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Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues

[QUESTION]

1.  On January 1, 2018, Riley Corp. acquired some of the outstanding bonds of one of its subsidiaries.  The bonds had a carrying value of $421,620, and Riley paid $401,937 for them.  How should you account for the difference between the carrying value and the purchase price in the consolidated financial statements for 2018?

A) The difference is added to the carrying value of the debt.

B) The difference is deducted from the carrying value of the debt.

C) The difference is treated as a loss from the extinguishment of the debt.

D) The difference is treated as a gain from the extinguishment of the debt.

E) The difference does not influence the consolidated financial statements.

Answer: D

Learning Objective: 06-03  

Topic: Intra-entity debt―Gain or loss for consolidation

Difficulty: 1 Easy

Blooms: Understand

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

[QUESTION]

2.  Regency Corp. recently acquired $500,000 of the bonds of Safire Co., one of its subsidiaries, paying more than the carrying value of the bonds.  According to the most practical view of this intra-entity transaction, to whom should the loss be attributed?

A) To Safire because the bonds were issued by Safire.

B) The loss should be allocated between Safire and Regency based on the purchase price and the original face value of the debt.

C) The loss should be amortized over the life of the bonds and need not be attributed to either party.

D) The loss should be deferred until it can be determined to whom the attribution can be made.

E) To Regency because Regency is the controlling party in the business combination.

Answer: E

Learning Objective: 06-03 

Topic: Intra-entity debt transactions―General

Difficulty: 1 Easy 

Blooms: Understand

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

 

[QUESTION]

3.  Which one of the following characteristics of preferred stock would make the stock a dilutive security for purposes of calculating earnings per share?

A) The preferred stock is callable.

B) The preferred stock is convertible.

C) The preferred stock is cumulative.

D) The preferred stock is noncumulative.

E) The preferred stock is participating.

Answer: B

Learning Objective: 06-06  

Topic: EPS―Consolidated diluted EPS

Topic: EPS―EPS of subsidiary by itself

Difficulty: 1 Easy  

Blooms: Remember

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

[QUESTION]

4.  Where do dividends paid to the noncontrolling interest of a subsidiary appear on a consolidated statement of cash flows?

A) Cash flows from operating activities.

B) Cash flows from investing activities.

C) Cash flows from financing activities.

D) Supplemental schedule of noncash investing and financing activities.

E) They do not appear in the consolidated statement of cash flows.

Answer: C

Learning Objective: 06-05 

Topic: Consolidated statement of cash flows

Difficulty: 1 Easy 

Blooms: Remember

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

[QUESTION]

5.  Where do dividends paid by a subsidiary to the parent company appear in a consolidated statement of cash flows?

A) Cash flows from operating activities.

B) Cash flows from investing activities.

C) Cash flows from financing activities.

D) Supplemental schedule of noncash investing and financing activities.

E) They do not appear in the consolidated statement of cash flows.

Answer: E

Learning Objective: 06-05 

Topic: Consolidated statement of cash flows

Difficulty: 1 Easy

Blooms: Remember

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

 

[QUESTION]

6.  Where do intra-entity transfers of inventory appear in a consolidated statement of cash flows?

A) They do not appear in the consolidated statement of cash flows.

B) Supplemental schedule of noncash investing and financing activities.

C) Cash flows from operating activities.

D) Cash flows from investing activities.

E) Cash flows from financing activities.

Answer: A

Learning Objective: 06-05 

Topic: Consolidated statement of cash flows

Difficulty: 1 Easy

Blooms: Understand

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

  

[QUESTION]

7.  How do intra-entity transfers of inventory affect the preparation of a consolidated statement of cash flows?

A) They must be added in calculating cash flows from investing activities.

B) They must be deducted in calculating cash flows from investing activities.

C) They must be added in calculating cash flows from operating activities.

D) Because the consolidated balance sheet and income statement are used in preparing the consolidated statement of cash flows, no special elimination is required.

E) They must be deducted in calculating cash flows from operating activities.

