dmp3e ch12 solutions 05.17.10 revised

7/27/2019 DMP3e CH12 Solutions 05.17.10 Revised

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Chapter 12

Reporting and AnalyzingIntercorporate Investments

Learning Objectives coverage by question

Mini-exercises

Exercises Problems Cases

LO1Explain and interpret the threelevels of investor influence over aninvestee passive, significant, andcontrolling.

11, 13, 14,

15, 16, 17,

18, 19, 20,

21, 22, 23

24, 25, 26, 27,

28, 29, 30, 31,

32, 33, 34, 35,

36, 37, 38, 39,

40, 41, 42

45, 46, 47,

48

49, 50, 51,

52

LO2 Describe and analyzeaccounting for passive investments.

11, 12, 13,

20, 21, 22

24, 25, 27, 29,

32, 35, 36, 3744, 47 50, 51, 52

LO3 Explain and analyze accounting forinvestments with significant influence.

13, 14, 15,

16

26, 30, 31, 32,

33, 34, 37, 3844, 47

49, 50, 51,

52

LO4 Describe and analyze accountingfor investments with control.

13, 17, 18,

19, 23

28, 39, 40, 41,

4245, 46, 48 49, 51

LO5 Appendix 12A Illustrate andanalyze accounting mechanics for equitymethod investments.

44, 47 49

LO6 Appendix 12B Apply equitymethod accounting mechanics toconsolidations.

42 45, 46, 48

LO7 Appendix 12C Discuss thereporting of derivative securities.

43

Cambridge Business Publishers, 2011

Solutions Manual, Chapter 12 12-1


2/41

QUESTIONS

Q12-1. a) Trading securities are reported at their fair market value in the balance

sheet. b) Available-for-sale securities are reported at their fair market valuein the balance sheet. c) Held-to-maturity securities are reported at theiramortized cost in the balance sheet.

Q12-2. An unrealized holding gain (loss) is an increase (decrease) in the fairmarket value of an asset (in this case, an investment security) that is stillowned.

Q12-3. Unrealized holding gains and losses related to trading securities arereported in the current-year income statement (and also retained earnings).Unrealized holding gains and losses related to available-for-sale securitiesare reported as a separate component of stockholders' equity called OtherComprehensive Income (OCI).

Q12-4. Significant influence gives the owner of the stock the ability to influencesignificantly the operating and financing activities of the company whosestock is owned. Normally, this is accomplished with a 20% through 50%ownership of the company's voting stock.

The equity method is used to account for investments with significantinfluence. Such an investment is initially recorded at cost; the investmentis increased by the proportionate share of the investee company's netincome, and equity income is reported in the income statement; theinvestment account is decreased by dividends received on theinvestment; and the investment account is reported in the balance sheet

at its book value. Unrealized appreciation in the market value of theinvestment is not recognized.

Q12-5. Yetman Company's investment in Livnat Company is an investment withsignificant influence, and should, therefore, be accounted for using theequity method. At year-end, the investment should be reported in thebalance sheet at $258,000 [$250,000 + (40% $80,000) - (40% x $60,000)].

Q12-6. A stock investment representing more than 50% of the investee company'svoting stock is generally viewed as conferring control over the investeecompany. The investor and investee companies must be consolidated forfinancial reporting purposes.

Q12-7. Consolidated financial statements attempt to portray the financial position,operating results, and cash flows of affiliated companies as a singleeconomic unit so that the scope of the entire (whole) entity is morerealistically conveyed.


Financial Accounting, 3rd Edition12-2


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Q12-8. The $750,000 investment in Murray Company appearing in Finn Company'sbalance sheet and the $300,000 common stock and $450,000 retainedearnings appearing on Murray Company's balance sheet are eliminated.The two balance sheets (less the accounts eliminated) are then summed toyield the consolidated balance sheet.

Q12-9. The $75,000 accounts payable on Dee's balance sheet and the $75,000accounts receivable on Bradshaw's balance sheet are eliminated. In aconsolidation, all intercompany items are eliminated so that theconsolidated statements show only the interests of outsiders.

Q12-10.Limitations of consolidated statements include the possibility that theperformances of poor companies in a group are "masked" in consolidation.Likewise, rates of return, other ratios, and percentages calculated fromconsolidated statements might prove deceptive because they arecomposites. Consolidated statements also eliminate detail about productlines, divisional operations, and the relative profitability of various businesssegments. (Some of this information is likely to be available in the footnote

disclosures relating to the business segments of certain public firms.)Finally, shareholders and creditors of subsidiary companies find it difficultto isolate amounts related to their legal rights by inspecting onlyconsolidated statements.




4/41

MINI EXERCISES

M12-11 (10 minutes)

a. Available-for-sale securities are reported at market value on the balance sheet.For 2008, this is equal to the original cost ($341 million) plus unrecognizedgains ($17 million) and less unrealized losses ($39) million), or $319 million.

b. Unrealized gains (and losses) on available-for-sale securities are reported as acomponent of Accumulated Other Comprehensive Income on the balancesheet.

M12-12 (15 minutes)

a. Wasley will report the dividends received of $6,600 (6,000 shares $1.10 pershare) as income. If the investment is accounted for as available-for-sale, theincrease in the market price of the stock will not be recognized as income untilthe stock is sold. Unrealized gains (losses) are reported as OtherComprehensive Income in the stockholders equity section of the balancesheet.

b. If the investment is accounted for as trading, Wasley will report $6,600 ofdividend income plus income relating to the increase in the market price of the

stock of $6,000 ($13 - $12 price increase for 6,000 shares).

M12-13 (10 minutes)

Abbott Laboratories is accounting for its investment securities as available-for-sale. As such, the unrealized losses of $49 million are not recognized in currentincome. Instead, they are reported as a decrease in Accumulated OtherComprehensive Income (AOCI). Abbott Labs stockholders equity is decreasedby the unrealized loss, but not its net income or retained earnings.




5/41

M12-14 (20 minutes)

a. Given the 30% ownership, significant influence is presumed and theinvestment must be accounted for using the equity method. The year-endbalance of the investment account is computed as follows:Beginning balance........................... $1,000,000

% Lang income earned.................... 30,000 ($100,000 0.3)% Dividends received...................... (12,000) ($40,000 0.3)Ending balance................................. $1,018,000

b. $30,000 ($100,000 0.3) - Equity earnings are computed as the reported netincome of the investee (Lang Company) multiplied by the percentage of theoutstanding common stock owned.

c. (1) In contrast to the market method, the equity method of accounting doesnot report investments at market value. The unrealized gain of $200,000 is not

reflected in either the balance sheet or the income statement.

d.1. Investment in Lang Company (+A) ................................................. 1,000,000

Cash (-A) ................................................................................ 1,000,000

2. Investment in Lang Company (+A) ................................................. 30,000Investment income (+R, +SE) ................................................... 30,000

3. Cash (+A) .................................................................................... 12,000Investment in Lang Company (-A) ............................................. 12,000

e.

+ Cash (A) - - Investment Income (R) +1,000,000 1. 30,000 2.

3. 12,000

+ Investment in Lang Company (A) -

1. 1,000,0002. 30,000

12,000 3.

f.

Balance Sheet Income Statement

Transaction CashAsset +NoncashAssets = Liabilities +

Contrib.Capital +

EarnedCapital Revenues - Expenses =

NetIncome

Purchase stock inLang Company.

-1,000,000Cash

+1,000,000Investment = - =

Recognize share ofLang income.

+30,000Investment =

+30,000RetainedEarnings

+30,000Investment

Income- = +30,000

Receive dividendfrom Lang.

