Chapter 12
Reporting and Interpreting Investments in
Other Corporations
ANSWERS TO QUESTIONS
1.
A short-term investment is one that meets the two tests of (1) ready marketability
and (2) management intention to convert it to cash in the short run. In contrast, a
long-term investment is one that does not meet both of these tests. Most longterm investments are marketable securities, either stocks or bonds. A short-term
investment is classified as a current asset on the balance sheet, while long-term
investments are reported as noncurrent assets.
2.
For passive investments in bonds, companies may report the investment at
unamortized cost if the intent is to hold the bonds until maturity. Otherwise, the
investments in bonds are to be accounted for using the same market value
method as is used for passive investments in equity securities. Each year-end,
the investments are adjusted to market value. Passive equity investments are
those in which the investor has less than 20% of the outstanding shares of voting
common stock, unless there is evidence to the contrary.
When a company can exert significant influence over the investing and financing
decisions of another company, the equity method is used to account for and
report the investment. In applying the equity method, considered a “one-line
consolidation,” dividends received from the investee company reduce the
investment account; the investor’s percentage share of the investee’s net income
or loss is included as income or loss on the investor’s income statement with a
corresponding change in the investment account. The ability to exert significant
influence over an investee company is presumed if the investor owns between
20% and 50% of the outstanding shares of voting common stock.
When an investor owns over 50% of the outstanding shares of voting common
stock, the investor has control over the investee. Consolidated statements are
prepared.
3.
Only bonds that management has the plans and ability to hold until maturity can
be reported in the held-to-maturity portfolio. The investment in held-to-maturity
bonds is reported on the balance sheet at unamortized cost, not market value, at
the end of each year.
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4.
When shares of capital stock of another company are purchased as an
investment, they are measured and recorded at cost in accordance with the cost
principle. Cost is defined as the total expenditures incurred in obtaining the other
shares. The total outlay includes the market price plus all commissions and other
buying costs.
5.
Under the market value method, revenues are measured by the investor
company in periods during which the other company declares a cash dividend.
Unrealized gains and losses are recorded when the stock price increases or
decreases.
6.
Under the equity method, investment revenue is measured on a proportionate
basis by the investor company when earnings are reported by the investee
company, rather than when the dividends are received. This is because the
equity method is applied in the situation where the investor company has a
sufficient number of the shares of voting stock of the other company to exercise a
significant influence. When a significant influence can be exercised over the
dividend policies of another corporation, it means that income of the other
corporation can be obtained, almost at will, by the investor company. Thus, when
the investee company reports income, the investor company should record a
proportionate share of that income as investment revenue because it is
considered earned under the requirements of the revenue principle.
7.
Under the equity method, dividends received from the investee company (the
other company) are not recorded as revenue because to record the dividends as
revenue would involve double counting. There would be double counting because
the investor company has already shown, as revenue earned, its proportionate
share of the earnings of the investee company. Because the dividends from the
investee company are paid out of those earnings, to record them as revenue by
the investor company would be double counting. As a consequence, under the
equity method, a dividend received from the investee company is debited to Cash
and credited to the Investment account.
8. A combination by purchase typically occurs when one corporation acquires a
controlling interest in the voting common stock of another corporation by
purchasing the shares either through the expenditure of cash, other assets, or by
incurrence of debt.
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Solutions Manual
9.
When there is a combination by purchase, goodwill is usually recognized on the
consolidated financial statements. Goodwill occurs when the parent company
pays a price for the shares of the subsidiary acquired which includes not only the
regular assets of the subsidiary, but an additional amount which is deemed to
represent a payment for the reputation and customer appeal which the subsidiary
has developed. The amount identified with this customer appeal and good
reputation is known as goodwill. In preparing the consolidated statements under
combination by purchase, the goodwill must be recognized as an asset and is not
expensed unless impaired.
10. A parent-subsidiary relationship exists when one company owns a sufficient
number of voting shares of the capital stock of another company to exercise
control over it. The number of shares usually required to establish a parentsubsidiary relationship is more than 50 percent. The investing company is known
as the parent and the other corporation is called the subsidiary. Both corporations
continue as separate legal entities and each prepares its own separate financial
statements. However, because of their special relationship, they are viewed for
financial measuring and reporting purposes as a single economic entity.
Therefore, the parent company (but not the subsidiary) is required to prepare
consolidated financial statements.
11. The basic concept underlying consolidated statements is that, when there is a
parent-subsidiary relationship (the parent company owns more than 50 percent of
the voting stock of the other corporation and there is economic compatibility), it
must be viewed as a single economic entity.
At the end of each period, both companies prepare their own separate financial
statements; then, under the concept of consolidated statements, these separate
statements are combined, or aggregated, by the parent on an item-by-item basis
to develop the consolidated financial statements. Thus, the consolidated
statements do not affect the accounting for the parent or the subsidiaries, but
affect only the reporting phase of the combined entity.
12. The basic element that must be present before consolidated statements are
appropriate is: control of another entity—control is assumed to exist when more
than 50 percent of the voting stock of another entity is owned by one investor.
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13. In combining the separate financial statements of a parent and a subsidiary in the
consolidation process, each item on the financial statements of each company is
added on a line-by-line basis to obtain the consolidated amount. However, before
aggregation (i.e., consolidation) in this manner, certain intercompany amounts
must be eliminated. These intercompany amounts are items that are strictly
between the two companies and if not eliminated would result in double counting.
For example, the investment account on the parent company’s books, in effect,
represents the assets of the subsidiary. When the assets of the subsidiary, item
by item, are added to those of the parent, the investment account must be
eliminated, otherwise the assets would be included in the consolidated amounts
twice. In a similar manner the proportionate share of owners’ equity of a
subsidiary owned by the parent must be eliminated.
MULTIPLE CHOICE
1. c)
2. d)
3. c)
4. d)
5. d)
6. c)
7. c)
8. b)
9. d)
10. c)
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Solutions Manual
Authors’ Recommended Solution Time
(Time in minutes)
Mini-exercises
No.
Time
1
3
2
3
3
6
4
6
5
6
6
6
7
6
8
6
9
5
10
10
11
5
Exercises
No.
Time
1
10
2
15
3
20
4
20
5
20
6
20
7
25
8
10
9
10
10
10
11
10
12
25
13
20
Problems
No.
Time
1
20
2
30
3
45
4
40
5
40
6
40
7
20
8
30
9
20
10
30
Alternate
Problems
No.
Time
1
20
2
30
3
45
4
40
5
20
6
30
7
20
Cases and
Projects
No.
Time
1
20
2
15
3
30
4
20
5
10
6
20
7
20
8
*
* Due to the nature of this project, it is very difficult to estimate the amount of time
students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While
students often benefit from the extra effort, we find that some become frustrated by
the perceived difficulty of the task. You can reduce student frustration and anxiety by
making your expectations clear. For example, when our goal is to sharpen research
skills, we devote class time to discussing research strategies. When we want the
students to focus on a real accounting issue, we offer suggestions about possible
companies or industries.