Answer: D

Learning Objective: 06-05

Topic: Consolidated statement of cash flows

Difficulty: 1 Easy

Blooms: Understand

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

 

[QUESTION]

8.  How would consolidated earnings per share be calculated if the subsidiary has no convertible securities or warrants?

A) Parent’s earnings per share plus subsidiary’s earnings per share.

B) Parent’s net income divided by parent’s number of shares outstanding.

C) Consolidated net income divided by parent’s number of shares outstanding.

D) Average of parent’s earnings per share and subsidiary’s earnings per share.

E) Consolidated income divided by total number of shares outstanding for the parent and subsidiary.

Answer: C

Learning Objective: 06-06  

Topic: EPS―Consolidated basic EPS

Difficulty: 1 Easy

Blooms: Remember

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

REFERENCE: 06-01

On January 1, 2018, Riney Co. owned 80% of the common stock of Garvin Co.  On that date, Garvin’s stockholders’ equity accounts had the following balances:

 

The balance in Riney’s Investment in Garvin Co. account was $552,000, and the noncontrolling interest was $138,000.  On January 1, 2018, Garvin Co. sold 10,000 shares of previously unissued common stock for $15 per share.  Riney did not acquire any of these shares.

[QUESTION]

REFER TO: 06-01

9.  What is the balance in Riney’s “Investment in Garvin Co. Account” following the sale of the 10,000 shares of common stock?

A) $552,000.

B) $560,000.

C) $460,000.

D) $404,000.

E) $672,000.

Answer: B

Learning Objective: 06-07  

Topic: Subsidiary stock―New issue-Percentage change

Difficulty: 2 Medium 

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: $250,000 / $5 = 50,000 shares × .80 = 40,000 shares owned by parent

Total Equity at Acquisition = $690,000 + Equity Added by Stock Offering (10,000 × $15) $150,000 = Total Equity after Stock Offering $840,000 × 40,000 Parent / 60,000 Total = $560,000 Parent’s Investment Account

 

[QUESTION]

REFER TO: 06-01

10.  What amount should be attributed to the Noncontrolling Interest in Garvin Co. following the sale of the 10,000 shares of common stock?

A) $288,000.

B) $101,000.

C) $280,000.

D) $230,000.

E) $168,000.

Answer: C

Learning Objective: 06-07  

Topic: Subsidiary stock―New issue-Percentage change

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: $250,000 / $5 = 50,000 shares × .80 = 40,000 shares owned by parent

Total Equity at Acquisition = $690,000 + Equity Added by Stock Offering (10,000 × $15) $150,000 = Total Equity after Stock Offering $840,000 × 20,000/60,000 = $280,000 Noncontrolling Interest

 

[QUESTION]

11.  Rojas Co. owned 7,000 shares (70%) of the outstanding 10%, $100 par, preferred stock and 60% of the outstanding common stock of Brett Co.  Assuming there are no excess amortizations or intra-entity transactions, and Brett reports net income of $780,000, what is the  noncontrolling interest in the subsidiary’s income?

A) $234,000.

B) $273,000.

C) $302,000.

D) $312,000.

E) $284,000.

Answer: C

Learning Objective: 06-04  

Topic: Subsidiary preferred stock

Difficulty: 3 Hard

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: $780,000 Net Income – Preferred Dividends (10,000 × $10) = $680,000 × .40 = $272,000 Noncontrolling Interest

$100,000 Preferred Dividends × .30 = $30,000 Noncontrolling Interest

$272,000 from Income + $30,000 Preferred Dividends = $302,000 Noncontrolling Interest in Income

 

REFERENCE: 06-02

Knight Co. owned 80% of the common stock of Stoop Co.  Stoop had 50,000 shares of $5 par value common stock and 2,000 shares of preferred stock outstanding.  Each preferred share received an annual per share dividend of $2 and is convertible into four shares of common stock.  Knight did not own any of Stoop’s preferred stock.  Stoop also had 600 bonds outstanding, each of which is convertible into ten shares of common stock.  Stoop’s annual after-tax interest expense for the bonds was $2,000.  Knight did not own any of Stoop’s bonds.  There are no excess amortizations or intra-entity transactions associated with this consolidation. Stoop reported net income of $300,000 for 2018.  Knight has 100,000 shares of common stock outstanding and reported net income of $400,000 for 2018. 

