Chapter 10
SUBSIDIARY PREFERRED STOCK, CONSOLIDATED EARNINGS PER SHARE,
AND CONSOLIDATED INCOME TAXATION
Answers to Questions
1
Flora’s investment income:
Arom’s net income
Less: Preferred income ($500,000  10%)
Income to common stockholders
Flora’s percentage owned
Investment income
Flora’s investment account balance (equal to book value):
Arom’s stockholders’ equity
Less: Preferred equity (no arrearages or call premiums)
Common equity
Flora’s percentage ownership
Investment account balance
$
$
300,000
(50,000)
250,000
60%
150,000
$2,500,000
(500,000)
2,000,000
60%
$1,200,000
2
The payment of two years preferred dividend requirements would not have affected Flora’s investment
income. Since the preferred stock is cumulative, the preferred dividend requirements are deducted from net
income each year regardless of whether preferred dividends are declared.
3
The preferred stock of a subsidiary does not appear in a consolidated balance sheet. If there is a
noncontrolling interest in the preferred stock, it is reported as a noncontrolling interest in the consolidated
balance sheet. In part a, the investment in preferred is eliminated against the preferred equity and there is no
noncontrolling interest in preferred. When 50 percent of the stock is held by the parent (part b), the
investment in preferred is eliminated against 50 percent of the preferred equity and the other 50 percent is
reported as a noncontrolling interest. In part c, all of the preferred stock is reported as a noncontrolling
interest.
4
Assuming that the parent does not hold any of the subsidiary’s preferred stock, the computation of
noncontrolling interest share for an 80 percent owned subsidiary is 100 percent of the income allocated to
preferred plus 20 percent of the income allocated to common.
5
There is no difference between consolidated and parent company EPS.
6
An investor company’s EPS computations must reflect the potential dilution of an equity investee’s
common stock equivalents and other potentially dilutive securities if the effect is material.
7
Procedures applied in computing a parent company’s EPS computations are the same as those for a
corporation without equity investments except when the subsidiary has outstanding common stock
equivalents or other potentially dilutive securities.
8
Subsidiary EPS computations are only needed when computing diluted EPS, never for basic EPS, and then
it is only needed when the subsidiary has potentially dilutive securities convertible into subsidiary common
stock.
9
If a subsidiary has dilutive securities convertible into subsidiary common stock, the parent’s diluted
earnings are adjusted by replacing the parent’s equity in subsidiary realized income with its equity in
subsidiary diluted EPS. Alternatively, when subsidiary securities are convertible into the parent’s common
stock, the parent’s diluted earnings and common shares are adjusted as if the dilutive securities had been
issued by the parent company.
325
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
326
10
The replacement computation does not involve unrealized profits from downstream sales because these
items relate solely to parent company operations and do not affect the noncontrolling interest. In the case of
unrealized profits from upstream sales, however, unrealized profits are deducted in the replacement
computation which involves subtracting the parent’s equity in subsidiary realized income and adding back
the parent’s equity in subsidiary primary or fully diluted EPS (also based on subsidiary realized income).
11
Consolidated tax returns are not required for a consolidated entity, but a consolidated entity that qualifies as
an “affiliated group” may elect to file consolidated tax returns. Once consolidated returns are elected, it may
be difficult to obtain IRS permission to file separate returns.
12
Yes. Consolidated entities that meet the requirements of an affiliated group can and often do elect to file
separate income tax returns.
13
The primary advantages of filing consolidated tax returns are (1) losses of affiliates are offset against gains
of other members of the affiliated group, (2) intercompany profits between group members are eliminated
from taxable income until realized, and (3) intercorporate dividends are fully excluded from taxable
income. (But note that 3 is not a unique advantage of filing a consolidated return.)
14
Dividends received by a member of an affiliated group from other group members are excluded from
federal income taxation regardless of whether the affiliated group elects to file consolidated tax returns.
15
Temporary differences result because investors that are not members of an affiliated group record income
from equity investments as it is earned, but pay taxes only when dividends are actually received.
16
In providing for income taxes on undistributed earnings of equity investees, the parent company/investor
debits income tax expense and credits deferred income taxes as part of the determination of all income taxes
for the period. The investment and investment income accounts are not affected.
17
Unrealized and constructive gains and losses give rise to temporary differences unless the consolidated
entity is a member of an affiliated group and elects to file consolidated tax returns.
SOLUTIONS TO EXERCISES
Solution E10-1
1
2
3
4
[AICPA adapted]
a
Moss income to preferred
$
2,000
$10,000  20% owned
Moss income to common
40,000
$50,000  80% owned
Income from Moss
$
42,000
b
$180,000  20% taxable  30% tax rate
d
All dividend income is excluded from a consolidated group.
d
Intercompany profit is deferred in the consolidated tax return until
realized through sale to an outside entity.