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MINI-EXERCISES
M12–1.
C
D
A
B
A
D
B
More than 50 percent ownership.
Bonds held to maturity.
Less than 20 percent ownership.
At least 20 percent but not more than 50 percent ownership.
Current market value.
Original cost less any amortization of premium or discount associated with the
purchase.
Original cost plus proportionate part of the income of the investee less
proportionate part of the dividends declared by investee.
M12–2.
Investment in bonds (+A) ......................................................
Cash (A) ..........................................................................
1,070,000
1,070,000
M12–3.
December 2, 2008:
Investment in TS (+A) ...........................................................
224,000
224,000
Cash (A) .......................................................................
Purchased 8,000 shares (16%) of Cox Corporation common stock at $28 per share.
December 15, 2008:
Cash (+A) ..............................................................................
Investment income (+R, +SE)........................................
Cash dividend received (8,000 shares x $2 = $16,000).
December 31, 2008:
Net unrealized loss/gain – TS (+Loss, SE)..........................
Allowance to value at market – TS (A) .........................
Market
$200,000

16,000
16,000
24,000
24,000
Cost = Allowance Balance  Unadjusted Balance = Adjustment
$224,000
$24,000
$0
$24,000
McGraw-Hill/Irwin
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Solutions Manual
M12–4.
December 2, 2008:
Investment in SAS (+A) .........................................................
224,000
224,000
Cash (A) .......................................................................
Purchased 8,000 shares (16%) of Cox Corporation common stock at $28 per share.
December 15, 2008:
Cash (+A) ..............................................................................
Investment income (+R, +SE)........................................
Cash dividend received (8,000 shares x $2 = $16,000).
16,000
16,000
December 31, 2008:
Net unrealized loss/gain – SAS (SE)...................................
Allowance to value at market – SAS (A) ......................
24,000
24,000
Market  Cost = Allowance Balance  Unadjusted Balance = Adjustment
$200,000
$224,000
$24,000
$0
$24,000
M12–5.
Transaction
Assets
12/2
+224,000
–224,000
12/15
+16,000
12/31
–24,000
Balance Sheet
Stockholders’
Liabilities
Equity
+16,000
–24,000
Income Statement
Revenues Expenses
+16,000
+24,000
Net
Income
+16,000
–24,000
M12–6.
Transaction
Assets
12/2
+224,000
–224,000
12/15
+16,000
12/31
–24,000
McGraw-Hill/Irwin
Financial Accounting, 5/e
Balance Sheet
Stockholders’
Liabilities
Equity
+16,000
–24,000
Income Statement
Revenues Expenses
+16,000
Net
Income
+16,000
© The McGraw-Hill Companies, Inc., 2007
12-7
M12–7.
July 2, 2008:
Cash (+A) ..............................................................................
Investments in associated companies (A) ....................
Cash dividend received (10,000 shares x $3 = $30,000).
30,000
30,000
December 31, 2008:
Investments in associated companies (+A) ...........................
50,000
Equity in earnings of associated companies (+R, +SE) ..
Recognize earnings from associated company (25% x $200,000)
50,000
M12–8.
Transaction
7/2
12/31
Assets
+30,000
–30,000
+50,000
Balance Sheet
Stockholders’
Liabilities
Equity
+50,000
Income Statement
Revenues Expenses
+50,000
Net
Income
+50,000
M12–9.
Property and equipment (+A) ................................................
Goodwill (+A) ........................................................................
Bonds payable (+L) .......................................................
Cash (–A) ......................................................................
McGraw-Hill/Irwin
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630,000
70,000
100,000
600,000
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
M12–10.
Net income
Average total assets*
Return on assets
=
2007
$195,000
$60,000
2008
$201,000
$101,000
2009
$212,000
$139,500
3.25
1.99
1.52
* 2007: ($52,000 + $68,000)/2 = $60,000
2008: ($68,000 + $134,000)/2 = $101,000
2009: ($134,000 + $145,000)/2 = $139,500
Return on assets measures how much a company earned for each dollar of
investment in assets. For M.A.D. Company, the ratio has declined every year,
suggesting that management is utilizing total assets of the firm less efficiently over
time. Asset growth has not generated proportionate increases in net income.
M12–11.
Disney reports a large amount of goodwill because it has purchased other
businesses, paying more than the fair market value of the net assets of the acquired
companies.
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EXERCISES
E12–1.
Req. 1
July 1, 2007:
Investment in bonds (+A) ...................................................... 10,000,000
Cash (–A) .......................................................................
10,000,000
Req. 2
Dec 31, 2007:
Cash (+A) .............................................................................
Interest revenue (+R, +SE) .............................................
($10 million x 10% x 6/12 of a year)
500,000
500,000
E12–2.
Questions
a
b
c
d
e
f
g
Method of Measurement
Market Value Method
Equity Method
Less than 20%.
At least 20% but not more than
50%.
At cost: 1,000 shares x $19 =
At cost: 5,000 shares x $19 =
$19,000.
$95,000.
When Co. B declares a cash
When Co. B reports income or
dividend; not for any holding
loss for the period; not when
gains and losses on securitiesdividends are declared or paid.
available-for-sale.
Record increases and decreases Increase the investment account
based on stock price changes
for proportionate part of income,
through the valuation allowance.
less proportionate part of
dividends and losses, of Co. B.
1,000 shares x $15 = $15,000
Cost of $95,000 plus $12,500
market value.
($50,000 x 25%) equity in
investee’s earnings minus $2,500
($10,000 x 25%) dividends
received equals $105,000.
Company A owns 5% of
$50,000 Company B net income
Company B (1,000 shares ÷
x 25% = $12,500 equity in
20,000 shares outstanding).
earnings of investee.
$10,000 dividends declared x 5%
= $500 dividend revenue for
Company A.
1,000 x ($19 – $15) = $4,000
None.
reported in stockholders’ equity.
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Solutions Manual
E12–3.
June 30, 2007:
Investment in TS (+A) ...........................................................
Cash (–A) ..........................................................................
200,000
Dec 31, 2007:
Allowance to value at market – TS (+A) ................................
Net unrealized loss/gain – TS (+Gain, +SE) ......................
40,000
Dec. 31, 2008:
Allowance to value at market – TS (+A). ...............................
Net unrealized loss/gain – TS (+Gain, +SE) ......................
70,000
Dec. 31, 2009:
Net unrealized loss/gain – TS (+Loss, –SE)..........................
Allowance to value at market – TS (–A) ............................
60,000
200,000
40,000
70,000
60,000
Computations:
Year Market  Cost = Allowance Balance  Unadjusted Balance = Adjustment
2007 $240,000 $200,000
+$40,000
$0
+$40,000
2008 310,000 200,000
+110,000
+ 40,000
+ 70,000
2009 250,000 200,000
+ 50,000
+ 110,000
 60,000
Feb. 14, 2010:
Cash (+A) (10,000 shares x $22) ..........................................
Loss on sale of investment (+Loss, –SE) ..............................
Investment in TS (–A). .......................................................
Allowance to value at market – TS (–A) ............................
