Consolidated Financial Statements - Ownership Patterns and Income Taxes

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes
CHAPTER 7
CONSOLIDATED FINANCIAL STATEMENTSOWNERSHIP
PATTERNS AND INCOME TAXES
Chapter Outline
I.
Indirect subsidiary control

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

A. A connecting affiliation exists whenever two or more companies within a business
combination hold an equity interest in another member of that organization.
B. Despite this variation in the standard ownership pattern, the consolidation process is
essentially the same for a connecting affiliation as for a father-son-grandson
organization.
C. Once again, any company in both a parent and a subsidiary position must recognize an
appropriate equity accrual in computing its own income.
III. Mutual ownership
A. A mutual affiliation exists whenever a subsidiary owns shares of its parent company.
B. Parent shares being held by a subsidiary are accounted for by the treasury stock
approach.
1. The cost paid to acquire the parent's stock is reclassified within the consolidation
process to a treasury stock account and no income is accrued.
2. The treasury stock approach is popular in practice because of its simplicity and is now
required by the FASB Codification.
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Education.
IV. Income tax accounting for a business combinationconsolidated tax returns

A. A consolidated tax return can be prepared for all companies comprising an affiliated group.
Any other companies within the business combination file separate tax returns.
B. A domestic corporation may be included in an affiliated group if the parent company (either
directly or indirectly) owns at least 80 percent of the voting stock of the subsidiary as well
as 80 percent of each class of its nonvoting stock.
C. The filing of a consolidated tax return provides several potential advantages to the
members of an affiliated group.
1. Intra-entity profits are not taxed until realized.
2. Intra-entity dividends are not taxed (although these distributions are nontaxable for all
members of an affiliated group whether a consolidated return or a separate return is
filed).
3. Losses of one affiliate can be used to reduce the taxable income earned by other
members of the group.
D. Income tax expenseeffect on noncontrolling interest valuation
1. If a consolidated tax return is filed, an allocation of the total expense must be made to
each of the component companies to arrive at the realized income figures that serve
as a basis for noncontrolling interest computations.
2. Income tax expense is frequently assigned to each subsidiary based on the amounts
that would have been paid on separate returns.
V. Income tax accounting for a business combinationseparate tax returns
A. Members of a business combination that are foreign companies or that do not meet the 80
percent ownership rule (as described above) must file separate income tax returns.
B. Companies in an affiliated group can elect to file separate tax returns. Deferred income
taxes are often recognized when separate returns are filed due to temporary differences
stemming from unrealized gains and losses as well as intra-entity dividends.
VI. Temporary tax differences can stem from the creation of a business combination
A. The tax basis of a subsidiary's assets and liabilities may differ from their consolidated
values (which is based on the fair value on the date the combination is created).
B. If additional taxes will result in future years (for example, it the tax basis of an asset is
lower than its consolidated value so that future depreciation expense for tax purposes will
be less), a deferred tax liability is created by a combination.
C. The deferred tax liability is then written off (creating a reduction in tax expense) in future
years so that the net expense recognized (a lower number) matches the combination's
book income (a lower number due to the extra depreciation of the consolidated value).
Vll. Operating loss carryforwards
A. Net operating losses recognized by a company can be used to reduce taxable income
from the previous two years (a carryback) or for the future 20 years (a carryforward).
B. If one company in a newly created combination has a tax carryforward, the future tax
benefits are recognized as a deferred income tax asset.
C. However, a valuation allowance must also be recorded to reduce the deferred tax asset to
the amount that is more likely than not to be realized.
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Education.
Answers to Questions
1. A father-son-grandson relationship is a specific type of ownership configuration often
encountered in business combinations. The parent possesses the stock of one or more
companies. At least one of these subsidiaries holds a majority of the voting stock of its own
subsidiary. Each subsidiary controls other subsidiaries with the chain of ownership going on
indefinitely. The parent actually holds control over all of the companies within the business
combination despite having direct ownership in only its own subsidiaries.
2. In a business combination having an indirect ownership pattern, at least one company is in
both a parent and a subsidiary position. To calculate the accrual-based income earned by that
company, a proper recognition of the equity income accruing from its own subsidiary must
initially be made. Structuring the income calculation in this manner is necessary to ensure that
all earnings are properly included by each company.
3. Able100% of income accrues to the consolidated entity (as parent company).
Baker70% (percentage of stock owned by Able).
Carter56% (80% of stock owned by Baker multiplied by the 70% of Baker controlled by
Able).
Dexter33.6% (60% of stock owned by Carter multiplied by the 80% of Carter controlled by
Baker multiplied by the 70% of Baker owned by Able).
4. When an indirect ownership is present, the quantity of consolidation entries will increase,
perhaps significantly. An additional set of entries is included on the worksheet for each
separate investment. Furthermore, the determination of realized income figures for each
subsidiary must be computed in a precise manner. For any company in both a parent and a
subsidiary position, equity income accruals are recognized prior to the calculation of that
company's realized income. This realized income total is significant because it serves as the
basis for noncontrolling interest calculations as well as the equity accruals to be recognized by