Chapter 10
Solution E10-3
1
2
3
4
327
[Preferred stock]
Cost/fair value differential:
Total stockholders’ equity January 1, 2010
Less: Preferred equity (10,000 shares  $115)
Common equity
$8,000,000
1,150,000
$6,850,000
Cost
$8,100,000
Implied total fair ($8,100,000 / 90%)
Book value of investment ($6,850,000  90%)
Excess fair over book value – Goodwill
$9,000,000
6,850,000
$2,150,000
Income from Star for 2010:
Star’s net income
Less: Preferred dividends for 2010
Income to common
$1,200,000
100,000
$1,100,000
Income from Star ($1,100,000  90%)
$
Investment in Star at December 31, 2010:
Investment cost January 1, 2010
Add: Income from Star
Less: Dividends ($600,000 - $200,000 preferred)  90%
Investment in Star
$8,100,000
990,000
(360,000)
$8,730,000
Noncontrolling interest for 2010:
Beginning stockholders’ equity
Add: Net income
Less: Dividends
Stockholders’ equity December 31, 2010
$8,000,000
1,200,000
(600,000)
$8,600,000
Preferred equity ($105  10,000)
Common noncontroling interest ($8,600,000+$2,150,000
(Goodwill)-$1,050,000)  10%
Noncontrolling interest December 31, 2010
Solution E10-2
1
2
990,000
$1,050,000
970,000
$2,020,000
[Preferred stock]
Fair value — book value differential:
Cost of 80% interest
$1,536,000
Implied total fair value ($1,536,000 / 80%)
Less: Book value ($2,500,000 total equity $630,000 preferred equity)
Excess fair value over book value - Goodwill
$1,920,000
(1,870,000)
$
50,000
Loss from Sommerfeld — 2009:
Sommerfeld’s net loss
Add: Income to preferred stockholders
Loss to common stockholders
Percent owned
Loss on investment in Sommerfeld
$
$
100,000
72,000
172,000
80%
137,600
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
328
Solution E10-2 (continued)
3
Income from Sommerfeld — 2010:
Net income
Less: Income to preferred stockholders
Income to common stockholders
Percent owned
Income from investment in Sommerfeld
4
Total stockholders’ equity at December 31, 2010
($2,500,000 - $100,000 loss in 2009 + $500,000 income
in 2010 - $344,000 dividends in 2010)
Less: Preferred equity
Common equity
Percent owned
Underlying equity
Add: 80% of Unamortized excess
Investment in Sommerfeld at December 31, 2010
$2,556,000
(630,000)
1,926,000
80%
1,540,800
40,000
$1,580,800
Check: Cost of investment
Loss — 2009
Income — 2010
Dividends 2010 ($344,000 - $144,000)  80%
Investment in Sommerfeld at December 31, 2010
$1,536,000
(137,600)
342,400
(160,000)
$1,580,800
[Preferred stock]
Investment cost (fair value equals book value):
Total stockholders’ equity of Sandalwood
Less: Preferred equity 10,000 shares  ($100 + $5 + $12)
Common equity
Percent owned
Investment cost (fair value and book value)
2
3
$
500,000
(72,000)
428,000
80%
342,400
Parnell’s investment in Sommerfeld account:
Solution E10-4
1
$
$4,000,000
1,170,000
2,830,000
80%
$2,264,000
Consolidated net income and noncontrolling interest share:
Penzance separate income
Add: Income from Sandalwood ($500,000 - $120,000)  80%
Consolidated net income
$3,000,000
304,000
$3,304,000
Noncontrolling interest share ($380,000 common income 
20%) + $120,000 preferred income
$
196,000
Underlying book value:
Total stockholders’ equity
Less: Preferred equity (10,000 shares  $105 call price)
Common equity
Percent owned
Underlying book value December 31, 2010
$4,200,000
1,050,000
3,150,000
80%
$2,520,000
Chapter 10
329
Solution E10-5
Preliminary computations:
Total equity of Shoshone at December 31, 2009
Less: Preferred equity (10,000 shares  $115)
Common equity December 31, 2009
1
$3,500,000
(1,150,000)
$2,350,000
Entries to record preferred stock investment:
600,000
Investment in Shoshone — preferred
Cash
600,000
To record purchase of 50% of Shoshone’s preferred stock.
Additional paid-in capital
25,000
25,000
Investment in Shoshone — preferred
To adjust investment in preferred account to underlying equity:
$600,000 cost - ($1,150,000 underlying equity  50%) = $25,000.
2
3
4
5
Excess of fair value over book value from common stock investment:
Cost of 80% investment in common stock
$2,000,000
Implied total fair value ($2,000,000 / 80%)
Book value
Excess fair value over book value
$2,500,000
(2,350,000)
$ 150,000
Pimlico’s income from Shoshone preferred — 2010:
$1,000,000 par  15%  50% owned
$
75,000
Pimlico’s income from Shoshone common — 2010:
Equity in Shoshone’s common income ($400,000 income $150,000 preferred dividends)  80% owned
Amortization of excess ($150,000/10 years)  80% owned
Income from Shoshone common
$
200,000
(12,000)
188,000
$
Noncontrolling interest at December 31, 2010:
Total equity at December 31 ($3,500,000 + $400,000
income - $300,000 dividends)
Less: Preferred equity
Common equity
Plus 20% of unamortized differential (20%  $135,000)
Common equity plus excess fair value
$3,600,000
(1,000,000)
$2,600,000
27,000
$2,627,000
Noncontrol. Int. — preferred ($1,000,000  50%) $500,000
Noncontrol. interest — common ($2,627,000  20%) 525,400
Total noncontrolling interest December 31
$1,025,400
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
330
Solution E10-6
1
2
[Preferred stock]
Fair value — book value differentials:
Cost of preferred stock
Book value of preferred 60,000 shares  ($100 par +
$5 call premium + $10 dividend arrearage)
Excess book value of preferred stock over cost
$ 6,500,000
Cost of common stock
$35,000,000
Implied total fair value ($35,000,000 / 70%)
Book value of common ($60,000,000 total equity $11,500,000 preferred equity)
Excess fair value over book value of common
$50,000,000
$
(6,900,000)
(400,000)
48,500,000
$ 1,500,000
The $400,000 negative differential should be treated as an increase in
the preferred investment and other paid-in capital accounts on Perry’s
books. Perry will record its investment in Sketch preferred as follows:
Investment in Sketch preferred
6,500,000
Cash
To record purchase of 60% of Sketch’s preferred stock.
6,500,000
Investment in Sketch preferred
400,000
Other paid-in capital
400,000
To adjust other paid-in capital for the constructive retirement of
60% of Sketch’s preferred shares.
