Consolidated Financial Statements - Ownership Patterns and Income Taxes

Use the following to answer questions 1 – 3:

REFERENCE: 07-01

Buckette Co. owned 60% of Shuvelle Corp. and 40% of Tayle Corp., and Shuvelle owned 35% of Tayle.

[QUESTION]

REFER TO: 07-01

1. When Buckette preparesconsolidated financial statements, it should include

A) Shuvelle but not Tayle.

B) Tayle but not Shuvelle.

C) Either Shuvelle or Tayle.

D) Shuvelle and Tayle.

E) Neither Shuvelle nor Tayle.

Answer: D

Learning Objective: 07-02

Topic: Consolidation―Connecting affiliation

Difficulty: 1 Easy

Blooms: Analyze

AACSB: Analytical Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

[QUESTION]

REFER TO: 07-01

2. What is this pattern of ownership called?

A) Pyramid ownership.

B) Aconnecting affiliation.

C) Mutual ownership.

D) An indirect affiliation.

E) An affiliated group.

Answer: B

Learning Objective: 07-02

Topic: Consolidation―Connecting affiliation

Difficulty: 1 Easy

Blooms: Understand

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

[QUESTION]

REFER TO: 07-01

3. What percentage of Tayle’s income is attributed to Buckette’s ownership interest?

A) 100%.

B) 75%.

C) 61%.

D) 40%.

E) 74%.

Answer: C

Learning Objective: 07-02

Topic: Consolidation―Connecting affiliation

Difficulty: 2 Medium

Blooms: Analyze

AACSB: Analytical Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: 40% + 21% [60% × 35%] = 61%

[QUESTION]

4. D Corp. had investments, direct and indirect, in several subsidiaries:

E Co. is a domestic firm in which D Corp. owned a 90% interest

F Co. is a domestic firm in which D Corp. owned 60% and E Co. owned 30%

G Co. is a domestic firm wholly owned by E Co.

H Co. is a foreign subsidiary in which D Corp. owned a 90% interest

I Co. is a domestic firm in which D Corp. owned 50% and G Co. owned 25%

Which of these subsidiaries may be included in a consolidated income tax return?

A) E, F, G, H, and I.

B) E, G, H, and I.

C) E and F.

D) E, F, G, and H.

E) E, F, and G.

Answer: E

Learning Objective: 07-04

Topic: Income tax criteria for an affiliated group

Difficulty: 3 Hard

Blooms: Analyze

AACSB: Analytical Thinking

AICPA: BBLegal

AICPA: FN Measurement

Feedback: Does D directly or indirectly own 80% or more of any of the domestic companies?

E: D owns 90%. Yes.

F: D owns 60% plus 27% (90% ×30%) = 87%. Yes.

G: D owns 90% × 100% = 90%. Yes.

H: Foreign subsidiary. No.

I: D owns 50% plus 22.5% (90% × 100% × 25%) = 72.5%. No.

[QUESTION]

5. Evanston Co. owned 60% of Montgomery Corp. Montgomery owned 75% of Noir Inc., and Noir owned 15% of Montgomery. This pattern of ownership would be called…

A) Mutual ownership.

B) Direct control.

C) Indirect control.

D) An affiliated group.

E) Aconnecting affiliation.

Answer: A

Learning Objective: 07-03

Topic: Consolidation―Mutual ownership

Difficulty: 1 Easy

Blooms: Understand

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

[QUESTION]

6. In a tax-free business combination,

A) The income tax basis for acquired assets and liabilities is adjusted to current fair value.

B) Any goodwill created by the combination may be amortized in calculating taxable income.

C) The subsidiary’s assets and liabilities are assigned an income tax basis of zero dollars, so that they will have no future income tax consequences.

D) Any goodwill created by the combination must be deducted in total in calculating taxable income.

E) The subsidiary’s cost basis for assets are retained for income tax calculations.

Answer: E

Learning Objective: 07-07

Topic: Temporary differences upon combination

Difficulty: 2 Medium

Blooms: Remember

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

Use the following to answer questions 7 – 11:

REFERENCE: 07-02

West Corp. owns 70% of the voting common stock of East Co. East owns 60% of Compass Co. West and East both use the initial value method to account for their investments. The following information isavailable from the financial statements and records of the three companies:

Separate company netincome includesintra-entity gainsbefore the consolidating deferral but doesnot include dividend income from investment in subsidiary.

