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[Solved] ACC 577 WEEK 7 Lecture 1 Finance

ACC 577 WEEK 7 Lecture 1 Finance Week 7 Lecture 1 Finance Which one of the following is not necessarily a post-combination characteristic of a legal acquisition? A. The combining firms remain separate legal entities. B. A parent-subsidiary relationship exists. C. The acquiring firm owns 100% of the voting stock of the acquired firm. D. The combining firms are under common economic control. Correct! The acquiring firm in a legal acquisition does not have to own 100% of the voting stock of the acquired firm. In a legal acquisition, the acquiring firm need only acquire greater than 50% (50% 1 share) of the acquired firm to obtaining a controlling interest. Both firms continue to exist and operate as separate legal entities, the acquiring firm as the parent and the acquired firm as a subsidiary. Under GAAP, which of the following can be issued as the primary form of public financial statement disclosure for a parent and its subsidiaries? Parent only Statement Separate Parent and Subsidiary Statements Consolidated Statements Yes Yes Yes Yes No No No Yes Yes No No Yes Correct! Under GAAP, only consolidated financial statements may be issued as the primary form of public disclosure for a parent and its subsidiaries. Parent only statements and separate parent and subsidiary statements may not be issued in lieu of consolidated financial statements. Penn, Inc., a manufacturing company, owns 75% of the common stock of Sell, Inc., an investment company. Sell owns 60% of the common stock of Vane, Inc., an insurance company. In Penn's consolidated financial statements, should consolidation accounting or equity method accounting be used for Sell and Vane? A. Consolidation used for Sell and equity method used for Vane. B. Consolidation used for both Sell and Vane. C. Equity method used for Sell and consolidation used for Vane. D. Equity method used for both Sell and Vane. Correct! If one looked just at Penn's interest in Vane's result of 45% (75% x 60%), one might say that the equity method would be appropriate. However, because Sell owns 60% of Vane, it controls Vane and would need to consolidate Vane. Because Penn owns 75% of Sell, it controls Vane and would need to consolidate Sell, which consolidated Vane. Thus, all three would be consolidated, making this response correct. Aceco has significant investments in three separate entities. These investments are: 1. 40% ownership of the voting stock of Kapco. 2. 60% ownership of the voting stock of Placo. 3. 100% ownership of the voting stock of Simco Which of Aceco's investments would be consolidated with Aceco in its consolidated financial statements? A. Simco only. B. Placo and Simco. C. Kapco, Placo, and Simco. D. Kapco only. Correct! Since Aceco owns controlling interest in Placo (60%) and in Simco (100%), each would be consolidated with Aceco. Kapco would not be consolidated, because Aceco does not have controlling interest in Kapco. In Aceco's consolidated financial statements, Kapco would be shown as an investment. Consolidated financial statements are typically prepared when one company has a controlling financial interest in another unless: A. The subsidiary is a finance company. B. The fiscal year-ends of the two companies are more than three months apart. C. The subsidiary is in bankruptcy. D. The two companies are in unrelated industries, such as manufacturing and real estate. Correct! Currently, the only reasons allowable for not consolidating a majority-owned subsidiary is where control does not reside with the majority owner, making this the correct response. Consolidated financial statements are based on the concept that: A. In the preparation of financial statements, legal form takes precedence over economic substance. B. In the preparation of financial statements, economic substance takes precedence over legal form. C. Financial information should be presented separately for each legal entity. D. Separate financial statements are more meaningful than consolidated financial statements. Correct! The preparation of consolidated financial statements is based on the concept that economic substance takes precedence over legal form. In form, the corporations are separate legal entities, but in substance, they are under the common economic control of the parent's shareholders. Which of the following information that exists at the date of an acquisition will be needed to carry out the consolidating process? I. Book values of a subsidiary's assets and liabilities. II. Fair values of a subsidiary's assets and liabilities. III. Parent's cost of its investment in the subsidiary. A. I, II, and III. B. I and II, only. C. II and III, only. D. III only. Correct! In order to prepare consolidated financial statements, the parent needs the book values and fair values of a subsidiary's assets and liabilities at the date of the business combination as well as the cost of its investment in the subsidiary. The preparation of consolidated statements likely will require the following information about the subsidiary's assets and