Financial Reporting Financial Statement Analysis and Valuation 9Th Edition Wahlen Solutions Manual Full Chapter PDF

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CHAPTER 8
INVESTING ACTIVITIES
Solutions to Questions, Exercises, Problems, and Teaching Notes to Cases
8.1 Capitalization versus Expensing Decision.

a. The effect in the first year would be an equal decrease in both the numerator
(adjusted net income) and the denominator (average total assets) of ROA.
Because net income is substantially smaller than average total assets, the
percentage decrease in the numerator would be greater, and ROA would be
understated. However, in the next two years, net income would be overstated
because it is not burdened by a depreciation charge, average total assets would
remain understated, and ROA would be overstated.
b. This error does not affect cash flows, but it does affect classification within the
statement of cash flows. Expensing results in an operating cash outflow in year
one. Capitalization results in an investing cash outflow.
8.2 Self-Constructed Assets. The company should capitalize the full costs of
construction, including direct labor, direct materials, and an allocation of overhead
(both variable and fixed). Also, if interest is incurred during the project, interest
cost should be capitalized.
8.3 Natural Resources. All costs are capitalized except for exploration costs associated
with dry wells, which may be capitalized if the firm chooses the full costing
approach or expensed if the firm chooses the successful efforts approach. Capitali-
zation is justified because most of the costs are necessary to yield probable future
economic benefits. Proponents of expensing unsuccessful exploration efforts argue
that no product was discovered and, thus, that the probable future economic bene-
fits criterion is not met.
8.4 Research and Development Costs. Standard setters require R&D costs to be
expensed because of the uncertainty in judging their future revenue-generating
potential. Although it is debatable whether capitalization better serves investors,
clearly in-depth disclosure of firms’ R&D expenditures serves the investor well.
This is particularly true for firms with large R&D expenditures, such as
biotechnology firms. However, under IFRS, the product development portion of
R&D is capitalized.
8-1
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 8
Investing Activities
8.5 Capitalization of Software Development Costs. Adobe capitalizes software

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

a. Depreciation is a process of allocating historical cost of depreciable assets to the
periods of their use in a rational and systematic manner. Three factors must be
considered when measuring depreciation expense: (1) acquisition cost, includ-
ing subsequent expenditures to add to or improve an existing depreciable asset;
(2) expected useful life of the depreciable asset; and (3) depreciation method.
b. Many illustrations involve altering one or more of the factors to manage
earnings. However, a key point to remember is that depreciation is a cost
allocation process. This means that it affects the timing of expense recognition.
For example, incorrectly expensing an acquisition cost (factor 1 above) to
8-2
Chapter 8
manage earnings accelerates expense recognition relative to capitalization.

Short useful lives (factor 2 above) accelerate expenses relative to long useful
lives. Transparency demands that firms disclose a change in policy for any of
these factors, and, as such, analysts can judge whether the change makes sense
from a business perspective or whether it appears to be a means for managing
earnings. For example, an airline that extends the useful life of aircraft because
of the implementation of more stringent maintenance and inspection schedules
might be understandable. On the other hand, a change in the useful lives of
aircraft that positions the firm as an outlier relative to other airlines would
appear to be a means of managing earnings. A firm may change from one
acceptable depreciation method to another to manage earnings. For example, an
accelerated depreciation method could be chosen to write-down book value too
quickly so that the firm creates a cookie jar reserve to allow the timing of gains
from asset sales in later periods. Because more firms in the United States use
the straight-line method, however, the change would position the firm as an
outlier and generate questions about the motivation for the change.
8.8 Corporate Acquisitions and Goodwill. The acquirer records the intercorporate
investment in the common stock of the acquired company at the fair value of the
consideration given. If the fair value exceeds the book value of the net assets
acquired, the acquiring company allocates the excess to identifiable assets (including
specifically identifiable intangible assets) and liabilities to revalue them to fair values.
The acquiring firm allocates any remaining excess to goodwill. If the fair value of
identifiable acquired assets (including intangibles other than goodwill) exactly equals
the fair value of the consideration given to acquire, no goodwill is recorded. If the fair
value of identifiable acquired assets (including intangibles other than goodwill)
exceeds the fair value of the consideration given to acquire (a bargain purchase), the
difference is recorded as a gain on acquisition and no goodwill is recorded.
8.9 Corporate Acquisitions and Acquisition Reserves. “Acquisition reserves” may

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

Firms report both available-for-sale and trading marketable equity securities at fair
value at the end of each reporting period. The reporting of any unrealized holding
gain or loss depends on the firm’s purpose for investing in securities. Firms that
actively buy and sell securities to take advantage of short-term differences or
changes in market values classify the securities as trading securities, a current asset
on the balance sheet. Firms include unrealized holding gains and losses on trading
securities in the calculation of net income each reporting period. Firms classify
marketable equity securities that do not qualify as trading securities as securities
available for sale, including them as either current or noncurrent assets depending
on the expected holding period. Unrealized holding gains or losses on securities
available for sale are not included in net income each period; instead, they appear as
a component of other comprehensive income, labeled Unrealized Holding Gain or
Loss on Securities Available for Sale. The cumulative unrealized holding gain or
loss on securities available for sale appears in the shareholders’ equity section of
the balance sheet as part of Accumulated Other Comprehensive Income.
When a firm sells a trading security, it recognizes the difference between the
selling price and the book value (that is, the market value at the end of the most
recent accounting period prior to sale) as a gain or loss in measuring net income.
When a firm sells a security classified as available for sale, it recognizes the
difference between the selling price and the acquisition cost of the security as a
realized gain or loss. At the time of sale, the firm must eliminate any amount in the
shareholders’ equity account, Accumulated Other Comprehensive Income, for the
unrealized holding gain or loss related to that security.
Note to instructor: New rules are in effect for fiscal years beginning after December
15, 2017. The available-for-sale classification is eliminated, and the accounting for
minority, passive investments mirrors the accounting for trading securities.
8.11 Equity Method for Minority, Active Investments.

a. Equity income of $35.14 million (0.35 × $100.4 million) will be reported by
Ace Corporation for 2017.
b. The statement of cash flows for Ace Corporation will report a net reduction in
operating cash flows of $26.39 million due to undistributed earnings of the
investee. Recall that $35.14 million of equity income is already shown in the
operating cash flow section under the indirect method, but dividends received in
cash equals only $8.75 million.
c. The balance in Investment in Spear Corporation at the end of 2017 is $1,126.39
million ($1,100 million + $35.14 million – $8.75 million).
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Chapter 8
8.12 Consolidation of Variable-Interest Entities. Often the structure of a VIE is such

that effective control is not captured by simply applying the rule of greater than
50% of equity ownership. In addition, the structure of the entity may take a legal
form other than that of a corporation and thus does not have outstanding equity
securities.
Determining whether an investing firm should consolidate the VIE is at the
heart of Interpretation No. 46R. An investing firm consolidates the VIE if it absorbs
the majority of the entity’s expected losses if they occur, receives a majority of the
entity’s expected residual returns if they occur, or both. The consolidating firm is
labeled the primary beneficiary. The firm considers the rights and obligations
conveyed by its variable interests and the relationship of its variable interests to
variable interests held by other firms to determine whether it will absorb a majority
of expected losses, receive a majority of expected residual returns, or both. If one
firm absorbs a majority of the expected losses and another firm receives a majority
of the expected residual returns, the firm absorbing a majority of the losses
consolidates the variable interest entity.
8.13 Choice of a Functional Currency. The following discussion applies the five criteria
of Statement No. 52 in determining the functional currency for Qing Corporation.
Cash Flows of Foreign Entity. No information is provided about cash flows,
which implies that Qing’s policy is to allow all of its foreign subsidiaries to retain
cash for growth rather than remit it to their U.S. parent. This suggests a foreign
currency (in this case, peso) rather than U.S. dollar perspective as the functional
currency.
Sales Prices. The fact that 50% of revenues are generated by sales to Qing Corpo-
ration is not unusual, given the subsidiary was formed primarily to serve the parent
company. The fact that third-party sales are denominated in the peso might suggest
the foreign currency as the functional currency, although this is not clear.
Cost Factors. All material contracts are denominated in the peso, also indicating
the peso as the functional currency.
Financing. Financing for manufacturing plants is denominated in U.S. dollars, with
some labor contracts denominated in U.S. dollars as well. These operational charac-
teristics point toward the U.S. dollar as the functional currency.
Relations between Parent and Foreign Unit. Senior management of the subsidi-
ary consists of employees of Qing Corporation transferred to Mexico for an interna-
tional tour of duty. Although this points toward the U.S. dollar as the functional
currency, this is not an uncommon arrangement for multinational corporations.
Overall, an argument can be made that the peso should be identified as the func-
tional currency. Mixed signals for choice of the functional currency are common,
and firms must weigh the various factors to determine which ones should dominate
in choosing a functional currency.
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Chapter 8
8.14 Foreign Currency as Functional Currency. The text provides a description of the
exchange rates used when the foreign currency is the functional currency. The logic
is that the management of the foreign unit likely makes operating, investing, and
financing decisions based primarily on economic conditions in that foreign country,
with minimal concern for economic conditions, exchange rates, and similar factors
in other countries.
8.15 Analyzing Disclosures Regarding Fixed Assets.