[QUESTION]

REFER TO: 07-02

7. The accrual-basednet income of East Co. is calculated to be

A) $401,100.

B) $510,000.

C) $551,000.

D) $573,000.

E) $615,000.

Answer: C

Learning Objective: 07-01

Topic: Consolidation―Grandfather-Father-Son

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback:

Separate company net income before investment income—East Co.

$600,000

Equity income accruing from Compass Co.:
Compass’sseparate net income
$120,000
Excess amortization related to East acquisition of Compass
(20,000)
Deferral of Compass’s intra-entity gain
(15,000)
Compass’s accrual-based net income
$ 85,000
East’s percentage ownership of Compass
60%
East’s share of Compass’s net income

51,000

Excess amortization from West’s acquisition of East

(30,000)

Deferral of East’s intra-entity gain

(70,000)

Accrual-based net income of East Co.

$551,000

[QUESTION]

REFER TO: 07-02

8. The accrual-basednet income of West Corp. is calculated to be

A) $734,000.

B) $1,261,000.

C) $1,123,900.

D) $1,140,700.

E) $1,149,700.

Answer: E

Learning Objective: 07-01

Topic: Consolidation―Grandfather-Father-Son

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback:

Separate company net income before investment income—West Corp.

$860,000

Equity income accruing from East Co.—70% of $551,000 (see below)

385,700

Deferral of West’s intra-entity gain

(96,000)

Accrual-based net income of West Corp.

$1,149,700

Separate company net income before investment income—East Co.

$600,000

Equity income accruing from Compass Co.:
Compass’s separate net income
$120,000
Excess amortization related to East acquisition of Compass
(20,000)
Deferral of Compass’s intra-entity gain
(15,000)
Compass’s accrual-based net income
$ 85,000
East’s percentage ownership of Compass
60%
East’s share of Compass’s net income

51,000

Excess amortization from West’s acquisition of East

(30,000)

Deferral of East’s intra-entity gain

(70,000)

Accrual-based net income of East Co.

$551,000

[QUESTION]

REFER TO: 07-02

9. What amount should be reported for consolidated net income?

A) $1,285,000.

B) $1,331,700.

C) $1,349,000.

D) $1,315,000.

E) $1,314,900.

Answer: C

Learning Objective: 07-01

Topic: Consolidation―Grandfather-Father-Son

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback:

Sum of West, East, and Compass separate company net income before amortizations and deferrals

$1,580,000

Less: Combined excess fair-value amortizations

(50,000)

Less: Combined intra-entity gain deferrals

(181,000)

Consolidated net income

$ 1,349,000

[QUESTION]

REFER TO: 07-02

10. For West Corp. and consolidated subsidiaries, what total amount would be reported for the net income attributable to the noncontrolling interest?

A) $165,300.

B) $199,300.

C) $191,000.

D) $228,000.

E) $153,000.

Answer: B

Learning Objective: 07-01

Topic: Consolidation―Grandfather-Father-Son

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Consolidated net income ($1,349,000) – Consolidated net income to West Corp. ($1,149,700) = Net income attributable to noncontrolling interest $199,300. Alternatively:

Accrual-based net income

Outside Ownership

Net Income Attributable to Noncontrolling Interest

Compass Co.

$85,000

40%

$ 34,000
East Co.

$551,000

30%

165,300
Net income attributable to
noncontrolling interest
$ 199,300

[QUESTION]

REFER TO: 07-02

11. What amount of dividends should West Corp. recognize in its consolidated net income with respect to dividends receivedfrom Compass Co.?

A) $-0-

B) $25,200.

C) $36,000.

D) $42,000.

E) $90,000.

Answer: A

Learning Objective: 07-01

Topic: Consolidation―Grandfather-Father-Son

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: [$0] — Dividends are not calculated in consolidated net income.

Use the following to answer questions 12 – 15:

REFERENCE: 07-03

River Co. owns 80% of Boat Inc. The two companies filea consolidated income tax return and River uses the initial value method to account for the investment. The following information isavailable from the two companies’ financial statements:

River Co.

Boat Inc.

