Advanced Financial Accounting Canadian 7th Edition

by Beechy Trivedi MacAulay ISBN 0132928930

9780132928939

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CHAPTER 6

Subsequent-Year Consolidations:
General Approach
This chapter presents the last of the material that is crucial to an understanding of
intercorporate investments, business combinations, and consolidations. The material in
the Appendices to Chapter 6 (parent company investment in non-voting shares and
intercompany bond holdings involving premiums or discounts) are additional aspects that
are interesting and that occasionally arise in Canadian practice, but are not central
concepts of consolidations.

The previous two chapters illustrated intercompany sales of inventory and non-
depreciable capital assets, but avoided the additional complexity of intercompany sales of
depreciable capital assets. Therefore, this chapter begins with a discussion of such asset
transfers.

The second major section presents the general approach to subsequent-year

consolidations. The example is of consolidation of a non-wholly owned subsidiary that
was acquired in a business combination—the most complex example. Consolidation of
wholly owned subsidiaries is simpler, and consolidation of wholly owned subsidiaries
that were founded by the parent are simpler still (and much more common). The direct
approach to consolidation is used throughout, as in the preceding chapters. The
worksheet approach is available on the companion website to this text. Equity basis
reporting and consolidated reporting of discontinued operations is also discussed.

Appendix 6A addresses those circumstances where the investee company has outstanding
restricted and/or preferred shares in addition to common shares. The treatment of these

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Chapter 6 – Subsequent-Year Consolidations

preferred shares, whether owned by the parent company or by outside interests, on

consolidation is discussed. The impact of restricted shares on control and the allocation of
earnings is also discussed.

Appendix B to Chapter 6, available only online, discusses consolidation of

intercompany bond holdings. The Appendix illustrates both the par value and
agency approaches to intercompany bond holdings, including the impact on non-
controlling interest of each approach. Although the challenges presented by open-
market purchases of a related company’s bonds at a premium or discount are
intellectually interesting, such transactions are very seldom encountered in
Canadian practice. This appendix may be omitted without seriously jeopardizing
students’ understanding of consolidations.

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 Chapter 6 – Subsequent-Year Consolidations: General Approach

SUMMARY OF ASSIGNMENT MATERIAL

Case 6-1: International Consolidators Inc.

An analyst friend compares the return on equity calculated based on consolidated numbers two
years after the acquisition of the subsidiary with the return on equity of the parent and the
subsidiary at the time of the acquisition of the latter and concludes that there is no synergy between
them. Students are required to adopt the role of the friend of the analyst and are required to first
calculate the separate entity financial statements of the parent using the consolidated statements
and the separate entity statements of the subsidiary, and second to explain to the friend why
consolidation-related adjustments might be clouding the return on equity calculation based on the
consolidated statements. Students are also required to explain whether and to what extent the
various financial statements truly represent the operations and financial position of the two entities.

Case 6-2: Alright Beverages Ltd.

Alright Beverages Ltd. is a multi-topic case that deals primarily with the reporting issues that arise
from a series of transactions among related companies. It is a demanding case that requires
students to look beyond the surface implications.

Case 6-3: Le Gourmand

Half of the issued voting shares of a small company have been purchased by the company’s largest
customer. Ownership of the other half of the voting shares is somewhat diffuse and the
shareholders are disinterested in the affairs of the company. Has the new owner acquired control?
The case requires a discussion of the alternative accounting options and a recommendation. A
calculation of net income is also required.

Case 6-4: Constructive Inspirations Inc.

This case is quite demanding, especially when assigned as an exam question. It tests students’
understanding of how consolidation-related adjustments relating to a non-wholly owned subsidiary
purchased a few years ago impact current net income and ending owners’ equity.
A couple is divorcing amicably, and the divorce settlement requires the valuation of an
architectural company run by one of them. Valuation is to be based on the greater of six times net
income or ending owners’ equity, both calculated based on IFRS. The architectural company, along
with the friends of the architect spouse, owns shares in a supplier of architectural products. The
appropriate accounting option to account for this investment has to be recommended. A discussion
of the impact of consolidation-related adjustments on net income and owners’ equity respectively
is required. The case also requires a discussion of the “fairness” of using IFRS-based financial
statements for determining the company’s value.

P6-1 (20 minutes, medium)

This problem requires adjustments over a four-year period, ignoring taxes, for an intercompany
depreciable capital asset sale. There is a non-controlling interest in the subsidiary, and the sale is
upstream.

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P6-2 (20 minutes, medium)

Upstream sale of a 70% depreciated asset by an 80% owned subsidiary. The need to restore the
original accumulated depreciation adds a slight twist to the exercise. Eliminations for two non-
consecutive years are required.

P6-3 (30 minutes, medium)

This problem examines the adjustments required for an unrealized profit in inventory and a gain on
the sale of land, both upstream, where there is a 30% non-controlling interest over a two-year
period.

P6-4 (30 minutes, medium)

Intercompany sales of inventory, land and building between a parent and two subsidiaries (80%
and 70% owned). Eliminating entries and NCI effects are required.

P6-5 (20 minutes, medium)

Calculation of NCI and consolidated net income four years after acquisition. A good problem for
practice at applying the techniques of consolidation without going through an entire set of
consolidated statements.

P6-6 (40 minutes, medium)

Computation of consolidated net income and retained earnings for a parent and two subsidiaries.
The emphasis is on intercompany sales of inventory wherein one subsidiary sells to the parent,
which in turn sells to the other subsidiary.

P6-7 (45 minutes, easy)

This is a straight-forward exercise on preparing a consolidated statement of financial position five
years after acquisition. It is a good practice exercise (or examination question) as it contains no
unexpected twists.

P6-8 (20 minutes, medium)

Cost versus equity reporting of the investment account five years after purchase. Includes
amortization of a FVI on a building.

P6-9 (10 minutes, easy)

Calculation of equity-basis earnings and investment account one year following acquisition. This
problem illustrates equity-basis adjustments for FVI’s, but does not include any intercompany
transactions. P6-10 extends this problem for one more year and does include intercompany sales of
inventory and unrealized profits.

P6-10 (20 minutes, medium)

This is an extension of P6-9 that adds intercompany transactions and unrealized profits. Equity-
basis investment income and investment account balance are required, two years after the
investment.

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P6-11 (20 minutes, easy)

Cost versus equity reporting of a 30% investment three years after purchase. An equity-basis
investor statement of comprehensive income is required, plus determination of the investment
account. There are no FVIs or intercompany transactions.

P6-12 (60 minutes, medium)

This problem involves investments in three other companies, with two reported on the equity basis
and one on the cost basis. Discussion of the appropriateness of the cost and equity methods is
required. The transactions and the entries required cover a one-year period.

P6-13 (75 minutes, medium)

Consolidated SFP amounts (not a full SFP) and equity basis earnings in the subsidiary are required
for an 80% subsidiary four years after acquisition. There are several unrealized profits (and one
intercompany loss that may be assumed to reflect a decline in recoverable value).

P6-14 (25 minutes, easy)

Preparation of a consolidated statement of financial position following upstream sales of inventory
and a downstream sale of equipment.

P6-15 (45 minutes, medium)

Calculation of the carrying value of goodwill when 80% of the shares have been purchased,
preparation of a consolidated statement of comprehensive income three years later, including
upstream and downstream unrealized profits and calculation of inventory and non-controlling
interest on the statement of financial position three years later.

P6-16 (50 minutes, medium)

This problem requires the calculation of consolidated net income and selected SFP amounts two
years after the purchase of a 70% interest in a subsidiary. In addition, the journal entry at the time
of acquisition is required.

P6-17 (50 minutes, medium)

This problem requires the preparation of a consolidated statement of comprehensive income and
consolidated statement of retained earnings six years after a 70% purchase, the calculation of
consolidated retained earnings at the beginning of the year and an explanation of the treatment of
the unrealized profit on an equipment sale. A number of adjustments are required including fair
value increments, unrealized profits on inventory (upstream) and a gain on sale of equipment
(downstream). This problem also includes an impairment of goodwill.

P6-18 (40 minutes, medium)

This problem requires the preparation of a consolidated statement of comprehensive income and
the calculation of specific accounts on the consolidated statement of financial position six years
after a 70% acquisition. In addition to unrealized upstream inventory profits, this problem
incorporates the sale to external parties of a trademark with an unrealized gain.

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P6-19 (40 minutes, medium)

This problem is similar to P6-16 as it requires the preparation of a consolidated statement of
comprehensive income and the calculation of specific accounts on the consolidated statement of
financial position four years after a 70% acquisition. There are a number of adjustments including
an unrealized profit on an upstream land sale, downstream unrealized inventory profits and a
goodwill impairment.

P6-20 (45 minutes, difficult)

The challenge in this problem is in preparing the consolidated statement of comprehensive income
given a variety of intercompany sales and other intercompany transactions. A challenging and
worthwhile problem.

Case 6A-1
This case is an adaptation of the comprehensive exam of the 1999 UFE. The students need to
consider the impact of an acquisition on the EPS and accounting policies. There is a potential for
loss of control depending on the method of financing that is selected for the acquisition. Audit
issues also need to be considered.

Case 6A-2
It is not always clear just when a joint venture qualifies for joint venture accounting. In this case, a
joint venture is described in which one partner does have a majority of the board of directors but is
restricted in its control by only 50% voting rights and by a joint venture agreement that requires
consent of both co-ventures for substantive alteration of the terms. The case asks students to
discuss the appropriateness of using four methods of accounting for the investment.

P6A-1 (40 minutes, easy)

This is an exercise in separating the reporting effects of an investment in both common and
preferred shares. Equity reporting is assumed rather than consolidation.

P6A-2 (45 minutes, medium)

A consolidated statement of financial position is required where the parent owns a portion of the
outstanding preferred shares. The purchase price of the subsidiary’s share differs from the
redemption value.

P6A-3 (15 minutes, easy)

Calculation of the non-controlling interest on the consolidated statement of financial position at the
date of acquisition and one year later is required. The subsidiary has preferred and common shares
outstanding and the parent owns 80% of the common shares.

P6B-1 (20 minutes, medium)

Elimination entry for an intercompany bond investment in a subsidiary, assuming first that the
subsidiary is wholly owned, and then that it is 75% owned. Both agency and par value approaches
are required.

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P6B-2 (30 minutes, medium)

Calculation of selected amounts one year after acquisition of an 80% interest, given downstream
sales of inventory and land and a purchase of subsidiary bonds by the parent at a premium.

P6B-3 (40 minutes, medium)

This problem has two distinct and separable parts: (1) an upstream sale of land and buildings by
one subsidiary, and (2) a purchase of another subsidiary’s bonds by the parent. Statement amounts
are required (including non-controlling interest in earnings) rather than eliminating entries. The
bond aspect requires use of the par-value method.

P6B-4 (50 minutes, medium)

A consolidated statement of comprehensive income is required, plus calculation of specified
statement of financial position amounts. The bond transaction does not affect non-controlling
interest. The fixed asset sale is upstream.

ANSWERS TO REVIEW QUESTIONS

Q6-1: Profits on intercompany sales are unrealized when the merchandise or other assets have not
been resold to outside third parties or been consumed by amortization or depreciation.

Q6-2: The unrealized loss on sale of a capital asset at its fair market value may or may not be
eliminated on consolidation. The key question is whether the reduced fair market value reflects an
impairment in the value of the asset. Under IFRS, an impairment loss exists when the carrying
value of the asset exceeds its recoverable value. The recoverable value of an asset represents the
higher of its (1) fair value less costs to sell, and (2) value in use. If the original carrying value of
the asset still does not exceed the asset’s recoverable value to the consolidated enterprise despite
the low resale value, then the loss would be eliminated. If, on the other hand, the resale value is
low because the recoverable value of the asset has been impaired, the intercompany loss would not
be eliminated.

Q6-3: When assets are sold horizontally between non-wholly owned subsidiaries, the unrealized
profit is in the accounts of the selling company. Further, such sales are treated as upstream sales.
Therefore, 100% of the unrealized gains has to be eliminated in the consolidated financial
statements, allocating 60% to the parent’s owners and the rest, 40%, to the non-controlling interest.
Thus, while the consolidated net income should be adjusted to the full extent of the unrealized gain
of $20,000, 60% or $12,000 should be allocated to the owners of P and 40%, $8,000 should be
allocated to the non-controlling interest.

Q6-4: Equity-basis earnings should be adjusted for the investor company’s share of unrealized
profits from sales between significantly influenced investee corporations. In this example, $20,000
of unrealized profit is in the reported net income of IE1, of which IR has a 30% share. Therefore,
the adjustment to IR’s share of IE1’s earnings will be $6,000.

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Q6-5: The profit on an intercompany sale of a depreciable asset is gradually realized over the
productive life of the asset, as the asset is used in the revenue generating activities of the buying
company. In accounting terms, the using up of the asset is reflected by depreciation. Therefore, the
unrealized profit is realized year-by-year as the asset is depreciated.

Q6-6: If a company sells a long-lived asset that is part of its inventory, either upstream or
downstream, it is accounted for as sales revenue with offsetting cost of sales instead of as a gain on
sale. The gross profit on the sale would still be considered unrealized.

Q6-7: IAS 38, Intangible Assets, requires disclosure of the gross carrying amount and any
accumulated amortization at the beginning and end of each period for each class of intangible
assets. Therefore, entities following IFRS will need to keep track of the gross and accumulated
amortization amounts separately in different accounts for various classes of intangible assets. Such
requirements apply to capital assets as well. Hence, under IFRS, adjustments required upon the sale
of an intangible asset with a limited life such as a patent will be the same as the adjustments
required on the sale of a capital asset. However, earlier standards did not impose the same
disclosure requirements as required under IFRS for intangible assets. Therefore, a separate
accumulated amortization amount may not have been maintained in relation to these intangible
assets. In such an event, upon the sale of an intangible asset instead of a capital asset, the two
amounts for the asset account and the accumulated amortization account would have been netted
together.

Q6-8: Consolidated retained earnings is comprised of the parent’s retained earnings, plus the
parent’s share of earnings retained by the subsidiary since the date of acquisition (less any
unrealized profits of the parent, the parent’s share of any unrealized profits of the subsidiary, and
amortization of any fair-value increments, decrements or goodwill).

Q6-9: Ordinarily, any unrealized profit on an upstream intercompany asset sale is deducted from
the recorded carrying value of the asset on the parent’s books and from the consolidated retained
earnings. However, a subsidiary might sell an asset on which an unamortized fair value increment
from the time of the purchase of the subsidiary by the parent exists. In such a case, the unamortized
fair value increment reduces the unrealized profit from the viewpoint of the consolidated entity.
Therefore, the unrealized profit elimination is not for the amount of profit booked by the subsidiary
but is for the difference between the intercompany sales price and the amortized fair value of the
asset (i.e. carrying value of the asset from the consolidated perspective). The remaining gain will
be offset by the unamortized fair value increment adjustment.

Q6-10: In the year of the sale, any unamortized fair value increment on the asset sold is charged to
the gain or loss that has been recorded for the sale. In subsequent years, the charge will be to
consolidated retained earnings.

Q6-11: When the equity method is used for recording, the parent’s share of the subsidiary’s
earnings is included in the parent’s retained earnings. Since the same amounts also appear in the
subsidiary’s retained earnings, the subsidiary’s earnings will be counted twice unless they are
adjusted. Therefore, the process of consolidation under the equity method differs from the process

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under the cost method of recording only in that the equity pick-up of earnings made by the parent
must be reversed or eliminated in order to avoid double counting the earnings and the investment
account must be eliminated.

Q6-12: The equity-basis balance represents the parent’s share of the amortized fair values of the
subsidiary’s net assets as originally acquired, plus the parent’s share of the change in the
subsidiary’s net assets since the date of acquisition less/plus any unrealized gains/losses relating to
inter-company transactions at year-end.

Q6-13: Under equity basis reporting, the “equity in earnings” captures all of the effects of the
relationship between the investor and the investee corporations, without disturbing the basic
financial reporting of the activities of the parent or investor corporation. In addition, the “equity in
earnings” reflects the change in the investor’s investment account and all changes in net asset
values that relate to that account.

CASE NOTES

Case 6-1

Role:
First, prepare the separate entity financial statements of ICI and the associated calculations.
Second, compare the financial statements prepared by me with the consolidated statements of ICI
and the separate entity statements of PTI and explain to my friend how the consolidation-related
adjustments may potentially mask the presence of synergy between ICI and PTI. Third, explain to
my friend to what extent the separate entity and consolidated financial statements of ICI
appropriately reflect the true economic operations and situation of ICI.

Constraints:
Since ICI has used IFRS to arrive at its financial statements, all consolidation-related adjustments
required under IFRS need to be undone.

Critical Success Factors:

Correctly prepare the separate entity FS of ICI and explain to my friend using non-technical
language the impact of consolidation-related adjustments on the financial results reported by ICI in
its consolidated financial statements. Further explain to my friend to what extent the separate entity
and consolidated financial statements of ICI respectively reflect its true economic operations and
position.

