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CHAPTER 10
ANSWERS TO QUESTIONS
Q10-1 The balance sheet, income statement, and statement of changes in retained earnings are
an integrated set and generally need to be completed as a unit. Once completed, these
statements can then be used in preparing a consolidated cash flow statement. Because both the
beginning and ending consolidated balance sheet totals (with all consolidation entries posted) are
needed in determining cash flows for the period, the cash flow statement cannot be easily
incorporated into the existing three-part worksheet format.
Q10-2 Consolidated retained earnings do not include the earnings assigned to noncontrolling
shareholders. As a result, dividends paid to noncontrolling shareholders are not included in the
consolidated retained earnings statement. On the other hand, all the cash generated by the
subsidiary is included in the consolidated cash flow statement and all uses of cash must also be
included, including cash distributed to noncontrolling shareholders in the form of dividends.
Q10-3 The indirect method focuses on reconciling between net income and cash flows from
operations and does not attempt to report payments to suppliers or other specific uses of cash. It
does report the change in inventory and accounts payable which are included in determining
payments to suppliers. While adjusting net income for changes in inventory and accounts payable
leads to a correct reporting of cash flows from operations, it does not permit explicit reporting of
payments to suppliers.
Q10-4 Changes in inventory balances are used in computing the amount reported as payments
to suppliers and do not need to be separately reported.
Q10-5 Sales must be included in the consolidated cash flows worksheet when the direct method
is used. They are excluded from the worksheet when the indirect method is used.
Q10-6 (a) When the indirect method is used, the changes in inventory are reported as a
reconciling item in the operating section of the statement of cash flows. (b) When the direct
method is used, changes in inventory are included in the computation of payments to suppliers
and not separately disclosed.
Q10-7 Only sales subsequent to the date of acquisition are included. The acquired company
was not part of the consolidated entity prior to the date of acquisition.
Q10-8 Dividends paid by the acquired company to the noncontrolling shareholders following
the date of acquisition are included as a cash outflow in the consolidated statement of cash
flows. Dividends paid by the acquired company prior to acquisition are excluded. The acquired
company was not part of the consolidated entity prior to the acquisition date. However, none of
the dividends paid by the subsidiary (before or after the acquisition date) will be reported in the
consolidated statement of changes in stockholders’ equity.
10-1
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Chapter 10 - Additional Consolidation Reporting Issues
Q10-9 The revenues and expenses of the subsidiary for the full year are included in the
consolidated income statement when the acquisition occurs at the beginning of the year. When
a mid-year acquisition occurs, the revenues and expenses of the acquired company prior to the
date of acquisition were not transactions of the consolidated entity. As a result, an additional
consolidation entry is made to close pre-acquisition account balances to retained earnings.
Q10-10 When there is a difference between the fair market value and the tax basis of an asset
acquired or liability assumed in an acquisition, a deferred tax asset or liability must be
recognized as part of the net identifiable assets in an acquisition. This usually occurs in a non-
taxable acquisition where the acquiree’s tax bases in the assets and liabilities carry over to the
consolidated entity after the acquisition.
Q10-11 The only book-tax difference that arises in acquisition that does not require the
inclusion of a related deferred tax asset or liability is goodwill. ASC805-740-25-9 states that
deferred taxes are not recognized when there is an excess of goodwill for financial reporting
over that for tax.
Q10-12 An accurate measure of the overall profit contribution from each segment of business
operations is often considered desirable in evaluating past operations and in planning future
strategy. In some cases the tax impact of operating a particular division is very different from
one or more other divisions, and that difference should be recognized in evaluating the
segment. Even when such differences do not exist, better knowledge of the approximate after
tax return from a particular subsidiary can be very helpful in assessing future investment and
operating strategies.
Q10-13 When a consolidated tax return is filed, all intercompany transfers are eliminated in
computing taxable income and there should be no need to adjust recorded tax expense in
preparing consolidated financial statements for the period. When the companies do not file a
consolidated return, tax payments and expense accruals recorded by the individual companies
presumably will include gains and losses on intercompany transfers. If an unrealized gain or loss
is eliminated in consolidation, the amount reported as tax expense also should be adjusted to
reflect only the tax expense on those items included in the consolidated income statement.
Q10-14 Assuming an unrealized profit has been reported, an additional consolidation entry is
needed to reduce tax expense and establish a deferred tax asset in the amount of the excess
payment. If a loss is eliminated, additional tax expense and taxes payable must be established in
the consolidation process.
