Chapter 3

Introduction to Consolidation: The Balance Sheet

SUMMARY OF ASSIGNMENT MATERIAL

Item Topic Covered Level TimeQ3.1 Discussion of why consolidated

statements are required for reporting following a business combination recorded as a stock acquisition.

Low 5-10

Q3.2 Understanding the nature of the consolidated entity.

Low 5-10

Q3.3 Explanation of why working paper eliminations are needed to eliminate double counting.

Low 5-10

Q3.4 Discussion of the concept of control in consolidation policy.

Mod 10-15

Q3.5 Reason for presence of both purchase premium and negative goodwill.

Low 5-10

Q3.6 Reconciliation of presence of positive goodwill when a purchase discount exists.

Mod 5-10

Q3.7 Procedure for valuation of individual assets and liabilities of S when neither a purchase premium nor a purchase discount exists.

Mod 10-15

Q3.8 Differences between consolidated statements and post-merger combined

Mod 10-15

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statements (as in Chapter 1).

3-2

SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)

Item Topic Covered Level TimeQ3.9 Explanation of whether the

wholly-owned versus partially owned subsidiary scenarios affect the total amount of reported consolidated assets.

Mod 10-15

Q3.10 Treatment of subsidiary's dividends unpaid at date of business combination.

Mod 10-15

Q3.11 Treatment of subsidiary's goodwill under purchase accounting.

Low 5-10

Q3.12 Explanation of assumptions underlying recognition of goodwill.

Mod 5-10

E3.1 Recording purchase combinations, investment eliminations, calculations of consolidated assets and retained earnings.

Low 15-20

E3.2 Investment eliminations under seven alternative stock purchase plans.

Mod 15-20

E3.3 Elimination entry and preparation of consolidated balance sheet for a pooling combination.

Mod 15-20

E3.4 Working paper entries to prepare consolidated balance sheet under purchase and pooling alternatives; purchase

Mod 20-25

3-3

premium and fair value adjustments.

3-4

SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)

Item Topic Covered Level TimeE3.5 Working paper entries to

prepare consolidated balance sheet in purchase combination; purchase premium and negative goodwill.

Mod 20-25

E3.6 Completion of elimination entries and working backward to book values.

Mod 15-20

E3.7 Consolidated balance sheet purchase premium and goodwill.

Mod 20-30

E3.8 Allocation of purchase premium and purchase discount; negative goodwill.

Mod 20-25

E3.9 Reconstruct working paper eliminations from pre-acquisition and consolidated information and compute acquired company's total assets.

Mod 20-25

E3.10 Under the purchase method, reconstruct the entry to record the business combination, the subsidiary's balance sheet, and the consolidation elimination entry.

Low 15-20

E3.11 Working backwards from elimination entries.

Mod 15-20

E3.12 Application of SFAS 94 and FASB 1999 Exposure Draft.

High 15-20

3-5

P3.1 Schedule to allocate purchase premium, working paper eliminations and consolidated balance sheet.

Mod 20-30

3-6

SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)

Item Topic Covered Level TimeP3.2 Consolidated balance sheet

working paper and formal consolidated balance sheet; purchase premium.

Mod 20-30

P3.3 Consolidated balance sheet working paper; unpaid dividends at acquisition, goodwill recorded by subsidiary, purchase premium and consolidated goodwill; pooling of interests.

Mod 50-60

P3.4 Consolidated balance sheets under complete ownership and partial ownership assumptions; purchase premium, purchase discount, and negative goodwill.

High 50-60

P3.5 Consolidated balance sheet working paper; purchase discount, positive and negative goodwill, minority interest.

Mod 50-60

P3.6 Reconstruction of consolidation elimination entry and P's balance sheet given consolidated balance sheet and S's balance sheet.

High 30-40

P3.7 Consolidation of three subsidiaries including the preparation of the consolidated balance sheet at combination date and the preparation of

Mod 30-40

3-7

elimination entries to consolidate each of the three subsidiaries.

3-8

SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)

Item Topic Covered Level TimeP3.8 Reconstruct working paper

eliminations and subsidiary's separate balance sheet from parent's separate balance sheet and consolidated balance sheet.

High 30-40

P3.9 Consolidated balance sheet under purchase and pooling of interests; effect on future income.

Mod 40-50

P3.10 Analysis of elimination entries for purchase and pooling; finding various data.

Mod 30-40

P3.11 Consolidated balance sheet working paper with both a purchased and a pooled subsidiary; no purchase premium or fair value adjustments.

Mod 30-40

P3.12 Consolidation policy; analysis using FASB 1999 Exposure Draft.

High 30-40

3-9

CARRYBACK TABLE

The carryback table identifies the assignment items which are new in this edition and those which are carried over from the seventh edition. For the latter, the problem number in the seventh edition is shown.

New Problem Number

SourceNew

Problem Number

Source

New Problem Number

Source

Q3.1 Q3.1 E3.1 E3.11 P3.1 P3.1Q3.2 Q3.2 E3.2 E3.2 P3.2 P3.2Q3.3 Q3.3 E3.3 new P3.3 P3.3Q3.4 Q3.4 E3.4 E3.4 P3.4 P3.9Q3.5 Q3.5 E3.5 E3.5 P3.5 P3.5Q3.6 Q3.6 E3.6 E3.6 P3.6 P3.6Q3.7 Q3.7 E3.7 E3.7 P3.7 P3.7Q3.8 Q3.8 E3.8 E3.8 P3.8 P3.8Q3.9 Q3.9 E3.9 E3.9 P3.9 P3.41

Q3.10 Q3.10 E3.10 E3.101 P3.10 P3.10

Q3.11 Q3.111

E3.11 E3.11 P3.11 P3.11

Q3.12 Q3.12 E3.12 E3.12 P3.12 P3.12

1 Revised for requirements of SFAS 141 and SFAS 142.

Carryforward tables for all chapters, identifying the disposition of seventh edition assignment items, appear at the beginning of the solutions manual.

3-10

ANSWERS TO QUESTIONS

Q3.1

In the case of a business combination recorded as a merger, the acquired company is absorbed into the acquiring company, resulting in a single entity. There is only one set of accounting records, and thus no consolidation is needed. In the case of a business combination recorded as a stock acquisition, both companies remain as separate entities, with their own accounting records. Consolidation is required to present one set of financial statements for this single economic entity.

Q3.2

While the parent company (P) is a legal entity and the subsidiary company (S) is a legal entity, the consolidated company (P+S) is not a legal entity in a strict sense. There is, however, considerable economic meaning to the consolidated entity. P controls the combined resources and operations of both companies. Investors and creditors would recognize this, and view P+S as the relevant entity for their investment or lending decisions. Under some circumstances, tax law recognizes P+S as the tax-paying entity. Thus, while P+S is an accounting creation, it is deemed to represent the economic reality of common ownership.

Q3.3

When two affiliated corporations engage in transactions with one another, double counting generally results. For example, an intercompany sale of merchandise will result in both companies recording Purchases (or Cost of Goods Manufactured) for the same merchandise. Similarly, the internal sale and the subsequent external sale mean that

3-11

Sales of the same goods are recorded twice within the same reporting entity.

3-12

Q3.3 (cont=d.)

The Investment in S duplicates the net assets of the subsidiary and the parents' stockholders' equity represents control over the subsidiary's stock as represented by the subsidiary's stockholders' equity. There are other examples.