Users & Objectives:

The financial statements and my report are being prepared for the sole use of my friend. My friend
is trying to analyze the financial results of ICI from the point of view of an analyst; specifically he
is looking to see whether the synergy between ICI and PTI touted by the management of ICI at the
time of its acquisition of PTI is indeed present. There are no other users of the financial statements
and report prepared by me. However, the financial statements provided to me, the consolidated

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financial statements of ICI and the separate entity financial statements of PTI were prepared and
reported by their respective management and thus may be biased to the extent the respective
management teams have tried to meet their objectives keeping in mind the users of their respective
financial statements and their objectives.

Separate Entity Financial Statements of ICI and Related Calculations:

Check to ensure no gain on bargain purchase:
Assets $4,150,000
Liabilities 600,000
$3,550,000
80% share 2,840,000
Purchase price 3,220,000
Excess of purchase price over share of net identifiable assets $380,000

Therefore, there is no gain on bargain purchase.

Measure:
$3,220,00
Purchase price 0
$4,025,00
Grossed-up fair value based on purchase price 0
Carrying value of assets 950,000
$3,075,00
Fair value adjustment 0

Fair FVA FVA All.

Carrying Value FVA FVA All. All. Total
Assets
Cash $75,000 $75,000 $0 $0 $0
Inventory 75,000 150,000 75,000 75,000 75,000
Accounts receivables 200,000 375,000 175,000 175,000 175,000
400,00
Buildings 500,000 600,000 400,000 (300,000) 0 400,000
Acc. depreciation--buildings (300,000) 300,000
300,00
Plant & equipment 800,000 700,000 300,000 (400,000) 0 300,000
Acc. depreciation--plant &
equipment (400,000) 400,000
1,500,00 1,000,00
Land 500,000 0 1,000,000 0 1,000,000
Patents 750,000 750,000 750,000 750,000

Liabilities & Owners’

Equity
Accounts payable $200,000 $200,000 $0 0
Long-term debt 300,000 400,000 (100,000) (100,000) (100,000)
FVA allocated to net identifiable assets $2,600,00

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0
Goodwill $475,000

Useful Amort./
FVA Total life year 20X6 20X7 Balance
Inventory $75,000 $75,000 $0
AR 175,000 175,000 0
Buildings 400,000 10 40,000 40,000 40,000 320,000
Plant &
Equipment 300,000 10 30,000 30,000 30,000 240,000
Land 1,000,000 1,000,000
Patents 750,000 10 75,000 75,000 75,000 600,000
Long-term Debt (100,000) 10 (10,000) (10,000) (10,000) (80,000)
Goodwill 475,000 300,000 175,000
Total $3,075,000 $385,000 $435,000 $2,255,000

Eliminate:
Eliminate Intercompany Transactions & Balances
Downstream Sales $1,472,900
Upstream Sales 1,499,680
Inter-company dividends 48,000

Eliminate Unrealized Gains:

Gross profit percentage on upstream sales
Gross profit $1,387,204
Revenue 3,749,200
37%

Gross profit percentage on downstream sales (provided) 45%

Upstream
Beginning inventory $100,000
Realized gain 37,000

Ending inventory $150,000

Unrealized gain 55,500

Downstream

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Beginning inventory $40,000

Realized 18,000

Ending inventory $50,000

Unrealized 22,500

Unrealized and Realized Gain on Upstream Sale of Depreciable Asset:

Sale price $200,000
Original cost $200,000
Accumulated depreciation 100,000
Carrying value 100,000
Gain 100,000
Remaining useful live 10
Additional depreciation charged by ICI 10,000

Separate Entity Statements of ICI:

Consolidated SCI of ICI for the Year PTI SE SCI
Ended December 31, 20X7 Subtracted Consolidated Adjustments Undone ICI SE SCI
Sales Revenue $6,668,220 $3,749,200 1,472,900 1,499,680 $5,891,600
COGS 2,652,796 2,361,996 1,472,900 1,499,680 37,000 18,000
(55,500) (22,500) 3,240,380
Gross profit $4,015,424 1,387,204 2,651,220
Dividend Income $0 48,000 48,000
Amortization expense 365,000 50,000 (40,000) (30,000) (75,000) 10,000 180,000
Administrative expenses 1,109,404 412,412 10,000 706,992
Selling & marketing
expenses 1,643,530 612,500 1,031,030
Loss on impairment of
goodwill 300,000 (300,000) 0
Income tax expense 209,098 62,458 146,640
Net income and
comprehensive income $388,392 249,834 634,558
Allocated to:
Shareholders of ICI $667,125
Non-controlling interest $21,267

Statement of Changes in Equity—Retained Earnings Section

Cons. ICI SE ICI
BRE parent $1,386,732 1,598,460
Net income attributable to
shareholders of ICI 427,125 634,558

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Dividends for the year (200,000) (200,000)

Ending RE $1,613,857 2,033,018

SFP as of December 31, 20X7

Cons. ICI PTI SE Consolidated Adjustments Undone ICI SE
Assets
Cash $515,202 $252,184 $263,018
Inventory 252,000 80,000 55,500 22,500 250,000
Accounts receivables 555,000 225,000 330,000
Buildings 2,100,000 500,000 300,000 (400,000) 1,500,000
Acc. depreciation—
buildings (990,000) (340,000) (300,000) 80,000 (870,000)
Plant & equipment 2,700,000 600,000 400,000 (300,000) 2,200,000
Acc. depreciation--plant
& equipment (1,540,000) (360,000) (400,000) 60,000 (20,000) 100,000 (1,440,000)
Land 3,250,000 800,000 (1,000,000) 1,450,000
Patents 600,000 (750,000) 150,000 0
Investment in PTI 0 3,220,000 3,220,000
Goodwill 175,000 (475,000) 300,000 0
TOTAL ASSETS $7,617,202 $1,757,184 $6,903,018
Liabilities & Owners’
Equity
Accounts payable $422,510 $172,510 $250,000
Long-term debt 655,000 175,000 (100,000) 20,000 400,000
Contributed capital 4,220,000 500,000 4,220,000
Retained earnings 1,613,857 909,674 2,033,018
NCI 705,835 0
TOTAL LIABILITIES
& OWNERS' EQUITY $7,617,202 $1,757,184 $6,903,018

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Independent Calculation of SE Beginning RE of ICI (not required):

Beg. SE RE ICI $1,598,460

Beg. RE PTI
Ending RE $909,674
Less income for the year (249,834)
Add dividends declared for the year 60,000
Beg. RE 719,840
RE at acquisition 450,000
Change in RE 269,840
Less FVA amortization 20X6 (385,000)
Less gain on sale of P&E (100,000)
Add realization of gain 10,000
Unrealized gain beginning upstream (37,000)
Adj. change RE of PTI (242,160)
ICI's share (193,728)
Unrealized gain beginning downstream (18,000)
Consolidated Beg. RE ICI $1,386,732

Independent Calculation of SE Ending RE of ICI:

RE Ending $2,033,018
Less Unrealized gain ending (22,500)

RE Ending 909,674
RE acquisition (450,000)
Change in RE 459,674
Less FVA amortization 20X6 (385,000)
Less FVA amortization 20X7 (435,000)
Less Unrealized gain ending (55,500)
Less unrealized gain P&E (80,000)
Adj. change in RE (495,826)
Parent's share (396,661)
Consolidated End RE ICI $1,613,857

Analysis of Financial Statements & Report to Friend:

I have calculated different returns on equity measures based on the separate entity financial
statements of ICI and PTI respectively, and alternate returns on equity measures based on the
consolidated financial statements of ICI. While these different measures can be used to compare
the performance of ICI and PTI in 20X7 with their performance at the time of the acquisition of

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PTI, it is important to understand that such comparison may not necessarily shed light on the
presence or absence of synergy between ICI and PTI.

Return of Equity of PTI in 20X7

Owners' equity $1,409,674
Net income 249,834
Return on equity 17.72%

Consolidated Return on Equity of ICI in 20X7 (provided):

Total owners' equity including NCI equity $6,539,692
Consolidated net income and comprehensive income 388,392
Return on equity 5.94%

Alternate Consolidated Return on Equity of ICI in 20X7 Excluding NCI:

Owners' equity excluding NCI equity $5,833,857
Net income attributable to shareholders of ICI 427,125
7.32%

Return of Equity of ICI in 20X7:

Owners' equity $6,253,018
Net income 634,558
Return on equity 10.15%

The provided returns on equity of PTI and ICI at the time of acquisition are 20.42% and 10.69%
respectively. In comparison, the returns on equity of PTI and ICI for 20X7, as calculated above, are
17.72% and 10.15%. Thus, both returns on equity in 20X7 are lower than their comparatives at the
time of acquisition. However, notice that both these returns of equity are far above the alternate
returns on equity calculated based on the consolidated numbers, 5.94% and 7.32%. In short, the
returns on equity based on the separate entity financial statements of PTI and ICI are not as bad as
those based on the consolidated financial statements. The reasons for this disparity are:
 The loss of $300,000 recognized in the consolidated SCI relating to the impairment of the
goodwill arising from the acquisition of PTI,
 The fair value adjustment amortization of $135,000 relating to the identifiable net assets of PTI
on the consolidated SCI in 20X7,
 The unrealized gains present in the ending inventories of PTI and ICI relating to the inter-
company sales of inventory between them being higher by $23,000 compared to the unrealized
gains in the beginning inventories of the two companies.

Note that these additional expenses/adjustments do not show up on the separate entity financial
statements of PTI. Thus, comparing the consolidated results with the results of PTI at the time of
its acquisition, based on its separate entity statements at that time, is incorrect. Nevertheless, note
that the consolidated adjustments highlighted above are done for genuine reasons. When one
company controls another, the consolidated statements should represent only the results of those

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transactions that exist between the consolidated entity and outside entities. Otherwise, a
consolidated entity can very easily inflate the results presented in the consolidated statements by
suitably structuring inter-company transactions.
Additional consolidation-related adjustments include the elimination of upstream as well as
downstream sales between ICI and PTI. Such sales represent 28.53% of the total sales of ICI and
PTI. Thus intercompany sales represent a significant proportion of the total sales of the two entities
and indicate the presence of strong links and potential synergy between them. It is not clear
whether such inter-company transactions existed prior to the acquisition of PTI and ICI. This opens
up the question of why ICI acquired PTI in the first place. ICI may have acquired PTI to
consolidate the market for the products of the two companies, or to fend off a competitor from
acquiring PTI. ICI may have perceived that the market for its products is slowly drying up or the
profit margins are being squeezed, and thus might have purchased PTI to prevent further erosion of
its market share or profitability. If that was the aim of acquiring PTI, the acquisition may indeed
have achieved its desired purpose despite the subsequent decrease in the return on equity.
Therefore, it is not clear why the management of ICI decided to take an impairment loss of
$300,000 in relation to the goodwill arising from the acquisition of PTI. While the separate entity
returns on equity of PTI and ICI in 20X7 are no doubt lower than their counterparts at the time of
the acquisition of PTI, the differences between them do not appear to be that large so as to warrant
writing off the goodwill. There may be many different reasons for such a decrease, some of which
were already pointed out earlier. Further, the recent downturn in the economy may be temporarily
depressing the returns of the two companies. In such an event I think writing off the goodwill may
not be warranted. On the other hand, and notwithstanding the previous reasons, the decrease in the
returns on equity may indeed indicate a permanent decrease in the profitability of the two
companies, meaning that the expected synergy has not occurred. Therefore, if the goodwill was
paid in relation to the expected synergy it is appropriate to write-off the portion of the goodwill that
has no future value. The performance of the combined entity with those of other companies in the
same industry may provide some clues on this issue. However, such comparison has to be done
with caution, since, as we have already seen, the method and type of accounting adopted by
individual companies can have a significant impact on their returns, thereby making an one-on-one
comparison of their results with those of other companies difficult if not impossible.
Another reason for exercising caution while using consolidated SFP numbers is the fact that the
consolidated SFP includes the net assets of ICI at their carrying values, while including the net
assets of PTI at their fair values at the time of PTI’s acquisition less related amortization. This is
like trying to add apples to oranges. Thus, it is really difficult to make sense of any ratios that you
might obtain based on the consolidated numbers. Consequently, it is incorrect to compare the
return on equity calculated based on the consolidated statements of ICI at the end of 20X7 to the
returns on equity at the time of acquisition and conclude that there is no synergy between ICI and
PTI.
In summary, it is premature to conclude based on the decrease in the return on equity of the two
companies subsequent to the acquisition of PTI that synergy between them is absent.

True Picture of the Operations and Financial Position of ICI and PTI:
None of the financial statements provide a true picture of the operations and economic situation of
ICI and PTI at the end of 20X7. Accounting based SFPs report the carrying values of a significant
portion of the net assets of entities most often than not at their historical values, not at their fair

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values. For example, it looks as if the fair values of the net assets of ICI including its land holdings
at the end of 20X7 are significantly higher than their carrying values on its separate entity SFP.
PTI’s assets including its significant land holding may also have similarly increased in value since
the time of its acquisition in 20X5. However, such increases are not reported on the any of the
financial statements, separate entity or consolidated. Since land appears to represent a significant
portion of the net assets of PTI and ICI, the consolidated and separate entity SFPs may be
significantly misreporting the true values of the net assets of both companies at the end of 20X7.
Consequently, if returns from holding land represent a significant source of returns for both
companies, such returns will not be shown on the separate entity or consolidated SCIs of the two
companies. In summary, both the returns and the financial positions of ICI and PTI may not be
correctly reflected in their respective separate entity and consolidated financial statements. This
misrepresentation can be alleviated partially if both companies use the revaluation method of
accounting for reporting their assets on their financial statements.

Case 6-2: Alright Beverages Ltd.

Objectives of the Case

This case deals with a number of issues, but the basic focus is on the reporting implications of
transactions among a family of related companies, including revenue recognition, adjustments for
unrealized profits, and reporting long-term installment purchase contracts. The required for the
case can be expanded to include income tax issues.

Objectives of Financial Reporting

The company is publicly held, and thus is IFRS-constrained. It also has debt financing (bank
loans). There is a bonus scheme for at least some of management, including the management of
Concentrated Vending Ltd. (CVL). There is explicit mention of tax deferral as an objective.
Therefore, the reporting objectives would include the following:

1. Performance evaluation
2. Tax deferral
3. Cash flow prediction
4. Profit maximization

Note that there may be different priorities for these objectives in the different reporting units. The
relative ranking of objectives shown above is essentially for the consolidated enterprise. For CVL
as a separate entity, however, profit maximization may move into first or second place due to the
bonus arrangement with the managers of CVL. If the other 30% of CVL is not publicly held, then
performance evaluation may not be an important objective for CVL.

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Accounting and Reporting Issues

Sales by VSL to Local Operators

VSL is selling the machines on an easy-payment plan to local operators. The sales contract
includes implicit interest. The alternatives for recognizing revenue include the following:

1. Recognize the present value of the payments, discounted at a market rate of interest for
conditional sales contracts. The interest would be recognized over the life of the sales contracts
on an effective yield basis. This alternative would cause recognition of at least some profit
above the $5,000 cost of the machines to VSL at the time the contract starts. This alternative
permits the earliest recognition of revenue. An allowance for doubtful contracts would have to
be set up. Given the lack of any track record for these contracts, there may be considerable
uncertainty associated with this alternative. If an allowance cannot be estimated, this method
would not be appropriate.

2. Discount the payments to the cost of the machines to VSL of $5,000 each. Revenue would be
recognized only in the form of interest as the contract matures. Revenue would be recognized
later in this alternative than in the former alternative, but it would also tend to delay income
taxes, as was considered desirable.

3. Discount the payments to the cost of the machines to CVL of $3,000 each. This alternative
would work on a consolidated basis, but not very well on a separate-entity basis for VSL. On the
other hand, there may be no need for separate-entity statements for VSL as it is a wholly-owned
subsidiary of ABL. This alternative would also solve the unrealized-profit problem on
consolidation, as will be discussed in the following section.

4. Recognize revenue on a cost-recovery basis. This is the most conservative approach and it
would delay recognition (and taxes) the longest. It is not advantageous for fulfilling the other
reporting objectives, however.

Sales by CVL to VSL

From the viewpoint of CVL as a separate entity, there is no problem with recording the sales when
they occur. However, there is some question as to the permanence of those sales. If VSL cannot
unload all of the machines that it takes, will CVL be required to accept them back? Are returns
estimable? VSL is already expecting to hold 1,200 machines in inventory at the end of the year,
almost 20% of the total purchases. There is a suggestion of profit manipulation for the benefit of
CVL (or its managers). Of course, the intercompany profit will have to be eliminated upon
consolidation.

A less obvious unrealized-profit issue arises from the sale of the machines by VSL to the local
operators. To the extent that the revenue from the outside sales has not been recognized, then that
portion of the intercompany profit per machine must also be eliminated. Therefore, there is a

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degree of interaction between the revenue recognition policy for sales by VSL and the realization
of profit by CVL within the consolidated reports of ABL.