220,000
30,000
200,000
50,000
Note: The net unrealized loss/gain is an income statement account. This item is
reported on the current income statement and affects the computation of net income.
It is closed to Retained Earnings at the end of each year.
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E12–4.
June 30, 2007:
Investment in SAS (+A) .........................................................
Cash (–A) ..........................................................................
200,000
Dec. 31, 2007:
Allowance to value at market – SAS (+A).. ...........................
Net unrealized loss/gain – SAS (+SE) ...............................
40,000
Dec. 31, 2008:
Allowance to value at market – SAS (+A). ............................
Net unrealized loss/gain – SAS (+SE) ...............................
70,000
Dec. 31, 2009:
Net unrealized loss/gain – SAS (–SE)...................................
Allowance to value at market – SAS (–A). .........................
60,000
200,000
40,000
70,000
60,000
Computations:
Year Market  Cost = Allowance Balance  Unadjusted Balance = Adjustment
2007 $240,000 $200,000
+$40,000
$0
+$40,000
2008 310,000 200,000
+110,000
+ 40,000
+ 70,000
2009 250,000 200,000
+ 50,000
+ 110,000
 60,000
Feb. 14, 2010:
Cash (+A) (10,000 shares x $22). .........................................
Net unrealized loss/gain – SAS (–SE)...................................
Allowance to value at market – SAS (–A). .........................
Investment in SAS (–A). ....................................................
Gain on sale of investment (+Gain, +SE) ..........................
220,000
50,000
50,000
200,000
20,000
Note: The net unrealized loss/gain account is a balance sheet account. It does not
affect the computation of net income each year. Because it is a balance sheet
account, it maintains its balance from year to year. Therefore, the decline in stock
price that occurs in 2009 is reported as an adjustment to the net unrealized loss/gain
account. When the stock is sold in 2010, the net unrealized loss/gain is closed along
with the Allowance to Value at Market account, and the difference between the
purchase price (original cost) and the selling price is reported as a gain on the income
statement.
McGraw-Hill/Irwin
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Solutions Manual
E12–5.
March 10, 2006:
Investment in TS (+A) ...........................................................
Cash (–A) ..........................................................................
250,000
Dec. 31, 2006:
Allowance to value at market – TS (+A) ................................
Net unrealized loss/gain – TS (+Gain, +SE) ......................
25,000
Dec. 31, 2007:
Net unrealized loss/gain – TS (+Loss, –SE)..........................
Allowance to value at market – TS (–A) ............................
75,000
Dec. 31, 2008:
Allowance to value at market – TS (+A) ................................
Net unrealized loss/gain – TS (+Gain, +SE) ......................
10,000
250,000
25,000
75,000
10,000
Computations:
Year Market  Cost = Allowance Balance  Unadjusted Balance = Adjustment
2006 $275,000 $250,000
+$25,000
$0
+$25,000
2007 200,000 250,000
 50,000
+ 25,000
 75,000
2008 210,000 250,000
 40,000
 50,000
+ 10,000
Sept. 12, 2009:
Cash (+A) (5,000 shares x $39) ............................................
Allowance to value at market – TS (+A) ................................
Loss on sale of investment (+Loss, –SE) ..............................
Investment in TS (–A) ........................................................
195,000
40,000
15,000
250,000
Note: The net unrealized loss/gain is an income statement account. This item is
reported on the current income statement and affects the computation of net income.
It is closed to Retained Earnings at the end of each year.
McGraw-Hill/Irwin
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12-13
E12–6.
March 10, 2006:
Investment in SAS (+A) .........................................................
Cash (–A) ..........................................................................
250,000
Dec. 31, 2006:
Allowance to value at market – SAS (+A) .............................
Net unrealized loss/gain – SAS (+SE) ...............................
25,000
Dec. 31, 2007:
Net unrealized loss/gain – SAS (–SE)...................................
Allowance to value at market – SAS (–A) ..........................
75,000
Dec. 31, 2008:
Allowance to value at market – SAS (+A) .............................
Net unrealized loss/gain – SAS (+SE) ...............................
10,000
250,000
25,000
75,000
10,000
Computations:
Year Market  Cost = Allowance Balance  Unadjusted Balance = Adjustment
2006 $275,000 $250,000
+$25,000
$0
+$25,000
2007 200,000 250,000
 50,000
+ 25,000
 75,000
2008 210,000 250,000
 40,000
 50,000
+ 10,000
Sept. 12, 2009:
Cash (+A) (5,000 shares x $39) ............................................
Allowance to value at market – SAS (+A) .............................
Loss on sale of securities (+Loss, –SE) ................................
Investment in SAS (–A) .....................................................
Net unrealized loss/gain – SAS (+SE) ...............................
195,000
40,000
55,000
250,000
40,000
Note: The unrealized loss/gain account is a balance sheet account. It does not affect
the computation of net income each year. Because it is a balance sheet account, it
maintains its balance from year to year. Therefore, the decline in stock price that
occurs in 2007 is reported as an adjustment to the net unrealized loss/gain account
and the increase in stock price that occurs in 2008 is also reported as an adjustment
to the net unrealized loss/gain account. When the stock is sold in 2009, the net
unrealized loss/gain is closed along with the Allowance to Value at Market account,
and the difference between the purchase price and the selling price is reported as a
loss on the income statement.
McGraw-Hill/Irwin
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Solutions Manual
E12–7.
Req. 1
The equity method must be used because the company owns 35% (21,000 ÷ 60,000)
of the total shares outstanding of Nueces Corporation. The equity method must be
used when there is at least 20% but not more than 50% ownership in existence. The
Felicia Company must use the equity method because it can exercise significant
influence, but not control, over the operating and financing policies of Nueces
Corporation.
Req. 2
January 10, 2008:
Investment in associated companies (+A) ............................
Cash (–A) ..........................................................................
Purchased 21,000 shares (35%) of the common stock of
Nueces Corp. at $12 per share.
December 31, 2008:
Investment in associated companies (+A). ...........................
Equity in earnings of associated companies (+R, +SE) .....
To record 35% of the revenue reported by Nueces Corp.
($90,000 x 35% = $31,500)
December 31, 2008:
Cash (+A) ..............................................................................
Investment in associated companies (–A). ........................
To record 35% of cash dividends paid by Nueces Corp.
(21,000 shares x $.60 = $12,600)
252,000
252,000
31,500
31,500
12,600
12,600
No entry is made under the equity method to record changes in market value.
Req. 3
Balance Sheet—At December 31, 2008
Long-term Investments:
Investment in associated companies (equity basis*) ....................................
$270,900
Income Statement—For the Year Ended December 31, 2008
Equity in earnings of associated companies .................................................
$ 31,500
*
Investment in Associated Companies
Cost
252,000
% Investee’s net income
31,500 12,600
% Investee’s dividends declared
270,900
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12-15
E12–8.
Req. 1
Req. 2
Investing activities
Purchase of investments in associated companies
–252,000
Operating activities
Net Income
Adjusted for:
Equity in earnings of associated companies
(no cash received)
Dividends received from associated companies
(cash received)
–31,500
+12,600
E12–9.
