Chapter 8
Consolidated Cash Flows and
Ownership Issues
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DESCRIPTION OF CASES AND PROBLEMS
CASES
Case 1
One day after purchasing 100% of the shares of a company, the parent sells 40% of these shares to
an unrelated party and realizes a substantial profit. The parent wants to recognize this gain on the
date of acquisition rather than the date of sale.
Case 2
The company pays a premium to buy out a minority shareholder who has been very aggravating to
the controlling shareholder. You are asked to resolve a dispute over how to account for the
acquisition differential.
Case 3
This case, adapted from a CA exam, involves a public company wishing to divest a wholly owned
subsidiary. You are asked to recommend accounting policies to maximize the selling price and how
the agreement should be changed to minimize disputes in the future.
Case 4
This case, adapted from a CA exam, involves a forestry company. You are asked to recommend
accounting policies relating to valuation of intangible assets, revenue recognition, asset impairment
and sale of a portion of a subsidiary.
PROBLEMS
Problem 1 (20 min.)
A consolidated cash flow statement is presented and the student is required to answer a series of
questions with regard to the consolidation process.
Problem 2 (40 min.)
This comprehensive problem requires the preparation of consolidated financial statements when the
subsidiary has preferred shares outstanding. Calculations involved with an ownership reduction and
unrealized profits in inventory and plant and equipment are also required.
Problem 3 (40 min.)
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This problem is concerned with the calculations of the investment account and unamortized
acquisition differential when there has been an increase and decrease in a parent’s ownership
interest.
Problem 4 (30 min.)
The preparation of a consolidated cash flow statement is required given that there has been a
reduction in the parent's investment during the year.
Problem 5 (25 min.)
This problem requires the calculation of consolidated profit and other consolidation amounts when
there is an indirect shareholding involved.
Problem 6 (20 min.)
This problem requires the calculation of consolidated profit, retained earnings, and non-controlling
interest for the first year after acquisition when the subsidiary has cumulative preferred shares
outstanding.
Problem 7 (30 min.)
The calculations of the gains and losses associated with ownership reductions are required along
with an explanation of whether the historical cost principle is used in accounting for the acquisition
differential.
Problem 8 (25 min.)
The straightforward preparation of a consolidated cash flow statement is required from a list of
consolidated financial statement items.
Problem 9 (25 min.)
A journal entry and calculations of unamortized acquisition differential are required when there has
been a reduction in the parent's ownership.
Problem 10 (40 min.)
This problem requires the calculation of patents, consolidated profit, retained earnings, and noncontrolling interest for the second year after acquisition when the parent increases its
percentage ownership from 75% to 95%.
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Problem 11 (25 min.)
This problem requires the calculation of consolidated profit attributable to the parent’s shareholders
and non-controlling interest when a parent has indirect holdings and an explanation of how the
revenue recognition principle supports adjustments for unrealized profits.
Problem 12 (20 min.)
The preparation of a consolidated balance sheet is required immediately after the parent's
ownership decreases due to a new share issue by the subsidiary.
Problem 13 (30 min.)
This problem requires the preparation of a consolidated balance sheet and a consolidated retained
earnings statement where indirect shareholdings are involved.
Problem 14 (30 min.)
The preparation of a consolidated cash flow statement is required along with an explanation on why
100% of the subsidiary’s dividends do not appear on the consolidated cash flow statement.
Problem 15 (40 min.)
This problem is concerned with the calculations of the investment account, unamortized acquisition
differential and non-controlling interest when the parent sells and is deemed to sell part of its
investment.
Problem 16 (70 min.)
This is a fairly comprehensive problem involving the step acquisitions of a subsidiary company that
has preferred shares in its capital structure.
There are unrealized profits in inventory and
equipment. The problem also requires the calculation of goodwill impairment loss and NCI under
the parent company extension theory. Non-controlling interest is valued using the market price of the
subsidiary’s shares at the date of acquisition.
Problem 17 (60 min.) (prepared by Peter Secord, Saint Mary’s University)
The preparation of consolidated financial statements is required when the subsidiary has convertible
preferred shares and there have been unrealized intercompany profits from asset transfers. Also
required is a brief discussion on the reporting implications if the preferred shares were converted to
common shares.
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Problem 18 (60 min.) (prepared by Peter Secord, Saint Mary’s University)
The question requires the calculation of amounts for certain consolidated financial statement items
when step purchases have occurred and there are unrealized profits in inventory and depreciable
property, plant and equipment.
WEB-BASED PROBLEMS
Problem 1
The student answers a series of questions based on the most recent financial statements of
Vodafone, a British company. The questions involve an analysis of the cash flow statement and
changes in the parent’s percentage ownership.
Problem 2
The student answers a series of questions based on the most recent financial statements of
Siemens, a German company. The questions involve an analysis of the cash flow statement and
changes in the parent’s percentage ownership.
REVIEW QUESTIONS
1.
It could be prepared by consolidating the cash flow statements of the parent and its
subsidiaries, but this would be a complex process. It is much easier to prepare the
statement by analyzing the yearly changes that have occurred in the noncash items in the
consolidated balance sheet.
2.
$700,000 (minus any cash on the balance sheet of the subsidiary company) would appear
as an outflow in the investing activities section. Because the $300,000 share issue did not
affect cash, it would not appear as a separate item on the consolidated cash flow
statement. However, complete footnote disclosure would be required and would indicate
the total acquisition price, the consideration given (cash and common shares), and a
summary of the assets, liabilities, and equity interest acquired.
3.
The amortization of the acquisition differential is similar to depreciation expense in that it is
deducted in the determination of net income but does not represent a cash outflow.
Therefore, similar to depreciation expense, the amortization of the acquisition differential is
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added back to consolidated net income to determine cash flow from operations in the
consolidated cash flow statement.
4.
Dividend payments to noncontrolling shareholders represent a flow of cash outside the
economic entity, and, as a result, they must be disclosed on the consolidated cash flow
statement. The only dividends that can be reported in the consolidated statement of
retained earnings are those that are paid to the parent's shareholders. From the
consolidated entity's point of view, dividends declared or paid to noncontrolling
shareholders represent a reduction of the equity of the non-controlling interest in the
subsidiary's assets. If a statement of changes in non-controlling interest were presented, it
would show an increase from the allocation of entity net income, and a decrease from
dividends to noncontrolling shareholders.
5.
The change from the cost to the equity method should be accounted for retroactively under
the following circumstances:
- when the reason for the change is to correct an error in prior periods i.e., the entity should
have been using the equity method in the past but was using the cost method, or
- when the entity could have been using either method in the past and is now changing
from one equally acceptable method to another. For example, the parent company can use
either the cost method or equity method for recording purposes when it controls the
subsidiary and prepares consolidated financial statements.
On the other hand, if the change is being made as a result of a change in circumstance,
the change should be accounted for prospectively. For example, if the investor company
increases its investment from 10% to 30% of the shares of the investee company and
thereby changes from having no influence to having significant influence, then the change
is made prospectively.
6.
No, the subsidiary’s net assets are only valued at fair value at the date of acquisition i.e.
when the parent first obtains control of the subsidiary. When increasing the percentage
ownership from 60% to 75%, the parent’s portion of the unamortized acquisition differential
increases and the NCI’s portion decreases by the same amount, which is the carrying value
of the portion sold by the NCI. Neither the parent’s portion nor the NCI’s portion is revalued
to fair value as a result of this transaction.
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7.
The non-controlling interest is not revalued to fair value because the parent’s interest is not
revalued at fair value. Revaluation only occurs when the purchaser’s position changes
from not having control to having control. In this situation, the parent had control at 76%
and still has control at 60%. The decrease in the parent’s carrying value is added to the
non-controlling interest.
8.
When the parent's ownership declines because of a subsidiary share issue, a loss to the
parent occurs due to the reduction in the parent's investment account. However, a gain
occurs from the perspective of the parent due to the parent's new share of the proceeds
from the subsidiary share issue. The two are netted and produce a net loss or gain on the
transaction. This gain or loss is reported as an equity transaction i.e. a transaction between
shareholders. The gain or loss is reported as a direct credit or charge to shareholders’
equity i.e. a credit to contributed surplus or a debit to retained earnings.
9.
No, a gain or loss realized by a parent company on the sale of part of its investment in the
common shares of its subsidiary is not eliminated in the preparation of the consolidated
financial statements because it represents a transaction between the consolidated entity
and parties outside the entity.
10. Yes, assuming that the parent company does not own all of the preferred shares. The
consolidated income statement will show a non-controlling interest equal to the noncontrolling interests’ share of the subsidiary's net income applicable to the preferred
shares. The consolidated balance sheet will show an amount for non-controlling interest
equal to the non-controlling interests’ share of the total shareholders' equity of the
subsidiary that is applicable to that company's preferred shares.
11. Net income for the year
Allocated to preferred shares
Net income for common shares
17,000)
(12,000)
5,000
The common shareholders have the right to income remaining after the claim of the
preferred shareholders. In this case, income of $5,000 “belongs” to the common
shareholders.
12. Because in most situations the market value of preferred shares is related to the general
level of interest rates, it does not make sense conceptually to use a preferred share
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acquisition differential to revalue the net assets of the subsidiary when consolidated
financial statements are prepared. Therefore, a negative acquisition differential should be
added to consolidated contributed surplus and a positive acquisition differential should be
deducted from consolidated contributed surplus (if there is any) or from consolidated
retained earnings.
13. When a parent company acquires less than 100% of its subsidiary's preferred stock, the
preferences associated with this preferred stock must be considered in determining the
amounts of the shareholders’ equity (net assets) that is assignable to both preferred and
common non-controlling interests. For example, if the preferred shares are cumulative, any
preferred dividends in arrears must be included in the shareholders' equity allocated to the
preferred shares. In this particular case, the non-controlling interest consists of 70% of the
preferred equity and 10% of the common equity, and income is allocated accordingly.
14. The subsidiary’s income is split between the preferred shareholders and common
shareholders prior to calculating the parent’s and NCI’s share of the subsidiary’s income. If
the preferred shares are cumulative, the preferred shareholders are entitled to a share of
the investee’s income each year regardless of whether dividends are actually paid in any
given year. However, if the preferred shares are noncumulative, the preferred shareholders
will only receive a portion of the investee’s income of a given year if dividends are actually
declared in that year. Similarly, when calculating consolidated retained earnings, the
change in the subsidiary’s retained earnings since acquisition must be split between the
preferred shareholders and the common shareholders prior to calculating the parent’s
share of the change in retained earnings. The preferred shareholders will receive a portion
of the investee’s income for all years for which they were entitled to receive a portion of the
income less the amount of dividends already received for those years.
15. The major consolidation problem associated with indirect shareholdings is the iterative
nature of the calculations. One must start at the lowest level of the corporate hierarchy and
work up the corporate structure. At each level, the income of the subsidiary has to be
adjusted for amortization of the acquisition differential and unrealized profits. Then, the
income is attributed to the controlling and non-controlling shareholders. In the end, the noncontrolling interest incorporates its share of each of the different entities on a cumulative
basis.
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MULTIPLE-CHOICE QUESTIONS
1.
a
2.
b
(900 – 440) – 1,270 = –810
3.
b
200 x .25 = 50
4.
b
40 x .25 = 10
5.
b
6.
d
7.
a
8.
d
100 x 8% x 2.5 years = 20
9.
d
10 x $13 = 130
10.
d
.20 x (264 / .8) = 66
11.
c
100 + (10 x 13 - 100) + (8% x 100 x 2.5) = 150
12.
a
13.
d
(750 / .75) – (500 + 240 + 90 x 8/12) – 40 = 160
160 – 160 / 10 x 4/12 = 154.667
14.
a
750 + .75(90 x 4/12) – .75(10) – [.75(40) /5 x 4/12] – [.75(160)/10 x 4/12] = 759
160 – .2(759) = 8.2
15.
b
16.
c
17.
c
18.
c
19.
a
75% – (.2[75%]) = 60%
CASES
Case 1
(a) A subsidiary is usually valued at fair value at the date of acquisition. Fair value is defined as
the amount of consideration that would be agreed upon in an arm’s-length transaction
between knowledgeable, willing parties who are under no compulsion to act. Since Pepper
and Salt were unrelated parties at the date of acquisition, one could argue that $720, the
amount paid by Pepper, represented the fair value of Salt. Using this same logic, one could
also argue that Salt was worth $1,250 on this date since an unrelated party was willing to pay
$500 for 40% of the shares of Salt one day after Pepper purchased Salt.