Sales by ABL to Bottlers

The bottlers in major cities are wholly owned subsidiaries of ABL. ABL sells the syrups to the
bottlers, presumably at a profit. Revenue could be recognized by ABL (as a separate entity) when
the syrup is sold, or only when the syrup has been used and the product sold by the bottler. As a
separate entity, profit should probably be recognized when the syrup is sold by ABL. For
consolidated reporting, however, unrealized profits on syrup held by the bottlers should be
eliminated, if material in aggregate.

Business Combination

The acquisition of CVL by ABL should be reported by the acquisition method. If the fair values of
the net assets acquired were greater than the purchase price paid by ABL, then the negative
goodwill would have to be recognized as a gain from a bargain purchase. Although the price paid
by ABL was well below the proportionate carrying value, it is possible that the fair value of the net
assets was even lower, thereby resulting in goodwill. Although the presence of goodwill is unlikely
given that CVL was in financial difficulty, a bargain purchase still could have occurred. If there is
goodwill, it must be tested for impairment on an annual basis.

Inventory Valuation

The case mentions that CVL’s current cost to manufacture the machines is “significantly lower
than in previous years.” This comment should trigger examination of CVL’s finished goods
inventory to see if there are machines in stock that are being carried at higher than replacement
cost. If so, a partial write-down may be appropriate if net realizable value has also declined.

Operating Segment Reporting

The additional sales by CVL to VSL will increase CVL’s revenues. Operating segments reporting
may therefore be appropriate. Management may argue, however, that the machine sale is just a part
of an integrated soft drink enterprise, and that the production and distribution of soft drinks
(including the manufacture of the vending machines) is a dominant industry segment that
comprises over 75% of the company’s revenue, profit, and assets.
Note: Segment reporting is discussed extensively in Chapter 7. However, most students will have
been exposed to segment reporting in Intermediate Accounting and therefore should be
familiar with the broad outlines of segment reporting requirements.

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Case 6-3: Le Gourmand

Objectives of the Case

This case asks the student to examine the evidence in a business combination and determine what
method of reporting is appropriate for the acquirer. It also requires the calculation of net income.

Objectives of Financial Reporting

Le Gourmand is an incorporated company, as indicated by the name (Le Gourmand Inc). It appears
to be owned by one shareholder, Francois LeClerc, whose main concern regarding the combination
with Ombre Wines is the cash flow from dividends. Le Gourmand has no long term debt
outstanding; its only financing is from short term creditors. Accordingly, unless a bank or other
user requires financial statements in accordance with IFRS, IFRS does not appear to be mandatory,
and the choice of accounting policy should be based on LeClerc’s needs, not on what is required
under IFRS. Accounting Standards for Private Enterprises (ASPE) are an option for Le Gourmand.

Alternative Accounting Policy Choices

Le Gourmand Inc. has purchased 50% of the outstanding voting shares (3,000 of 6,000 issued
common shares) of Ombre Wines Ltd. This is not a majority of the outstanding voting shares, but
may be sufficient to elect a majority of the Board of Directors and to control the operations of
Ombre Wines. The evidence must be examined. Under IAS 27, Consolidated and Separate
Financial Statements, control exists when one entity has the power to direct the financing and
operating activities of another entity to derive benefits from that entity.

While the ownership of a majority of voting shares is usually evidence of control, control can exist
when there is ownership of 50% or less of the voting shares, combined with: (1) an irrevocable
agreement with other shareholders conferring their voting rights to the enterprise, or (2) ownership
of rights, options, warrants, convertible debt, convertible non-voting equity or other instruments,
which, if converted, would result in the enterprise owning a majority voting interest. Further, the
existence of de facto control by a minority shareholder should also be considered in the absence of
formal arrangements which would give it majority of the voting rights. For example, control is
possible when the ownership of the balance of shares is dispersed and such owners have not
organized themselves in such a manner as to exercise more voting shares than the minority
shareholder.

Francois LeClerc’s expectation of future dividends implies that LeClerc intends to hold the shares
for a long time. It also indicates that he expects to be able to control or at least influence the
declaration of dividends, thus control or influence the company. LeClerc purchased most of the
Ombre Wines trading shares, further indicating his desire for control. The fact that he only
purchased 50%, when there were more than 50% trading (since some shares were still available to
the public) indicates that LeClerc felt that 50% was enough to obtain control. He may have based
this on the following: (1) Le Gourmand was Ombre Wines’ largest customer, and (2) although the
founders of the company are still active, their children are selling their interests and do not plan to

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take over the business. Thus, there is evidence that Le Gourmand has acquired control of Ombre
Wines.

The common shares held by the original founders and their families must be less than 50%.
However, the original founders own the preferred shares of the company and could potentially
acquire the 1,000 common shares that have not been issued, unless LeClerc is in a position to block
the issue of such shares. This would effectively block Le Gourmand’s control of the company.
Further evidence of control by Le Gourmand, or lack of control on the part of the original owners,
needs to be gathered before it can be concluded that Le Gourmand has control.

If Le Gourmand could show control, consolidation would be the appropriate accounting policy for
reporting its investment in Ombre Wines under IFRS. However, under ASPE, LeClerc can also
elect to account for an investment subject to control using either the cost or equity methods. If
control cannot be exercised, the equity method would be appropriate. Here, LeClerc could elect to
use the cost method if ASPE are adopted. Le Gourmand’s 20X5 net income would be identical
under the consolidation and equity methods. The cost method would not be appropriate under IFRS
since Le Gourmand has more than a passive interest. As mentioned above, however, the owner,
Francois LeClerc, could elect the cost method under ASPE, or accept a qualified or adverse report.
It is possible that Francois may want to minimize his bookkeeping costs and therefore choose the
method that is the least costly.

Measure Step:
Purchase price of 50% of the shares of Ombre $207,000
Imputed value of 100% of Ombre based on purchase price $414,000
Carrying value of net identifiable assets:
Preferred shares $20,000
Common shares 137,000
Retained earnings 170,000
Net assets 327,000
Less: Preferred shares (20,000)
Dividends in arrears (2004 - $20,000 × 0.06) (1,200) (305,800)

Fair Market Value Increments

Investment land 20,000
Factory land 15,000
Grape press 4,000 (39,000)
Goodwill @ 100% $69,200

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Amortization:
Grape press $4,000 ÷ 5 years = $800/year 800

Net Income Calculations:

Le Gourmand's net income $25,000
Ombre Wines net income $76,400
Less write down of land not sold* (2,000)
Amortization of FVIs:
Piece of land sold (10,000)
Impairment of land not sold (10,000)
Grape press amortization (800)
Unrealized profit on upstream sales [$60,000 × $200,000 ÷ $300,000]** (40,000)
Less preferred dividends for 20X5 (1,200)
Adjusted earnings of Ombre Wines $12,400
Le Gourmand's share @ 50% $6,200
Less unrealized gain on sale of office equipment - downstream
Debt forgiven of $5,000 ($20,000 – $15,000) less carrying value of
equipment of $1,000*** (4,000)
Le Gourmand's equity in earnings of Ombre 2,200
Net income of Le Gourmand under equity method/net income
attributable to owners of Le Gourmand on consolidation $27,200

Notes:

* Since the company recently sold one of two identical pieces of land for $2,000 less than its
historical cost, the value of the land still held is questionable and should be written down.
However, there is a fair value increment of $20,000 on the land. Since one piece of land has
been sold, $10,000 should be included in the loss on sale and the other $10,000 should be
written down as it is impaired.

** There is no adjustment for the unrealized profit at the beginning of the year as the parties were
at arm's length at that time.

*** As the office equipment was transferred at year-end, amortization for 20X5 would have been
charged.

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Case 6-4: Constructive Inspirations Inc.

Overview

Accounting Experts LLP (AE) has been engaged by Jennifer and Johnnie to provide advice on the
accounting alternatives available under IFRS for valuing CI. Specifically, such choices will be used
to prepare CI’s financial statements, which will be used to value CI in relation to Jennifer's and
Johnnie's divorce settlement. While Jennifer will continue to own CI, assets equal to the value of
CI will be transferred to Johnnie as part of the divorce settlement. The value of CI will be equal to
six times the net income of CI in 20X9 or equal to the ending owners’ equity of CI in 20X9,
whichever amount is higher.

CI appears to have been in existence for quite some time. Forty percent of the shares of CEDS
were also purchased by CI three years ago on Jan. 1 20X7. Therefore, general purpose financial
statements must have been generated in the past aimed at providing financial information about CI
and its investments to various users, including employees and the bank. The bank in any case will
want to look at the separate entity financial statements of CI. The investors in CEDS will mainly
focus on the FS of CEDS, not those of CI. Accounting Experts has not been engaged to provide
advice relating to these general purpose statements. Rather, the advice is specific to the calculation
of net income and owners’ equity to be used to value CI for the purpose of the divorce settlement
between Jennifer and Johnnie.

Therefore, the present report will focus only on the accounting alternatives to be used for preparing
the special purpose financial statements needed for valuing CI. These financial statements will not
be available to other users of CI’s general purpose financial statements. Such users and their
objectives are irrelevant for the purpose of this report and thus will not be considered here.

Constraints

Jennifer and Johnnie have agreed that IFRS for public entities have to be used as long as the end
results are logical. Thus, for the purpose of this report IFRS is a constraint unless the results
therefrom are not logical.

Critical Success Factor

Critical success factors that affect the long-run success of CI are irrelevant here since this report is
not being provided for preparing the general purpose financial statements of CI.
However, it is critical to us that our advice is found acceptable by both Jennifer and Johnnie. Both
of them are long-term clients of AE, and we would like to keep both as our clients in the future as
well. However, this factor is not a CSF that applies to CI, rather it is critical to AE in maintaining
its long-term relationship between it and Jennifer and Johnnie respectively.

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Users’ Objectives

Jennifer:
Everything else being equal, Jennifer would like those accounting choices that will reduce both the
net income of CI in 20X9 and the owners’ equity of CI at the end of 20X9. This will reduce the
value of CI and therefore the value of the assets that will be transferred to Johnnie.

Johnnie:
Everything else being equal, Johnnie will have objectives that are exactly the opposite of Jennifer's.
He would prefer those accounting alternatives and choices that will increase both the net income of
CI in 20X9 and the owners’ equity of CI at the end of 20X9. At worst, he would like a fair
evaluation of NI of 20X9 and OE at end of 20X9, such that he obtains a fair value of CI.

Ranking of Users and Objectives

The divorce settlement has been amicable so far. Therefore, it is reasonable to assume that both
Jennifer and Johnnie would like to continue to keep it that way. Thus, neither party would want to
be unfair or appear unfair to the other party. However, as pointed out above, everything else being
equal, each would like those accounting alternatives that cater to their objectives.

Both Jennifer and Johnnie are important and long-term clients of AE. Therefore, it appears prudent
for AE not to be seen to be biased towards one over the other while providing their advice. Further,
AE has a fiduciary duty to both of them.
Given the above, it appears reasonable to provide advice that fairly reflects the economic situation
of CI. Towards this end, the most appropriate alternative under IFRS for public entities will be
provided for each relevant accounting issue. Non-IFRS alternatives will be considered only when
all IFRS alternatives are found to be unsuitable.

Accounting Issues and Alternatives

Net Income versus Owners’ Equity

A fair value for CI can be based on either an income or cash-flow approach, wherein, the future
income or cash-flow is discounted to present value terms, or based on the fair value of the existing
assets and liabilities of CI as at the end of 20X9. Jennifer and Johnnie have agreed to value CI
based on six times the NI of 20X9 or the ending owners’ equity of CI. Thus, while the former
measure appears to be roughly approximating the income approach of valuation, the latter, based
on owners’ equity, appears to be approximating the financial position basis of valuation. However,
both figures are historical cost based and do not necessarily reflect the impact of present values or
of future operations. For example, on the SCI, amortization and depreciation values are historical
cost based. Similarly, on the SFP, the assets and liabilities are valued at their historical cost.
Further, the assets and liabilities on the SFP of CI at the end of 20X9 may not accurately represent
the income generating potential of CI in the future. One glaring example is the value of Jennifer to
CI. Some of these problems can be mitigated by using the replacement model for measuring the
assets and liabilities of CI. This is discussed in further detail in the next section.

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Cost versus Revaluation Model of Valuing Assets of CI and CEDS

IFRS allows the use of either the cost or the revaluation model to value the assets of an entity.
Potentially a more accurate value of CI can be obtained by using the revaluation model to measure
assets such as property, plant and equipment and intangible assets. While such revaluation can
increase owners’ equity (assuming asset values are increasing), thereby increasing the value of CI,
it will also lead to higher amortization expenses on the SCI. Revaluation gains are not taken to net
income except to the extent of revaluation losses taken to net income in prior periods. On the
whole, however, following the revaluation model will lead to a higher valuation of CI, since such
value is based on the higher of six times NI or owners’ equity.

Since revaluation amounts are not available at this time, the discussion in the latter sections
assumes the use of the cost model.

CEDS
CI owns 40% of the shares of CEDS and one of its employees is on the BOD of CEDS. However,
the other 15 owners of CEDS, who are friends of Jennifer, have, via a written agreement, given CI
the authority to make operating and investing decisions in relation to CEDS. Further, CEDS also
appears to be a supplier of supplies to CI. CI’s employees are also working for CEDS. Finally, CI
did not charge a management fee to CEDS.

All of the above indicate that under IFRS, CI has control over the operating and investment
decisions of CEDS. Therefore, the investment is CEDS has to be accounted for as a business
combination. Consequently, the financial statements of CEDS have to be consolidated with those
of CI using the acquisition method. Under the acquisition method, both CI’s share as well as the
share of the other 15 owners (NCI) has to be accounted at their fair value at the time of acquisition.

However, we do not presently have sufficient information to carry out a full consolidation of
CEDS’ FS with those of CI. In fact, such consolidation may not be required for the purpose of this
report since the issue of importance is the impact of the accounting alternatives on the net income
of CI in 20X9 and the owners’ equity of CI in 20X9. Therefore, the following discussion will
restrict itself to the consolidation-related accounting adjustments required under IFRS for the
various issues relating to CEDS.

Fair Value of CEDS and Fair Value Increments at the Time of Acquisition

The balance of the FVI of $100,000 has been allocated to goodwill. This indicates that there is no
gain on bargain purchase. Consequently, the initial accounting for CEDS will not impact the net
income of CI nor its owners’ equity. The acquisition method allows for the use of either the entity
method or the parent-company extension method. The difference between the two methods affects
valuation of goodwill and valuation of NCI. Neither will affect the NI for 20X9 or owners’ equity
at the end of that year.

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Furthermore, the FVI allocated to inventory and patent will also not affect either net income or
owners’ equity at the time of acquisition. However, post-acquisition, both amounts will have the
following impact on net income of 20X9 and owners’ equity:

FVI allocated to inventory

There is a fair value decrement of $50,000 in relation to inventory. Inventories are assumed to be
sold in the very next year after acquisition. From the consolidated perspective the true cost of the
inventory is less by the FVD of $50,000, compared to the cost shown on the separate entity FS of
CEDS.

Therefore, the consolidated COGS would have been reduced by the $50,000 FVD in 20X7. This
would have increased the net income of that year by $50,000. 40% of the $50,000 increase, i.e.,
$20,000 is attributable to CI, while the remaining 60% or $30,000 is attributable to the NCI. Since
consolidation related adjustments do no carryover to later periods, suitable consolidation related
adjustments have to be made in later years to capture the cumulative impact of previous years’
consolidation adjustments. Therefore, in 20X9, focusing just on CI’s portion, an adjustment to
increase beginning owners’ equity of CI by $20,000 will have to be made. This adjustment will
carry over to ending owners’ equity, increasing it by $20,000. Thus, the value of CI for the purpose
of the divorce settlement will go up by $20,000 consequent to this adjustment.

FVI allocated to patent

The FVI allocated to patent is equal to $100,000. The patent had a further useful life of 10 years at
the time of the acquisition of CEDS by CI. Therefore, in its consolidated statements CI will make
consolidation adjustments to amortize the FVI of $100,000 over this 10-year period. Therefore, the
FVI amortization in 20X7 and 20X8 would have been $10,000 per year. A further $10,000
amortization of this FVI will be made in 20X9 as well.

While the $10,000 amortization of FVI in 20X9 will decrease the CI’s consolidated net income by
$10,000, CI’s share is only $4,000. Therefore, this will decrease the ending owners’ equity of CI in
20X9 by that amount. In addition, the cumulative impact of the adjustments relating to the
amortization of the FVI in previous years on CI’s ending retained earnings in 20X9 will be a
negative $8,000. Therefore, in total, the amortization of the FVI relating to the patent over the
three-year 20X7-20X9 period will have a negative impact of $12,000 on ending owners’ equity in
20X9. Therefore, for the purpose of the divorce settlement the cumulative impact of the FVI
amortization over the three-year period will be to decrease the value of CI by $12,000. In contrast,
the impact of the FVI amortization in 20X9 on the value of CI (using net income) for the purpose
of the divorce settlement will be greater, decreasing it by 6 × $4,000 or $24,000.