[QUESTION]

REFER TO: 06-02

12.  What would Knight Co. report as consolidated basic earnings per share (rounded)?

A) $6.37

B) $6.40

C) $7.00

D) $5.68

E) $6.00

Answer: A

Learning Objective: 06-06  

Topic: EPS―Subsidiary earnings for consolidated EPS

Difficulty: 3 Hard 

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Sub net income (300,000) – preferred divs(4,000) = $296,000 x 80% = 236,800 included in consolidated EPS.  Parent net income (400,000)+ portion of sub net income = (400,000 + 236,800) / 100,000 shares =  $6.37

 

[QUESTION]

REFER TO: 06-02

13.  What would Knight Co. report as consolidated diluted earnings per share (rounded)?

A) $4.00.

B) $. 4.71

C) $8.71.

D) $5.89.

E) $6.37.

Answer: D

Learning Objective: 06-06  

Topic: EPS―EPS of subsidiary by itself

Difficulty: 3 Hard

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Sub Net income $300,000 + Interest saved $2,000 (no preferred divs)= $322,000. New ownership percentage = 40,000 / (50,000 + if-converted preferred shares 8,000 + if-converted bonds 6,000 shares) = 62.5%.  Consolidated DEPS = 400,000 + (62.5% x 302,000) = 588,750/100,000 = $5.89 Knight Co.’s Consolidated Diluted Earnings per Share

 

[QUESTION]

14.  Campbell Inc. owned all of Gordon Corp.  For 2018, Campbell reported net income (without consideration of its investment in Gordon) of $280,000 while the subsidiary reported $112,000.  There are no excess amortizations associated with this consolidation. The subsidiary had bonds payable outstanding on January 1, 2018, with a book value of $297,000.  The parent acquired the bonds on that date for $281,000.  During 2018, Campbell reported interest income of $31,000 while Gordon reported interest expense of $29,000.  What is consolidated net income for 2018?

A) $406,000.

B) $374,000.

C) $378,000.

D) $410,000.

E) $394,000.

Answer: A

Learning Objective: 06-03  

Topic: Intra-entity debt―Effect on consolidated balances

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Income of the Parent $280,000 + Income of the Sub $112,000 – Difference in Interest Income over Interest Expense on Intra-Entity Bonds ($31,000 – $29,000) $2,000 + Gain on Bonds Purchase ($297,000 – $281,000) $16,000 = $406,000 Consolidated Net Income

  

[QUESTION]

15.  Vontkins Inc. owned all of Quasimota Co.  The subsidiary had bonds payable outstanding on January 1, 2017, with a book value of $265,000.  The parent acquired the bonds on that date for $288,000.  Subsequently, Vontkins reported interest income of $25,000 in 2017 while Quasimota reported interest expense of $29,000.  Consolidated financial statements were prepared for 2018.  What adjustment would be required for the retained earnings balance as of January 1, 2018?

A) Reduction of $27,000.

B) Reduction of $4,000.

C) Reduction of $19,000.

D) Reduction of $30,000.

E) Reduction of $20,000.

Answer: C

Learning Objective: 06-03  

Topic: Intra-entity debt―Effect on consolidated balances

Difficulty: 2 Medium  

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Bond Acquisition Price $288,000 – Bonds carrying amount $265,000 = $23,000 R/E Reduction.

Intra-Entity Interest $29,000 – $25,000 = $4,000 R/E Increase

$23,000 – $4,000 = $19,000 R/E Reduction

[QUESTION]

16. Tray Co. reported current earnings of $560,000 while paying $56,000 in cash dividends.  Sparrish Co. earned $140,000 in net income and distributed $14,000 in dividends.  Tray held a 70% interest in Sparrish for several years, an investment that it originally acquired by transferring consideration equal to the book value of the underlying net assets.  Tray used the initial value method to account for these shares.