(in millions)
Assets (+A, not detailed). ......................................................
Goodwill (+A) ........................................................................
Liabilities (+L, not detailed) ..............................................
Cash (–A) ..........................................................................
550
320
170
700
E12–10.
1.
Return on Assets =
$117,879
($538,671 + $641,716)  2
Net Income
Average Total Assets
= .20 (20%)
2. ROA measures how much the firm earned for each dollar of investment. It is the
broadest measure of profitability and management effectiveness, independent of
financing strategy.
McGraw-Hill/Irwin
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Solutions Manual
E12–11.
Consolidation is an accounting process that brings together financial information from
two or more companies to make it appear as if there is a single economic entity.
These companies may have engaged in transactions with each other during the year
(these transactions are called intercompany transactions). Some examples are
lending money or selling merchandise. During consolidation, intercompany
transactions are eliminated or reversed so that on the consolidated statements, it
appears as if the transactions never took place.
It is necessary to eliminate intercompany transactions because a single economic
entity cannot logically do business with itself. It makes no sense, for example, to
report as a liability an amount that an entity owes itself.
E12–12.
Req. 1
Investment in Co. S (100%) (+A) ..........................................
Cash (–A) ...................................................................
Purchased all of the outstanding stock (4,000 shares) of Co. S.
80,000
Req. 2
Purchase price for 100% interest in Co. S ....................................................
Market value of Company S net assets purchased equaled book value
($60,000 – $9,000) ....................................................................................
Goodwill purchased .......................................................................................
McGraw-Hill/Irwin
Financial Accounting, 5/e
80,000
$80,000
51,000
$29,000
© The McGraw-Hill Companies, Inc., 2007
12-17
E12–12. (continued)
Req. 3
COMPANY P AND ITS SUBSIDIARY, COMPANY S (100% OWNED)
Consolidated Balance Sheet (purchase method)
January 1, 2007 (immediately after acquisition)
Separate Balance Sheets
Company P Company S
Assets:
Cash .................................
$ 12,000
Investment in Co. S (at cost)
80,000
Property and equipment (net)
48,000
Goodwill ............................
Totals ............................
$140,000
Liabilities:
Liabilities ...........................
$ 40,000
Stockholders’ Equity:
Common stock, Co. P .......
90,000
Common stock, Co. S .......
Retained earnings, Co. P ..
10,000
Retained earnings, Co. S ..
Totals ............................
$140,000
Consolidated
Eliminations Balance Sheet
$18,000
$ 30,000
– 80,000
42,000
$60,000
90,000
29,000
$149,000
$ 9,000
$ 49,000
+ 29,000
90,000
– 40,000
40,000
10,000
– 11,000
11,000
$60,000
$149,000
E12–13.
Goodwill calculation:
Purchase price
Market value of net assets
Goodwill
$100,000
96,000
$ 4,000
Additional Depreciation ($6,000  3 years)
$
Revenues ($500,000 + 75,000)
Expenses ($350,000 + $50,000 + $2,000)
Net Income
$575,000
402,000
$173,000
McGraw-Hill/Irwin
12-18
2,000
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
PROBLEMS
P12–1.
Req. 1
When the bonds are purchased, the company increases Investment in Bonds
Held-to-Maturity and decreases Cash.
Req. 2
When interest is received on the investments, Cash increases and Interest
Revenue increases. The bonds were purchased at par; the Investment in Bonds
Held-to-Maturity account is not affected.
Req. 3
No journal entry is required. A decrease in the market value of bonds in the heldto-maturity portfolio is not recorded.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
12-19
P12-2.
Req. 1
March 1, 2006
Investment in TS (+A) ..........................................................
Cash (–A) ..........................................................................
200,000
Dec. 31, 2006
Net unrealized loss/gain – TS (+Loss, –SE)..........................
Allowance to value at market – TS (–A) ............................
30,000
Dec. 31, 2007
Allowance to value at market – TS (+A) ................................
Net unrealized loss/gain – TS (+Gain, +SE) ......................
70,000
Dec. 31, 2008
Allowance to value at market – TS (+A) ................................
Net unrealized loss/gain – TS (+Gain, +SE) ......................
70,000
200,000
30,000
70,000
70,000
Req. 2
March 1, 2006
Investment in SAS (+A) .........................................................
Cash (–A) ..........................................................................
200,000
Dec. 31, 2006
Net unrealized loss/gain – SAS (–SE)...................................
Allowance to value at market – SAS (–A) ..........................
30,000
Dec. 31, 2007
Allowance to value at market – SAS (+A) .............................
Net unrealized loss/gain – SAS (+SE) ...............................
70,000
Dec. 31, 2008
Allowance to value at market – SAS (+A) .............................
Net unrealized loss/gain – SAS (+SE) ...............................
70,000
200,000
30,000
70,000
70,000
Computations:
Year Market  Cost = Allowance Balance  Unadjusted Balance = Adjustment
2006 $170,000 $200,000
$30,000
$0
$30,000
2007 240,000 200,000
+ 40,000
 30,000
+ 70,000
2008 310,000 200,000
+110,000
+ 40,000
+ 70,000
McGraw-Hill/Irwin
12-20
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P12–3.
Req. 1
The market value method must be used for both the Q common stock and R preferred
stock. The market value method must be used for Q common stock because only
14% of it is owned. If less than 20% of the outstanding stock is owned, it is assumed
there can be no exercise of significant influence or control; therefore, the market value
method must be used. The market value method is used for R preferred stock,
regardless of the level of ownership, because it is nonvoting stock; there is no
significant influence or control.
Req. 2
2008
a.
Acquisition of the investments:
Investment in SAS (+A)* ...................
Cash (–A) ......................................
Q common stock: 12,600 shares x $5
R preferred stock: 12,000 shares x $30
Total investment .................................
2009
423,000
423,000
=
=
$ 63,000
360,000
$423,000
* Investment is classified as a security available for sale because management
intends to hold the investment long term.
b.
Income reported by Corporations Q & R:
No entry is required for either the common or preferred stock because, under the
market value method, revenue is recognized only when dividends are declared.
c.
Dividends received:
Cash (+A) ..........................................
Investment income (+R, +SE) .......
22,710
2008: Q common stock: 12,600 shares x $.85
R preferred stock: 12,000 shares x $1.00
Total .........................................................
2009: Q common stock: 12,600 shares x $.90
R preferred stock: 12,000 shares x $1.10
Total .........................................................