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What is the fair value of Salt as a whole? That is the big question. Once we have
determined the fair value of Salt as a whole, we can determine the fair value of Salt’s
goodwill and whether Pepper can record a gain on purchase.
The following consolidated balance sheets were prepared at December 31, Year 7 under
three different valuation alternatives:
A.
The fair value of Salt as a whole is $720 and Salt’s goodwill is valued at $450,
the excess of amount paid by Pepper ($720) over the fair value of Salt’s identifiable net
assets ($120 + $350 – $200)
B.
The fair value of Salt as a whole is $1,250 and Salt’s goodwill is valued at the
excess of amount paid by Pepper over the fair value of Salt’s identifiable net assets
C.
The fair value of Salt as a whole is $1,250 and Salt’s goodwill is valued as the
difference between the value of Salt as a whole ($1,250) and the fair value of Salt’s
identifiable net assets ($120 + $350 – $200)
A
B
C
$ 620
$ 620
$ 620
Intangible assets (200 + 350)
550
550
550
Goodwill
450
450
980
$1,620
$1,620
$2,150
$ 600
$ 600
$ 600
1,020
1,020
1,550
$1,620
$1,620
$2,150
Tangible assets (500 + 120)
Liabilities (400 + 200)
Shareholders’ equity (300 + 720)
The shareholders’ equity in C includes a gain on purchase of $530, which is the difference
between the value of the subsidiary as a whole ($1,250) and the amount paid by Pepper
($720).
To answer which method best reflects economic reality, one needs to know what the true
value of the subsidiary is. If it is $720, then column A best reflects economic reality and
would be required under GAAP. If the true value of the subsidiary is really $1,250, then
column C best reflects economic reality. However, GAAP requires that goodwill of the
subsidiary is valued as the difference between the amount paid and the fair value of the
identifiable net assets. Therefore, Pepper could not report a gain on purchase in Year 7 and
would have to use column B.
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(b) When a parent sells a portion of its interest in the subsidiary and retains control over the
subsidiary, the value of the subsidiary’s assets and liabilities on the consolidated balance
sheet do not change – they are retained at carrying value. The carrying value of the portion
sold is transferred from the parent’s interest to the non-controlling interest. The parent will
report a gain or loss for the difference between the proceeds received from the sale and the
carrying value of consideration sold. This gain will not be reported in net income but will be
reported as a direct adjustment to shareholders’ equity – either to retained earnings or
contributed surplus.
The following consolidated balance sheets were prepared at January 1, Year 8 under the
same three valuation alternatives considered above.
A
B
C
$ 500
$ 500
$ 500
Tangible assets (500 + 120)
620
620
620
Intangible assets (200 + 350)
550
550
550
Goodwill
450
450
980
$2,120
$2,120
$2,650
$ 600
$ 600
$ 600
288
288
500
1,232
1,232
1,550
$2,120
$2,120
$2,650
A
B
C
$ 720
$ 720
$ 1,250
40%
40%
40%
Value assigned to non-controlling interest
288
288
500
Proceeds received from non-controlling interest
500
500
500
Gain on sale of 40% interest
212
212
0
1,020
1,020
1,550
$1,232
$1,232
$1,550
Cash
Liabilities (400 + 200)
Non-controlling interest (Note 1)
Shareholders’ equity (Note 1)
Note 1:
Carrying value of Salt’s net assets
on consolidated balance sheet
Portion sold to non-controlling interest
Shareholders’ equity prior to sale
Shareholders’ equity subsequent to sale
In scenarios A and B, a gain on sale is reported on January 1, Year 8 as a direct credit to
contributed surplus. In scenario C, no gain on sale is recorded on January 1, Year 8
because a gain of $530 was reported on December 31, Year 7. In all cases, non-controlling
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interest is valued at 40% of the carrying values of the subsidiary’s assets and liabilities on
the consolidated balance sheet at the date of the sale.
Case 2
Both the CFO and controller are wrong. The transaction is a capital transaction between
shareholders of Stiff. Since Prince controlled Stiff both before and after this transaction, the
valuation of Stiff’s assets and liabilities for consolidation purposes will not change. Only the
parent’s and non-controlling interests’ share of the consolidated net assets will change. Any
difference between the amount paid by Prince and the carrying value given up by the noncontrolling interest will not be reported in profit but will be reported as an adjustment to
shareholders’ equity. For this transaction, the difference is $700,000 calculated as follows:
Purchase price (110 x 100,000 x 20%)
2,200,000
Book value of Stiff shares acquired (70 x 100,000 x 20%)
Book value of acquisition differential acquired (500,000 x 20%)
1,400,000
100,000
Excess
1,500,000
700,000
The $700,000 will be reported as a reduction to contributed surplus, if any exists, or a reduction
to retained earnings.
Even if the acquisition differential were allocated to assets and liabilities, the entire amount
would not have been allocated to goodwill. $260,000 (20% x $1,300,000) should be allocated to
the patents in order to recognize the value of the patents. The remaining amount would be
allocated to goodwill. Then, the goodwill would have to be assessed for impairment at the end of
Year 13 and all subsequent years by determining the fair value of Stiff’s shares. The recent
trading price of $100 is not necessarily a true indication of the fair value of the shares. It
represents the exchange price for the parties exchanging shares on that particular date. To
acquire control of Stiff, investors may be willing to pay more or less than $100 per share. An
independent business valuation could determine the fair value of the shares. If the fair value is
less than $110 per share, the goodwill will have to be written down to reflect the impairment in
value. For example, if the fair value of the shares were only $105 per share, the purchase price
would have been inflated by $100,000 ($5 x 100,000 x 20%). In turn, goodwill would have been
overstated by $100,000 and would have to be written down by $100,000 in Year 13.
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The $260,000 allocated to the patent would have to be amortized over the useful life of the
patent commencing in Year 14. Given a useful life of 4 years, the amortization expense would
be $65,000 ($260,000 / 4) per year and would cause a decrease in income of $65,000 for Year
14.
Case 3
Canada Transport Enterprises Inc. ("CTE")
Attention: Andrew Joel
DRAFT REPORT
Dear Andrew:
Sale of Traveller Bus Lines ("TBL")
As requested, we have reviewed the information provided. Our report:
 recommends ways in which the selling price can be maximized
 provides comments and recommendations on how the agreement should be changed to
minimize possible disputes in the future, and
 summarizes the accounting issues of significance to CTE that will arise on the sale of
TBL
Generally, the net book value (NBV) of a company does not approximate its fair value (FV). This is
especially true of TBL. Many of its assets are worth significantly more than the NBV recorded in the
financial statements, mainly because TBL's assets have increased in value over time. For example,
the bus routes are recorded at a fraction of what they are worth today; they are discussed in more
detail below.
Recommendations on ways to maximize the selling price
The sale of TBL will have a significant impact on CTE's share price. Therefore, by maximizing the
sale price, you will be maximizing the share value as well. However, the sale of TBL, one of CTE's
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profitable divisions, may adversely affect the share price. Management should consider the impact
of the sale on the share price.
Other alternatives are available for valuing a business and should be considered. Specifically, a
capitalized earnings approach would be a better way to value TBL. The reason is that future
earnings will reflect the value of assets that are not fully recorded on the balance sheet – for
example, intangible assets. This approach can also be justified on the grounds that earnings have
been stable and could be used to calculate the sale price.
Earnout clause
The new owners of TBL will be preparing the July 31, Year 8 financial statements, which will be
used to calculate the earnout amount. They will want to minimize the sale price. We should specify
in the agreement that the accounting policies cannot be changed in the year in which the earnout is
calculated. In addition, the new owners could make overly aggressive accruals to further minimize
the selling price. For example, they could pay unusually high salaries or bonuses to reduce income.
Restrictions should be placed in the agreement to prevent such measures, and CTE should be
allowed to independently verify the July 31, Year 8 results.
Possible adjustments to the selling price
The accounting policies chosen for TBL's financial statements will impact the calculation of the
selling price. Adjustments that increase the net value of TBL assets sold are more desirable than
adjustments that affect the earnout payment because CTE will receive all increases in the NBV and
only 55% of increases that affect the July 31, Year 8 earnings.
We must determine whether we must use generally accepted accounting principles or whether we
can use a disclosed basis of accounting. If a disclosed basis of accounting is acceptable, then FVs
should be used. TBL is worth significantly more on a FV basis, and these adjustments will result in
an increased selling price. Therefore, we recommend using FV for accounting purposes.
Bus routes
The bus routes obtained approximately 40 years ago currently have no NBV. This situation is
unreasonable given the significant amounts paid for similar routes in subsequent years. The FV of
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all bus routes should be included in the selling price. Therefore, the NBV of bus routes should be
increased to reflect FV. The FV can be estimated on the basis of the amount paid for similar bus
routes purchased.
However, the FV of the bus routes may be included in the value of the goodwill already recorded. We
must determine whether the goodwill represents the value of these routes. In addition, the earnout
may also compensate CTE for the underlying value of the bus routes. Further information is needed.
School buses – useful life
The value of the school buses on TBL's balance sheet appears to be understated, based on a recent
report. The reason may be because we have depreciated these assets over 10 years instead of 15
years. An adjustment should be made to the financial statements and, as a result, the selling price
will increase. The amount of the adjustment will depend on the age of the buses. We should
determine whether the fair value excess recorded in prior years already reflects an adjustment to
depreciation.
For accounting purposes, we must find out whether the value is understated as a result of a change
in an accounting estimate or as a result of an error. If it is the result of a change in an accounting
estimate, the adjustment will be made prospectively. If CTE can argue that it was the result of an
error, the adjustment will be made retroactively to the fixed asset account, thereby increasing the
selling price.
Non-refundable deposits
We must find out whether these deposits were recorded in income for the July 31, Year 7
period. The entire deposit relating to the cancelled contract should be included in the July 31,
Year 7 income because, at year-end, the amount has been earned and no future services must
be provided.
In addition, it may be possible to justify including all deposits received prior to July 31, Year 7, in
income as well. We could argue that the deposit is intended to guarantee service and does not
relate to the costs of providing the service. If this assumption can be successfully argued, CTE will
receive 100% of the income, rather than 55%, with no related costs. This approach will increase the
selling price. We must consider the wording of the contract to determine the proper accounting
treatment.
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Travel the country
It appears that the liability for giving skis or skates to customers must be provided for. This will
decrease the selling price. In addition, the cash received for the passes could be reported as
revenue even though the three-month passes have not yet expired. The revenue could be recorded
in Year 7 since there is no incremental costs of having ticket-holders take the bus thereby increasing
the selling price.
Consolidation entries
Fair value increments (fixed assets and goodwill) are not currently included in the selling price.
However, these amounts should be included in the selling price since they probably represent the
FV of the assets being sold. Pushdown accounting treatment is recommended. It may be preferable
to revalue the company since the goodwill and fair value increments have likely changed since they
were first recorded.
Long-term receivables
We must determine whether this amount should be written down to fair value. If so, it will decrease
the selling price. Although the security does not cover the amount of the outstanding balance,
receivable is being collected. Therefore, we should argue that the loan is not impaired and a writedown is not necessary.
