On January 1, year 1, Palm, Inc. purchased 80% of the stock
of Stone Corp. for $4,000,000 cash. Prior to the acquisition,
Stone had 100,000 shares of stock outstanding. On the date of
acquisition, Stone’s stock had a fair value of $52 per share. During
the year Stone reported $280,000 in net income and paid
dividends of $50,000. What is the balance in the noncontrolling
interest account on Palm’s balance sheet on December 31, year
(c) The fair value of the 20,000 (100,000 × 20%) shares
of noncontrolling interest in Stone on the date of acquisition is
$1,040,000 (20,000 shares × $52 per share). This amount is
adjusted for the noncontrolling interest’s share of net income and
dividends received as calculated below.
Fair value of noncontrolling
interest, acquisition date $1,040,000
Plus: Share of net income (20%
× $280,000) 56,000
Less: Share of dividends
(20% × 50,000) (10,000)
When a parent-subsidiary relationship exists, consolidated
financial statements are prepared in recognition of the accounting
(d) The requirement is to determine which accounting
concept relates to the preparation of consolidated financial
statements. Answer (d) is correct because when a parentsubsidiary
relationship exists, the financial statements of each
separate entity are brought together, or consolidated. When
financial statements represent a consolidated entity, the concept
of economic entity applies. Answer (a) is incorrect because reliability
is a concept that applies to all financial statements, not just
consolidated financial statements. Reliability is a primary quality
that makes accounting information useful for decision making.
This quality should be found in all statements. Answer (b) is
incorrect because the concept of materiality applies to all financial
statements, not just consolidated financial statements. The
concept of materiality, as applied to financial statements, deals
with the impact an item in the financial statements will have on a
user’s decision-making process. Answer (c) is incorrect because
the concept of legal entity refers to the form or type of combination
that takes place between entities (i.e., mergers, consolidations
or acquisitions), not the basis on which financial statements
A subsidiary was acquired for cash in a business combination
on January 1, year 1. The consideration given exceeded the
fair value of identifiable net assets. The acquired company
owned equipment with a market value in excess of the carrying
amount as of the date of combination. A consolidated balance
sheet prepared on December 31, year 1, would
(b) In general, all assets and liabilities (including equipment)
should be reported at market value. The excess of the
equipment’s market value over its carrying amount is allocated to
the equipment and amortized over the equipment’s useful life.
The unamortized portion of the excess of the market value over
the carrying amount of the equipment is then reported as part of
plant and equipment. Only the excess of the acquisition cost
over the market value of the net identifiable assets acquired is
reported as goodwill. The excess of the market value over the
carrying amount of the equipment is capitalized and subsequently
amortized over the equipment’s useful life, not expensed
on the date of the acquisition.
Pride, Inc. owns 80% of Simba, Inc.’s outstanding common
stock. Simba, in turn, owns 10% of Pride’s outstanding common
stock. What percentage of the common stock cash dividends
declared by the individual companies should be reported as dividends
declared in the consolidated financial statements?
Dividends declared by Pride
Dividends declared by Simba
(a) When two companies own stock in each other, a
reciprocal ownership relationship exists. In this case, Pride (the
parent) owns 80% of Simba (the sub), and Simba owns 10% of
Pride. When Pride declares a cash dividend, 90% of it is distributed
to outside parties and 10% goes to Simba. Because Simba is
part of the consolidated entity, its 10% share of Pride’s dividend
is eliminated when determining consolidated dividends declared.
Thus, only 90% of dividends declared by Pride will be reported in
the consolidated financial statements. When Simba declares a
dividend, 80% of the dividend is distributed to Pride (the parent),
and 20% is distributed to outside parties (the noncontrolling
interest of Simba stock). The 80% share to Pride is eliminated
when determining consolidated dividends declared
because it represents an intercompany transaction. The remaining
20% to the noncontrolling interest is likewise not included in
consolidated dividends declared because, from the parent company’s
point of view, subsidiary dividends do not represent dividends
of the consolidated entity and must be eliminated.
It is generally presumed that an entity is a variable interest
entity subject to consolidation if its equity is
(c) It is presumed that an entity with equity of less than
10% of total assets does not have sufficient funding to finance its
activities unless there is definitive evidence to the contrary (e.g., a
source of outside financing).
Morton Inc., Gilman Co., and Willis Corporation established
a special-purpose entity (SPE) (variable interest entity) to
perform leasing activities for the three corporations. If at the
time of formation the SPE is determined to be a variable interest
entity subject to consolidation, which of the corporations should
consolidate the SPE?
(b) A variable interest entity should be consolidated by
the primary beneficiary. A primary beneficiary has the power to
direct the activities of the VIE that most significantly impact the
VIE’s economic performance, and has the obligation to absorb
the majority of the entity’s expected losses if they occur, or receive
the majority of the residual returns if they occur, or both.
The determination of whether an interest holder must consolidate
a variable interest entity is made
(a) The determination of whether an entity is a variable
interest entity and which enterprise should consolidate that entity
is made at the time the enterprise initially gets involved with
the variable interest entity and is reassessed on an ongoing basis.
Matt Co. included a foreign subsidiary in its year 5 consolidated
financial statements. The subsidiary was acquired in year 1
and was excluded from previous consolidations. The change was
caused by the elimination of foreign exchange controls. Including
the subsidiary in the year 5 consolidated financial statements
results in an accounting change that should be reported
(d) Accounting changes that result in financial statements
that are, in effect, financial statements of a different reporting
entity (such as presenting consolidated statements in
place of statements of individual companies) should be reported
by restating the financial statements of all prior periods presented
so that the resulting restated prior periods’ statements on a consolidated
basis are the same as if the subsidiary had been consolidated
since it was acquired.
Clark Co. had the following transactions with affiliated parties
during year 1:
• Sales of $60,000 to Dean, Inc., with $20,000 gross profit.
Dean had $15,000 of this inventory on hand at year-end.
Clark owns a 15% interest in Dean and does not exert
• Purchases of raw materials totaling $240,000 from Kent
Corp., a wholly owned subsidiary. Kent’s gross profit on
the sale was $48,000. Clark had $60,000 of this inventory
remaining on December 31, year 1.
Before eliminating entries, Clark had consolidated current assets
of $320,000. What amount should Clark report in its December
31, year 1 consolidated balance sheet for current assets?
(c) Unrealized profit in ending inventory arises when
intercompany sales are made at prices above cost and the merchandise
is not resold to third parties prior to year-end. The
profit is unrealized because the inventory has not yet been sold
outside of the consolidated entity. In this case, there is no unrealized
profit on the sales to Dean because the consolidated
statements would not include Dean, and the equity method is not
applicable. (Clark owns only 15% of Dean). However, there is
unrealized profit on the materials sold by Kent, a wholly owned
subsidiary, to Clark. Sixty thousand dollars of the $240,000 of
materials sold by Kent to Clark remains in ending inventory. The
gross profit Kent recognized on this $60,000 of materials at the
time of sale was $12,000 ($48,000 ÷ $240,000 = 20% gross profit
rate; 20% × $60,000 = $12,000). For the consolidated entity, this
$12,000 gross profit has not been earned and must be eliminated.
Therefore, consolidated current assets should be $308,000
($320,000 – $12,000).
During year 1, Pard Corp. sold goods to its 80%-owned
subsidiary, Seed Corp. At December 31, year 1, one-half of these
goods were included in Seed’s ending inventory. Reported year 1
selling expenses were $1,100,000 and $400,000 for Pard and
Seed, respectively. Pard’s selling expenses included $50,000 in
freight-out costs for goods sold to Seed. What amount of selling
expenses should be reported in Pard’s year 1 consolidated income
(d) The requirement is to determine the amount of
selling expenses to be reported in Pard’s year 1 consolidated
income statement. Pard’s selling expenses for year 1 include
$50,000 in freight-out costs for goods sold to Seed, its subsidiary.
This $50,000 becomes part of Seed’s inventory because it is a
cost directly associated with bringing the goods to a salable condition.
None of the $50,000 represents a selling expense for the
consolidated entity, and $1,450,000 ($1,100,000 + $400,000 –
$50,000) should be reported as selling expenses in the consolidated