McGraw-Hill/Irwin
Financial Accounting, 5/e
24,540
22,710
=
=
=
=
24,540
$10,710
12,000
$22,710
$11,340
13,200
$24,540
© The McGraw-Hill Companies, Inc., 2007
12-21
P12–3. (continued)
2008
d. Market value effects:
Net unrealized gain/loss – SAS (–SE)
24,600
Allowance to value at market – SAS (–A)
2009
24,600
Allowance to value at market - SAS (+A)
Net unrealized gain/loss - SAS (+SE)
12,000
12,000
Computations:
Year
Market  Cost = Allowance Balance  Unadjusted Balance = Adjustment
2008 Q $50,400 $63,000
$12,600
$0
$12,600
(12,600 x $4)
R 348,000 360,000
(12,000 x $29)
2009 Q 50,400
(12,600 x $4)
63,000
R 360,000 360,000
(12,000 x $30)
 12,000
 12,600
0
 12,600
0
 12,000
Req. 3
a. Balance Sheet:
Long-term Investments:
Investment in SAS (at market)...........................................
b. Stockholders’ Equity:
Net unrealized loss/gain – SAS .........................................
c. Income Statement:
Investment income ............................................................
McGraw-Hill/Irwin
12-22
 12,000
 24,600
0
+ 12,000
+ 12,000
2008
$398,400
2009
$410,400
(24,600)
(12,600)
22,710
24,540
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P12–4.
Req. 1
Aug. 4, 2007
Investment in TS (+A) ...........................................................
45,000
Cash (–A) .......................................................................... 45,000
Dec. 31, 2007 Allowance to value at market – TS (+A) ................................
7,000
Net unrealized loss/gain – TS (+Gain, +SE) ......................
June 1, 2008
7,000
Cash (+A) ..............................................................................
2,000
Investment income (+R, +SE) ...........................................
2,000
Dec. 31, 2008 Net unrealized loss/gain – TS (+Loss, –SE) .........................
5,000
Allowance to value at market – TS (–A) ............................
5,000
June 1, 2009
Cash (+A) ..............................................................................
2,000
Investment income (+R, +SE) ...........................................
2,000
Dec. 31, 2009 Net unrealized loss/gain – TS (+Loss, –SE) .........................
9,000
Allowance to value at market – TS (–A) ............................
9,000
Computations for Year-End Adjustments to Market:
Year Market  Cost = Allowance Balance  Unadjusted Balance = Adjustment
2007 $52,000
$45,000
+$7,000
$0
+$7,000
2008 47,000
45,000
+ 2,000
+ 7,000
 5,000
2009 38,000
45,000
 7,000
+ 2,000
 9,000
Req. 2
Aug. 4, 2007
Investment in SAS (+A) .........................................................
45,000
Cash (–A) .......................................................................... 45,000
Dec. 31, 2007 Allowance to value at market – SAS (+A) .............................
7,000
Net unrealized loss/gain – SAS (+SE) ............................... 7,000
June 1, 2008
Cash (+A) ..............................................................................
2,000
Investment income (+R, +SE) ........................................... 2,000
Dec. 31, 2008 Net unrealized loss/gain – SAS (–SE) ..................................
5,000
Allowance to value at market – SAS (–A) .......................... 5,000
June 1, 2009
Cash (+A) ..............................................................................
2,000
Investment income (+R, +SE) ........................................... 2,000
Dec. 31, 2009 Net unrealized loss/gain – SAS (–SE) ..................................
9,000
Allowance to value at market – SAS (–A) .......................... 9,000
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
12-23
P12–4. (continued)
Req. 3
Aug. 4, 2007
Investment in associated companies(+A) .............................
Cash (–A) ..........................................................................
Dec. 31, 2007
Investment in associated companies (+A) ............................
Equity in earnings of associated companies (+R, +SE) .....
(30% x $50,000)
June 1, 2008
Cash (+A) ..............................................................................
Investment in associated companies (–A) .........................
Dec. 31, 2008
Investment in associated companies (+A) ............................
Equity in earnings of associated companies (+R, +SE) .....
(30% x $50,000)
June 1, 2009
Cash (+A) ..............................................................................
Investment in associated companies (–A) .........................
Dec. 31, 2009
Investment in associated companies (+A) ............................
Equity in earnings of associated companies (+R, +SE) .....
(30% x $50,000)
McGraw-Hill/Irwin
12-24
45,000
45,000
15,000
15,000
2,000
2,000
15,000
15,000
2,000
2,000
15,000
15,000
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P12–5.
Req. 1
CASE A
CASE B
The market value method must be used by Company D because it owns 12%
(3,600 ÷ 30,000) of the total outstanding common shares of Company C. The
market value method must be used when less than 20% of the outstanding
shares are owned because the investor (Company D) cannot exercise
significant influence or control.
The equity method must be used by Company D because it owns 35% (10,500
÷ 30,000) of the outstanding common shares of Company C. The equity
method must be used if the level of ownership is at least 20% but not more
than 50% because the investor (Company D) can exercise significant influence,
but not control, over the operating and financing policies of Company C.
Req. 2
Case A-12%
Case B-35%
a. January 1, 2007 purchase:
Investment in SAS (+A) ....................
(3,600 shares x $25)
Cash (–A) ..................................
Investment in assoc. co. (+A) ...........
(10,500 shares x $25)
Cash (–A) ..................................
b. Income reported by Company C:
90,000
90,000
262,500
262,500
None
Investment in assoc. company (+A) ..
Equity in earnings of assoc. co.
(+R, +SE) .....................................
($50,000 x 35%)
c. Dividends declared and paid by Co. C:
Cash (+A) .........................................
Investment income (+R, +SE) .......
17,500
17,500
3,060
3,060*
Cash (+A)..........................................
Investment in assoc. company (–A)
*Computations
d.
8,925
8,925*
$25,500 x 12% = $3,060
$25,500 x 35% = $8,925
Net unrealized loss/gain (–SE)..........
10,800
Allowance to value at market– SAS
(–A) ...............................................
3,600 shares x ($22 market – $25 cost) =
$10,800.
McGraw-Hill/Irwin
Financial Accounting, 5/e
None
10,800
© The McGraw-Hill Companies, Inc., 2007
12-25
P12–5. (continued)
Req. 3
Case A-12%
Balance Sheet:
Investments:
Investment in SAS (1)
Investment in associated company (2) .
Stockholders’ Equity:
Other comprehensive income:
Net unrealized loss/gain – SAS .......
Income Statement:
Investment income ................................
Equity in earnings of associated co. .....
Case B-35%
$79,200
$271,075
(10,800)
3,060
None
None
None
17,500
(1) Cost $90,000 – Allowance to value at market $10,800 = $79,200 market value
(reported on balance sheet)
(2) Cost $262,500 + % Investee’s net income $17,500 – % Investee’s dividends
declared $8,925 = $271,075 book value (reported on balance sheet)
Req. 4
Assets (investments), stockholders’ equity (retained earnings), and revenues (from
investments) are different because (1) different methods of recognizing revenue are
required and (2) adjustments for changes in market value are recorded only under the
market value method.
McGraw-Hill/Irwin
12-26
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P12–6.
Req. 1
CASE The market value method must be used by the company because it owns 10%
A
(10,000 ÷ 100,000) of the total shares of the outstanding common stock of Ship
Corporation. The market value method must be used when less than 20% of the
outstanding stock is owned because the investor cannot exercise either significant
influence or control.