Solution E10-7
1
2
3
d
c
d
Solution E10-8
1
2
3
4
[EPS]
[EPS]
a
Solaid’s diluted earnings for consolidated EPS purposes:
Polar’s equity in Solaid’s income $176,000/.8
c
Solaid’s outstanding shares
Add: Incremental shares 10,000 shares - ($100,000
assumed proceeds/$20 average market price)
Solaid’s common shares and common share equivalents
$
220,000
50,000 shares
5,000 shares
55,000 shares
b
Polar’s net income
Less: Equity in Solaid’s income
Add: Equity in Solaid’s diluted earnings (40,000 shares 
Solaid’s $4 diluted EPS)
Polar’s diluted earnings
$
$
316,000
(176,000)
160,000
300,000
d
Polar’s diluted earnings $300,000/300,000 Polar outstanding common
shares = $1
Chapter 10
Solution E10-9
331
[EPS]
Sheridan’s basic and diluted EPS
Basic
Income to common (equal to Sheridan’s net income) = a $18,000
Common shares and common share equivalents:
Outstanding shares
Additional shares using treasury stock method:
1,000 - (1,000  $9)/$15
Common shares and common share equivalents = b
Sheridan’s EPS = a/b
$
Diluted
$18,000
5,000
5,000
5,000
400
5,400
3.60
$
3.33
Putman’s basic and diluted EPS
Income to common (equal to Putman’s net income)
$20,000
Replacement of Putman’s equity in Sheridan’s realized
income with Putman’s equity in Sheridan’s diluted
earnings: Equity in Sheridan’s income to common
($18,000  80%)
$20,000
(14,400)
Equity in Sheridan’s diluted earnings
(4,000 shares  $3.33)
Putman’s basic and diluted earnings = a
13,320
$20,000
$18,920
8,000
8,000
Outstanding common shares = b
Putman’s EPS = a/b
Solution E10-10
$
2.50
$
[EPS]
Basic
a
b
2.37
Stanley’s earnings per share:
Net income
Stanley’s common shares outstanding
Incremental shares from warrants
Diluted: 5,000 — ($120,000 assumed
proceeds/$30 average price)
Common shares and equivalents
Earnings per share
Prince’s basic and diluted EPS:
Prince’s income to common ($80,467 - $12,000
to preferred)
Replacement computation:
Equity in Stanley’s income
Equity in Stanley’s EPS
16,000 shares  $1.26
$26,400
20,000
Diluted
$26,400
20,000
1,000
$
20,000
1.32
$68,467
$
21,000
1.26
$68,467
(21,120)
20,160
a
b
Earnings
Prince’s common shares outstanding
$68,467
10,000
$67,507
10,000
a/b
Earnings per share
$
$
6.85
6.75
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
332
Solution E10-11
[EPS]
Diluted
Scony’s earnings per share:
Scony’s earnings:
1
a
Income to Scony common (equals net income)
$630,000
Scony’s outstanding shares
50,000
Incremental shares from warrants
Diluted: 10,000 — ($240,000 assumed
proceeds/$40 average price)
b
Common and equivalent shares
a/b
Scony’s earnings per share
4,000
54,000
$
Consolidated earnings per share:
2
Poway’s income to common (equals net
income)
Basic
$1,480,000
Diluted
$1,480,000
Replacement:
80% of Scony’s income
(504,000)
Equity in diluted earnings
40,000 shares  $11.67
diluted EPS
a
Poway’s earnings
b
Poway’s outstanding shares
a/b
Consolidated earnings per share
Solution E10-12
1
2
3
4
b
c
c
b
[Tax]
11.67
466,800
$1,480,000
$1,442,800
1,000,000
1,000,000
$
1.48
$
1.44
Chapter 10
Solution E10-13
1
333
[Tax]
c
Assigned value of equipment
Related deferred tax liability
($6,000,000 - $4,000,000 tax basis)  34% tax rate
$6,000,000
$
680,000
2
c
Income tax expense = $500,000 investment income  20% taxable  34% tax
rate
3
c
Income taxes currently payable:
$30,000 dividends  20% taxable  34% tax rate = $2,040
Income tax expense:
$60,000 income from Springer  20% taxable  34% tax rate = $4,080
Deferred tax liability:
$30,000 undistributed earnings  20% taxable  34% tax rate = $2,040
4
d
Income taxes currently payable:
$17,500 dividends  20% taxable  34% tax rate = $1,190
Deferred income taxes:
$17,500 share of undistributed earnings  20%
taxable  34% tax rate = $1,190
5
a
No income tax is assessed on dividends received from a 100% owned
domestic subsidiary
Solution E10-14
1
[Tax]
Separate company tax returns:
Pruit’s income taxes currently payable:
Pretax accounting income $600,000  34% tax rate =
$204,000
Solo’s income taxes currently payable:
Pretax accounting income $200,000  34% tax rate =
68,000
Income taxes currently payable
Less: Increase in deferred tax asset ($400,000  34%)
Consolidated income tax expense
2
272,000
(136,000)
$ 136,000
Consolidated tax return:
Combined pretax accounting income
Less: Unrealized gain on downstream sale of land
Taxable income
Tax rate
Consolidated income tax expense
$800,000
(400,000)
400,000
34%
$ 136,000
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
334
Solution E10-14 (continued)
3
Separate tax returns:
Pruit’s income taxes currently payable:
Pretax accounting income $300,000  34% tax rate =
$102,000
Solo’s income taxes currently payable:
Pretax accounting income $100,000  34% tax rate =
34,000
Income taxes currently payable
136,000
Consolidated tax return:
Combined pretax accounting income
Less: Unrealized gain on downstream sale of land
$400,000
(200,000)
Taxable income
Tax rate
200,000
34%
Income taxes currently payable
$ 68,000
Note: No tax is paid on intercompany profits when consolidated returns
are filed.
Solution E10-15
[Tax]
Preliminary computations — Because there is only one tax rate, a schedule
approach to this solution is not necessary.
Sales
Gain on equipment
Cost of sales
Other expenses(includes $50,000 patent
amortization)
Pretax operating income
Income taxes payable on operating income
at 34% income tax rate
Income taxes payable on dividends ($400,000
paid  70% interest  20% taxable  34%)
Income taxes currently payable
Increase in deferred tax asset*
Income tax expense
Separate incomes
Add: Income from Sutter ($528,000  70%
owned - $160,000 unrealized gain)
Net income
*
Paxton
Sutter
$8,000,000 $4,000,000
200,000
(5,000,000) (2,000,000)
(1,850,000) (1,200,000)
1,350,000
800,000
(459,000)
(272,000)
(19,040)
(478,040)
48,307
(429,733)
920,267
(272,000)
(272,000)
528,000
209,600
$1,129,867
$
528,000
Deferred tax asset ($160,000 unrealized gain  34%) - ($128,000 future dividends 
70% owned  20% taxable  34% enacted tax rate) = $48,307
Chapter 10
335
Solution E10-15 (continued)
Paxton Corporation and Subsidiary
Consolidated Income Statement
for the year 2009
Consolidated sales
$12,000,000
Less: Cost of sales
(7,000,000)
Less: Other expenses ($3,000,000 + $50,000 - $40,000)
(3,010,000)
Income before income taxes and noncontrolling interest share 1,990,000
Income tax expense**
(701,733)
Total consolidated income
1,288,267
Noncontrolling interest share
(158,400)
Controlling share of onsolidated net income
$ 1,129,867
** Taxes currently payable of $478,040 for Paxton + $272,000 for Sutter - $48,307
increase in deferred tax asset = $701,733
Solution E10-17
1
[Tax]
One-line consolidation entries:
Separate tax returns are filed
Income from Sullivan
40,000
Investment in Sullivan
40,000
To eliminate unrealized profit on downstream sale of merchandise.