liabilities at the date of acquisition: Book Value Fair Value Yes No No Yes Yes Yes No No Correct! Both book values and fair values of a subsidiary's assets and liabilities will need to be determined at the date of acquisition in order to prepare consolidated financial statements after a business combination. Consolidated financial statements can be prepared for a business combination that was accounted for using which of the following accounting methods? Acquisition Method Pooling of Interests Method Yes Yes Yes No No Yes No No Correct! Consolidated statements can be prepared when a business combination was accounted for using either the acquisition method or the pooling of interests method. Although the pooling of interests method can no longer be used (since June 30, 2001) to account for new business combinations, business combinations carried out under the pooling of interests method prior to that time still require the preparation of consolidated financial statements. Following a business combination accomplished through a legal acquisition, transactions between the affiliated entities can originate with the/a: Parent Company Subsidiary Company Yes Yes Yes No No Yes No No Correct! Transactions between affiliated entities, called intercompany transactions, can originate with either the parent company or a subsidiary company. Which one of the following kinds of eliminations, if any, will be required in every consolidating process? Intercompany Receivables/Payables Intercompany Investment Intercompany Revenues/Expenses Yes Yes Yes Yes No Yes No Yes No Yes Yes No Correct! An intercompany investment elimination will be required in every consolidating process (to eliminate the parent's investment against the subsidiary's shareholders' equity). Intercompany receivables/payables and intercompany revenues/expenses eliminations will not be required in every consolidating process. Those kinds of eliminations will be required only if the affiliated companies have engaged in intercompany transactions that resulted in such balances. Which one of the following kinds of accounts is least likely to be eliminated through an eliminating entry on the consolidating worksheet? A. Receivables. B. Investment. C. Goodwill. D. Payables. Correct! Goodwill may be recognized by the entry that eliminates the parent's investment in the subsidiary against the parent's share of the subsidiary's shareholders' equity, but goodwill will not be eliminated through an eliminating entry. Which one of the following circumstances will not impact directly the adjustments, eliminations, or related amounts in the consolidating process? A. Whether the parent company is a manufacturing firm or a service firm. B. Whether the parent uses the cost or equity method to carry the investment in a subsidiary on its books. C. Whether the parent owns 100% or less than 100% of the subsidiary. D. Whether transactions between the affiliated entities originate with the parent or with a subsidiary. Correct! Whether the parent company is a manufacturing firm or a service firm (or other type of firm) will not impact directly the adjustments, eliminations, or related amounts in the consolidating process. Whatever the type of firm, the same kinds of adjustments, eliminations, and amounts would have to be made in the consolidating process. Which of the following statements, if any, concerning the preparation of consolidated financial statements is/are correct? I. The consolidating process is carried out on the books of the parent entity. II. The consolidated financial statements report two or more legal entities as though they are a single economic entity. A. I only. B. II only. C. Both I and II. D. Neither I nor II. Correct! The consolidated financial statements report two or more legal entities (a parent and its subsidiary/ies) as though they are a single economic entity. Because the entities are under the common economic control of the parent's shareholders, GAAP requires that consolidated statements be the primary form of financial statement disclosure. The results of the consolidating process are recorded in the books of the: Parent Subsidiary Yes Yes Yes No No Yes No No Correct! The consolidating process takes place on worksheets and schedules, and the results are presented in the form of consolidated financial statements. Some of the worksheet and schedule data is carried forward from period end to period end to facilitate the recurring consolidating process. This question has been adapted from the original AICPA released question. On April 1, 2005, Dart Co. paid $620,000 for all the issued and outstanding common stock of Wall Corp. in a transaction properly accounted for as an acquisition. The recorded assets and liabilities of Wall Corp. on April 1, 2005 follow: Cash $ 60,000 Inventory 180,000 Property and equipment (net of accumulated depreciation of $220,000) 320,000 Goodwill (net of accumulated amortization of $50,000) 100,000 Liabilities (120,000) Net assets $540,000 ======== On April 1, 2005, Wall's inventory had a fair value of $150,000, and the property and equipment (net) had a fair value of $380,000. What is the amount of goodwill resulting from the business combination? A. $150,000 B. $120,000 C. $50,000 D. $20,000 Correct! First the fair value of the identifiable net assets must be determined: Cash $60,000 Inventory $150,000 P&E (net) $380,000 Liabilities ($120,000) Net Assets $470,000 Once this has been determined it is a simple matter of subtracting this amount from the purchase price to determine the goodwill. ($620,000 - $470,000 = $150,000 goodwill). Penn Corp. paid $300,000 for the outstanding common stock of Star Co. At that time, Star had the following condensed balance sheet: Carrying amounts Current assets $40,000 Plant and equipment, net 380,000 Liabilities 200,000 Stockholders' equity 220,000 The fair value of the plant and equipment was $60,000 more than its recorded carrying amount. The fair values and carrying amounts were equal for all other assets and liabilities. What amount of goodwill, related to Star's acquisition, should Penn report in its consolidated balance sheet? A. $20,000 B. $40,000 C. $60,000 D. $80,000 Correct! In an acquisition business combination, all assets and liabilities are revalued to fair value. Any excess of investment value over fair value of the revalued identifiable net assets is assigned to goodwill. Book value of net assets was $220,000. Plant and Equipment needed to be written up by $60,000, making fair value of net assets $280,000. Since Penn paid $300,000 for Star, that leaves $20,000 in goodwill ($300,000-$280,000). Thus, this is the correct response. A subsidiary, acquired for cash in a business combination, owned inventories with a market value different from the book value as of the date of combination. A consolidated balance sheet prepared immediately after the acquisition would include this difference as part of: A. Deferred Credits B. Goodwill C. Inventories D. Retained Earnings Correct! The difference between (fair) market value and book value of inventories would be recognized by adjusting inventories to fair value on the consolidated balance sheet. Beni Corp. purchased 100% of Carr Corp.'s outstanding capital stock for $430,000 cash. Immediately before the purchase, the balance sheets of both corporations reported the following: Beni Carr Assets $2,000,000 $750,000 Liabilities $750,000 $400,000 Common stock 1,000,000 310,000 Retained earnings __250,000 __40,000 Liabilities and stockholders' equity $2,000,000 $750,000 On the date of purchase, the fair value of Carr's assets was $50,000 more than the aggregate carrying amounts. In the consolidated balance sheet prepared immediately after the purchase, the consolidated stockholders' equity should amount to: A. $1,680,000 B. $1,650,000 C. $1,600,000 D. $1,250,000 Correct! On the date of a business combination using acquisition accounting, the consolidated stockholders' equity will exactly equal the parent company stockholders' equity. This will continue to be the case as long as the parent company uses a complete equity method of accounting for the subsidiary. A subsidiary, acquired for cash in a business combination, owned equipment with a market value in excess of book value as of the date of combination. A consolidated balance sheet prepared immediately after the acquisition would treat this excess as: A. Goodwill B. Plant and Equipment C. Retained Earnings D. Deferred Credits Correct! The excess of (fair) market value over book value of equipment would be recognized by writing up plant and equipment to fair value on the consolidated balance sheet. On November 30, 2004, Parlor, Inc. purchased for cash at $15 per share all 250,000 shares of the outstanding common stock of Shaw Co. On November 30, 2004, Shaw's balance sheet showed a carrying amount of net assets of $3,000,000. On that date, the fair value of Shaw's property, plant, and equipment exceeded its carrying amount by $400,000. In its November 30, 2004, consolidated balance sheet, what amount should Parlor report as goodwill? A. $750,000 B. $400,000 C. $350,000 D. $0 Correct! Goodwill is the difference between the purchase price of $3,750,000 (250,000 x $15.00) and the fair value of the net assets ($3,000,000 $400,000) or $350,000. Under which of the following methods of carrying a subsidiary on its books, if any, will the carrying value of the investment normally change following a combination? Cost Method Equity Method Yes Yes Yes No No Yes No No Correct! If the parent uses the equity method to carry on its books the investment in a subsidiary, the carrying value of the investment will change as the equity of the subsidiary changes. However, if the parent uses the cost method, the carrying value on its books normally will not change. A parent company may use which of the following methods to carry an investment in its subsidiary on the parent's books? Cost Method Equity Method Yes Yes Yes No No Yes No No Correct! A parent company may use the cost method or the equity method (or any variation thereof) to carry an investment in a subsidiary on the parent's books. Since a subsidiary will be consolidated with the parent (and possibly other subsidiaries) for reporting purposes, the