CASE The equity method must be used by the company because it owns 40% (40,000 ÷
B
100,000) of the total shares of the outstanding common stock of Ship Corporation.
The equity method must be used when at least 20% but not more than 50% of the
outstanding stock is owned, because the investor can exercise significant influence,
but not control, over the operating and financing policies of the other company.
Req. 2
Case A-10%
a.
b.
c.
d.
1
Jan. 10, 2008 Stock acquisition:
Investment in SAS (+A) .....................
(10,000 shares x $20)
Cash (–A) ...................................
Investment in assoc. co. (+A) ............
(40,000 shares x $20)
Cash (–A) ...................................
200,000
200,000
800,000
800,000
None1
Net income of Ship Co.:
Investment in assoc. company (+A) ..
Equity in earnings of assoc. co.
(+R, +SE) ($300,000 x 40%) ........
120,000
120,000
Dividends paid by Ship Corporation:
Cash (+A) ..........................................
Investment income (+R, +SE) .......
(10,000 shares x $.60)
Cash (+A) ..........................................
Investment in assoc. company (–A)
(40,000 shares x $.60)
6,000
6,000
24,000
24,000
Year-end valuation:
Net unrealized loss/gain – SAS (–SE)
20,000
Allowance to value at market –
SAS (–A) .......................................
[10,000 x ($18 market – $20 cost) = $20,000]
Not recorded under market value method.
McGraw-Hill/Irwin
Financial Accounting, 5/e
Case B-40%
2
None2
20,000
Not recorded under the equity method.
© The McGraw-Hill Companies, Inc., 2007
12-27
P12–6. (continued)
Req. 3
Case A
a. Balance Sheet:
Long-term Investments:
Investment in SAS, at market (1) ......................................
Investment in assoc. co. (2) ..............................................
b. Stockholders’ Equity
Other comprehensive income:
Net unrealized loss/gain – SAS ....................................
c. Income Statement:
Investment income ...........................................................
Equity in earnings of assoc. co. .......................................
Case B
$180,000
$896,000
(20,000)
6,000
120,000
(1) Cost $200,000 – Allowance to value at market $20,000 = Market value $180,000
reported on the balance sheet
(2) Cost $800,000 + % Investee’s net income $120,000 – % Investee’s dividends
declared $24,000 = $896,000 reported on the balance sheet
Req. 4
The amounts reported in Requirement (3) are different because of (1) the two
different approaches used in recognizing investment revenue and (2) adjustments for
changes in market value that are made only under the market value method.
P12–7.
Since Oscar Company acquired 45% (40,500/90,000) of Selma’s outstanding
common stock, this investment is accounted for using the equity method.
Statement of Cash Flows:
Operating activities
Net Income
$xxx,xxx
Adjusted for:
Equity in earnings of associated companies (no cash received) –99,000
Dividends received from associated companies (cash received) +81,000
Investing activities
Purchase of investments in associated companies
–1,336,500
(Note that the change in market value does not have any effect on the cash flow
statement.)
McGraw-Hill/Irwin
12-28
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P12–8.
Req. 1
Purchase price for the net assets
Market value of net assets acquired*
Goodwill purchased
$120,000
83,000
$ 37,000
*$23,000 cash + $72,000 property and equipment – $12,000 liabilities = $83,000
Req. 2
Property and equipment (+A) ................................................
Goodwill (+A) ........................................................................
Liabilities (not detailed) (+L) .............................................
Cash (–A) ($120,000 paid - $23,000 received)..................
72,000
37,000
12,000
97,000
Req. 3
Pronti Company
Consolidated Balance Sheet
January 4, 2007 (immediately after acquisition)
Cash
Property and equipment (net)
Goodwill
Total assets
$ 21,000 ($141,000 - $120,000)
204,000 ($132,000 + $72,000)
37,000
$262,000
Liabilities
Common stock
Retained earnings
Total liabilities and stockholders’ equity
$ 39,000 ($27,000 + $12,000)
120,000
103,000
$262,000
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
12-29
P12–9.
Req. 1
Net income
Average total
assets*
Return on assets
=
2003
2002
2001
$3,077
$166,718
$4,079
$169,131.5
$389
$167,765
.018 (or 1.8%)
.024 (or 2.4%)
.002 (or 0.2%)
* 2003: ($165,968 + 167,468)/2 = $166,718
2002: ($167,468+ 170,795)/2 = $169,131.5
2001: ($170,795+ 164,735)/2 = $167,765
Req. 2
ROA measures how much the firm earned for each dollar of investment. It is the
broadest measure of profitability and management effectiveness, independent of
financing strategy. Verizon’s ROA increased in 2002, but decreased in 2003,
suggesting that management’s efficiency at utilizing assets to generate income is
changing over time.
McGraw-Hill/Irwin
12-30
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P12-10
Req. 1
January 4, 2008:
Investment in Syracuse Co. (8,000 shares) (+A) ..................
Cash (8,000 shares x $12) (–A).........................................
Purchased 100% of stock of Syracuse Co. at $12 per share.
96,000
96,000
Req. 2
Purchase price for 100% interest in Syracuse Co. .......................................
Market value of net assets purchased ($23,000 + $72,000 – $12,000) ........
Goodwill purchased .......................................................................................
$96,000
83,000
$13,000
Req. 3
The assets of Syracuse Company will be included on the consolidated balance sheet
prepared by Penn Company at their market values at date of acquisition. This is a
combination by purchase; therefore, the cost principle is applied.
Req. 4
PENN COMPANY AND SUBSIDIARY
Consolidated Balance Sheet
January 4, 2008 (immediately after acquisition)
Separate
Balance Sheets
Penn
Syracuse
Company
Company
Assets:
Cash ..................................
Investment in Syracuse Co.
Property & equipment (net) ..
Goodwill ............................
Totals .............................
Liabilities:
Liabilities ...........................
Stockholders’ Equity:
Common stock, Penn ........
Common stock, Syracuse .
Retained earnings, Penn...
Retained earnings, Syrac ..
Totals .............................
McGraw-Hill/Irwin
Financial Accounting, 5/e
Eliminations
Consolidated
Balance Sheet
$ 22,000
96,000
132,000
$23,000
$250,000
$88,000
204,000
13,000
$262,000
$ 27,000
$12,000
$ 39,000
65,000
$ 45,000
–
+
+
96,000
7,000
13,000
120,000
120,000
40,000
–
40,000
36,000
$88,000
–
36,000
103,000
$250,000
103,000
$262,000
© The McGraw-Hill Companies, Inc., 2007
12-31
ALTERNATE PROBLEMS
AP12–1.
Req. 1
When the bonds are purchased, the company increases Investment in Bonds
Held-to-Maturity and decreases Cash.
Req. 2
When interest is received on the investments, Cash increases (based on the
stated rate) and Interest Revenue increases (based on the effective rate). The
bonds were purchased at a premium, so the Investment in Bonds Held-toMaturity account is decreased for the difference between the cash received and
the interest revenue recorded.
Req. 3
No journal entry is required. A decrease in the market value of bonds in the heldto-maturity portfolio is not recorded.