Advertising
Plans call for an aggressive advertising campaign ($500,000), and the agreement states that CTE
will pay for these costs. However, the benefit is likely to be received in years subsequent to the
earnout. The payment of advertising costs should be considered further.
Bus retrofit
TBL is planning substantial costs to retrofit the fleet of buses. These costs will occur next year yet
will benefit TBL for many years to come. These costs should be capitalized or excluded from the
agreement.
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Futures taxes
The deferred taxes should either not be considered in determining the selling price or should be
discounted if they are to be included. Otherwise, the selling price would be reduced.
Lease facility
We must determine whether a loss should be accrued for future lease payments. If so, the selling
price will decrease. TBL is receiving the benefit; therefore, CTE should not bear the cost of moving.
One possible alternative to providing for this amount is to account for these payments on a cash
basis, assuming that CTE will be able to sublet.
Significant accounting issues – CTE
There are various accounting issues that CTE must consider on the sale of TBL.
Reporting the sale of TBL
Although CTE can announce the sale and the potential profit that would result, it cannot report the
sale in its first quarter's income statement because of the timing of the sale. CTE may want to
change the timing of the sale accordingly. Otherwise, note disclosure can be provided. Under the
efficient market hypothesis, note disclosure would have the same impact on the share price.
In addition, the sale may have to be reported as a sale of discontinued operations. If so, the
gain in the financial statements should be reported separately, net of applicable taxes.
Recognition of the gain on sale of TBL
Rather than recognize the gain right away, an argument could be made that the gain should not be
recognized until the full proceeds have been received because of the guarantee included in the sale
price. However, such an approach seems unduly conservative considering who the purchasers are.
Generally, the cost of future advertising, bus restoration, or environmental liabilities should be
accrued and applied against the gain on sale. Finally, the consulting income should not be
recognized until it is earned.
The earnout payment should be recognized in income in the year in which it is determinable. An
argument could be made to recognize the earnout payment in the current year since TBL's income
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is static, but this approach may be too aggressive.
Comments on current agreement
The terminology used in the draft agreement is open to interpretation. The ambiguous wording may
create arguments in the future if one party disagrees with the other's interpretation or earnings
calculation. To minimize future disputes, we recommend the following changes to the agreement:
1.
Clause 1. The assets and liabilities included in the purchase and sale agreement should be
based on the audited financial statements rather than on the draft July 31, Year 7 financial
statements. The audited financial statements will provide you with greater assurance with
respect to the accuracy of the figures and accounts reported.
2.
Clause 2. The environmental liabilities that are not included in the agreement should be
limited to those that are CTE's responsibility up to the date of sale. In addition, this clause
should be effective for only a limited period of time. In addition, you may want to have an
environmental assessment performed prior to the sale to determine what the potential
exposure is.
3.
Clause 3. The term "net reported income" must be clearly defined to ensure that there is
no misunderstanding as to what is and what is not included in the calculation. In addition,
this calculation is based on TBL’s net income, and future profits may differ from past results,
especially if the new management is inefficient in the short term and incurs significant "startup" costs.
4.
Clause 5. You should clarify what "compete" means and what is included in the
limitation. For example, does it mean that you cannot operate any bus line service
anywhere in the world?
5.
Clause 6. The loan guarantee is for an unlimited period of time. Unless a specific expiry
date is used, CTE will be responsible for the loan until it is ultimately paid.
6.
Clause 7. "Cost" must be explicitly defined. For example, defining cost as "fulI cost"
(including overhead allocations) or as "out-of-pocket cost" produces very different
results.
7.
Clause 8. The phrase "restored to its original condition" must be defined. This clause
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121
could result in a significant cost to CTE if it is not clarified. For example, it could mean a
complete reconstruction of the building.
8.
Clause 9. You should place a limit on the dollar value of advertising that CTE is
obliged to provide under the agreement. As the clause is now worded, CTE could incur
very large costs.
9.
Clause 12. The longer payment terms will lower the effective purchase price given
the present value of money. Either the purchase price can be increased or payment can
be made sooner.
10.
Clause 14. You must determine the nature of the consulting agreement – what it
does and does not include.
We would be pleased to discuss our comments and recommendations with you at your
convenience.
Yours truly,
CA
Case 4
Memo to:
From:
Subject:
Engagement Partner
CA
Analysis of Accounting Issues Concerning Capilano Forest Company Limited
(CFCL or the Company)
Overview
For the current year, the newly hired controller intends to make changes to some of the existing
financial accounting policies of CFCL. His rationale for these changes is to maximize the value
of the Company because it may be sold to a large Japanese lumber importer.
It should be noted at the outset that financial statements might be of very limited usefulness in
the valuation of this company. Although the purchasers may use the statements to assess
logging costs or management performance, they will probably focus on timber reserves, since
that is the primary value of a forestry company. Therefore, as auditors working for Don Strom,
we must ensure that the controller is not changing the financial statements simply for his own
benefit, given that his bonus is based on net income. Such changes would clearly not be in the
best interests of Mr. Strom. In fact, Mr. Strom's primary concern may be to minimize income
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thereby reducing bonus and tax costs. As mentioned, the buyers may not be too concerned with
the financial statements in valuing CFCL, so Mr. Strom may not be well served by the
controller’s efforts to increase income.
(Most candidates failed to evaluate the objectives and needs of the preparers and users.)
The controller has identified several areas where he would like to change the accounting policy.
I have analyzed these proposals with reference to generally accepted accounting principles, and
have provided alternatives where appropriate.
(Most candidates failed to present alternative accounting treatments for the issues presented in the
question.)
Rights granted for Crown land
An argument could be made for recording the fair value of the rights, as the controller has
suggested in the financial statements. Future value will be associated with the rights because
revenues from logging will probably exceed the payments to the government for logs harvested
and the costs of reforestation. In addition, one could argue that fair value is appropriate since
this is essentially a non-monetary transaction - obtaining logging rights may be considered the
culmination of an earnings process in the forestry industry. This viewpoint is, however difficult to
defend.
If CFCL adopts this alternative, it will be very difficult to estimate the fair value of these rights.
Many assumptions would have to be made, and gathering the relevant information would take
considerable time.
We will also have to consider the basis of amortization of these rights. Alternatives include
expensing as trees are sold or amortizing the cost evenly over the life of the right.
There are strong arguments against recording the rights in the financial statements. The
historical cost principle as well as the conservatism concept support no recognition in the
accounts; essentially, no asset was given up to obtain these rights. In addition, it is unlikely that
this transaction could be accepted as a culmination of an earnings process. It should therefore
be recorded at the amount of the asset that was given up, which is nil in this case.
The controller's proposal to reflect the fair value of the timber rights on the financial statements
may be intended solely to generate a windfall profit and is thus self serving. Disclosure of these
rights in a note may be sufficient for the purposes of the purchasers in valuing the Company.
(Candidates failed to present valid arguments that supported recording the rights at fair value or at a nil
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123
amount. Candidates did not make use of basic accounting concepts in their analysis.)
The rights granted in the prior periods should be accounted for in a manner consistent with that
of the current rights. If it were decided to record them at fair value, then it would be necessary to
restate prior years' amounts retroactively since recording them at fair value represents a change
in accounting policy.
Logging fees
Fees paid to the government for logs cut could be recognized as a period expense, instead of
being expensed when the trees are sold. We would have to view the logging records and the
agreement with the government to gain assurance that year-end accruals are done properly.
There is unlikely to be a lot of inventory on hand at any given time, so it is likely that expenses
will be reasonably well matched to revenues.
Reforestation costs
The current year's financial statements for CFCL must show an accrual for the reforestation
costs associated with trees logged under the Ministry rights. Depending on the degree of
reforestation currently done by CFCL, this amount may be difficult to estimate.
It will also be necessary to accrue costs for the reforestation of the rights granted in prior years.
This cost would be expensed in the current year since it is a result of actions taken by the
Ministry of Forests in the current year. CFCL may want to consider separate line disclosure of
this cost, as it is not tied to the current year's operations and would not be relevant for the buyers
in trying to estimate logging costs.
If CFCL were able to log the reforested trees in the future, then an alternative would be to
capitalize the reforestation costs since a future benefit will be derived.
Purchased rights at mine site
There is a serious valuation problem with regard to the five-year timber rights acquired at a
future mine site. Due to insect infestation, a write-down in the value of the purchase rights may
be appropriate given that a net future benefit may no longer be associated with these timber
rights. The fact that the controller may not agree is not surprising given his bonus arrangement.
Assuming that a future net benefit is associated with the timber rights, the cost of the timber
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rights must be amortized in a manner that matches the income from the logs. The alternatives
are as follows:
1.
Amortize the cost of the rights based on the total number of trees cut, or
2.
Allocate the cost based only on good trees cut during the time period, or
3.
Expense the cost evenly over five periods.
The first two alternatives will be difficult to implement because it will be difficult to ascertain how
many trees can be logged in five years, let alone how many good logs as opposed to insectinfested logs can be logged. Assuming it is likely that the same number of logs can be logged in
most seasons and given that the Company has a demonstrated ability to sell all logs cut, it may
be simpler to amortize the rights equally over the five years.
(Candidates could have arrived at a different conclusion as long as it was supported by the facts of the
case and by their analysis.)
Tree costing
It seems illogical to suggest that little or no cost is associated with the trees that are harvested. The
purchase price of forest property is based on the trees on the property rather than on the land. If the
Company had purchased the lands with no timber on it some time ago and had regenerated the
timber, the controller's argument would have some merit. However, since it takes 60 to 80 years to
grow trees to maturity for logging, trees that will be grown through reforestation have no present
value.
Ongoing maintenance costs of timber properties could be expensed because the cost of replanting
and spraying pesticides is not large in comparison to other expenditures of the company. An
argument can be made that they should be capitalized as the expenditures relate to revenues that
will be earned in the future. Similarly, a case could be made to capitalize other carrying costs such
as property taxes.
Pacific tract acquisition
In order to assess whether the $25,000 allocated to the sold parcel is an appropriate amount, it is
necessary to determine the value of this tract to CFCL upon its purchase. The $25,000 allocation
may be considered reasonable considering its limited usefulness to CFCL at the time of purchase.
However, it is important to note that any allocation is arbitrary and will be difficult to substantiate.
The gain or loss on the sale of this land to developers should be disclosed separately in the income
statement since it is not part of recurring operations. Again, this information may be useful to the
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125
purchasers in assessing ongoing costs.
(Candidates did not provide relevant arguments as to whether the allocation was appropriate.)
A write-down of the remaining timber property may be warranted. Value may be impaired since the
environmentalists may have permanently halted the generation of revenue. If it is found that the
question of logging on the property has not been settled and a write-down is inappropriate, a
potential contingent loss exists and should be disclosed in the financial statements, if material.
(Again, candidates failed to consider the significant valuation issue.)
The controller's interest in capitalizing costs for legal fees, public relations and idle time appears to
be motivated by furthering his own objectives of maximizing current income. These costs cannot be
capitalized as goodwill since goodwill can arise only upon the purchase of a business. However,
these costs may be capitalized as part of the costs of the trees since the costs were necessary to
obtain a future benefit - the ability to log the trees in the future. However, this future benefit is highly
questionable in light of the significant uncertainty involved, and conservatism would suggest
expensing these costs.
(Candidates did not provide support for capitalization in accounts other than goodwill.)
Forest fires
The costs of the forest fires cannot be capitalized as goodwill since, as mentioned previously,
goodwill arises only upon the purchase of a business. However, they can be capitalized as part of
the protected trees. These costs were incurred to ensure a future benefit from these trees.
However, this treatment may not be appropriate given the uncertainty of this future benefit. In fact,
we must investigate whether these fires still present a threat to CFCL's forests, since there may be a
significant impairment in value of these sites. It will be very difficult for us to obtain assurance, as
predicting the course and outcome of fires is probably impossible.