Impairment of Goodwill
It is assumed that the $100,000 FVI allocated to goodwill represents 100% of the value of
goodwill. Therefore, of the impairment loss of $20,000 relating to goodwill in 20X8, only $8,000
is attributable to CI. Therefore, the related cumulative adjustment in 20X9 will reduce the
beginning and thus the ending retained earnings of 20X9 by $8,000 and as a consequence the value
of CI for the purpose of the divorce settlement by $8,000.

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Management Fees

CI did not charge management fees to CEDS since 20X7. IFRS require all intercompany
transactions be eliminated while preparing consolidated statements, since these statements
represent the financial status of all the entities forming part of the consolidated group as one single
economic entity. Therefore, even if CI had originally charged management fees to CEDS, such
management fees would have been eliminated at the consolidated level for 20X9. No elimination is
required for the management fees in earlier years. Therefore, failure of CI to charge management
fees to CEDS does not have any impact on either the 20X9 net income attributable to CI or to the
owners’ equity of CI.

Interest on the 10% $100,000 Interest Bearing Note

CEDS would have paid $5,000 interest in 20X8 and $10,000 interest in 20X9 to CI. While such
interest would have been accounted for as an expense by CEDS, CI would have included such
amounts as income in its statement of comprehensive income for 20X8 and 20X9 respectively.
However, again, at the consolidated level, such intercompany interest payments and receipts made
in 20X9 have to be eliminated. Since both income and expense of $10,000 for 20X9 are
eliminated, the net impact on OE and NI will be zero. There is no need to adjust for the interest
income and expense of 20X8 since the net impact on the consolidation retained earnings of these
amounts is zero.

Sale of Equipment by CEDS to CI

The calculations underlying the various adjustments that need to be made in relation to the sale of
the depreciable asset by CEDS to CI on Jan. 1 20X8 are provided below:
Original cost to CEDS $300,000
Depreciation by CEDS (75,000)
Carrying value at time of sale to CI 225,000
Price at which sold to CI 270,000
Gain on sale on Jan. 1. 20X8 45,000
Remaining useful life on Jan 1. 20X8 3 years
Excess depreciation per year 15,000
Excess depreciation in 20X8 15,000
Excess depreciation in 20X9 15,000
Unrealized gains by beginning of 20X9 30,000

CEDS would have recognized a gain of $45,000 on the sale of the equipment to CI on Jan. 1,
20X8. CI in turn would have recorded the equipment at the price paid by it of $270,000 and started
depreciating it over three years at $90,000 per year. This is $15,000 higher per year than the
$75,000 depreciation that CEDS would have charged on its books if the sale had not occurred.

From a consolidated perspective no sale has actually occurred. Therefore, the adjustment in 20X9
to capture the cumulative impact of the consolidation-related adjustments made in 20X8 would be

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to eliminate the remaining unrealized gain of $30,000 ($45,000 – $15,000) at the beginning of
20X9. Specifically, the equipment account would be decreased by $30,000 while reducing
beginning retained earnings by 40% of that amount, i.e. $12,000 and reducing NCI by the
remaining 60% or $18,000. Another adjustment is also required to eliminate the excess
depreciation of $15,000 in 20X9. This adjustment will increase the net income attributable to CI by
$15,000 × 40% or $6,000, while increasing the net income attributable to NCI by the remaining
amount of $9,000.

Thus, the cumulative impact on the ending retained earnings of CI would be to decrease it by
$12,000 – $6,000 or $6,000. Consequently, for the purpose of the divorce settlement the value of
CI will be reduced by $6,000. In contrast, if the net income of 20X9 is used to value CI, the value
of CI will in fact increase by $6,000 × 6 or $36,000. Clearly, in this case, diametrically different
results will ensue depending on which amount is used to value CI, net income of CI in 20X9 or
ending retained earnings of CI in 20X9.

Inter-company Sale of Inventory

Under IFRS, gains on inter-company sales of inventory are deemed to be unrealized as long as the
inventory remains within the consolidated group. Therefore, such unrealized gains are required to
be eliminated while preparing consolidated financial statements.

Unrealized gains exist in both the beginning as well as the ending inventory of CI in 20X9.
Beginning inventories are assumed to have been sold during the year, and therefore are assumed to
have been realized during the year. The following calculations provide the amount of unrealized
gains present in the opening and closing inventories respectively, and CI’s share of such gains:

Beginning Inventory Ending Inventory

Inter-company sale 80,000 90,000
Proportion remaining unsold 0.2 0.3
Inventory remaining unsold 16,000 27,000
Profit proportion 0.4 0.4
Unrealized profit 6,400 10,800
CI’s ownership proportion 0.4 0.4
CI’s share of unrealized profit 2,560 4,320

Impact on 20X9 Ending RE None (4,320)

Impact on 20X9 CI NI share 2,560 (4,320)

Of the unrealized gains present in the opening inventory, $2,560 is attributable to CI. Since this
unrealized gain would have been eliminated in 20X8, to capture the impact of that adjustment the
corresponding cumulative adjustment in 20X9 will reduce opening retained earnings by that
amount. However, to reflect the fact that the gain was realized in 20X9 the COGS of 20X9 will
also be reduced by that amount. The overall impact on ending retained earnings will therefore be
zero. Therefore, while ending owners’ equity remains unaffected by these changes and thus does

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not affect the value of CI, the increase in profit in 20X9 will mean that the value of CI based on the
net income amount will increase by 6 × $2,560 or $15,360.

The consolidation-related adjustment relating to the unrealized gain in the ending inventory will
decrease profit by $4,320 and therefore the ending retained earnings. The impact on the value of CI
for the divorce settlement will therefore be (1) if based on net income, a decrease of 6 × $4,320 or
$25,920, or (2) if based on ending owners’ equity, a decrease of $4,320.

No dividends have been declared by CEDS from the time of its acquisition by CI. That means that
the separate entity FS of CI would not have included any portion of the operating results of CEDS
in any of the three years 20X7-20X9. However, the consolidated FS of CI should not only include
the results from the operations of CI but also the operating results of CEDS as well. This difference
will affect both the ending owners’ equity as well as the net income of 20X9.

Since the impact of the other consolidation-related adjustments were discussed previously, we can
now focus solely on the impact of the consolidation-related adjustment relating to CEDS’
operations, without any adjustments. CEDS’ change in retained earnings since its acquisition by CI
until the beginning of 20X9 will be added to that of CI to the extent of CI’s ownership of CEDS.
The remaining 60% will be adjusted against the NCI balance. The impact will either be negative or
positive depending on the nature of the change in retained earnings of CEDS during the period.

The individual items of the statement of comprehensive income of CEDS are also included line-by-
line in the consolidated statement of comprehensive income of CI. The result will be the same as
adding the net income of CEDS to the net income of CI. Thus, the consolidated income will either
increase or decrease depending on whether CEDS had a net loss or net income during 20X9. CI’s
portion will be apportioned to CI, and will suitably increase or decrease ending retained earnings.

Thus, the operations of CEDS will influence the value of CI either through its influence on the net
income of CI in 20X9 or through its impact on the ending retained earnings of CI. We will need to
obtain these details from Jennifer to be able to quantify the impact.

The table below summarizes the impact of the various known adjustments relating to CEDS on the
value of CI calculated based on (1) net income in 20X9 and (2) the ending owners’ equity at the
end of 20X9:
Owners'
Net Income Equity
FVI allocated to inventory 0 20,000
FVI allocated to patent (24,000) (12,000)
Impairment of goodwill 0 (8,000)
Inter-company sale of equipment 36,000 (6,000)
Unrealized gains in opening inventory 15,360 0
Unrealized gains in ending inventory (25,920) (4,320)
Net income of CEDS Unknown Unknown
Sum of known amounts 1,440 (10,320)

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It is clear that the adjustments will have a negative impact on the value of CI if ending owners’
equity in 20X9 is used for such valuation. As opposed to this, the impact of using NI is marginally
positive. However, we do not have full details on the net income and owner's equity amounts
related to CEDS. Therefore, we are unable at this time to conclude which of the two figures will
lead to either a lower or higher value for CI.

Fairness of Using IFRS-based Financial Statements to Value CI

IFRS has, over the years, been moving more towards a fair-value basis of accounting and away
from the historical basis of accounting. While monetary assets and liabilities are reported at their
fair values on the SFP, many non-monetary assets like inventories are also reported at fair values.
In addition, IFRS also allows the use of the revaluation model of valuating assets such as property,
plant and equipment and intangible assets. Thus, the impact of the historical basis of accounting,
which does not appropriately reflect fair values, is reduced. Nonetheless, accounting is backward
looking and may not appropriately reflect the future operations of CI. It may be argued that CI
should be valued based on its future potential and not on its past performance.

Further, under IFRS, the results of the operations of CEDS have to be included in the financial
statements of CI either by including CI’s equity in the earnings of CEDS or by consolidation. It is
not clear what Jennifer and Johnnie mean by the fair value of CI. Do they intend for CI’s value to
include the value of CEDS as well? If not, CEDS will form part of the other assets which Johnnie
will get. Excluding CEDS from the value of CI most probably will decrease the amount which
Johnnie will get as part of the divorce settlement.

Finally, the criterion of fairness is a bit nebulous. Should the value of CI also include the value of
Jennifer to it? Under IFRS, the value of Jennifer to CI cannot be recognized as an identifiable
intangible asset. In any case, it is not clear that CI’s value should be based on its future operations.
Maybe the value of CI should be based only on the fair values of the existing assets and liabilities
of CI and that of CEDS attributable to CI.

SOLUTIONS TO PROBLEMS

P6-1

The various adjustments (rounded to the nearest dollar) are being provided in journal entry format
below:

20X2:
Gain on sale of fixtures $45,000
Fixtures $45,000

Accumulated depreciation 8,000

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Depreciation expense 8,000

The net impact of the above adjustments on net income will be to decrease it by $40,000.
Of this amount, 30%, i.e. $12,000 is attributable to the NCI, while the rest belongs to the
owners of the parent.

20X3:
Retained earnings, opening 28,000
NCI 12,000
Accumulated depreciation 8,000
Fixtures 48,000

Accumulated depreciation 8,000

Depreciation expense 8,000

The decrease in the depreciation expense of $8,000 will increase net income by that
amount. Of this amount, $2,400 is attributable to the NCI, while the rest is attributable to
the owners of the parent.

20X4:
Retained earnings, opening 22,400
NCI 9,600
Accumulated depreciation 16,000
Fixtures 48,000

Accumulated depreciation 8,000

Depreciation expense 8,000

Again, the decrease in depreciation expense of $8,000 will increase net income by that
amount. Of this amount, $2,400 is attributable to the NCI, while the rest is attributable to
the owners of the parent.

20X5:
Retained earnings, opening 16,800
NCI 7,200
Accumulated depreciation 24,000
Fixtures 48,000

Accumulated depreciation 667

Depreciation expense 667
(assuming 1 month’s depreciation is taken)

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Fixtures 48,000
Accumulated depreciation 24,667
Gain on sale of fixtures 23,333

The overall impact of the above entries on net income will be to increase it by $22,666.
30%, i.e. $6,800 is attributable to the NCI, while the rest is attributable to the owners of the
parent.

P6-2

a. 20X3:
Gain on sale of building $1,740,000
Accumulated depreciation $560,000
Buildings 1,180,000

(Eliminates the gain, reduces the building to its cost to Sub, and restores the accumulated
depreciation.)

The elimination of the gain on sale of building amount of $1,740,000 will decrease net income by
that amount. Therefore, 20% of that amount, or $348,000, should be attributed to the NCI.
NCI (SFP) 348,000
NCI in earnings of Sub (SCI) 348,000
(20% of the unrealized gain of $1,560,000.)

Accumulated depreciation 290,000

Depreciation expense 290,000
[($1,980,000/6) – (800,000/20)]
The decrease in depreciation expense of $290,000 will increase net income by that amount.
Therefore, 20% or $58,000 should be attributed to the NCI:

NCI in earnings of Sub (SCI) 58,000

NCI (SFP) 58,000
(20% of depreciation adjustment.)

b. 20X5:
Accumulated depreciation (3 × 290,000) 870,000
Retained earnings 0.80[1,740,000 – (2 × 290,000)] 928,000
NCI (SFP) 0.20 × [1,740,000 – (2 × 290,000)] 232,000
Depreciation expense 290,000

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Accumulated depreciation 560,000

Buildings 1,180,000

The decrease in depreciation expense of $290,000 will increase net income by that amount.
Therefore, 20% or $58,000 should be attributed to the NCI.

NCI in earnings of Sub (SCI) 58,000

NCI (SFP) 58,000
(20% of depreciation adjustment.)

P6-3

1. Eliminating entries, 20X4:

Sales $800,000
Cost of goods sold $800,000

Cost of goods sold 80,000

Inventory 80,000

Accounts payable 500,000

Accounts receivable 500,000

Gain on sale of land 80,000

Land 80,000

Interest revenue 13,000

Interest expense 13,000

Note payable 273,000

Note receivable 273,000

Eliminating entries 2005:

Retained earnings, opening 56,000

NCI 24,000
Cost of goods sold 80,000

NCI 24,000
Retained earnings, opening 56,000
Land 80,000

Interest revenue 26,000

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Interest expense 26,000

Note payable 273,000

Note receivable 273,000

2. Non-controlling interest share of earnings, 20X4:

30% of Sub Ltd. reported net income 204,000
Unrealized profit in inventory:
$400,000 × 20% × 30% (24,000)
Unrealized profit on sale of land:
$80,000 × 30% (24,000)
156,000

Non-controlling interest share of earnings, 20X5:

30% of Sub Ltd. reported net income 264,000
Realized profit from opening inventory:
$300,000 × 20% × 30% 18,000
282,000

P6-4

1. Eliminations

a. Sales from Adam to Bob (downstream):

Sales $800,000
Cost of sales $740,000
Inventory (20% × $300,000) 60,000

The entry above is a combination of two entries, the first entry reducing sales and cost of
sales by $800,000 for the inter-company sale, and the second entry increasing cost of sales
and decreasing ending inventory by $60,000, the unrealized gain in the ending inventory
remaining unsold from the intercompany sale.

b. Sales from Xena to Adam (upstream):

Sales 600,000
Cost of sales 460,000
Inventory (70% × $200,000) 140,000

The elimination of the unrealized gain on the intercompany sale of $140,000 above will
reduce net income by that amount. Since the unrealized gain relates to an upstream sale of
inventory, 30% of the reduction in net income or $42,000 needs to be allocated to the NCI.

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c. Sale of land from Adam to Bob (downstream):

Land 40,000
Loss on sale of land 40,000

d. Sale of land and building from Xena to Adam:

Gain on sale of capital assets 243,000

Land 80,000
Building 130,000
Accumulated depreciation 33,000

The elimination of the gain on the sale of capital assets will reduce net income by a similar
amount, i.e. $243,000. Since this is an upstream sale, 30% of the reduction in net income,
i.e. $72,900 should be allocated to NCI.

Accumulated depreciation 8,150

Depreciation expense 8,150
(depreciation elimination for three months)

The reduction in depreciation expense by $8,150 will increase net income by that amount.
Therefore, the NCI’s share of such a reduction is $2,445.

e. Intercompany balances (assuming both companies have

accrued the interest):

Due to Xena Ltd. 410,000

Interest revenue 10,000
Receivable from Adam Ltd. 410,000
Interest expense 10,000

2. Non-controlling interest

Bob Ltd.: Intercompany sales between Adam and Bob were downstream, therefore there is
no unrealized profit in the earnings of Bob and non-controlling interest is not affected.

Xena Ltd.:

Unrealized profit in inventory (upstream):

70% × ($600,000 - $400,000) = $140,000
NCI interest share at 30% $ 42,000

Unrealized profit from sale of land:

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40% ($400,000) - $80,000 = $80,000

NCI interest share at 30% 24,000

Unrealized profit from sale of building:

60% ($400,000) - (70%) ($110,000) = $163,000
NCI interest share at 30% 48,900

Realized profit from depreciation:

1/4 ($163,000) (1/5) = $8,150
NCI interest share at 30% (2,445)
Decrease in earnings attributed to NCI interest $112,455

P6-5

Measure:
70% Purchase of Susan Limited, January 1, 20X2
Purchase price $147,000
100% fair value based on purchase price [$139,200 × (100%/70%)] $210,000
Less carrying value of Susan’s net identifiable assets (161,000)
= Fair Value Increment, allocated below $49,000

Fair value
Adjustment FVA
Allocated
Inventory $2,500 $2,500
Depreciable capital assets 7,500 7,500
Total fair value adjustment allocated to identifiable assets (10,000)
Balance of FVA allocated to goodwill @ 100% $39,000

NCI value = 30% of $210,000 $63,000

Amortize:
Amort./ Amort./ Balance of
impairment in impair- FVA
previous ment loss remaining
FVA Amort. Amort. years 20X2- during at the end of
Allocated Period per year 20X4 20X5 20X5
Inventory $2,500 $2,500 $0
Depreciable capital assets 7,500 10 $750 2,250 $750 4,500
Goodwill 39,000 39,000
Total $49,000 $4,750 $750 $43,500

1.