method the parent uses to carry the investment on its books will not impact the consolidated statements. The consolidated statements will be the same regardless of the method the parent uses on its books to carry a subsidiary; only the consolidating process will be different. Which one of the following would be of concern in preparing consolidated financial statements at the end of the operating period following a business combination that would not be a concern in preparing financial statements immediately following a combination? A. Whether or not there are intercompany accounts receivable/accounts payable. B. Whether or not goodwill resulted from the business combination. C. Whether the parent carries its investment in the subsidiary using the cost method or the equity method. D. Whether or not there is a noncontrolling interest in the subsidiary. Correct! Whether the parent carries its investment in the subsidiary using the cost method or the equity method would be of concerning in preparing consolidated financial statements at the end of the operating period following a business combination but would not be of concern in preparing financial statements immediately following the combination. When consolidated financial statements are prepared immediately following a combination, there has been no period over which the parent has "carried" the investment on its books. Therefore, the method it WILL (going forward) use is not of concern immediately after the combination. Which of the following financial statements, if any, prepared by a parent immediately after a business combination is likely to be different from financial statements it prepares immediately before the business combination? Balance Sheet Income Statement Yes Yes Yes No No Yes No No Correct! While a parent's balance sheet prepared immediately after a business combination will be different from its balance sheet prepared immediately before the business combination, the parent's income statement is not likely to be different than the consolidated income statement prepared immediately after the combination. As a result of the combination, the parent will have on its balance sheet an investment account (and probably other accounts/amounts) that it did not have before the combination, but the consolidated income statement prepared immediately after a business combination will likely be the same as the parent's pre-combination income statement. Which one of the following is not a characteristic of consolidated financial statements prepared following an operating period that occurred after the date of a business combination? A. A full set of consolidated financial statements will be required. B. The method used by the parent to carry on its books its investment in the subsidiary will affect the consolidating process. C. Intercompany transactions may have occurred since the business combination. D. The method used by the parent to carry on its books its investment in the subsidiary will affect the final consolidated financial statements. Correct! The method used by the parent to carry on its books its investment in the subsidiary will not affect the final consolidated financial statements. The method used by the parent (cost, equity, or other) will affect how the investment account has changed since the date of the investment and, therefore, the investment elimination process but not the final consolidated financial statements. Which of the following financial statements, if any, prepared by a parent following an operating period that occurred after a business combination, is likely to be different from financial statements it prepares immediately before the business combination? Balance Sheet Income Statement Yes Yes Yes No No Yes No No Correct! Both a parent's balance sheet and income statement prepared following an operating period that occurred after a business combination are likely to be different from financial statements it prepares immediately before the business combination. As a result of the combination, the parent will have on its balance sheet an investment account (and probably other accounts/amounts) that it did not have before the combination as well as the effects of post-combination transactions on the assets, liabilities, and equities of the parent and its subsidiaries. In addition, whereas the consolidated income statement prepared immediately before (or immediately after) the combination will consist of only the parent's revenues and expenses, an income statement prepared after an operating period will include the subsidiaries' revenues and expenses as well as the result of post-combination transactions on the revenues and expenses of the parent. Which one of the following is not a characteristic associated with the reciprocity entry? A. Adjusts the investment account to reflect changes in a subsidiary's retained earnings. B. Is used when a parent uses the cost method to carry its investment in a subsidiary. C. Is used in lieu of an investment elimination entry. D. Is recorded only on the consolidating worksheet. Correct! A reciprocity entry is not used in lieu of an