Double counting is eliminated in consolidation so that consolidated assets, liabilities, revenues and expenses will not include internal transactions and, accordingly, will not be overstated.

Q3.4

Control involves unshared decision-making power over assets. An individual company possesses that unshared power over its own assets, enabling it to include them in its own balance sheet. Only when a parent has that same degree of control over a subsidiary=s assets is it appropriate to consolidate the subsidiary=s assets (and liabilities) and include them with those of the parent.

Legal control is the unconditional ability to direct decision-making and is indicated by direct or indirect ownership of a majority of another entity=s voting shares, enabling the parent to direct decision-making by dominating a subsidiary=s governing board. In contrast, effective control exists when a parent possesses that decision-making power without majority ownership. By its very nature effective control is somewhat more tentative than legal control and, as the text discussion indicates, is conditioned on the strength of the parent=s interest and the weakness of other interests in a subsidiary.

Q3.5

A purchase premium results when the investment cost is greater than the book value of the net assets required. Negative goodwill arises when the fair value of the net assets

3-13

acquired exceeds the investment cost. The two are not mutually exclusive. While the more common case involves a purchase premium and positive goodwill, there is no inherent reason why negative goodwill could not have been present instead.Q3.6A purchase discount results when the investment cost is less than the book value of the net assets required. (Positive) goodwill arises when the fair value of the net assets acquired is less than the investment cost. The two are not mutually exclusive. While the more common case involves a purchase premium and positive goodwill, there is no inherent reason why a purchase discount could not have been present instead.

Q3.7

The identifiable assets and liabilities of a purchased company must be stated at their fair values at date of business combination. This is done when consolidated statements are prepared in a stock acquisition; for other types of business combinations the allocation takes place on the books of the acquiring company. The need for establishing these fair values is independent of the existence of a purchase premium or discount. Without the need to allocate a purchase premium or discount, the fair value adjustments may be made directly on the consolidated working paper. Alternatively, the schedule used in the text to allocate a purchase premium or discount could also be used here. Some items would be above book value, others below. In sum, the net difference between book and fair value is zero. Equivalently, a redistribution has taken place as a way of allocating a zero purchase premium (discount).

Q3.8

In a stock acquisition, the combining companies continue as separate legal entities with their own separate financial statements. Consolidated statements which bring together

3-14

these separate statements are prepared only for reporting purposes and the necessary allocation of any purchase premium or discount must be made at consolidation points. Since the companies acquired in a statutory merger or statutory consolidation lose their separate legal identities, the allocation is made by the acquiring company on its books at date of acquisition. Other things being equal, the financial statements following a merger would be no different from consolidated statements prepared after a stock acquisition.Q3.9

The total consolidated assets could be different in such a case. A difference would occur in the case where the purchase method is used and fair values of the subsidiary's net assets differ from book values. The reason for a difference is that fair value adjustments are recorded only to the extent of the parent's ownership interest. Thus 100 percent of the fair value adjustment would be recorded in the wholly-owned case, and less than 100 percent would be recorded in the partially-owned case.

Note that no difference would occur if (a) the pooling of interests method were used or (b) the purchase method were used and investment cost equaled book value of net assets acquired.

Q3.10

To compute the purchase premium, the dividends of $80,000 declared on the shares of S held by P must be offset against the investment account. S's stockholders' equity of $2,000,000 already has been reduced by the entire $100,000 dividend declaration. Thus the purchase premium is $20,000 (= $1,700,000 - $80,000 - .8($2,000,000)). P must explicitly recognize the $80,000 in dividends as follows.

Dividends Receivable 80,003-15

0Investment in S 80,00

0To record P's share of dividends declared by S company.

3-16

Q3.11

Goodwill recorded by a subsidiary is ignored when assigning fair values to S's identifiable assets and liabilities. At most, the subsidiary's goodwill would be reflected in any purchased goodwill implicit in the parent's purchase price. Only $720,000 is carried to consolidated assets.

Q3.12

The assumption underlying recording goodwill as an asset is that the investment cost represents a fair price for the interest in S that was acquired, and that the tangible and intangible items acquired have future value. It is assumed that the investment cost arises from a market process that fairly values these items.

In some cases, this assumption may not be warranted. An acquisition price could be too high, especially if the acquisition follows a bidding process where egos of the acquiring executives get involved. If an excessive price is paid, the excess should not be considered an asset.

Unfortunately, there is no good way to determine if an acquisition price is excessive. Much judgement is involved. Thus the assumption that a fair market price was reached typically prevails.

SOLUTIONS TO EXERCISES

E3.1COMBINATION AND CONSOLIDATION

Investment in S 150,000Common Stock 15,000Additional Paid-in Capital 135,000

To record the acquisition of 90 percent of S Company=s outstanding stock through an exchange of 15,000 shares of P Company stock worth $150,000.

Common Stock-S 30,000Additional Paid-in Capital-S 70,000Retained Earnings-S 40,000Purchase Premium (Goodwill)

24,000

Investment in S 150,000Minority Interest in S 14,000

To eliminate the investment in S against the stockholders= equity of S Company and establish the purchase premium (attributable to goodwill) and the minority interest.

Consolidated Assets: $1,224,000 (=$1,000,000 + $200,000 + $24,000)

Consolidated Retained Earnings: $300,000 (P Company's retained earnings

only.)

E3.2ELIMINATION ENTRY: VARIOUS CASES

Working Paper Eliminations(000 Eliminated)

Dr. (Cr.)

1. (100%)

2. (100%)

3. (100%)

4. (80%) 5. (80%)

6. (80%)

7. (80%)

Common Stock 1,000 1,000 1,000 1,000 1,000 1,000 (1) 5,000

Additional Paid-In Capital 300 300 300 300 300 300 (2)

4,300Donated Capital 100 100 100 100 100 100 100Appropriated Retained Earnings

150 150 150 150 150 150 150

Retained Earnings 350 350 350 350 350 350 350Purchase Premium (Discount)

100 - (300) 80 - (240) 80

Minority Interest in Saturn - - - (380) (380) (380) (1,980)Investment in Saturn (2,000) (1,900) (1,600) (1,600) (1,520) (1,280) (8,000)

(1) $1,000,000 + (400,000 x $10) (2) $300,000 + 400,000 ($20 - $10)

E3.3CONSOLIDATING A POOLING OF INTERESTS

Requirement 1:

Consolidated Financial Statement Working PaperCommon Stock - S 100,000Additional Paid-In Capital - S 700,000Retained Earnings - S 800,000

Investment in S 1,600,000

Requirement 2:

Consolidated Financial Statement Working PaperCommon Stock - S 100,000Additional Paid-In Capital - S 700,000Retained Earnings - S 800,000

Investment in S 1,440,000Minority Interest in S 160,000

Requirements 3 and 4:P and S Companies

Consolidated Balance SheetsRequirement 3

(100%)Requirement 4

(90%)Assets $8,000,000 $8,000,000Liabilities $3,400,000 $3,400,000Minority Interest in S C 160,000Common Stock, Par Value $1 700,000 680,000Additional Paid-In Capital 1,600,000 1,540,000Retained Earnings 2,300,000 2,220,000

$8,000,000 $8,000,000NOTE: Common stock includes the par value of the new shares issued by P and retained earnings includes P=s share of S=s retained earnings. Additional paid-in capital includes P=s precombination amount plus P=s share of S=s total paid-in capital - par value of P shares issued; e.g., $2,220,000 = $1,500,000 + .9($100,000 + $700,000) - $180,000.