a. NewMarket Monsanto Olin
Corporation Company Corporation
Average depreciable assets at cost:
0.5($752 + $777) .............................. $765
0.5($4,611 + $4,604) ........................ $4,608
0.5($1,796 + $1,826) ........................ $1,811
Divide by depreciation expense ............ $27 $328 $72
Equals average depreciable life ............ 28.3 14.0 25.2
b. Accumulated depreciation, Year-end ... $ 611 $ 2,517 $ 1,348

Divide by depreciation expense ............ $ 27 $ 328 $ 72
Equals average age................................ 22.6 7.7 18.7
Relative age (age divided by average
life) ................................................... 80% 55% 74%
c. Depreciation—straight-line method ..... $ 27 $ 328 $ 72

Difference between straight-line and
accelerated depreciation:
($9 – $13) ÷ 0.35 ................................ (11)
($256 – $267) ÷ 0.35 .......................... (31)
($96 – $83) ÷ 0.35 .............................. 37
Depreciation—Accelerated for tax ....... $ 16 $ 297 $ 109
d. Net income as reported ......................... $ 33 $ 267 $ 55
Add back depreciation expense on
straight-line method (net of taxes):
(1 – 0.35)($27) ............................... 18
(1 – 0.35)($328) ............................. 213
(1 – 0.35)($72) ............................... 47
Subtract depreciation expense for tax
reporting (net of taxes):
(1 – 0.35)($16) ............................... (10)
(1 – 0.35)($297) ............................. (193)
(1 – 0.35)($109) ............................. (71)
Net income as restated .......................... $ 41 $ 287 $ 31
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Chapter 8
e. NewMarket Monsanto Olin

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

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

a. U.S. GAAP Treatment: Because total undiscounted future cash flows of
$1,920,000 ($160,000 × 12) exceed the carrying value of $1,200,000, the paper
company reported no impairment loss. If the total estimated undiscounted future
cash flows were to fall below the carrying value, the paper company would
compute an impairment loss as the difference between the carrying value and
the fair market value of the press (in this case, $1,000,000). The company
would report the impairment loss of $200,000 in income from continuing
operations, and the press would be reduced to the “new” carrying value of
$1,000,000. Although the firm uses undiscounted future cash flows to decide
whether an impairment charge is necessary, fair value is used to measure the
actual impairment charge.
IFRS Treatment: Under IFRS, first identify the greater of the asset’s value in use
and fair value from sale. Value in use is $1,090,191, obtained by using the 10%
discount rate to compute the present value of a 12-year annuity of $160,000 cash
inflow. The value from a sale is $950,000 (the $1,000,000 fair value – $50,000 in
disposal costs). Compare the larger of the two, $1,090,191, to the carrying value
8-7
Chapter 8
of $1,200,000 to justify a $109,809 impairment charge. The company would

report the impairment loss in income from continuing operations, and the press
would be reduced to the “new” carrying value of $1,090,191.
b. Compare the carrying amount of the unit to the unit’s fair value:
Fair value of Vineyard unit at 12/31/17 ........................................ $1,800,000
Carrying value of Vineyard unit at 12/31/17:
Identifiable assets ............................................... $1,500,000
Goodwill ............................................................. 400,000 $1,900,000
If the fair value of the unit exceeds the carrying amount, goodwill is deemed not
to be impaired. However, in this case, the carrying value exceeds the fair value
of the unit, so Sterling must measure the amount of goodwill impairment by
simulating a reacquisition. The fair value of the unit is compared to the fair
value of the identifiable assets to yield an implied goodwill, as follows:
Fair value of Vineyard unit at 12/31/17 ............................................. $1,800,000

Fair values of Vineyard’s assets other than goodwill at
12/31/17 ......................................................................................... (1,500,000)
Implied goodwill at 12/31/17 ............................................................. $ 300,000
c. Goodwill is written down from $400,000 to $300,000 and a $100,000 impair-

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

a. Fair value increases above original acquisition cost in 2016, causing a €10,000
upward revaluation of the land and an increase in other comprehensive income
(OCI) but not net income. The increase is accumulated in accumulated other
comprehensive income (AOCI) in the shareholders’ equity section. In 2017, the
land is revalued downward €5,000, causing a partial reversal in the unrealized
gains accumulated in AOCI. Downward revaluations are accumulated in AOCI
on the balance sheet as long as fair value is greater than original acquisition
cost. In 2018, fair value falls below original acquisition cost, causing a reversal
of the remaining €5,000 of accumulated unrealized gains in AOCI and the
recognition in net income of €10,000 unrealized loss. The land recovers €5,000
of its value in 2019, and this partial reversal of the prior year’s unrealized loss
reported in income is reported in 2019 income as an unrealized gain.
b. [Note: This concept was not covered in the text.] The company will record
$16,000 depreciation expense. At the same time, the company will remove
$1,000 of unrealized gain from AOCI and increase retained earnings by $1,000.
8-8
Chapter 8
8.18 Application of Statement No. 115 for Investments in Marketable Equity

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

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

millions).
a. Fair value of Chalfont ......................................................................... $ 504
Book value of Chalfont ....................................................................... (300)
Excess ................................................................................................. $ 204
Allocation (Fair value/book value differences):
Fixed assets ......................................................................................... $ 80
Copyright ............................................................................................ 50
Reserve for lawsuit ............................................................................. (30)
Goodwill ............................................................................................. $ 104
b. Cash..................................................................................................... $ 130
Accounts receivable ............................................................................ 330
Fixed assets ($1,000 + $360 + $80) .................................................... 1,440
Copyright ............................................................................................ 50
Deferred tax asset................................................................................ 40
Goodwill ............................................................................................. 104
Total assets ..................................................................................... $2,094
8-9
Chapter 8
Accounts payable and accruals ($240 + $80 + $30) ........................... $ 350

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

Fair value at date of acquisition ................................. $ 312 million
Book value at date of acquisition............................... (125 million)
Excess ........................................................................ $ 187 million
Allocated to:
Fixed assets...................................................... $50 million
Patent ............................................................... 40 million
Accounts payable and accruals........................ (25 million)
Post-employment benefits ............................... (20 million) (45 million)
Goodwill .............................................................. $ 142 million
a. Date of Acquisition Consolidated Ormond Daytona Elimina- Consoli-
Worksheet (January 1, 2017) Company Company tions dated
Balance Sheet (amounts in millions)
Cash........................................................... $ 25 $ 15 $ 40
Accounts receivable .................................. 60 40 100
Investment in Daytona Company.............. 312 0 $(312) 0
Fixed assets (net) ...................................... 250 170 50 470
Patent ........................................................ 0 0 40 40
Deferred tax asset...................................... 10 0 10
Goodwill ................................................... 0 0 142 142
Total assets ............................................. $657 $225 $ (80) $802
Accounts payable and accruals ................. $ (60) $ (40) $(25) $(125)
Long-term debt.......................................... (120) (60) (180)
Deferred tax liability ................................. (40) 0 (40)
Other noncurrent liabilities ....................... (30) 0 (20) (50)
Common stock .......................................... (392) (50) 50 (392)
Retained earnings ...................................... (15) (75) 75 (15)
Total liabilities and shareholders’
equity ................................................. $(657) $(225) $80 $(802)
Revenues, gains, and net income are in parentheses to indicate that their signs
are opposite those of expenses and losses; that is, they are credits for those in-
terpreting the worksheet from the accountant’s traditional debit/credit approach.
Liabilities and shareholders’ equity accounts are in parentheses to indicate that
they are claims against assets; again, they are credits in the traditional debit/
credit framework.
8-10
Chapter 8
b. Consolidation Worksheet for Ormond Company and Daytona Company 2017