McGraw-Hill/Irwin
12-32
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP12–2.
Req. 1
Sept 15, 2007
Investment in TS (+A) ...........................................................
Cash (– A) (5,000 shares x $32)........................................
160,000
Dec. 31, 2007
Allowance to value at market – TS (+A) ................................
Net unrealized loss/gain – TS (+Gain, +SE) ......................
10,000
Dec. 31, 2008
Net unrealized loss/gain – TS (+Loss, –SE)..........................
Allowance to value at market – TS (– A) ...........................
45,000
Dec. 31, 2009
Net unrealized loss/gain – TS (+Loss, –SE)..........................
Allowance to value at market – TS (– A) ...........................
20,000
160,000
10,000
45,000
20,000
Computations for Year-End Adjustments to Market:
Year Market  Cost = Allowance Balance  Unadjusted Balance = Adjustment
2007 $170,000 $160,000
+$10,000
$0
+$10,000
2008 125,000
160,000
 35,000
+10,000
 45,000
2009 105,000
160,000
 55,000
35,000
 20,000
Req. 2
Sept 15, 2007
Investment in SAS (+A) .........................................................
Cash (– A) .........................................................................
160,000
Dec. 31, 2007
Allowance to value at market – SAS (+A) .............................
Net unrealized loss/gain – SAS (+SE) ...............................
10,000
Dec. 31, 2008
Net unrealized loss/gain – SAS (– SE)..................................
Allowance to value at market – SAS (– A) .........................
45,000
Dec. 31, 2009
Net unrealized loss/gain – SAS (– SE)..................................
Allowance to value at market – SAS (– A) .........................
20,000
McGraw-Hill/Irwin
Financial Accounting, 5/e
160,000
10,000
45,000
20,000
© The McGraw-Hill Companies, Inc., 2007
12-33
AP12–3.
Req. 1
The market value method of accounting for long-term investments must be used in
this situation because 6% of the outstanding voting stock of Seven Corporation is
owned. The market value method must be used when less than 20% of the
outstanding stock is owned because the investor company cannot exercise significant
influence or control.
Req. 2
a.
Acquisition:
Investment in SAS (+A) .....................
Cash (– A) .....................................
Purchased 12,000 shares of Seven
Corp. no-par stock at $30 per share.
b.
Income reported by Seven Company:
Revenue should not be recognized by the company on the basis of Seven Corp.
income in either 2008 or 2009 because, under the market value method, revenue
is not recognized until dividends are declared.
c.
Dividends received:
Cash (+A) ..........................................
Investment income (+R, +SE) .......
2008: $60,000 x 6% = $3,600
2009: $80,000 x 6% = $4,800
d.
Market value effects:
Net unrealized loss/gain – SAS (– SE)
Allowance to value at market – SAS
(– A) .............................................
Allowance to value at market – SAS (+A)
Net unrealized loss/gain – SAS (+ SE)
2008
360,000
360,000
3,600
2009
4,800
3,600
4,800
24,000
24,000
12,000
12,000
Computations for Year-End Adjustments to Market:
Year
Market  Cost = Allowance Balance  Unadjusted Balance = Adjustment
2008
$336,000 $360,000
$24,000
$0
$24,000
(12,000 x $28)
2009
348,000
360,000
 12,000
 24,000
+ 12,000
(12,000 x $29)
McGraw-Hill/Irwin
12-34
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP12–3. (continued)
Req. 3
2008
a. Balance sheet:
Long-term Investments:
Investment in SAS (at market) ..........................................
$336,000
b. Stockholders’ Equity:
Other comprehensive income:
Net unrealized gain/loss – SAS ...................................
(24,000)
c. Income Statement:
Investment income ............................................................
3,600
McGraw-Hill/Irwin
Financial Accounting, 5/e
2009
$348,000
(12,000)
4,800
© The McGraw-Hill Companies, Inc., 2007
12-35
AP12–4.
Req. 1
CASE A
CASE B
The market value method must be used by the company because it owns 15%
(30,000 ÷ 200,000) of the total shares. When ownership is less than 20% the
market value method must be used because the investor cannot exercise
either significant influence or control.
The equity method must be used by the company because it owns 40%
(80,000 ÷ 200,000) of the total shares. When ownership is at least 20% but not
more than 50%, the equity method must be used because the investor can
exercise significant influence, but not control, over the operating and financing
policies of the other company.
Req. 2
Case A-15%
January 10, 2009:
Investment in SAS (+A) ............................
450,000
(30,000 shares x $15)
Investment in associated company (+A) .
(80,000 shares x $15)
Cash (– A) .........................................
450,000
Purchased common stock at $15 per share.
36,000
18,000
48,000
48,000
18,000
December 31, 2009:
Net unrealized loss/gain – SAS (–SE) .....
180,000
Allowance to value at market – SAS (–A)
CASE A—30,000 shares x ($9 market price
– $15 cost) = $180,000 unrealized loss
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1,200,000
36,000
December 31, 2009:
Cash (+A) .................................................
Investment in assoc. company (–A)......
Investment income (+R, +SE)...............
CASE A—30,000 x $.60 = $18,000
CASE B—80,000 x $.60 = $48,000
Not recorded under market value method.
1,200,000
None1
December 31, 2009:
Investment in associated company (+A) ..
Equity in earnings of investee (+R, +SE)
CASE B—$90,000 x 40% = $36,000
1
Case B-40%
2
None2
180,000
Not recorded under the equity method.
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Solutions Manual
AP12–4. (continued)
Req. 3
Case A
December 31, 2009:
Balance sheet (partial):
Investments:
Investment in common stock, Boston Corporation ..........
Stockholders’ Equity:
Other comprehensive income:
Net unrealized loss/gain – SAS ..................................
$270,000
Income Statement (partial):
Investment income ............................................................
Equity in earnings of investee ............................................
18,000
(180,000)
Case B
$1,188,000
None
36,000
AP12–5.
On the Statement of Cash Flows:
Case A
Operating Activities:
Net income
Adjusted for:
Equity in earnings of assoc. co. (no cash received)
Dividends received
Investing Activities:
Purchase of investments
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$ xxx,xxx
Case B
$xxx,xxx
– 36,000
+ 48,000
– 450,000
– 1,200,000
© The McGraw-Hill Companies, Inc., 2007
12-37
AP12–6.
Req. 1
Purchase price for the net assets
Market value of net assets acquired*
Goodwill purchased
$120,000
111,000
$ 9,000
*($13,000 cash + $180,000 property and equipment – $82,000 liabilities)
Req. 2
Property and equipment (+A) ................................................
Goodwill (+A) ........................................................................
Liabilities (not detailed) (+L) .............................................
Cash (–A) ($120,000 paid – $13,000 received) .................
180,000
9,000
82,000
107,000
Req. 3
Kappa Company
Consolidated Balance Sheet
June 1, 2008 (immediately after acquisition)
Cash
Property and equipment (net)
Goodwill
Total assets
$ 69,000 ($189,000 - $120,000)
532,000 ($352,000 + $180,000)
9,000
$610,000
Liabilities
Common stock
Retained earnings
Total liabilities and stockholders’ equity
$175,000 ($93,000 + $82,000)
250,000
185,000
$610,000
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Solutions Manual
AP12–7.