Q10-15 When one of the companies in the consolidated entity has recorded tax expense on
unrealized profit in a preceding period, its retained earnings balance at the start of the period will
be overstated by the amount of unrealized profit less the tax expense recorded thereon. In the
period in which the item is sold and the profit is considered realized, the consolidation entries
must include a debit to the Investment in Subsidiary account for the amount of the net
overstatement and a debit to deferred tax expense for the proper amount of expense to be
recognized. If the original transfer was upstream, the entry would also include a debit to the NCI
in NA of the Subsidiary account.
Q10-16 When taxes are not considered, income assigned to noncontrolling shareholders is
reduced by a proportionate share of the unrealized profit. When taxes are considered, the
reduction is based on a proportionate share of the after tax balance of unrealized profits.
Q10-17 Perhaps the most important reason is that the earnings per share data reported by the
separate companies may include unrealized profits that must be eliminated in computing the
consolidated totals. Even without unrealized profits, simple addition could not be used when the
10-2
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of McGraw-Hill Education.
Chapter 10 - Additional Consolidation Reporting Issues
companies do not have an equal number of shares outstanding or when the parent does not hold
all the common or preferred shares of the subsidiary.
Q10-18 The full amount of dividends paid to unaffiliated preferred shareholders of the parent are
deducted from consolidated net income in arriving at consolidated earnings per share. Preferred
dividends paid by the subsidiary to noncontrolling shareholders and income assigned to
noncontrolling common shareholders are deducted from consolidated revenue and expenses in
computing consolidated net income and earnings per share. Subsidiary preferred dividends paid
to the parent or other affiliates must be eliminated and are not deducted in computing consolidated
earnings per share.
Q10-19 A subsidiary's contribution to consolidated earnings per share may be different from its
contribution to consolidated net income if the subsidiary has convertible bonds or preferred stock
outstanding that are treated as if they had been converted, or if the treasury stock method is used
to include the dilutive effects of subsidiary stock rights or stock options outstanding.
Q10-20 The net of tax interest savings from the assumed conversion of the bond into common
stock is included in the numerator and the additional shares are added to the denominator of the
earnings per share computation for the subsidiary. In doing so, earnings per share of the
subsidiary will be reduced. Moreover, the additional shares added to the denominator will
potentially alter the ownership ratio held by the parent; thus, the amount of subsidiary income
included in the consolidated earnings per share computation is likely to be reduced.
Q10-21 Those rights, warrants, and options treated as stock outstanding in the denominator of
the earnings per share computation of the subsidiary will reduce the amount of subsidiary income
included in the consolidated earnings per share computation to the extent that the ownership ratio
held by the parent is reduced. The actual shares will not be reported as such, because they are
assumed to be either eliminated or assigned to the noncontrolling interest.
Q10-22 In the earnings per share computation, the amount of income assigned to noncontrolling
interest may change as it is assumed that convertible securities are converted or rights, warrants,
and options are exercised. Both the amount of subsidiary income included in the numerator and
the proportion of parent company ownership may vary, thereby changing the amount of subsidiary
income included in the consolidated earnings per share computation.
10-3
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Chapter 10 - Additional Consolidation Reporting Issues
SOLUTIONS TO CASES
a. Until the securities are converted, the interest expense on bonds and the preferred dividends
must both be deducted in determining income available to common shareholders when basic
earnings per share is computed. Because interest expense is deductible for tax purposes and
preferred dividends are not, the increase in earnings available to common shareholders will be
less with conversion of the debentures. The decrease in earnings per share will be greater with
conversion of the convertible debentures since the two securities convert into an equal number
of common shares.
b. Interest expense is deducted in computing net income and preferred dividends are not. Thus,
conversion of the bonds will increase net income and conversion of the preferred stock will have
no effect on the reported net income of Stage Corporation. If Stage Corporation is a parent
company, consolidated net income will increase by the full amount of the interest saving (net of
tax) if the bonds are converted. In the event Stage Corporation is a subsidiary of another
company, consolidated net income again will increase if the bonds are converted, but the amount
of the increase depends on the percentage ownership of Stage by the parent. Conversion of the
preferred stock will increase consolidated net income because it increases Stage’s income
available to common shareholders, of which the parent is one. The increase will be greater than
the effect of the bond conversion because the preferred dividends have no tax effect, but the
amount of the increase will depend on the parent’s percentage ownership.
c. If the preferred shares are those of a parent company, they will be excluded entirely if (1) all
the shares are owned by its subsidiaries, or (2) the preferred shares are noncumulative and have
had no dividends declared during the period. If the shares are those of a subsidiary, the preferred
shares will have an effect on basic earnings per share unless (1) the parent or other affiliates own
all the common and preferred shares outstanding, or (2) the preferred shares are noncumulative
and have had no dividends declared during the period.
d. Interest expense will be deducted in computing Stage's net income. The preferred dividends
will then be deducted from net income in computing Stage's income available to common
shareholders. Assuming both securities are dilutive, interest expense (net of tax) will be added
back to Stage's net income, no preferred dividends will be deducted, and the increased number
of shares from the conversion of both securities will be added to the denominator in computing
Stage’s diluted earnings per share. These earnings per share amounts will then be used by Prop
Company in determining the income from the subsidiary to be included in its consolidated
earnings per share computations.