+12,000Cash

-12,000Investment = - =




6/41

M12-15 (10 minutes)

Equity income on this investment is computed as the investee company (Penno)earnings multiplied by the percentage of the company owned. In this case, equityearnings equal:

$600,000 40% = $240,000Note that dividends are treated as a return ofinvestment (reduce the investmentbalance by $80,000, computed as $200,000 40%), and not as income. Also, theinvestment is recorded at adjusted cost, not at market value, and unrealized gains(losses) are neither recognized on the balance sheet nor in the income statement.

M12-16 (15 minutes)

a. Merck reports income from its equity method investments at $2,560.6 millionon its 2008 income statement. Equity method investments are reported on the

balance sheet at adjusted cost, not at current market value. Adjusted cost isthe original purchase price plus (minus) Mercks proportionate share ofinvestee companies profits (losses), less dividends received.

b. Merck will account for dividends received on equity method investments as areduction of the investment balance, not as income.

M12-17 (10 minutes)

The $600,000 investment in Hirst Company appearing on Philipich Company'sbalance sheet and the $300,000 common stock and $450,000 retained earnings of

Hirst Company would be eliminated.In addition, a $150,000 minority interest [20% of ($300,000 + $450,000)] wouldappear on the consolidated balance sheet. Many analysts treat the minority interestas an equity account, and FASB has issued an exposure draft requiringpresentation as such if the proposal becomes GAAP.

M12-18 (10 minutes)

Benartzi Company net income............................................... $600,00090% of $150,000 Liang Company net income....................... 135,000Consolidated net income....................................................... $735,000

M12-19 (10 minutes)

Consolidated earnings under the pooling of interests method would be higherbecause pooling-of-interest does not recognize current market values of assets andgoodwill. As a result, consolidated earnings will not be reduced by the depreciationand/or amortization of those additional asset values, nor will subsequent incomestatements be burdened by any impairment of goodwill.




7/41

M12-20 (40 minutes)a.201010/1 Investment in Skyline, Inc. (+A) ...................................................... 486,000

Cash (-A) ................................................................................ 486,000

12/31 Interest receivable (+A) ................................................................. 8,750Interest revenue (+R, +SE) ....................................................... 8,750

12/31 Investment in Skyline, Inc. (+A) ...................................................... 4,000Unrealized gain (+R, +SE) ........................................................ 4,000

20113/31 Cash (+A) ................................................................................. 17,500

Interest receivable (-A) ....................................................... 8,750Interest revenue (+R, +SE) .................................................. 8,750

4/1 Cash (+A) ................................................................................. 492,300Realized gain (+R, +SE) ...................................................... 2,300

Investment in Skyline, Inc. (-A) ........................................... 490,000

b. Assuming the firms fiscal year ends 12/31, the unrealized gain of $4,000 inSkyline Inc. bonds is closed to retained earnings in 2007 increasing netincome and retained earnings.

+ Cash (A) - - Interest Revenue (R) +

486,000 10/1/10 8,750 12/31/103/31/11 17,500 8,750 3/31/11

4/1/11 492,300

+ Investment in Skyline Bonds (A) - - Unrealized Gain (R) +

10/1/10 486,000 4,000 12/31/10

12/31/10 4,000 490,000 4/1/11

+ Interest Receivable (A) - - Realized Gain (R) +

12/31/10 8,750 8,750 3/31/11 2,300 4/1/11

c.Balance Sheet Income Statement

Transaction CashAsset +

NoncashAssets =

Liabil-ities +

Contrib.Capital +

EarnedCapital Revenues - Expenses = Net Income

10/1/10 Purchase$500000 of Skylinebonds at 97.

- 486,000Cash

+ 486,000Investment = - =

12/31/10Recognize interestrevenue.

+8,750InterestReceivable

= +8,750RetainedEarnings

+8,750InterestRevenue

- = +8,750

12/31/10Record unrealizedgain.

+4,000Investment =


+4,000Unrealized

Gain

- =+4,000

3/31/11 Recognizeinterest income.

+17,500Cash

-8,750Interest

Receivable

=+8,750RetainedEarnings


- =+8,750

4/1/11Sold Skylineinvestment.

+492,300Cash

-490,000Investment =


+2,300Realized

Gain

- =+2,300




8/41

M12-21 (40 minutes)a.201011/15 Investment in Lane, Inc. (+A) .......................................................... 72,750

Cash (-A) ................................................................................ 72,750

12/22 Cash (+A) ..................................................................................... 6,600Dividend income (+R, +SE) ....................................................... 6,600

12/31 Unrealized loss (+E, -SE) ............................................................... 5,250Investment in Lane, Inc. (-A) ..................................................... 5,250

20111/20 Cash (+A) ................................................................................. 66,900

Loss on sale of investment in Lane, Inc. (+E, -SE) ........................ 600Investment in Lane, Inc. (-A) .............................................. 67,500

b. Assuming the firms fiscal year ends 12/31, the unrealized loss of $5,250 is closedto the income summary in 2010, reducing net income and retained earnings.

+ Cash (A) - + Investment in Lane Inc (A) -

12/22 6,600 72,750 11/15 11/15 72,750 5,250 12/311/20 66,900 67,500 1/20

+ Loss (E) -

1/20 600

+ Unrealized Loss (E) - - Dividend Income (R) +

12/31 5,250 6,600 12/22


TransactionCashAsset +

NoncashAssets =

Liabil-ities

+ Contrib.Capital +EarnedCapital Revenues - Expenses =

NetIncome

11/15 Purchase 6,000shares of Lane Inc common.

-72,750Cash

+72,750Investment

= =

12/22 Dividend income. +6,600Cash =


+6,600DividendIncome

=+6,600

12/31 Decrease inInvestment.

-5,250Investment =

-5,250RetainedEarnings

+5,250Unrealized

Loss=

-5,250

1/20 Sale of Lanecommon.

+66,900Cash

-67,500Investment =

-600Retained

Earnings

+600Realized

Loss

=-600




9/41

M12-22 (30 minutes)The main effect is to defer the loss in value experienced in 2010 to the year 2011.

201011/15 Investment in Lane, Inc. (+A) .......................................................... 72,750

Cash (-A) ................................................................................ 72,750

12/22 Cash (+A) ..................................................................................... 6,600Dividend income (+R, +SE) ....................................................... 6,600

12/31 Unrealized loss AOCI (-SE) .......................................................... 5,250Investment in Lane, Inc. (-A) ..................................................... 5,250

2011 The adjusting entry can be done on the date of sale or 12/31/2010.1/20 Cash (+A) ................................................................................. 66,900

Loss on sale of investment in Lane, Inc. (+E, -SE) ........................ 5,850Unrealized loss AOCI (+SE) ............................................. 5,250Investment in Lane, Inc. (-A) .............................................. 67,500

+ Cash (A) - + Investment in Lane Inc (A) -

12/22 6,600 72,750 11/15 11/15 72,750 5,250 12/31

1/20 66,900 67,500 1/20

+ Loss (E) -

1/20 5,850

+ Unrealized Loss (AOCI) - - Dividend Income (R) +

12/31 5,250 5,250 1/20 6,600 11/22

M12-23 (10 minutes)Halen Inc. now owns all of Jolson. The company reports will be consolidated. Thetotal in the consolidated stockholders equity section on 1/1 is determined asfollows:

Common stock.. $600,000Retained earnings.. 310,000

Total Equity $910,000

Halen paid cash exactly equal to the net book value of Jolsons assets. Jolsonsequity accounts are eliminated in the consolidation process. (No goodwill resultswhen the purchase price equals the book value of the acquired company.)