E3.4ELIMINATION ENTRIES: PURCHASE vs POOLING

Requirement 1:

Consolidated Financial Statement Working Paper

Purchase Premium 300,000Investment in Small 300,000

To reclassify the purchase premium. $300,000 = $2,000,000 + $100,000 - .9($2,000,000)

Inventories [.9 ($1,140,000 - $1,040,000)] 90,000Plant Assets (net) [.9 ($1,800,000 - $1,600,000)] 180,000Long-Term Investments in Debt Securities [.9($80,000-$60,000)]

18,000

Goodwill 102,000Long-Term Debt [.9 ($500,000 - $600,000)] 90,000Purchase Premium 300,000

To allocate the purchase premium to Small's assets and liabilities and to Goodwill.

Capital Stock - Small 400,000Retained Earnings - Small 1,600,000

Investment in Small 1,800,000

Minority Interest in Small 200,000To eliminate the Investment in Small against the stockholders' equity of Small and establish the minority interest.

E3.4 (cont=d.)

Requirement 2:

Consolidated Financial Statement Working Paper

Capital Stock - Small 400,000Retained Earnings - Small 1,600,000

Investment in Small 1,800,000Minority Interest in Small 200,000

To eliminate the Investment in Small against the stockholders' equity of Small and establish the minority interest.

E3.5ELIMINATION ENTRIES

Consolidated Financial Statement Working PaperPurchase Premium 240,000

Investment in S [$240,000 = $2,200,000 +$40,000 - .8 ($2,500,000)] 240,000

To reclassify the purchase premium.

Inventories [.8($1,600,000-$1,500,000)] 80,000 Land 67,200 (1)Other Plant Assets 108,800 (2)Long-Term Investment in Debt Securities [.8 ($250,000 - $200,000)]

40,000

Long-term Debt [.8($470,000-$400,000)] 56,000Purchase Premium 240,000

To allocate the purchase premium among the assets and liabilities of S Company.

Negative Goodwill = $240,000 - .8 ($100,000 + $100,000 + $200,000 + $50,000 - $70,000)

= $240,000 - $304,000= ($64,000)

(1) $ 67,200 = .8($100,000-[($200,000/$1,000,000)x$64,000] = $80,000 - $12,800(2) $108,800 = .8($200,000)-[($800,000/$1,000,000)x$64,000] = $160,000 - $51,200

Stockholders' Equity - S 2,500,000Investment in S 2,000,000Minority Interest in S 500,000

To eliminate the investment accountagainst the stockholders' equity of S and establish the minority interest.

E3.6INTERPRETING ELIMINATION ENTRIES

Requirement 1:

The missing values in the two entries are as follows:(a) $15,000 ($750 minority interest/.05 minority ownership)(b) $33,750 ($48,000 + $750 - $15,000)(c) $4,300 (after solving for (d), $3,800 + $4,750 +

$33,750 - $38,000)(d) $33,750 (must be same as (b))

Requirement 2:

The book value of S's assets and liabilities at time of acquisition are as follows:Current assets $30,00

0In the purchase premium allocation, current assets are reduced by $3,800. Thus, the given fair value of $26,000 must be $4,000 (=$3,800/.95) less than book value.

Noncurrent assets

55,000 In the purchase premium allocation, noncurrent assets are increased by $38,000. Thus the given fair value of $95,000 must be $40,000 (=$38,000/.95) more than book value.

Current liabilities 20,000 Same as fair value, since there is no adjustment in the purchase premium allocation.

Noncurrent liabilities

50,000 In the purchase premium allocation, noncurrent liabilities are increased by $4,750. Thus the given fair value of $55,000 must be $5,000 (=$4,750/.95) more than book value.

E3.7CONSOLIDATED BALANCE SHEET

Bates, Inc. and Wilkens Corp.Consolidated Balance Sheet

January 31, 20X0

ASSETSCurrent Assets $ 945,000(1)Plant and Equipment, net 4,740,000(2)Goodwill 910,000(3)Total Assets $6,595,000LIABILITIES AND STOCKHOLDERS = EQUITY Current Liabilities $ 650,000 Long-Term Liabilities 2,300,000 Total Liabilities $2,950,000Minority Interest in Wilkins Corp. $ 45,000(4)Common Stock ($10 par value) 500,000(5)Additional Paid-in Capital 2,000,000(6)Retained Earnings 1,100,000 Total Stockholders= Equity $3,645,000Total Liabilities and Stockholders= Equity $6,595,000

(1) $945,000 = $1,000,000 - $300,000 + $200,000 + .9($50,000).(2) $4,740,000 = $3,500,000 + $700,000 + .9($600,000).(3) $910,000 = $1,900,000 - .9($50,000 + $600,000 + $450,000).(4) $45,000 = .1($450,000).(5) $500,000 = $300,000 + 20,000($10).(6) $2,000,000 = $600,000 + 20,000 ($80 - $10).

E3.8ALLOCATION OF PURCHASE PREMIUM AND PURCHASE DISCOUNT

Requirement 1:

Cost of acquisition $3,075,000

Book value acquired (.8 x $1,600,000) 1,280,000Purchase premium $1,795,00

0

FV BV FV-BV Alloc (80%)

Cash and receivables $

100,000 $

100,000 B B

Inventories 500,000 400,000 $ 100,000

$ 80,000

Land 600,000 300,000 300,000 240,000 Buildings, net 2,400,00

0 1,500,00

0 900,000 720,000

Equipment, net

1,800,000

1,200,000

600,000 480,000

Long-term investments 850,000 600,000 250,000 200,000 Current liabilities

(700,000) (700,000) B B

Long-term liabilities (2,100,00

0)(1,800,00

0)(300,000) (240,000

)$3,450,0

00$1,600,0

00$1,850,0

001,480,000

Goodwill 315,000 Total purchase premium

$1,795,000

E3.8 (cont=d.)

Requirement 2:

Cost of acquisition $2,305,000

Book value acquired (.9 x $1,600,000) 1,440,000Purchase premium $

865,000

FV BV FV-BV Alloc (90%)

Cash and receivables $

100,000 $

100,000 B B

Inventories 500,000 400,000 $ 100,000

$ 90,000

Land 600,000 300,000 300,000 270,000 Buildings, net 2,400,00

0 1,500,00

0 900,000 810,000

Equipment, net

1,800,000

1,200,000

600,000 540,000

Long-term investments 850,000 600,000 250,000 225,000 Current liabilities

(700,000) (700,000) B B

Long-term liabilities (2,100,00

0)(1,800,00

0)(300,000) (270,000

) $3,450,0

00$1,600,0

00$1,850,0

001,665,000

Negative Goodwill (800,000)Total purchase premium

$ 865,000

The second stage of the allocation process involves the

allocation of $800,000 in negative goodwill among land, and buildings and equipment.