10-4
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of McGraw-Hill Education.
Chapter 10 - Additional Consolidation Reporting Issues
MEMO
To: Treasurer
Cowl Corporation
The following comments are provided in response to your concern with respect to the transfer of
cash from Plum Corporation to the parent company. Intercompany borrowings often offer an
opportunity for one company to borrow money from an affiliate at rates favorable to both parties.
As a result, transfers of cash between affiliates are very common. These transactions are
eliminated in preparing the consolidated statements and the financial statement reader will be
unaware of them unless supplemental disclosures are made.
In general, the FASB does not require separate disclosure of transactions between consolidated
entities when they are eliminated in the preparation of consolidated or combined financial
statements. [ASC 850-10-50-4]
Nevertheless, the fact that Cowl Company is unable to generate sufficient cash from its separate
operations to pay its bills appears to be of sufficient importance that disclosure would be
appropriate in both the Management Discussion and Analysis (MD&A) section of Cowl’s annual
report and in the notes to the financial statements. The SEC establishes the disclosure
requirements for MD&A and requires discussion of currently known trends, demands,
commitments, events, or uncertainties that are reasonably expected to have material effects on
the registrant’s financial condition or results of operations, or that would cause reported financial
information not to be necessarily indicative of future operating results or financial condition. [SEC
Regulation S-K, Item 303]
The SEC also requires discussion of both short- and long-term liquidity and capital resources.
[SEC Financial Reporting Release 36]
ASC 230 does not specify those situations in which a discussion of operating cash flows must be
included in the notes to the financial statements. However, if the negative cash flow from Cowl
Company’s operations significantly affects the operating cash flows of the consolidated entity,
one or more notes to the financial statements should be used to provide information to the
financial statement readers. One possible form for doing so would be to include supplemental
cash flow information if the operations of the parent are identified as a separate reportable
segment [ASC 280-10-50-10].
Primary citations:
ASC 850-10-50-4
SEC Regulation S-K, Item 303
Secondary citations:
ASC 230
ASC 280-10-50-10
10-5
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Chapter 10 - Additional Consolidation Reporting Issues
a. When prior-period intercompany profits are realized through resale to a nonaffiliate in the
current period, tax expense reported by the consolidated entity will be greater than actual tax
payments made by the separate companies.
b. Report the additional amount paid as a deferred tax asset or as prepaid income tax in the
consolidated balance sheet. (An alternate approach is to net the overpayment for unrealized
profits against deferred income taxes payable, but this was not discussed in the chapter.)
c. Whenever separate tax returns are filed and unrealized profits/gains are recorded on
intercompany transfers of land, buildings and equipment, or other assets, income tax expense
reported in the consolidated income statement in the period of the intercompany transfer will be
less than tax payments made. A similar effect occurs when one affiliate purchases the bonds of
another affiliate and a constructive loss on bond retirement is reported in the consolidated income
statement.
d. When unrealized profits from a prior period are realized in the current period, income tax
expense recognized in the current period will be greater than the actual tax payment made. Also,
when unrealized losses are recorded on intercompany transfers (like land, buildings, equipment
or other assets), tax expense reported in the consolidated income statement in the period of the
transfer will be greater than the actual tax payment. A constructive gain on bond retirement on a
purchase of an affiliate's bonds will also result in an excess of consolidated tax expense over tax
payments.