10/41

EXERCISES

E12-24 (30 minutes)

a. Trading securities

1 Investment in Liu, Inc. (+A) ............................................................ 72,000Cash (-A) ................................................................................ 72,000

2 Cash (+A) ..................................................................................... 6,600Dividend income (+R, +SE) ....................................................... 6,600

3 Unrealized loss (+E, -SE) ............................................................... 4,500Investment in Liu, Inc. (-A) ....................................................... 4,500

4 Cash (+A) ..................................................................................... 66,900Loss on sale of investment (+E, -SE) ............................................... 600

Investment in Liu, Inc.(-A)........................................................ 67,500

b.+ Cash (A) - + Investment in Liu (A) -

2. 6,600 72,000 1. 1. 72,000 4,500 3.

4. 66,900 67,500 4.

- Retained Earnings (SE) +

6,600 2.

+ Unrealized Loss (E) - + Loss on Sale (E) -

4. 4,500 4. 600



NoncashAssets = Liabilities +

Contrib.Capital +

EarnedCapital Revenues - Expenses = Net Income

1. Purchased 6,000common shares of Liu,Inc., for $12 per share.

-72,000Cash

+72,000Investment

= - =

2. Received a cashdividend of $1.10 percommon share from Liu.

+6,600Cash



- = +6,600

3. Year-end market priceof Liu common stock is$11.25 per share.

-4,500Investment

=-4,500

RetainedEarnings

-+4,500

UnrealizedLoss = -4,5004. Sold all 6,000 commonshares of Liu for $66,900. +66,900

Cash- 67,500Investment

=600RetainedEarnings

- +600Loss

= 600




11/41

d. Available-for-Sale Securities

1 Investment in Liu, Inc. (+A) ............................................................ 72,000Cash (-A) ................................................................................ 72,000


3 Unrealized loss (-SE) ..................................................................... 4,500Investment in Liu, Inc. (-A) ....................................................... 4,500

4 Cash (+A) ..................................................................................... 66,900Loss on sale of investment (+E, -SE) ............................................... 5,100

Unrealized loss (+SE) .............................................................. 4,500Investment in Liu, Inc.(-A)........................................................ 67,500

+ Cash (A) - + Investment in Liu (A) -

2. 6,600 72,000 1. 1. 72,000 4,500 3.

4. 66,900 67,500 4.

- Retained Earnings (SE) +

6,600 2.

+ Unrealized Loss (SE) - + Loss (E) -

3. 4,500 4,500 4. 4. 5,100




Contrib.Capital +


NetIncome

1. Purchased6,000 commonshares of Liu,Inc., for $12 pershare.

-72,000Cash

+72,000Investment

= - =

2. Received acash dividend of$1.10 percommon sharefrom Liu.

+6,600Cash



- =+6,600

3. Year-endmarket price ofLiu commonstock is $11.25per share.

-4,500Investment

= -4,500AOCI

- =

4. Sold all 6,000common shares ofLiu for $66,900.

+66,900Cash

-67,500Investment

=

+4,500AOCI

-5,100RetainedEarnings

- +5,100Loss

= 5,100




12/41

E12-25 (30 minutes)

a. Investments classified as trading securities

1 Investment in Freeman, Inc. (+A) .................................................... 80,000Cash (-A) ................................................................................ 80,000


3 Investment in Freeman, Inc. (+A) .................................................... 7,500Unrealized gain (+R, +SE) ........................................................ 7,500

4 Cash (+A) ..................................................................................... 86,400Loss on sale of investment (+E, -SE) ............................................... 1,100

Investment in Freeman, Inc.(-A)................................................ 87,500

+ Cash (A) - + Investment in Freeman (A) -

2. 6,250 80,000 1. 1. 80,0004. 86,400 3. 7,500 87,500 4.

- Dividend Income (R) +

6,250 2.

- Unrealized Gain (R) + + Loss on Sale (E) -

7,500 3. 4. 1,100

Balance Sheet Income StatementTransaction Cash

Asset +NoncashAssets = Liabilities +

Contrib.Capital +


NetIncome

1. Ohlson Co. purchases5,000 common shares ofFreeman Co. at $16 cashper share.

-80,000Cash

+80,000Investment

= - =

2 Ohlson Co. receives acash dividend of $1.25 percommon share fromFreeman.

+6,250Cash


+6,250DividendRevenue

- = +6,250

3 Year-end market priceof Freeman commonstock is $17.50 per share.

+7,500Investment


+7,500Unrealized

Gain

- = +7,500

4. Ohlson Co. sells all5,000 common shares ofFreeman for $86,400 cash.

+86,400Cash

-87,500Investment

= + -1,100RetainedEarnings

- +1,100Loss =

-1,100




13/41

b. Available for Sale Securities

1 Investment in Freeman, Inc. (+A) .................................................... 80,000Cash (-A) ................................................................................ 80,000


3 Investment in Freeman, Inc. (+A) .................................................... 7,500Unrealized gain (+SE) .............................................................. 7,500

4 Cash (+A) ..................................................................................... 86,400Unrealized gain (-SE) .................................................................... 7,500

Gain on sale of investment (+R, +SE) ........................................ 6,400Investment in Freeman, Inc.(-A)................................................ 87,500

+ Cash (A) - + Investment in Freeman (A) -

2. 6,250 80,000 1. 1. 80,000

4. 86,400 3. 7,500 87,500 4.

- Dividend Income (R) +

6,250 2.

- Unrealized Gain (SE) + - Gain on Sale ( R) +

4. 7,500 7,500 3 6,400 4.




Contrib.Capital +


Net

Income1. Ohlson Co.purchases 5,000common shares ofFreeman Co. at $16cash per share.

-80,000Cash

+80,000Investment

= - =

2. Ohlson Co. receives acash dividend of $1.25per common share fromFreeman.

+6,250Cash


+6,250DividendRevenue

- = +6,250

3. Year-end marketprice of Freemancommon stock is $17.50per share.

+7,500Investment

= +7,500AOCI

- =

4. Ohlson Co. sells all

5,000 common shares ofFreeman for $86,400cash.

+86,400Cash

-87,500Investment

=

-7,500

AOCI+6,400RetainedEarnings

+6,400Gain

- = +6,400




14/41

E12-26 (15 minutes)

a. The equity securities investment portfolio is reported at its current marketvalue of $59,479 = $2,308 + $57,171 thousand. The amount includes theunrealized loss on the Auction Rate Certificates, the unrealized loss on theStock Mutual Fund, and the unrealized gain on the Bond Mutual Fund.

b. None

c. The net unrealized investment loss is $1,657 thousand, calculated as $2,304 +$389 - $12 = $2,681 thousand less tax savings of $1,024 thousands (38.2% x$2,681) = $1,657 thousand




15/41

E12-27 (30 minutes)

a.2010:11/1 Investment in Joos, Inc. (+A) ......................................................... 306,900

Cash (-A) ................................................................................ 306,900

12/31 Interest receivable (+A) ................................................................ 4,500Interest revenue (+R, +SE) ....................................................... 4,500

12/31 Unrealized loss (+E, -SE) .............................................................. 5,400Investment in Joos, Inc. (-A) ..................................................... 5,400

2011:4/30 Cash (+A) ................................................................................... 13,500

Interest receivable (-A) ............................................................ 4,500Interest revenue (+R, +SE) ....................................................... 9,000

5/1 Cash (+A) ................................................................................... 300,900Loss on sale of investments (+E, -SE) ............................................ 600

Investment in Joos, Inc.(-A)...................................................... 301,500

b.+ Cash (A) - + Investment in Joos Inc. (A) -

4/30 13,500 306,900 11/1 11/1 306,900 5,400 12/315/1 300,900 301,500 2/1

+ Unrealized Loss (E) - + Interest Receivable (A) -

12/31 5,400 12/31 4,500 4,500 4/30

- Interest Revenue (R) + + Loss on Sale of Investments (E) -

4,500 12/31 5/1 600

9,000 4/30




Contrib.Capital +

EarnedCapital Revenues - Expenses = Net Incom

11/1. Buy $300,000Joos bonds @102.