investment eliminating entry. Rather, a reciprocity entry is used to bring the investment account, as brought onto the worksheet, in balance with the subsidiary's retained earnings as of the beginning of the period so that the investment eliminating entry can then be made. On January 1, 20X1, Prim, Inc. acquired all the outstanding common shares of Scarp, Inc. for cash equal to the book value of the stock. The carrying amount of Scarp's assets and liabilities approximated their fair values, except that the carrying amount of its building was more than fair value. In preparing Prim's 20X1 consolidated income statement, which of the following adjustments would be made? A. Depreciation expense would be decreased, and goodwill would be recognized. B. Depreciation expense would be increased, and goodwill would be recognized. C. Depreciation expense would be decreased, and no goodwill would be recognized. D. Depreciation expense would be increased, and no goodwill would be recognized. Correct! Although the cost of the investment was equal to book values, the cost of the investment was greater than the fair values, because the carrying amount of Scarp's building was more than its fair value. For consolidated statement purposes, the building would be written down to its lower fair value, and the excess of cost over fair values would be assigned to recognize goodwill. Since for consolidated purposes the building has a lower fair value than its carrying value, the depreciation expense taken on the carrying value would be greater than the depreciation expense for consolidated purposes. Thus, depreciation expense would be decreased in the consolidating process, and goodwill would be recognized. If the parent uses the cost method to account for its investment in a subsidiary, the parent will recognize: A. the parent's share of the subsidiary's net income. B. the parent's share of the subsidiary's dividends. C. amortization of parent's excess cost of investment over the book value of the subsidiary. D. the parent's share of the subsidiary's net loss. Correct! When a parent company uses the cost method to account for its investment in a subsidiary, the parent will recognize its share of the subsidiary's dividends declared as income to the parent. When a parent company uses the cost method on its books to carry its investment in a subsidiary, which one of the following will be recorded by the parent on its books? A. Parent's share of subsidiary's net income/net loss. B. Parent's amortization of goodwill resulting from excess investment cost over fair value of subsidiary's net assets. C. Parent's share of subsidiary's cash dividends declared. D. Parent's depreciation of excess investment cost over book values of subsidiary's net assets. Correct! Under the cost method of carrying an investment in a subsidiary, the parent does recognize its share of the subsidiary's dividends declared and, ultimately, the cash received in payment of the dividend. The dividend income (CR.) so recognized by the parent would be eliminated in the consolidating process against the retained earnings decrease (DR.) recognized by the subsidiary. On January 1, 20x6, Ritt Corp. purchased 80% of Shaw Corp.'s $10 par common stock for $975,000. On this date, the carrying amount of Shaw's net assets was $1,000,000. The fair values of Shaw's identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net), which were $100,000 in excess of the carrying amount. Those plant assets had a 10-year remaining life, depreciated on a straight-line basis. The fair value of the 20% noncontrolling interest in Shaw was properly determined to be $200,000 at that time. For the year ended December 31, 20x6, Shaw had a net income of $190,000 and paid cash dividends totaling $125,000. Which one of the following is the amount of noncontrolling interest that should be reported in a consolidated balance sheet prepared December 31, 2006? A. $213,000 B. $235,000 C. $246,000 D. $248,000 Correct! The noncontrolling interest on December 31, 2006, is 20% of the consolidated net assets attributable to Shaw on that date. The consolidated net assets attributable to Shaw on December 31, 2006, would include the book value of the net assets on the date of the combination ($1,000,000), plus the write up of the plant assets to fair value ($100,000), plus the goodwill at acquisition ($75,000), plus Shaw's net operating results for 2006 ($190,000), less 20% of the worksheet depreciation taken on the write up of plant assets ($100,000/10 years =) $10,000 less the dividends paid by Shaw during 2006 ($125,000), or $1,175,000 at acquisition plus ($190,000 - $10,000 - $125,000 =) $55,000 for 2006, or $1,230,000 x .20 noncontrolling interest = $246,000, the correct answer. On January 1, 20x1 Ritt Corp. purchased 80% of Shaw Corp.'s $10 par common stock for $975,000. Ritt's cost reflects an appropriate fair value measure for all of Shaw's outstanding common stock. The original cost to the noncontrolling investors for the 20% of Shaw's common stock not acquired by Ritt was $200,000. At the date of Ritt's purchase, the carrying amount of Shaw's net