extraordinary items occurring in a quarter subsequent to the first
quarter of a year .... based on whether expected to be material to the full year.
10. understand what are and are not acceptable geographic groupings under FAS 131.
10. understand disclosure rules for reportable segments, geographic disclosures
11. re interim reporting, know disclosure rules, the meaning of integral vs. discrete
methods (which is acceptable) and how to handle LOCOM adjustments, disposition of
LIFO layers, seasonal nature of business and income tax expense accruals (using
estimated effective tax rate for full year).
Foreign Exchange (Chapters 9 and 10)
1. understand how to convert a foreign currency balance to US dollars; you may be

told one unit of FC= a certain amount of dollars (easy) or be told that 1 US dollar
= a cetain amount ofFC.
2. understand what it means when a foreign currency strengthens/appreciates against
the dollar, as opposed to weaken/depreciate against the dollar; be able to calculate
a FX gain or loss between two periods.
3. understand the differences between a FX spot contract, an FX forward contract
and an FX option contract.
4. know that the above contracts can be used in hedging activities (understand the 4
types of activities.
5. understand the terms hedge accounting and hedge effectiveness; know
directionally how the revaluation of the hedge and the item that is hedged move
m.
6. understand the difference between economic, transaction and translation
exposure.
IO I
7. be able to explain the differences between the results of fair value hedge
accounting vs. cash flow hedge accounting ........... know the accounts that are
used to record translation adjustments from FC to US dollars.
8. explain the criteria necess/;ll"y to qualify for cash flow hedge accounting.
9. know the definition of the functional currency of a foreign operation.
10. be comfortable describing the correct order of steps to translation.
11. using the temporal method, be able to describe which exchange rates are used to
REMEASURE assets and liabilities, the various components of equity as well as
the income statement; know where the remeasurement adjustment is recorded in
the financial statements .......... understand the process by which the amount is
determined
12. using the current rate method, be able to describe which exchange rates are used
to TRANSLATE assets and liabilities, the various components of equity as well
as the income statement; know where the translation adjustment is recorded in the
financial statements .............. understand the process by which the amount is
determined.
13. understand the rules for dealing with highly inflationary economies, i.e. what rate
of inflation, and what is the accounting used; be able to calculate the cumulative
inflation rate.
14. be able to calculate a balance sheet net asset exposure or net liability exposure
(accounting exposure) to changes in foreign currency rates ......... and then be able
to calculate whether there is a remeasurement gain or loss or a translation gain or
loss (based on the functional currency designation).
15. understand why foreign exchange rates move relative to the dollar.
16. know the relevant FASB statement numbers re FX (SF AS 52) and derivative
financial instruments (SFAS 133, 138)
17. know what it means to hedge a net investment in a foreign operation and the
resulting accounting, which depends on the functional currency.
Partnerships (Chapter 14 and 15)
1. Accounting for initial capital contributions ........ cash, property, intangibles using
either the Bonus method or the Goodwill method.
2. Accounting for additional capital contributions at fair value
3. Capital withdrawals----drawings as a contra account to partners capital (closed out
at year end).
4. Allocation of income to partners capital is all of the following (review class
example):
a. credit on beginning capital balance
b. compensation allowance
c. share of residual profits
5. Partnership Dissolution-Admittance of a new·partner-be able to calculate

ending balance in the partner capital accounts
a. new partner purchases share from existing partner using either the Book
Value(Bonus) Method or the Goodwill Method.
I OJ...
b. new partner contributes to the partnership using either the Book Value
(Bonus) Method or the Goodwill Method.
6. Partnership Dissolution----Withdrawal of a partner----be able to c;:alculate ending

balance in the partner capital accounts
a, using the Bonus method
b. using the Goodwill method.
7. know the other forms of ownership.