E3.8 (cont'd.)Allocation

(1) (2) (3)[(2)x$800,000]

(4) (5)[(4)-(3)]

Noncurrent Asset Fair Value

Percent of Fair Value

Allocation of Negative Goodwill

Initial Allocation Final Allocation

Land $ 600,000

12.5% $100,000 $ 270,000

$170,000

Buildings 2,400,000

50.0% 400,000 810,000 410,000

Equipment

1,800,000

37.5% 300,000 540,000 240,000

$4,800,000

100.0%

$800,000 $1,620,000

$820,000

Inventories 90,000 Long-term investments 225,000 Long-term liabilities (270,000)

Total purchase premium $865,000

E3.9RECONSTRUCTION OF ELIMINATION ENTRIES AND BOOK VALUE

Requirement 1:Since all of Bay's identifiable assets and liabilities were fairly stated, the purchase premium must equal the Goodwill of $340,000. Therefore, the book value of 90 percent of Bay's stock was $1,260,000 (=$1,600,000 - $340,000). Bay's total stockholder's equity was $1,400,000 (=$1,260,000/.9) and the minority interest amounts to $140,000. The following working paper entries were made in consolidation.

Consolidated Financial Statement Working Paper

Goodwill 340,000Investment in Bay 340,000

To reclassify the purchase premium as Goodwill.

Stockholder's Equity - Bay 1,400,000Investment in Bay 1,260,000Minority Interest in Bay 140,000

To eliminate the investment account against the stockholders' equity of Bay and establish the Minority Interest.

Requirement 2:

Before the acquisition, Cove's total assets amounted to $9,000,000 (=$5,200,000 + $3,800,000). Recording the acquisition of Bay left this total unchanged since the cash spent of $1,600,000 was replaced by the investment account with the same balance. Since consolidated total assets were $13,000,000, and Cove's total assets were $9,000,000, Bay's total assets appear to have been $4,000,000 (=$13,000,000 - $9,000,000). Because $1,260,000 of Cove's Investment in Bay

was eliminated (the goodwill of $340,000 remains), however, Bay's total assets actually amounted to $5,260,000 [=$13,000,000 - ($9,000,000 - $1,260,000)].

E3.10 RECONSTRUCTING ELIMINATION ENTRIES, SUBSIDIARY'S BALANCE SHEET, AND ACQUISITION ENTRY

Requirement 1:

Arnold's entry to record the business:

Investment in Oliver 400,000Common Stock 200,000Additional Paid-in Capital 200,000

Requirement 2:Oliver Corp.

Balance SheetCurrent Assets $100,000Noncurrent Assets 300,000

$400,000Current Liabilities $ 50,000Noncurrent Liabilities 50,000Stockholders= Equity 300,000

$400,000

Requirement 3:

Consolidation elimination entry:

Goodwill 100,000Stockholders= Equity - Oliver 300,000

Investment in Oliver 400,000

E3.11 INTERPRETING ELIMINATION ENTRIES

Requirement 1:

At least $11,000 ($10,000 + ($800/.8)). But since there is no goodwill, the fair value may have initially been higher, but negative goodwill resulted and the fair value of equipment (a noncurrent asset) was reduced.

Requirement 2:

In this case, $11,000.

Requirement 3:

Stockholders' Equity - S 2,800Purchase Premium ($3,000 - .9 x $2,800) 480

Investment in S 3,000Minority interest 280

E3.12 CONSOLIDATION POLICY

Requirement 1:

Randolph owns 64% of the voting rights [.64 = (.8 X .60) + (.4 X .40)], and meets the majority ownership test for consolidation of SFAS 94.

Requirement 2:

The 1999 FASB ED also recognizes the legal control signified by ownership of 64% of the voting rights and consolidation would occur.

Requirement 3:

Randolph=s ownership of the Class A shares produces 48% ( = .8 X .60) of the voting interest. The other investor owns 40% of the voting rights. Thus none of the 1999 ED=s presumptions of control exist and decision-making authority appears to be shared. However, the influence of the other 12% of the Class A shares voting rights would have to be examined. If Randolph can demonstrate sufficient influence over that other 12% to dominate Marshall=s governing board, effective control may exist, but it seems unlikely without additional information. In sum, the available evidence points away from consolidation.

Requirement 4:

Now Randolph owns 42% ( = .7 X .60) of the voting interest and all other interests are dispersed, representing one of the 1999 ED=s presumptions of control. These facts suggest that Randolph can dominate Marshall=s governing board thereby possessing unshared decision-making power and consolidation would be required under the 1999 ED.

SOLUTIONS TO PROBLEMS

P3.1 CONSOLIDATED BALANCE SHEET--PURCHASE PREMIUM

Requirement 1:P Corporation and S Corporation

Schedule for Determining and Allocating thePurchase Premium Arising in the Stock Acquisition of January 2, 20X2

Cost of the acquisition $18,000,000Book value of the stockholders' equity acquired:

Common stock $ 1,000,000Additional paid-in capital 500,000Retained earnings 1,800,000Other comprehensive income (300,000)

Total book value of S $ 3,000,000Purchase Premium $15,000,000

Assets and Liabilities of S Corporation Fair Value Book Value (FV-BV)

Allocation Based on P = s Interest

(100%)Cash $ 800,000 $ 800,000 - -Accounts receivable, net

550,000 550,000 - -

Inventory 1,250,000 1,250,000 - -Plant assets, net 16,000,000 3,100,000 12,900,00

012,900,000

Other assets 700,000 700,000 - - Current liabilities (900,000) (900,000) - -Long-term debt (2,000,000) (2,500,00

0)500,000 500,000

$16,400,000 $3,000,000

$13,400,000

$13,400,000

Goodwill 1,600,000Total purchase $15,000,000

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premium

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P3.1 (cont'd.)

Requirement 2:Consolidated Balance Sheet Working Paper

Common Stock 1,000,000

Additional Paid-in Capital - S 500,000Retained Earnings - S 1,800,000Purchase Premium 15,000,00

0Other Comprehensive Income - S

300,000

Investment in S 18,000,000

To eliminate the Investment in S against the stockholders' equity of S and establish the purchase premium.

Plant Assets, net 12,900,000

Long-Term Debt 500,000Goodwill 1,600,00

0Purchase Premium 15,000,00

0To allocate the purchase premium to the assets and liabilities of S and establish goodwill of $1,600,000.

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P3.1 (cont=d.)