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Non-controlling interest in adjusted earnings of Susan in 20X5:

30% of net income of Susan of $11,000 $3,300
Adjustments:
Less 30% of amortization of FVI attributed to capital assets of $750 225
NCI's share of Susan's adjusted income in 20X5 $3,075

2.

Non-controlling interest balance at Dec. 31, 20X5:

30% of Susan's net asset carrying value of $170,000 on Dec. 31, 20X5 $51,000
Add 30% of unamortized FVA of $43,500 at Dec. 31, 20X5 13,050
NCI balance at Dec. 31, 20X5 $64,050

Alternate:
NCI balance at time of acquisition on Jan. 1, 20X2 $63,000
Add 30% of change in carrying value of net assets of Susan ($170,000 - $161,000) 2,700
Less 30% of amortization of FVI till end of 20X5 ($4,750 + $750) (1,650)
$64,050

3.

Consolidated 20X5 net income:

Peter’s reported net income $44,000

Less dividends received from Susan (700)
Susan’s reported net income 11,000
Less depreciation of FVA on capital assets:
$7,500 × 1/10 (750)
Consolidated net income and comprehensive income $53,550
Net income attributable to:
Owners of the parent $50,475
Non-controlling interests $ 3,075

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P6-6

1. Consolidated net income:

Anita net income (cost basis) $550,000

Less dividends received from Brian (160,000)
Less dividends received from Gabriel (90,000)
Anita separate entity earnings 300,000
Brian net income 348,000
Gabriel net income 310,000
Unadjusted consolidated earnings 958,000
Plus unrealized profits, January 1:
Gabriel to Anita 70,000
Anita to Brian 60,000
Less unrealized profits, December 31:
Gabriel to Anita (50,000)
Anita to Brian (80,000)
Consolidated net income and comprehensive income $958,000
Net income attributable to:
Owners of the parent $756,400
Non-controlling interests $201,600

Consolidated net income and comprehensive income attributable to owners of Anita:

Anita net income (cost basis) $550,000
Less dividends received from Brian (160,000)
Less dividends received from Gabriel (90,000)
300,000
80% of Brian net income 278,400
60% of Gabriel net income 186,000
Unadjusted Anita earnings 764,400
Plus unrealized profits, January 1:
Gabriel to Anita 42,000
Anita to Brian 60,000
Less unrealized profits, December 31:
Gabriel to Anita (30,000)
Anita to Brian (80,000)
Consolidated net income and comprehensive income attributable to owners $756,400

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Consolidated net income and comprehensive income attributable to NCI:

Brian net income $348,000
20% of Brian adjusted net income attributable to NCI $69,600

Gabriel net income $310,000

Plus unrealized profits, January 1:
Gabriel to Anita 70,000
Less unrealized profits, December 31:
Gabriel to Anita (50,000)
Gabriel adjusted net income $330,000
40% of Gabriel adjusted net income attributable to NCI 132,000

Consolidated net income and comprehensive income attributable to NCI $201,600

Note that the intercompany lease payment of $60,000 ($5,000 per month) requires no adjustment to
consolidated net income (even though it would be eliminated on unrealized consolidation) because
there is no unrealized profit.

2. Statement of consolidated retained earnings:

Consolidated retained earnings, January 1, 20X5* $1,053,800

Net income for 20X5 756,400
Dividends declared (250,000)
Retained earnings, December 31, 20X5 $1,560,200

*Anita retained earnings, January 1 $ 742,000

Brian retained earnings, January 1 $686,000
Less RE at date of acquisition 450,000
Change since acquisition 236,000
Anita share, 80% 188,800

Gabriel retained earnings, January 1 475,000

Less RE at date of acquisition 100,000
Change since acquisition 375,000
Anita share, 60% 225,000
1,155,800
Unrealized profits, January 1 ($60K + 60% of 70K) (102,000)
Consolidated retained earnings, Jan. 1, 20X5 $1,053,800

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3.

If all transactions had been with unrelated parties, then consolidated net income would not have
been adjusted for the realized and unrealized gains relating to the intercompany sale of inventory.
Specifically, the consolidated net income would not have been increased by the sum of $70,000
and $60,000, i.e. $130,000 since this amount would have been treated as having been realized in
the previous year itself. Similarly, the sum of $ (50,000) and $ (80,000), i.e. $ (130,000) would not
have been deducted from consolidated net income, since again, this amount would have been
considered realized in 20X5. Therefore, consolidated net income would have been $958,000, as
shown in part a as “unadjusted consolidated earnings”. In the present problem, the adjusted and
unadjusted consolidated net incomes are the same since the adjustments sum to zero.

P6-7

Measure:
70% Purchase of Slide Limited, June 30th, 20X1
Purchase price ($3,210,000 cash + $1,200,000 shares) $4,410,000
100% fair value based on purchase price [$4,410,000 × (100%/70%)] $6,300,000
Less carrying value of Slide’s net identifiable assets (3,440,000)
= Fair Value Adjustment, allocated below $2,860,000

Fair value
Adjustment
FVA Allocated
Inventory $225,000 $225,000
Capital assets $(1,000,000) $(1,000,000)
Total fair value adjustment allocated to identifiable assets 775,000
Balance of FVA allocated to goodwill @ 100% $3,635,000

NCI value = 30% of $6,300,000 $1,890,000

Eliminate intercompany balances:

Accounts receivables/accounts payables ($200,000)
Dividends receivable/payable ($480,000 × 0.70) ($336,000)

Eliminate unrealized gains and recognize realized gains:

Realized gain on upstream sale ($160,000 × 25%) $40,000
(no effect on SFP)
Unrealized gain on downstream sale ($200,000 × 30%) ($60,000)

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Amortize:
Amort./ Balance of
impairment in Amort./ FVA
previous impairment remaining
FVAI Amort. Amort. years 20X2- loss during at the end
Allocated Period per year 20X4 20X5 of 20X5
Inventory $ 225,000 $225,000 $0
Capital assets $ (1,000,000) 20 $(50,000) $(150,000) $(50,000) $(800,000)
Goodwill 3,635,000 3,635,000
Total $ 2,860,000 $75,000 $(50,000) $2,835,000

Consolidated Statement of Financial Position

Punt Corporation
Consolidated Statement of Financial Position
June 30, 20X5
Current assets:
Cash and marketable securities (4,548,000 + 321,000) $4,869,000
Accounts and other receivables (2,153,000 + 950,000 – 336,000 –
200,000) 2,567,000
Inventory (2,940,000 + 1,206,000 – 60,000) 4,086,000
11,522,000
Capital assets (net) [17,064,000 + 7,161,000 – 1,000,000 + (4 × 50,000) 23,425,000

Other assets:
Long-term investments (3,038,000 + 2,240,000) 5,278,000
Goodwill 3,635,000
Total assets $43,860,000

Liabilities:
Current liabilities (3,025,000 + 2,090,000 – 336,000 – 200,000) $4,579,000
Mortgage notes payable (12,135,000 + 4,000,000) 16,135,000
20,714,000
Shareholders’ equity:
Common shares 10,000,000
Retained earnings [8,993,000 + 0.70 × (2,888,000 – 540,000)
– 0.70 × 225,000 + 4 × 35,000 – 60,000] 10,559,100
NCI [0.30 × (5,788,000 + 2,835,000)] 2,586,900
Total 23,146,000
Total liabilities and shareholders’ equity $43,860,000

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 Chapter 6 – Subsequent-Year Consolidations: General Approach

P6-8

Purchase price $150,000

Carrying value of net assets
acquired
$80,000 × 90% 72,000
FVA- Land $10,000 × 90% 9,000
FVA- Building $20,000 × 90% 18,000
99,000
Goodwill $51,000

1. Investment account:

Purchase price $150,000

Cumulative net income $62,000
90% equity of ABC × .90 55,800

Cumulative cash
dividends $64,000
90% received × .90 (57,600)
Amortization:
Building: $18,000 ×
5/10 (9,000)
Balance, December 31, 20X5 $139,200

2. Cost method of recording:

20X4: no entry, as no cash dividends are received. Stock dividends do not represent income to
ABC.

20X5: Under the cost method of recording, ABC will recognize its 90% share of the dividend paid
by XYZ during 20X5 as dividend income:

Cash $46,800
Dividend income $46,800

ABC will have to make appropriate adjustments to eliminate the dividend income if it uses either
the equity method or the consolidation method to report its investment in XYZ.

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P6-9

Purchase transaction

Carrying value of 40% of net assets $7,200,000

Fair value adjustments (40%):
Land $1,200,000
Building (400,000)
Equipment 800,000 1,600,000

Fair value of 40% of net assets 8,800,000

Purchase price 12,400,000
Goodwill $3,600,000

(1) Equity in earnings of Jasmine

40% of Jasmine net income $720,000

Amortization
:
Building FVD, $400,000/10 40,000
Equipment FVI, $800,000/5 (160,000)
Curry’s equity in earnings of Jasmine $600,000

(2) Investment account

Purchase price $12,400,000

Equity in earnings, per above 600,000
Dividends received (40% × 60% × $1,800,000) (432,000)
Balance, March 31,
20X5 $12,568,000

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 Chapter 6 – Subsequent-Year Consolidations: General Approach

P6-10
Curry owns 40% of the voting shares of Jasmine and five of its nominees are on Jasmine’s board.
This suggests that Curry can exercise significant influence but not control over Jasmine. Curry had
to negotiate to get five of its nominees be nominated on Jasmine’s board. Therefore, the proprietary
theory has to be used when accounting for Curry’s investment in Jasmine under the equity method.

1. Investment income
40% of Jasmine net income $960,000
Amortization, per P6-9:
Building $40,000
Equipment (160,000)
(120,000)
Unrealized profits:
Downstream (Curry to Cinammon):
$2,500,000 × 60% × 30% gross margin 450,000
Upstream (Jasmine to Curry):
Raw materials inventory:
$1,200,000 × 40% gross margin $480,000
Finished goods inventory:
$2,320,000 × 40% gross margin 928,000
Total unrealized profit $1,858,000
Curry share, 40% (743,200)
Curry equity in Jasmine earnings $96,800

(Note: the gross margin percentages are obtained from the condensed statements of comprehensive
income included in the problem.)

2. Investment account
Balance, March 31, 20X5, per P6-9 $12,568,000
Equity in 20X6 earnings, per above 96,800
Dividends received —
Balance, March 31, 20X6 $12,664,800

P6-11

Purchase price $1,600,000

30% of fair value of Rogan net assets, Jan. 1, 20X3 1,200,000
Excess of purchase price over share of fair value* $ 400,000

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* Excess of purchase price over share of the fair value of the net identifiable assets is not allocated
to goodwill since the investment is in an associate and not in a controlled entity.

1. (a) Statement of comprehensive income for 20X5:

Slater Company
Statement of Comprehensive Income
Year ended December 31, 20X5

Sales $3,000,000
Equity in earnings of subsidiary 54,000
Other revenues 176,000* $3,230,000

Cost of goods sold 1,500,000

Other expenses 300,000 1,800,000

Net income $1,430,000

* Assuming dividends received were recorded here.

(b) Investment account, December 31, 20X5:

Purchase price, January 1, 20X3 $1,600,000

20X3 earnings (30% equity):
loss $(60,000)
dividends (15,000)
(75,000)
20X4 earnings (30%):
income 54,000
dividends (18,000)

36,000
20X05 earnings (30%):
income 54,000
dividends (24,000)
30,000
Balance, December 31, 20X5 $1,591,000

2. No significant influence, entry for 20X5:

Cash $24,000
Dividend income $24,000

If Slater is a publicly accountable enterprise, it has to report its investment in Rogan using the fair
value method. On the other hand, if Slater is a private enterprise, it can either use the fair value
method or the cost method to report its investment in Slater.

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P6-12

1. The equity method assumes the investor can significantly influence the investee company. As a
result, and to avoid income manipulation, all earnings of the investee (remitted and retained)
accruing to the investor are reported as earned via the investment account. Dividends received are
deducted from the investment account. The fair value or cost methods assume no significant
influence. Income from the investment is recognized only to the extent to which it has been
remitted as dividends. As the name denotes, the investment account is retained at cost under the
cost method. In contrast, under the fair value method, the investment is reported at its fair value on
each reporting date. Reporting must follow the following guidelines.

i. IFRS requires the use of the equity method when there is significant influence, and
the fair value method when there is no significant influence. Accounting standards
for private enterprises allows the cost method as an additional reporting choice for
reporting investments both when significant influence is present as well as when it
is absent. The equity reporting requirement pertains to both significantly-influenced
minority-owned investees and to unconsolidated subsidiaries.
ii. A quantitative guideline only is that ownership of less than 20% suggests the
absence of significant influence while ownership of greater than 20% and less than
51% suggests the presence of significant influence.

2. General journal entries:

Feb. 15: Investment in Lub Oil Co. (70%) $ 640,000

Cash $ 640,000
(Includes goodwill of $80,000)

Apr. 13: Investment in Richman Refineries (60%) 1,540,000

Cash 1,540,000

May 17: Investment in Discovery Co. Ltd. (2%) 250,000

Cash 250,000

June 30: Equity in earnings of Lub Oil 26,250

Investment in Lub Oil 26,250
(The investment was held for 4.5 of the 6 months; assuming the loss is
incurred evenly over the 6 month period leads to recognition of 75% of
the loss: $50,000 × 75% × 70% share.)

June 30: Investment in Richman Refineries 30,000

Equity in earnings of Richman 30,000
(Investment held for 2.5 months, or 5/12 of the period:
$120,000 × 5/12 × 60% share = $30,000.)

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June 30: Dividends receivable 14,000

Investment in Richman Refineries 14,000
(140,000 shares @ $0.10)

Aug. 15: Cash 14,000

Dividends receivable 14,000

Oct. 11: Cash 2,500

Dividend income 2,500
(50,000 shares @ $0.05; see note below)

Dec. 31: Investment in Lub Oil 7,000

Equity in earnings of Lub Oil 7,000
($10,000 profit for last six months × 70% share)

Dec. 31: Investment in Richman Refineries 48,000

Equity in earnings of Richman 48,000
($80,000 profit for last six months × 60% share)

Note: The October 11 dividend by Discovery Co. was $0.05 per share. King Oil owns 50,000
shares for a 2% interest. Therefore Discovery must have 2,500,000 shares outstanding for a
total dividend of $125,000. As earnings since acquisition are only $50,000, 60% of the
dividend could be considered by King to be a return of investment, and would be recorded as
follows:

Oct. 11: Cash 2,500

Dividend income 1,000
Investment in Discovery Co. 1,500

In addition, since the investment in Discovery Co. is a passive investment, IFRS requires it to be
reported at fair value on the SFP on Dec. 31. No fair value has been calculated since the problem
does not provide us with the necessary information.

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P6-13

Measure:
80% Purchase of Sloan Ltd., January 1, 20X2
Purchase price $3,000,000
100% fair value based on purchase price [$3,000,000 × (100%/80%)] $3,750,000
Less carrying value of Sloan’s net identifiable assets (3,300,000)
= Fair Value Increment, allocated below $450,000
Fair value
Increment
FVI Allocated
Accounts receivable $(75,000) $(75,000)
Capital assets $200,000 $200,000
Long-term liabilities $62,500 $62,500
Total fair value increment allocated to identifiable assets (187,500)
Balance of FVI allocated to goodwill @ 100% $262,500

NCI value = 20% of $3,750,000 $750,000

Amortize:
Balance of
Amort./ Amort./ FVI
impairment in impairment remaining at
FVI Amort. previous years loss during the end of
Allocated Period Amort. 20X2-20X4 20X5 20X5
per year
Accounts receivable $(75,000) $(75,000) $0
Capital assets $200,000 20 $10,000 $30,000 $10,000 $160,000
Long-term liabilities $62,500 8.5 $7,353 $22,059 $7,353 $33,088
Goodwill $262,500 $262,500
Total $450,000 $(22,941) $17,353 $455,588

1. Consolidated SFP amounts, December 31, 20X5:

a. Patents:
(1) If the intercompany sale was at fair value,
then the loss should not be reversed and the
patents would remain at carrying value $263,000
(2) If the original carrying value of the sold patent
is unimpaired, then the unrealized loss can
be amortized: 263,000 + (20,000 × 2/5) or,
263,000 + 20,000 – 20,000 × 3/5 $271,000

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b.