8. understand marshaling of assets and the order of priority
9. understand the priority of claims against a partnership
10. know what a predistribution plan is about
11. understand what a liquidation plan is and how it differs from a predistribution
plan
12. understand the concept of the safe balance
13. be able to calculate "safe payments" based on applying the safe balance
presumptions.
14. understand what does and does not cause a partnership to dissolve
15. know how deficit partner balances are handled under_ the Uniform Partnership Act
and under the safe balance concept.
16. understand purpose of Articles of Partnership and what you would expect to find
there.
I 03
Accounting 311 Practice Final Exam
1 ABC Corp., a US corporation, purchased goods on credit from a British

company on April 8, 2007. ABC made a payment of 10,000FC on May 8,
2007. The exchange rate was $1= FC .50 on April 8 and $1= FC .60 on
May 8. What amount of foreign exchange gain or loss should be recognized
on May 8?
2 XYZ Company sells goods to a foreign customer on June 8. Payment of

3,000,000 foreign currency units (FC) is due in one month. June 30 is XYZ
Company's fiscal year-end. The following exchange rates were in effect
during the period:
June 8 Spot rate $1.10

June 8 3 0 day forward rate $1.15
June 30 Spot rate $1.14
July 8 Spot rate $1.20
A For what amount should XYZ Accounts Receivable be debited on June 8
B How much foreign exchange gain or loss should XYZ record on June 30
3 On April 1, 2007, Shannon, a US bank, made a one year loan (asset to

Shannon) of 200,000 swiss francs to Scott Co. The dollar value of the loan
at various dates was as follows:
April 1, 2007: $100,000 December 31, 2007: $115,000
April 30, 2007: $110,000 April 1, 2008 : $ 97,000
A What amount of foreign exchange gain or loss should be recorded in April

2007 for Shannon
B What amount of foreign exchange gain or loss should be recorded in full

year 2007 for Shannon
C What amount of foreign exchange gain or loss should be included in

Shannon's 2008 income statement.
The following is the foreign currency balance sheet for Lee Company at
December 31, 2006 (use for questions 4 and 5)
Cash 100,000
Fixed Assets 30,000
Liabilities 60,000
Common Stock 20,000
Retained Earnings 50,000
The following FX rates were in effect at December 31:

Current (Spot) rate: 1 US= .40 FC
Historical rate: 1 US= .30 FC
Forward rate: 1 US= .25 FC
4 Assume the US dollar is the functional currency:

What is US dollar value of Cash at Dec 31
What is the US dollar value of Fixed Assets at Dec 31
Where is the FX remeasurement gain or loss under the temporal method at

Dec 31 reported
5 Assume the FC is the functional currency.

What is the US dollar value of Cash at Dec 31
What is the US dollar value of Fixed Assets at Dec 31
Where is the FX translation adjustment under the current rate method at Dec
31 reported
6 A foreign operation has the following local inflation rates:

Year 1: 10% Year 2: 20% Year 3: 30% Year 4: 10% Year 5: 15%
What is the applicable cumulative inflation rate that should be used for
reporting as of end of year 5.
What method will be used for remeasurement or translation of the foreign
operation's foreign currency financial statements.
7. XYZ, a US company has a subsidiary in Korea. The Korean sub sells
inventory to a Japanese company with the sale denominated in US dollars.
Between the date of sale and the date the receivable is collected the Korean
won strengthens 10% against the US dollar. Explain if there is a foreign
exchange gain or loss or no FX impact and why.
8 A, Band C formed a partnership on January 1, 2007 with investments of

$200,000, $300,000 and $400,000 respectively. The profit and loss sharing
ratio is 20% for A, 30% for Band 50% for C. For division of income, they
have agreed:
1. interest of 10% of beginning capital balance each year
2. annual compensation of $10,000 for B.
The partnership earns $500,000 in its first year of operation. Each partner
draws $1000 a month.
What is B's share of the net income
What is C's capital balance at the end of the first year
9 Able and Baker are partners with capital balances and profit and loss
sharing percentages as follow:
Able: $300,000 (40%)
Baker:$ 300,000 (60%)
Cooper approaches the partnership and it is agreed that for a payment of
$80,000, Cooper will receive a 10% interest in future partnership profits.
The goodwill method is to be used.
What is the balance in Able's capital account after the admittance of Cooper.
f O(,,
10 Dexter, Edwards and French are partners with the following capital
balance and profit and loss sharing percentages:
Dexter $200,000 (70%)
Edwards 120,000 (20%)
French 60,000 (10%)
It is agreed that Edwards will withdraw from the partnership and receive his
capital balance plus his share of any increase in the fair value over book
value of the underlying assets of the partnership. Assume the total increase
in fair value is $100,000.
a. if the bonus method is used what is the balance in Dexter's capital
account after the withdrawal of Edwards ?
b. if the goodwill method is used, what is balance of French's capital
account after the withdrawal of Edwards ?
11 Apple, Banana and Pear partnership began the liquidation process with
the following balance sheet (profit and loss sharing percentages are in
parenthesis):
Cash $30,000 Liabilities $150,000