-306,900Cash

+306,900Investment

= - =

12/31. Accrueinterest.

+4,500Interest

Receivable

=+4,500Retained

Earnings

+4,500Interest

Revenue

- = +4,500

12/31. Recognizedecline in value ofbonds.

-5,400Investment

=-5,400

RetainedEarnings

-+5,400

UnrealizedLoss

= -5,400

4/30. Receiveinterest.

+13,500Cash

-4,500Interest

Receivable



- = +9,000

5/1. Sold Joosbonds.

+300,900Cash

-301,500Investment

=-600

RetainedEarnings

- +600Loss

= -600




16/41

E12-28 (10 minutes)

Baylor Company now owns 75% of Reed. The company reports will beconsolidated. The total in the consolidated stockholders equity section on 1/1 isdetermined as follows:Minority interest in Reed Company. ... $200,000

Common stock. 900,000Retained earnings... 440,000

Total equity $1,540,000

E12-29 (15 minutes)

a. The equity securities investment portfolio is reported at its current marketvalue of $29,758 million. The cost of the portfolio is $35,171 million, there are$654 million in unrealized gains and $6,067 million ($2,774 million + $3,293

million) of unrealized losses.

b. Because the investments are accounted for as available-for-sale, unrealizedgains (losses) on investments are reported in Accumulated OtherComprehensive Income (AOCI), rather than current income. The investmentsare reported on the balance sheet at current market value on the statementdate.

c. Impairment losses are recognized in current income when the securitiesdecline in market value and the decline is deemed to be other than temporary.Gains and losses realized from the sale of securities are recognized in current

income. A reclassification adjustment is required in Other ComprehensiveIncome. Because the gains and losses from the sale of securities will berecognized in current income (and retained earnings), they need to beremoved from AOCI to avoid double-counting the gains and losses instockholders equity.




17/41

E12-30 (30 minutes)

a.

1 Investment in Barth Co. (+A) ......................................................... 108,000Cash (-A) ................................................................................ 108,000

2 Cash (+A) .................................................................................... 15,000Investment in Barth Co. (-A) ..................................................... 15,000

3 Investment in Barth Co. (+A) ......................................................... 24,000Investment revenue (+R, +SE) .................................................. 24,000

4 Cash (+A) .................................................................................... 120,500Gain on sale of investment (+R, +SE) ........................................ 3,500Investment in Barth Co. (-A) ..................................................... 117,000

b.

+ Cash (A) - + Investment in Barth (A) -

2. 15,000 108,000 1. 1. 108,000 15,000 2.4. 120,500 3. 24,000 117,000 4.

- Investment Revenue (R) +

24,000 3.

- Gain (R) +

3,500 4.

c.

Balance Sheet Income StatementTransaction Cash

Asset +NoncashAssets = Liabilities +

Contrib.Capital +


NetIncome

1. Buy 30% ofBarth stock.

-108,000Cash

+108,000Investment

= - =

2. Receivedividend.

+15,000Cash

-15,000Investment

= - =

3. Recognize shareof net income ofBarth.

+24,000Investment =


+24,000InvestmentRevenue

- =

+24,000

4. Sold Barthinvestment.

+120,500Cash

-117,000Investment =


+3,500Gain - =

+3,500




18/41

E12-31 (30 minutes)a.

1 Investment in Palepu Co. (+A) ....................................................... 120,000Cash (-A) ................................................................................ 120,000

2 Cash (+A) .................................................................................... 12,000Investment in Palepu Co. (-A) ................................................... 12,000

3 Investment in Palepu Co. (+A) ....................................................... 30,000Investment revenue (+R, +SE) .................................................. 30,000

4 Cash (+A) .................................................................................... 140,000Gain on sale of investment (+R, +SE) ........................................ 2,000Investment in Palepu Co. (-A) ................................................... 138,000

b.+ Cash(A) - + Investment in Palepu(A) -

2. 12,000 120,000 1. 1. 120,000 12,000 2.4. 140,000 3. 30,000 138,000 4.

- Investment Revenue (R) +

30,000 3.

- Gain(R) +

2,000 4.




Contrib.Capital +


NetIncome

1. Buy 25% ofPalepu stock. -120,000Cash +120,000Investment = - =

2. Receivedividend.

+12,000Cash

-12,000Investment

= - =

3. Recognizeshare of netincome of Palepu.

+30,000Investment



- = +30,000

4. Sold Palepuinvestment.

+140,000Cash

-138,000Investment


+2,000Gain

- = +2,000




19/41

E12-32 (40 minutes)a. Market Value Method (AFS Securities)

1.1 Investment in Leftwich Co. (+A) ..................................................... 150,000

Cash (-A) ................................................................................ 150,000

2 No entry

3 Cash (+A)..................................................................................... 11,000Dividend revenue (+R, +SE) ...................................................... 11,000

4 Investment in Leftwich Co. (+A) ..................................................... 40,000Unrealized gain (+SE) .............................................................. 40,000

2.+ Cash (A) - + Investment in Leftwich (A) -

3. 11,000 150,000 1. 1. 150,000

4. 40,000

- Unrealized Gain (AOCI) + - Dividend Income (R) +40,000 4. 11,000 3.

3.Balance Sheet Income Statement



Contrib.Capital +


NetIncome

1. PurchaseCommon shares.

-150,000Cash

+150,000Investment

= - =

2. No entry. = - =3. Received a cashdividend of $1.10

per common share.

+11,000

Cash

=+11,000Retained

Earnings

+11,000Dividend

Revenue

- = +11,00

4. Recognizeincrease ininvestment value atyearend .

+40,000Investment

=+40,000

AOCI - =




20/41

b. Equity Value Method1.1 Investment in Leftwich Co. (+A) ..................................................... 150,000

Cash (-A) ................................................................................ 150,000

2 Investment in Leftwich Co. (+A) ..................................................... 24,000Investment revenue (+R, +SE) .................................................. 24,000

3 Cash (+A) .................................................................................... 11,000Investment in Leftwich Co. (-A) ................................................. 11,000

4 No entry required

2.+ Cash (A) - + Investment in Leftwich (A) -

3. 11,000 150,000 1. 1. 150,000 11,000 3.

2. 24,000

- Investment Income (R) +

24,000 2.




Contrib.Capital +


NetIncome

1. PurchaseCommon shares.

-150,000Cash

+150,000Investment

= - =

2. Recognize 30%portion of Leftwichnet income.

+24,000Investment


+24,000Investment

Income

- = +24,000

3. Received a cash

dividend of $1.10per commonshare.

+11,000Cash -11,000Investment = - =

4. No entry. = - =




21/41

E12-33 (25 minutes)

a. DuPonts equity method investments are reported at adjusted cost, not marketvalue. Adjusted cost is the purchase price of the investment, plus theinvestors proportionate share of investee company profits (losses) and lessdividends received.

b. DuPonts investment balance of $844 million is approximately 60% of the netassets of the affiliates ($844 / [$2,942 - $1,529]). However, if DuPont purchasedthese investments at a price that was greater than the book value of theinvestees equity, the actual percentage ownership would be lower.

c. The reconciliation of the investment balance from 2007 to 2008 isapproximated as follows:

(in $ million)Beginning balance ..................................................... $818

Equity in net profit of affiliates ................................. 81Dividends received..................................................... (87)Ending balance........................................................... $812

There is a $32 million unexplained difference between our computed amountand the $844 reported in DuPonts footnote. We are unable to explain thechange based on the data available.

d. The equity method reports only the equity owned as an investment on thebalance sheet and equity in earnings on the income statement. As a result,use of this method arguably omits assets and liabilities from the face of the

balance sheet and sales and expenses from the income statement (comparedwith the assets and liabilities and sales and expenses that would be recordedwith consolidation). Net income and stockholders equity are the samewhether the equity method or consolidation is used.