NCI value = 20% of $3,750,000 750,000

Sloan, change since acquisition
December 31, 20X5 1,409,000
January 1, 20X2 1,100,000
309,000
× 20% 61,800
Unrealized profits (ending inventory):
Unrealized gain in EI from upstream sale (2,500 ×
20%) (500)

Amortizations of FVI:
Accounts receivable 75,000
Capital assets: ($200,000/20) × 4 (40,000)
Long-term liabilities: ($62,500/8.5) × 4 (29,412)
5,588
× 20% 1,118
Non-controlling interest assuming (a)(1) $812,418
Plus 20% of remaining unrealized loss
20,000 × 3/5 2,400
Non-controlling interest assuming (a)(2) $814,818

Alternate calculation of NCI:

20% of Sloan equity on Dec. 31, 20X5 $721,800
Unamortized FVI on Dec. 31, 20X5 $455,588
× 20% 91,118
Unrealized gain in EI from upstream sale (2,500 ×
20%) (500)
$812,418
Plus 20% of remaining unrealized loss
20,000 × 3/5 2,400
Non-controlling interest assuming (a)(2) $814,818

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c. Retained earnings:

Porter, per books $4,833,000

Sloan, change since acquisition
December 31, 20X5 1,409,000
January 1, 20X2 1,100,000
309,000
× 80% 247,200

Unrealized profits (ending inventory):

Downstream (10,000)
Upstream (2,500 × 80%) (2,000)
Unrealized profit on land (downstream) (21,000)

Amortizations of FVI:
Capital assets: 8,000 × 4 (32,000)
Accounts receivable 60,000
Long-term liabilities: 5,882 × 4 (23,528)
Balance, assuming (a)(1) 5,051,672
Remaining unrealized loss on patent:
12,000 × 80% 9,600
Balance, assuming (1)(2) $5,061,272

2. Porter’s equity in the earnings of Sloan, 20X5:

Sloan book net income @ 80% $141,600

Unrealized profits in inventory:
Upstream beginning (1,500 × 80%) 1,200
Upstream ending (2,500 × 80%) (2,000)
Downstream beginning 14,000
Downstream ending (10,000)
Unrealized profit on land (downstream) (21,000)
Amortizations:
Capital assets (8,000)
Long-term liabilities (5,882)
Assuming (1)(1) 109,918
Amortization of loss on patent (4,000 × 80%) 3,200
Assuming (1)(2) $113,118

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P6-14

80% Purchase of Sum Company, January 1, 19X8

Purchase price $3,900,000
100% fair value based on purchase price [$3,900,000 × (100%/80%)] $4,875,000
Less carrying value of Sum’s net identifiable assets (4,000,000)
= Fair Value Increment, allocated to goodwill $875,000

NCI value = 20% of $4,875,000 $975,000

Partial Company
Consolidated Statement of Financial Position
December 31, 20X5

Cash $4,000,000
Accounts receivable ($9,000,000 – $60,000) 8,940,000
Inventories ($7,100,000 – $100,000) 7,000,000
Total current assets 19,940,000
Capital assets (net) ($12,000,000 – $70,000) 11,930,000
Goodwill 875,000
Total assets $32,745,000

Liabilities ($8,000,000 – $60,000) $7,940,000

Common shares 7,000,000
Retained earnings (below) 16,050,000
Non-controlling interest (below) 1,755,000
Total liabilities and shareholders’ equity $32,745,000

Calculation of NCI balance at end of 20X5:

NCI value, 20% × $4,875,000 $975,000
Change in retained earnings, 20% × ($6,000,000 – $2,000,000) 800,000
Unrealized profits in EI from upstream sale, 20% × $100,000 (20,000)
$1,755,000

Retained earnings:
Partial Co. $13,000,000
Sum Co., 80% × ($6,000,000 – $2,000,000) 3,200,000
Unrealized profits:
Inventory, 80% × $100,000 (upstream) (80,000)
Equipment, $100,000 × 7/10 (downstream) (70,000)
$16,050,000

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P6-15

Measure:
80% Purchase of Slade Paper Limited, January 1, 20X3
Purchase price $800,000
100% fair value based on purchase price [$800,000 × (100%/80%)] $1,000,000
Less carrying value of Slade’s net identifiable assets (590,000)
= Fair Value Increment, allocated below $410,000
Fair value
Increment
FVI Allocated
Inventory $50,000 $50,000
Capital assets $120,000 $120,000
Bonds $(60,000) $(60,000)
Total fair value increment allocated to identifiable assets (110,000)
Balance of FVI allocated to goodwill @ 100% $300,000

NCI value = 20% of $1,000,000 $200,000

Eliminate inter-company transactions and balances

Upstream sales (250,000)
Dividends (50,000)
Downstream sales (108,000)
Loan by Paris to Slade (200,000)
Interest revenue/expense on loan (8,000)
Interest receivable/payable (8,000)

Eliminate unrealized gains and recognize realized gains

Upstream sales EI (30,000)
Downstream sales EI (5,600)
Unrealized gain on upstream sale of land (100,000)
Realized gain on upstream sales BI 25,000

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Amortize:
Amort./ Balance of
impairment Amort./ FVI
in previous impairment remaining
FVI Amort. Amort. Per years loss during at the end
Allocated Period year 20X3-20X4 20X5 of 20X5

Inventory $50,000 $50,000 $0

Capital assets $120,000 12 $10,000 $20,000 $10,000 $90,000
Bonds $(60,000) 6 $(10,000) $(20,000) $(10,000) $(30,000)
Goodwill $300,000 $300,000
Total $410,000 $50,000 $0 $360,000

1. Carrying value of goodwill on Dec. 31, 20X5 $300,000

2. Consolidated Statement of Comprehensive Income

Paris Ink Company

Consolidated Statement of Comprehensive Income
For the year ended December 31, 20X5

Sales (3,850 + 1,650 – 250 – 108) $5,142,000

Cost of goods sold (2,550 + 1,120 – 220 – 25 – 102.4) 3,322,600
Gross profit 1,819,400

Expenses
Administration and Selling (550 + 384) 934,000
Amortization (136 + 74 + 10) 220,000
Interest (56 – 8 – 10) 38,000
1,192,000

Other income
Interest & Dividends (76 + 4 – 8 – 40) 32,000
Gain on sale of land (100 – 100) 0

Income before taxes 659,400

Income tax expense (260 + 30) 290,000
Net income and comprehensive income $ 369,400
Net income attributable to:
Owners of the parent $ 366,400
NCI (see below) $ 3,000

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Non-controlling interest in adjusted earnings of Slade

Slade separate entity earnings $90,000
Upstream sales EI (30,000)
Unrealized gain on upstream sale of land (100,000)
Realized gain on upstream sales BI 25,000 (105,000)
Amortization
Depreciable assets (10,000)
Bonds 10,000 0
Adjusted earnings of Slade $(15,000)
Non-controlling interest [0.20 × (15,000)] $(3,000)

3.

a.
Inventory
Paris $420,000
Slade 350,000
770,000
Less unrealized profit
Upstream (30,000)
Downstream (5,600)
$734,400

b.
Non-controlling interest balance
Shareholders' equity Slade $740,000
Unamortized FVI 360,000
Less unrealized profit
Inventory ending (upstream) (30,000)
Land (upstream) (100,000)
$970,000
NCI @ 20% $194,000

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P6-16

Measure:
70% Purchase of Son Limited, January 1, 20X4
Purchase price $343,000
100% fair value based on purchase price [$345,000 × (100%/70%)] $490,000
Less carrying value of Son’s net identifiable assets (300,000)
= Fair Value Adjustment, allocated below $190,000
Fair value
Adjustment
FVA Allocated
Capital assets $50,000 $50,000
Long-term debt 100,000 100,000
Total fair value adjustment allocated to identifiable assets (150,000)
Balance of FVA allocated to goodwill @ 100% $40,000

NCI value = 30% of $490,000 $147,000

Eliminate unrealized gains and recognize realized gains

Realization of 1/5th of unrealized gain on downstream sale of capital asset 6,000
Unrealized gain on upstream sale of land (25,000)

Amortize:
Amort./ Amort./
Amort. impairment in impairment Balance of FVA
FVA Amort. per previous years loss during remaining at the
Allocated Period year 20X3-20X4 20X5 end of 20X5
Capital assets $50,000 10 $5,000 $5,000 $5,000 $40,000
Long-term debts 100,000 5 20,000 20,000 20,000 60,000
Goodwill 40,000 40,000
Total $190,000 $25,000 $25,000 $140,000

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1. Consolidated net income:

Pop’s net income $244,000

Less dividends received from subsidiary (10,000 × 70%) (7,000)
Add realized gain-downstream sale of capital asset 6,000
243,000
Equity in earnings of subsidiary:
Son’s net income $85,000
Less unrealized gain-upstream sale of land (25,000)
60,000 60,000
Amortization of FVA allocated to:
Capital assets (5,000)
Long-term debt (20,000) (25,000)
Consolidated net income for December 31, 20X5 $278,000

2.

a. Consolidated Capital Assets, Net:

Pop Company $900,000
Son Limited 450,000
Intercompany transactions:
Downstream sale of capital asset (30,000)
Two years of amortization 12,000
Upstream sale of land (25,000)

Undervalued capital assets:

Undervaluation: 50,000
Two years of amortization (10,000)
Consolidated net capital assets $1,347,000

b. Non-controlling interest, SFP:

Subsidiary’s net carrying value end of 20X5 ($100,000 + $325,000) $425,000
Add unamortized FVA at the end of 20X5 140,000
Less unrealized gain - upstream sale of land (25,000)
540,000
× 30%
Non-controlling interest, SFP for December 31, 20X5 $162,000

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c. Consolidated Retained Earnings

Pop’s retained earnings $400,000

Less unrealized gain - downstream sale of capital asset
[$30,000 – (2 × 6,000)] (18,000)
382,000
70% of equity in earnings of sub since acquisition
($325,000 – $200,000) $125,000
Less unrealized gain-upstream sale of
land (25,000)
100,000 × 70% 70,000
Amortization (2 years):
Capital assets (2 x $5,000) × 70% (7,000)
Long-term debt (2 x $20,000) × 70% (28,000) (35,000)

Consolidated retained earnings at December 31, 20X5 $417,000

3. Journal entry

Common shares 100,000

Retained earnings 200,000
Capital assets, net 50,000
Long-term debt 100,000
Goodwill 40,000
Investment in Son Limited 343,000
Non-controlling interest 147,000

P6-17

Note: All amounts are in ‘000’s.

Measure:
70% Purchase of Amin Limited, December 31, 19X9
Purchase price $7,000
100% fair value based on purchase price [$7,000 × (100%/70%)] $10,000
Less carrying value of Amin’s net identifiable assets (4,750)
= Fair Value Adjustment, allocated below $5,250

Fair value
Adjustment FVA Allocated
Inventory $100 $100

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Equipment $500 $500

Total fair value adjustment allocated to identifiable assets (600)
Balance of FVA allocated to goodwill @ 100% $4,650

NCI value = 30% of $10,000 $3,000

Eliminate inter-company transactions and balances:

Upstream sales (10,000)
Consulting services revenue/expense (600)
Dividends paid by Amin (Hari’s share @ 70% is $560) (800)

Eliminate unrealized gains and recognize realized gains:

Upstream sales EI (1,000)
Realized gain on upstream sales BI 800

Realized and unrealized gain on sale of equipment by Hari to Amin in 20X1:

Gain on sale of equipment 200
Remaining useful life of equipment 8
Realization of gain per year 25
Realization during 20X1-20X4 100
Realization during 20X5 25
Balance gain unrealized at end of 20X5 75

Amort./
impairment Amort./
in previous impairment Balance of FVA
FVA Amort. years 20X0- loss during remaining at the
Allocated Period Amort. 20X4 20X5 end of 20X5
per year
Inventory $100 $100 $0 $0
Equipment $500 10 $50 $250 $50 $200
Goodwill $4,650 $3,550 $70 $1,030
Total $5,250 $3,900 $120 $1,230

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 Chapter 6 – Subsequent-Year Consolidations: General Approach

1.
Hari Company
Consolidated Statement of Income
Year Ended December 31, 20X5

Sales ($21,900 + $7,440 – $10,000) $ 19,340

Cost of Sales ($14,800 + $3,280 – $10,000 + $1,000 – $800) 8,280
Gross profit 11,060
Other revenue ($1,620 – $560 – $600) 460
Amortization expense ($840 + $420 + $50 – $25) (1,285)
Goodwill impairment loss (70)
Other expenses ($5,320 + $2,040 – $600) (6,760)
Income before income taxes 3,405
Income tax expense ($800 + $680) 1,480
Consolidated net income and comprehensive income $ 1,925
Consolidated net income and comprehensive income attributable to:
Owners of Hari $ 1,715
NCI (see below) $ 210

NCI share of Amin’s adjusted earnings

Amin's unadjusted earnings 1,020
Negative adjustments:
Goodwill written off (70)
Amortization of equipment FVA (50)
Unrealized gain on EI upstream (1,000) (1,120)
Positive adjustments:
Realized gain on BI upstream 800
700
NCI share @ 30% 210

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 Chapter 6 – Subsequent-Year Consolidations: General Approach

2.
Hari Company
Consolidated Retained Earnings
January 1, 20X5

Hari's retained earnings, beginning of year $10,420

FVA —Inventory (70)
—Equipment ($500/10 × 5) × 70% (175)
—Goodwill ($4,650 – $1,100) × 70% (2,485)
Gain on sale of equipment (200)
Gain on machine realized (200 × 4/8) 100
Subtotal 7,590
Amin's retained earnings, beginning of 20X5 $5,180
Amin's retained earnings, at acquisition 4,500
Change in retained earnings since acquisition 680
Profit in beginning inventory (800)
$(120)
Hari's share @ 70% (84)
Consolidated retained earnings $7,506

Hari Company
RE/SCE
Year ended December 31, 20X5

Retained earnings, beginning of year $ 7,506

Net income 1,715
Dividends paid (1,600)
Retained earnings, end of year $ 7,621

3. When unrealized profit is eliminated from the carrying value of the equipment, the equipment
ends up being reported at the original cost of the equipment less accumulated amortization based
on the original cost, as if the intercompany transaction had never taken place. So, in effect, the
equipment is reported at its historical cost.

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 Chapter 6 – Subsequent-Year Consolidations: General Approach

P6-18

1.
Measure:
70% Purchase of Sombrero Company, January 1, 20X0
Purchase price $84,700
100% fair value based on purchase price [$7,000 × (100%/70%)] $121,000
Less carrying value of Sombrero’s net identifiable assets (60,000)
= Fair Value Adjustment, allocated below $61,000
Fair value
Increment
FVI Allocated
Inventory $10,000 $10,000
Equipment 20,000 20,000
Total fair value adjustment (30,000)
Balance of FVA allocated to goodwill @ 100% $31,000
NCI value = 30% of $121,000 $36,300
Eliminate inter-company transactions and balances:
Upstream sales (50,000)
Accounts payable/receivable (18,000)

Sale of trademark from Mariachi to Sombrero in 20X2:

Sale price 28,000
Carrying value 20,000
Unrealized gain in 20X2 8,000

Eliminate unrealized gains and recognize realized gains:

Upstream sales EI (4,000)
Realized gain on upstream sales BI 2,000
Realized gain on trademark downstream 8,000

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 Chapter 6 – Subsequent-Year Consolidations: General Approach

2.
Mariachi Corporation
Consolidated Statement of Comprehensive Income
Year ended December 31, 20X5
Sales ($750,000 + $600,000 – $50,000) $1,300,000

Cost of goods sold ($500,000 + $450,000 – $50,000 – $2,000 + $4,000) (902,000)

Gross margin 398,000
Gain on sale of trademark ($12,000 + $8,000) 20,000
Amortization expense ($35,000 + $20,000 + $2,000) (57,000)
Other expenses ($86,000 + $62,000) (148,000)
Income tax expense ($60,000 + $32,000) (92,000)
Net income and comprehensive income $121,000
Net income and comprehensive income attributable to:
Owners of Mariachi $107,800
NCI (see below) $13,200

Non-controlling interest in adjusted earnings of Sombrero:

Sombrero separate entity unadjusted earnings $48,000
Upstream sales EI (4,000)
Realized gain on upstream sales BI 2,000
Amortization of FVA attributed to equipment (2,000) (4,000)
Sombrero adjusted earnings $44,000
NCI share 30%
NCI share of sombrero's adjusted earnings $13,200

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 Chapter 6 – Subsequent-Year Consolidations: General Approach

3.

a) Accounts receivable $90,000 + $65,000 – $18,000 = $137,000

b) Inventory $250,000 + $90,000 – $4,000 = $336,000
c) Equipment $225,000 + $150,000 + $8,000
(Capital assets) (being $20,000 × 4/10) = $383,000

d) Non-controlling interest balance:

Shareholders' equity of Sombrero ($35,000 + $50,000) $85,000
Unamortized FVI 39,000
Unrealized gain EI upstream (4,000)
$120,000
NCI share 30%
NCI balance end of 20X5 $36,000
Alternate method of calculating NCI balance:
NCI balance at time of acquisition $36,300
Sombrero change in RE till 20X4
RE end of 20X4 $32,000
RE at time of acquisition 25,000
Increase in RE 7,000
Less FVI amortization:
Inventory (10,000)
Equipment (10,000)
Less unrealized gains
Unrealized gain EI upstream (2,000)
(15,000)
NCI share of adjusted change in RE till 20X4 30% (4,500)
Add NCI share of earnings 20X5 13,200
45,000
Less NCI share of dividends (9,000)
NCI balance end of 20X5 $36,000