Separate operating income (excludes equity or dividend income from subsidiary)

$600,000

$120,000

Net intra-entity gains on assets remaining in the consolidated entity in current year income (included in separate operating income above)

50,000

15,000

Dividends received from Boat Inc. (not included in separate operating income above)

24,000

–0–

Dividends paid

110,000

30,000

The income tax rate was 30%.

[QUESTION]

REFER TO: 07-03

12. What is the amount of taxable income reported on the consolidated income tax return?

A) $720,000.

B) $625,000.

C) $621,000.

D) $665,000.

E) $655,000.

Answer: E

Learning Objective: 07-05

Topic: Tax calculation for consolidated returns

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Combined operating income $720,000 ($600,000 + $120,000) – Combined deferred intra-entity gains on assets$65,000 ($50,000 + $15,000) = Taxable income $655,000

[QUESTION]

REFER TO: 07-03

13. What isthe amount of income tax expense that should be assigned to Boat using the percentage allocation method?

A) $31,500

B) $32,750

C) $36,000

D) $32,660

E) $30,390

Answer: A

Learning Objective: 07-05

Topic: Tax expense―Percentage allocation

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Consolidated income tax $655,000 × .30 = $196,500

Parent’s portion of the taxable income $600,000 – $50,000 = $550,000 / Total taxable income $655,000 = 84%

Subsidiary’s (Boat) portion of the taxable income $655,000 – $550,000 = $105,000 / Total taxable income $655,000 = 16%

Income tax expense assigned to Boat $196,500 × .16 = $31,500

[QUESTION]

REFER TO: 07-03

14. The amount of income tax expense that should be assigned to Boat using the separate return method is approximately:

A) $36,000

B) $31,500

C) $33,390

D) $32,750

E) $32,660

Answer: D

Learning Objective: 07-05

Topic: Tax expense―Separate return method

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback:

River

Boat

Total

Taxable income (separate operating income)

$600,000

$120,000

Tax rate

30%

Income tax expense—separate returns

$180,000

$ 36,000

$216,000

Tax expense portion of Boat

$36,000/$216,000 = 16.67%

Tax expense:

Combined operating income $720,000 ($600,000 + $120,000) – Combined deferred intra-entity gains on assets $65,000 ($50,000 + $15,000) = Taxable income $655,000

Consolidated income tax $655,000 × .30 = $196,500

Tax expense assigned to Boat: $196,500 × 16.67% = approximately $32,750

[QUESTION]

REFER TO: 07-03

15. What was the net income attributable to the noncontrolling interest, assuming that the separate return method was used to assign the income tax expense?

A) $16,800

B) $14,450

C) $14,700

D) $17,450

E) $13,800

Answer: B

Learning Objective: 07-05

Topic: Income tax expense—separate returns

Difficulty:3 Hard

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback:

Boat Inc.—reported operating income

$120,000

Less: Intra-entity gains on assets remaining in the consolidated entity

(15,000)

Less: Assigned income tax expense (see below)

(32,750)

Boat Inc.—adjusted income

$72,250

Outside ownership

20%

Net income attributable to the noncontrolling interest

$ 14,450

Calculation of assigned income tax expense:

River

Boat

Total

Taxable income (separate operating income)

$600,000

$120,000

Tax rate

30%

Income tax expense—separate returns

$180,000

$ 36,000

$216,000

Tax expense portion of Boat

$36,000/$216,000 = 16.67%

Tax expense:

Combined operating income $720,000 ($600,000 + $120,000) – Combined deferred intra-entity gains on assets $65,000 ($50,000 + $15,000) = Taxable income $655,000

Consolidated income tax $655,000 × .30 = $196,500

Tax expense assigned to Boat: $196,500 × 16.67% = approximately $32,750

Use the following to answer questions 16 and 17:

REFERENCE: 07-04

Prescott Corp. owned 90% of Bell Inc., while Bell owned 10% of the outstanding common shares of Prescott. No goodwill or other allocations were recognized in connection with either of these acquisitions. Prescott reported netincome of $266,000 for 2018 whereas Bellrecognized$98,000 during the same period. No investment income was included within either of these income totals.

[QUESTION]

REFER TO: 07-04

16. On a consolidated income statement, what is thenet income attributable to the noncontrolling interest?

A) $9,800.

B) $13,692.

C) $10,836.

D) $12,460.

E) $11,214.