Consequently, ROE is the same. However, profit margins (income/sales) andasset turnover rates (sales / average assets) will differ with the omission ofassets and sales.




22/41

E12-34 (25 minutes)

a. The investee company reports total assets of $462 million, liabilities of $318million, and equity of $144 million. CATs investment balance of $66 million isless than its proportionate (50%) interest ($144 million 50% = $72 million),indicating that the investment was acquired for less than book value.

b. CAT reports the investment on its balance sheet at $66 million. Because CATreports an asset of only $66 million, most of the assets and all of the liabilitiesof the investee company are not reported on CATs balance sheet. If thisinvestment is critical to CATs strategic plan, it arguably does not present aclear picture of the capital investment required to conduct CATs business orthe degree of financial leverage inherent in its operations, even though itsaccounting is in conformity with GAAP.

c. If the investee company were to fail, would CAT have to invest additionalcapital to support it? Probably not from a strictly legal standpoint. Yet, if this

type of investment is necessary for CATs strategic plans, it might find itdifficult to finance future ventures of this type if it does not support the failinginvestee. These conditions mean that there can be an effective liability evenwhen no legal liability exists. Analysts can, of course, replace the equityinvestment with the assets and liabilities to which it relates (constructiveconsolidation for analysis purposes) if they feel it to be a better representationof the balance sheet and income statement of the company.

d. The equity method reports only the equity owned as an investment on thebalance sheet and equity in earnings on the income statement. As a result,use of this method arguably omits assets and liabilities from the face of the

balance sheet and sales and expenses from the income statement (comparedwith the assets and liabilities and sales and expenses that would be recordedwith consolidation). Net income and stockholders equity are the samewhether the equity method or consolidation is used. Thus, ROE is the same,but profit margins (net income/sales) and asset turnover rates (sales / averagenet operating assets) will differ with the omission of assets and sales.




23/41

E12-35 (30 minutes)

a.201011/15 Investment in Core, Inc. (+A) ......................................................... 80,900

Cash (-A) ................................................................................ 80,900

12/22 Cash (+A) .................................................................................... 6,250Dividend income (+R, +SE) ....................................................... 6,250

12/31 Investment in Core, Inc. (+A) ......................................................... 6,600Unrealized gain (+R, +SE) ........................................................ 6,600

20111/20 Cash (+A) .................................................................................... 86,400

Loss on sale of investment (+E, -SE) .............................................. 1,100Investment in Core, Inc. (-A) ..................................................... 87,500

b.

Assuming the firms fiscal year ends 12/31, the unrealized gain of 6,600 increasesnet income and retained earnings in 2010.

+ Cash (A) - + Investment in Core Inc (A) -

12/22/10 6,250 80,900 11/15/10 11/15/10 80,9001/20/11 86,400 12/31/10 6,600 87,500 1/20/11

+ Loss on Sale of Investment (E) -

1/20/11 1,100

- Unrealized Gain (R) + - Dividend Income (R) +

6,600 12/31/10 6,250 12/22/10




Contrib.Capital +


NetIncome

11/15Purchase 5,000shares of CoreInc common.

-80,900Cash

+80,900Investment

= =

12/22 Dividendincome.

+6,250Cash



= +6,250

12/31 Increasein Investment. +6,600Investment =+6,600RetainedEarnings

+6,600Unrealized

Gain= +6,600

1/20 Sale ofCore common.

+86,400Cash

-87,500Investment

=-1,100

RetainedEarnings

+1,100Loss on

Sale= -1,100




24/41

E12-36 (30 minutes)

a.201011/15 Investment in Core, Inc. (+A) ......................................................... 80,900

Cash (-A) ................................................................................ 80,900

12/22 Cash (+A) .................................................................................... 6,250Dividend income (+R, +SE) ....................................................... 6,250

12/31 Investment in Core, Inc. (+A) ......................................................... 6,600Unrealized gain (+SE) .............................................................. 6,600

20111/20 Cash (+A) .................................................................................... 86,400

Unrealized gain (-SE) .................................................................... 6,600Investment in Core, Inc. (-A) ..................................................... 87,500Gain on sale of investment (+R, +SE) ........................................ 5,500

b. + Cash (A) - + Investment in Core Inc (A) -12/22/10 6,250 80,900 11/15/10 11/15/10 80,9001/20/11 86,400 12/31/10 6,600 87,500 1/20/11

- Gain on Sale of Investment (R) +

5,500 1/20/11

- Unrealized Gain (AOCI) + - Dividend Income (R) +

1/20/11 6,600 6,600 12/31/10 6,250 12/22/10




Contrib.Capital +


NetIncome

11/15 Purchase5,000 shares ofCore Inccommon.

-80,900Cash

+80,900Investment

= - =

12/20 Dividendincome.

+6,250Cash



- = +6,250

12/31 Increase inInvestment.

+6,600Investment

= +6,600AOCI

- =

1/20 Sale of Corecommon. +86,400Cash -87,500

Investment

=

-6,600AOCI


+5,500Gain- = +5,500




25/41

E12-37 (30 minutes)

a. The trading stock investments will be reported at $225,300. This amount iscomputed using their market values at year-end; specifically, $65,300 +$160,000, or $225,300.

b. The available-for-sale stock investments will be reported at $346,700. This

amount is computed using their market values at year-end; specifically,$192,000 + 154,700, or $346,700.

c. The equity method stock investments will be reported at $236,000. Thisamount is computed using their equity method value at year-end; specifically,$100,000 + $136,000, or $236,000.

d. Unrealized holding losses of $5,200 will appear in the 2010 income statement.These losses relate to the trading securities; specifically Barth: $68,000 -$65,300 = $2,700; Foster: $162,500 - $160,000 = $2,500; total of $2,700 + $2,500= $5,200.

e. (i) Unrealized holding losses of $7,300 will appear in the stockholders' equitysection of the December 31, 2010, balance sheet under other comprehensiveincome. These losses relate to the available-for-sale securities; specificallyMcNichols: $197,000 - $192,000 = $5,000; Patell: $157,000 - $154,700 = $2,300;total of $5,000 + $2,300 = $7,300.

(ii) Unrealized holding losses of $5,200 will appear in the stockholders equitysection of the December 31, 2010, balance sheet under retained earnings.These losses relate to the trading securities; specifically Barth: $68,000 -$65,300 = $2,700; Foster: $162,500 - $160,000 = $2,500; total of $2,700 + $2,500= $5,200.

(iii) Total unrealized holding losses in equity of $12,500total of (i) & (ii)

f. (i) A fair market value adjustment to investments of $7,300 will appear in theDecember 31, 2010, balance sheet. This adjustment relates to theavailable-for-sale securities. See part (e) for the supporting computations. Thefair value adjustment decreases the book value of the available-for-salesecurities to their year-end market value.

(ii) A fair market value adjustment to investments of $5,200 will appear in theDecember 31, 2010, balance sheet. This adjustment relates to the tradingsecurities. See part (e) for supporting computations. The fair value adjustment

decreases the book value of the trading securities to their year-end marketvalue.