Computation: $50,000 gross profit  80% unrealized.
Note: that the tax effect of the unrealized profit is $13,600, but
that amount is a deferred tax asset to be included in the
computation of Peddicord’s income tax expense. The deferred tax
asset may be reduced by a valuation allowance following FIN 48.
Consolidated income tax returns are filed
Income from Sullivan
40,000
Investment in Sullivan
40,000
To eliminate unrealized profit on downstream sale of merchandise.
Computation: $50,000 gross profit  80% unrealized.
Note: since no tax is paid on the inventory profit, no income tax
adjustment is necessary.
2
Consolidation working paper entries:
Separate Income Tax
Consolidated Income
Returns Filed
Tax Returns Filed
Sales
100,000
100,000
Cost of goods sold
100,000
100,000
To eliminate reciprocal sales and purchases.
Cost of goods sold
40,000
40,000
Inventory
40,000
To eliminate unrealized profits in ending inventory.
40,000
Note: No adjustments for tax effects are needed because consolidated
income tax is equal to combined separate company income taxes under FASB
Statement No. 109.
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
336
Solution E10-16
1
[Tax]
One-line consolidation entry:
Income from Sweeney
80,000
Investment in Sweeney
80,000
To eliminate unrealized profit on upstream sale. Computation:
$100,000 unrealized profit  80% owned.
2
Consolidation working paper entries:
Gain on sale of equipment
100,000
Equipment
100,000
To eliminate unrealized gain and reduce equipment to its cost
basis.
3
Noncontrollig interest share:
Net income of Sweeney (includes the tax effect of the gain) $800,000
Less: Unrealized profit
(100,000)
Realized income of Sweeney
700,000
Noncontrolling interest percentage
20%
Noncontrolling interest share
$140,000
Solution E10-19
Possible Estimated
Outcome
Individual
Probability
of Occurring (%)
Cumulative Probability
of Occurring (%)
$500,000
10
10
400,000
25
35
300,000
25
60
200,000
20
80
100,000
10
90
0
10
100
Because $300,000 is the largest amount of benefit that is greater than 50
percent likely of being realized, Pax would recognize a tax benefit of
$300,000. in the financial statements (Deferred tax asset of $500,000 less a
valuation allowance of $200,000).
Chapter 10
337
Solution E10-18
Possible Estimated
Outcome
Individual
Probability
of Occurring (%)
Cumulative Probability
of Occurring (%)
$150,000
50
50
125,000
20
70
100,000
10
80
50,000
10
90
0
10
100
Because $125,000 is the largest amount of benefit that is greater than 50
percent likely of being realized, Pony would recognize a tax benefit of
$125,000. in the financial statements (Deferred tax asset of $150,000 less a
valuation allowance of $25,000).
SOLUTIONS TO PROBLEMS
Solution P10-1
1
2
[Preferred stock] (amounts in thousands)
Undervaluation of the building from Parrella’s investment in Stanley
Cost of 180,000 shares of common stock
$3,600
Implied total fair value ($3,600 / 90%)
Less: Book value
Stockholders equity
$4,150
1,150
Less: Preferred equity (10,000  $115)*
Common equity
Excess fair value = Goodwill
* Preferred equity at liq. Pref. (!0,000  $105)
+ Div. in arrears ($100,000)
$4,000
Income from Stanley
Stanley’s reported income
Less: Preferred dividend for 2009
Stanley’s adjusted income to common
$
(
$
90% of Stanley’s adjusted income
3
3,000
$1,000
500
100)
400
$
360
$
100
$
$
40
140
Noncontrolling interest share for 2009
Income allocable to preferred
Stanley’s adjusted income
Noncontrol. common interest share (10%)
Noncontrolling interest share
$400
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
338
Solution P10-1 (continued)
4
Noncontrolling interest December 31, 2009
Total stockholders’ equity ($4,150,000
+ $500,000 net income $400,000 dividends)
Less: Preferred equity (No div. in
arrears)
Common equity – book value
Plus Unamortized fair value at 12/31
Common equity at fair value
Noncontrolling interest December 31
5
$4,250
1,050  100%
$3,200
1,000
$4,200  10%
$1,050
420
$1,470
Investment in Stanley December 31, 2009
Investment cost
Add: Income from Stanley
Less: Dividends ($400,000 - $100,000 preferred dividends
in arrears - $100,000 current preferred dividends)  90%
Investment in Stanley December 31
Check:
Equity of common ($3,200,000  90%)
Undepreciated excess ($1,000,000  90%)
Investment in Stanley December 31
Solution P10-2
$3,600
360
(180)
$3,780
$2,880
900
$3,780
[Preferred stock]
Preliminary computations
Stockholders’ equity July 1, 2009
$900,000 - ($46,000 income  1/2 year)
Less: Preferred equity July 1, 2009
Par value with call premium
Dividend arrearage — 2008 ($200,000  9%)
Dividend arrearage — 2009 ($200,000  9% 
1/2 year)
Common equity July 1, 2009
$877,000
$210,000
18,000
9,000
237,000
$640,000
Cost of 90% interest in Starky’s common stock
$630,000
Implied total fair value ($630,000 / 90%)
Book value of common equity
Goodwill
$700,000
(640,000)
$ 60,000
Cost of 80% interest in Starky’s preferred stock
Book value acquired ($237,000  80%)
Book value over cost of preferred
$175,000
(189,600)
$(14,600)
Chapter 10
339
Solution P10-2 (continued)
1
Investment account balances at December 31, 2009
Common
Investment cost
$630,000
Adjust preferred to book value and recognize
a constructive retirement
Income to preferred ($18,000  1/2 year  80%)
12,600
Income to common ($28,000  1/2 year  90%)
Investment balances December 31
2
$642,600
Preferred
$175,000
14,600
7,200
$196,800
Consolidated balance sheet working paper entries
9% preferred stock, $100 par
Retained earnings — Starky
Investment in Starky — preferred
Noncontrolling interest — preferred
200,000
46,000
196,800
49,200
To eliminate reciprocal preferred equity and investment balances
and enter noncontrolling interest. The preferred stockholders’
claim on Starky’s retained earnings consists of $18 per share
preferred dividends in arrears plus a $5 per share call premium.