(amounts in millions)
Ormond Daytona Elimina- Consoli-
Consolidated Worksheet Company Company tions dated
Income Statement (2017)
Sales .......................................................... $(600) $ (450) $ (1,050)
Equity in earnings of Daytona Company .. (30) $ 30 0
Operating expense..................................... 550 395 13 958
Interest expense......................................... 10 5 15
Loss (Gain) on lawsuit .............................. 0 20 (25) (5)
Income tax expense ................................... 28 12 40
Net income ................................................ $ (42) $ (18) $ 18 $ (42)
Balance Sheet (12/31/17)

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

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

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

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

shows amortizations of the excess amounts and remaining excess amounts at the
end of 2017.
Revenues, gains, and net income are in parentheses to indicate that their signs are
opposite those of expenses and losses; that is, they are credits for those interpret-
8-11
Chapter 8
ing the worksheet from the accountant’s traditional debit/credit approach. Lia-
bilities and shareholders’ equity accounts are in parentheses to indicate that they
are claims against assets; again, they are credits in the traditional debit/credit
framework.
Date of Acquisition
Differences Charged (Credited) to Expense or Loss Balance One Year Later
Fixed assets: $50 million $50 million/5 years = $10 million increase
in operating expense $40 million
Patent: $40 million $40 million/10 years = $4 million increase
in operating expense $36 million
Accounts payable and
accruals: $25 million ($25 million) to reduce loss on lawsuit $0
Post-employment benefits: $20 million/20 years = ($1 million)
$20 million decrease in operating expense $19 million
Goodwill: $142 million $0 (not impaired) $142 million
Net effects: $50 + $40 + Increase income by ($10) + ($4) + $25 + Increase net assets by $40 +
($25) + ($20) + $142 = $187 $1 million = $12 million $36 + ($19) + $142 = $199
million million
The balance of adjustments to net assets (that is, assets minus liabilities) is greater one
year later because the liabilities have been satisfied faster than the assets have been
amortized.
8.21 Variable-Interest Entities.

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

Grolsch with the financial statements of the parent. Thus, the depreciation re-
ported by the VIEs increased the parent’s depreciation by $13.1 million for 2004.
8.22 Accounting for a Merger under the Acquisition Method.
Solution a Solution b
Fair value of Sanders (as evidenced by fair value of
cash given and liability incurred by Pace) ............ $3,150,000 $2,150,000
Fair value of Sanders’ net assets ................................ (2,400,000) (2,400,000)
Goodwill .................................................................... $ 750,000
Gain on bargain acquisition ....................................... $ 250,000
a. Financial Statement Effects of a Merger

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

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

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

Cash .......................................................................... 20,000
To record legal fees and management time.
8-14
Chapter 8
b. If the cash consideration is only $2,000,000, Pace records a gain from a bargain
acquisition of $250,000, and no goodwill is reported.
8.23 Consolidation Subsequent to the Date of Acquisition (Noncontrolling Interests).
a. Allocations of Fair Value

(in millions)
Charged Balance
Allocation (Credited) on
of Fair Estimated to Expense Dec. 31,
Values Life Each Year 2018
Booking fair value at
acquisition date ........... $ 1,462.5
Booking book value at
acquisition date ........... (1,110)
Fair value in excess of
book value ............... 352.5
Land (not depreciated) ...... (90) NA $ 0 $ 90
Equipment ......................... 15 10 (1.5) (12)
Customer lists ................... (180) 20 9 162
Long-term liabilities
(lower fair value) ........ (60) 8 7.5 45
Goodwill ..................... $ 37.5 Indefinite 0 37.5
$ 15
b. Investor Interests in Booking, Inc.

(in millions)
Prestige Properties Noncontrolling

(80% Controlling Interest) Interest (20%)
Acquisition date fair value (1/1/17) =
$292.5
$1,462.5 $1,170
2017 Net income of Booking = $105 $ 84 $ 21
Annual excess amortizations = $15 (12) (3)
Equity in Booking’s earnings for 2017 72 18
Investment in Booking, Inc. (12/31/17) $1,242 $310.5
2018 Net income of Booking = $135 $108 $ 27
Annual excess amortizations = $15 (12) (3)
Equity in Booking’s earnings for 2018 96 24
Dividends paid by Booking in 2018 = $75 (60) (15)
Investment in Booking, Inc. (12/31/18) $1,278 $319.5
8-15
Chapter 8
c. Consolidation worksheet at December 31, 2018:

A = elimination of the Investment in Booking account
B = elimination of the Booking’s shareholders’ equity accounts
C = allocation of the fair value excesses at the date of acquisition to expenses
and to the balance sheet from Solution a
D = elimination of the Equity in Booking’s earnings account
E = recognition of a $24 noncontrolling claim on consolidated net income and
recognition of noncontrolling equity of $319.5 that should be reported as a
component of shareholders’ equity.
Consolidation Worksheet at December 31, 2018

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

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

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

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

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

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

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

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

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

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

for Year 1 (Monetary/Nonmonetary Translation Method)

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

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

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

Operations.
a. Translation of the Accounts of Canadian Subsidiary

for Year 2 (All-Current Translation Method)

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

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

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

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

for Year 2 (Monetary/Nonmonetary Translation Method)

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

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

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

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

product life cycles, high research and development costs) and tend not to assume
major financing risks as well. Thus, the foreign subsidiaries probably do not engage
in heavy borrowing. The financing for those foreign subsidiaries appears to come
from the retention of earnings, suggesting the foreign currency as the functional
currency.
Relations between Parent and Foreign Unit. The segment data indicate a high
volume of intercompany operations, particularly from the United States. Although
the path is not fully evident, it appears that ACS sources components in the Canada,
Far East, and Americas segment, assembles them in the United States, and exports
finished products to sales subsidiaries abroad. This flow suggests the U.S. dollar as
the functional currency.
Mixed signals emerge regarding ACS’s functional currency. Three characteris-
tics (cash flows, cost factors, and financing) suggest the foreign currency as the
functional currency, and two characteristics (sales prices and relations between par-
ent and foreign unit) suggest the U.S. dollar as the functional currency.
The application of these criteria to ACS demonstrates a possible flaw in Statement
No. 52’s functional currency concept. Firms like ACS that are truly global in all
aspects of their operations often do not have an identifiable functional currency. The
implication presumably is that firms with no clearly identifiable functional currency
use the U.S. dollar as the functional currency.
The solution attempts to identify the functional currency for all of ACS’s opera-
tions. It is likely that ACS will use the local currency for some activities and the
U.S. dollar for others. This problem uses data from Digital Equipment Corporation,
which uses the U.S. dollar for all of its foreign operations.
8-24
Chapter 8
Integrative Case 8.1: Walmart

a. Average total estimated useful life = Average depreciable assets acquisition cost ÷
Depreciation expense =
Amounts in millions January 31, 2016 January 31, 2015

Property and equipment (Note 1) $176,958 $177,395
Property under capital leases (Balance
11,096 5,239
sheet)
Land (Note 1) (25,624) (26,261)
Construction in progress (Note 1) (4,539) (5,787)
Depreciable acquisition cost A $157,891 B $150,586
Average depreciable cost = (A + B) ÷ 2 $154,239
Depreciation expense (Note 1 and SCF) ÷ 9,454
Average total estimated useful life 16.3 years
The largest property and equipment categories are Buildings and improvements
and Fixtures and equipment. In Note 1, Walmart provides a range of useful lives
for these two categories of 3–40 and 1–30 years, respectively. Thus, an average
useful life of 16.3 years appears consistent with accounting policy as stated.
b. Analysts can track this number over time to see if companies are changing esti-
mated useful lives (for strategic or earnings management purposes) or changing
the mix of PP&E. Analysts also can explain differences in earnings and asset
book values among competitors by comparing useful life estimates. The differ-
ences across firms may be due to different operating strategies or differences in
accounting quality.
c. Because the amount of accumulated depreciation depends on the number of years

for which depreciation has been taken, the average age of depreciable assets
equals the average amount of accumulated depreciation (and accumulated amorti-
zation on capital leases, all found on Walmart’s balance sheet) divided by depre-
ciation expense (and amortization expense on capital leases), found in both Note
1 and the Statement of Cash Flows, as follows:
0.5($66,787 + $4,751 + $63,115 + $2,864) ÷ $9,454 = 7.27 years average age
The proportion of depreciable assets consumed equals total accumulated