10-6
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DANCE ON STILTS AT THE GIRLS’ UNYAGO, NIUCHI
I see increasing reason to believe that the view formed some time
back as to the origin of the Makonde bush is the correct one. I have
no doubt that it is not a natural product, but the result of human
occupation. Those parts of the high country where man—as a very
slight amount of practice enables the eye to perceive at once—has not
yet penetrated with axe and hoe, are still occupied by a splendid
timber forest quite able to sustain a comparison with our mixed
forests in Germany. But wherever man has once built his hut or tilled
his field, this horrible bush springs up. Every phase of this process
may be seen in the course of a couple of hours’ walk along the main
road. From the bush to right or left, one hears the sound of the axe—
not from one spot only, but from several directions at once. A few
steps further on, we can see what is taking place. The brush has been
cut down and piled up in heaps to the height of a yard or more,
between which the trunks of the large trees stand up like the last
pillars of a magnificent ruined building. These, too, present a
melancholy spectacle: the destructive Makonde have ringed them—
cut a broad strip of bark all round to ensure their dying off—and also
piled up pyramids of brush round them. Father and son, mother and
son-in-law, are chopping away perseveringly in the background—too
busy, almost, to look round at the white stranger, who usually excites
so much interest. If you pass by the same place a week later, the piles
of brushwood have disappeared and a thick layer of ashes has taken
the place of the green forest. The large trees stretch their
smouldering trunks and branches in dumb accusation to heaven—if
they have not already fallen and been more or less reduced to ashes,
perhaps only showing as a white stripe on the dark ground.
This work of destruction is carried out by the Makonde alike on the
virgin forest and on the bush which has sprung up on sites already
cultivated and deserted. In the second case they are saved the trouble
of burning the large trees, these being entirely absent in the
secondary bush.
After burning this piece of forest ground and loosening it with the
hoe, the native sows his corn and plants his vegetables. All over the
country, he goes in for bed-culture, which requires, and, in fact,
receives, the most careful attention. Weeds are nowhere tolerated in
the south of German East Africa. The crops may fail on the plains,
where droughts are frequent, but never on the plateau with its
abundant rains and heavy dews. Its fortunate inhabitants even have
the satisfaction of seeing the proud Wayao and Wamakua working
for them as labourers, driven by hunger to serve where they were
accustomed to rule.
But the light, sandy soil is soon exhausted, and would yield no
harvest the second year if cultivated twice running. This fact has
been familiar to the native for ages; consequently he provides in
time, and, while his crop is growing, prepares the next plot with axe
and firebrand. Next year he plants this with his various crops and
lets the first piece lie fallow. For a short time it remains waste and
desolate; then nature steps in to repair the destruction wrought by
man; a thousand new growths spring out of the exhausted soil, and
even the old stumps put forth fresh shoots. Next year the new growth
is up to one’s knees, and in a few years more it is that terrible,
impenetrable bush, which maintains its position till the black
occupier of the land has made the round of all the available sites and
come back to his starting point.
The Makonde are, body and soul, so to speak, one with this bush.
According to my Yao informants, indeed, their name means nothing
else but “bush people.” Their own tradition says that they have been
settled up here for a very long time, but to my surprise they laid great
stress on an original immigration. Their old homes were in the
south-east, near Mikindani and the mouth of the Rovuma, whence
their peaceful forefathers were driven by the continual raids of the
Sakalavas from Madagascar and the warlike Shirazis[47] of the coast,
to take refuge on the almost inaccessible plateau. I have studied
African ethnology for twenty years, but the fact that changes of
population in this apparently quiet and peaceable corner of the earth
could have been occasioned by outside enterprises taking place on
the high seas, was completely new to me. It is, no doubt, however,
correct.
The charming tribal legend of the Makonde—besides informing us
of other interesting matters—explains why they have to live in the
thickest of the bush and a long way from the edge of the plateau,
instead of making their permanent homes beside the purling brooks
and springs of the low country.
“The place where the tribe originated is Mahuta, on the southern
side of the plateau towards the Rovuma, where of old time there was
nothing but thick bush. Out of this bush came a man who never
washed himself or shaved his head, and who ate and drank but little.
He went out and made a human figure from the wood of a tree
growing in the open country, which he took home to his abode in the
bush and there set it upright. In the night this image came to life and
was a woman. The man and woman went down together to the
Rovuma to wash themselves. Here the woman gave birth to a still-
born child. They left that place and passed over the high land into the
valley of the Mbemkuru, where the woman had another child, which
was also born dead. Then they returned to the high bush country of
Mahuta, where the third child was born, which lived and grew up. In
course of time, the couple had many more children, and called
themselves Wamatanda. These were the ancestral stock of the
Makonde, also called Wamakonde,[48] i.e., aborigines. Their
forefather, the man from the bush, gave his children the command to
bury their dead upright, in memory of the mother of their race who
was cut out of wood and awoke to life when standing upright. He also
warned them against settling in the valleys and near large streams,
for sickness and death dwelt there. They were to make it a rule to
have their huts at least an hour’s walk from the nearest watering-
place; then their children would thrive and escape illness.”