Computations: Investment in Starky preferred = $123  1,600
shares. Noncontrolling interest — preferred = $123  400 shares.
Capital stock, $10 par — Starky
Paid-in capital in excess of par — Starky
Retained earnings — Starky
Goodwill
Investment in Starky — common
Noncontrolling interest — common
500,000
40,000
114,000
60,000
642,600
71,400
To eliminate reciprocal common equity and investment amounts and
enter goodwill and noncontrolling interest in common.
NOTE: Noncontrolling interest includes 10% of Goodwill.
Solution P10-4 [Preferred stock]
Preliminary computations
Cost of 70% interest in Sal January 1, 2008
Implied total fair value of Sal ($490,000 / 70%)
Book value acquired of common equity
Excess of fair value over book value
$490,000
$700,000
700,000
$
0
Cost of 20% interest in Sal April 1, 2009
$152,000
Implied total fair value of Sal ($152,000 / 20%)
Book value of Sal($850,000 + $22,500 - $12,500 - $100,000)
Excess of fair value over book value
$760,000
760,000
$
0
Pat’s investment income from Sal for 2009
Sal’s net income
$
Less: Preferred income ($100,000  10%)
Income to common
$
Income from Sal($80,000  70%  1 year)+($80,000  20%  3/4 year) $
90,000
10,000
80,000
68,000
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
340
Solution P10-4 (continued)
Pat Corporation and Subsidiary
Consolidation Working Papers
for the year ended December 31, 2009
(in thousands)
Pat
Income Statement
Sales
Income from Sal
Cost of sales
Other expenses
Preacquisition income
Noncontrolling int. share
Controlling share of NI
$1,233
68
610*
390*
Adjustments and
Eliminations
Sal
$
700
$1,933
a
301
$
501
68
400*
210*
b
d
$
$
Consolidated
Statements
1,010*
600*
4*
18*
$ 301
4
18
90
Retained Earnings
Retained earnings — Pat
$
Retained earnings — Sal
Net income
Dividends
Retained earnings
December 31
Balance Sheet
Cash
Other current assets
Plant assets
Investment in Sal**
Current liabilities
$10 preferred stock
Common stock
Other paid-in capital
Retained earnings
$
301
200*
200
b 200
301
90
50*
a
d
b
34
14
2
200*
$
602
$
240
$
$
191
200
900
711
$
50
300
600
$
$2,002
$
950
$
$
60
100
500
50
240
950
200
a 34
b 677
1,200
602
$2,002
602
241
500
1,500
$
$2,241
$
c 100
b 500
b 50
602
b
Noncontrolling interest — preferred
Noncontrolling interest December 31
c 100
Deduct
** Common equity of Sal = $790 x 90% = $711
260
1,200
Noncontrolling interest — common
*
501
d
75
4
179
$2,241
Chapter 10
341
Solution P10-3 [Preferred stock]
Preliminary computations
Cost — book value differential:
Investment cost
Implied total fair value of Sak ($240,000 / 80%)
Less: Book value acquired
Sak’s stockholders’ equity January 1, 2008
Less: Preferred equity
Sak’s common equity
Excess fair value over book value = Goodwill
Income from Sak for 2009:
Equity in Sak’s income ($60,000 - $10,000 pf)  80%
Add: Intercompany profits beginning inventory
($50,000  40%  3/5)
Less: Intercompany profits ending inventory
($60,000  40%  4/6)
Add: Realization of 80% of $10,000 profit deferred on
land from 2005
Add: Constructive gain on bonds ($9,000  80%)
Less: Piecemeal recognition of gain
($9,000/3 years  1/2 year  80%)
Income from Sak
Investment in Sak December 31, 2009:
Underlying book value ($390,000 - $100,000)  80%
Add: 80% of Goodwill
Less: Unrealized inventory profit
Add: Constructive gain less 1/2 year piecemeal
recognition ($9,000 - $1,500)  80%
Investment in Sak December 31
Noncontrolling interest share — common:
Sak’s reported income less income to preferred
($60,000 - $10,000)
Recognition of previously deferred gain on land
Constructive gain on bonds less 1/2 year piecemeal
recognition of gain ($9,000 - $1,500)
Sak’s realized income to common
Noncontrolling interest percentage
Noncontrolling interest share — common
$240,000
$300,000
$325,000
100,000
225,000
$ 75,000
$ 40,000
12,000
(16,000)
8,000
7,200
(1,200)
$ 50,000
$232,000
60,000
(16,000)
6,000
$282,000
$ 50,000
10,000
7,500
67,500
20%
$ 13,500
342
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution P10-3 (continued)
Pari Corporation and Subsidiary
Consolidation Working Papers