On January 1, 2018, Sparrish acquired in the open market $70,000 of Tray’s 8% bonds.  The bonds had originally been issued several years ago at a price that would yield a 10% effective interest rate.  On the date of the bond purchase, the book value of the bonds payable was $67,600.  Sparrish paid $65,200 based on a 12% effective interest rate over the remaining life of the bonds.

What is the noncontrolling interest’s share of the subsidiary’s net income?

A) $42,000.

B) $37,800.

C) $39,600.

D) $40,070.

E) $44,080.

Answer: A

Learning Objective: 06-03  

Topic: Intra-entity debt―Effect on consolidated balances

Difficulty: 2 Medium 

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Sub’s income $140,000 × .30 = $42,000 NCI’s Portion of Income (gain or loss is assigned to the parent only)

 

[QUESTION]

17.  A company had common stock with a total par value of $18,000,000 and fair value of $62,000,000; and 7% preferred stock with a total par value of $6,000,000 and a fair value of $8,000,000.  The book value of the company was $85,000,000.  Assuming ninety percent (90%) of the company’s total equity is acquired, what amount must be attributed to the noncontrolling interest?

A) $8,500,000.

B) $7,000,000.

C) $6,200,000.

D) $2,400,000.

E) $6,929,400.

Answer: B

Learning Objective: 06-04

Topic: Subsidiary preferred stock

Difficulty: 1 Easy  

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: FV Common Stock $62,000,000 + FV Preferred Stock $8,000,000 = $70,000,000 × .10 = $7,000,000 Noncontrolling Interest

[QUESTION]

18.  Cadion Co. owned a controlling interest in Knieval Inc.  Cadion reported sales of $420,000 during 2018 while Knieval reported $280,000.  Inventory costing $28,000 was transferred from Knieval to Cadion (upstream) during the year for $56,000.  Of this amount, twenty-five percent was still in ending inventory at year’s end.  Total receivables on the consolidated balance sheet were $112,000 at the first of the year and $154,000 at year-end.  No intra-entity debt existed at the beginning or ending of the year.  Using the direct approach, what is the consolidated amount of cash collected by the business from its customers?

A) $602,000.

B) $644,000.

C) $686,000.

D) $714,000.

E) $592,000.

Answer: A

Learning Objective: 06-05  

Topic: Consolidated statement of cash flows

Difficulty: 2 Medium  

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: Parent’s Sales $420,000 + Sub’s Sales $280,000 – Intra-Entity Sales $56,000 – increase in A/R $42,000 ($154,000 – $112,000) = $602,000 Consolidated Cash Collected

[QUESTION]

19.  Parker owned all of Odom Inc.  Although the Investment in Odom Inc. account had a balance of $834,000, the subsidiary’s 12,000 shares had an underlying book value of only $56 per share.  On January 1, 2018, Odom issued 3,000 new shares to the public for $70 per share.  How does this transaction affect the Investment in Odom Inc. account?

A) It should be decreased by $210,000.

B) It should be increased by $210,000.

C) It should be increased by $168,000.

D) It should be decreased by $1,200.

E) It is not affected since the shares were sold to outside parties.

Answer: D

Learning Objective: 06-07  

Topic: Subsidiary stock―New issue-Percentage change

Difficulty: 2 Medium 

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback:

Subsidiary’s unamortized fair value of prior to new share issue

                  (12,000 × $56) ……………………………………………………..                             $834,000

            Parent’s ownership …………………………………………………                                    100%

            Unamortized subsidiary fair value  …………………………                             $834,000

 

            Subsidiary unamortized fair value after issuing new 

                  shares (above value plus 3,000 shares at $70 each)                   $1,044,000

            Parent’s ownership 12,000 ÷ 15,000 shares) …………                                      80%

            Unamortized subsidiary fair value after stock issue…………………..     $835,200

 

            Investment in Odom increases by $1,200 ($835,200 less $834,000).

 

REFERENCE: 06-03

These questions are based on the following information and should be viewed as independent situations.

Popper Co. acquired 80% of the common stock of Cocker Co. on January 1, 2016, when Cocker had the following stockholders’ equity accounts.