The $300,000 commitment should be disclosed in the notes to the financial statements. There is
very little justification for including a liability in the financial statements for this amount since it may
not relate to past fire fighting efforts, and is probably not a legally enforceable commitment.
(Most candidates recognized the valuation implications of these forest fires.)
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Modern Advanced Accounting in Canada, Sixth Edition
Revenue recognition from sales of pine and wood chips
The strong demand for the pine produced by the Company is not sufficient to support the
recognition of revenue when the logs are cut, as suggested by the controller. Many uncertainties still
exist at that time, with the result that the risks and rewards of ownership have not transferred and
that revenues and costs cannot be measured within a reasonable degree of accuracy. Specifically:

CFCL retains the risks associated with the wood until it is accepted by the purchasers (i.e.,
title to the wood is not transferred until delivery in Japan). The risk also exists that CFCL may
become unable to provide satisfactory delivery to the purchasers.

The price can change by up to 5%, depending on the grade. This may be a material
amount on large orders.

The price can change due to foreign currency fluctuations.
(Candidates did not consider the relevant facts in deciding whether to recognize revenue.)
It is also not appropriate to recognize the revenue on the wood chips as they are produced. Again,
significant uncertainties still exist at that time. CFCL retains the risks associated with these chips
until they are in the hands of the buyer. Furthermore, delivery may be difficult, as the current strike
may last a long time, despite the controller's probably optimistic assumption to the contrary.
Furthermore, the strike settlement may increase the costs associated with these sales, thereby
decreasing the estimated profit.
It is necessary for us to examine this contract with Remul Ltd. to ensure that CFCL does not face
any liabilities as a result of late or non-delivery.
Sale of 25% interest in subsidiary
The pending sale of a 25% interest in NAN is a capital transaction since Capilano controlled
NAN both before and after this transaction. Therefore, the valuation of NAN’s assets and
liabilities on the consolidated financial statements will not change. Only the parent’s and noncontrolling interests’ share of the consolidated net assets will change. Any difference between
the selling price of the shares and the carrying value given up by Capilano will not be reported in
net income but will be reported as an adjustment to shareholders’ equity. The carrying value of
the investment will need to be updated to the date of the sale by accruing the income earned by
NAN and amortizing the acquisition differential pertaining to the timber rights.
The sale should be reported on the closing date of the sale because that is when the benefits
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127
and risks of the net assets being sold are transferred to the new shareholders.
(Most candidates appropriately did not spend much time on these relatively minor issues.)
(Candidates failed to analyze the issues in adequate depth. Alternatives were often not provided, or the
validity of the alternatives was not adequately analyzed. Furthermore, candidates failed to incorporate the
users' needs into their analysis.)
PROBLEMS
Problem 1
(a)
Since the cash flow statement is based on consolidated net income, the loss on sale of
equipment shown must have resulted from a sale to a nonaffiliate. A loss on sale to an
affiliate would be eliminated from consolidated net income, and any amount of amortized
loss from a previous sale would be included in the adjustment for depreciation expense.
(b)
Bonds issued at a premium reflect a market rate that is lower than the bond's stated rate,
and as a result investors are willing to pay more to purchase the bond. When this
excess payment is amortized, it decreases the interest expense so that it reflects the
market rate when the bonds were issued. Therefore, the bond premium amortization
represents a noncash amount that decreases interest expense and increases income. In
this case, consolidated net income is higher as a result of a noncash item and that item
must be deducted to calculate cash flow from operations.
(c)
Non-controlling interest in subsidiary's income =
Non-controlling interest's percentage
9,800 / 40%
(d)
9,800
40%
24,500
Goodwill impairment loss
1,000
Subsidiary's net income
25,500
Dividend payments to noncontrolling shareholders do represent a flow of cash outside
the economic entity, and as a result they must be presented on the consolidated cash
flow statement. However, from the consolidated entity's point of view, these dividends
are reported as a reduction of the non-controlling interest on the consolidated balance
sheet. The only dividends that can be reported in the consolidated statement of retained
earnings are those that are paid to the parent's shareholders.
(e)
Non-controlling interest's share of dividends =
Non-controlling interest's percentage
6,000
40%
Subsidiary's total dividends declared – 6,000 / 40% 15,000
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Modern Advanced Accounting in Canada, Sixth Edition
Problem 2
PART A
Cost of 70% (1400  2000) of Star
280,000
Implied value of 100%
400,000
Shareholders' equity
Total
Preferred
Preferred stock
50,000)
50,000)
Common shares
200,000)
Retained earnings
(80,000)
8,000*
170,000
58,000)
Common
200,000) Dr
(88,000) Dr
112,000
Acquisition differential
Allocated:
288,000
FV – BV
Accounts receivable
(2,000)
Inventory
7,000
Plant
Long-term liabilities
50,000
(20,000)
35,000
Goodwill
253,000
* Dividends in arrears: 500 shares  $8  2 years = 8,000
Acquisition Differential Amortization Schedule
Balance
Amortization
Balance
Jan. 1, YR 5
YR 5 to 11
(2,000)
(2,000)
–
–
7,000)
7,000)
–
–
50,000)
50,000)
–
–
Long-term liabilities
(20,000))
(17,500))
(2,500)
–
Goodwill
253,000)
138,970)
19,710
94,320
288,000)
176,470)
17,210
94,320
Accounts receivable
Inventory
Plant
YR 12
Dec. 31, YR 12
Intercompany receivables and payables
December management fee
Solutions Manual, Chapter 8
2,000
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129
Intercompany profits
Before tax
Tax 40%
After tax
Opening inventory – Star selling
30,000
12,000
18,000
– Par selling
21,000
8,400
12,600
51,000
20,400
30,600
Closing inventory – Star selling
35,000
14,000
21,000
– Par selling
37,000
14,800
22,200
72,000
28,800
43,200
Equipment – Star selling
July 1, Year 7
22,000
Depreciation to Dec. 31, Year 11
(4,400  4½ years)
19,800
Balance December 31, Year 11
2,200
880
1,320
Depreciation Year 12
2,200
880
1,320
–0–
–0-
–0–
Balance December 31, Year 12
Star Year 12 dividends
Preferred 500  $8
Common
20,000
4,000
16,000
70%
Intercompany dividends
11,200
Deferred income tax, December 31, Year 12
Closing inventory profit
28,800
Calculation of Year 12 consolidated net income
Par net income (loss)
Less: Dividends
Closing inventory profit
30,000)
11,200)
22,200)
33,400)
(3,400)
Add: Opening inventory profit
12,600
9,200
Star net income (loss)
Less: Acquisition differential amortization
(24,000)
17,210)
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Modern Advanced Accounting in Canada, Sixth Edition
Preferred claim on net income
4,000)
Common net income (loss)
(45,210)
Less: closing inventory profit
21,000)
(66,210)
Add: Opening inventory profit
18,000)
Equipment profit
1,320)
(46,890)
Preferred claim on net income
4,000)
(33,690)
Consolidated net income
Attributable to:
Par’s shareholders
(23,623)
Non-controlling interests (100% x 4,000 + 30% x -46,890)
(10,067)
(33,690)
Calculation of consolidated retained earnings – Jan. 1, Year 12
Par opening retained earnings
180,000
Less: Opening inventory profit
12,600
167,400
Star retained earnings, Jan. 1, Year 12
208,000)
Acquisition
(88,000)
Increase
296,000)
Less: Acquisition differential amortization
Opening inventory profit
176,470
18,000
Unrealized equipment profit
1,320
Adjusted increase
195,790)
100,210)
70%
Consolidated opening retained earnings
70,147
237,547
(a)
Par Corp.
Consolidated Retained Earnings Statement
Year Ended December 31, Year 12
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131
Balance January 1
$237,547
Net loss
23,623
213,924
Dividends
35,000
Balance December 31
$178,924
Calculation of non-controlling interest – December 31, Year 12
Preferred
Preferred stock
Common
Total
50,000
Common shares
200,000)
Retained earnings
164,000)
364,000)
Closing inventory profit
(21,000)
50,000
343,000
.
94,320
50,000
437,320
100%
30% )
50,000
131,196)
Unamortized acquisition differential
181,196
(b)
Par Corp.
Consolidated Balance Sheet
as at December 31, Year 12
Cash (40,000 + 1,000)
Accounts receivable (100,000 + 85,000 – 2,000)
Inventory (55,000 + 48,000 – 72,000)
41,000
183,000
31,000
Land (30,000 + 70,000)
100,000
Plant and equipment (net) (220,000 + 400,000)
620,000
Deferred income tax
28,800
Goodwill
94,320
1,098,120
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Modern Advanced Accounting in Canada, Sixth Edition
Accounts payable (92,000 + 180,000 – 2,000)
270,000
Accrued liabilities (8,000 + 10,000)
18,000
Common shares
450,000
Retained earnings
178,924
Non-controlling interest
181,196
1,098,120
PART B
Since dividends paid by Star in Year 12 exceeded the annual minimum of $4,000 (500 x $8 per
share), the income attributed to the preferred shareholders would be the same regardless of
whether the preferred shares were cumulative or noncumulative. Therefore, consolidated net
income attributable to Par’s shareholders would not change.
PART C
Investment account – cost basis, Dec. 31, Year 12
280,000)
Retained earnings – Par – equity basis
178,924
Retained earnings – Par – cost basis
175,000
3,924
Investment account – equity basis – Dec. 31, Year 12
283,924
January 1, Year 13
Ownership reduction 70% – 56% = 14%
14%  70% = 20%
Reduction in investment account
20%  283,924
New assets of Star
56,785)
100,000
56%
Loss
56,000)
785
This loss will be debited to contributed surplus, if any exists, or to retained earnings in shareholders’
equity. If Par were using the equity method, the following entry would be made:
Retained earnings
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785
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133
Investment in Star
785
Problem 3
Dec. 31, Year 5 – Regent owns 90%  8,000 shares = 7,200 shares
April 1, Year 6 – 2000 shares issued by Argyle
Regent’s % =
7,200
=
(8,000 + 2,000)
7,200
10,000
= 72%
Regent
Ownership before share issue
90%
Ownership after share issue
72%
Change
18%
Percentage of investment reduction: 18% / 90% = 20%
Oct. 1, Year 6 – Regent acquires 1,300 shares
Regent’s % =
7,200 + 1,300
8,500
=
= 85%
10,000
10,000
Therefore a step purchase of 13% has occurred.
(a)
Dec. 31, Year 5 (90/10)
Land
Equipment
Trademarks
Total
Parent
NCI
28,333
44,444
52,223
125,000
112,500
12,500
–
(1,389)
(1,305)
(2,694)
(2,425)
(269)
28,333
43,055
50,918
122,306
110,075
12,231
(22,015)
22,015
Amort to April 1
April 1
20% sold to NCI
–
(2,778)
(2,611)
(5,389)
(3,880)
(1,509)
28,333
40,277
48,307
116,917
84,180
32,737
15,200
(15,200)
Amort– April to Oct. 1 (72/28)
Oct. 1
13/28 sold to parent
Amort – Oct. to Dec. 31 (85/15)
Dec. 31, Year 6
–
(1,389)
(1,305)
(2,694)
(2,290)
(404)
28,333
38,888
47,002
114,223
97,090
17,133
(b)
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Parent
NCI
315,000
35,000
Net income to April 1 (50,000  3/12  90%)
11,250
1,250
Acquisition differential amortization to April 1
(2,425)
(269)
323,825
35,981
(64,765)
64,765
108,000
42,000
Net income April to Oct. (50,000  6/12  72%)
18,000
7,000
Acquisition differential amortization April 1 to Oct. 1
(3,880)
(1,509)
381,180
148,237
Oct. 1 acquisition from NCI (13/28 x 148,237)
68,825
(68,825)
Net income Oct. to Dec. (50,000  3/12  85%)
10,625
1,875
(2,290)
(404)
Dividends (20,000  85%)
(17,000)
(3,000)
Balance December 31, Year 6
441,340
77,883)
Investment account Dec. 31, Year 5
Result of Argyle share issue
20%  323,825
New shares (2,000  $75)
150,000
72%
Acquisition differential amortization Oct. to Dec.