for the year ended December 31, 2009
Pari
Income Statement
Sales
Gain on land
Interest income
Gain on bonds
Income from Sak
Cost of sales
$
$
50,000
600,000*
Operating expenses
Interest expense
Noncontrolling share
Preferred
Noncontrol. Share — common
Controlling share of NI
900,000
10,000
6,500
Adjustments and
Eliminations
Sak 80%
300,000
140,000*
208,500*
a
e
6,500
f
c
50,000
16,000
90,000*
10,000*
i
i
$
158,000
$
132,000
60,000
$
Consolidated
Statements
d
10,000
$1,140,000
20,000
e
9,000
9,000
a
b
60,000
12,000
e
5,000
684,000*
298,500*
5,000*
10,000
13,500
10,000*
13,500*
60,000
$
158,000
$
132,000
Retained Earnings
— Pari
Retained earnings — Sak
Retained earnings
$
Net income
Dividends
Retained earnings
December 31
Balance Sheet
Cash
Accounts receivable
Inventories
Other current assets
Land
Plant and equipment
50,000
158,000
100,000*
190,000
$
90,000
$
5,500
26,000
80,000
100,000
160,000
268,000
92,500
$
15,000
20,000
60,000
5,000
30,000
420,000
— Sak bonds
Investment — Sak stock
282,000
$1,014,000
$
550,000
$
$
15,000
100,000
45,000
200,000
100,000
90,000
24,000
100,000
700,000
190,000
$1,014,000
$
Noncontrolling interest December 31
12,000
8,000
75,000
8,000
12,000
j
c
5,000
16,000
e
92,500
100,000*
$
190,000
$
20,500
41,000
124,000
105,000
190,000
688,000
f 42,000
h 260,000
75,000
$1,243,500
j
5,000
e 100,000
$
34,000
145,000
700,000
h 200,000
g 100,000
190,000
550,000
— common (beginning)
Noncontrolling interest — preferred (beginning)
Noncontrolling interest
158,000
f
i
b
d
h
Goodwill
Accounts payable
10% bonds payable
Other liabilities
Capital stock
10% preferred stock
Retained earnings
50,000
60,000
20,000*
$
Investment
h
d
2,000
h
65,000
g 100,000
i
11,500
174,500
$1,2243500
Chapter 10
343
Solution P10-5 [EPS]
Requirement 1 Requirement 2
Diluted
Diluted
Skinner’s EPS
Skinner’s net income (equal to income to common
stockholders)
Add: Net-of-tax interest on convertible bonds
Skinner’s earnings = a
$ 60,000
6,000
$ 66,000
$ 60,000
NA
$ 60,000
Skinner’s outstanding common shares
Add: Shares from assumed conversion of bonds
Common shares and common share equivalents = b
Skinner’s EPS = a/b
50,000
10,000
60,000
$
1.10
50,000
NA
50,000
$
1.20
Palace’s EPS
Palace’s net income (equal to income to common
stockholders)
$150,000
Add: Net-of-tax interest on convertible bonds
of Skinner
Replacement of Palace’s equity in Skinner’s
income with Palace’s equity in Skinner’s diluted (42,000)
38,500
EPS (35,000 shares  $1.10) and convertible
to Palace securities (35,000 shares  $1.20)
Palace’s earnings = a
$146,500
Palace’s outstanding common shares
Add: Shares from assumed conversion of bonds
Common shares and common share equivalents = b
Palace’s EPS = a/b
a
100,000
$
100,000
1.47
$150,000
6,000
(42,000)a
42,000a
$156,000
100,000
10,000
110,000
$
1.42
When subsidiary securities are convertible into parent company common stock, the
replacement calculation is not needed. The replacement is included in this solution
only to show that it has no effect on the calculation.
344
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution P10-8 [EPS]
Basic
a
b
a
b
a
Sheridan’s earnings per share
Income to common
Income to preferred assumed converted
Earnings
Common shares and common share equivalents:
Common shares outstanding
Add: Common shares issuable on preferred
Add: Incremental shares issuable on options
2,000 - [($2,000  $15)/$30]
Common and common equivalent shares
EPS a/b
Pensacola’s earnings per share
Income to common
Replacement calculation
Equity in Sheridan’s income to common
($45,000  80%)
Equity in Sheridan’s EPS
8,000  $4.50 basic EPS
8,000  $3.93 diluted EPS
Earnings
Common shares
EPS a/b
$ 45,000
$ 45,000
10,000
Diluted
$ 45,000
10,000
$ 55,000
10,000
3,000
1,000
10,000
14,000
$
4.50 $
3.93
$150,000
(36,000)a
$150,000
(36,000)
36,000a
31,440
$150,000
$145,440
20,000
20,000
$
7.50 $
7.27
A replacement calculation is never needed when calculating basic earnings per
share. It is only included here to illustrate the point that the replacement will
have no impact on the earnings per share calculation.
Chapter 10
345
Solution P10-7 [EPS]
1
a
b
Basic
Starch’s earnings per share
Income to common $50,000 - $14,000
$36,000
Add: Income to preferred assumed
converted
Earnings
$36,000
Common shares outstanding
6,000
Common shares from conversion of preferred
Common and common equivalent shares
2
a
b
$
Consolidated earnings per share
Net income to Protein
Replacement calculation for diluted EPS
$36,000  80% share of realized income
$5.00 diluted EPS  4,800 shares
Earnings
Outstanding common shares
EPS a/b
Net income of Protein
Add: Income to preferred
Earnings
Common stock of Protein
Common shares from conversion of
preferred
Common and common share equivalents
EPS a/b
Solution P10-6
$ 36,000
14,000
$ 50,000
6,000
4,000
6,000
EPS a/b
a
b
Diluted
10,000
6.00
$
5.00
$93,800
$ 93,800
$93,800
20,000
$
4.69
(28,800)
24,000
$ 89,000
20,000
$
4.45
$93,800
$93,800
20,000
$ 93,800
14,000
$107,800
20,000
20,000
$
4.69
5,000
25,000
$
4.312
[EPS]
Premble’s net income
Replacement calculation:
Premble’s equity in Smithfield’s realized
income ($500,000 - $60,000)  80%
Premble’s equity in Smithfield’s diluted EPS
(40,000 shares  $7.44)
Consolidated diluted earnings = a
Premble’s outstanding common shares = b
Consolidated diluted EPS = a/b
$1,262,000
$352,000
297,600
54,400
$1,207,600
100,000
$
12.08
346
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution P10-9 [EPS]
Basic
a
b
a
b
Sim’s earnings per share
Income to common
Less: Unrealized profit — upstream sale
Add: Income to preferred
Earnings
Common shares outstanding
Add: Shares from conversion of preferred
Add: Incremental shares from warrants
10,000 - ($150,000/$20)
Common and common equivalent shares
EPS a/b
$200,000
(20,000)
$180,000
50,000
50,000
$
3.60
Consolidated (and Pike’s) earnings per share
Pike’s income to common
$450,000
Replacement calculation
Equity in Sim’s realized income
($200,000 - $20,000)  80%
Equity in Sim’s diluted EPS 40,000  $3.39
Earnings
$450,000
Outstanding common shares
100,000
EPS a/b
$
4.50
Diluted
$200,000
(20,000)
100,000
$280,000
50,000
30,000
2,500
82,500
$
3.3939
$450,000
(144,000)
135,600
$441,600
100,000
$
4.42
Solution P10-10 [Tax]
Pactor Corporation
Income Statement
for the current year
Sales
Gain on sale of land
Income from Shrama
Cost of sales
Operating expenses
Income before income taxes
Income tax expenseb
Net income
(a)
Assuming Separate
Tax Returns
$1,200,000
50,000
49,000
(600,000)
(350,000)
349,000
(85,000)
$ 264,000
(b)
Assuming Consolidated
Tax Return
$1,200,000
50,000
49,000
(600,000)
(350,000)
349,000
(85,000)
$ 264,000
Supporting computations:
a
b
Income from Shram
Equity in Shram’s income
($150,000 - $51,000 income taxes)  100%
Less: Unrealized profit
Income from Shram
Income tax expense
Income tax currently payable:
Pactor’s $300,000 taxable income  34%
Consolidated taxable income of
$400,000  34%  $250,000/$400,000
Deferred income taxes:
Deferred tax asset ($50,000  34%)
Income tax expense
$
99,000
(50,000)
$ 49,000
$99,000
(50,000)
$49,000
$102,000
$85,000
(17,000)
$ 85,000
$85,000
Note: There is no tax on undistributed income because Pactor and Shram are an
affiliated group.
Chapter 10
347
Solution P10-12 [Tax]
Preliminary computations
Investment cost
$577,500
Implied total fair value of Silky($577,500 / 70%)
Less: Book value of Silky
Excess fair value over book value = Goodwill
$825,000
800,000
$ 25,000
1
Income tax expense (separate tax returns required)
Panama
Tax on operating income
($500,000  34%)
($200,000  34%)
Tax on dividends received
($50,000  70%)  20% taxable  34% tax rate
Income taxes currently payable
Deferred tax on undistributed income
($49,000*  70%)  20% taxable  34% tax rate
Deferred tax asset on unrealized inventory
profit ($50,000  34%)
Income tax expense
*
2
Silky
$170,000
$ 68,000
2,380
172,380
68,000
2,332
(17,000)
$170,048
$ 51,000
Undistributed income (Silky’s operating income of $200,000 - $51,000 tax $50,000 unrealized profit - $50,000 dividends paid) = $49,000
Income from Silky
$104,300
(35,000)
$ 69,300
Equity in Silky’s net income ($200,000 - $51,000 tax)  70%
Unrealized inventory profit ($50,000  70%)
Income from Silky
3
Panama Corporation and Subsidiary
Consolidated Income Statement
for the year ended December 31, 2009
Sales ($5,000,000 - $120,000)
Cost of sales ($2,550,000 + $50,000 - $120,000)
Gross profit
Operating expenses
Income before income taxes and noncontrolling interest
Less: Income taxes ($170,048 + $51,000)
Total consolidated income
Less: Noncontrolling interest share ($149,000
net income - $50,000 unrealized)  30%
$4,880,000
2,480,000
2,400,000
1,750,000
650,000
221,048
428,952
Controlling share of NI
$
399,252
$
329,952
69,300
399,252
Check:
Panama’s separate income ($500,000 - $170,048)
Income from Silky
Panama’s and Controlling share of NI
29,700
$
348
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution P10-11 [Tax]
Pulaski Corporation and Subsidiary
Partial Consolidation Working Papers
for the year ended December 31, 2009
Pulaski
Income Statement
$500,000
Sales
Dividends received
from Stewart
28,000
Cost of sales
250,000*
Operating expenses
78,000*
Income tax expense
58,222*
Noncont. Share**
Control. Share - NI $141,778
*
**
70%
Stewart
$300,000
120,000*
80,000*
34,000*
Adjustments and
Eliminations
Noncont.
Interest
a 90,000
c 28,000
b 10,000
Consolidated
Statements
$
710,000
$
290,000*
158,000*
92,222*
19,800*
149,978
a 90,000
$19,800
$ 66,000
Deduct
Noncontrolling interest share = $66,000  30%
Supporting computations:
Pulaski
Income taxes currently payable
Taxes on operating income
($172,000  34%)
($100,000  34%)
Tax on dividends received
($40,000  70%)  20% taxable  34% tax rate
Tax on undistributed income
($26,000  70%)  20% taxable  34% tax rate
Less: Deferred tax on inventory profit
$10,000  34% tax rate
Income tax expense
Consolidated net income check:
Stewart’s net income of $66,000  70%
Less: Unrealized inventory profit
Income from Stewart — equity basis
Less: Stewart’s income — cost basis
Cost — equity method difference
Add: Pulaski’s reported net income
Controlling share of NI
Stewart
$58,480
$ 34,000
1,904
60,384
34,000
1,238
(3,400)
$58,222
$ 34,000
$ 46,200
(10,000)
36,200
(28,000)
8,200
141,778
$149,978
Chapter 10
Solution P10-13
349
[Tax]
Preliminary computations
Investment cost
$900,000
Implied total fair value of Soo($900,000 / 90%)
Less: Book value of Soo
Excess fair value over book value = Goodwill
$1,000,000
900,000
$ 100,000
Soo
$200,000
$221,430
$ 62,700
(475,000)
(180,000)
(117,300)
(6,270)
$ 221,430
Pen’s income tax expense is calculated:
Sales
Cost of Sales
Expenses
Pretax income
Tax rate
Income tax expense
800,000
(400,000)
(150,000)
250,000
.34
85,000
Sales
Gain on land sale
Income from Soo
Cost of sales
Expenses
Income tax expense
Noncontrolling share
Controlling share of NI
a
Adjustments and
Eliminations
Pen
$800,000
20,000
36,430
(400,000)
(150,000)
(85,000)a
Consolidated
$1,000,000
a 20,000
b 36,430
(75,000)
(30,000)
(32,300)
Preliminary computations
Income from Soo for 2009:
Share of Soo’s net income ($62,700  90%)
Less: Unrealized profit on intercompany sale of land
Income from Soo
$ 56,430
(20,000)
$ 36,430
Investment in Soo account December 31, 2009
Cost of 90% interest in Soo January 1
Add: Income from Soo
Less: Dividends from Soo
Investment December 31
$900,000
36,430
(45,000)
$891,430
a
Gain on sale of land
20,000
Land
20,000
To eliminate unrealized intercompany profit from downstream sale
of land.
b
Income from Soo
36,430
Investment in Soo
8,570
Dividends from Soo
45,000
To eliminate investment income and dividends and return the
investment in Soo account to its beginning of the period balance.
c
500,000
Capital stock — Soo
400,000
Retained earnings — Soo
Goodwill
100,000
Investment in Soo
900,000
Noncontrolling interest January 1
100,000
To eliminate reciprocal beginning of the period investment and
equity balances, establish beginning noncontrolling interest, and
enter goodwill.
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
350
Solution P10-14 [Tax]
1
Allocation schedule
Cost of investment = Fair value (100% purchase)
Book value
Excess fair value over book value
Excess allocated:
Land
Buildings — net
Equipment — net
Goodwill for the remainder
Excess fair value over book value
$280,000
170,000
$110,000
$ 40,000
30,000
10,000
30,000
$110,000
(10 year life)
(2 year life)
Note: In a taxable combination transaction there are no deferred tax
liabilities since the tax basis and book basis are the same. A current
tax deduction will affect the future recognized income from Studio
Corporation.
2
Allocation schedule
Cost (fair value) of investment
Book value
Excess fair value over book value
Excess allocated:
Land
Buildings — net
Equipment — net
Deferred tax liability
($80,000  35%)
Goodwill for the remainder
Excess fair value over book value
a
3
$280,000
170,000
$110,000
$ 40,000
30,000
10,000
(10 year life)
(2 year life)
(28,000)a
58,000
$110,000
On a tax-free reorganization a deferred tax liability must be set up for all
the tax basis/book basis differentials, other than goodwill. Since the
transaction is recorded at purchase price on the books but has no change in
tax basis from the original books, differences in basis occur and are equal
to any fair value write-ups of the assets.
Parson’s income from Studio for 2009
Taxable
Studio’s reported income
Less: Depreciation on excess allocated to
buildings — net ($30,000/10 years)
Less: Depreciation on excess allocated to
equipment — net ($10,000/2 years)
Add: Income tax reductions due to the prior adjustments
Income from Studio
a
$ 50,000
(3,000)
(5,000)
2,800a
$ 44,800
Since all three items are currently deductible for tax purposes they will
reduce the income taxes Parson will have to pay.
Chapter 10
351
Solution P10-14 (continued)
Tax free
Studio’s reported income
Less: Depreciation on excess allocated to
buildings — net ($30,000/10 years)
Add: Amortization of deferred tax liability
allocated to buildings ($3,000  .35)
Less: Depreciation on excess allocated to
equipment — net ($10,000/2 years)
Add: Amortization of deferred tax liability
allocated to equipment ($5,000  .35)
Income from Studio
$50,000
(3,000)
1,050
(5,000)
1,750
$44,800
Solution P10-15
1
Income tax expense
Pommer
Income taxes currently payable:
Taxes on operating income
$1,400,000  34%
$800,000  34%
Tax on dividends received:
$280,000  20% taxable  34% tax rate
Income taxes currently payable
Tax on undistributed income:
$128,000  70%  20% taxable  34% tax rate
Less: Deferred tax on gain on equipment
$400,000  34% tax rate
Income tax expense
2
$476,000
$272,000
19,040
495,040
272,000
6,093
(136,000)
$365,133
$272,000
Loss from Sooner
Income from Sooner on an equity basis
Sooner’s net income of $528,000  70%
Less: Unrealized gain ($500,000 - $100,000)
Income from Sooner — equity basis (loss)
3
Sooner
$
$
369,600
(400,000)
(30,400)
Pommer Corporation and Subsidiary
Consolidated Income Statement
for the year ended December 31, 2009
Sales
Cost of sales
Gross profit
Other expenses ($2,100,000 + $1,200,000 - $100,000)
Income before income taxes
Income tax expense ($365,133 + $272,000)
Total consolidated income
Less: Noncontrolling interest share ($528,000  30%)
Controlling share of NI
$12,000,000
(7,000,000)
5,000,000
(3,200,000)
1,800,000
(637,133)
1,162,867
(158,400)
$ 1,004,467
Check: Pommer’s pretax income of $1,400,000 - $30,400 loss from Sooner $365,133 income taxes = $1,004,467 Controlling share of NI
Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
352
Solution P10-16
1
[Tax]
Selica’s net income
Pretax income
Less: Income tax expense:
Taxes currently payable ($860,000  34%)
Less: Deferred tax asset — land
($60,000  34%)
Selica’s net income
2
860,000
$
(272,000)
588,000
$
529,200
$
(54,000)
(30,000)
445,200
$292,400
(20,400)
Phoenix’s income from Selica
Share of Selica’s net income ($588,000  90%)
Less: Unrealized gain on upstream sale
of land ($60,000  90%)
Less: Unrealized inventory profit
Income from Selica on an equity basis
3
$
Phoenix’s net income
Sales
Income from Selica
Less: Cost of sales and expenses
Income before income taxes
Income tax expense ($418,200 currently payable less
$10,200a deferred tax asset)
Net income
a
$7,630,000
445,200
(6,400,000)
1,675,200
$
(408,000)
1,267,200
The deferred tax asset is $10,200 deferral for the inventory profit.