(iii) Total market value adjustment is $12,500total of (i) & (ii)




26/41

E12-38 (30 minutes)

a. $158.5 million = 50% ($1,354 million - $1,037 million)

b. The receipt of dividends is treated as a reduction of the equity methodinvestment. The reduction in the investment account is offset by an increase in

cash, and total assets are unaffected. No income is recorded upon the receipt ofthe dividend.

c. Abbott Laboratories reports equity income equal to its proportionate share of

TAPs net income or $498 million (50% $996 million).

d. Undistributed earnings are earnings that have not yet been paid out asdividends, or retained earnings. Of TAPs $317 million of stockholders equity,$136 is, apparently, retained earnings. Given the profitability of this company, itappears to pay out a substantial portion of its earnings in dividends. (In fact, thefootnotes to Abbott Laboratories 2007 10-K reveal that TAP paid it $502 individends in 2007, more than Abbott Labs recorded in equity earnings for thatyear).

e. The equity method reports only the equity owned as an investment on thebalance sheet and equity in earnings on the income statement. As a result,use of this method arguably omits assets and liabilities from the face of thebalance sheet and sales and expenses from the income statement (comparedwith the assets and liabilities and sales and expenses that would be recordedwith consolidation). Net income and stockholders equity are the samewhether the equity method or consolidation is used. Thus, ROE is the same.But profit margins (net income/sales) and asset turnover rates (sales / average

net operating assets) will differ with the omission of the investees assets andsales.




27/41

E12-39 (40 minutes)

1 & 2.

Healy Miller Consolidatingadjustments Consolidated

Current assets

Investment in Miller

$1,700,000

500,000

$ 120,000

$(500,000)

$ 1,820,000

0

Plant assets..................... 3,000,000 410,000 15,000 3,425,000

Goodwill........................... . . 45,000 45,000

Total assets..................... $5,200,000 $530,000 $5,290,000

Liabilities......................... $ 700,000 $90,000 $790,000

Contributed capital......... 3,500,000 400,000 (400,000) 3,500,000

Retained earnings.......... 1,000,000 40,000 (40,000) 1,000,000

Total liabilities &stockholders equity.......

$5,200,000 $530,000 $5,290,000

3.Miller contributed capital (-SE) ..................................................... 400,000Miller retained earnings (-SE)........................................................ 40,000Plant assets (+A) ........................................................................... 15,000Goodwill (+A) ................................................................................. 45,000

Investment in Miller Co. (-A) .............................................. 500,000

4.+ Investment in Miller Co. (A) - + Goodwill (A) -

500,000 1/1 1/1 45,000

- Miller Contributed Capital (SE) +

1/1 400,000

+ Plant Assets (A) - - Miller Retained Earnings (SE) +

1/1 15,000 1/1 40,000


Transaction CashAsset + NoncashAssets = Liabilities + Contrib.Capital + EarnedCapital Revenues - Expenses = NetIncome1/1 To consolidateHealy & Miller.

-500,000Investment

in Miller

+45,000Goodwill

+15,000Plant Assets

=

-400,000Miller

ContributedCapital

-40,000Miller

RetainedEarnings

- =




28/41

E12-40 (30 minutes)

1 & 2Rayburn Company purchased all of Kanodia Company's common stock for cash onJanuary 1, after which the separate balance sheets of the two corporationsappeared as follows:

Rayburn Kanodia Consolidatingadjustments Consolidated

Investment in Kanodia.... $ 600,000 (600,000) $ 0

Other assets..................... 2,300,000 $ 700,000 20,000 3,020,000

Goodwill............................ . . 40,000 40,000

Total assets...................... $2,900,000 $700,000 $3,060,000

Liabilities.......................... $ 900,000 $160,000 $1,060,000

Contributed capital.......... 1,400,000 300,000 (300,000) 1,400,000

Retained earnings............ 600,000 240,000 (240,000) 600,000

Total liabilities &stockholders equity........

$2,900,000 $700,000 $3,060,000

3.Kanodia contributed capital (-SE) ........................................ 300,000Kanodia retained earnings (-SE) .......................................... 240,000Other assets (+A) ............................................................... 20,000Goodwill (+A) ..................................................................... 40,000

Investment in Miller Co. (-A)....................................... 600,000

4.

+ Investment in Kanodia Inc. (A) - + Goodwill (A) -600,000 1/1 1/1 40,000

-Kanodia Contributed Capital (SE) +

1/1 300,000

+ Other Assets (A) - - Kanodia Retained Earnings (SE) +

1/1 20,000 1/1 240,000




Contrib.Capital + Earned Capital Revenues - Expenses =

NetIncome

1/1 To consolidateRayburn &Kanodia.

-600,000Investmentin Kanodia

+40,000Goodwill

+20,000Plant Assets

=

-300,000Kanodia

ContributedCapital

-240,000KanodiaRetainedEarnings

=




29/41

E12-41 (20 minutes)

a. The investment is initially recorded on Engels balance sheet at the purchaseprice of $16.8 million, including $600,000 of goodwill. Because the market valueof Ball is less than the carrying amount of the investment on Engels balancesheet, the goodwill may be deemed to be impaired. To determine impairment, the

imputed value of the goodwill is determined to be 12.5 million - $12.3 million =$200,000. Because this is less than the carrying amount of the goodwill, it isdeemed to be impaired.

b. Goodwill must be written down by $400,000. The write-down will reduce thecarrying amount of goodwill by $400,000, and the write-down will be recorded asa loss in Engels income statement, thereby reducing retained earnings by thatamount.

E12-42B (60 minutes)

a.Cash paid........................................................................... $210,000Fair market value of shares issued................................. 180,000Purchase price................................................................. 390,000Less: Book value of Harris.............................................. 280,000Excess payment................................................................ 110,000Excess payment assigned to specific

accounts based on fair market value:Buildings........................................................................ 40,000Patent............................................................................. 30,000Goodwill............................................................................. $ 40,000




30/41

b.Easton, Harris Consolidation Consolidated

Accounts Company Co. Entries Totals

Cash $ 84,000 $ 40,000 $ 124,000

Receivables 160,000 90,000 250,000

Inventory 220,000 130,000 350,000

Investment inHarris 390,000 [S] $(280,000) -

[A] (110,000)Land 100,000 60,000 160,000

Buildings, net 400,000 110,000 [A] 40,000 550,000

Equipment, net 120,000 50,000 170,000

Patent 0 - [A] 30,000 30,000

Goodwill - - [A] 40,000 40,000Totals $1,474,000 $ 480,000 $1,674,000

Accounts payable $ 160,000 $ 30,000 $ 190,000

Long-term liabilities 380,000 170,000 550,000

Common stock 500,000 40,000 [S] (40,000) 500,000

Additional paid-incapital 74,000 - 74,000

Retained earnings 360,000 240,000 [S] (240,000) 360,000

Totals $1,474,000 $ 480,000 $1,674,000

c. The tangible assets are accounted for just like any other acquired asset. Thereceivables are removed when collected, inventories affect future cost of goodssold, and depreciable assets are depreciated over their estimated useful lives.Intangible assets with a determinable life are amortized (depreciated) over thatuseful life. Finally, intangible assets with an indeterminate useful life (such asgoodwill) are not amortized, but are either tested annually for impairment, ormore often if circumstances require.




31/41

E12-43 (20 minutes)

a. Companies use derivative securities in order to mitigate risks, such ascommodity price risks, risks relating to foreign exchange fluctuations, or risksrelating to fluctuations in interest rates.

b. Derivatives are reported on the balance sheet as are the assets or liabilities towhich they relate. Generally, derivatives and the related assets/liabilities arereported on the balance sheet at their fair market value.

c. The unrealized gains (losses) on HPs derivatives are reported in the OtherComprehensive Income section of its stockholders equity. This reportingindicates that they have not yet affected HPs profits. Once the underlyingtransaction is settled, these unrealized gains (losses) will be removed from OCIand transferred into current income, thus affecting HPs profitability.