assets was $1,000,000. The fair values of Shaw's identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net) which were $100,000 in excess of the carrying amount. Which one of the following is the amount of noncontrolling interest that should be reported in a consolidated balance sheet prepared immediately following the business combination? A. $125,000 B. $200,000 C. $220,000 D. $243,750 Correct! Noncontrolling interest at the date of the business combination should be the noncontrolling interest proportionate share of total fair value at that date, including goodwill. The total fair value of Shaw (including goodwill) at the date Ritt acquired 80% of Shaw's common stock would be $1,218,750 ($975,000/.80). The noncontrolling interest would be .20 x $1,218,750 = $243,705, the correct answer. The investment eliminating entry made immediately following the business combination would be: DR: (Various) Identifiable Net Assets $1,100,000 Goodwill 118,750 CR: Investment in Shaw $975,000 Noncontrolling Interest (in Shaw) 243,750 On October 1, 2008, Potato Company acquired 100% of the voting stock of Spud Company in a legal acquisition. Potato chose to account for its investment in Spud on its books using the cost method. Spud had the following incomes and dividends for the periods shown: 10/1 - 12/31/08 1/1 - 12/31/09 Net Income $3,000 $15,000 Dividends Declared/Paid 1,000 3,000 In its December 31, 2009, consolidating process, which one of the following is the amount of the reciprocity entry Potato will make on the consolidating worksheet? A. $2,000 B. $3,000 C. $14,000 D. $18,000 Correct! The purpose of the reciprocity is to bring the investment account (on the worksheet) in balance with the subsidiary's retained earnings as of the beginning of the period being consolidated. Therefore, only the undistributed income of the subsidiary since the business combination up to the beginning of the period being consolidated (January 1, 2009) will be the reciprocity entry at the end of 2009. The undistributed income from October 1 to December 31, 2008 (the beginning of 2009) is net income ( $3,000) less dividends declared and paid (-$1,000), or $2,000. On January 1, 20x6 Ritt Corp. purchased 80% of Shaw Corp.'s $10 par common stock for $975,000. On this date, the carrying amount of Shaw's net assets was $1,000,000. The fair values of Shaw's identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net) which were $100,000 in excess of the carrying amount. Those plant assets had a 10-year remaining life, depreciated on a straight-line basis. The fair value of the 20% noncontrolling interest in Shaw was properly determined to be $200,000 at that time. For the year ended December 31, 20x6, Shaw had net income of $190,000 and paid cash dividends totaling $125,000. Which one of the following is the amount of goodwill that should be recognized as a result of the business combination? A. $ 43,000 B. $ 75,000 C. $ 95,000 D. $175,000 Correct! Goodwill is determined as the excess of investment value over the fair value of the subsidiary's net assets. Investment value is the sum of the parent’s investment (which is the fair value of consideration paid) the fair value of any noncontrolling interest, which in this question is $975,000 $200,000 = $1,175,000. The fair value of Shaw's identifiable net assets is book value $1,000,000 write up in plant assets $100,000 = $1,100,000. Therefore, goodwill is investment value $1,175,000 - fair value of identifiable assets $1,100,000 = $75,000, the correct answer. Parco owns 100% of its subsidiary, Subco, which it acquired at book value. It carries its investment in Subco on its books using the equity method of accounting. At the beginning of its 2009 fiscal year, the investment in Subco account was $552,000. During 2009, Subco reported the following: Net Income $42,000 Dividends Declared/Paid 12,000 There were no other transactions between the firms in 2009. In preparing its 2009 fiscal year consolidated statements, which one of the following is the amount of the investment eliminating entry that Parco will make as a result of its ownership of Subco? A. $552,000 B. $582,000 C. $594,000 D. $606,000 Correct! The amount of an investment eliminating entry is the balance in the investment account as of the beginning of the period being consolidated. In this case, that was $552,000. If the parent uses the equity method to account for its investment in the subsidiary, the entries it makes during the year are reversed so that the investment account has its beginning of the year balance. If a parent uses the equity method on its books to carry its investment in a subsidiary, which one of the following current year entries (made by the parent) must be reversed on the consolidating worksheet? Income from Subsidiary Dividends from Subsidiary Yes Yes Yes No No Yes No No Correct! When a parent uses the equity method to account for its investment in a subsidiary, the parent will recognize on its books during the year its share of the subsidiary's income (or loss) and its share of dividends declared by the subsidiary. Therefore, in the consolidating