depreciation (and accumulated amortization on capital leases) divided by acquisi-
tion cost, as follows:
($66,787 + $4,751) ÷ $157,891 = 45.3%
8-25
Chapter 8
The remaining useful life can be obtained by dividing net depreciable PP&E and
capital leases by annual depreciation and amortization expense, as follows:
($157,891 – $66,787 + $6,345) ÷ $9,454 = 10.3 years average age
Forecasting future financial statements requires expectations of future tangible

asset acquisitions for replacement of existing production or service capacity and
for growth in capacity. Although the analyst must rely on knowledge of industry
conditions and firm strategy to estimate capital expenditure growth, the analyst
can make these computations to gain a better understanding of when existing
long-lived assets must be replaced. The analyst can track average age and propor-
tion consumed through time and compare them to those of competitors to ascer-
tain whether assets are getting older, on average, and whether they are at a point
where large capital expenditures might be necessary to replace them. Also, older
assets and high proportion consumed provide an indication that the firm is in a
later stage of average product life cycle.
d. In Note 1 on page 33, Walmart discloses that (1) it did have impairments of
PP&E, but they were not material, and (2) there were no impairments of goodwill.
Analysts should search the financial statements and notes for evidence of income
statement items such as impairments, gains and losses on sales, and restructuring
charges. Most of these items are transitory in nature and should be excluded when
developing profitability ratios to predict future earnings.
e. The primary difference in U.S. GAAP is that the tests to consider whether PP&E
is impaired involves a comparison of the gross (i.e., undiscounted) future cash
flows from PP&E use with book value. For goodwill impairment, the comparison
is between the implied fair value of goodwill (generally based on discounted
future cash flows) and book value.
f. Noncontrolling interest in net income equals the portion of the net income of a
partially owned subsidiary that is not owned by the parent. In a consolidation,
100% of the revenues and expenses of a partially owned subsidiary are added to
the revenues and expenses of the parent to determine consolidated net income.
However, parent shareholders only have a right to their ownership percentage of
that net income. The noncontrolling interest has a right to its ownership percent-
age of the subsidiary’s net income.
Similarly, in a consolidation, 100% of the assets and liabilities (i.e., net assets)
of a partially owned subsidiary are added to the assets and liabilities of the parent
to determine consolidated net assets. However, parent shareholders only have a
right to their ownership percentage of those net assets. The noncontrolling interest
in net assets equals its ownership percentage times the net assets of the subsidiary.
8-26
Chapter 8
The two concepts are related as follows:
Noncontrolling interest in net assets, beginning of the period XXX

+ Noncontrolling interest in net income of the period XXX
− Noncontrolling interest in subsidiary dividends (XX)
= Noncontrolling interest in net assets, end of the period XXX
g. Based on the formula in Part f above and the condition that firms typically
pay less than 100% of net income as dividends, one would expect that a
noncontrolling interest in net assets would increase during the period. However, it
is possible for a company to pay more dividends than net income of the period,
for the parent to acquire more shares in the subsidiary, and for the noncontrolling
interest to share other comprehensive losses during the period. These events
reduce the noncontrolling interest. Each of these events happened in the most
recent year at Walmart. The 2016 Statement of Shareholders’ Equity reports
“cash dividends declared to noncontrolling interest” of $691 million, while the
income statement reports $386 million of “consolidated net income attributable to
noncontrolling interest.” In addition, the noncontrolling interest shares $541
million of other comprehensive losses during the period. Finally, “other”
reductions totaled $632 million. The other reductions represent the carrying value
of the noncontrolling interest in Yihaodian, the e-commerce operation in China
(see Note 13).
h. The loss on currency translation for 2016 is $5,220 million, an amount that is
primarily responsible for turning a $14,694 million net income into a $10,265
comprehensive income. The loss is reported as other comprehensive income and
loss on the Statement of Comprehensive Income. The rationale for not including it
in net income is the long-term nature of investments in foreign subsidiaries. The
translation process uses the current rate for translation even though it is highly
unlikely that foreign currency cash flows from assets and liabilities will be
currently converted to U.S. dollars. The expectation is that, in the long run, the
changes will reverse sign. Note from observation of the currency translation
amount during the last three years, however, that the signs are persistent (a loss)
and the amounts are growing.
i. Walmart’s investments in foreign operations are net asset positions. The loss indi-
cates that the foreign currency is falling in strength relative to the U.S. currency.
8-27
Chapter 8
Case 8.2: Disney Acquisition of Marvel Entertainment