32/41

PROBLEMS

P12-44 (50 minutes)

a. Available-for-sale investments are reported at market value on the balancesheet. Thus, Met Lifes bond investments are reported at:

$188,251 million as of 2008$232,336 million as of 2007

b. Net unrealized gains (losses) for 2008 are$(21,257) million ($7,564 million - $28,821 million)

Net unrealized gains (losses) for 2007 are$2,982 million ($7,250 million - $4,268 million)

Because the investments are accounted for as available-for-sale, theseunrealized gains (losses) did not affect reported income for 2008 and 2007.(Note: Had these investments been accounted for as trading securities, thoseunrealized gains (losses) would have affected reported income.)

c. Realized gains (losses) are gains (losses) that occur as a result of sales of

securities. These are reported in the income statement and affect reportedincome.

Unrealized gains (losses) reflect the difference between the current marketprice of the security and its acquisition cost. Only unrealized gains (losses)from trading securities are reported in income.

d. The evaluation of investment performance is difficult as companies have

discretion over the timing of realized investment gains (losses) and can,thereby, affect reported income. By including unrealized gains (losses) in theanalysis, we are able to get a clearer picture of overall investmentperformancealbeit, with an understanding that these gains and losses arenot yet realized. These returns could then be compared with those ofcompetitors and market rates in general for investments of comparable risk.We believe this reporting metric provides useful insights as noted.




33/41

P12-45 (30 minutes)

Gem AlpineConsolidatingadjustments Consolidated

Current assets

Investment in Alpine

$200,000450,000

$160,000

$(450,000)

$ 360,000

0Plant assets (net) 265,000 460,000 34,800 759,800

Goodwill............................ . . 23,200 23,200

Total assets...................... $915,000 $620,000 $1,143,000

Liabilities $ 50,000 $ 60,000 $ 110,000

Minority interest .............. 0 0 168,000 168,000

Common stock................. 700,000 420,000 (420,000) 700,000

Retained earnings............ 165,000 140,000 (140,000) 165,000

Total liabilities &

stockholders equity........$915,000 $620,000 $1,143,000




34/41

P12-46 (40 minutes)

a. (in $millions)

Current assets, principally cash and marketable securities... $ 252Deferred tax assets................................................................ 290

Property, plant, and equipment............................................... 220Other assets............................................................................Liabilities: principally debt

75(743)

Total tangible assets............................................................... $ (94)

Acquired IPR&D...................................................................... $ 1,101Identifiable intangible assets,

product technology and core technology............................. 320Goodwill.................................................................................. 684

Total intangible assets................................................................. $2,105

The intangible assets were valued by Amgen at more than 100% of theAbgenixs value. Essentially the value of the acquired company was captured byits research and development potential.

b. All assets of the acquired company are reported on the consolidated balancesheet at their fair market values on the date of the acquisition, not at the their netbook value.

c. The tangible assets are accounted for just like any other acquired asset: thereceivables are removed when collected, inventories affect future cost of goodssold, and depreciable assets are depreciated over their estimated useful lives.Intangible assets with a determinable life are amortized (depreciated) over that

useful life. Finally, intangible assets with an indeterminate useful life are notamortized, but are tested annually for impairment, or more often ifcircumstances require.

d. In-process R&D is valued at the discounted present value of expected futurecash flows. This approach is very imprecise and involves significant estimates,both of the expected cash flows and of the discount rate.

e. If the in-process R&D were estimated at a lesser amount, more of the purchaseprice would be allocated to goodwill. Current profitability would be higher (lessin-process R&D expense), and future earnings would be impacted only if the

goodwill is deemed to be impaired and written down.




35/41

P12-47 (40 minutes)

a. The trading security investments will be reported at $375,300. This value iscomputed using their market values at year-end; specifically, $105,300 +$270,000.

b. The available-for-sale investments will be reported at $359,000. This value iscomputed using their market values at year-end; specifically, $199,000 +160,000.

c. The held-to-maturity bond investments will be reported at $237,200. This valueis computed using their amortized cost value at year-end; specifically,$101,200 + $136,000.

d. Unrealized holding gains of $10,400 will appear in the 2010 income statement.These gains relate to the trading securities; specifically Ling: $105,300 -$102,400 = $2,900 gain; Wren: $270,000 - $262,500 = $7,500; total of $2,900 +$7,500 = $10,400. The calculation is only possible because this is the first yearthe bonds have been held. Therefore, the entire price difference occurred thisyear.

e. (i) Unrealized holding gains of $8,000 will appear in the stockholders' equitysection of the December 31, 2010, balance sheet under accumulated othercomprehensive income (AOCI). These losses relate to the available-for-salesecurities; specifically Olanamic: $199,000 - $197,000 = $2,000; Fossil:$160,000 - $154,000 = $6,000; total of $2,000 + $6,000 = $8,000.(ii) Unrealized holding gains of $10,400 will appear in the stockholders equitysection of the December 31, 2010, balance sheet under retained earnings (seeanswer to requirement d).(iii) Total unrealized holding gains in equity of $18,400totals of (i) & (ii).

f. (i) A fair market value adjustment to investments of $8,000 will appear in theDecember 31, 2010, balance sheet. This adjustment relates to theavailable-for-sale securities. See part (e) for the supporting computations. Thefair value adjustment increases the book value of the available-for-salesecurities to their year-end market value.

(ii) A fair market value adjustment to investments of $10,400 will appear in theDecember 31, 2010, balance sheet. This adjustment relates to the tradingsecurities. See part (d) for supporting computations. The fair value adjustmentincreases the book value of the trading securities to their year-end marketvalue.

(iii) No fair market adjustment is made to the bonds to be held to maturity.However, the reported value of each bond is adjusted for the amortization ofpremium or discount. Thus the Meander bond will be shown at a value of$101,200 and the Resin bond will be valued at $136,000. The changes in theseasset values on the Columbia Company balance sheet will be matched by therelated interest revenue.




36/41

P12-48 (60 minutes)

a. Yes, each individual company (e.g., parent and subsidiary) maintains its ownfinancial statements. This approach is necessary to report on the activities ofthe individual units and to report to the respective stakeholders of each unit.

The purpose of consolidation is to combine these separate statements tomore clearly reflect the operations and financial condition of the combined(whole) entity.

b. The Investment in Financial Products Subsidiaries is reported on theparents (Machinery and Engines) balance sheet at $3,727 million.

This amount is the same balance as reported for stockholders equity of theFinancial Products subsidiary.

This relation will always exist so long as the investment is originallypurchased at book value (e.g., no goodwill from the purchase).

c. The consolidated balance sheet more clearly reflects the actual assets andliabilities of the combined company vis--vis that revealed in the equitymethod of accounting. That is, it better reflects operations as one entity as faras investors and creditors are concerned.

The equity method of accounting that is used by the parent company toaccount for its investment in the subsidiary reflects only its proportionateshare (100% in this case) of the investee company stockholders equity anddoes not report the individual assets and liabilities comprising that equity.

d. The consolidating adjustments generally accomplish three objectives:(i) They eliminate the equity method investment on the parents balance sheet

and replace it with the actual assets and liabilities of the investee company towhich it relates.

(ii) They record any additional assets that are included in the investmentbalance that may not be reflected on the subsidiarys balance sheet, likegoodwill, for example.