 

To acquire this interest in Cocker, Popper paid a total of $682,000 with any excess acquisition date fair value over book value being allocated to goodwill, which has been measured for impairment annually and has not been determined to be impaired as of January 1, 2019.

Popper did not pay any premium when it acquired its original interest in Cocker. On January 1, 2019, Cocker reported a net book value of $1,113,000 before the following transactions were conducted.  Popper uses the equity method to account for its investment in Cocker, thereby reflecting the change in book value of Cocker.

[QUESTION]

REFER TO: 06-03

20.  On January 1, 2019, Cocker issued 10,000 additional shares of common stock for $35 per share.  Popper acquired 8,000 of these shares.  How would this transaction affect the additional paid-in capital of the parent company?

A) Increase it by $28,700.

B) Increase it by $16,800.

C) $0.

D) Increase it by $280,000.

E) Increase it by $593,600.

Answer: C

Learning Objective: 06-07  

Topic: Subsidiary stock―New issue-No percentage change

Difficulty: 1 Easy  

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback: No Adjustment is made to the APIC of the Parent as a Result of Sub’s Stock Issue because the same Level of Ownership Interest is Maintained

[QUESTION]

REFER TO: 06-03

21.  On January 1, 2019, Cocker issued 10,000 additional shares of common stock for $21 per share.  Popper did not acquire any of this newly issued stock.  How would this transaction affect the additional paid-in capital of the parent company?

A) $0.

B) Decrease it by $23,240.

C) Decrease it by $68,250.

D) Decrease it by $45,060.

E) Decrease it by $64,720.

Answer: E

Learning Objective: 06-07  

Topic: Subsidiary stock―New issue-Percentage change

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback:

                  Consideration transferred ………………………………………………………     $682,000

                  Noncontrolling interest acquisition-date fair value ……………….        170,500

                  Increase in Sub book value (1,113,000-721,000)…………………….        392,000

                  Stock issue proceeds………………………………………………………………        210,000

            Subsidiary valuation basis……………………………………………………………    1,454,000

            New parent ownership (32,000 shs. ÷ 50,000 shs.) …………………….              64%

            Parent’s post-stock issue ownership balance…………………………….     $930,880

            Parent’s investment account ($682,000 + [80% × 392,000]) ……….        995,600

                  Required adjustment —decrease …………………………………………..      $(64,720)

  

[QUESTION]

REFER TO: 06-03

22.  On January 1, 2019, Cocker reacquired 8,000 of the outstanding shares of its own common stock for $34 per share.  None of these shares belonged to Popper.  How would this transaction have affected the additional paid-in capital of the parent company?

A) $0.

B) Decrease it by $32,900.

C) Decrease it by $45,700.

D) Decrease it by $23,100.

E) Decrease it by $50,500.

Answer: D

Learning Objective: 06-07  

Topic: Subsidiary stock―Treasury stock acquired

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA: BB Critical Thinking

AICPA: FN Measurement

Feedback:

Adjusted acquisition-date fair value ($852,500 + $392,000) …………………. $1,244,500

            Less Stock repurchase………………………………………………………………… $ ( 272,000)

            Adjusted fair value after stock repurchase………………………………….     $972,500

            New parent ownership (32,000 shs. ÷ 32,000 shs.) …………………….            100%

                  Fair value equivalency of parent’s ownership ………………………     $972,500

            Parent’s investment account ($682,000 + [80% × 392,000]) ……….        995,600

                  Required adjustment—decrease…………………………………………….     $ (23,100)

 

[QUESTION]

23.  If new bonds are issued from a parent to its subsidiary, which of the following statements is false?

A) Any premium or discount on bonds payable is exactly offset by a premium or discount on bond investment.

B) There will be $0 net gain or loss on the bond transaction.

C) Interest expense needs to be eliminated on the consolidated income statement.

D) Interest revenue needs to be eliminated on the consolidated income statement.

E) A net gain or loss on the bond transaction will be reported.

Answer: E

Learning Objective: 06-03  

Topic: Intra-entity debt transactions―General

Difficulty: 2 Medium

Blooms: Understand

AACSB: Reflective Thinking

AICPA: BB Critical Thinking

AICPA: FN Measurement

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