process, those entries (and any other equity-based entries made by the parent) must be reversed so that the elements that make up those entries (revenues, expenses, etc.) can be individually recognized on the consolidating worksheet and the consolidated financial statements. Parco owns 100% of its subsidiary, Subco, which it acquired at book value. It carries its investment in Subco on its books using the equity method of accounting. At the beginning of its 2009 fiscal year, the investment in Subco account was $552,000. During 2009, Subco reported the following: Net Income $42,000 Dividends Declared/Paid 12,000 There were no other transactions between the firms in 2009. In preparing its 2009 fiscal year consolidated statements, which one of the following is the amount of investment that Parco will have to reverse for 2009 as a result of its ownership of Subco? A. $12,000 B. $30,000 C. $42,000 D. $54,000 Correct! During 2009 Parco would recognize Subco's reported net income of $42,000 as equity revenue; the entry would be: DR: Investment in Subco and CR: Equity Revenue. The $12,000 dividends would not be recognized as equity revenue but rather as a liquidation of part of Parco's investment in Subco; the entry would be: DR: Dividends Receivable/Cash and CR: Investment in Subco. Therefore, the net amount of investment to be reversed would be $30,000, computed as $42,000 - $12,000 = $30,000. If a parent uses the equity method on its books to account for its investment in a subsidiary, which one of the following will result in an increase in the investment account on the parent's books? Subsidiary Reports Income Subsidiary Declares Dividend Yes Yes Yes No No Yes No No Correct! Under the equity method, when a subsidiary reports income, the parent recognizes its share as: DR: Investment and CR: Equity Income. Therefore, the subsidiary's reported income increases the investment account. In addition, when a subsidiary declares a dividend, the parent recognizes its share as: DR: Dividends Receivable/Cash and CR: Investment. Therefore, the subsidiary's dividends do not increase the investment account but rather decrease the investment account. Assume that in acquiring a subsidiary, the parent determined that several depreciable assets had a fair value greater than book value. If the parent accounts for its investment in the subsidiary using the equity method, what effect will the amortization of the excess fair value over the book value of the subsidiary's assets have on the following parent's accounts? Investment in Subsidiary Equity Revenue from Subsidiary Increase Increase Increase Decrease Decrease Increase Decrease Decrease Correct! When the fair value of a subsidiary's assets is greater than book value, it is as though the parent paid more for the assets than the subsidiary paid for those assets. Using the equity method of accounting for the investment, the parent must depreciate the excess of fair value over book value. That equity entry would be: DR: Equity Revenue - to reduce it by the amount of depreciation on the excess of fair value over book value, and CR: Investment in Subsidiary - to offset a portion of the net income (or increase the amount of net loss) recognized from the subsidiary. Thus, both accounts would be decreased. On January 2 of the current year, Peace Co. paid $310,000 to purchase 75% of the voting shares of Surge Co. Peace reported retained earnings of $80,000, and Surge reported contributed capital of $300,000 and retained earnings of $100,000. The purchase differential was attributed to depreciable assets with a remaining useful life of 10 years. Peace used the equity method in accounting for its investment in Surge. Surge reported net income of $20,000 and paid dividends of $8,000 during the current year. Peace reported income, exclusive of its income from Surge, of $30,000 and paid dividends of $15,000 during the current year. What amount will Peace report as dividends declared and paid in its current year's consolidated statement of retained earnings? A. $8,000 B. $15,000 C. $21,000 D. $23,000 Correct! This is the amount ($15,000) that Peace will report as dividends in its consolidated statement of retained earnings. Only Peace's (the parent's) dividends paid of $15,000 are shown on the Peace/Surge consolidated statement of retained earnings. The dividend paid by Surge to Peace ($8,000 x .75 = $6,000) will not show on the consolidated statement of retained earnings, because it will be eliminated as intercompany dividend (you can't pay a dividend to yourself!). The balance of Surge's dividend ($8,000 x .25 = $2,000) goes to the 25% minority shareholders in Surge and reduces their claim to Surge's retained earnings, not Peace's consolidated retained earnings. The separate condensed balance sheets and income statements of Purl Corp. and its wholly-owned subsidiary, Scott Corp., are as follows: BALANCE SHEETS December 31, 2005 Purl Scott Assets Current assets Cash $80,000 $60,000 Accounts receivable (net) 140,000 25,000 Inventories 90,000 50,000 Total current assets 310,000 135,000

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