Proof:
Investment account Dec. 31, Year 6
441,340)
Shareholders' equity Jan. 1
225,000
New shares issued (2,000 x 75)
150,000
Net income
50,000
Dividends Dec. 31
(20,000)
Shareholders' equity Dec. 31, Year 6
405,000
85% )
Parent’s share of unamortized acquisition differential
344,250)
97,090)
Problem 4
Shareholders' equity of Sub Dec. 31, Year 1:
1,120,000
Parent's investment account Dec. 31, Year 1:
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135
(1,120,000 + 565,000)
1,685,000
Parent's journal entry Jan. 1, Year 2:
Cash
629,000
Investment (30%  1,685,000)
505,500
Retained earnings - gain on sale
123,500
Effect on consolidated statements:
Cash
629,000
Non-controlling interest (30%  1,685,000)
505,500
Retained earnings - gain on sale
123,500
* Calculation of dividends paid to noncontrolling shareholders:
Opening balance of non-controlling interest
Carrying value of shares purchased from parent (30%  1,685,000)
Add non-controlling interest’s share of sub's income
0
505,500
38,400
543,900
Less: Ending balance of non-controlling interest
Non-controlling interest in sub's dividends
515,000
28,900
Parent Ltd.
Consolidated Cash Flow Statement
For the Year Ended December 31, Year 6
Operating cash flow:
Profit
414,900)
Add (deduct):
Depreciation
Goodwill impairment loss
370,000)
35,000)
Increase in inventory
(499,500)
Decrease in current liabilities
(701,500)
Decrease in accounts receivable
Cash used in operations
110,000)
(271,100)
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Investing cash flow:
Proceeds from sale of investment in Sub
629,000)
Acquisition of plant and equipment
(250,000)
Cash from investing
379,000)
Financing cash flow:
Issuance of long-term debt
500,000)
Dividends – to Parent Ltd. shareholders
(104,000)
– to noncontrolling shareholders
(28,900)*
Cash from financing
367,100)
Net increase in cash
475,000)
Cash – January 1
335,000)
Cash – December 31
810,000)
Problem 5
Cost of 70% of Simon
910,000
Implied value of 100% of Simon
1,300,000
Book value of Simon
Common shares
550,000
Retained earnings Jan. 1
400,000
Profit to April 1 (¼  200,000)
50,000
1,000,000
Acquisition differential
300,000
Allocated: FV – BV
–0–
Balance – broadcast rights
300,000
Cost of 60% of Fraser
600,000
Implied value of 100% of Fraser
1,000,000
Book value of Fraser
Common shares
300,000
Retained earnings Jan. 1
300,000
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Profit to April 1 (¼  150,000)
37,500
637,500
Acquisition differential
362,500
Allocated FV – BV
–0–
Balance – broadcast rights
362,500
Closing inventory profits
Before
Tax
After
tax
40%
tax
Simon selling
32,000
12,800
19,200
Princeton selling
18,000
7,200
10,800
(a)
Princeton Corp.
Calculation of Consolidated Profit
for the Year Ended December 31, Year 7
Income of Princeton
100,000
Less: Dividends from Simon (70%  30,000)
21,000
Closing inventory profit after tax
10,800
31,800
68,200
Income of Simon (¾  200,000)
150,000
Less: Broadcast rights amortization – see part (c) 22,500
Dividend from Fraser
(60%  70,000)
Closing inventory profit after tax
42,000
19,200
83,700
66,300
Income of Fraser (¾  150,000)
Less: Broadcast rights amortization – see part (c)
112,500
27,188
85,312
Consolidated profit
219,812
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Attributable to:
Princeton’s shareholders (68,200 + 70% x [66,300 + 60% x 85,312])
150,441
Non-controlling interests (30% x [66,300 + 60% x 85,312] + 40% x 85,312) 69,371
219,812
(b) Calculation of non-controlling interest – Dec. 31, Year 7
Fraser shareholders' equity – Dec. 31
680,000
Unamortized broadcast rights – Fraser (see part c)
335,312
1,015,312
Non-controlling interest’s share
40%
Simon shareholders' equity – Dec. 31
1,120,000
Retained earnings Fraser – Dec. 31
380,000
Acquisition
337,500
Increase
42,500
Less: Broadcast rights amortization
27,188
406,125
15,312
60%
9,187
1,129,187
Unamortized broadcast rights – Simon (see part c)
277,500
1,406,687
Less: Closing inventory profit after tax
19,200
1,387,487
Non-controlling interest’s share
30%
Non-controlling interest
416,246
822,371
(c) Calculation of consolidated broadcast rights – Dec. 31, Year 7
Broadcast rights – Simon
300,000
Less: amortization – Year 7
(300,000  10 × ¾)
Broadcast rights – Fraser
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22,500
277,500
362,500
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139
Less: amortization – Year 7
(362,500  10 × ¾)
27,188
335,312
612,812
Problem 6
Cost of 80% (800  1000) of SET
56,000
Implied value of 100% of SET
70,000
Shareholders' equity
Total
Preferred
Common
Preferred stock
40,000
42,0001
(2,000)
Common shares
20,000
Retained earnings
30,000
8,0002
90,000
50,000)
20,000
22,000
40,000
Acquisition differential (all allocated to patents)
30,000
Patent amortization – Year 5 (six year life)
(5,000)
Unamortized patent, December 31, Year 5
25,000
Calculation of consolidated profit
PET profit
30,000
Less: Dividends from SET3
(2,400)
27,600
SET profit
20,000
Less: Patent amortization
(5,000)
Consolidated profit
15,000
42,600
Attributable to:
PET’s shareholders
NCI
(4,0004
+ 20% x
36,400
[15,0003
–
4,0004])
6,200
42,600
Notes:
1. Liquidation value of 40,000 x 1.05 = 42,000
2. Dividends in arrears: 4,000 shares x $1/year x 2 years = 8,000
3. Dividends on common shares: (15,000 – 4,000 x $1/year x 3 years) x 80% = 2,400
4. Income for preferred: 4,000 x $1/year x 1 year = 4,000
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Modern Advanced Accounting in Canada, Sixth Edition
(a)
PET Company
Statement of Retained Earnings
For the year ended December 31, Year 5
Retained earnings, beginning of year
$50,000
Profit
36,400
Dividends
(25,000)
Retained earnings, end of year
$61,400
(b)
PET’s retained earnings
55,000
Total
Preferred
Common
SET’s retained earnings,
End of Year 5
35,000
At acquisition
30,000
8,000
22,000
5,000
(8,000)
13,000
(5,000)
0
(5,000)
(000)
(8,000)
8,000
Change since acquisition
Amortization of patents
35,000
PET’s share
80%
Consolidated retained earnings, December 31, Year 5
6,400
61,400
(c)
Calculation of non-controlling interest – income statement
Interest in preferred shares (100% x 4,000)
4,000
Interest in common shares (20% x 11,000 as per above)
2,200
Total
6,200
Calculation of non-controlling interest – statement of financial position
Preferred
Preferred stock
Common
Total
(2,000)
40,000
20,000
20,000
.
35,000
35,000
42,000
53,000
95,000
.
25,000
42,000
78,000
42,000
Common shares
Retained earnings
Unamortized acquisition differential
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141
100%
20% )
42,000
15,600)
57,600
Problem 7
(a)
July 1, Year 8
Proceeds from sale 720  $30
21,600
Book value sold (see * in part (c) below for calculation)
26,550
Loss on sale Year 8
4,950
Dec. 29, Year 9
Reduction in investment account
** 118,800  ***1/9 (see ** and *** in part (c) below for calculation
of investment account and new percentage ownership)
13,200
Gain due to new assets
500  $46
23,000
Plumber’s %
64%
Gain on share issue, Year 9
14,720
1,520
(b) The parent, using the equity method, would not report the gain (loss) on its income statement.
These two transactions resulting from the ownership change are viewed as capital transactions
between shareholders of the same consolidated entity. For capital transactions, gains are
reported in contributed surplus and losses are shown first as a reduction in contributed surplus,
if any exists, and then as a reduction to retained earnings. The gain or loss from the capital
transactions would not be eliminated in the consolidation process and therefore would appear
in shareholder’s equity on the consolidated balance sheet in the same manner as it appears on
Plumber’s separate entity balance sheet.
(c)
Total Parent’s
Investment account Jan. 1, Year 8 (90%)
Implied value of 100%
NCI’s
126,000
140,000
126,000
14,000
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Common shares (4,000 shares)
20,000
Retained earnings
70,000
90,000
81,000
9,000
50,000
45,000
5,000
(50,000  10 = 5,000  1/2 year)
(2,500)
(2,250)
(250)
Balance July 1, Year 8, before sale
47,500
42,750
4,750
(8,550)
8,550
Trademarks Jan. 1, Year 8
Amortization to July 1, Year 8
Sale (720 / 3,600 = 20%)
Balance after sale July 1, Year 8 (72% & 28%)
47,500
34,200
13,300)
Amortization to Dec. 31, Year 8
(2,500)
(1,800)
(700)
Amortization Year 9
(5,000)
(3,600)
(1,400)
Balance Dec. 29, Year 9 before ownership change
40,000
28,800
11,200
(3,200)
3,200
25,600
14,400
*** Disposal due to share issue (1/9)
Plumber’s share of trademarks Dec. 31, Year 9 (64%)
Ownership before share issue 2,880/4,000 =
72%
Ownership after share issue 2,880/4,500 =
64%
8%
40,000
8%  72% = 1/9 reduction***
Calculation of investment account balances
Investment account Jan. 1, Year 8
126,000
Trademark amortization to July 1, Year 8
(2,250)
Net income to July 1 (10,000  90%)
9,000
Balance before sale
132,750
Sale (720 / 3,600 = 20%)
(26,550)*
Balance after sale July 1, Year 8
106,200
Net income July to Dec. (10,000  [2,880 / 4,000])
7,200
Dividend Year 8 (5,000  72%)
(3,600)
Trademark amortization to Dec. 31, Year 8
(1,800)
Balance Dec. 31, Year 8
108,000
Net income Year 9 (28,000  72%)
20,160
Dividend Year 9 (8,000  72%)
(5,760)
Trademark amortization Year 9
(3,600)
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143
Balance before share issue
118,800**
Gain on share issue (see part (a))
1,520
Balance after share issue
120,320
Proof of Investment Account Components
Book value of sub’s net assets
(64% x [90 + 20 – 5 + 28 – 8 + 23])
94,720
Unamortized fair value excess of trademarks
25,600
Total investment account
(d)
120,320
Yes, the trademarks are recorded at historical cost less accumulated amortization on the
consolidated balance sheet. On the date of acquisition, the trademarks were recorded at
$45,000 which was the amount paid by Plumber when it purchased a 90% interest in
Summer. Since the date of acquisition, the cost of the trademarks has been amortized
and reduced for the portion deemed to be sold.