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P6-19

1.
Measure:
70% Purchase of Inca Limited, January 1, 20X2
Purchase price $84,000
100% fair value based on purchase price [$80,000 × (100%/70%)] $120,000
Less carrying value of Inca’s net identifiable assets (80,000)
= Fair Value Adjustment, allocated below $40,000
Fair value
Adjustment FVA
Allocated
Inventory ($9,000) ($9,000)
Equipment 24,000 24,000
Total fair value adjustment allocated to identifiable
assets (15,000)
Balance of FVA allocated to goodwill @ 100% $25,000

NCI value = 30% of $120,000 $36,000

Amortize:
Amort./ Amort./
impairment in impairment Balance of FVA
FVA Amort. Amort. previous years loss during remaining at the
Allocated Period per year 20X2-20X4 20X5 end of 20X5
Inventory ($9,000) ($9,000) $0 $0
Equipment 24,000 6 4,000 12,000 4,000 8,000
Goodwill 25,000 21,500 3,500
Total $40,000 $3,000 $25,500 $11,500

Eliminate intercompany transactions and balances:

Management fee ($2,000 × 12) $ 24,000

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Downstream sales $100,000

Interest ($40,000 × 8% × 9/12) $ 2,400
Notes payable $ 40,000
Dividends paid by Inca (Aztec’s portion @ 70% = $14,000) $ 20,000

Eliminate unrealized gains and recognize realized gains:

Unrealized gain on sale of land— upstream $ 20,000
Ending inventory— downstream ($30,000 × 35%) $ 10,500

2.
Aztec Corp.
Consolidated Statement of Comprehensive Income
Year ended December 31, 20X5
Sales ($798,000 + $300,000 – $100,000) $998,000
Management fee revenue ($24,000 – $24,000) 0
Investment income ($14,000 + $3,600 – $14,000 – $2,400) 1,200
Gain on sale of land ($20,000 – $20,000) 0
Total revenue 999,200
Cost of sales
($480,000 + $200,000 – $100,000 + $10,500) 590,500
Interest expense ($10,000 – $2,400) 7,600
Amortization expense ($40,000 + $12,000 + $4,000) 56,000
Other expenses ($106,000 + $31,600 – $24,000) 113,600
Goodwill impairment loss ($25,000 – $3,500) 21,500
Income taxes ($80,000 + $32,000) 112,000
Total expenses 901,200
Consolidated net income and comprehensive income $98,000
Net income and comprehensive income attributable to:
Owners of Aztec $97,250
NCI (see below) $750

Non-controlling interest in adjusted earnings of Inca:

Inca separate entity unadjusted earnings $48,000
Upstream sale of land (20,000)
Impairment loss of goodwill (21,500)
Amortization of FVI attributed to equipment (4,000) (45,500)
Inca adjusted earnings $2,500
NCI share 30%
NCI share of Inca's adjusted earnings $750

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3.
a) Inventory ($66,000 + $44,000 – $10,500) $99,500

b) Land ($150,000 + $30,000 – $20,000) $160,000

c) Notes payable
The notes payable would not be shown on the consolidated statement of financial
position.

d) Non-controlling interest
[shareholders’ equity ($50,000 + $120,000) + unamortized FVI $48,450
($11,500) – unrealized gain on sale of land ($20,000)] × (30%)

e) Common shares (only those of Aztec) $150,000

P6-20

Original cost on Jan 1, 19X5 of machine $ 100,000

Less accumulated depreciation ($100,000/20) × 5 (25,000)
Carrying value of machine 75,000
Sale price to Apache 60,000
Loss on sale $ (15,000)
Remaining useful life 15
Realized loss each year $ 1,000

Eliminate intercompany transactions:

Upstream sale of inventory (400,000)
Dividends (80% or $4,800 to Apache) (6,000)
Management fee (10,000)
Interest on loan @ 10% on $100,000 for 6 months (5,000)

Eliminate unrealized gains and recognize realized gains:

Unrealized gain on sale of land (15,000)
Realized gain BI -- downstream 16,000
Realized loss each year on machine sold (1,000)
Unrealized gain EI -- upstream (24,000)

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1. Consolidation:
Apache Company
Consolidated Statement of Comprehensive Income
Year Ended December 31, 20X5
Merchandise sales ($3,000,000 + $2,000,000 – $400,000) $4,600,000
Investment income ($60,000 – $4,800 – $5,000) 50,200
Other revenue ($50,000 + $70,000 – $15,000 – $10,000) 95,000
Total revenues 4,745,200
Cost of goods sold (below) 2,808,000
Depreciation expense ($400,000 + $400,000 + $1,000) 801,000
Selling and administrative expense ($500,000 + $200,000 – $10,000 – $5,000) 685,000
Loss on sales of investments 26,000
Total expenses 4,320,000
Net income and comprehensive income $ 425,200
Net income attributable to:
Owners of Apache $424,400
NCI (see below) $ 800

Cost of goods sold:

Apache $1,800,000
Navaho 1,400,000
Intercompany sales (400,000)
Realized profit (beginning inventory): $40,000 × 40% (16,000)
Unrealized profit (ending inventory): $60,000 × 40% 24,000
$2,808,000

NCI share of earnings of Navaho:

Navaho separate entity unadjusted income $44,000
Less:
Realization of loss on sale of machinery (1,000)
Unrealized gain in EI -- upstream (24,000)
Unrealized gain on upstream sale of land (15,000) (40,000)
Adjusted earnings of Navaho $4,000
NCI share 20%
NCI share of adjusted earnings of Navaho $800

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2. Equity reporting:

Navaho net income:

$44,000 × 80% $ 35,200
Realized inventory profit (downstream) 16,000
Unrealized inventory profit (upstream): $24,000 × 80% (19,200)
Unrealized gain on land (upstream): $15,000 × 80% (12,000)
Realized loss from depreciation of machine (upstream):
$15,000/15 × 80% (800)
Equity in earnings of Navaho 19,200
Apache separate-entity net income 410,000
Less dividends received from Navaho (4,800)
Apache net income, equity basis $424,400

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Appendix 6A

ANSWERS TO REVIEW QUESTIONS

6A-1: P’s net income attributable to its owners will include 60% of S’s earnings available to
common shareholders plus 45% of the preferred dividends paid by S. (Note that the intercompany
preferred dividends will be eliminated on consolidation and the dividends paid to the other 55% of
the preferred shares will be attributed to the non-controlling interest on the SCI as part of non-
controlling interest in earnings of subsidiary.)

6A-2: S has earnings available to common shareholders of $500,000, of which P will include as
part of the net income attributable to its owners (either by the equity method or by consolidation)
70%, or $350,000. In addition, P will include as part of income attributable to its owners 20% of
the preferred dividends, or $20,000. In total, P’s net income attributable to its owners will be
increased by $370,000 from the earnings of S. (Alternative approach: of S’s total earnings of
$600,000, the outside shareholders will receive 80% of the preferred dividends ($80,000) plus 30%
of the earnings available to common ($150,000), leaving $370,000 in P’s net income after
consolidation attributable to its owners.)

6A-3: The parent’s proportionate interest is determined by the proportion of the subsidiary’s
common shares that is held by the parent. The preferred shares are not taken into account unless
they are voting shares, and then they must be included with the common in determining whether or
not the parent actually has the ability to control the subsidiary.

6A-4: The excess of the purchase price is charged to shareholders’ equity to a contributed surplus
account for that class of shares if one exists. If an appropriate contributed surplus account does not
exist, the charge is to retained earnings. The shares are treated as if they had been retired.

6A-5: A restricted share is a common share that has reduced voting power, compared to a regular
common share. A restricted share may have no voting power at all.

6A-6:
a. There are 1,400,000 votes available in Irene Ltd. (1,000,000 for regular shares and 400,000 for
restricted shares). Gordon has 750,000 votes for its 165,000 shares and, therefore, controls Irene.

b. Since all shares participate equally in earnings, Gordon has equity in 165,000/500,000 or 33% of
Irene’s earnings.

6A-7: A coattail provision protects the holders of the restricted shares by providing that in the
event of a takeover attempt, the restricted shares become fully voting for limited purposes.

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CASE NOTES

Case 6A-1: A La Mode Inc.

Objectives of the Case

This case is an adaptation of the comprehensive exam of the 1999 UFE. The students need to
consider the impact of an acquisition on the EPS and accounting policies. There is a potential for
loss of control depending on the method of financing that is selected for the acquisition. Audit
issues also need to be considered. The following is an adaptation of the suggested response from
the 1999 UFE Report Paper I.

Suggested Response
Memo to: Partner

This memo discusses the audit issues and the information you need to respond to Mr. Jones’ and
Mr. Grenier’s requests based on the information provided to me. In order to be clear as to exactly
what Mr. Jones and Mr. Grenier are seeking from you, I have reiterated below what I believe to be
their requests.

Mr. Jones and Mr. Grenier have asked for an analysis of the number of A La Mode Inc. (ALM)
shares that have to be issued in order to complete the purchase of CI. They would also like to know
the implications, if any, arising from the proposed financing arrangement with the pension fund.
Further, Mr. Jones would like to know whether ALM can consolidate CI’s results as he believes
that doing so will show better EPS for ALM.

The acquisition of CI and its convertible debt financing arrangement will cause the controlling
shareholders of ALM to lose their controlling position. This matter should be brought to the
client’s attention immediately to allow them to consider possible courses of action to prevent a loss
of control. The detailed impacts of the financing arrangement are discussed later in this memo.
There are also a few audit matters mentioned.

Acquisition of USA Chic Inc. (CI)

The due diligence related to the purchase of CI has been completed, and the purchase is scheduled
to close on May 1, 20X4. On this date the purchase of a 20.27% interest in CI will be recorded in
the books of ALM. At the purchase price of $5.73 per share, $32.812 million of goodwill will be
recorded on the consolidated statements (refer to Appendix I). Otherwise, if the equity method is
followed, the investment account will include ALM’s share of the goodwill at $ 6.6 million.

Recommended Accounting Treatment for Acquisition of CI

Mr. Jones and Mr. Grenier have asked whether it is possible to consolidate CI’s results. In order to
consolidate, ALM must control CI. Control is present if the shareholders have the right to elect the
majority of the Board of Directors. Control is determined by looking at the number of votes a

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shareholder or group of shareholders has, not just the number of shares that are owned. Control is
presumed if more than 50% of the voting interest is held. However, having control is a question of
fact and each case must be assessed on its own.

ALM, with the purchase of 3.5 million shares, will hold 27% of the votes in CI if BCG does not
sell the rest of its shares to the public. ALM will have 30% if BCG sells the rest of its shares to the
public. The higher percentage results from the side agreement ALM struck with BCG which
converts the Class B shares into single voting Class A shares if BCG sells to the general public.
Thirty percent of the votes is not sufficient in itself to allow consolidation of CI.

However, Mr. Jones and Mr. Grenier already hold 22% of the votes in CI. In addition, since they
are the controlling shareholders of ALM, they will effectively control 49% of the votes in CI as
long as BCG does not sell any of its remaining shares to the public. For Jones/Grenier control of CI
to increase from 49% to 50%, BCG would have to sell some of its shares to the public. If BCG
sells the remainder of its shares, Jones/Grenier will control 54% of the votes in CI. This percentage
is in itself sufficient to support the consolidation of CI’s results.

Consideration should be given to the fact that with 49%, the Jones/Grenier group will be entitled to
2 out of 5 seats on the Board. The rest of the shareholdings are widely held, so it appears that
Jones/Grenier group may have effective control. Determining whether they have effective control
will depend on how much influence they have over the decisions being made.

Having effective control would allow ALM to consolidate CI’s results. Since BCG is having cash
flow difficulties, ALM may want to consider renegotiating a side deal with BCG to help ensure
that ALM gets control.

If ALM consolidates on the basis of effective control, a note to the financial statements explaining
the reason for consolidating will be required. Only the results of the operations from May 1, 20X4,
the date of acquisition, can be consolidated. It should be noted that the non-controlling interest is
80%. Thus, the purchase of CI will not have as big an impact on EPS as ALM management seems
to expect, since only a small percentage of CI’s earnings would be attributed to the owners of CI.
IAS 33, Earnings per Share requires an entity to present in its statement of comprehensive income
EPS figures relating to profit and loss attributable to the ordinary equity holders of the parent
company. Thus, this figure will exclude the profit and loss attributable to the NCI.

Management seems to think that consolidating CI will show better EPS. The basis for this belief is
not known. In actual fact, the same financial results will be shown whether CI is consolidated or is
accounted for on the equity basis. This point should be brought to management’s attention.

Financing the Acquisition of CI

The acquisition of CI’s shares is to be financed through the issuance of $20,055,000 of convertible
debt to a pension fund. The debt will be convertible at the option of the holder into multiple-voting
shares on May 1, 20X5. The exercise price is to be determined using the average of the 20X4 and
20X5 consolidated EPS before discontinued operations, multiplied by the price-earnings ratio. Mr.

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Jones and Mr. Grenier have asked us to determine how many shares of ALM must be issued to
complete the purchase of CI. Since no ALM shares are issued at the time of purchase, I assume that
the client is in fact asking us to determine the number of shares ALM would have to issue to the
pension fund if the conversion feature is exercised. Based on the formula and the given average
EPS, 3,952,815 multiple voting shares would have to be issued to the pension fund. This translates
into 55.07% of the votes in ALM (Mr. Grenier and Mr. Jones each own 1,128,600 multiple voting
shares each, and both together approximately own 70% of the voting shares; therefore, the total
multiple voting shares outstanding before the conversion must be 3,224,571 shares and after the
conversion must be 7,177,386 shares). Mr. Jones and Mr. Grenier should be made immediately
aware that they are surrendering control of ALM under the current financing arrangement. This is
most likely not what they intended. Jones and Grenier should try to change the agreement so that
control is maintained.

Other options should be considered. One option is to consider issuing subordinated voting shares
instead of multiple-voting shares. Another option might be to make only part of the debt
convertible. This would mean that a certain amount of interest expense would remain on the
statement of comprehensive income even after the conversion was exercised. This option could
have a positive impact on the EPS depending on the number of shares issued.

If ALM has not already done so, it should look to other sources of financing, such as traditional
bank financing, to reduce or eliminate the need to pursue financing with the pension fund. Of
course, this option would result in increased interest expense, which in turn would reduce the EPS.

ALM could consider using some of its cash or cash equivalents, if available.

ALM should look at which of the above options is best suited to its situation and decide on a
course of action as quickly as possible. The pension fund must be advised immediately that the
agreement needs to be revised. However, management must consider the possibility that it is too
late to change the deal. Of course, the pension fund could decide not to exercise its option. We do
not know its motivation in making this deal. It could prefer to keep its guaranteed return of 8%. If
the pension fund does not exercise its conversion option, there is no loss of control to Jones and
Grenier.

Audit Issues
The client should be informed that due to the atypical transactions occurring in 20X5, increased
work will be required and as a result the audit fee will be higher.

The engagement risk for the ALM audit will be increased by the following factors: the 20X5 and
20X4 financial statements will be relied upon by the pension fund to determine the share
conversion. The pension fund is a new user of the financial statements. Being a public company,
ALM wants to show strong results. It has even more reason to do so in light of the pension fund
financing. The purchase of CI is a large transaction. CI is a US company and ALM will face
foreign currency issues for the first time. (Foreign currency issues are covered in chapter 8.)

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Audit of CI
The issue of greatest concern for the 20X5 audit is how we will gain audit assurance on CI. Since
CI’s current auditors are to remain in place for the 20X5 audit, we must rely on them. We must
therefore consider their personal qualifications.

As part of our planning we should communicate with CI’s auditors in advance of the audit to
advise them that we will be relying on their audit report. We should ask them to identify any
transactions or balances that should be eliminated on consolidation. We should confirm that they
agree to inform us of any matters that could affect our opinion. We should ensure that their audit is
completed before we report on the consolidated statements. CI should not have a problem meeting
the deadlines as its 20X4 report was issued on or before March 20X4.

A letter of representation should be obtained from CI’s auditors confirming the following: they are
aware of our reliance on their report, they are independent from ALM, they have identified all
differences between CI and ALM, and they have complied with all of our instructions.

We have to ensure that CI’s accounting policies are in accordance with IFRS. A key area of our
audit is the purchase of CI. Any differences will need to be identified and adjusted for on the
Canadian financial statements. We will also need to determine the functional currency of CI for
foreign currency reporting. We also have noted that the pension debt is convertible with an equity
component, the equity component will be valued and presented separately.

A large part of our audit will focus on the purchase transaction. We will have to obtain the
purchase agreement and review it in detail. The purchase price allocation will have to be verified to
determine the appropriate amount of goodwill. We will need to discuss and enquire of management
to ensure all separately identifiable intangible assets are recorded on purchase.