Requirement 3:

P Corporation and S Corporation Consolidated Balance Sheet

January 2, 20X2

ASSETSCash $ 4,100,000Accounts Receivable, net 2,550,000Inventories 2,450,000Plant Assets, net ($3,000,000+$3,100,000+$12,900,000)

19,000,000

Other Assets 2,300,000Goodwill 1,600,000 Total Assets $32,000,000LIABILITIES AND STOCKHOLDERS' EQUITYCurrent Liabilities $ 3,400,000Long-Term Debt ($8,000,000+$2,500,000-$500,000)

10,000,000

Total Liabilities $13,400,000Common Stock 10,000,000Additional Paid-in Capital 3,500,000Retained Earnings 4,500,000Other Comprehensive Income 600,000 Total Stockholders' Equity $18,600,000 Total Liabilities and Stockholders' Equity $32,000,000

3-40

P3.2CONSOLIDATION WORKING PAPER--PURCHASE PREMIUM, MINORITY INTEREST

Requirement 1:

Investment cost $12,000,000Book value of the stockholders' equity acquired:

Common stock (.75 X $3,000,000) $ 2,250,000Additional paid-in capital (.75 X $1,400,000) 1,050,000Retained earnings (.75 X $1,700,000) 1,275,000

Book value of 75% of Spear=s stockholders= equity $ 4,575,000Purchase Premium $ 7,425,000

Assets and Liabilities of Spear Company Fair Value Book Value (FV-BV) Allocation Based on

P = s Interest (75%) Cash $ 1,800,000 $1,800,000 - -Accounts receivable, net

1,700,000 1,700,000 - -

Inventory 1,900,000 2,300,000 (400,000) (300,000)Plant assets, net 8,000,000 4,000,000 4,000,000 3,000,000 Patents 4,800,000 1,000,000 3,800,000 2,850,000 Current liabilities (2,000,000) (2,000,000

)- -

Other liabilities (3,600,000) (2,700,000)

(900,000) (675,000)

$12,600,000 $6,100,000 $6,500,000

$4,875,000

Goodwill 2,550,000Total purchase premium

$7,425,000

3-41

P3.2 (cont'd.)Requirement 2:

Pierce Company and Spear CompanyConsolidated Balance Sheet Working Paper, 7/1/X8, α = .75

(000 Eliminated)Adjustments & Eliminations

ASSETS Pierce Spear Dr. Cr. ConsolidatedCash 6,300 1,800 8,100 Receivables, net 5,400 1,700 7,100 Inventory 3,200 2,300 (2)

3005,200

Plant assets, net 13,000 4,000 (2) 3,000

20,000

Investment in Spear (75%) 12,000 - (1) 7,425

(3) 4,575

Patents 2,200 1,000 (2) 2,850

6,050

Purchase Premium - - (1) 7,425

(2) 7,425

Goodwill - - (2) 2,550

2,550

Total Assets 42,100 10,800 15,825 19,725 49,000

LIABILITIES AND STOCKHOLDERS = EQUITY Current Liabilities 2,500 2,000 4,500 Other Liabilities 18,000 2,700 (2)

67521,375

Capital Stock-Pierce 10,000 - 10,000 Capital Stock-Spear - 3,000 (3) 3,000Additional Paid-in Capital-Pierce

5,000 - 5,000

Additional Paid-in Capital-Spear

- 1,400 (3) 1,400

Retained Earnings-Pierce 7,500 - 7,500 Retained Earnings-Spear - 1,700 (3) 1,700

3-42

Treasury Stock (900) - (900)Minority Interest in S - - (3)

1,525 1,525

Total Liabilities and Stockholders= Equity 42,100 10,800 6,100 2,200 49,000

21,925 21,925(1) To reclassify the purchase premium.(2) To allocate the purchase premium.(3) To eliminate the Investment in Spear against the stockholders' equity of Spear and establish the minority interest

in Spear.

3-43

P3.2 (cont'd.)

Requirement 3:

Pierce Company and Spear Company Consolidated Balance Sheet

July 1, 20X8

ASSETSCash $ 8,100,000 Accounts Receivable, net 7,100,000 Inventory ($3,200,000+$2,300,000-$300,000) 5,200,000 Plant Assets, net ($13,000,000+$4,000,000+$3,000,000)

20,000,000

Patents ($2,200,000+$1,000,000+$2,850,000) 6,050,000 Goodwill 2,550,000 Total Assets $49,000,000LIABILITIES AND STOCKHOLDERS' EQUITYCurrent Liabilities $ 4,500,000 Other Liabilities ($18,000,000+$2,700,000+$675,000)

21,375,000

Total Liabilities $25,875,000Minority Interest in Spear (.25 X $6,100,000) $ 1,525,000 Common Stock 10,000,000 Additional Paid-in Capital 5,000,000 Retained Earnings 7,500,000 Treasury Stock (900,000) Total Stockholders= Equity $23,125,000 Total Liabilities and Stockholders' Equity $49,000,000

3-44

P3.3CONSOLIDATED BALANCE SHEET WORKING PAPER--PURCHASE PREMIUM, MINORITY INTEREST

Requirement 1Placid Corporation and Stagnant Company Consolidated

Balance Sheet Working Paper, 6/30/X0; α = .7(000 Eliminated)

Adjustments & Eliminations

ASSETS Placid Stagnant Dr. Cr. ConsolidatedCash & Receivables 7,945 2,000 (a)

56(1) 56

9,805

(3) 140

Marketable Debt Securities - 600 (3) 280

880

Inventory 7,000 2,400 (3) 140

9,540

Plant Assets, net 10,000 3,600 13,600Copyrights 1,000 200 (3)

1,2602,460

Goodwill - 500 (3) 109

(3) 500

109

Investment in Stagnant 4,215 - (a) 56

-

(2) 1,359

(4) 2,800

Purchase Premium - - (2) 1,359

(3) 1,359

-

Total Assets 30,160 9,300 36,394

LIABILITIES ANDSTOCKHOLDERS = EQUITY Current Liabilities 6,000 2,000 (1) 7,944

3-45

56Noncurrent Liabilities 4,000 3,300 (3)

2107,090

Capital Stock - Placid 200 - 200Capital Stock - Stagnant - 100 (4)

100-

APIC - Placid 4,960 - 4,960APIC - Stagnant 400 (4)

400Retained Earnings - Placid 15,000 - 15,000Retained Earnings - Stagnant - 3,500 (4)

3,500Minority Interest in Stagnant - - - (4)

1,200 1,200

Total Liab. and Stock. Equity 30,160 9,300 7,470 7,470 36,394

P3.3 (cont=d.)

(a) This adjusting entry records the dividends receivable from Stagnant and reduces the investment account accordingly; $56,000 = .7 x $80,000. The adjustment is based on the assumption that Placid's share of Stagnant's dividends was not deducted from the investment account at acquisition. Had the dividends been handled properly, the investment account would have been recorded at $4,159 (= $4,125 - $56) and Cash and Receivables shown at $8,001 (= $7,945 + $56), thereby negating the need for adjustment (a).

(1) To eliminate intercompany dividends receivable and payable.(2) To reclassify the purchase premium of $1,359,000.(3) To allocate the purchase premium among the assets and liability of Stagnant to

the extent of Placid's 70 percent interest and to establish purchased goodwill of $109,000. See Schedule A.

(4) To eliminate the Investment in Stagnant against 70 percent of the stockholders' equity of Stagnant and reclassify the remaining 30 percent as minority interest.

3-46

Even though Stagnant's goodwill is removed as part of the purchase premium allocation, the minority interest is not affected and is assigned 30 percent of Stagnant's recorded stockholders' equity.

3-47

P3.3 (cont'd.) Placid Corporation and Stagnant CompanySchedule for Determining and Allocating Purchase Premium

Cost of the Acquisition: Fair value of stock given $4,180,000 Direct cash costs 35,000 Total cost of the acquisition $4,125,000 Less unrecorded dividends receivable from Stagnant (.7 x $80,000) (56,000)Book value of stockholders' equity acquired (.7($1,000,000 + $3,000,000))

(2,800,000)

Purchase Premium $1,359,000

Assets and Liabilities of Stagnant

Fair Value Book Value (FV - BV)Allocation Based

on Placid=s Interest (70%)

Cash and Receivables $1,800,000 $2,000,000 $(200,000) $(140,000)

Marketable Debt Securities 1,000,000 600,000 400,000 280,000

Inventory 2,600,000 2,400,000 200,000 140,000

Plant Assets, net 3,600,000 3,600,000 -- --

Copyrights 2,000,000 200,000 1,800,000 1,260,000

Goodwill C 500,000 (500,000) (500,000)

Current Liabilities (2,000,000) (2,000,000) C C

Noncurrent Liabilities (3,000,000) (3,300,000) 300,000 210,000

$6,000,000 $4,000,000 $2,000,000 $1,250,000

Goodwill 109,000

Purchase Premium $1,359,000

3-48

P3.3 (cont'd.)