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

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

identifiable assets and liabilities at fair value in its own financial records. The
consolidation process is not necessary because there would be no records of
Marvel to consolidate. If Marvel continues to exist as a separate legal entity (an
acquisition), then Disney will record an “Investment in Marvel” in its own
records. During the consolidation process, the investment account will be
eliminated, and Disney will replace the account by adding goodwill and Marvel’s
identifiable assets and liabilities at fair value to the consolidated totals. The
financial statements issued by Disney will be exactly the same regardless of
whether the business combination is a merger or an acquisition.
8-28
Chapter 8
e. Most current assets and liabilities have book values that do not materially differ
from fair values. An exception is the nonmonetary asset “Inventories,” which is
likely to have a fair value greater than its book value (which is based on the lower
of cost or market). Long-lived assets such as Fixed assets, net; Film inventory,
net; and Goodwill are also likely to have fair values greater than their book values
(which are based on historical cost or historical cost adjusted for depreciation
unless reduced for impairment). Also, Marvel likely has a number of identifiable
intangible assets such as the artistic-related intangible assets: video and
audiovisual material, including motion pictures, music videos, and television
programs, and character brand names, and the contract-based intangible assets:
licensing, royalty, standstill agreements. Book values of these intangibles are
probably small, but the fair values are large. Finally, Marvel has a number of
noncurrent receivables and payables. Long-term contractual agreements involving
future cash receipt and payment have fair values that depend on current market
interest rates. If the current market interest rates differ from contractual rates on
the receivables and payables, then differences between book and fair values will
exist. Before allocation of the large excess consideration given to goodwill,
Disney will allocate amounts to the aforementioned differences between fair and
book values. The remainder will be classified as goodwill.
8-29
Another random document with
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now and again added slightly to the body of knowledge which the
world possessed on the subject. Of these we might mention such
names as Archimedes in the second century b.c., and Mathesius in
the sixteenth century a.d. But Solomon de Caus, or Carrs, in the first
half of the seventeenth century showed that the steam given off by
boiling water could be used for raising water, and Giovanni Branca,
about the same time, brought about what is really the progenitor of
the modern turbine. In this seventeenth century, also, another
ingenious Italian, Evangelista Torricelli, proved that the atmosphere
in which we live possessed weight, and to-day everyone is aware
that this is so, and that the pressure of the air is 15 lb. per square
inch. The working of the mercurial barometer is the simplest proof of
this. We shall see presently how an isolated fact unearthed in one
age becomes the foundation of the mighty success of a later
inventor, and thus the assertion which we made on an earlier page,
that the credit of inventing the steamboat belongs neither to one man
nor to one age, is not devoid of truth.
Otto von Guericke, about the middle of the same century,
showed the practical utility of producing a vacuum, of which the
syringe and the common suction pump are such excellent examples.
But we are not writing a history of inventions, nor of steam, but of the
steamship, and we shall pass on presently to see how each of these
separate important discoveries eventually blended to form the
subject of our present study. In 1663 Edward Somerset, the second
Marquis of Worcester, to whom we have already referred, also
published his description of “An Admirable and most Forcible Way to
drive up Water by Fire,” and in this year he obtained protection by
Act of Parliament for his “water commanding engine.” When he had
interested himself so much in the problem of sending a craft against
a current, and simultaneously was obtaining success in the
development of steam power, it certainly seems a little strange that
the Marquis did not advance just that one step farther which was
necessary to complete the syllogism, and apply steam for the
purpose of solving the problem of going against the tide or stream.
That, however, was reserved for another inventor, and of a different
nationality.
And so we come to one whose name is deserving of especial
mention in the history of the steamship, for it was he who was the
first to do what myriads of others have since done. Many writers
have asserted wrongly that this man or the other was the first to
succeed: they have gone back as far as de Garray and as short a
distance as Fulton. Some have stated timidly and with reserve that
Denis Papin is said to have been associated with this honour. But
there can be no manner of doubt that to Papin certainly belongs the
high distinction of having caused the steamboat to be an actual fact
and not merely a figment of imagination. Papin was a French
engineer, who, being a Calvinist was, after the revocation of the
Edict of Nantes, obliged to go into exile. For that reason, therefore,
he betook himself to the Court of the Landgrave of Hesse, where he
found refuge. In 1690 he published a suggestion for obtaining power
by means of steam. His idea was to have a cylinder made of thin
metal; water was to be placed therein and heated. In the cylinder
were to be also a piston and rod on which was a latch, and when the
water had been heated sufficiently so that enough steam had been
generated, the piston would be moved upwards and be kept there by
means of the latch. Thereupon the fire was to be taken away, and,
the steam then condensing, as soon as the latch was loosed the
piston was bound to drop to the bottom of the cylinder; and if a rope
and pulley were attached to the rod, then the descent of the piston
would be able to raise a weight at the end of the rope. This was
practically what was afterwards known as the atmospherical engine,
and Papin was of the opinion that it could be employed for draining
rivers, throwing bombs and other purposes. But it is especially
notable for our purpose that he firmly believed that it could be
employed for rowing a craft against the wind, and indeed would be
preferable to the working of galley slaves for getting quickly over the
sea; for men, he explained, occupied too much space, consumed too
much food, and his tubes and pumps would make a far less
cumbersome arrangement. It is worth while noting that the idea of
these early inventors of the steamboat was not so much to propel
the ship as to row her mechanically by oars or paddles. We still call
them paddle-wheels rather than propelling wheels, and the early
wheels used for the steamboat were practically paddles placed
crosswise, with a blade at the end of each spar. When fitted to an
axle, of course, they moved in a circular fashion. The French “roue à
aubes,” which is the expression that these French inventors made
use of in describing their creations, conveys precisely the same idea.
Papin, casting about for some method of bringing about the
steamboat, suggests the use of these rotatory oars, and mentions
having seen them fixed to an axle in a boat belonging to Prince
Robert of Hesse. This latter was one more of those attempts to
propel a craft by physical means, for these revolving oars were
turned by horses. Papin, in considering the matter, thought that
instead of horses the wheels might be made to go round by steam
force, and in 1707 he actually constructed the first steamboat, which
he successfully navigated on the River Fulda, in Hanover. He even
did so well that he set off in her to steam down to the sea and cross
to London; but, of course, the old, conservative prejudice of the local
boatmen was bound to make its appearance as soon as so historical
a craft had shown her ability. And so, arriving at Münden, the
watermen, either through fear that this new self-propelling craft
would take away their livelihood through inaugurating a fresh era, or,
being envious of a success which no man had ever before obtained,
they attacked this steamboat, smashed it to pieces, and Papin
himself barely escaped with his life. Thus, a craft and its engines,
which to-day would be welcomed by any museum in the world, was
annihilated by the men who had the privilege of witnessing the first
steamship. Papin never got over the grief caused by so cruel a
reception of his brilliant labours, and it is deplorable to think that
such scant encouragement was possible. Besides being the
successful originator of the steamboat, he was also the inventor of
the safety valve.
The publication of Papin’s correspondence with Leibnitz puts the
case beyond all possibility of doubt, and the reader who cares to
pursue the subject will find the facts he requires in “Leibnizens und
Huygens’ Briefwechsel mit Papin,” by Dr. Ernst Gerland. From this
we see that Papin had already published a treatise dealing with the
application of heat and water. In a letter, dated March 13, 1704, he
wrote to Leibnitz of his intention to build a boat which could carry
about four thousand pounds in weight, and expressed the opinion
that two men would be able to make this craft easily and quickly to
ascend the current of a river by means of a wheel which he had
adjusted for utilising the oars. That Papin made no aimless plunge,
but went into the matter scientifically, is quite clear. He studied
carefully the important fact of the resistance which is offered to a
vessel passing through the water, and thus found what he believed
to be the correct lines on which his ship was to be built. He shows
that he had been hard at work expanding his theories, and was
longing to have the opportunity to put them to a practical test. On
July 7, 1707, he writes to say that he has many enemies at Cassel
(where he was then sojourning) and contemplates going to England;
and in asking permission so to do he brings forward the plea that it is
important that the new type of ship should have a chance of proving
its worth in a seaport such as London. He does not conceal the great
faith which he reposes in this novel craft: “qui, par le moien du feu,
rendra un ou deux hommes capables de faire plus d’effect que
plusieurs centaines des rameurs.” Then, writing again to Leibnitz,
also from Cassel, under date of September 15 of the same year,