Noncash Assets $400,000 Apple Capital $100,000 (30%)
Banana Capital $ 60,000 (20%)
Pear Capital $120,000 (50%)
A If the noncash assets are sold for $250,000 what amount of the loss will be
allocated to Apple ?
B If the noncash assets are sold for only $100,000 which partner(s) capital
accounts will be in a deficit balance and require a contribution of assets to
the partnership.
,01
12 Roscoe is insolvent and still owes $60,000 to his personal creditors. The
personal creditors now attempt to collect from the partnership, where Roscoe
has been a partner. Roscoe has a capital account balance of $15,000. His
partner Jordan has a capital account balance of $25,000. The partnership
has cash of $200,000 and liabilities of $160,000. How much does Roscoe's
personal creditors have a right to recover from the partnership ?
13 RST partnership begins the liquidation process with the following

balance sheet and profit and loss percentages
Cash 280,000 Liabilities 200,000

Noncash Assets 300,000 R Capital (40%) 100,000
S Capital (30%) 150,000
T Capital (30%) 130,000
Liquidation expenses are estimated at $50,000. Assume any deficit balance
in a partner's capital account will not be repaid.
What is the safe payment that can be made to partner T

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Chapter 1

Important Definitions- Chapters 1 and 2

Investor (equity method)

Investee (equity method)

Book Value of Net Assets Acquired (BVNAA)

Fair Value (of asset or liability)

Fair Value of Consideration Transferred (purchase price)

Fair Value of Net Assets Acquired (FVNAA)

Arms Length Transaction

Premium over Book Value (purchase premium)

Fair Value Allocations

Initial Value (cost) Method

Partial Equity Method

'P~,,.. v-(A I tie, e(Y' on

Transferor---entity doing the selling (either

Transferee---entity doing the buying (either

Downstream transfer---from investor to investee

Upstream transfer---from investee to investor or

Economic entity---ownership structure formed by

Arms length transaction---completed at price a

Unrealized gain on intercompany transfer---

Principle: lntercompany transactions (between

Formula to calculate equity income in year 2:

Net Income of Investee (year 2) x ownership

Minus: Unrealized gain from inventory ~ransfer

The unrealized gain from each year is calculated

Equity Consolidated Financial

20% -50~/o 100,

M€G~a~t4:J.Jfli;l111rwin © The McGraw-Hill Companies, Inc., . 107

Participation in the investee's policy-

© The McGraw-Hill Companies, Inc., : '07

Change in Fair Value

Interco Inventory Transfe

Amortize Premium over E ook

Important points to note:

Book Value(BV) Fair Value(FV) Difference

Assets 100 140

A (the investor) pays 30 for a 20% interest in B. Calculate goodwill.

Allocation of Excess to Specific assets or

Entry to record the sale (assume cash received):

Entry to record deferral of portion of intercompany gain related to unsold inventory

Supporting calculation using the 4 step approach

Step 1: Calculate gross profit percentage

Step 2: Determine ending inventory on the books of the transferee

Step 3: Determine the unrealized gain in the ending inventoy

Step 4 Apply ownership percentage to the result from step 3

Entry to reflect equity pick up :

Important points to note:

January 1- June 30 50,000 30,000

July 1- December 31 70,000 40,000

1. How much equity income is recognized by A in 2012.

2. How much dividend income is recognized by A in 2012

3. What is the balance of A's Investment in B as of December 31, 2012

Change from Equity Method to Fair Value Method (prospective treatment)

January 1- June 30 50,000 30,000

July 1- December 31 70,000 40,000

4. How much equity income is recognized by A in 2012.

5. How much total income is recognized by A in 2012

6. What is the balance of A's Investment in B as of December 31, 2012

February 08, 2010

825 Financial Instruments

Fair Value Option

> Overall Guidance