Problem 8
Consolidated Enterprises
Consolidated Cash Flow Statement
for the Year Ended December 31, Year 2
Operations
Net income (450,000 + 14,000)
464,000)
Add (deduct):
Goodwill impairment loss
3,000)
Depreciation
73,000)
Gain on sale of equipment
(8,000)
Equity earnings – Pacific Finance
Dividends from Pacific Finance
Increase in inventory
Increase in accounts payable
Decrease in accounts receivable
Total cash from operations
(90,000)
25,000)
(15,000)
5,000)
23,000)
480,000)
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Investing
Purchase of building
(580,000)
Sale of equipment (8 + 37)
45,000)
Total cash from investing
(535,000)
Financing
Bond issue
120,000)
Dividends – to parent's shareholders
(60,000)
– to noncontrolling shareholders
(6,000)
Total cash from financing
54,000)
Total decrease in cash
(1,000)
Cash – January 1
42,000)
Cash – December 31
41,000)
Problem 9
Part A
Investment account (9,500 sh) – January 1, Year 6
Book value of Sub
320,000
270,000
95%
256,500
Parent’s share of acquisition differential
63,500
Allocated: Land 35%
22,225
Equipment 40%
25,400
Patents 25%
15,875
63,500
Implied value of 100% of acquisition differential
Land (22,225 / 95%)
23,395
Equipment (25,400 / 95%)
26,737
Patents (15,875 / 95%)
16,710
Total
P sold
66,842
1,900 sh
= 20%
9,500 sh
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145
New ownership
7,600 sh
= 76%
10,000 sh
(a)
Cash
66,500
Investment in Sub (20%  320,000)
64,000
Contributed surplus – gain on sale
2,500
(b)
Balance Jan. 1, Year 6
Land
Equipment
Patents
Total
23,395
26,737
16,710
66,842
–
6,684
1,671
8,355
23,395
20,053
15,039
58,487
Amortization Year 6
Balance Dec. 31, Year 6
(c)
Investment account Jan. 1, Year 6
320,000
20% sold
(64,000)
Acquisition differential amortization (8,355 x 76%)
(6,350)
Net income (76%  150,000)
114,000
Dividends (76%  70,000)
(53,200)
Balance Dec. 31, Year 6 – equity method
310,450
Shareholders' equity Sub (270,000 + 150,000 – 70,000)
350,000
76%
266,000
Balance – Parent’s share of unamortized acquisition differential
44,450
100% of unamortized acquisition differential (44,450 / 76%)
58,487
Part B
Cash
66,500
Contributed surplus - gain on sale
2,500
Non-controlling interest [19%  (270,000 + 66,842)]
64,000
Change in non-controlling interest
After sale (100 – 76)
24%
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Modern Advanced Accounting in Canada, Sixth Edition
Before sale (100 – 95)
5%
Change
19%
or,
Change in non-controlling interest
Shares sold by P:
1,900
= 19%
10,000
Problem 10
1st
2nd
Cost of purchase
600,000
166,000
Implied value of 100%
800,000
Book value of Sic’s net assets
Common shares
200,000
200,000
Retained earnings
300,000
310,000
500,000
510,000
100 %
Acquisition differential
500,000
20%
102,000
300,000
64,000
300,000
48,0001
Allocated to:
Patents
Direct charge to retained earnings for excess of cost over
Carrying value transferred from NCI
Total
Solutions Manual, Chapter 8
16,000
300,000
64,000
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147
Allocation and amortization of acquisition differential allocated to patents
Total
Parent
NCI
Purchase on Jan 1, Year 5
300,000
225,000
75,000
Amort. for Year 5 (5 years)
(60,000)
(45,000)
(15,000)
Dec 31, Year 5
240,000
180,000
60,000
48,0001
(48,000)
1
NCI sold 2,000/2,500 x 60,000
240,000
228,000
12,000
Amort. for Year 6 (4 years)
(60,000)
(57,000)
(3,000)
Dec 31, Year 6
180,000
171,000
9,000
(a) Calculation of consolidated profit for Year 6
Pic profit
140,000
Less: Dividends from Sic (95% x 90,000)
(85,500)
54,500
Sic profit
110,000
Less: patent amortization
60,000
Consolidated profit
50,000
104,500
Attributable to:
Pic’s shareholders
102,000
NCI (5% x 50,000])
2,500
104,500
(b)
(i) Patents (see patent amortization schedule above)
180,000
(ii) Sic’s common shares
200,000
Sic’s retained earnings
330,000
530,000
NCI’s ownership
5%
26,500
NCI’s share of unamortized patent
9,000
Total NCI on statement of financial position
35,500
(iii) Pic’s retained earnings
Sic’s retained earnings
550,000
1st
2nd
310,000
330,000
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Sic’s retained earnings, at acquisition
Change since acquisition
Cumulative amort. of patents
Pic’s ownership
300,000
310,000
10,000
20,000
(60,000)
(60,000)
(50,000)
(40,000)
75%
95%
(37,500)
(38,000)
(75,500)
Excess of purchase price over carrying value for 2 nd purchase
(16,000)
458,500
Consolidated retained earnings
Problem 11
(a & b)
York
Queens
McGill
Carleton
Trent
Total
Profit
54,000)
22,000)
26,700)
15,400)
Less – inventory profits
(6,000)
)
(600)
(1,440)
)
(8,040)
Consolidated profit
48,000)
22,000)
26,100)
13,960)
11,600)
121,660
11,600) 129,700)
Allocate Trent
60% to McGill
6,960)
(6,960)
Allocate Carleton
70% to Queens
9,772)
McGill’s profit – equity method
)
(9,772)
33,060)
Allocate McGill
10% to Queens
80% to York
26,448)
Queen’s profit – equity method
3,306)
(3,306)
)
(26,448)
35,078)
Allocate Queens
90% to York
31,570)
Unallocated
(31,570)
)
)
)
3,508)
3,306)
4,188)
4,640)
Consolidated profit – attributable to York’s shareholders (part a)
Yorks’s profit – equity
*
(c)
15,642 *
106,018 **
106,018
Consolidated profit – attributable to non-controlling interest (part b)
It makes no difference whether McGill sells to York, its parent, or to Carleton, another
subsidiary. In both cases, the entire amount of the unrealized profits is eliminated on
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149
consolidation because the sales were within the consolidated entity. Therefore, the profit
has not been realized with an entity outside of the consolidated entity and should be
eliminated on consolidation. The unrealized profit will be deducted from McGill’s income
and 10% of the unrealized profit will be absorbed by the non-controlling interest in McGill
regardless of whether McGill sold to Carleton or York.
Problem 12
Investment in Delta
Book value of Delta
490,000
600,000
80%
480,000
Craft’s share of unamortized patent Dec. 31, Year 12
10,000
Value of 100% of unamortized patent Dec. 31, Year 12
12,500
Before share issue, Craft's holdings (80%  49,000) = 39,200 sh.
After share issue, Delta's shares outstanding (49,000 + 12,250) = 61,250 sh
Craft's ownership before
80%
Craft's ownership after (39,200  61,250)
64%
Change
16%
Reduction in ownership 16%  80 = 20%
Analysis
Reduction in investment (20%  490,000)
New shares (12,250 sh  $15)
98,000
183,750
64%
Net gain from share issue
117,600
19,600
Non-controlling interest – Dec. 31, Year 12
Previous common shares
250,000
New shares issued
183,750
Retained earnings
350,000
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Modern Advanced Accounting in Canada, Sixth Edition
783,750
Add: Unamortized patent
12,500
796,250
36%
286,650
Craft Ltd.
Consolidated Statement of Financial Position
as at December 31, Year 12
Buildings and equipment (600,000 + 400,000)
Patent
1,000,000)
12,500)
Inventory (180,000 + 200,000)
380,000)
Accounts receivable (90,000 + 120,000)
210,000)
Cash (50,000 + 65,000 + 183,750)
298,750)
1,901,250)
Common shares
480,000)
Retained earnings
610,000)
Contributed surplus
19,600
Non-controlling interest
286,650)
Mortgage payable
250,000)
Accrued liabilities
85,000)
Accounts payable (70,000 + 100,000)
170,000)
1,901,250)
Problem 13
A's 40% of C
Acquisition differential – equipment Jan. 1, Year 4
(10,000)
Amortization, Years 4–6
3,000)
Balance, Dec. 31, Year 6
(7,000)
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151
Proof:
Investment in C, Jan. 1, Year 7
85,000)
Shareholders' equity, C Jan. 1, Year 7
230,000
40%
92,000)
Unamortized acquisition differential – as above
(7,000)
Note:
A business combination occurred on January 1, Year 7 when B Company purchased its 40%
interest in C Company because A Company now controls C Company. A Company will be able to
control 80% of the votes in C Company because it owns 40% of C Company directly and controls B
Company, which owns another 40% of C Company.
On the date of the business combination, C Company will be valued at 100% of its fair value.
Therefore, A Company revalues its existing investment in C Company to fair value of $92,000. A
Company will record a gain of $7,000 ($92,000 – $85,000). Accordingly, the $7,000 negative
acquisition differential related to equipment will disappear and there will be no acquisition differential
related to C Company.
A's 75% of B
Bal.
Jan. 1/6
Amort.
Bal.
Amort.
Bal.
Year 6 Dec. 31/6
Year 7 Dec. 31/7
Buildings (20 yrs)
40,000
2,000
38,000
2,000
36,000
Patents (8 yrs)
53,333
6,667
46,666
6,667
39,999
93,333
8,667
84,666
8,667
75,999
70,000
6,500
63,500
6,500
57,000
A’s share (75%)
Proof:
Investment in B, Jan. 1, Year 7
Shareholders' equity B, Jan. 1, Year 7
409,250
461,000
75%
Unamortized acquisition differential – as above
345,750
63,500
B's 40% of C
Investment in C, Jan. 1, Year 7
92,000
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Modern Advanced Accounting in Canada, Sixth Edition
Shareholders' equity C, Jan. 1, Year 7
230,000
40%
92,000
–0–
Acquisition differential
Intercompany receivables and payables
22,000
Unrealized profits
Before
Tax
After
tax
40%
tax
Closing inventory – A selling
2,400
960
1,440
– C selling
3,000
1,200
1,800
5,400
2,160
3,240
A Company
Calculation of Consolidated Net Income
for the Year Ended December 31, Year 7
A
Net income
118,800)
Gain on revaluation of C
Consolidated net income
Total
55,300)
20,000)
194,100
7,000
(8,667)
(8,667)
(1,440)
)
(1,800)
(3,240)
124,360)
46,633)
18,200)
189,193)
7,280)
(7,280)
)
(7,280)
Allocate C – 40% to B
– 40% to A
C
7,000
Amortization – purch. discr.
Inventory profits
B
7,280)
B’s net income
53,913)
Allocate B – 75% to A
40,435)
Attributable to NCI
Attributable to A’s shareholders
A’s net income – equity
(40,435)
)
13,478)
3,640)
)
17,118) *
172,075)
172,075)
(a) Non-controlling interest’s share of consolidated net income
17,118*
(b)
A Company
Consolidated Retained Earnings Statement
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153
for the Year Ended December 31, Year 7
Balance Jan. 1
314,250
Net income
172,075
486,325
Dividends
70,000
Balance Dec. 31
416,325
Calculation of non-controlling interest – Dec. 31, Year 7
Shareholders' equity C
250,000
Less: closing inventory profit
1,800
248,200
20%
49,640
Shareholders' equity B
Common shares
400,000
Retained earnings Jan. 1
61,000
Net income (55,300 + 7,280)
62,580
523,580
Unamortized acquisition differential
75,999
599,579
25%
149,894
Preferred shares
50,000
199,894
249,534
(c)
A Company
Consolidated Balance Sheet
as at December 31, Year 7
Cash (117.8 + 49.3 + 20)
187,100)
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Accounts receivable (200 + 100 + 44 – 22)
322,000)
Inventory (277 + 206 + 58 – 5.4)
535,600)
Property, plant and equipment (2,800 + 1,500 + 220 + 40)
Accumulated depreciation (1,120 + 593 + 90 + 4)
Patents
4,560,000)
(1,807,000)
39,999)
Deferred income tax
2,160)
3,839,859)
Accounts payable (206 + 88 + 2 – 22)
274,000)
Bonds payable (1000 + 700)
1,700,000)
Common shares
1,200,000)
Retained earnings
416,325)
Non-controlling interest
249,534)
3,839,859)
Problem 14
(a)
Parento Inc.
Consolidated Cash Flow Statement
for the Year Ended December 31, Year 4
Operating
Net Income
Add (deduct):
Database amortization
52,200)
)
2,400)
Depreciation
37,000)
Bond premium amortization
(1,200)
Loss on sale of land
Decrease in accounts receivable
Increase in inventory
2,000)
11,000)
(40,000)
Increase in accounts payable
23,200)
Decrease in accrued liabilities
(19,800)
66,800)
Investing
Proceeds from sale of land
Purchase of buildings and equipment
26,000)
(88,000)
(62,000)
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155
Financing
Issue of bonds payable
80,000)
Dividends – to shareholders of Parento
(14,400)
– to noncontrolling shareholders
(1,600)
64,000)
Increase in cash during the year
68,800)
Cash at beginning of year
49,800)
Cash at end of year
(b)
118,600)
Santana paid dividends of $8,000 of which 20% went to the non-controlling interest and 80%
went to Parento.
Only the 20% paid to the non-controlling interest shows up on the
consolidated cash flow statement because the non-controlling interest is an outside entity
wheras Parento is within the consolidated entity.
Problem 15
Wellington owns 90% of Sussex, therefore: 90%  7,200 = 6,480 shares
Sussex issues 1,800 additional shares: 7,200 + 1,800 = 9,000 shares outstanding
6,480
9,000
Wellington's new ownership percentage
Ownership before share issue
90%
Ownership after share issue
72%
Change
= 72%
18%
Percentage of investment reduction: 18% / 90% = 20%
Wellington sells 648 shares = 10% reduction
Ownership after sale
(6,480 – 648)
9,000
= 64.8%
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(a) Investment account Jan. 1, Year 5 for 90% interest
Total
235,800
Parent
NCI
90,000
10,000
(18,000)
18,000
100,000
72,000
28,000
30,000
(21,600)
(8,400)
70,000
50,400
19,600
(5,040)
5,040
45,360
24,640
Implied value of 100%
262,000
Shareholders' equity – Sussex
162,000
Unamortized acquisition differential – land
100,000
Less: 20% sale to NCI (share issue)
Less: 30% of land sold to outsiders
Less: 10% sale to NCI
Unamortized acquisition differential – land
Balance Dec. 31, Year 5
70,000
(b) Investment account Jan. 1, Year 5
235,800)
Net income to April 1 (3/12  36,000  90%)
8,100)
243,900)
Sussex share issue – April 1
Net book value deemed sold (20%  243,900)
New shares (1,800  $25)
48,780)
45,000
Parent’s share
72%
Loss due to share issue
32,400)
(16,380)
June 30 dividend (12,000  72%)
(8,640)
Sept. 15: 30% of land sold
(21,600)
Net income April to Dec. (9/12  36,000  72%)
19,440)
216,720)
Dec. 31 sale of 10% of shares
(21,672)
Balance Dec. 31, Year 5
195,048)
(c) Calculation of non-controlling interest Dec. 31, Year 5
Common shares
Solutions Manual, Chapter 8
28,000)
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157
Retained earnings Jan. 1
Net income
Dividends
Issue of new shares (1,800  $25)
134,000)
36,000)
(12,000)
45,000)
203,000
231,000
Unamortized acquisition differential – land
70,000
301,000
Non-controlling interest share (100% – 64.8%)
35.2%
Non-controlling interest
105,952
Proof of Investment Account Components
Book value of sub’s net assets (64.8% x 231,000)
149,688
Unamortized acquisition differential – land
70,000
Parent’s share
64.8%
Total investment account
45,360
195,048
Problem 16
It is assumed that Panet’s first purchase of 8% does not provide significant influence or control.
Therefore, it is not necessary to allocate the purchase price. It is assumed that Panet’s second
purchase of 27%, which brings the percentage ownership to 35%, does result in significant
influence. Therefore, it is necessary to allocate the purchase price.
When Panet acquires an
additional 45%, it would gain control. A business combination has occurred. The subsidiary is
valued at fair value and a gain or loss is recognized when adjusting the previous investments to fair
value.
Panet’s investment:
Cost of
40,000 common shares (8%)
500,000
Cost of 135,000 common shares (27%)
1,890,000
175,000 common shares (35%)
2,390,000
Book value
Common shares
3,000,000
Retained earnings
2,700,000
5,700,000
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Panet's %: 175,000 / 500,000 =
35%
1,995,000
Acquisition differential Jan. 1, Year 10
395,000
Allocated:
120,000  35%
42,000
1,000,000  35%
350,000
Inventory
Land
392,000
Balance – goodwill
3,000
Balance
Amortization
Balance
Jan. 1, YR 10
YR 10
Dec. 31, YR 10
42,000
42,000
350,000
–
Inventory
Land
Goodwill
3,000
.395,000
350,000
3,000
42,000
353,000
Investment in Saffer, Jan 1, Year 10
2,390,000
Share of change in retained earnings during Year 10
(3,200,000 – 2,700,000) x 35%
175,000
Amortization of acquisition differential for Year 10
(42,000)
Carrying value of investment in Saffer, Dec 31, Year 10
2,523,000
Fair value of investment using value paid for Jan 1, Year 11 purchase
3,600,000 / 225,000 x 175,000
2,800,000
Gain in value of investment
277,000
Panet
NCI
80%
20%
Cost of 225,000 common shares (45%)
3,600,000
Implied value of 80% (3,600,000 x 80 / 45)
6,400,000
Fair value of NCI’s interest in Saffer (15 x 100,000)
1,500,000
Book value of Saffer’s shareholders’ equity
Common shares
3,000,000
Retained earnings
3,200,000
Acquisition differential Jan. 1, Year 11
6,200,000
4,960,000
1,240,000
1,700,000
1,440,000
260,000
– 60,000
-48,000
-12,000
Allocated:
Accounts receivable
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159
Plant and equipment
900,000
720,000
180,000
Long-term liabilities
- 200,000
-160,000
-40,000
Balance – goodwill
1,060,000
928,000
132,000
Balance
Jan. 1, YR 11to Dec. 31, YR 11
Amortization
YR 12
Balance
Dec. 31, YR 12
Accounts receivable
– 60,000
– 60,000
Plant and equipment
900,000
45,000
45,000
810,000
- 200,000
- 20,000
- 20,000
- 160,000
640,000
- 35,000
25,000
650,000
928,000
73,600
46,400
808,000
132,000
18,400
11,600
102,000
1,700,000
57,000
83,000
1,560,000
1,440,000
45,600
66,400
1,328,000 (d)
260,000
11,400
16,600
232,000 (e)
Long-term liabilities
Goodwill – Panet’s purchase
– NCI’s purchase
Panet’s share
(80% x subtotal + Goodwill)
NCI’s share
(20% x subtotal + Goodwill)
Total dividends paid by Saffer
200,000
Preferred
50,000
Common
150,000
Panet's %: 400,000 / 500,000
Dividend revenue
80%
120,000
Intercompany sales – Saffer
2,600,000
– Panet
3,900,000
6,500,000
Intercompany receivables and payables
30%  450,000 =
Unrealized profits
135,000
Before tax
Tax 40%
After tax
85,000
34,000
51,000
Opening inventory
Saffer selling
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Panet selling
190,000
76,000
114,000
275,000
110,000
165,000
Saffer selling (400,000  35%)
140,000
56,000
84,000
Panet selling (250,000  45%)
112,500
45,000
67,500
252,500
101,000
151,500
210,000
84,000
126,000
10,000
4,000
6,000
200,000
80,000
120,000
Closing inventory
Equipment – Saffer selling
July 1, Year 12
Depreciation Year 12
(210,000 ÷ 10½  ½)
Balance Dec. 31, Year 12
Calculation of consolidated net income – Year 12
Panet
1,620,000
Less: Dividends from Saffer
120,000
Closing inventory profit after tax
67,500
187,500
1,432,500
Add: opening inventory profit after tax
114,000
1,546,500
Saffer
1,100,000
Less: Acquisition differential amort.
Closing inventory profit after tax
Equipment profit after tax
83,000
84,000
120,000
287,000
813,000
Add: opening inventory profit after tax
51,000
864,000
Consolidated net income
2,410,500
Attributable to:
Panet’s shareholders (1,546,500 + 80% x (864,000 – 50,000)
NCI (20% x 814,000 + 100% x 50,000)
2,197,700
212,800
2,410,500
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161
(a) (i)
Panet Company
Consolidated Income Statement
for the Year Ended Dec. 31, Year 12
Sales (15,000 + 9,000 – 6,500)
$17,500,000
Cost of sales (9,500 + 6,200 – 6,500 – 275 + 252.5)
9,177,500
Selling and admin (2,500 + 530 + 45 – 10)
3,065,000
Other (468 + 440 – 20 + 58 + 210)*
1,156,000
Income tax (1,032 + 730 + 110 – 101 – 84 + 4)
1,691,000
Total expenses
15,089,500
Consolidated net income
2,410,500
Attributable to:
Panet’s shareholders
2,197,700
NCI (20% x 814,000 + 100% x 50,000)
212,800
2,410,500
* Gain on sale of equipment was not shown as a separate income statement item, therefore must
have been netted against other expenses. Upon consolidation it must be added back, as it is
unrealized.
Calculation of consolidated retained earnings – Dec. 31, Year 12
Panet retained earnings
9,500,000
Less: Closing inventory profit
67,500
9,432,500
Retained earnings Saffer
Jan. 1, Year 11
3,200,000
Jan. 1, Year 10
2,700,000
Increase
500,000
35%
175,000
Acquisition differential amort. for Year 10
(42,000)
Gain on revaluation of investment at date of business combination
277,000
Dec. 31, Year 12
4,900,000
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Jan. 1, Year 11
3,200,000
Increase
1,700,000
Less: Acquisition differential amort. for Years 11 and 12
(57,000 + 83,000)
140,000
Closing inventory profit
84,000
Equipment profit
120,000
344,000
1,356,000
80%
1,084,800
10,927,300
Calculation of non-controlling interest – Dec. 31, Year 12
Share capital
Preferred
Common
500,000
3,000,000
Retained earnings
4,900,000
7,900,000
Less: unrealized profits
204,000
500,000
7,696,000
100%
20%
1,539,200
NCI’s share of unamortized acquisition differential
(650 x 20% + 102)
232,000
500,000
1,771,200
2,271,200
(a) (ii)
Panet Company
Consolidated Balance Sheet
as at December 31, Year 12
Cash (500 + 200)
Accounts receivable (2,400 + 300 – 135)
Solutions Manual, Chapter 8
700,000
2,565,000
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163
Inventory (500 + 400 – 252.5)
647,500
Plant and equipment (10,610 + 9,000 + 810 – 200)
20,220,000
Land (5,500 + 1,000)
6,500,000
Goodwill
910,000
Deferred income taxes (101 + 80)
181,000
31,723,500
Current liabilities (3,000 + 500 – 135)
3,365,000
Long-term liabilities (4,000 + 2,000 + 160)
6,160,000
Common shares
9,000,000
Retained earnings
10,927,300
Non-controlling interest
2,271,200
31,723,500
(b)
Goodwill impairment loss under entity theory
58,000
Less: NCI’s share (20%)
11,600
Goodwill impairment loss under parent company extension theory
46,400
NCI on income statement under entity theory
212,800
Add: NCI’s share of goodwill impairment (20%)
11,600
NCI on income statement under parent company extension theory
(c)
224,400
The debt to equity ratio would increase because debt would remain the same while equity
would decrease under the parent company extension ratio.