The explanation of the name Makonde given by my informants is
somewhat different from that contained in the above legend, which I
extract from a little book (small, but packed with information), by
Pater Adams, entitled Lindi und sein Hinterland. Otherwise, my
results agree exactly with the statements of the legend. Washing?
Hapana—there is no such thing. Why should they do so? As it is, the
supply of water scarcely suffices for cooking and drinking; other
people do not wash, so why should the Makonde distinguish himself
by such needless eccentricity? As for shaving the head, the short,
woolly crop scarcely needs it,[49] so the second ancestral precept is
likewise easy enough to follow. Beyond this, however, there is
nothing ridiculous in the ancestor’s advice. I have obtained from
various local artists a fairly large number of figures carved in wood,
ranging from fifteen to twenty-three inches in height, and
representing women belonging to the great group of the Mavia,
Makonde, and Matambwe tribes. The carving is remarkably well
done and renders the female type with great accuracy, especially the
keloid ornamentation, to be described later on. As to the object and
meaning of their works the sculptors either could or (more probably)
would tell me nothing, and I was forced to content myself with the
scanty information vouchsafed by one man, who said that the figures
were merely intended to represent the nembo—the artificial
deformations of pelele, ear-discs, and keloids. The legend recorded
by Pater Adams places these figures in a new light. They must surely
be more than mere dolls; and we may even venture to assume that
they are—though the majority of present-day Makonde are probably
unaware of the fact—representations of the tribal ancestress.
The references in the legend to the descent from Mahuta to the
Rovuma, and to a journey across the highlands into the Mbekuru
valley, undoubtedly indicate the previous history of the tribe, the
travels of the ancestral pair typifying the migrations of their
descendants. The descent to the neighbouring Rovuma valley, with
its extraordinary fertility and great abundance of game, is intelligible
at a glance—but the crossing of the Lukuledi depression, the ascent
to the Rondo Plateau and the descent to the Mbemkuru, also lie
within the bounds of probability, for all these districts have exactly
the same character as the extreme south. Now, however, comes a
point of especial interest for our bacteriological age. The primitive
Makonde did not enjoy their lives in the marshy river-valleys.
Disease raged among them, and many died. It was only after they
had returned to their original home near Mahuta, that the health
conditions of these people improved. We are very apt to think of the
African as a stupid person whose ignorance of nature is only equalled
by his fear of it, and who looks on all mishaps as caused by evil
spirits and malignant natural powers. It is much more correct to
assume in this case that the people very early learnt to distinguish
districts infested with malaria from those where it is absent.
This knowledge is crystallized in the
ancestral warning against settling in the
valleys and near the great waters, the
dwelling-places of disease and death. At the
same time, for security against the hostile
Mavia south of the Rovuma, it was enacted
that every settlement must be not less than a
certain distance from the southern edge of the
plateau. Such in fact is their mode of life at the
present day. It is not such a bad one, and
certainly they are both safer and more
comfortable than the Makua, the recent
intruders from the south, who have made USUAL METHOD OF
good their footing on the western edge of the CLOSING HUT-DOOR
plateau, extending over a fairly wide belt of
country. Neither Makua nor Makonde show in their dwellings
anything of the size and comeliness of the Yao houses in the plain,
especially at Masasi, Chingulungulu and Zuza’s. Jumbe Chauro, a
Makonde hamlet not far from Newala, on the road to Mahuta, is the
most important settlement of the tribe I have yet seen, and has fairly
spacious huts. But how slovenly is their construction compared with
the palatial residences of the elephant-hunters living in the plain.
The roofs are still more untidy than in the general run of huts during
the dry season, the walls show here and there the scanty beginnings
or the lamentable remains of the mud plastering, and the interior is a
veritable dog-kennel; dirt, dust and disorder everywhere. A few huts
only show any attempt at division into rooms, and this consists
merely of very roughly-made bamboo partitions. In one point alone
have I noticed any indication of progress—in the method of fastening
the door. Houses all over the south are secured in a simple but
ingenious manner. The door consists of a set of stout pieces of wood
or bamboo, tied with bark-string to two cross-pieces, and moving in
two grooves round one of the door-posts, so as to open inwards. If
the owner wishes to leave home, he takes two logs as thick as a man’s
upper arm and about a yard long. One of these is placed obliquely
against the middle of the door from the inside, so as to form an angle
of from 60° to 75° with the ground. He then places the second piece
horizontally across the first, pressing it downward with all his might.
It is kept in place by two strong posts planted in the ground a few
inches inside the door. This fastening is absolutely safe, but of course
cannot be applied to both doors at once, otherwise how could the
owner leave or enter his house? I have not yet succeeded in finding
out how the back door is fastened.