Requirement 2:Placid Corporation and Subsidiary

Consolidated Balance Sheet June 30, 20X0

ASSETSCash and Receivables $ 9,945,000

(1)Marketable Debt Securities 600,000 Inventory 9,400,000 Plant Assets, net 13,600,000 Copyrights 1,200,000 Goodwill 500,000 Total Assets $35,245,000LIABILITIES AND STOCKHOLDERS = EQUITY Current Liabilities $ 7,928,000

(2)Noncurrent Liabilities 7,300,000 Minority Interest in Stagnant 400,000 Capital Stock, par value $1 200,000 Additional Paid-in Capital 1,250,000 (3)Retained Earnings 18,167,000 (4)Total Liabilities and Stockholders= Equity $35,245,000

(1) $9,945,000 = $8,000,000 + $2,000,000 - $55,000. (2) $7,928,000 = $6,000,000 + $2,000,000 - $72,000 (= .9 x $80,000). (3) $1,250,000 = $900,000 + (.9($100,000 + $400,000)) -

$100,000. (4) $18,167,000 = $15,000,000 - $55,000 + $72,000

+ .9($3,500,000).Note: In calculating consolidated retained earnings, expenses of the business combination of $55,000 were deducted and the dividends to be received from Stagnant were added as

3-49

they will not be paid to outsiders.

3-50

P3.4CONSOLIDATED BALANCE SHEET--PARTIALLY OWNED SUBSIDIARY AND NEGATIVE GOODWILL

Requirements 1 and 2: 100% 90% Cost of the acquisition $1,800,00

0 $1,620,00

0 Book value of the stockholders= equity acquired (1,295,00

0)(1,165,50

0)Purchase Premium $

505,000 $

454,500

Allocation based onAssets and Liabilities of Saxon Fair Value Book Value (FV-BV) 100% 90% Cash and receivables $ 720,000 $ 720,000 Inventory 1,000,000 900,000 100,000 100,000 90,000 Equity Method Investments 250,000 300,000 (50,000) (50,000) (45,000)Land 420,000 175,000 245,000 245,000 220,500 Bldgs. and Equip. (net) 900,000 600,000 300,000 300,000 270,000

Current Liabilities (1,000,000) (1,000,000) - - Long-term Debt (290,000) (400,000

) 110,000 110,00

0 99,000

$2,000,000 $1,295,000 $705,000 $705,000

$634,000

Negative Goodwill (200,00 0)

(180,000)

Total Purchase Premium $505,000

$454,500

The negative goodwill must now be allocated among the noncurrent assets of Saxon, except for long-term investments in marketable securities, in accordance with their fair values. Total fair value of Buildings and Equipment and land is $1,320,000 (=$900,000 + $420,000). Of this amount, Buildings

3-51

and Equipment account for 68% (=$900,000/$1,320,000) and Land for 32% (=$420,000/$1,320,000). The final allocations for these accounts in part 1 follow.

3-52

P3.4 (cont'd.)

Requirement 1:

Allocation(1) (2) (3) (4)=(3)-(2)

Percent of Fair Value

Allocation ofNegative Goodwill((1) x $200,000)

P=s Interest (100%)

Final Allocation

Buildings and Equipment

68% $136,000 $300,000 $164,000

Land 32% 64,000 245,000 181,00 0

Total 100% $200,000 $545,000 $345,00 0

For Requirement 2, we allocate the negative goodwill of $180,000 in the next schedule.

Requirement 2:

(1) (2) (3) (4)=(3)-(2)Percent of Fair

ValueAllocation of

Negative Goodwill((1) x $180,000)

P=s Interest (90%)

Final Allocation

Buildings and Equipment

68% $122,400 $270,000 $147,600

Land 32% 57,000 220,500 162,90 3-53

0Total 100% $180,000 $490,500 $310,50

0

3-54

P3.4 (cont'd.)Paxon Corporation and Saxon Company

Consolidated Balance Sheets December 31, 20X2

ASSETS Req. 1 Req. 2Cash and Receivables

$1,780,000(1)

$1,960,000(4)

Inventory 2,700,000 2,690,000 Equity Method Investments

250,000 255,000

Land 1,006,000(2) 987,900(5)Equipment $4,164,000(3

)$4,147,600(6

)Less Acc. Depr. (1,000,000) 3,164,000 (1,000,000) 3,147,600

$8,900,000 $9,040,500LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities

$2,500,000 $2,500,000

Long-term Debt 2,290,000 2,301,000 Minority Interest in Saxon

B 129,500(7)

Common Stock, Par Value $1

500,000 500,000

Additional Paid-in Capital

1,200,000 1,200,000

Retained Earnings

2,410,000 2,410,000

Total Liabilities & Stockholders' Equity $8,900,000 $9,040,500

(1) $2,860,000 + $720,000 - $1,800,000.(2) $650,000 + $175,000 + $181,000.(3) $3,400,000 + $600,000 + $164,000.(4) $2,860,000 + $720,000 - $1,620,000.(5) $650,000 + $175,000 + $162,900.

3-55

(6) $3,400,000 + $600,000 + $147,600.(7) .1($100,000 + $350,000 + $845,000).

3-56

P3.4 (cont'd.)

Requirement 3

Purchase of the 80 percent interest for $1,000,000 generates a purchase discount of ($36,000); (= $1,000,000 - .8($100,000 + $350,000 + $845,000)). Initial allocation of the purchase discount leads to: Inventory $ 80,000 =.8($1,000,000 - $900,000)Equity Method Investments

(40,000) = .8($250,000) - $300,000)

Land 196,000 = .8($420,000 - $175,000)Buildings and Equip. (net)

240,000 = .8($900,000 - $600,000)

Long-Term Debt 88,000 =.8(($290,000)-($400,000))$564,000

Negative Goodwill (600,000)Total Purchase Discount $

(36,000)

The second stage of the allocation process involves the allocation of $600,000 in negative goodwill among land, and buildings and equipment.