Problem 17
Part A
Cost of 70% of common (70,000 x $30)
2,100,000
Implied value of 100%
3,000,000
Book value of net assets
1,525,000
Less: preferred shares
1,400,000
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Book value of common shares
125,000
Acquisition differential
2,875,000
Allocated:
Land
95,000
Patents
300,000
Inventory
105,000
Brand name
2,375,000
2,875,000
Balance: goodwill
0
Land
Balance
Amort.
Amort.
12/31/YR 6
YR 7
YR 8
95,000
Patent Balance
Sold
12/31/YR 8
95,000
Patent
300,000
60,000
Inventory
105,000
105,000
2,375,000
59,375
59,375
2,256,250
2,875,000
224,375
117,375
14,000 2,519,250
Brand name (40 years)
*
58,000* 14,000* 168,000
Patents (12/31/YR 6)
Amort. Year 7
Amort.
1st
300,000
60,000
half Year 8
30,000
Balance June 30, Year 8
90,000
210,000
Portion sold (20/300 x 210,000)
14,000
196,000
Amort. 2nd half Year 8
30,000 – (20/300 x 30,000)
28,000
168,000
Intercompany profits PPC selling
Before
tax
Tax
40%
After
tax
Opening inventory (15,000 x 60%)
9,000
3,600
5,400
Closing inventory (22,000 x [60 – 42] / 60)
6,600
2,640
3,960
The intercompany loss on the transfer of computer hardware is allowed to stand because it is
indicative of a permanent decline in value.
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165
Intercompany sales
60,000
Annual dividends to preferred shareholders (12 x 12,500 shares)
150,000
Calculation of consolidated net income, Year 8
Ultra net income
PPC net income
Add: opening inventory profit
220,000
1,135,000
5,400
1,140,400
Less: closing inventory profit
3,960
1,136,440
Less: Acquisition differential amortization
117,375
Acquisition differential, sold patents
14,000
Consolidated net income
1,005,065
1,225,065
Attributable to:
Shareholders of Ultra
818,546
NCI (100% x 150,000 + 30% x [1,005,065 – 150,000])
406,519
1,225,065
(a)
Consolidated Income Statement
For the Year Ended December 31, Year 8
Sales (6,200 + 4,530 – 60)
Other income (120 + 7)
Gain on patent sale (50 – 14)
10,670,000
127,000
36,000
10,833,000
Cost of purchases (4,035 + 2,590 – 60)
6,565,000
Change in inventory (15 + 10 – 9 + 6.6)
22,600
Loss on write-down of computer equipment
1,080,000
Other expenses (850 + 675 + 3.6 – 2.64)
1,525,960
Depreciation and amortization (75 + 142 + 117.375)
Interest (45 + 35)
334,375
80,000
9,607,935
Net income
1,225,065
Attributable to:
Shareholders of Ultra
818,546
NCI
406,519
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1,225,065
(b) Calculation of consolidated retained earnings – Jan. 1, Year 8
Ultra retained earnings
1,300,000
PPC retained earnings
117,000
Acquisition *
25,000
Increase since acquisition
92,000
Less: Inventory profit
5,400
86,600
Less: acquisition differential amort
224,375
(137,775)
70%
(96,442)
1,203,558
*
Net assets
Preferred shares
Net book value of common shares
Common shares
Retained earnings
1,525,000
1,400,000
125,000
100,000
25,000
Consolidated Retained Earnings Statement
For the Year Ended December 31, Year 8
Balance January 1
1,203,558
Net income
818,546
Balance December 31
(c)
2,022,104
(i) Software patents and copyrights (350 + 450 + 168)
968,000
(ii) Inventory – software (350 + 380 – 6.6)
723,400
(iii) Non-controlling interest December 31, Year 8
Total
R/E Jan. 1
Net income
Dividends
R/E Dec.31
Common
117,000
—
117,000
1,135,000
150,000
985,000
1,252,000
150,000
1,102,000
150,000
150,000
—
1,102,000
Preferred shares 1,400,000
Solutions Manual, Chapter 8
Preferred
—
1,400,000
1,102,000
—
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167
100,000
—
100,000
2,602,000
1,400,000
1,202,000
Common shares
Bal. Dec. 31
Shareholders’ equity
Preferred
1,400,000
Common
1,202,000
Add: unamortized acquisition differential
2,519,250
Less: inventory profit
(3,960)
3,717,290
30%
Non-controlling interest
1,115,187
2,515,187
Part B
Conversion of the preferred would result in no change in the dollar amount of shareholders’
equity of PPC but all net income earned in the future would belong to the common shares.
Twenty-five thousand new common shares would be issued. The parent’s ownership would
change from 70% to 56% (70,000/125,000), a 20% reduction while the non-controlling interest
would increase to 44%. The unamortized acquisition differential would remain the same in total
but the split between the parent and non-controlling interest would change to their new
percentage ownership. The parent’s investment account would be reduced by 20% for the
deemed sale of 20% of its previous holdings and then would be increased by 56% of the value
attributed to the new common shares, which would normally be the net book value of the
preferred shares prior to their conversion to common shares.
Problem 18
Purchase Price Allocation Schedule for first two steps
Jan 1/YR 2
Jan 1/YR 4
50,700
98,300
Cost
BV –
CS
200,000
200,000
RE
28,000
69,000
228,000
269,000
% Acquired
20%
Acquisition differential
45,600
5,100
30%
80,700
17,600
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Land
2,550
8,800
Patents
2,550
8,800
Amortization
Year 2
255
Year 3
255
Year 4
255
1,100
Value Dec. 31, Year 4
1,785
7,700
Purchase Price Allocation Schedule for third step when Phase obtains control
Jan 1/YR 5
Cost of 30% investment
108,000
Implied value of 100% investment
360,000
BV –
CS
200,000
RE
104,000
304,000
Acquisition differential
56,000
Land
28,000
Patents
28,000
Amortization
Year 5
(4,000)
Value Dec. 31, Year 5
24,000
Intercompany profits Step selling
Before
tax
Opening inventory (10,000 x 20%)
2,000
800
1,200
Closing inventory (5,000 x 20%)
1,000
400
600
Sale of depreciable assets (Phase selling)
60,000
24,000
36,000
5,000
2,000
3,000
55,000
22,000
33,000
Realized in Year 5 (1/6 x ½)
Unrealized end of Year 5
Tax
40%
After
tax
Calculation of gain on revaluation of investment account when Phase obtains control
The investment account would show the following activity under the equity method:
Cost of 20% investment
50,700
Phase’s share of change in Step’s retained earnings during Years 2 & 3
(69,000 – 28,000) x 20%
8,200
Amortization of patent during Years 2 and 3 (255 + 255)
Solutions Manual, Chapter 8
(510)
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169
Cost of 30% investment
98,300
Phase’s share of change in Step’s retained earnings during Year 4
(104,000 – 69,000) x 50%
17,500
Amortization of patent during Year 4(255 + 1,100)
(1,355)
Phase’s share of unrealized profit in inventory at end of Year 4
(50% x 1,200)
(600)
Investment account balance, January 1, Year 5 before revaluation
172,235
Value of 10,000 shares (108,000 / 6,000 x 10,000)
180,000
Gain on revaluation to fair value on January 1, Year 5
7,765
(a)
Patents total
24,000
(b)
Property, plant, and equipment (540,000 + 298,000 + 28,000 – 55,000)
811,000
(c)
Current assets (173,000 + 89,000 – [80,000 +10,000] x 50% -1,000)
216,000
(d)
Non-controlling interest on statement of financial position
Step’s common shares
200,000
Step’s retained earnings (104 + 400 – 260 – 55 – 40)
149,000
Unrealized profit in ending inventory
(600)
Unamortized acquisition differential
52,000
400,400
NCI’s ownership
20%
NCI on statement of financial position
(e)
80,080
Retained Earnings, beginning
Phase’s retained earnings, beginning
360,000
Phase’s share of change in Step’s retained earnings during Years 2 and 3
(69,000 – 28,000) x 20%
Amortization of patent during Years 2 and 3 (255 + 255)
8,200
(510)
Phase’s share of change in Step’s retained earnings during Year 4
(104,000 – 69,000) x 50%
Amortization of patent during Year 4(255 + 1,100)
Phase’s share of unrealized profit in beginning inventory (50% x 1,200)
17,500
(1,355)
(600)
Consolidated retained earnings, beginning
383,235
(f)
Cost of goods sold (610 + 260 – 80 – 10 – 2 + 1)
779,000
(g)
Phase profit (1,002 – 610 – 190)
202,000
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Less: dividends (80% x 40)
(32,000)
unrealized gain on sale
(33,000)
Step profit (400 – 260 – 55)
85,000
Unrealized profit in ending inventory
Amortization of acquisition differential
(600)
(4,000)
80,400
Gain on revaluation
7,765
Consolidated profit
225,165
Attributable to:
Shareholders of Phase
209,085
NCI (20% x 80,400)
16,080
225,165
WEB-BASED PROBLEMS
Problem 1
The following answers are based on Vodafone’s March 31, 2009 consolidated financial statements:
(a)
Vodafone uses the indirect method as per note 31.
(b)
Purchase of property, plant and equipment of £5,204 as per the cash flow statement.
(c)
The cost of purchase of interests in subsidiary undertakings and joint ventures, net of
cash acquired was £1,389 as per the investing activities section of the cash flow
statement. The details of the acquisition are provided in note 29, which includes the
following:

breakdown of cash consideration paid by major acquisition

allocation of purchase price for the major acquisition

proforma information assuming that acquisition had occurred at the beginning of
the fiscal year
(d)
There were not any transactions during the year that resulted in a loss of control of any
subsidiaries as per note 30 on disposals and as per note 9 on intangible assets.
(e)
There were not any transactions during the year with respect to a subsidiary that did not
result in gaining or losing control as per note 30 on disposals.
(f)
Gains or losses reported in continuing operations generally have a more profound
impact on share prices than gains or losses reported in discontinued operations.
Activities reported in continuing operations are expected to reoccur in the future wheras
activities reported in discontinued operations may not be expected to reoccur. The
Solutions Manual, Chapter 8
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171
share price generally reflects future expectations i.e. what is expected to occur in the
future.
Problem 2
The following answers are based on Siemens’ September 30, 2009 consolidated financial
statements:
(a)
Siemens uses the indirect method as per the statement of cash flows.
(b)
Additions to intangible assets and property, plant and equipment of €2,923 as per the
cash flow statement.
(c)
The cost of acquisitions was €208 as per the investing activities section of the
statement of cash flows. While none of the fiscal 2009 acquisitions were material, either
individually or in aggregate, details of the fiscal 2008 acquisitions are provided in note
4, which includes the following:
(d)

cash consideration paid by major acquisition

allocation of purchase price for the major acquisition
There were no transations in fiscal 2009 between the Siemens and non-controlling
shareholders that resulted in a loss of control of a subsidiary. However, in fiscal 2008,
Siemens sold two major operating segments – Siemens VDO Automotive and the
Communications operating segment as per note 4. Income earned from these
subsidiaries and gains or losses on sale of these segments were reported on the
income statement under discontinued operations for the current and all prior years. The
assets and liabilities for these divisions were reported as held for disposal for the prior
year’s comparative amounts. Siemens also sold its Global Tungsten & Powders unit
and it’s Wireless Modules Business. The gains on these transactions were included in
other operating income. Goodwill declined by €107 in the current year, and €630 in
fiscal 2008 as a result of these sales or reclassifications.
(e)
There were not any transactions during the year with respect to a subsidiary that did not
result in gaining or losing control as per note 4 on disposals.
(f)
Gains or losses reported in continuing operations generally have a more profound
impact on share prices than gains or losses reported in discontinued operations.
Activities reported in continuing operations are expected to reoccur in the future
whereas activities reported in discontinued operations may not be expected to reoccur.
The share price generally reflects future expectations i.e. what is expected to occur in
the future.
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172
Modern Advanced Accounting in Canada, Sixth Edition