relating the result of his experiment of this first steamboat, he
remarks: “Je Vous diray que l’experience de mon batteau a êté faitte
et qu’elle a reussi de la manière que Je l’esperois: la force du
courant de la riviere ètoit si peu de chose en comparaison de la
force de mes rames qu’on avoit de la peine à reconnoitre qu’il allât
plus vite en dêcendant qu’en montant.”
With such statements as these before us, we can no longer be in
any doubt as to the first author of the steamboat.
Papin had discovered a method of producing a vacuum by the
condensation of steam, but Thomas Savery is one of the many
instances of the case where two men in different countries were
working separately and unknown to each other at a common
problem. The latter had patented an apparatus for raising water by
the impellent force of fire so far back as the year 1698, or nine years
before Papin’s steamboat made her appearance; but he had also
independently discovered a method of producing a vacuum by the
condensation of steam just as had Papin. And this same Savery had
shown that the same problem which Papin had succeeded in solving
was also interesting himself: for he had gone so far as to ask for a
patent for an invention for moving a paddle-wheel on either side of a
ship by means of a capstan, which capstan was to be revolved by
men. Eventually it occurred to him, as it had not occurred to the
Marquis of Worcester, that steam might be employed as helpful to
ships. Nevertheless, Savery did not carry this idea to any practical
test.
We come now to Thomas Newcomen, who, notwithstanding the
fact that his home was at Dartmouth, where in the Elizabethan years
so much had been done in connection with ship-building and the
sending forth of so many naval expeditions across the seas, does
not seem ever to have done anything directly for the development of
the steamboat. But indirectly Newcomen did much, and the machine
which he introduced, and with which his name is inseparably
connected, was practically an English equivalent of Papin’s
atmospheric engine, to which we have already referred.
Newcomen’s engine is important to us, inasmuch as it embodied in a
practical manner the main characteristics of what eventually became
the familiar reciprocating steam engine; and had it not been for this,
Watt might not have evolved his historic engine, and consequently
Fulton not succeeded as he did. I shall endeavour not to weary the
non-technical reader, but I must pause a moment here to give some
idea of the nature of Newcomen’s engine, because of the close
relation which it bears to the subsequent development of the steam
engine as fitted in ships and boats. It consisted, then, of a vertical
cylinder, which, unlike our modern cylinders, was open at the top. It
was provided with a piston to which were attached chains that
connected with one end of a beam, the centre of the beam being so
fixed as to allow it to oscillate. Steam was generated in a boiler, on
the top of which was a primitive cylinder, and by opening a valve,
steam was admitted into the cylinder and so pushed up the piston.
When the piston had reached the top of the cylinder the valve was
closed so that the steam was shut off. Then cold water from a cistern
was allowed to enter the bottom of the cylinder, and by this means
the steam was condensed, so causing a vacuum; by the pressure of
the air—which, as already mentioned, is 15 pounds to the square
inch—the piston was forced down again. We get here, then, the
essential features of that steam engine which is so familiar to all who
travel by land or by sea. But these early atmospheric engines were
not invented for the purpose of transport: it was for the pumping of
water from mines that they were principally contrived, and in the
case of the Newcomen engine, the other end of the beam opposite
to that which was worked upwards by steam pressure (and
downwards by atmospheric pressure) was attached to pump-rods
that worked in connection with the buckets for pumping out the
water. Thus, like the movement of the see-saw, when the piston-rod
was down at the bottom of the cylinder the pump-rods were
correspondingly elevated, and vice versa. As soon as the piston
descended to the base of the cylinder through the cessation of the
vacuum the spray of cold water was stopped, and steam was again
admitted into the cylinder to cause another upward stroke. At the
same time it was necessary to discharge the hot water which had
accumulated at the bottom of the cylinder, and this was done through
a pipe fitted with a valve which would not allow of its return; any air
admitted with the steam and the cooling water was blown out
through a snifting valve (so-called because of the noise it makes) as
the powerful steam came in. But, the reader may ask, what about the
open top of the cylinder? How can it be any good to use an
uncovered cylinder in conjunction with steam? The answer is, that
since the top of the piston was always kept flooded with water, all air
was excluded.
We have thus seen the steam engine in its most elementary
form; how that it employs boiling water until it becomes steam which
is then admitted to a cylinder and by its own force moves a tight-
fitting disc or piston up and down. We have also seen that by
attaching a rod to this disc, and, further, by connecting this rod to a
beam, we can make the latter go up (by means of the steam
pressure) or come down (through the pressure of the air). In order to
effect the latter we have remarked the fact that a vacuum had to be
made by condensing the steam through spraying cold water.
With this explanation in the mind of the general reader, to whom
engineering matters do not usually appeal, we may proceed with the
progress of our story, and pass on to the year 1730, when a method
differing entirely from any that we have yet mentioned was brought
forward. Strictly speaking it had nothing to do with steam, but, as we
shall see when we come to consider the subject of steam lifeboats, it
embodied an idea which could only be satisfactorily employed by the
adoption of steam. In the year mentioned there was published a little
book under the title “Specimina Ichnographica: or a Brief Narrative of
several New Inventions and Experiments: particularly, The
Navigating a Ship in a Calm, etc.,” by John Allen, M.D. The author’s
idea was to propel a ship by forcing water, or some other fluid,
through the stern by means of a proper engine. To this end he
experimented with a tin boat 11 inches long, 5 inches broad and 6
inches deep. Placing this little ship into stagnant water, he loaded it
until it sank in the water to a depth of 3¾ inches. Into the boat he
also placed a cylindrical-shaped object 6 inches high and about 3
inches in diameter and filled it with water. At the bottom of the
cylinder was a small pipe, a quarter of an inch square, and this led
through the stern of the craft at a distance of an inch and a half
below the surface of the water in which the boat was floating. As
soon as Allen removed his finger from the outlet of the pipe in the
stern the water, of course, ran out from the cylinder, and this action
caused the boat to travel, the speed being reckoned, in the case of
the model, at about one-fifth of a mile per hour. Although nothing
actually came of this theory at the time, it is none the less perfectly
workable, with some adaptations, and some of the steam lifeboats,
in order to avoid using propellers, which are liable to get foul of
wreckage when going alongside a ship in distress, have an
elaboration of this principle. They are propelled by engines which
work a pump that drives a stream of water through pipes placed
below the water-line in much the same manner as in Allen’s model.
Allen at first contemplated working the pumps by men, and then
causing them to be driven by an atmospheric steam engine. A
similar device was employed in Virginia, U.S.A., by James Rumsey
in 1787. In his boat water was sucked in at the bow and ejected at
the stern. It was found that as long as the vessel travelled at all she
went at the rate of four miles an hour, but as she only covered less
than a mile and then stopped, it cannot be said that this experiment
was conclusive. In 1788, the following year, however, another boat
was made actually to go a distance of four miles in one hour, and the
device was patented in that country during the year 1791, but Allen
had already patented his invention in England thirty years earlier.
It is when we come to Jonathan Hulls or Hull that we encounter
the first Englishman to apply steam to ships. Hulls was a native of
Gloucestershire, who, in 1736, patented a method of propelling
vessels by steam, and in the following year issued a booklet on the
subject of his invention which was subsequently reprinted. The title
reads thus: “A Description and Draught of a New-Invented Machine
for Carrying Vessels or ships out of or into any harbour, port or river,
against wind and tide or in a calm ... by Jonathan Hulls.” His idea
was to provide a steam tug so that it should be able to render
beneficial service to those sailing ships accepting it. His preference
for placing the “machine,” or engines, into a separate ship, and thus
using her as a tug-boat, instead of installing the engines on board
each vessel was because he believed the “machine” might be
thought cumbersome and take up too much room in a vessel laden
with cargo. But besides the advantage of having a tow-boat always
in readiness in any port, he suggested that an old ship which was not
able to go far abroad could well be adapted for receiving this
“machine.”
“In some convenient part of the Tow-Boat,” he explains, “there is
placed a Vessel about two-thirds full of Water, with the Top close
shut. This Vessel being kept boiling, rarefies the Water into a Steam:
this Steam being convey’d thro’ a large Pipe into a Cylindrical Vessel
and there condens’d, makes a Vacuum, which causes the weight of
the Atmosphere to press on this Vessel, and so presses down a
Piston that is fitted into this Cylindrical Vessel in the same manner as
in Mr. Newcomen’s Engine, with which he raises Water by Fire.”
It will thus be seen that Hulls was an adapter of Newcomen’s
atmospherical engine to marine purposes rather than an actual
inventor of something new and unheard of. But Hulls seems to have
anticipated this criticism, for he adds: “if it should be said that this is
not a New Invention, because I make use of the same Power to drive
my Machine that others have made use of to Drive theirs for other
Purposes, I Answer, The Application of this Power is no more than
the Application of any common and known Instrument used in
Mechanism for new-invented Purposes.”
JONATHAN HULLS’ STEAM TUG-BOAT.