(1) (2) (3) (4)=(3)-(2)

Noncurrent Asset

% of Fair Valu

e

Allocation of Negative Goodwill

((1)x$600,000)

P's Interest (80%)

Final Allocation

Land 32% $192,000 $196,000

$ 4,000

Bldgs. & Eq. (net)

68% 408,000 240,000 (168,000)

100%

$600,000 $436,000

$(164,000)

Other accounts

3-57

Inventory 80,000 Equity Method Investments

(40,000)

Long-term Debt

88,000

Total Purchase Discount ($36,000 )

3-58

P3.5 CONSOLIDATED BALANCE SHEET WORKING PAPER--PURCHASE DISCOUNT

Requirement 1Penn Company and Stark Company

Consolidated Balance Sheet Working Paper, 1/2/X6: α = 1(000 Eliminated)

Adjustments & EliminationsASSETS Penn Stark Dr. Cr. ConsolidatedCash & Receivables 4,500 1,000 (2)

1005,400

Inventories 10,000 3,000 (2) 200 13,200Plant Assets, net 12,000 5,000 (2)

50016,500

Investment in Bonds 1,000 500 (2) 200

1,300

Investment in Stark 3,500 - (1) 500 (3) 4,000

-

Purchase Discount - - (2) 500 (1) 500

-

Goodwill - - (2) 1,100 1,100 Total Assets 31,000 9,500 37,500

LIABILITIES ANDSTOCKHOLDERS = EQUITY Current Liabilities 6,000 2,500 8,500Noncurrent Liabilities 8,000 3,000 (2)

1,00012,000

Capital Stock-Penn 4,000 - 4,000Capital Stock-Stark - 1,000 (3) 1,000 - Retained Earnings-Penn 13,000 - 13,000Retained Earnings-Stark - 3,000 (3) 3,000 - Total Liabilities and 31,000 9,500 6,300 6,300 37,500

3-59

Stockholders= Equity(1) To reclassify the purchase discount; ($500,000) = $3,500,000 - ($1,000,000 + $3,000,000). (2) To allocate the purchase discount by assigning fair values to Stark's assets and liabilities; Goodwill of

$1,100,000 equals the difference between investment cost of $3,500,000 and net fair value of assets and liabilities, $2,400,000.

(3) To eliminate the Investment in Stark against the stockholders' equity accounts of Stark.

3-60

P3.5 (cont=d)Requirement 2

Penn Company and Stark CompanyConsolidated Balance Sheet Working Paper, 1/2/X6: α = .8

(000 Eliminated)Adjustments & Eliminations

ASSETS Penn Stark Dr. Cr. ConsolidatedCash & Receivables 5,000 1,000 (2)

805,920

Inventories 10,000 3,000 (2) 160 13,160Plant Assets, net 12,000 5,000 (2) 680 17,680Investment in Bonds 1,000 500 (2)

1601,340

Investment in Stark 3,000 - (1) 200 (2) 3,200

Purchase Discount - - (2) 200 (1) 200

-

Total Assets 31,000 9,500 38,100

LIABILITIES ANDSTOCKHOLDERS = EQUITY Current Liabilities 6,000 2,500 8,500Noncurrent Liabilities 8,000 3,000 (2)

80011,800

Capital Stock-Penn 4,000 - 4,000Capital Stock-Stark - 1,000 (3) 1,000Retained Earnings-Penn 13,000 - 13,000Retained Earnings-Stark - 3,000 (3) 3,000Minority Interest in Stark - - (3)

800 800

Total Liabilities and Stockholders= Equity

31,000 9,500 5,240 5,240 38,100

(1) To reclassify the purchase discount; ($200,000) = $3,000,000 - .8($1,000,000 + $3,000,000).

3-61

(2) To allocate the purchase discount by assigning fair values to 80 percent of Stark=s assets and liabilities. Initially this assignment produced negative goodwill o $520,000 = $160,000 + $1,200,000 - $80,000 - $160,000 - $800,000 - ($200,000), the purchase discount. The negative goodwill is credited entirely to Plant Assets, net, thereby reducing the allocation to that account to $680,000 (= $1,200,000 -$520,000).

(3) To eliminate the Investment in Stark against 80 percent of Stark=s stockholders= equity and reclassify the remaining 20 percent as minority interest.

3-62

P3.6RECONSTRUCTING P'S BALANCE SHEET

Requirement 1:

All elements of the ownership elimination entry are known except for the purchase premium or discount:

Common Stock - S 400,000Retained Earnings - S 1,000,00

0Investment in S 900,000Minority Interest in S 210,000

To balance the entry, a credit (purchase discount) of $290,000 is needed.

The purchase discount would be applied to the valuation of the plant assets of S, reducing this amount from the $1,000,000 book value to $710,000. Even though the plant assets have a fair value of $2,000,000, the negative goodwill must be applied to this item. Note that the problem implied a forced sale, explaining why P was able to make a "bargain" purchase.

The consolidation elimination entries therefore are:Common Stock - S 400,000Retained Earnings - S 1,000,00

0Purchase Discount 290,000Investment in S 900,000Minority Interest in S 210,000

Purchase Discount 290,000Plant Assets 290,000

3-63

P3.6 (cont=d)

Requirement 2:

P's separate balance sheet is determined by working backwards from the consolidated balance sheet, subtracting S's separate balance sheet and the effects of the above two eliminating entries. This process results in P's separate balance sheet as follows:

Current Assets $ 7,100,000

Plant Assets 6,000,000Investment in S 900,000

$14,000,000

Liabilities $ 4,000,000

Common Stock 3,000,000Retained Earnings 7,000,000

$14,000,00 0

3-64

P3.7CONSOLIDATION OF THREE SUBSIDIARIES--PURCHASE METHOD

Requirement 1:Malcolm Management #4

Balance SheetJanuary 2, 20X5

Investment in A $2,000,000 Long-Term Debt $4,000,000

Investment in B 1,600,000 Common Stock 100,000Investment in C 800,000 Additional Paid-in Capital 300,00

0$4,400,000 $4,400,00

0

Requirement 2:

Consolidation elimination entriesA B C

Common stock 800,000 1,200,000 500,000 Additional paid-in capital 700,000 500,000 100,000 Retained earnings 100,000 (400,000) (100,000)Purchase premium 400,000 560,000 500,000 Investment in subsidiary (2,000,000) (1,600,000) (800,000)Minority interest 0 (260,000) (200,000)

All purchase premium is attributed to noncurrent assets.

Requirement 3:

Malcolm Management #4Consolidated Balance Sheet

January 2, 20X5Current Assets $ 2,000,000 Current Liabilities $

2,700,000Noncurrent Assets 9,360,000 Long-Term Debt 7,800,000

Minority Interest-B 260,000Minority Interest -C 200,000Common Stock 100,000

3-65

Additional Paid-in Capital

300,000

$11,360,000 $11,360,000

P3.8WORKING BACKWARDS--ELIMINATING ENTRIES AND PREPARING SUBSIDIARY'S SEPARATE BALANCE SHEET

Requirement 1:

The purchase premium was $2,800,000 (=$10,000,000 - .8 x $9,000,000); it was allocated as follows:

Current Assets (Inventory)

$ 400,000 (= .8 x $500,000)

Plant Assets (Net) 960,000 (= .8 x $1,200,000) Goodwill 1,440,000 (Given) Total Purchase Premium $2,800,000

Consolidated Financial Statement Working Paper

Purchase Premium 2,800,000 Investment in S 2,800,000

To reclassify the purchase premium.

Current Assets (Inventory) 400,000Plant Assets (net) 960,000Goodwill 1,440,000

Purchase Premium 2,800,000 To allocate the purchase premium to S's identifiable assets and to Goodwill.

Stockholders' Equity - S 9,000,000Investment in S 7,200,000Minority Interest in S 1,800,000

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To eliminate the investment account against the stockholders' equity of S and establish the minority interest.

P3.8 (cont=d.)