(iii) They eliminate any intercompany sales and receivables/payables.

e. The consolidated stockholders equity and the stockholders equity of theparent company are equal. This equality will always be the case. Theconsolidation process replaces the investment account with the assets and

liabilities to which it relates. Thus, stockholders equity remains unaffected.

f. Consolidated net income will equal the net income of the parent company. Thereason for this result is that the parent reflects the income of the subsidiaryvia the equity method of accounting for its investment. The consolidationprocess merely replaces the equity income account with the actual andindividual sales and expenses to which it relates. Net income is unaffected.




37/41

g. The equity method of accounting reports investments at adjusted cost(beginning balance plus equity earnings and less dividends received)thiscontrasts with the market method. Unrealized gains for a subsidiary are,therefore, not reflected on the consolidated balance sheet and incomestatement. Instead, the subsidiary is reflected on the balance sheet at its

purchase price net of depreciation and amortization, just like any other asset.The consolidation process merely replaces the investment account with theactual assets and liabilities to which it relates. Thus, there can existsubstantial unrealized gains subsequent to the acquisition that are notreflected in the consolidated financial statements.




38/41

CASES

C12-49 (60 minutes)

a. General Mills accounts for the investments in its joint ventures using theequity methodsee middle of its note disclosure. Consolidation is notappropriate because General Mills does not control these entities (not >50%equity interest); also, the market method is inappropriate because GeneralMills is able to exert significant influence in the management of thesebusinesses.

Under the equity method, these investments are reflected on General Millsbalance sheet at adjusted cost (e.g., beginning balance plus proportionateshare of investee company earnings less any dividends received). Theproportionate share of investee company earnings is recorded as income bythe investor company. Dividends are not income. Instead, under the equity

method, they are treated as a return of the investment.

b. The investment balance is always equal to the investors proportionate shareof the stockholders equity of the investee company. In the case of GeneralMills, the combined net assets (stockholders equity) of all joint ventures is$355.0 million ($1,021.5 million current assets + $1,002.0 million noncurrentassets - $1,592.6 million current liabilities - $75.9 million noncurrent liabilities);these details are in the table at the end the footnote. Because the investmentbalance is equal to $278.6 million, it owns 78.5% ($278.6 million / $355.0million), on average. General Mills will, therefore, report approximately 78.5%of the investee company earnings or approximately $149.5 million ($190.4

million 78.5%).

c. The $278.6 million investment balance on General Mills balance sheetrepresents the net equity of the joint ventures that it owns. Its proportionateshare of the assets of the joint ventures as well as its proportionate share ofthe joint ventures liabilities is not reflected on its balance sheet, only the netequity. As a result, the actual investing and actual financing amounts requiredto conduct these operations is not reflected on-balance-sheet. This omissionis the primary criticism of equity method accounting.

d. Although General Mills does not have legal liability for the obligations of most,

if not all, of its joint ventures, it often has an implicit obligation to standbehind the entities that it has created (which includes their financing). That is,General Mills would be hard-pressed to walk away from one of these entitiesshould it fail to provide sufficient funds to satisfy its liabilities.




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e. Equity method accounting presents at least two challenges for analysispurposes. (i) Equity method accounting obscures the actual assets andliabilities of the investee company on the books of the investor company. (ii)The equity investments are reported at adjusted cost. As a result, unrealizedgains (say, from market value adjustments) are not reflected on the balance

sheet or in the income statement.

C12-50 (50 minutes)

a.20101/2 Investment in Dye, Inc. (+A) .......................................................... 420,000

Cash (-A) ................................................................................ 420,000

12/31 Dividend receivable (+A) .............................................................. 16,000Dividend income (+R, +SE) ....................................................... 16,000

12/31 Unrealized loss (+E, -SE) .............................................................. 60,000Investment in Dye, Inc. (-A) ...................................................... 60,000

20111/18 Cash (+A) ................................................................................... 16,000

Dividend receivable (-A) ........................................................... 16,000

b.+ Cash (A) - + Investment in Dye Inc. (A) -

1/18/11 16,000 420,000 1/2/10 1/2/10 420,000 60,000 12/31/10

+ Dividend Receivable (A) -

12/31/10 16,000 16,000 1/18/11

+ Unrealized Loss (E) - - Dividend Income (R) +

12/31/10 60,000 16,000 12/31/10




Contrib.Capital +


1/2/10 Buy 20,000shares of Dye.

-420,000Cash

+420,000Investment

= - =

12/31/10 Declaredividend $.8/share.

+16,000Dividend

Receivable



- = +16,000

12/31/10 Recognizedecline ininvestment.

-60,000Investment

=-60,000RetainedEarnings

-+60,000Unrealized

Loss= -60,000

1/18/11 Receipt ofdividend.

+16,000Cash

-16,000Dividend

Receivable

= - =




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d.20101/2 Investment in Dye, Inc. (+A) .......................................................... 420,000

Cash (-A) ................................................................................ 420,000

12/31 Dividend receivable (+A) .............................................................. 16,000Investment in Dye, Inc. (-A) ...................................................... 16,000

12/31 Investment in Dye, Inc. (+A) .......................................................... 112,000Investment revenue (+R, +SE) .................................................. 112,000

20111/18 Cash (+A) ................................................................................... 16,000

Dividend receivable (-A) ........................................................... 16,000

e.+ Cash (A) - + Investment in Dye Inc. (A) -

1/18/11 16,000 420,000 1/2/10 1/2/10 420,000

12/31/10 112,000 16,000 12/31/10

+ Investment Revenue (R) - + Dividend Receivable (A) -

112,000 12/31/10 12/31/10 16,000 16,000 1/18/11

f.Balance Sheet Income Statement



Contrib.Capital +


1/2/10 Buy 20,000shares of Dye.

-420,000Cash

+420,000Investment

= - =

12/31/10 Declaredividend $.8/share.

+16,000Dividend

Receivable

-16,000Investment

= - =

12/31/10 Recognizeincome frominvestment.

+112,000Investment



- = +112,00

1/18/11 Receipt ofdividend.

+16,000Cash

-16,000Dividend

Receivable

= - =




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C12-51 (15 minutes)

a. Consolidated statements present the total assets and liabilities of all firms inwhich the reporting firm has more than a fifty percent ownership withintercompany accounts and transactions eliminated.

b. Demski has a controlling interest in Asare and Demski Finance. Therefore,their assets and liabilities are all added to those of Demski Inc. Demski doesnot have a controlling interest in Knechel. Therefore, it must show itsinvestment in Knechel Inc. as an asset.

c. This excess is the amount paid to Asare in excess of the net book value ofAsares assets (assets less liabilities assumed) when Asare was acquired byDemski. The amount is known more commonly as Goodwill and reflects thefact that Demski believed the company was worth more than the net bookvalue of its assets.

d. The amount represents the 25% of outside ownership of Asares assets, which

are aggregated in the balances of Demskis accounts.

e. Under GAAP, the value is the pre-acquisition value of the net assets involved.Under IFRS, the minority interest would be valued at the fair market vaue ofthe assets.

C12-52 (30 minutes)

a. While the approach recommended by Gayle is not disallowed by a specificaccounting standard, it is not consistent with the intent of GAAP. Certainly

from a position of representational faithfulness, it specifically does notrepresent how management regards the investment or intends to treat it in thefuture. The approach recommended is a flagrant attempt to violate the spirit ofGAAP in order to manage earnings.

Such practice may get by the firms auditors once or twice, but failure to beconsistent in the accounting treatment over time is unlikely to be toleratedunder SOX and the increased scrutiny applied by the SEC in the wake of thenumerous accounting scandals of the recent past.Further, such practice can lead to lawsuits by investors who can argue thatmanagement was not accounting truthfully.

b. We believe the practice to be highly unethical.

dmp3e ch12 solutions 05.17.10 revised

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