After the Drawing attached to his Specification for the Patent.
We have already noticed that the most which Newcomen could

get out of his engine was an up-and-down movement, which was all
very well for the purpose for which it was intended, namely, pumping
up water, but before it was applicable for propelling a ship the power
had to be adapted to give a rotary motion. The accompanying
illustration, which is taken from Hulls’ specification for his patent, and
reproduced in the booklet mentioned above, will afford some idea of
his proposal. In the lower half of the picture the “tow-boat” is seen in
imagination hauling an eighteenth century full-rigged ship, a
performance which in actual truth she never achieved. There is, in
fact, some doubt as to whether Hulls ever did put the idea to a
practical test. Admiral Preble, a distinguished American Naval officer,
in his “Chronological History of the Origin and Development of
Steam Navigation,” published in Philadelphia in 1883, a volume
which contains a vast amount of interesting detail up to that date,
says that Hulls did not produce a satisfactory experiment. Scott
Russell, one of the greatest authorities on such matters in the
nineteenth century, affirmed that Hulls did carry out his theory in
definite shape, and the recent “Dictionary of National Biography” also
states that at any rate he experimented with a vessel on the River
Avon in the neighbourhood of Evesham in 1737. One thing is certain,
that whatever merits the proposition might have had in certain
respects, it was, commercially, a complete failure. On the other
hand, in enunciating a method of converting the rectilineal motion of
the piston-rod into a rotary movement Hulls undoubtedly showed the
direction in which others were to follow.
In the upper half of the illustration of Hulls’ drawing, beginning at
the bottom right-hand corner, we see the details of his “machine.” P
is the pipe which comes from the furnace and brings the steam to Q,
the cylinder in which the steam was also condensed. (This last
remark is important to bear in mind, as we shall see later to what
extent this feature was modified.) The point marked R is the valve
which enables the steam to be cut off from entering the cylinder
whilst that amount of steam which has already been allowed to go in
is being condensed. The other small pipe S conveys the cooling
water which condenses the steam in the cylinder, and T is the cock
which lets in the condensing water after the cylinder is full of steam
and the valve is shut. U is the rope which is fixed to the piston that
slides up and down the cylinder, and this is the same rope that goes
round the wheel D in the machine shown in the larger illustration.
In this latter picture, too, wherein the tow-boat is seen steaming
along, A denotes, of course, the chimney “coming from the furnace,”
while B is the tow-boat and CC are the two pieces of timber which
are framed to support the machine. It will be noticed that inboard are
three wheels marked respectively Da, D, and Db. These are on one
axis and receive the ropes as shown. Ha and Hb are two wheels
also on the same axis projecting beyond the stern, and the six fans
or paddles are marked I, which move alternately in such a manner
that when the wheels Da, D, and Db move backwards or forwards
they keep the fans or paddles in a direct motion. When these three
wheels Da, D, and Db move forward then the rope Fb must move the
wheel Hb forward, and so cause the paddles to revolve in the same
direction. So also the rope Fa connects the wheel Ha to Da, and
when the latter and its two sister wheels revolve the wheel Da, then
the wheel Ha draws the rope F and raises the weight G (barely
decipherable in the sketch to the left of Da), at the same time as the
wheel Hb brings the paddles forward.
Furthermore, when the weight G is raised while the wheels Da,
D and Db are moving backwards, the rope Fa gives way and the
power of the weight G brings the wheel Ha forward and the paddles
with it: so that the latter always keep going forward, notwithstanding
that the three wheels Da, D, and Db move backwards and forwards
as the piston moves up and down in the cylinder. LL—scarcely
recognisable owing to the reduction of the sketch—indicate the teeth
for a catch to drop in from the axis, and are so contrived that they
catch in an alternate manner to cause the paddles to move always
forward, for the wheel Ha, by the power of the weight G, is
performing its work while the other wheel Hb goes back in order to
fetch another stroke. Hulls explains that the weight G must contain
but half the weight of the pillar of air pressure on the piston, because
the weight G is raised at the same time as the wheel Hb is doing its
duty, so that in effect there are really two machines acting alternately
by the weight of one pillar of air of such a diameter as is the diameter
of the cylinder.
Hulls expressed another crude idea for when the ship was
navigating “up in-land Rivers” and the bottom could be reached. The
paddles were then to be removed and “cranks placed at the
hindmost Axis to strike a Shaft to the bottom of the River, which will
drive the Vessel forward with greater Force.”
Daniel Bernoulli, in the year 1753, proved on paper that it was
mathematically possible to use a steam engine for propelling ships,
the medium being also wheels with vanes attached. There were not
wanting other theories and experiments also in the eighteenth
century which attained little or no success, their defects arising
sometimes through lack of sufficient power to go against a stream, or
through some erroneous principle. Of these we might mention
especially the experiment made in France by Périer, who, after
devoting careful consideration to the problem of the amount of power
required, and, after reckoning the necessary force likely to be
essential, by the number of horses which were required for drawing
along a boat from the towing-path, set to work in his own manner. It
happened that in the year 1775, to which we are now referring, there
was on view in Paris a unique engine which the now famous and
ever memorable James Watt had made. This aroused so much
interest that it was decided to hire a boat on the Seine and place
therein a Watt machine of one horse-power. Périer carried out his
experiment, though owing to the force of the current of the Seine,
and the too limited horse-power which the engine was capable of
producing, the result was a failure. But one of Périer’s associates,
the Marquis de Jouffroy, had also been excited by the advent of this
English engine which was an improvement on anything that the
world had yet seen, and he resolved to try for himself to find some
means of making a ship to go against swift-running rivers
independent of horse-towage. In spite of the prejudice which was
likely to be aroused in case he should prove successful (for the
owners of the monopoly of the more primitive form of inland water
transport would not quietly consent to see their living taken away
from them), he set forth with considerable courage and an heroic
determination. Since it is doubtful whether these interesting
experiments would ever have been made had it not been for the
happy coincidence of Watt’s engine becoming known when it did, it
is only right that we should first see something of the circumstances
which combined to bring the Englishman’s work into such
prominence, and then return to follow de Jouffroy in his efforts.
To James Watt, notwithstanding that his work and ingenuity were
expended for the purpose of land engines, belongs the honour of
having removed the most harassing obstacles which were delaying
the full and entire possibility of the marine steam engine. In the chain
of discoveries which leads back into early times, without whose
cumulative effect he himself would not have done what he did,
James Watt comes immediately next to Thomas Newcomen.
Despised in his weak, delicate boyhood by his companions, his is
another instance of the stone which the builders rejected becoming
the head corner-stone. Or, to put the proposition in another way,
Watt absorbed all the existing good that there was in the latest
engineering knowledge, and advanced that several steps further until
it reached the goal of practicability.
In the Newcomen engine there were several notable defects
which marred its usefulness, and it was not until these could be
improved upon that there could possibly be a future for the
steamboat. This type of “machine” was not closely enough related to
the work which it was called upon to perform. Its pre-eminent fault
lay in the fact that the condensation took place in the cylinder. This
meant a considerable waste, for after the latter had been made cool
by the admission of the cold water for condensing the steam, the
cylinder had to be heated again before every upward stroke. Heat, in
fact, was literally thrown away. It was in the year 1764 that Watt,
while endeavouring to repair a model of one of these Newcomen
engines and to remedy its poor performance, was struck by the
inadequacy of its mechanism and realised that some means should
be found to ensure a greater economy of steam. From his ingenious
brain, therefore, came an improvement. He provided for the
condensation to take place not in the cylinder but in a separate
condenser, in which a jet of water was to spray, and finally the
condensed steam, the injected water, and the air which had also
found its way in, were to be drawn off by means of an air-pump. After
a delay of several years Watt was introduced to Matthew Boulton,
founder of the Soho Engineering Works, near Birmingham, and in
1769 Watt’s invention, embodying the principle of the separate
condenser, was patented. Although he had worked out his idea as
far back as the year 1765, it was not till four years after that he had
the means to secure its protection. In the specification for his patent
Watt enunciated what is appreciated as an essential doctrine to-day,
that the walls of the cylinder should be maintained at the same heat
as the steam which was about to enter into the cylinder. And he
proposed to bring about this improvement by adding an external
casing to the cylinder, leaving a space between the casing and the
outside of the cylinder itself and keeping always in this space steam
so as to preserve a high temperature.
But, as was mentioned on a previous page, the steam engine at
this date was not developed with a view to transport, but for the
convenience of pumping up water from mines. As a result of Watt’s
success a considerable demand arose among Cornish mine-owners
for these engines made by Boulton and Watt, who were now working
in partnership together. For the work of pumping, these machines
continued to serve admirably, so long as a vertical up-and-down
motion was required. At length Watt turned his mind to some method
of obtaining rotary movement from his engine, but in a manner
different from that in which Hulls had attempted to attain his end.
Watt had covered in the top of his cylinder to keep out the cooling
effect of the air, and his well-known beam pumping engine was an
improvement on Newcomen’s, owing to the simple fact that in
economising steam it halved the cost of fuel, and not even to-day are
these old-fashioned engines in disuse. As we shall see later on, the
beam engine is very much in evidence in some of the river
steamships of the United States, apart altogether from those beam
engines which are still worked for pumping in some parts of our own
country.
With such satisfactory results to encourage him it was inevitable
that sooner or later so brilliant a schemer would think out some
means for rotary movement, and Watt’s first intention was to cause
the beam (which was pushed up by the rod joining the piston) to
drive a fly-wheel by introducing a crank in something of the same
manner in which nowadays the crank of a bicycle drives round the
cog-wheel, the cyclist’s leg being, so to speak, the connecting rod
which joins the beam. But before Watt had a chance of getting legal
protection for this method his secret was stolen by one of his
workmen, named Pickard, who revealed it to a Bristol man of the
name of Wasbrough, who was also in search of some method of
obtaining rotary motion. The latter, therefore, having in 1780
obtained his patent by stealth, Watt was compelled to cast about for
some other means of attaining the same end: but his fertile mind
soon gave forth what was required, and in the following year he
patented what is known as the “sun-and-planet” gear, which
converted the vertical movement into a rotary. Put in a few words,
the working of the engine was as follows: At the top was the straight
beam of wood; from one side of this there hung vertically a rod which
connected with the piston in the cylinder, and was thus made to go
up and down as in the Newcomen engine. It will be remembered that
in Newcomen’s machine, at the opposite end of the beam was the
other rod for pumping the water. Now in Watt’s rotary engine the
piston-rod was moved up and down as before, but the opposite rod,
at the other end of the beam, was connected with a spur-wheel
having cogs in it. There was also a large fly-wheel which had a
similar cog-wheel on its shaft, and thus, as the piston rod pushed up
its end of the beam the opposite end of the beam was lowered and
its rod also. But through the arrangement of the two cog-wheels the
connecting rod caused the fly-wheel to revolve, and at twice the rate
at which it would have gone round had Watt’s original rod and crank
idea been employed, for the “planet” cog-wheel goes round in a
circle but does not revolve on its own axis. Some of his engines of
this type were so arranged that the speed of the fly-wheel shaft was
not so much greater than in the case where a crank was employed.
Thus, in this important adaptation of the vertical to the rotary
movement, we get the nucleus of the future steamboat engine, which
was to turn the paddle-wheels round. But Watt did not stop there. We
have seen that whilst it was the steam which pushed the piston and
its rod upwards, it was yet the pressure of the air and the weight of
the parts which caused the piston and rod to descend. Now, as we
have seen, Watt had already resolved to cover in the top of the
cylinder in order to keep out the air from cooling the latter. It was,
then, but a natural transition to utilise the steam not merely for
pushing the piston upwards, but also for sending the same down
after its ascent had been made. We thus get what is the well-known
double-action of the modern reciprocating engine, in which steam is
employed from either side of the piston alternatively, so that each
stroke becomes a working stroke and the power of the engine is
doubled. It was Watt who, as early as the year 1782, discovered the
advantages which were possessed by the expanditure of steam, but
as this does not enter into practical application just yet, we can
postpone the subject to a later chapter. We need only emphasise the
fact that the fly-wheel which is so familiar to all of us was the
invention of Watt, and it is perhaps scarcely necessary to explain
that the reason for the existence of this wheel is in order that it may,
at the beginning of the stroke, when the engine is at its strongest,
store up the surplus energy and give it back towards the end of the
stroke. It thus maintains an equal motion throughout the whole
stroke given forth by the piston and its rod.
The earliest marine steam engines were very much on these
lines, then, and were really a slightly modified form of land engine.
But, as we shall soon come to refer to the more complicated type of
engine, and to make use of other terms, it may not be out of place
here to deal at once with the expression “horse-power,” which is
used for the purpose of indicating the force which an engine is
capable of developing. The origin of this expression is not without
interest, and Sir Frederick Bramwell, Bart., F.R.S., D.C.L., in his
entertaining article on the life of Watt in the “Dictionary of National
Biography,” points out that Savery, to whom we have referred, was
accustomed to calculate that where any machinery had to be driven
by means of a single horse, it would entail a stock of three of these
animals being kept, so that one should be able always to be at work.
Thus supposing that the power exerted by six horses was necessary
to drive a pump, and Savery made an engine capable of doing the
same work by mechanical means, he would call it not a six horse-
power engine, but an eighteen horse-power. Watt, however, did not
credit his engine with the idle horses. He satisfied himself that an
average horse could continue working for several hours when
exerting himself so as to raise one hundredweight to a height of 196
feet in one minute, which is about equal to lifting 22,000 pounds one
foot high in the same time, as the reader will find by simple
arithmetic. But in order that no purchaser of his engines should have
any ground for complaint, Watt went one step better, and determined
that each horse-power of his engine should be capable of raising to
a height of one foot, in one minute, not 22,000 pounds, but 33,000
pounds, or half as much again. And so to-day when we speak of an
engine possessing such and such horse-power we still mean that it
is equivalent to such a power as would raise 33,000 foot-pounds per
minute. I make no apology for dwelling to such an extent on this
point, but since at least one writer on steamships has seen fit to refer
to this assessment of horse-power as being entirely arbitrary, and to
admit in the same paragraph that he was altogether ignorant as to
what power a horse was actually capable of producing, I have
thought it not inappropriate to make the point clear in the mind of the
reader.
THE MARQUIS DE JOUFFROY’S STEAMBOAT.