Answer: A

Learning Objective: 07-01

Topic: Consolidation―Grandfather-Father-Son

Difficulty: 1 Easy

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Bell’s net income ($98,000) × Noncontrollinginterest (10 %) = $9,800

[QUESTION]

REFER TO: 07-04

17. How would the 10% Investment in Prescott owned by Bell be presented in the consolidated balance sheet?

A) The 10% investment would be eliminated and no amount would be shown in the consolidated balance sheet.

B) The 10% investment would be reclassified in Bell’s balance sheet as Treasury Stock before the consolidation process begins.

C) The 10% investment would be eliminated and the same dollar amount would appear as treasury stock in the consolidated balance sheet.

D) The 10% investment would be included as part of Additional Paid-In Capital because it is less than 20% and therefore indicates no significant influence is present.

E) Prescott would treat the shares owned by Bell as if they had been repurchased on the open market, and a treasury stock account would be set up on Prescott’s books recording the shares at their fairvalue on the date of combination.

Answer: C

Learning Objective: 07-03

Topic: Consolidation―Mutual ownership

Difficulty: 1 Easy

Blooms: Understand

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

[QUESTION]

18. On January 1, 2018, a subsidiary bought 10% of the outstanding shares of its parent company. Although the total book value and fair value of the parent’s net assets were $5.5 million, the consideration transferred for these shares was $590,000. During 2018, the parent reported separate netincome of $714,000, before including investment income, while dividends declared were $196,000. How were these shares reported at December 31, 2018?

A) The investment was recorded for $641,800 at the end of 2018 and then eliminated for consolidation purposes.

B) Consolidated stockholders’ equity was reduced by $641,800.

C) The investment was recorded for $590,000 at the end of 2018 and then eliminated for consolidation purposes.

D) Consolidated stockholders’ equity was reduced by $639,800.

E) Consolidated stockholders’ equity was reduced by $590,000.

Answer: E

Learning Objective: 07-03

Topic: Consolidation―Mutual ownership

Difficulty: 2 Medium

Blooms: Analyze

AACSB: Analytical Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

[QUESTION]

19. Jastoon Co. acquired all of Wedner Co. for $588,000 cash in a tax-free transaction. On that date, the subsidiary had net assets with a $560,000 fair value but a $420,000 book value and income tax basis. The income tax rate was 30%. What amount of goodwill should have been recognized on the date of the acquisition?

A) $70,000.

B) $28,000.

C) $(14,000).

D) $ 19,600.

E) $65,000.

Answer: A

Learning Objective: 07-07

Topic: Temporary differences upon combination

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: FV ($560,000) – Tax Basis ($420,000) = Temporary Tax Difference ($140,000) × .30 = Deferred Tax Liability ($42,000) + [Cash Paid ($588,000) – FV Assets ($560,000)] $28,000 = Goodwill ($70,000)

Use the following to answer questions 20 – 22:

REFERENCE: 07-05

Beagle Co. owned 80% of Maroon Corp. Maroon owned 90% of Eckston Inc. Separate company net incomes for 2018 are shown below; these figures contained no investment income. Amortization expense was not required by any of these acquisitions. Included in Eckston’s operating income was a $56,000 gross profit onintra-entity transfers to Maroon.

[QUESTION]

REFER TO: 07-05

20. The accrual-basednet income of Eckston Inc. is calculated to be

A) $234,000.

B) $211,000.

C) $221,000.

D) $224,000.

E) $246,000.

Answer: D

Learning Objective: 07-01

Topic: Consolidation―Grandfather-Father-Son

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Netincome ($280,000) – deferral of gross profit from intra-entity transfers ($56,000) = Accrual-based net income $224,000

[QUESTION]

REFER TO: 07-05

21. The accrual-basednet income of Maroon Corp. is calculated to be

A) $481,600.

B) $472,700.

C) $488,900.

D) $502,300.

E) $358,800.

Answer: A

Learning Objective: 07-01

Topic: Consolidation―Grandfather-Father-Son

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback:

Separate company net income before investment income—Maroon Corp.

$280,000

Equity income accruing from Eckston Inc.:
Eckston’s separate net income
$280,000
Deferral of Eckston’s intra-entity gross profit
(56,000)
Eckstons’s accrual-based net income
$224,000
Maroon’s percentage ownership of Eckston
90%
Maroon’s share of Eckston’s net income

201,600

Accrual-based net income of Maroon

$481,600