Appendix I

Measure (all amounts in thousands of dollars):

Consideration paid $20,055
Fair value of CHI based on purchase price $20,055 ×
(17,266,000/3,500,000) $98,934
Net book value of CHI 01/31/X4 63,046
Adjust for three months of operation 3,076
66,122
Goodwill @ 100% $32,812

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Case 6A-2: Voice Limited

Overview

This case describes a scenario that is essentially a joint venture; each of the two joint venture
partners has one share of voting common stock, and a joint venture agreement exists. However, the
situation is complicated by the fact that one partner in the venture is given a majority
representation on the board of directors and also has the right to appoint the CEO. In addition, the
ability of the two partners to benefit from the earnings of the joint venture is inhibited by an
agreement not to issue dividends. As a result, arguments can be made in favour of each of the four
methods of reporting the investment of the principal partner.

(1) Cost

The cost method normally would not be appropriate when the investor can control or significantly
influence the operations of the investee, and it certainly is the case that NC can significantly
influence the operations of VL. However, the joint venture agreement provides that no dividends
can be declared unless both parties agree, and thus it could be argued that there is an impediment to
the investor’s realization of the benefits of control. While this argument can be made, it is not
strong enough to justify use of the cost method, as intercompany transactions are significant.

(2) Equity

The equity method is appropriate when significant influence is exercisable, which seems to be the
case here. NC has three of the five nominees on the VL board, NC selects VL’s CEO, and NC
engages in significant intercompany transactions with VL. Despite its majority representation on
the VL board, however, NC does not have more than 50% of the votes and cannot control VL
without the other partner’s approval.

(3) Proportionate Consolidation

Proportionate consolidation is appropriate when there is joint control. NC appears to have joint
control of VL as it has 50% of the votes and both NC and HT must agree on any change to the
dividend policy. However, NC’s control of 60% of VL’s Board and NC’s ability to select VL’s
CEO indicate that NC may have control.

(4) Consolidation

Consolidation is appropriate when the investor controls the investee, and under IAS 27,
Consolidated and Separate Financial Statements, control exists when one entity has the power to
direct the financing and operating activities of another entity to derive benefits from that entity. In
this case, NC can elect a majority of the VL board, which would indicate the power of control,
although this has been obtained by the terms of the joint venture agreement rather than by voting
power; NC’s vote is equal to HT’s vote. However, NC cannot change the dividend policy without
the agreement of HT so NC’s control is limited in this respect. IAS 27 does not indicate that the

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ability to control must come from voting rights, however, and therefore consolidation could be
used even though there are substantial restrictions on NC’s exercise of control over VL.

Summary

A strong case could be made for the use of equity, proportionate consolidation or consolidation
methods. (The case for using the cost method is significantly weaker.) NC appears to have more
than significant influence given its ability to control most of the decisions. However, it cannot
control all the decisions without the cooperation of HT. Therefore, the proportionate consolidation
method would be the most appropriate.

SOLUTIONS TO PROBLEMS

P6A-1

Analysis of purchase transaction:

Total cost of purchase, July 1, 2003 $4,900,000

Preferred shares purchased: 4,000 @ $95 380,000
Cost of common shares purchased (240,000 shares) 4,520,000
Common share equity acquired:
Total net assets $6,000,000
PS redemption value 1,000,000
Total common equity $5,000,000
80% acquired 4,000,000
Goodwill $ 520,000

1. SFP amounts, December 31, 20X3 and 20X4 (not consolidated):

Investment in Paltry preferred shares, December 31, 20X3 $ 380,000

Investment in Paltry preferred shares, December 31, 20X4 $ 380,000

Investment in Paltry common shares (equity basis):

Cost (July 1, 20X3) $4,520,000
Equity in 20X3 earnings:
Paltry net income $600,000
Preferred dividends 150,000
Earnings available to common 450,000

Super’s share (80% for 1/2 year) 180,000

Dividends received on common:
$250,000 × 1/2 year × 80% (100,000)
Balance, December 31, 20X3 4,600,000

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Equity in 20X4 earnings:

Paltry net income $800,000
Preferred dividends 150,000
Earnings available to common 650,000
Super’s share (80%) 520,000
Dividends received on common:
$300,000 × 80% (240,000)
Balance, December 31, 20X4 $4,880,000

b. Sale of 1,000 preferred shares:

Carrying value of preferred, December 31, 20X4 $ 380,000
Sale of 25% of holdings 95,000
Balance after sale $ 285,000

P6A-2

Measure:
Cost of 60% common shares purchased $7,200,000
Imputed price for 100% of common shares (7,000,000 x 100/60) $12,000,000
Less fair value of net identifiable assets attributable to common:
Carrying value of Serious net assets $12,000,000
PS redemption value 4,500,000
Total common equity 7,500,000
FVI on capital assets 3,000,000
Fair value of net assets acquired 10,500,000
Goodwill $1,500,000

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Playful, Inc.
Consolidated
SFP
December 31,
20X5

Current assets ($12,000,000 + $7,000,000 – $20,000) $18,980,000

Capital assets (1) 44,800,000
Goodwill 1,500,000
Total assets $65,280,000

Current liabilities ($10,000,000 + $6,000,000 – $20,000) $15,980,000

Long-term liabilities 15,000,000
Total liabilities 30,980,000
Shareholders’ equity:
Common shares $8,200,000
Additional contributed capital (3) 200,000
Retained earnings (4) 17,180,000
Non-controlling interest (2) 8,720,000 34,300,000

Total liabilities & equities $65,280,000

(1)
Capital assets:
Per books $42,000,000
Fair value increment 3,000,000
Amortization of FVI (200,000)
$44,800,000

(2)
Non-controlling interest:
Net assets of Serious $13,000,000
Less redemption value of preferred shares (4,500,000)
Carrying value of common shares 8,500,000
Unamortized FVI capital assets 2,800,000
Goodwill 1,500,000
Total amortized fair value of Serious $12,800,000
NCI share of common @ 40% $5,120,000
80% of preferred: 80,000 shares @ $45 3,600,000
Non-controlling interest $8,720,000

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(3) Additional contributed capital:

Difference between the redemption value and the cost of Playful’s
investment in Serious’s preferred shares:
($45 - $35) × 20,000 shares = $200,000

(4) Retained earnings:

Serious’s earnings retained in 20X5 $ 1,000,000
Playful share (60%) 600,000
Share of amortization of FVI on capital assets (120,000)
Playful’s share of Serious R.E. 480,000
Playful R.E., December 31, 20X5 16,700,000
Consolidated retained earnings, December 31, 20X5 $17,180,000

P6A-3

Purchase price for 80% common shares 1,200,000

Value of 100% common based on price for 80% $1,500,000
Carrying value of net identifiable assets 1,008,000
Fair value increment attributable to goodwill $492,000

1. Non-controlling interest, January 1, 20X5

Preferred shares (100%) $200,000

Common shares (20% of $1,008,000) 201,600
Goodwill (20% of $492,000) 98,400
$500,000

2. Non-controlling interest, December 31, 20X5

Preferred shares (100%) $200,000

Common shares (20% of $1,008,000 + $100,000) 221,600
Goodwill (20% of $492,000) 98,400
$520,000

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Appendix 6B

ANSWERS TO REVIEW QUESTIONS

6B-1: Since Sub’s debentures were purchased as part of the original offering, the carrying value of
the bonds should be the same on the books of both companies. The elimination, therefore, will
require only that the net liability on Sub’s books be eliminated against the investment asset on
Parent’s books.

6B-2: On consolidation, intercompany purchases of bonds are treated as retirements of the

obligation. Any difference between the carrying value of bond indebtedness of the issuing company
and the carrying value of the bond investment to the buying company is treated as a gain or loss on
redemption. In this example, a gain would be reported on the consolidated statements.

6B-3: Under the par-value approach, an intercompany bond purchase is viewed as though the
issuing company was retiring the bonds at par, and redemption gains and losses are allocated to the
issuer and the buyer accordingly. Under the agency approach, an intercompany bond purchase is
viewed as a retirement of the bonds by the issuer at the price paid by the buyer, and any gain or loss
is attributed entirely to the issuing corporation. Under the agency approach, the buying corporation
is treated as the agent of the issuing corporation.

6B-4: The agency approach better satisfies “substance over form” because it recognizes that the
two corporations are not unrelated but instead are part of a single economic entity. The par-value
approach, on the other hand, maintains the fiction that the two corporations are acting
independently as buyer and seller - an arm’s length transaction.

SOLUTIONS TO PROBLEMS

P6B-1

Analysis: Face value of bonds purchased $50,000

Unamortized premium on Beluga’s books 3,000 *
Carrying value at January 1, 20X5 $53,000
Purchase price by Orcas 41,000
Total gain on redemption $12,000
* (3/10 × 40,000) × 50,000/200,000

1. Beluga is 100% owned:

Bonds payable $50,000

Interest income (Orcas) 2,500
Premium on bonds payable 2,000
Bond investment $41,000
Gain on bond redemption 12,000

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Interest expense (Beluga) 1,500

2. Beluga is 75% owned:

a. Agency method

Bonds payable $50,000

Interest income (Orcas) 2,500
Premium on bonds payable 2,000
Bond investment $41,000
Gain on bond redemption 12,000
Interest expense (Beluga) 1,500

$3,000, i.e. 25% of ($53,000 – 41,000) is attributable to the NCI.

b. Par-value method

Bonds payable $50,000

Interest income 2,500
Premium on bonds payable 2,000
Bond investment $41,000
Gain on bond redemption 12,000
Interest expense 1,500

$750, i.e. 25% of ($53,000 – 50,000) is attributable to the NCI.

Note: The preceding solution assumes that Orcas is not amortizing the bond purchase discount on
its books. Income tax effects have been ignored.

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P6B-2
Measure:
80% Purchase of Submarine Ltd., January 1, 20X5
Purchase price $470,000
100% fair value based on purchase price [$470,000 × (100%/80%)] $587,500
Less carrying value of Submarine's net identifiable assets (320,000)
= Fair Value Increment, allocated below $267,500
Fair value
Increment FVI
(c)=(b)–(a) Allocated
Inventory $40,000 $40,000
Land 70,000 70,000
Capital assets net (30,000) (30,000)
Total fair value increment (80,000)
Balance of FVI allocated to goodwill @ 100% $187,500
1. Inventory
P Ltd. $ 240,000
S Ltd. 80,000
Unrealized profit: ($500,000 – $400,000) x 20% (20,000)
$ 300,000
2. Land
P Ltd. $ 600,000
S Ltd. 240,000
Fair value increment 70,000
Unrealized profit (60,000)
$ 850,000
3. Capital assets (net)
P Ltd. $ 800,000
S Ltd. 250,000
Fair value decrement, unamortized: $30,000 × 9/10 (27,000)
$1,023,000
4. Bonds payable
S Ltd. $ 100,000
Less amount (par) held by P Ltd. (60,000)
$ 40,000
5. Retained earnings
P Ltd. (includes $80,000 share of S unadjusted net income) $1,343,898
Unrealized profit in inventory (20,000)
Unrealized profit from sale of land (60,000)
Loss on bond purchase, less amortization:
$4,000 × 38/39 × 80% (agency approach) (3,118)
Amortizations:
Inventory FVI (32,000)
Capital assets FVD: $24,000 × 1/10 2,400

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$1,231,180

P6B-3

1. 1. Land and buildings:

Land: 4,200,000 + 8,400,000 - 100,000 $12,500,000 Dr.

Buildings, net: 4,982,000 + 9,178,000 – 110,000 + 10,000) 14,060,000 Dr.
Depreciation expense: 420,000 + 570,000 – 10,000 980,000 Dr.

2. Bonds:

Investment in bonds 0
Interest income: 111,000 – (600,000 × 6%) + (680,000 - 668,571) 86,429 Cr.
Bonds payable: 2,000,000 – 600,000 1,400,000 Cr.
Discount on bonds: 97,500 × 70% (1.4/2) 47,775 Dr.
Interest expense: 392,462 – 36,000 – (0.3)(130,000 – 97,500)(0.5) 351,587 Dr.
Parent:
Face value $600,000
Discount unamortized:
0.3(130,000 + 97,500)/2 (34,125)
Carrying value on date of retirement 565,875
Face value 600,000
Loss on retirement allocable to SubTwo 34,125
SubTwo: 680,000 – 600,000 80,000
Total loss (680,000 – 565,875) 114,125 Dr.

2. A stock split will not affect the total ownership interests in SubThree of either Parent or the NCI
shareholder(s). Only the per share carrying values of SubThree’s shares will be affected, and that
fact does not require any formal accounting recognition except for a notation that the number of
shares has tripled.

3. Non-controlling interest in earnings:

SubOne: 0.30 × (–421,000 – 210,000 + 10,000) = (186,300)
SubTwo: 0.10 [400,000 – (680,000 – 600,000)] + (680,000 – 668,571) = 33,143

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 Chapter 6 – Subsequent-Year Consolidations: General Approach

P6B-4

Measure:
70% Purchase of Scot Limited, January 1, 20X5
Purchase price $506,100
100% fair value based on purchase price [$506,100 × (100%/70%)] $723,000
Less carrying value of Scot's net identifiable assets (550,000)
= Fair Value Increment, allocated below $173,000
Fair value
Increment FVI
(c)=(b)–(a) Allocated
Accounts receivable $6,000 $6,000
Inventory (17,000) (17,000)
Capital assets net (50,000) (50,000)
Preferred shares (3,500) (3,500)
Total fair value increment 64,500
Balance of FVI allocated to goodwill @ 100% $237,500

Alternative calculation:
Cost of 70% common shares purchased $506,100
Imputed price for 100% of common shares ($506,100 × 100/70) $723,000
Less fair value of net identifiable assets attributable to common:
Carrying value of Scot net assets $725,000
Less preferred shares redemption value 178,500
Total common equity 546,500
FVI attributed to different assets and liabilities (61,000)
Fair value of net assets acquired 485,500
Goodwill $237,500

1. Consolidated Statement of Comprehensive Income:

Sales $1,700,000
Cost of goods sold (500,000 + 500,000 – 17,000) 983,000
Gross margin 717,000
Depreciation expense [80,000 + 70,000 – 5,000 – 18,750] 126,250
Interest expense (42,000 – 9,000 – 1,500) 31,500
Other expenses (100,000 + 80,000 + 6,000) 186,000
Interest income on bonds (11,250 – 11,250) 0
Gain on retirement of bonds 14,250
Gain on sale of land (40,000 – 40,000) 0
Gain on sale of building (75,000 – 75,000) 0

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Net income $ 359,000

Net income attributable to:
Owners of Paco $316,175
NCI (see below) 42,825

Non-controlling interest in earnings of Scot:

Scot separate-entity unadjusted earnings $183,000

Unrealized gains on upstream sale of building
Gain on sale of building $(75,000)
Less realized component of gain 18,750 (56,250)
Amortization of FVI/FVD
Accounts receivable (6,000)
Inventory 17,000
Capital assets, net 5,000 16,000
Adjusted earnings of Scot $142,750
NCI share @ 30% $42,825

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2. Balances at December 31, 20X5:

a) Inventory: 500,000 + 400,000 = $ 900,000

b) Capital assets, net:

Paco carrying, net $1,000,000

Scot carrying, net 800,000
Fair value decrement $(50,000)
Less amortization of FVD 5,000 (45,000)

Unrealized gain on upstream sale of building (75,000)

Less realized gain 18,750 (56,250)
Unrealized gain on downstream sale of land (40,000)
Capital assets, net Dec. 31 20X5 $1,658,750

c) Bond discount: 54,000 × 50% = $ 27,000

d) Non-controlling interest:

Net assets of Scot on Dec. 31, 20X5 $908,000

Less redemption value of preferred shares (178,500)
Carrying value of common shares 729,500
Unamortized FVI capital assets (45,000)
Goodwill 237,500
Unrealized gain on building, (75,000 – 18,750) (56,250)
Total amortized fair value of Scot $865,750
NCI share of common @ 30% $259,725
Preferred shares [$175,000 + $2($175,000/$100)] 178,500
Non-controlling interest $438,225

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SSP 6-1
2007 Gain on sale of equipment 40,000
Equipment 40,000

Depreciation expense 5,000

Accumulated depreciation 5,000

2008 Beginning Retained Earnings 40,000

Equipment 40,000

Depreciation expense 10,000

Accumulated depreciation 10,000

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 Chapter 6 – Subsequent-Year Consolidations: General Approach

SSP 6-2

a.
Consolidated Statement of Comprehensive Income
For the Year Ended December 31, 20X9

Sales (2,000,000 + 900,000 – 400,000 – 250,000) $2,250,000

Investment income (1,000,000 +100,000 – 32,000) 1,068,000

Total Revenue 3,318,000

Cost of goods sold (1,300,000 +500,000 – 373,000 – 226,000

+30,000 + 28,000) 1,259,000

Other operating expenses (960,000 +320,000 +6,000 – 60,000) 1,226,000

Total expenses 2,485,000

Total Comprehensive Income $ 833,000

b.

740,000 - 32,000 +(248,000-68,000+28,000-24,000

+30,000-27,000+60,000-6000)*.8 = 900,800

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