From Mr. R. Prosser’s Pen-and-Ink Sketch in the Victoria and Albert Museum, South Kensington.
Let us now cross the Channel again to France, and

remembering that Watt had patented his engine in 1769 and that
Périer, after seeing one of the Englishman’s engines, had installed
one in his boat on the Seine in 1775, and failed in his experiment, let
us see the attempts at steamboat navigation continued by the
Marquis de Jouffroy. Here again writers have cast some doubt on the
achievements accomplished by this distinguished Frenchman, but if
we turn to an interesting little book entitled “Une Découverte en
Franche-Comté au XVIIIe siècle. Application de la vapeur à la
navigation,” by Le Mis. Sylvestre de Jouffroy D’Abbans (Besançon,
1881), we shall find the facts verified. Briefly, the story is that in 1776
the Marquis, undismayed by Périer’s failure, obtained a Watt engine
suitable for his boat, which was only 13 metres long, and in width 1
metre 91 centimetres, so that she was quite a small craft. She was
propelled by steam, the revolving blades being 2 metres 60
centimetres in length and suspended on each side of the ship near
the bows. The engine was placed in the middle of the boat and
worked the revolving blades by means of chains. This experiment
took place at Baume-les-Dames, though it does not appear to have
contributed much to the ultimate success of steam navigation. But in
1781 this same François Dorothée, Comte de Jouffroy D’Abbans,
made a much bolder essay and built a far larger steamboat, which
measured 46 metres long, 5 metres wide, and had a draught of 1
metre. This steamship was tried at Lyons on the Saône on July 15,
1783, not 1781 nor 1782, as some writers have asserted. Her
success was undoubted, for she went against the stream from Lyons
to the Isle of Barbe several times, not in any secret manner, but in
the presence of 10,000 witnesses. There is no possible doubt, for
the interesting event was duly attested and, I believe, this declaration
exists still in Paris. The illustration here given has been
photographed from the pen-and-ink sketch which was copied in the
year 1830 by Mr. R. Prosser from a French print that was published
in 1816, and was alleged to represent this steamboat to which we
are referring. But this illustration, from the fact that it was issued so
many years after the occurrence, and also that it differs in some
details as given by French writers, should be regarded with caution.
It shows a boat whose paddle-wheels are turned by a single
horizontal steam cylinder, the piston-rod engaging the shaft of the
paddle-wheels by means of a ratchet arrangement which will be
easily recognised. But it is also affirmed that Jouffroy’s vessel of
1783 had two cylinders, that the piston of each of these was
connected with an iron flexible chain, and that these revolved the
paddle-wheels. The latter were 14 feet in diameter and the paddle-
boards themselves were 6 feet wide. The two cylinders were placed
behind each other and communicated with each other by means of a
wide tube. The French Revolution followed, in 1789, when the
Marquis de Jouffroy, in order to save his life, had to go into exile for
some time, and on his return, ere he was able to obtain a patent for
his achievement, someone else had stepped in and forestalled him.
In the meantime, in England, something more practicable than
Hulls’ efforts had brought about was to be witnessed. If the reader
will examine the illustration facing this page he will see a model of a
curious double-hulled ship, which was one of eight or more paddle-
propelled vessels that were employed in the experiments carried out
by Patrick Miller, a wealthy Edinburgh banker. This particular vessel
was built at Leith in 1787, and it is amusing to see in her that old
idea of physical propulsion brought forward once more. Between the
two hulls sufficient space was left for the insertion of five paddle-
wheels, 7 feet in diameter, immediately behind each other, which
were driven by thirty men, heaving away at the capstan placed on
deck. We find pretty much the same speed to be obtained as in the
experiments which we have mentioned in connection with other craft
thus propelled, for the best effort when all these hands were working
to get her through the water appears to have been under 4½ knots
per hour. In our illustration she is seen with masts and sails which
she used when the paddle-wheels were lifted out of the water and
placed on deck. It will be noticed that she was steered by a couple of
rudders; her displacement was 255 tons. This probably represents
the final development of Miller’s design using muscular power, but an
earlier and smaller ship belonging to the previous year carried only
two paddle-wheels, 6 feet in diameter and 4 feet wide, which were
placed on each side of the middle hull, for this ship was not double-
but triple-hulled.
PATRICK MILLER’S DOUBLE-HULLED PADDLE-BOAT.
From the Model in the Victoria and Albert Museum.

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Financial Reporting Financial

Statement Analysis and Valuation 9th

8.1 Capitalization versus Expensing Decision.

8.5 Capitalization of Software Development Costs. Adobe capitalizes software

8.7 Earnings Management and Depreciation Measurement.

manage earnings accelerates expense recognition relative to capitalization.

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

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

8.11 Equity Method for Minority, Active Investments.

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

8.15 Analyzing Disclosures Regarding Fixed Assets.

b. Accumulated depreciation, Year-end ... $ 611 $ 2,517 $ 1,348

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

e. NewMarket Monsanto Olin

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

8.16 Asset Impairments.

of $1,200,000 to justify a $109,809 impairment charge. The company would

Fair value of Vineyard unit at 12/31/17 ............................................. $1,800,000

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

8.17 Upward Revaluations under IFRS.

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

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

8.19 Effect of an Acquisition on the Date of Acquisition Balance Sheet (amounts in

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

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

b. Consolidation Worksheet for Ormond Company and Daytona Company 2017

Balance Sheet (12/31/17)

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

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

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

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

8.21 Variable-Interest Entities.

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

8.22 Accounting for a Merger under the Acquisition Method.

a. Financial Statement Effects of a Merger

Cash 3,000,000 Accounts Payable 400,000

Legal and Management Costs

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

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

a. Allocations of Fair Value

b. Investor Interests in Booking, Inc.

Prestige Properties Noncontrolling

c. Consolidation worksheet at December 31, 2018:

Consolidation Worksheet at December 31, 2018

Cash $ 780 $ 600 $ 1,380

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

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

b. Net Monetary asset (liability)

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

a. Translation of the Accounts of Canadian Subsidiary

Canadian Exchange U.S.

Retained Earnings Statement:

Computation of Translation Adjustment for Year 1

Canadian Exchange U.S.

b. Translation of the Accounts of Canadian Subsidiary

Canadian Exchange U.S.

Retained Earnings Statement:

Computation of Translation Loss for Year 1

Canadian Exchange U.S.

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

a. Translation of the Accounts of Canadian Subsidiary

Canadian Exchange U.S.

Retained Earnings Statement: