Chapter 07 IMSM

CHAPTER 7
CONSOLIDATED FINANCIAL STATEMENTS - OWNERSHIP

PATTERNS AND INCOME TAXES
Chapter Outline
I.
Indirect subsidiary control

A. Control of subsidiary companies within a business combination is often
of an indirect nature; one subsidiary possesses the stock of another rather
than the parent having direct ownership.
1. These ownership patterns may be developed specifically to enhance control or for
organizational purposes.
2. Such ownership patterns may also result from the parent company's acquisition of a
company that already possesses subsidiaries.
B.
One of the most common corporate structures is the
father-son-grandson configuration where each subsidiary in turn owns one or
more subsidiaries.
C.
The consolidation process is altered somewhat when indirect control is
present.
1. The worksheet entries are effectively doubled by each corporate ownership layer
but the concepts underlying the consolidation process are not changed.
2. Calculation of the accrual-based income of a subsidiary recognizing the
consolidated relationships is an important step in an indirect ownership structure.
a. The determination of accrual-based income figures is
needed for equity income accruals as well as for the
computation of noncontrolling interest balances.
b. Any company within the business combination that is in both
a parent and a subsidiary position must recognize the equity
income accruing from its subsidiary before computing its own
income.
II. Indirect subsidiary control-connecting affiliation
A. A connecting affiliation exists whenever two or more companies within a business
combination hold an equity interest in another member of that organization.
B. Despite this variation in the standard ownership pattern, the consolidation process is
essentially the same for a connecting affiliation as for a father-son-grandson
organization.
C. Once again, any company in both a parent and a subsidiary position must recognize an
appropriate equity accrual in computing its own income.
III. Mutual ownership

A. A mutual affiliation exists whenever a subsidiary owns shares of its parent
company.
B. Parent shares being held by a subsidiary are accounted for by the treasury stock
approach.
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IV.
A.
B.
C.
1.
2.
3.
A.
B.
A.
B.
C.
A.
1. The cost paid to acquire the parent's stock is reclassified within the consolidation
process to a treasury stock account and no income is accrued.
2. The treasury stock approach is popular in practice because of its simplicity and is now
required by SFAS 160.
Income tax accounting for a business combinationconsolidated tax returns
A consolidated tax return can be prepared for all companies comprising an affiliated
group. Any other companies within the business combination file separate tax returns.
A domestic corporation may be included in an affiliated group if the parent company
(either directly or indirectly) owns at least 80 percent of the voting stock of the subsidiary
as well as 80 percent of each class of its nonvoting stock.
The filing of a consolidated tax return provides several potential advantages to the
members of an affiliated group.
Intercompany profits are not taxed until realized.
Intercompany dividends are not taxed (although these distributions are nontaxable for all
members of an affiliated group whether a consolidated return or a separate return is
filed).
Losses of one affiliate can be used to reduce the taxable income earned by other
members of the group.
D. Income tax expenseeffect on noncontrolling interest valuation
1.
If a consolidated tax return is filed, an allocation of the total expense must be made to
each of the component companies to arrive at the realized income
figures that serve as a basis for noncontrolling interest computations.
2.
Income tax expense is frequently assigned to each subsidiary based on the amounts
that would have been paid on separate returns.
V. Income tax accounting for a business combinationseparate tax returns

Members of a business combination that are foreign companies or that do not meet the
80 percent ownership rule (as described above) must file separate income tax returns.
Companies in an affiliated group can elect to file separate tax returns. Deferred income
taxes are often recognized when separate returns are filed due to temporary differences
stemming from unrealized gains and losses as well as intercompany dividends.
VI. Temporary tax differences can stem from the creation of a business combination
The tax basis of a subsidiary's assets and liabilities may differ from their consolidated
values (which is based on the fair market value on the date the combination is created).
If additional taxes will result in future years (for example, it the tax basis of an asset is
lower than its consolidated value so that future depreciation expense for tax purposes will
be less), a deferred tax liability is created by a combination.
The deferred tax liability is then written off (creating a reduction in tax expense) in future
years so that the net expense recognized (a lower number) matches the combination's
book income (a lower number due to the extra depreciation of the consolidated value).
Vll. Operating loss carryforwards
Net operating losses recognized by a company can be used to reduce taxable income
from the previous two years (a carryback) or for the future 20 years (a carryforward).
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B.
C.
If one company in a newly created combination has a tax carryforward, the future tax
benefits are recognized as a deferred income tax asset.
However, a valuation allowance must also be recorded to reduce the deferred tax asset
to the amount that is more likely than not to be realized.
Learning Objectives
Having completed Chapter 7, "Ownership Patterns and Income TaxesConsolidated Financial
Statements," students should be able to fulfill each of the following learning objectives:
1. Differentiate between a father-son-grandson ownership configuration and a connecting
affiliation.
2. Calculate realized income figures for all companies in a business combination when either a
father-son-grandson or connecting affiliation is in existence.
3. Prepare a consolidation worksheet for both a father-son-grandson ownership pattern and a
connecting affiliation.
4. Eliminate a subsidiary's ownership interest in its parent using the treasury stock approach.
5. Explain the rationale underlying the treasury stock approach to a mutual ownership.
6. List the criteria for being a member of an affiliated group for income tax filing purposes.
7. Discuss the advantages to a business combination of filing a consolidated tax return.
8. Allocate the income tax expense computed on a consolidated tax return to the various
members of a business combination according to their separate taxable incomes.
9. Compute taxable income for an affiliated group based on information presented in a
consolidated set of financial statements.
10. Compute the deferred income tax expense to be recognized when separate tax returns are
filed by any of the members of a business combination.
11. Determine the deferred tax liability that is created when the tax bases of a subsidiary's
assets and liabilities are below consolidated values.
12. Explain the impact that a net operating loss of an acquired affiliate has on consolidated
figures.
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Answers to Questions
1.
A father-son-grandson relationship is a specific type of ownership configuration often

encountered in business combinations. The parent possesses the stock of one or more
companies. At least one of these subsidiaries holds a majority of the voting stock of its
own subsidiary. Each subsidiary controls other subsidiaries with the chain of ownership
going on indefinitely. The parent actually holds control over all of the companies within
the business combination despite having direct ownership in only its own subsidiaries.
2.
In a business combination having an indirect ownership pattern, at least one company is

in both a parent and a subsidiary position. To calculate the accrual-based income
earned by that company, a proper recognition of the equity income accruing from its
own subsidiary must initially be made. Structuring the income calculation in this manner
is necessary to ensure that all earnings are properly included by each company.
3.
Able100% of income accrues to the consolidated entity (as parent company).
Baker70% (percentage of stock owned by Able).
Carter56% (80% of stock owned by Baker multiplied by the 70% of Baker controlled by
Able).
Dexter33.6% (60% of stock owned by Carter multiplied by the 80% of Carter controlled by
Baker multiplied by the 70% of Baker owned by Able).
4. When an indirect ownership is present, the quantity of consolidation entries will increase,
perhaps significantly. An additional set of entries is included on the worksheet
for each separate investment. Furthermore, the determination of realized
income figures for each subsidiary must be computed in a precise manner. For
any company in both a parent and a subsidiary position, equity income accruals
are recognized prior to the calculation of that company's realized income. This
realized income total is significant because it serves as the basis for
noncontrolling interest calculations as well as the equity accruals to be
recognized by that company's parent.
5. In a connecting affiliation, two (or more) companies within a business combination own
shares in a third member. A mutual ownership, in contrast, exists whenever a
subsidiary possesses an equity interest in its own parent.
6.
In accounting for a mutual ownership, SFAS 160 requires the treasury stock approach.
The treasury stock approach presumes that the cost of the parent shares
should be reclassified as treasury stock within the consolidation process. The
subsidiary is being viewed, under this method, as an agent of the parent. Thus,
the shares are accounted for as if the parent had actually made the acquisition.
7. According to present tax laws, an affiliated group can be comprised of all domestic
corporations in which a parent holds 80 percent ownership. More
specifically, the parent must own (directly or indirectly) 80 percent of the
voting stock of the corporation as well as at least 80 percent of each class
of nonvoting stock.
8. Several basic advantages are available to combinations that file a consolidated tax
return. First, intercompany profits are not taxed until realized. For
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companies with large amounts of intercompany transactions, the deferral

of unrealized gains causes a delay in the making of significant tax
payments. Second, losses incurred by one company can be used to
reduce or offset taxable income earned by other members of the affiliated
group. In addition, intercompany dividends are not taxable but that
exclusion applies to the members of an affiliated group regardless of
whether a consolidated or separate tax return is filed.
Members of a business combination may be forced to file separate tax returns. Foreign
corporations, for example, must always file separately. Domestic companies that do not meet
the 80 percent ownership rule are also required to file in this manner. Furthermore,
companies that are in an affiliated group may still elect to file separately. If all companies
within the combination are profitable and few intercompany transactions are carried out, little
advantage may accrue from preparing a consolidated return. With a separate filing, a
subsidiary has more flexibility as to accounting methods as well as its choice of a fiscal
year-end.
9. The allocation of income tax expense among the component companies of a business
combination has a direct bearing on realized income totals and, therefore,
noncontrolling interest calculations. Obviously, the more expense that is
assigned to a particular company the less realized income is attributed to
that concern. Income tax expense can be allocated based on the income
totals that would have been reported by various companies if separate tax
returns had been filed or on the portion of taxable income derived from
each company.
10. In filing a separate tax return (assuming that the two companies do not qualify as members
of an affiliated group), the parent must include as income the dividends
received from the subsidiary. For financial reporting purposes, however,
income is accrued based on the ownership percentage of the realized
income of the subsidiary. Because income is frequently recognized by the
parent prior to being received in the form of dividends (when it is subject
to taxation), deferred income taxes must be recognized.
Either the parent or the subsidiary might also have to record deferred income taxes in
connection with any unrealized intercompany gain. On a separate tax return, such gains are
reported at the time of transfer while for financial reporting purposes they are appropriately
deferred until realized. Once again, a temporary difference is created which necessitates the
recognition of deferred income taxes.
11.
If the consolidated value of a subsidiarys assets exceeds their tax basis, depreciation
expense in the future will be less on the tax return than is shown for external
reporting purposes. The reduced expense creates higher taxable income and,
thus, increases taxes. Therefore, the difference in values dictates an anticipated
increase in future tax payments. This deferred liability is recognized at the time the
combination is created. Subsequently, when actual tax payments do arise, the
deferred liability is written off rather than recognizing expense based solely on the
current liability. In this manner, the expense is shown at a lower figure, one that is
matched with reported income (which is also a lower balance because of the extra
depreciation).
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Recognition of this deferred liability at date of acquisition also reduces the net amount
attributed to the subsidiary's assets and liabilities in the initial allocation process. Therefore,
the residual asset (goodwill) is increased by the amount of any liability that must be
recognized.
12.
A net operating loss carryforward allows the company to reduce taxable income for
up to 20 years into the future. Thus, a benefit may possibly be derived from the
carryforward but that benefit is based on Wilson (the subsidiary) being able to
generate taxable income to be decreased by the carryforward. To reflect the
potential tax reduction, a deferred income tax asset is recorded for the total
amount of anticipated benefit. However, because of the uncertainty, unless the
receipt of this benefit is more likely than not to be received, a valuation allowance
must also be recorded as a contra account to the asset. The valuation allowance
may be for the entire amount or just for a portion of the asset.
13. At the date of acquisition, the valuation allowance was $150,000. As a contra asset
account, recognition of this amount reduced the net assets attributed to the
subsidiary and, hence, increased the recording of goodwill (assuming that the
price did not indicate a bargain purchase). If the valuation allowance is
subsequently reduced to $110,000, the net assets have increased by $40,000.
This change is reflected by a decrease in income tax expense.
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Solutions Manual
Answers to Problems
1. D
2. B
3. D
4. C
5. C
6. C
7. A Damson's accrual-based income:
Operational income ....................................................................
Defer unrealized gain .................................................................
Damson's accrual-based income ........................................
$200,000
(40,000)
$160,000
Crimson's accrual-based income:

Investment Income (90% of Damsons realized income) .......
Crimson's accrual-based income ........................................
$200,000
144,000
$344,000
Bassett's accrual-based income:

Investment income (80% of Crimson's realized income) .......
Bassett's accrual-based income .........................................
$300,000
275,200
$575,200
8. C Icede's accrual-based income:

Icede's accrual-based income .............................................
Outside ownership .....................................................................
Noncontrolling interest ........................................................
$220,000
(60,000)
$160,000
20%
$32,000
Healthstone's accrual-based income:

Investment income (80% of Icede's accrual-based income) .
Healthstone's accrual-based income .................................
Outside ownership .....................................................................
Noncontrolling interest ........................................................
$300,000
(30,000)
128,000
$398,000
20%
$79,600
Total noncontrolling interest = $111,600 ($32,000 + $79,600)
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9. D Juvyn's Operational Income ...........................................................

Dividend Income ..............................................................................
Juvyn's Income ................................................................................
Outside Ownership ..........................................................................
Noncontrolling Interest ...................................................................
$50,000
14,000
$64,000
10%
$6,400
10. A Equity Income (60% of $200,000) ...................................................

Dividend Income (60% of $40,000) .................................................
Tax Difference .............................................................................
Dividend Deduction upon Eventual Distribution (80%) ..............
Temporary Portion of Tax Difference .......................................
Tax Rate ............................................................................................
Deferred Income Tax Liability ...................................................
$120,000
24,000
$96,000
(76,800)
$19,200
30%
$5,760
11. C Unrealized Gain:

Total Gain ......................................................................................
Portion Still Held ..........................................................................
Unrealized Gain ..........................................................................
Tax Rate ............................................................................................
Deferred Tax Asset ......................................................................
$30,000
20%
$6,000
25%
$1,500
12. A Recognition of this gain is not required on a consolidated tax return.

13. C Because fair value of the subsidiary's assets exceeds the tax basis by
$100,000 a deferred tax liability of $30,000 (30%) must be recorded. Goodwill
is then computed as follows:
Consideration transferred ........................................
Fair Value .................................................................
Deferred Tax Liability .................................................
Goodwill ......................................................................
$420,000
$400,000
(30,000)
370,000
$50,000
14. (35 Minutes) (Series of reporting and consolidation questions pertaining to a

father-son-grandson combination. Includes unrealized inventory gains)
a. Consideration transferred (by Tree) ..............................
Noncontrolling interest fair value ..................................
Limbs business fair value..............................................
Book value
.................................................................
Trade name........................................................................
Life ....................................................................................
Annual amortization ........................................................
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$252,000
108,000
360,000
(300,000)
$60,000
30 years
$2,000

Solutions Manual
14. (continued)
Consideration transferred for Leaf (by Limb) ..............
Leafs business fair value ...............................................
Book value
.................................................................
Trade name........................................................................
Life ....................................................................................
a. Investment in Limb
Limb's reported income-2009
Amortization expense
Accrual-based income
Limbs percentage ownership
Equity accrual-2009
Dividends received 2009
Limb's reported income-2010
Amortization expense
Income from Leaf
Limbs percentage ownership
Equity accrual-2010
Dividends received 2010
Investment in Limb 12-31-10
$91,000
39,000
$130,000
(100,000)
$30,000
30 years
$1,000
$252,000
$40,000
(2,000)
$38,000
70%
$26,600
(7,000)
$60,000
(2,000)
6,300
$64,300
70%
$45,010
(14,000)
$302,610
b. Leaf2010 income (revenues minus expenses)

Amortization
Limb's ownership percentage
Equity Income accrual
Income recognized ($2,000 dividends 70%)
Retained earnings increase (Limb), 1/1/11
Limb2009 operating income
Limb2010 operating income
Amortization (2 years at $2,000 per year)
Equity income from ownership of Leaf (above)
Total income for previous periods
Tree's ownership percentage
Equity Income accrual
Income recognized ($10,000 [2009] + $20,000 [2010]
dividends 70% ownership)
Retained earnings Increase (Tree), 1/1/11
$10,000
(1,000)
$9,000
70%
$6,300
(1,400)
$4,900
$40,000
60,000
(4,000)
6,300
102,300
70%
71,610
(21,000)
$50,610
14. (continued)
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c. Consolidated sales (total for the companies)

Consolidated expenses (total for the companies)
Total amortization expense (see a.)
Consolidated net income for 2011
d. Noncontrolling interest in income of Leaf
Revenues less expenses
Excess amortization
Noncontrolling interest percentage
Noncontrolling interest in income of Leaf
$1,260,000
(1,025,000)
(3,000)
$232,000
$30,000
(1,000)
$29,000
30%
$8,700
Noncontrolling interest in income of Limb:

Revenues less expenses
$65,000
Excess amortization
(2,000)
Equity in Leaf income [(30,000-1,000) 70%] 20,300
Realized income of Limb2011
$83,300
Outside ownership
30%
NCI share of consolidated income
$24,990
$33,690
e. 2010 Realized income of Limb (prior to accounting

for unrealized gains) (see a)
2009 Transfer-gain recognized in 2010
2010 Transfer-gain to be recognized in 2011
2010 Realized income Limb
$64,300
10,000
(16,000)
$58,300
2011 Realized Income of Limb (prior to accounting

for unrealized gains) (see d.)
2010 Transfer-gain recognized in 2011
2011 Transfer-gain to be recognized in 2012
2011 Realized incomeLimb
$83,300
16,000
(25,000)
$74,300
f.
In b., an adjustment of $50,610 was made to the beginning 2011 retained

earnings. Question e. takes this same question and alters it by
including unrealized gains. The $10,000 gain does not affect the
answer because the 2010 and 2011 effects cancel each other.
Thus, only the $16,000 gain must be taken into consideration on January 1,
2011. Limbs realized income in 2010 is reduced by $16,000 because of the
deferred gain. The parent's equity accrual would be reduced by $11,200 or 70%
of that figure. The adjustment as of January 1, 2011 is $39,410 ($50,610
$11,200).
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15.
(15 minutes) (Income and noncontrolling interest with mutual

ownership.)
a. Consideration transferred by Uncle ..............................

Nephews business fair value ........................................
Book value ........................................................................
Intangible Assets .............................................................
Life ....................................................................................
Amortization expense (annual) ......................................
Income reported by Nephew2011...............................
Amortization expense (above) .......................................
Accrual-based income.....................................................
Uncle's ownership percentage ......................................
Income of subsidiary recognized by Uncle ..................
$500,000
125,000
$625,000
600,000
$25,000
10 years
$2,500
$50,000
(2,500)
47,500
80%
$38,000
b. To the outside owners, the $6,000 intercompany dividends ($20,000 30%) paid
by Uncle are viewed as income because the book value of Nephew is
increasing. Thus, the noncontrolling interest's share of income is $10,700 or
20% of [$47,500 income ($50,000 operational income less $2,500 excess
amortization) plus the $6,000 in dividends].
16.
(35 Minutes) (Consolidated income for a father-son-grandson combination.)
a. Mesa's operating income

Butte's operating income
Valley's operating income
Amortization expenseMesa's investment in Butte
Amortization expenseButte's investment in Valley
Consolidated net income
b. Valley's operating income
$140,000
Amortization expense (on Butte's investment)
(8,000)
Valley's accrual-based income
$132,000
Outside ownership
45%
Noncontrolling interest in Valley's income
Butte's operating income
$ 98,000
Amortization expense (on Mesa's investment)
(22,500)
Equity accrual from ownership of Valley
($132,000 55%)
72,600
Butte's accrual-based income
$148,100
Outside ownership
20%
Noncontrolling interest in Butte's income
Total noncontrolling interest in income of subsidiaries
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$250,000
98,000
140,000
(22,500)
(8,000)
$457,500
$59,400
$29,620
$89,020

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16. (Continued)
Mesas operating income
$250,000
Mesas share of Buttes operating income (80% $98,000)
78,400
Mesas share of Valleys operating income (80% 55% $140,000)
61,600
Mesas share of Buttes excess amortization (80% $22,500)
(18,000)
Mesas share of Valleys excess amortization (80% 55% $8,000)
(3,520)
Controlling interest in consolidated net income
$368,480
Noncontrolling interest in consolidated net income
89,020
$457,500
17. (30 Minutes) (Consolidated income figures for a connecting affiliation)
UNREALIZED GAINS:
Cleveland ($12,000 remaining inventory 25% markup) = $3,000
Wisconsin ($40,000 remaining inventory 30% markup) = $12,000
NONCONTROLLING INTERESTS:
CLEVELAND:
Operational income (sales minus cost of goods sold and
expenses) ....................................................................
$60,000
Defer unrealized gain (above) ........................................
(3,000)
Realized incomeCleveland ....................................
$57,000
Outside ownership ..........................................................
20%
Noncontrolling interest in Cleveland's income ......
$11,400
WISCONSIN:
Operational income (sales minus cost of goods sold and
expenses) ....................................................................
$110,000
Defer unrealized gain (above) ........................................
(12,000)
Investment income (60% of Cleveland's realized income of
$57,000) ......................................................................
34,200
Realized incomeWisconsin ...................................
$132,200
10%
Noncontrolling interest in Wisconsin's income .....
$13,220
TOTAL NONCONTROLLING INTERESTS: $24,620 ($11,400 + $13,220)
CONSOLIDATION TOTALS
Sales = $1,590,000 (add the three book values and eliminate
intercompany transfers of $40,000 and $100,000)
Cost of Goods Sold = $1,015,000 (add the three book values, eliminate
intercompany transfers of $40,000 and $100,000, and defer [add]
unrealized gains of $3,000 and $12,000)
17. (continued)
Expenses
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= $200,000 (add the three book values)

Solutions Manual
Dividend Income = -0- (eliminated for consolidation purposes)

Consolidated net income = $375,000 (consolidated revenues less
consolidated cost of goods sold and expenses)
Noncontrolling Interests in subsidiaries' income = $24,620 (computed
above)
Controlling interest in consolidated net income = $350,380 (consolidated
net income less noncontrolling interest share)
18. (15 Minutes) (Consolidated income and equity accounts--mutual ownership.)
a. CONSOLIDATED TOTALS
Sales = $1,800,000 (add the two book values)
Cost of goods sold = $1,020,000 (add the two book values)

Expenses = $352,000 (add the two book values and include the amortization
expense of $12,000)
Dividend income = -0- (eliminated for consolidation purposes)

Consolidated net income = $428,000 (consolidated revenues less
consolidated cost of goods sold and expenses)
Noncontrolling interest in Wonderland's income = $11,400 (10 percent of the
reported balance less $12,000 excess amortization). Dividend
income is included because it increases the book value of the
subsidiary and, therefore, the noncontrolling interest.)
b.
Common Stock = $880,000 (the parent company balance only)

Treasury Stock = $111,000 (cost paid by subsidiary for the shares of the
parent company)
19.
(25 Minutes) (Tax expense with separate tax returns for a combination.)
a. CONSOLIDATED TOTALS
Sales = $790,000 (add the two book values and eliminate the $110,000
intercompany transfer)
Cost of Goods Sold = $340,000 (add the book values, eliminate
intercompany transfers of $110,000, recognize [subtract]
$30,000 deferred gain from 2010, and defer [add] $40,000
intercompany gain deferred into 2011)
Operating expenses = $234,000 (add the two book values)
Dividend Income = -0- (eliminated for consolidation purposes)

Consolidated net income = $216,000 (Revenues less expenses)
Noncontrolling interest in Down's Income = $18,000 (20 percent of reported
Income of $100,000 plus $30,000 gain deferred from 2010 less
$40,000 gain deferred into 2011)
Controlling interest in consolidated net income = $198,000
19. (continued)
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b. On separate returns, the unrealized gains are reported as taxable income.

Because Up owns 80 percent of Down's stock, the dividends are tax- free and
no deferred tax liability is necessary on the undistributed income.
DUE TO GOVERNMENT: (separate returns)
UP:
Income (without dividend income) ................................
Tax rate ............................................................................
Currently payable to government ............................
$126,000
30%
$37,800
DOWN:
Reported income .............................................................
Tax rate ............................................................................
Currently payable to government ............................
$100,000
30%
$30,000
Total Income Tax Payable: Current = $67,800 ($37,800 + $30,000)

CURRENT EXPENSE:
Consolidated net income (part a.) ............................
Eliminate noncontrolling interest .............................
Income to be taxed ...............................................
Tax rate ....................................................................
Income tax expense ...................................................
$198,000
+18,000
$216,000
30%
$64,800
The $3,000 difference between the liability and the expense is an increase in the
Deferred Income Tax Asset account. It is created by the tax effect (30%) on the
net unrealized gain for the period ($10,000 or $40,000 $30,000).
20. (45 Minutes) (Series of questions requires computation of income tax expense
and the related payable balance)
a. $260,000 ($650,000 40%)
The affiliated group would be taxed on its operating income of $650,000 (the
net unrealized gain is deferred on a consolidated return). The intercompany
income and dividends are not relevant since a consolidated return is filed.
b. $260,000 ($650,000 40%)
net unrealized gain is deferred on a consolidated return). The intercompany
income and dividends are not relevant because a consolidated return is filed.
The percentage ownership does not affect the figures on a consolidated
return.
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Solutions Manual
20.(continued)
c. $296,000 ($96,000 + $200,000)
Rogers would pay $96,000 or 40% of its $240,000 operating income. Clarke
would pay $200,000 or 40% of its $500,000 operating income. The unrealized
gain is not deferred when separate returns are filed. Intercompany dividends
are not taxable because the parties qualify as an affiliated group even though
separate returns are being filed. Answer (c.) differs from (a.) and (b.) because
tax on the $90,000 unrealized gain (40% or $36,000) is paid immediately.
d. $268,064
Rogers would record income tax expense of $96,000 or 40% of its $240,000
operating income.
Clarke must record its expense based on the revenue recognized during the
period. Thus, the tax expense is based on operating income of $410,000 (the
net unrealized gain is not being recognized in this period) plus equity income
accruing from Rogers of $100,800 (70% of that company's after-tax income).
Clarke will record an income tax expense of $164,000 in connection with the
operating income ($410,000 40%). The expense recognized in connection with
the equity accrual is affected by the dividends-received deduction:
Equity income of subsidiary...........................................
Dividends-received deduction (when received) (80%).
Income subject to taxation .............................................
Tax rate ............................................................................
Income tax expenseequity income (Clarke) .............
Income tax expenseoperating income (Clarke)
(above) .........................................................................
Income tax expenseoperating income (Rogers)
(above) .........................................................................
Income tax expense ........................................................
$100,800
80,640
$20,160
40%
$8,064
164,000
$172,064
96,000
$268,064
e. $204,480
Clarke will pay $200,000 in connection with its operating income ($500,000
40%) because the unrealized gain cannot be deferred. Clarke also receives
$56,000 in dividends from Rogers ($80,000 70%). Tax payment on these
dividends is $4,480 ($56,000 20% 40%). The difference between the payment
by Clarke ($204,480) and the company's expense in (d.) ($172,064) is created by
the premature payment of the tax (a deferred tax asset) on the unrealized gain
($90,000) less the deferred tax liability on the parent's equity accrual ($100,800)
in excess of dividends received ($56,000).
McGraw-Hill/Irwin

7- 15
21. (20 Minutes) (Comparison of income tax expense and payable on separate and
consolidated tax returns.)
a. Consolidated Return2010
Piranto income 2010 (sales less expenses) .......................................
Slinton income 2010 (sales less expenses) .......................................
2009 gain realized in 2010.....................................................................
2010 deferred gain..................................................................................
Taxable income ................................................................................
Tax rate ..................................................................................................
Income tax payablecurrent ..........................................................
$300,000
100,000
120,000
(150,000)
$370,000
40%
$148,000
Because no temporary differences exist in this problem, the income tax

expense would also be $148,000. The unrealized gain is not taxed until realized.
Dividend income is not important because a consolidated return is being filed.
b. Separate Returns2010
On its separate tax return, Piranto will report taxable income of $300,000the
unrealized gains cannot be deferred. The dividends would not be taxable
because Slinton still meets the criteria to be a member of an affiliated group. A
consolidated return is not a requirement for these dividends to be excluded.
Thus, income taxes payable by Piranto would be $120,000 ($300,000 40%).
To determine the income tax expense for Piranto, the two temporary
differences must be taken into account:
Taxable income ................................................................
Gain taxed in 2009 although realized
in 2010 .........................................................................
Gain taxed in 2010 although not yet realized................
2010 realized income subject to taxation .....................
Tax rate .............................................................................
$300,000
120,000
(150,000)
$270,000
40%
$108,000
The $12,000 difference between the expense and the payable is the tax effect
on the net unrealized gain ($30,000 40%).
Slinton will have an expense and payable of $40,000 ($100,000 40%).
McGraw-Hill/Irwin
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Solutions Manual
22. (45 Minutes) (Comparison of income tax expense and payable on separate and
consolidated tax returns. Includes question on mutual ownership and the
conventional approach.)
a. Total income tax expense is $156,877. Because of the level of ownership,
separate returns must be filed. Unrealized gains are taxed immediately as are
intercompany dividends.
Because the unrealized gains are deferred on the consolidated financial
statements, Boxwood's expense would be $34,400 or 40% of $86,000 in realized
income ($100,000 + $18,000 $32,000).
Lake's income subject to taxation includes its $300,000 in operating income
plus $30,960 in income accruing from its investment in Boxwood (60% of the
after-tax Income of $51,600 [$86,000 $34,400]). Income tax expense for Lake is
computed as follows:
Operating income ............................................................
Equity income ..................................................................
Taxable portion ................................................................
Income eventually subject to taxation ..........................
Tax rate..............................................................................
Income tax expense Lake (rounded)..............................
Income tax expense Boxwood (above)..........................
Total income tax expense ...............................................
$300,000
$30,960
20%
6,192
$306,192
40%
$122,477
34,400
$156,877
b. Boxwood will pay $40,000 ($100,000 40%) because separate returns are filed.
Lake, however, will pay its taxes based on dividends received rather than on
the equity accrual. A deferred income tax liability would be established for the
difference. Lake's payment for the current year is computed as follows:
Operating income.............................................................
Dividend income (60% $10,000) ..................................
Taxable portion ................................................................
Income currently taxable ................................................
Tax rate ............................................................................
Income tax payableLake .............................................
Income tax payableBoxwood (above) .......................
Total Income tax payable current ..................................
McGraw-Hill/Irwin
$300,000
$6,000
20%
1,200
$301,200
40%
$120,480
40,000
$160,480

7- 17
22.(continued)
The $3,603 difference between the expense in a. and the payable in b. is created
by the following two effects:
Deferred income tax liability on equity income accrual not yet taxed
($30,960 $6,000 = $24,960 20% 40%)...................................
Deferred income tax asset on net unrealized gain
($32,000 $18,000 = $14,000 40%)............................................
Net decrease in expense.....................................................................
$1,997
5,600
$3,603
c. Because a consolidated tax return is filed, unrealized gains are deferred in the
same manner as for external reporting purposes. Dividend income is not
taxable.
Lake's operating income ................................................
Boxwood's operating income ........................................
Prior year unrealized gain ...............................................
Current year unrealized gain ..........................................
Income subject to taxation (and currently taxable)......
Tax rate .............................................................................
$300,000
$100,000
18,000
(32,000)
86,000
$386,000
40%
$154,400
23. (30 Minutes) (Computation of income tax expense and income tax payable on
consolidated and separate tax returns.)
a. Operating Income ............................................................
Tax rate .............................................................................
Taxes to be paid ..............................................................
$450,000
40%
$180,000
$50,000 unrealized gain is deferred). Intercompany income and dividends are
not relevant because a consolidated return is filed.
b. Total taxes to be paid are $200,000. Robertson would have to pay $80,000 or
40% of its $200,000 operating income. Garrison would pay $120,000 or 40% of
its $300,000 operating income. The unrealized gain is not deferred because
separate returns are being filed. Intercompany dividends are not taxable
because the parties still qualify as an affiliated group even though separate
returns are being filed.
c. Robertson must report an income tax expense of $80,000 or 40% of its $200,000
operating income.
McGraw-Hill/Irwin
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Solutions Manual
23. (continued)
Garrison records its expense based on the revenue recognized during the
period. Thus, the expense is computed on an operating income of $250,000 (the
net unrealized gain is not recognized in this period) along with equity income
from Robertson of $84,000 (70% of that company's $120,000 after-tax income).
Garrison will record an income tax expense of $100,000 in connection with the
operating income ($250,000 40%) and $6,720 resulting from its equity income
($84,000 20% 40%). Total expense to be reported amounts to $186,720 for
Garrison and Robertson ($80,000 + $100,000 + $6,720).
d. Garrison will pay $120,000 in connection with its operating income ($300,000
40%) and $2,400 because of the dividends received from Robertson. Garrison
will receive $30,000 in dividends based on its 60% ownership. Of this total, only
$6,000 (20%) is taxable. Thus, at a 40% rate, the tax on the dividends would
amount to $2,400 ($6,000 40%). The total income taxes payable by Garrison is
$122,400 ($120,000 + $2,400).
24. (10 Minutes) (Impact on goodwill of assets with a different tax vs. book value.)
The assets and liabilities of Kew (the subsidiary) will be consolidated at their
individual fair values (netting to $500,000). However, both the buildings and
equipment have a tax basis that is lower than fair value. Thus, for tax purposes,
future depreciation expense will be lower on the tax return so that taxable
income will exceed book income. The higher taxable income (anticipated in the
future) creates a deferred tax liability at the time the combination is created.
Buildings ..........................................
Equipment ........................................
Total temporary difference .......
Tax rate .......................................
Deferred tax liability ..................
Tax
Basis
$140,000
150,000
Fair
Value
$180,000
200,000
Temporary
Difference
$40,000
50,000
$90,000
30%
$27,000
Consequently, Kew's accounts will be consolidated as follows: (parentheses

indicate a credit balance)
Accounts receivable ........................................................
Inventory ...........................................................................
Land .................................................................................
Buildings ..........................................................................
Equipment.........................................................................
$110,000
130,000
100,000
180,000
200,000
24. (continued)
McGraw-Hill/Irwin

7- 19
Liabilities...........................................................................
Deferred tax liability ........................................................
Assigned to specific accounts ......................................
Purchase price .................................................................
Excess assigned to goodwill .........................................
(220,000)
(27,000)
473,000
650,000
$177,000
25. (55 Minutes) (Consolidation worksheet for a father-son-grandson combination.

Includes intercompany inventory transfers.)
The following computations are needed before the consolidation worksheet is
prepared: calculation of the deferred gains in beginning and ending inventory.
Beginning Unrealized Gain (Wilson)
(January 1, 2011 Inventory
Balance)
Ending Unrealized Gain (Wilson)

(December 31, 2011 Inventory
Balance)
Transfer Price (goods remaining) =

Cost + .25 Cost
$60,000 = 1.25 Cost
$48,000 = Cost
$12,000 is Unrealized Gain
Transfer Price (goods remaining) =
Cost + .25 Cost
$90,000 = 1.25 Cost
$72,000 = Cost
$18,000 is Unrealized Gain
CONSOLIDATION ENTRIES
Entry *G
Retained Earnings, 1/1/11 (Wilson) ..........................
12,000
Cost of Goods Sold ..............................................
12,000
(To recognize income on intercompany inventory transfers made in previous
year but not resold until current year as per above computation.)
Entry *C
Retained Earnings, 1/1/11 (House) ................................
11,200
Investment in Wilson Company ..........................
11,200
(To convert investment account from partial equity method to equity method.
Unrealized gain shown in Entry *G is not properly reflected by parent under
partial equity method [12,000 70% = $8,400 income decrease] nor would the
$2,800 in amortization expense for 20092010. Thus, a reduction of $11,200 is
required. Because Cuddy is a current year acquisition, no prior conversion to
equity method is required for the investment.)
McGraw-Hill/Irwin
7- 20

Solutions Manual
25.(continued)
Entry S1
Common Stock (Cuddy) ..................................................
150,000
Retained Earnings, 1/1/11 (Cuddy) ................................
150,000
Investment in Cuddy Company (80%)......................
240,000
Noncontrolling Interest in Cuddy Common Stock (20%)
60,000
(To eliminate Cuddy's stockholders' equity against the corresponding
investment balance and to recognize noncontrolling interest on common
stock.)
Entry S2
Common Stock (Wilson) .................................................
310,000
Retained Earnings, 1/1/11 (Wilson)
(adjusted by Entry *G) ...............................................
578,000
Investment in Wilson Company (70%) ...............
621,600
Noncontrolling Interest in Wilson (30%) ............
266,400
(To eliminate Wilson's stockholders' equity against corresponding investment
balance and to recognize noncontrolling interest.)
Entry A
Buildings............................................................................
54,000
Franchise Contracts ........................................................
32,000
Goodwill.............................................................................
140,000
Equipment ...................................................................
10,000
Investment in Wilson Company ...............................
151,200
Noncontrolling interest in Wilson Company...........
64,800
(To allocate excess payment made in connection with purchase of Wilson
shown above. Amortization for 2009 and 2010 has been taken into account in
determining the January 1, 2011 value for each account.)
Entry I1
Income of Cuddy Company ......................................
56,000
Investment in Cuddy Company ...........................
56,000
(To eliminate intercompany income accrued by both House and Wilson
during the year.)
Entry I2
Income of Wilson Company ......................................
91,000
Investment in Wilson Company ..........................
91,000
(To eliminate intercompany income accrued by House during the year.)
Entry D1
Investment in Cuddy Company ................................
40,000
Dividends Paid (80%) (Cuddy) ............................
(To eliminate effects of intercompany dividend payments.)
40,000
25. (continued)
McGraw-Hill/Irwin

7- 21
Entry D2
Investment in Wilson Company ...............................
67,200
Dividends Paid (70%) (Wilson) ............................
(To eliminate effects of intercompany dividend payments.)
67,200
Entry E
Operating Expenses ..................................................
2,000
Equipment .................................................................
5,000
Franchise Contracts .............................................
4,000
Buildings.................................................................
3,000
(To record 2011 amortization on excess payment made in connection with
acquisition of Wilson Company.)
Entry TI
Sales and Other Revenues ........................................
200,000
200,000
(To eliminate intercompany inventory sales for the current year.)
Entry G
Cost of Goods Sold ....................................................
Inventory.................................................................
18,000
(To defer unrealized gain in ending inventory.)
18,000
Noncontrolling Interest in Net Income of Cuddy

Reported net income
Outside ownership
Noncontrolling interest in Cuddy incomecommon
$70,000
20%
$14,000
Noncontrolling Interest in Net Income of Wilson*

Reported operational income
Equity income of Cuddy ($70,000 40%)
Excess amortization.......................................................................
Recognition of 2010 gain (Entry *G)
Deferral of 2011 unrealized gain (Entry G)
Realized income
Outside ownership
Noncontrolling interest in net income of Wilson
McGraw-Hill/Irwin
7- 22
$130,000
28,000
(2,000)
12,000
(18,000)
$150,000
30%
$45,000

Solutions Manual
25. (continued)
HOUSE CORPORATION AND CONSOLIDATED SUBSIDIARIES
Consolidation Worksheet
December 31, 2011
Accounts
Sales and other revenue
Cost of goods sold
Operating expenses
Income of Wilson Company
Income of Cuddy Company
Net Income
Noncontrolling interest in
Wilson net income
Cuddy net income
To House Corporation
Retained earnings, 1/1/11:
House Corporation
Wilson Company
Cuddy Company
Net Income
Dividends paid
House Corporation
Wilson Company
Cuddy Company
Retained earnings, 12/31/11
House
Corp.
Wilson
Company
Cuddy
Company
Consolidation EntriesNoncontrollingConsolidated
Debit
Credit
Interest
Balance
(900,000)
(700,000)
(300,000) (TI) 200,000
551,000
300,000
140,000 (G) 18,000
219,000
(91,000)
(28,000)
(249,000)
270,000
90,000 (E)
2,000
(I2) 91,000
(I1) 56,000
(70,000)
(28,000)
(158,000)
(1,700,000)
(*G) 12,000
(TI) 200,000
797,000
581,000
-0-0(322,000)
(820,000)
(590,000)
(249,000)
(158,000)
(45,000)
45,000
(14,000)
14,000
(263,000)
(*C) 11,200
(*G) 12,000
(S2)578,000
(150,000) (S1)150,000
(70,000)
(808,800)
-0-0(263,000)
100,000
96,000
(969,000)
McGraw-Hill/Irwin
(652,000)
50,000
(170,000)

7- 23
(D2) 67,200
(D1) 40,000
28,800
10,000
100,000
-0-0(971,800)
25. (continued)
Accounts
House
Corp.
Wilson
Company
Cuddy
Company
Debit
Credit
Interest
Balance
Cash and receivables

Inventory
Investment in Wilson Company
220,000
390,200
807,800
334,000
320,000
Investment in Cuddy Company
128,000
128,000
(D1) 40,000
Buildings
Equipment
Land
Goodwill
Franchise Contracts
Total assets
385,000
310,000
180,000
320,000
130,000
300,000
2,421,000
1,532,000
144,000 (A) 54,000

88,000 (E)
5,000
16,000
(A) 140,000
(A) 32,000
418,000
Liabilities
Noncontrolling interest in Cuddy
Noncontrolling interest in Wilson
subsidiary companies
Common stock
Retained earnings (above)
Total liabilities and equities
(632,000)
67,000
103,000
(D2) 67,200
(570,000)
(E)
(310,000)
(969,000)
(2,421,000)
(652,000)
(1,532,000)
-0900,000
523,000
496,000
140,000
28,000
3,503,200
4,000
(1,300,000)
(S1) 60,000
(S2) 266,400
(A) 64,800
(820,000)
621,000
795,200
-0-
18,000
11,200
621,600
91,000
151,200
240,000
56,000
3,000
10,000
(98,000)
(150,000) (S1) 150,000

(S2) 310,000
(170,000)
(418,000)
1,916,400
Parentheses indicate a credit balance.
McGraw-Hill/Irwin
7- 24
(G)
(*C)
(S2)
(I2)
(A)
(S1)
(I1)
(E)
(A)

Solutions Manual
1,916,400
(60,000)
(331,200)
411,400
(411,400)
(820,000)
(971,800)
(3,503,200)
26.
(20 Minutes)
combination)
(Consolidation
entries
for
mutual
holding
business
a. Acquisition Price Allocation and Amortization Mighty's Purchase of Lowly

Consideration transferred .............................................
$420,000
280,000
Lowlys business fair value.............................................
700,000
Book value acquired........................................................
(600,000)
Trademarks........................................................................
$100,000
Annual amortization (20-year life)..................................
$5,000
Entry *C
Investment in Lowly ...................................................
117,000
Retained Earnings, 1/1/10 (Mighty) .....................
117,000
(To record $180,000 income accruing to parent during the previous years as
measured by increase in book value [$200,000 60%] and amortization
expense of $3,000 [$5,000 60%] for the previous year.)
Entry S1
Common Stock (Lowly) .............................................
300,000
Retained Earnings, 1/1/10 (Lowly) ............................
500,000
Investment in Lowly (60%) ..................................
480,000
Noncontrolling Interest in Lowly 1/1/10 (40%) . .
320,000
(To eliminate subsidiary stockholders' equity accounts against investment
account and to recognize noncontrolling interest ownership.)
Entry S2
Treasury Stock ...........................................................
240,000
Investment in Mighty ............................................
(To reclassify cost of parent shares as treasury stock.)
240,000
Entry A
Trademarks .................................................................
95,000
Investment in Lowly .............................................
57,000
Noncontrolling Interest in Lowly 1/1/10 (40%) . .
38,000
(To recognize unamortized portion of acquisition-date excess fair value.)
Entry E
Amortization Expense ...............................................
Trademarks ............................................................
(To record trademarks amortization expense for 2010.)
5,000
5,000
Noncontrolling interest in subsidiary income = 40% ($40,000 - $5,000) = $14,000
McGraw-Hill/Irwin
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Solutions Manual
27.(80 Minutes) (Prepare consolidation worksheet for a father-son-grandson

combination. Also asks about income taxes paid on both a separate and a
consolidated return)
a. Acquisition-Date Allocation and Amortization
The January 1, 2009 book values are determined by removing the 2009 income
from the January 1, 2010 book values (based on equity accounts).
Consideration transferred for Stookey..........................
Stookey business fair value ...........................................
Stookey book value .........................................................
Customer List....................................................................
Life .....................................................................................
$344,000
86,000
$430,000
(380,000)
$50,000
10 Years
$5,000
Consideration transferred for Yarrow............................

Yarrow business fair value .............................................
Yarrow book value............................................................
Copyright ..........................................................................
Life .....................................................................................
$720,000
80,000
$800,000
740,000
$60,000
15 Years
$4,000
Entry *G
Retained Earnings, 1/1/10 (Stookey) ........................
7,680
7,680
(To give effect to unrealized gain from 2009. Amount is calculated based on
normal 48% markup [found from Income Statement] multiplied by $16,000
retained inventory [20% of $80,000])
Entry *C1
Investment in Stookey ...............................................
85,856
Retained Earnings, 1/1/10 (Yarrow) ....................
85,856
(To recognize equity income accruing from Yarrow's investment in Stookey
during 2009. Because the initial value method is applied and no dividends
paid, no income has been recognized in connection with the 2009 ownership
of Stookey. Reported income of $120,000 [2009] less unrealized gain of
$7,680 deferred above indicates income of $112,320. Based on 80%
ownership, an $89,856 accrual is needed, which is reduced by the $4,000
amortization (80% $5,000) for that year.
27.(continued)
Entry *C2
McGraw-Hill/Irwin

7- 27
Investment in Yarrow .................................................

217,670
Retained Earnings, 1/1/10 (Travers) ...................
217,670
(To recognize equity income accruing from Travers' investment in Yarrow
during 2009. Because the initial method is applied and no dividends paid,
income has not been recognized in connection with the 2009 ownership of
Yarrow. Income of $245,856 is calculated based on reported income of
$160,000 [2009] plus the $85,856 accrual recognized in Entry *C1. Ownership
of 90% dictates a $221,270 accrual that is then reduced to $217,670 by the
$3,600 [90% $4,000] amortization applicable to 2009.)
Entry S1
Common Stock (Stookey) .........................................
200,000
Retained Earnings, 1/1/10 (Stookey, as adjusted
by Entry *G) ...........................................................
292,320
Investment in Stookey (80%) .........................
393,856
Noncontrolling Interest in Stookey (20%) ....
98,464
(To eliminate stockholders' equity accounts of subsidiary [Stookey] against
corresponding balance in investment account and to recognize
noncontrolling interest ownership.)
Entry S2
Common Stock (Yarrow) ...........................................
300,000
Retained Earnings, 1/1/10 (Yarrow, as adjusted
by Entry *C1) .........................................................
685,856
Investment in Yarrow (90%) ...........................
887,270
Noncontrolling Interest in Yarrow (10%) ......
98,586
(To eliminate stockholders equity accounts of subsidiary Yarrow against
corresponding balance in investment account and to recognize
noncontrolling interest ownership.)
Entry A1
Customer List..............................................................
Investment in Stookey .........................................
Noncontrolling Interest in Stookey (20%) ..........
45,000
36,000
9,000
(To recognize January 1, 2010 unamortized portion of acquisition price

assigned to Stookeys customer list.)
McGraw-Hill/Irwin
7- 28

Solutions Manual
27. (continued)
Entry A2
Copyright .....................................................................
56,000
Investment in Yarrow ...........................................
50,400
Noncontrolling interest in Yarrow.......................
5,600
(To recognize January 1, 2010 unamortized portion of acquisition price
assigned to copyright.)
Entry E
Operating Expenses ...................................................
9,000
Customer List.........................................................
5,000
Copyright................................................................
4,000
(To recognize amortization expense for 2010$5,000 in connection with
Travers' investment and $3,000 in connection with Yarrow's investment.)
Entry Tl
Sales ............................................................................
100,000
100,000
(To eliminate intercompany inventory transfers made during 2010.)
Entry G
9,600
Inventory (current assets) ...................................
9,600
(To defer unrealized gain on ending inventory$20,000 48% markup.)
Noncontrolling Interest in Stookey's Net Income
2010 Reported net income ..............................................
Customer list amortization .............................................
Realization of 2009 deferred income (*G) .....................
Deferral of 2010 unrealized gain (G) ..............................
Realized income 2010 .....................................................
Noncontrolling interest in Stookey's net income ........
Noncontrolling Interest in Yarrow's Net Income
2010 Reported net income ..............................................
Copyright amortization ...................................................
Accrual of Stookey's income (80% of $93,080
realized income [computed above]) ........................
Realized Income2010 ...................................................
Noncontrolling interest in Yarrow's net income ..........
McGraw-Hill/Irwin
$100,000
(5,000)
7,680
(9,600)
$93,080
20%
$18,616
$200,000
(4,000)
74,464
$270,464
10%
$27,046

7- 29
.
27. (continued)
Accounts
TRAVERS COMPANY AND CONSOLIDATED SUBSIDIARIES

Consolidation Worksheet
December 31, 2010
Travers
Yarrow
Stookey
Company
Company
Company
Debit
Credit
Interest
Balances
Sales and other revenues

Cost of goods sold
(900,000)
480,000
(600,000)
320,000
(500,000)
260,000
(Tl)
(G)
100,000
9,600
Operating expenses
Separate company net income
NCI in Yarrow's net income
NCI in Stookey's net income
To controlling interest
Retained earnings, 1/1/10:
Travers Company
Yarrow Company
Stookey Company
100,000
(320,000)
80,000
(200,000)
140,000
(100,000)
(E)
9,000
Net Income (above)

Dividends paid
Retained earnings, 12/31/10
Current assets
Investment in Yarrow Company
(700,000)
(600,000)
(300,000)
(320,000)
128,000
(892,000)
(200,000)
329,000
444,000
720,000
380,000
(800,000)
2,113,000
(*C2) 217,670
836,000
1,560,000
(*C1)
(917,670)
-0-0-
85,856
(G)
(S2)
(A2)
(S1)
(A1)
9,600
887,270
50,400
393,856
36,000
1,094,400
-0-0-
520,000
(A2)
800,000
(460,000)
(300,000)
(200,000)
(200,000)
Retained earnings, 12/31/10 (above)

NCI interest in Stookey, 1/1/10
(892,000)
(800,000)
(400,000)
(1,560,000)
(*C2) 217,670
(*C1) 85,856
(800,000)
(609,080)
27,046
18,616
(563,418)
(563,418)
128,000
(1,353,088)
280,000
(721,000)
(500,000)
(2,113,000)
685,856
7,680
292,320
(400,000)
344,000
949,000
(S2)
(*G)
(S1)
(100,000)
Liabilities
Common stock
Noncontrolling interest in Yarrow, 1/1/10

Noncontrolling interests in subsidiaries
Total liabilities and equities
(1,900,000)
961,920
7,680
100,000
(27,046)
(18,616)
Investment in Stookey Company

Land, buildings, & equipment (net)
Customer List
Copyright
Total assets
(*G)
(TI)
(A1)
45,000
56,000
(E)
(E)
4,000
2,305,000
40,000
5,000
52,000
3,491,400
(1,381,000)
(S1)
(S2)
200,000
300,000
(S1)
(A1)
(S2)
(A2)
2,008,982
98,464
9,000
98,586
5,600
2,008,982
(500,000)
(1,353,088)
(107,464)
(104,186)
(257,312)
(257,312)
(3,491,400)
27.(continued)
b. Travers' reported income .....................................................................
Yarrow's reported income ....................................................................
Dividend income (none collected) ......................................................
Intercompany gains (no transfers) ......................................................
Amortization expense ...........................................................................
Taxable income ......................................................................................
Tax rate ...................................................................................................
Income tax payable ...............................................................................
$320,000
200,000
-0-0(9,000)
$511,000
45%
$229,950
c. Stookey's reported income ..................................................................

(Unrealized gains are not deferred on a separate
tax return.)
Tax rate ...................................................................................................
Income tax payable ...............................................................................
$100,000
45%
$45,000
d. (1) Because 80% of Stookey's stock is owned by Yarrow, intercompany

dividends would be nontaxable. Consequently, no temporary difference is
created by Stookey's failure to pay a dividend.
(2) Stookey's unrealized gains are recognized in one time period for financial
reporting purposes and in a different time period for tax purposes. A
temporary difference is created. The net effect is an increase in taxable
income by $1,920 over reported income:
2010 Unrealized gain taxed in 2010......................................................
2009 Unrealized gain taxed previously in 2009..................................
Increase in taxable income ..................................................................
Tax rate ...................................................................................................
Deterred income tax asset ....................................................................
$9,600
(7,680)
$1,920
45%
$864
Income Tax Expense:

Travers and Yarrowpayable (part b) ...........................................
Stookeypayable (part c) ...............................................................
Total taxes to be paid2010...........................................................
Prepayment (Asset) (above) ...........................................................
Income tax expense 2010.................................................................
$229,950
45,000
$274,950
(864)
$274,086
27. d. (continued)
Because a single rate is used, income tax expense can also be computed by
taking consolidated net income (prior to noncontrolling interest reduction) of
$609,080 (part a.) and multiplying by the 45% tax rate to obtain $274,086.
Income Tax ExpenseCurrent ......................................
Deferred Income TaxAsset .........................................
Income Tax Payable ...................................................
274,086
864
274,950
28. (40 Minutes) (Series of questions about a business combination and its income
tax reporting)
a. Partial equity method. "Income of Soludan" is 80% of Soludan's reported total.
b. $12,000. Reduction is evidenced by a $338,000 figure reported for consolidated
inventory rather than the $350,000 total for the two companies.
c. $37,500. Consolidated operating expenses have increased by $2,500, evidently
the annual amortization. Because a 15-year life is assumed by the combination,
the amount originally allocated to trademarks must have been $37,500.
d. $120,000. Decrease shown in consolidated sales account.
e. Upstream. "Noncontrolling interest in Soludan Company's income" is $18,700.
Because this amount is not equal to 20% of Soludan's reported income less
excess amortization ($100,000 $2,500), realized income must have been
adjusted for unrealized gains. Subsidiary income is only adjusted to show the
effects of upstream transfers.
f. $20,000. For both receivables and liabilities, the consolidated total is $20,000
less than the sum of the two companies.
g. $8,000. Consolidated cost of goods sold is decreased by $120,000 (to $780,000)
in eliminating intercompany sales. The increase of $12,000 created by the
ending unrealized gain (see part b.) would then leave a $792,000 balance.
Because $784,000 is the ending balance reported for consolidated cost of
goods sold, an $8,000 unrealized gain must have been deferred from the
previous year.
28.(continued)
h. Because the trademarks balance now stands at $32,500, amortization expense
of $2,500 has been recognized, $2,500 in the previous year. In addition, an
$8,000 unrealized gain from the prior year (see part g.) is recognized.
Amortization expenseprior years 80%....................
Unrealized gainupstream effect on
parent's retained earnings is $8,000 80%.............
Adjustment to parents beginning retained earnings. .
i. This figure is computed as follows:
Book value of subsidiary1/1 .......................................
Unrealized gain in beginning inventory (see above) . .
Realized book value ......................................................
Excess allocation
......................................................
Total to noncontrolling interest .....................................
Noncontrolling interest in Soludan's income
(as reported) ...............................................................
Noncontrolling interest in Soludan's dividends
($20,000 20%) ...........................................................
Ending noncontrolling interest ......................................
$2,000
6,400
$8,400
$370,000
(8,000)
$362,000
35,000
397,000
20%
$79,400
18,700
(4,000)
$94,100
j. For a consolidated return, unrealized gains are deferred as in the consolidated

statements. At a 40% rate, both the expense and payable would be $117,400.
Income Tax Expense .......................................................
117,400
117,400
Consolidated Taxable Income:

Sales ................................................................................................ $1,280,000
Cost of goods sold .........................................................................
(784,000)
Operating expenses .......................................................................
(202,500)
Taxable income ......................................................................... $293,500
k. On a separate return, Politan would report its operating income of $200,000
leading to a tax expense and payable of $80,000. Because of the level of
ownership, intercompany dividend (or investment) income is omitted.
80,000
80,000
28. k. (continued)
On a separate return, Soludan would report $100,000 operating income for a
payable of $40,000. The unrealized gains are accounted for in different time
periods in the financial statements, thus, a temporary difference is created. The
beginning gain of $8,000 was taxed in the previous year rather than currently.
The current gain of $12,000 is taxed now rather than next year; the tax paid this
year on the net $4,000 ($1,600) is a prepayment.
Deferred Income Tax - Asset ..........................................
38,400
1,600
Soludan's entry can also be computed as follows:

Reported Income ..............................................................................
Unrealized gain from previous period realized currently ............
Deferral of current unrealized gain ................................................
Realized Income ...............................................................................
Tax rate
.......................................................................................
Income tax expense .........................................................................
Taxes payable....................................................................................
Deferred tax asset .................................................................................
40,000
$100,000
8,000
(12,000)
$96,000
40%
$38,400
40,000
$1,600
29. (45 Minutes) Develop worksheet entries that were used to consolidate the
financial statements of a father-son-grandson combination.
Entry *G
Retained Earnings, 1/1/11 (Delta) .............................
15,000
15,000
(To recognize gain that was unrealized in 2010 [amount provided].)
Entry *C1
Retained Earnings, 1/1/11 (Delta) .............................
7,000
Investment in Omega Company ..........................
7,000
(To recognize amortization expense from Deltas acquisition for 2010.)
29. (continued)
Entry *C2
Retained Earnings, 1/1/11 (Alpha) ............................
27,600
Investment in Delta Company .............................
27,600
To recognize accrual adjustments for excess amortization
and inventory deferral as follows:
Excess amortization from Delta acquisition
(80% $6,250 2 years).........................................
$10,000
Deltas share of excess amortization from Omega acquisition
(80% [70% $10,000] 1 year)...........................
5,600
Inventory profit deferral at 1/1/11 (80% $15,000)..
(12,000)
*C2 adjustment............................................................
$27,600
Entry S1
Common Stock (Omega) ...........................................
100,000
Retained Earnings, 1/1/11 (Omega) ..........................
100,000
Investment in Omega (70%) .................................
140,000
Noncontrolling Interest in Omega (30%) ............
60,000
(To eliminate stockholders' equity accounts of Omega against parent's
Investment account and to recognize outside ownership.)
Entry S2
Common Stock (Delta) ...............................................
120,000
Retained Earnings, 1/1/11 (Delta, as adjusted) .......
378,000
Investment in Delta (80%) ....................................
398,400
Noncontrolling Interest in Delta (20%) ...............
99,600
(To eliminate stockholders' equity accounts of Delta [as adjusted as Entry
*G and Entry *C1] against corresponding balance in Investment account and
to recognize outside ownership.)
Entry A
Copyrights ..................................................................
222,500
Investment in Delta ...............................................
90,000
Investment in Omega ...........................................
77,000
Noncontrolling interest in Delta...........................
22,500
Noncontrolling interest in Omega.......................
33,000
(To recognize January 1, 2011 unamortized copyrights, 2 years amortization
recorded on first investment but only one year for second.)
Entry I1
Income of Subsidiary .................................................
144,000
Investment in Delta ...............................................
144,000
(To eliminate intercompany income accrual found on Alpha's records.)
29. (continued)
Entry I2
Income of Subsidiary .................................................
49,000
Investment in Omega ...........................................
49,000
(To eliminate intercompany income accrual found on Delta's records.)
Entry D1
Investment in Delta ....................................................
32,000
Dividends Paid (Delta) ..........................................
32,000
(To eliminate intercompany dividend payments, 80% of Delta's payment.)
Entry D2
Investment in Omega .................................................
35,000
Dividends Paid (Omega) ......................................
35,000
(To eliminate intercompany dividend payments, 70% of Omega's payment.)
Entry E
Operating Expenses ..................................................
16,250
Copyrights .............................................................
16,250
(Current year amortization, $6,250 on first acquisition and $10,000 on
second.)
Entry Tl
Sales ............................................................................
(To eliminate intercompany inventory transfer.)
200,000
200,000
Entry G
22,000
Inventory.................................................................
22,000
(To defer ending unrealized gain on intercompany transfers.)
Noncontrolling Interest in Omega's Income:
Reported income .............................................................
Excess fair value amortization .......................................
Accrual-based income.....................................................
Noncontrolling interest in Omegas income ................
$70,000
(10,000)
60,000
30%
$18,000
29. (continued)
Noncontrolling Interest in Delta's Income:
Reported operating income ............................................
Equity income investment in Omega (70% $60,000)
Amortization expense .....................................................
2010 Unrealized income realized in 2011.......................
2011 Unrealized income realized in 2011 ......................
Accrual-based incomeDelta (2011) ............................
Noncontrolling interest in Delta's income (2011) ........
Noncontrolling interest in Delta Company....................
Noncontrolling interest, 1/01/11 (Entry S2)..............
Noncontrolling interest, 1/01/11 (Entry A)................
Noncontrolling interest in Deltas income (above).
Dividends paid to noncontrolling interest
($40,000 20%).........................................................
Noncontrolling interest in Delta, 12/31/11..........
Noncontrolling interest in Omega Company.................
Noncontrolling interest, 1/01/11 (Entry S1)..............
Noncontrolling interest in Omegas income (above)
Noncontrolling interest, 1/01/11 (Entry A)................
Dividends paid to noncontrolling interest ($50,000 30%)
Noncontrolling interest in Omega, 12/31/11.......
$131,000
42,000
(6,250)
15,000
(22,000)
$159,750
20%
$31,950
$99,600
22,500
31,950
(8,000)
$146,050
$60,000
18,000
33,000
(15,000)
$96,000
Chapter 7 Excel Case Solution
Summit
Treeline
Basecamp
Operating
income
$345,000
$280,000
$175,000
Ownership percentages
Summit-->Treeline
Treeline-->Basecamp
Dividends
paid
$150,000
$100,000
$40,000
Excess
amortizations
$20,000
$25,000
90%
70%
Treeline's share of Basecamp income:

Basecamp operating income
Excess amortization
Accrual based income
Treeline ownership percentage
Equity income from Basecamp
$175,000
(25,000)
$150,000
70%
$105,000
Summit's share of Treeline income:

Treeline operating income
Equity income from Basecamp
Excess amortization
Treeline adjusted income
Summit ownership percentage
Summit's share of reported income
$280,000
105,000
(20,000)
$365,000
90%
$328,500
Controlling interest in net income

Summit's operating income
Equity earnings in Treeline and Basecamp
Summits net income
$345,000
328,500
$673,500
Comparison
Consolidated net income (operating incomes less
amortizations)
Noncontrolling interest in consolidated net income
(30% $150,000 plus 10% $365,000)
Controlling interest in consolidated net income
$755,000
$81,500
$673,500
Difference between Summits net income and controlling interest in

consolidated net income = -0-
RESEARCH CASE: CONSOLIDATED TAX EXPENSE

At www.thecoca-colacompany.com the annual financial statements and 10-K
provide an excellent set of statements and footnotes to review disclosures for
consolidated income tax issues.
In particular Note 17 provides details of the consolidated tax expense in
Coca-Colas 2006 annual report. The excerpt below shows the portion of the
footnote relating to components of deferred tax assets and liabilities and
carryforwards.

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CHAPTER 7

CONSOLIDATED FINANCIAL STATEMENTS - OWNERSHIP

Indirect subsidiary control

III. Mutual ownership

The McGraw-Hill Companies, Inc., 2009

V. Income tax accounting for a business combinationseparate tax returns

The McGraw-Hill Companies, Inc., 2009

The McGraw-Hill Companies, Inc., 2009

A father-son-grandson relationship is a specific type of ownership configuration often

In a business combination having an indirect ownership pattern, at least one company is

The McGraw-Hill Companies, Inc., 2009

companies with large amounts of intercompany transactions, the deferral

The McGraw-Hill Companies, Inc., 2009

The McGraw-Hill Companies, Inc., 2009

Crimson's accrual-based income:

Bassett's accrual-based income:

8. C Icede's accrual-based income:

Healthstone's accrual-based income:

Total noncontrolling interest = $111,600 ($32,000 + $79,600)

The McGraw-Hill Companies, Inc., 2009

9. D Juvyn's Operational Income ...........................................................

10. A Equity Income (60% of $200,000) ...................................................

11. C Unrealized Gain:

12. A Recognition of this gain is not required on a consolidated tax return.

14. (35 Minutes) (Series of reporting and consolidation questions pertaining to a

The McGraw-Hill Companies, Inc., 2009

b. Leaf2010 income (revenues minus expenses)

The McGraw-Hill Companies, Inc., 2009

c. Consolidated sales (total for the companies)

Noncontrolling interest in income of Limb:

e. 2010 Realized income of Limb (prior to accounting

2011 Realized Income of Limb (prior to accounting

In b., an adjustment of $50,610 was made to the beginning 2011 retained

The McGraw-Hill Companies, Inc., 2009

(15 minutes) (Income and noncontrolling interest with mutual

a. Consideration transferred by Uncle ..............................

(35 Minutes) (Consolidated income for a father-son-grandson combination.)

a. Mesa's operating income

The McGraw-Hill Companies, Inc., 2009

= $200,000 (add the three book values)

Dividend Income = -0- (eliminated for consolidation purposes)

Sales = $1,800,000 (add the two book values)

Cost of goods sold = $1,020,000 (add the two book values)

Dividend income = -0- (eliminated for consolidation purposes)

Common Stock = $880,000 (the parent company balance only)

Dividend Income = -0- (eliminated for consolidation purposes)

The McGraw-Hill Companies, Inc., 2009

b. On separate returns, the unrealized gains are reported as taxable income.

Total Income Tax Payable: Current = $67,800 ($37,800 + $30,000)

The McGraw-Hill Companies, Inc., 2009

The McGraw-Hill Companies, Inc., 2009

Because no temporary differences exist in this problem, the income tax

The McGraw-Hill Companies, Inc., 2009

The McGraw-Hill Companies, Inc., 2009

The McGraw-Hill Companies, Inc., 2009

Consequently, Kew's accounts will be consolidated as follows: (parentheses

The McGraw-Hill Companies, Inc., 2009

25. (55 Minutes) (Consolidation worksheet for a father-son-grandson combination.

Ending Unrealized Gain (Wilson)

Transfer Price (goods remaining) =

The McGraw-Hill Companies, Inc., 2009

The McGraw-Hill Companies, Inc., 2009

Noncontrolling Interest in Net Income of Cuddy