Req. 1
Net income
Average total
assets*
Return on assets
=
2003
2002
2001
$502
$8,236.5
$277
$8,701.5
$236
$8,672.0
.061 (or 6.1%)
.032 (or 3.2%)
.027 (or 2.7%)
* 2003: ($8,177 + 8,296)/2 = $8,236.5
2002: ($8,296 + 9,107)/2 = $8,701.5
2001: ($9,107 + 8,237)/2 = $8,672.0
Req. 2
ROA measures how much the firm earned for each dollar of investment. It is the
broadest measure of profitability and management effectiveness, independent of
financing strategy. Marriott International’s ROA increased each year, suggesting that
management is more efficient at utilizing assets over time to generate income.
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CASES AND PROJECTS
FINANCIAL REPORTING AND ANALYSIS CASES
CP12-1
Req. 1
Note 1 indicates that short-term investments consist of auction rate securities,
corporate debt securities, U.S. treasury debt/agency and commercial paper.
Req. 2
The Statement of Cash Flows indicates that Pacific Sunwear of California
received $ 1,150,125,000 of cash during fiscal 2004 when its available-for-sale
short-term investments matured and $36,957,000 when its held-to-maturity shortterm investments matured.
Req. 3
ROA Analysis
Net Income / Average Total
Assets
2004
$106,904 = 0.162
$661,132.5*
2003
$80,200 = 0.145
$554,240**
* $(677,778 + 644,487)/2
**$(644,487 + 463,993)/2
This implies that the company has increased its performance from 2003 to 2004.
McGraw-Hill/Irwin
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Solutions Manual
CP12–2.
Req. 1
American Eagle reported $314,546,000 on its balance sheet as at January 29,
2005, for short-term investments. Note 2 indicates that these consisted of taxexempt municipal bonds, taxable federal agency notes, corporate bonds and
auction rate securities.
Req. 2
The company purchased investments for $483,083,000 during fiscal 2004, as
disclosed on its statement of cash flows.
Req. 3
A balance of $10,136,000 was reported for goodwill on the January 29, 2005,
balance sheet. The change in goodwill during fiscal 2004 was zero. Since goodwill
can only result from the acquisition of another company at a price which exceeds
the individual fair market values of the assets and liabilities, it is unlikely that the
company purchased another company during this time period. The notes do not
indicate that American Eagle acquired any companies over this time period. They
do discuss that they disposed of their Bluenotes division during fiscal 2003.
Req. 4
ROA Analysis
Net Income / Average Total
Assets
2004
2003
$213,343 = 0.192 $59,622 = 0.069
$1,113,036.5*
$867,634**
* $(1,293,659 + 932,414)/2
** $(932,414 + 802,854)/2
This implies that the company has decreased its performance from 2003 to 2004.
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CP12–3.
Req. 1
American Eagle
Pacific Sunwear of
Outfitters
California
$213,343 = 0.113 $106,904 = 0.087
$1,881,241
$1,229,762
ROA Analysis
Profit Margin
Net Income
Net Sales
Asset Turnover
Return on Assets
Net Sales
Average Total Assets
Net Income
Average Total Assets
$1,881,241 =1.69 $1,229,762 = 1.86
$1,113,036.5*
$661,132.5**
$213,343 = 0.192 $106,904
$1,113,036.5
$661,132.5
= 0.162
* $(1,293,659 + 932,414)/2
** $(677,778 + 644,487)/2
American Eagle Outfitters provided the higher return on assets.
Req. 2
The difference in ROA results primarily from profitability differences, not
efficiency. Although Pacific Sunwear of California is slightly more efficient than
American Eagle Outfitters, American Eagle’s higher profitability gives it the
advantage in ROA.
Req. 3
ROA =
Industry
Average
8.40%
American Eagle
Outfitters
19.2%
Pacific Sunwear
of California
16.2%
Both American Eagle Outfitters’ and Pacific Sunwear of California’s Return on
Assets are above the industry average. This means that they are both using their
assets better to generate profits. The extreme difference in ROA is probably due to
American Eagle and Pacific Sunwear of California using leased stores that are not
included as assets on the Balance Sheet.
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Solutions Manual
CP12–4.
Req. 1
Under the equity method, the investment amount (i.e., $560,000) was increased by
the proportionate share in income reported by the investee corporation and decreased
by the proportionate share of the dividends declared by the investee corporation.
Thus, the increase in the investment account was caused by an excess of investment
income over dividends received.
Req. 2
The net increase in the investment account was $160,000 (i.e., $720,000 –
$560,000). Dividends during 2008 reduced the investment account by the amount of
$80,000; therefore, investment revenue must be $240,000 (i.e., $160,000 + $80,000).
Req. 3
If the market value method were used, investment revenue for 2008 would be
$80,000 (the amount of dividends received). The unrealized gain does not affect the
income statement because the securities would be classified as available for sale
(held long term).
Req. 4
The market price of Trevor stock increased during 2008; therefore, the amount of the
investment account balance would be $600,000.
CP12–5.
Under the purchase method of accounting in this country, the excess of the cost of
the investment over the book value of the assets is used to revalue the tangible
assets to their fair market value and record goodwill. Prior to 2001, goodwill was
recorded on the balance sheet as an intangible asset and amortized over a period not
to exceed 40 years. Under new rules, goodwill is not amortized, but is reviewed
annually for possible impairment.
In England, tangible assets are also recorded at fair market value after an acquisition
similar to our purchase method. The major difference is the treatment of goodwill. The
recorded amount of goodwill is subtracted from retained earnings and not recorded as
an asset. As a result, the combined entity in England will show a lower amount for
total assets, but net income will not be affected by the rules in either country.
The amount for “significant owned brands” in the Diageo note would typically be
included in goodwill for a U.S. company. In England, the amount for owned brands is
not expensed unless there is a permanent decline in value.
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CRITICAL THINKING CASES
CP12–6.
This case deals with inside information. The plan to acquire 80% of another company
is significant because, when announced, it will affect the stock price of the other
company. It is wrong both legally and ethically to trade on insider information
regardless the size of your proposed investment. It is also wrong to pass insider
information on to another individual even if you do not profit directly from the
information.
CP12-7.
The assets, liabilities, revenues and expenses of the two companies will be added
together. It is unlikely that the two companies have significant intercompany
transactions such as intercompany sales. The analyst cannot simply add the two
financial statements together because the investment account must be eliminated and
the assets of the acquired company stated at their fair value. Unfortunately, this
information is not available publicly. Because the assets of the subsidiary are restated
to fair value, the return on assets ratio for the combined company will be less than a
weighted average of the two companies before consolidation.
FINANCIAL REPORTING AND ANALYSIS PROJECTS
CP12–8
The solutions to this project will depend on the company and/or accounting period
selected for analysis.
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Solutions Manual