that company's parent.
5. In a connecting affiliation, two (or more) companies within a business combination own shares
in a third member. A mutual ownership, in contrast, exists whenever a subsidiary possesses
an equity interest in its own parent.
6. In accounting for a mutual ownership, U.S. GAAP requires the treasury stock approach. The
treasury stock approach presumes that the cost of the parent shares should be reclassified as
treasury stock within the consolidation process. The subsidiary is being viewed, under this
method, as an agent of the parent. Thus, the shares are accounted for as if the parent had
actually made the acquisition.
7. According to present tax laws, an affiliated group can be comprised of all domestic
corporations in which a parent holds 80 percent ownership. More specifically, the parent must
own (directly or indirectly) 80 percent of the voting stock of the corporation as well as at least
80 percent of each class of nonvoting stock.
8. Several basic advantages are available to combinations that file a consolidated tax return.
First, intra-entity profits are not taxed until realized. For companies with large amounts of intraentity transactions, the deferral of unrealized gains causes a delay in the making of significant
tax payments. Second, losses incurred by one company can be used to reduce or offset
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taxable income earned by other members of the affiliated group. In addition, intra-entity
dividends are not taxable but that exclusion applies to the members of an affiliated group
regardless of whether a consolidated or separate tax return is filed.
Members of a business combination may be forced to file separate tax returns. Foreign
corporations, for example, must always file separately. Domestic companies that do not meet
the 80 percent ownership rule are also required to file in this manner. Furthermore, companies
that are in an affiliated group may still elect to file separately. If all companies within the
combination are profitable and few intra-entity transactions are carried out, little advantage
may accrue from preparing a consolidated return. With a separate filing, a subsidiary has
more flexibility as to accounting methods as well as its choice of a fiscal year-end.
9. The allocation of income tax expense among the component companies of a business
combination has a direct bearing on realized income totals and, therefore, noncontrolling
interest calculations. Obviously, the more expense that is assigned to a particular company
the less realized income is attributed to that concern. Income tax expense can be allocated
based on the income totals that would have been reported by various companies if separate
tax returns had been filed or on the portion of taxable income derived from each company.
10. In filing a separate tax return (assuming that the two companies do not qualify as members of
an affiliated group), the parent must include as income the dividends received from the
subsidiary. For financial reporting purposes, however, income is accrued based on the
ownership percentage of the realized income of the subsidiary. Because income is frequently
recognized by the parent prior to being received in the form of dividends (when it is subject to
taxation), deferred income taxes must be recognized.
Either the parent or the subsidiary might also have to record deferred income taxes in
connection with any unrealized intra-entity gain. On a separate tax return, such gains are
reported at the time of transfer while for financial reporting purposes they are appropriately
deferred until realized. Once again, a temporary difference is created which necessitates the
recognition of deferred income taxes.
11. If the consolidated value of a subsidiarys assets exceeds their tax basis, depreciation
expense in the future will be less on the tax return than is shown for external reporting
purposes. The reduced expense creates higher taxable income and, thus, increases taxes.
Therefore, the difference in values dictates an anticipated increase in future tax payments.
This deferred liability is recognized at the time the combination is created. Subsequently,
when actual tax payments do arise, the deferred liability is written off rather than recognizing
expense based solely on the current liability. In this manner, the expense is shown at a lower
figure, one that is matched with reported income (which is also a lower balance because of
the extra depreciation).
Recognition of this deferred liability at date of acquisition also reduces the net amount
attributed to the subsidiary's assets and liabilities in the initial allocation process. Therefore,
the residual asset (goodwill) is increased by the amount of any liability that must be
recognized.
12. A net operating loss carryforward allows the company to reduce taxable income for up to 20
years into the future. Thus, a benefit may possibly be derived from the carryforward but that
benefit is based on Wilson (the subsidiary) being able to generate taxable income to be
decreased by the carryforward. To reflect the potential tax reduction, a deferred income tax
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asset is recorded for the total amount of anticipated benefit. However, because of the
uncertainty, unless the receipt of this benefit is more likely than not to be received, a valuation
allowance must also be recorded as a contra account to the asset. The valuation allowance
may be for the entire amount or just for a portion of the asset.
13. At the date of acquisition, the valuation allowance was $150,000. As a contra asset account,
recognition of this amount reduced the net assets attributed to the subsidiary and, hence,
increased the recording of goodwill (assuming that the price did not indicate a bargain
purchase). If the valuation allowance is subsequently reduced to $110,000, the net assets
have increased by $40,000. This change is reflected by a decrease in income tax expense.
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Answers to Problems
1. D
2. B
3. D
4. C
5. C
6. C
7. D Sapphire's accrual-based income:
Operating income ......................................................................
Defer unrealized gain ................................................................
Sapphire's accrual-based income ......................................
$210,000
(50,000)
$160,000
Emerald's accrual-based income:

Investment Income (90% of Sapphires accrual income) .......
Emerald's accrual-based income .......................................
$228,000
144,000
$372,000
Diamond's accrual-based income:

Investment income (80% of Emerald's accrual income) ........
Diamond's accrual-based income ......................................
$348,000
297,600
$645,600
8. C Cherry's accrual-based income:

Cherry's accrual-based income ..........................................
Outside ownership ....................................................................
Net income attributable to noncontrolling interest ............
$280,000
(50,000)
$230,000
20%
$ 46,000
Beech's accrual-based income:

Investment income (80% of Cherry's accrual-based income) .....
Beech's accrual-based income ...........................................
Outside ownership ....................................................................
Net income attributable to noncontrolling interest ...........
$315,000
(19,000)
184,000
$480,000
20%
$ 96,000
Total net income attributable to noncontrolling interest =

($46,000 + $96,000) = $142,000
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9. A Stark's operating income................................................................

Dividend income from Arryn ..........................................................
Stark 's income ...............................................................................
Outside ownership .........................................................................
Noncontrolling interest ..................................................................
$78,000
18,000
$96,000
5%
$ 4,800
10. B Equity income (75% of $415,000) ..................................................

Dividend income (75% of $110,000) ..............................................
Tax difference ............................................................................
Dividends received deduction upon eventual distribution (80%)
Temporary portion of tax difference ........................................
Tax rate ..........................................................................................
Deferred income tax liability ....................................................
$311,250
82,500
$228,750
(183,000)
$ 45,750
40%
$ 18,300
11. C Unrealized Gross Profit:

Total gross profit ........................................................................
Portion still held ..........................................................................
Unrealized gross profit .............................................................
Tax rate ..........................................................................................
Deferred tax asset .......................................................................
$30,000
20%
$ 6,000
25%
$ 1,500
12. A Recognition of this gross profit is not required on a consolidated tax return.
13. A Because fair value of the subsidiary's assets exceeds the tax basis by
$144,000, a deferred tax liability of $57,600 (40%) must be recorded. Goodwill
is then computed as follows:
Consideration transferred .......................................
Fair value ...............................................................
Deferred tax liability .................................................
Goodwill ....................................................................
$450,000
$454,000
(57,600)
396,400
$ 53,600
14. (30 Minutes) (Series of reporting and consolidation questions pertaining to a

father-son-grandson combination. Includes unrealized inventory gains)
a. Consideration transferred (by Aspen) .........................
Noncontrolling interest fair value .................................
Birchs business fair value ............................................
Book value
...............................................................
Trade name ......................................................................
Life ..................................................................................
Annual amortization ......................................................
$288,000
72,000
360,000
(300,000)
$ 60,000
30 years
$ 2,000
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14. (continued)
Consideration transferred for Cedar (by Birch) ..........
Cedars business fair value ..........................................
Book value
...............................................................
Trade name ......................................................................
Life ..................................................................................
$104,000
26,000
$130,000
(100,000)
$30,000
30 years
$ 1,000
Investment in Birch
Birch's reported income-2012
Amortization expense
Accrual-based income
Birchs percentage ownership
Equity accrual-2012
Dividends received 2012
Birch's reported income-2013
Amortization expense
Income from Cedar [80% x ($10,000 - $1,000)]
Birchs percentage ownership
Equity accrual-2013
Dividends received from Birch 2013
Investment in Birch 12-31-13
$288,000
$40,000
(2,000)
$38,000
80%
$30,400
(8,000)
$60,000
(2,000)
7,200
$65,200
80%
$52,160
(16,000)
$346,560
Note: Dividends declared by Cedar to Birch do not affect Aspens Investment