Requirement 2:S Company

Condensed Balance Sheet December 31, 20X7

ASSETSCurrent Assets $

6,000,000(=$21,400,000 - 400,000 - 15,000,000)

Plant Assets (Net) 9,040,000 (=$30,000,000 -960,000 - 20,000,000)

Total $15,040,000

LIABILITIES AND STOCKHOLDERS' EQUITYLiabilities $

6,040,000(=$25,040,000 -19,000,000)

Stockholders= Equity 9,000,00 0

Total $15,040,000

3-67

P3.9CONSOLIDATION UNDER POOLING AND PURCHASE

Requirement 1:P and S Companies

Consolidated Balance SheetCurrent Assets: Cash and Receivables $

5,000,000 Inventories 7,500,00

0$12,500,0

00Equity Method Investments 500,000Plant Assets, net 43,800,00

0Other Assets: Patents $

1,500,000 Goodwill 3,700,00

0 5,200,00

0$62,000,0

00Current Liabilities $

7,500,000Noncurrent Liabilities 24,000,00

0Stockholders' Equity:Common Stock, par $15,000,0

00Additional Paid-in Capital 3,500,000Retained Earnings 12,000,0

0030,500,00

0$62,000,0

00

Requirement 2:

P could consider selling some of the equity investments held by S, as these have unrecorded appreciation of $4,500,000. Sale or licensing of patents, which have unrecorded appreciation of $5,500,000, could also be considered. Whether such sales would significantly impact the long-term profitability of S would need to be considered before choosing to generate short-term profits by such sales.

P3.9 (cont=d.)

Requirement 3:P and S Companies

Consolidated Balance SheetCurrent Assets: Cash and Receivables $

5,000,000 Inventories 8,000,00

0$13,000,0

00Equity Method Investments 5,000,000Plant Assets, net 47,000,00

0Other Assets: Patents $

7,000,000 Goodwill 5,000,00

012,000,00

0$77,000,0

00Current Liabilities $

7,500,000Noncurrent Liabilities 24,000,00

0Stockholders' Equity: Common Stock $15,000,0

00 Additional Paid-in Capital 23,000,00

0 Retained Earnings 7,500,000 45,500,00

0$77,000,0

00

Requirement 4:

Because the fair values of S's assets are used for the consolidated balance sheet under the purchase method, there is no unrecorded appreciation (except for that which may have occurred since the acquisition). Thus, the plan set forth earlier would not result in an increase in earnings.

P3.10 INTERPRETATION OF ELIMINATION ENTRIES: PURCHASE AND POOLING

Requirement 1:

The acquisition was a stock acquisition because consolidation elimination entries were subsequently made. Such entries only follow a stock acquisition; they are unnecessary in the case of a statutory merger.

Requirement 2:

The acquisition was recorded under the purchase method because a purchase premium is shown in the elimination entries. No purchase premium or purchase discount exists in consolidation elimination entries under the pooling of interests method.

Requirement 3:

P acquired 90 percent of S's stock. We observe that the minority interest ($800) is 10 percent of the total stockholders' equity of S ($8,000).

Requirement 4:

The cost of the acquisition was $9,500, the amount recorded in (and eliminated from) the Investment in S account.

Requirement 5:

(a) Current assets have a fair value of $900 (book value of $1,000 minus $100 (=$90/.9) fair value adjustment).

(b) Noncurrent assets have a fair value of $14,000 (book value of $12,000 plus $2,000 (=$1,800/.9) fair value adjustment).

(c) Total liabilities have a fair value of $5,000, the same as the book values ($2,000 current liabilities plus $3,000 noncurrent liabilities); no fair value adjustments were

made to liabilities.

P3.10 (cont=d.)

Requirement 6:

If the pooling of interests method had been used to record the acquisition, the Investment in S would have been recorded at $7,200, the book value of net assets acquired (=$8,000 x .9) and the only consolidation elimination entry would be:

Stockholder's Equity - S 8,000Investment in S 7,200Minority interest 800

P3.11 CONSOLIDATION WORKING PAPER WITH PURCHASED AND POOLED SUBSIDIARIES

Consolidated Balance Sheet Working PaperAdjustments and

EliminationsASSETS Frank George Hal Dr. Cr. Consolidat

edCash and Receivables 8,900,00

01,100,0

001,680,00

011,680,00

0Inventory 7,000,00

01,650,0

001,170,00

09,820,000

Investment in George 3,060,000

- - (1) 3,060,000

-

Investment in Hal 3,550,000

- - (2) 670,000

-

(3) 2,880,000

Other Assets 12,000,000

2,250,000

2,650,000

16,900,000

Goodwill - - (2) 670,000

670,00 0

Total Assets 34,510,000

5,000,000

5,500,000

670,000 6,610,000 39,070,000

LIABILITIES AND STOCKHOLDERS = EQUITY Liabilities 15,000,0

001,600,00

02,300,00

018,900,00

0Common Stock 3,000,00

0500,000 400,000 (1)

500,0003,000,000

(3) 400,000

Additional Paid-In Capital 7,000,000

1,100,000

800,000 (1)1,100,000

7,000,000

(3) 800,000

Retained Earnings 9,510,00 1,800,00 2,000,00 (1)1,800,0 9,510,000

0 0 0 00 (3)2,000,0

00 Minority Interest in George - - - (1)

340,000340,000

Minority Interest in Hal - - - (3) 320,000

320,00 0

Total Liabilities and Shareholders= Equity 34,510,000

5,000,000

5,500,000

6,600,000 660,000 39,070,000

7,270,000 7,270,000

Explanations of Working Paper Entries:(1) To eliminate the Investment in George against the stockholders' equity of George and establish the minority

interest.(2) To reclassify the purchase premium paid for the interest in Hal as goodwill; $670,000 = $3,550,000 - .9($400,000

+ $800,000 + $2,000,000). (3) To eliminate the Investment in Hal against the stockholders' equity of Hal and establish the minority interest.

P3.12 APPLYING PROPOSED ALTERNATIVE CONSOLIDATION POLICY

Subcase SFAS 94 1999 Exposure Draft1A Do not consolidate Consolidate1B Do not consolidate Consolidate1C Do not consolidate Consolidate2A Do not consolidate Possibly consolidate2B Do not consolidate Possibly consolidate2C Do not consolidate Possibly consolidate

Under SFAS 94, consolidation is not appropriate, as no case has majority ownership. Under the 1999 FASB Exposure Draft, the following considerations apply.

In subcases 1A, 1B, and 1C, two different presumptions of effective control exist:

1. Andrews owns a large minority interest (40 to 49 percent) and the remaining ownership is widely dispersed (no single party holds more than 3 percent).

2. A recent election has shown that Andrews is able to cast a majority of votes cast (53 to 58 percent).

Absent evidence to the contrary, either one of these is sufficient to presume that Andrews has effective control, and that consolidated statements should be prepared.

In subcases 2A, 2B, and 2C, the conclusion is less clear. While Andrews owns a fairly large minority interest (25 to 35 percent) and other ownership is widely dispersed, it would be a matter of judgment as to whether Andrews' interest is large enough. Andrews was able to nominate its director candidates, solicit some proxies, and convince other stockholders to vote for its nominees in order to obtain a majority of the votes. While a conclusion of effective control seems highly likely here, it is not automatic. Further, case 2A is stronger than case 2B, which in turn is stronger than case

2C.