account.
b. Consolidated sales (total for the companies)
Consolidated expenses (total for the companies)
Total amortization expense (see a.)
Consolidated net income for 2014
c. Noncontrolling interest in income of Cedar
Revenues less expenses
$30,000
Excess amortization
(1,000)
$29,000
Noncontrolling interest percentage
20%
Noncontrolling interest in income of Cedar
Noncontrolling interest in income of Birch:
Revenues less expenses
$65,000
Excess amortization
(2,000)
Equity in Cedar income [(30,000-1,000) 80%]
23,200
Realized income of Birch2014
$86,200
Outside ownership
20%
NCI share of 2014 consolidated income
$1,298,000
(1,025,000)
(3,000)
$ 270,000
$5,800
$17,240
$23,040
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14. (continued)
d. 2013 Realized net income of Birch (prior to accounting
for unrealized gross profit) (see a)
2012 Transfer-gross profit recognized in 2013
2013 Transfer-gross profit to be recognized in 2014
2013 Realized net income - Birch
$65,200
10,000
(16,000)
$59,200
2014 Realized net income of Birch (prior to accounting

for unrealized gross profit) (see c.)
2013 Transfer-gross profit recognized in 2014
2014 Transfer-gross profit to be recognized in 2015
2014 Realized net incomeBirch
$86,200
16,000
(25,000)
$77,200
15. (15 minutes) (Income and noncontrolling interest with mutual ownership.)
a. Consideration transferred by Uncle .............................
Nephews business fair value .......................................
Book value ......................................................................
Intangible assets ............................................................
Life ..................................................................................
Amortization expense (annual) .....................................
Net income reported by Nephew2014 ........................
Amortization expense (above) ......................................
Accrual-based income....................................................
Uncle's ownership percentage .....................................
Net income of subsidiary recognized by Uncle ...........
$500,000
125,000
$625,000
600,000
$25,000
10 years
$2,500
$50,000
(2,500)
47,500
80%
$38,000
b. To the outside owners, the $6,000 intra-entity dividends ($20,000 30%)

declared by Uncle are viewed as income because the book value of Nephew
increases. Thus, the noncontrolling interest's share of income is computed as
follows:
Nephews accrual-based income (above)
Dividends declared by Uncle to Nephew
Income to outside owners
Noncontrolling interest percentage
Noncontrolling interest share of Nephews net income
$47,500
6,000
$53,500
20%
$10,700
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16. (35 Minutes) (Consolidated net income for a father-son-grandson combination.)

a. Mesa's operating income
Butte's operating income
Valley's operating income
Amortization expenseMesa's investment in Butte
Amortization expenseButte's investment in Valley
Consolidated net income
b. Valley's operating income
$140,000
Amortization expense (on Butte's investment)
(8,000)
Valley's accrual-based net income
$132,000
Outside ownership
45%
Noncontrolling interest in Valley's income
Butte's operating income
$ 98,000
Amortization expense (on Mesa's investment)
(22,500)
Equity accrual from ownership of Valley
($132,000 55%)
72,600
Butte's accrual-based net income
$148,100
Outside ownership
20%
Noncontrolling interest in Butte's net income
Total net income attributable to noncontrolling interests
$250,000
98,000
140,000
(22,500)
(8,000)
$457,500
$59,400
$29,620
$89,020
Reconciliation:
Mesas operating income
$250,000
Mesas share of Buttes operating income (80% $98,000)
78,400
Mesas share of Valleys operating income (80% 55% $140,000)
61,600
Mesas share of Buttes excess amortization (80% $22,500)
(18,000)
Mesas share of Valleys excess amortization (80% 55% $8,000)
(3,520)
Controlling interest in consolidated net income
$368,480
Net income attributable to noncontrolling interest
89,020
$457,500
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17. (30 Minutes) (Consolidated net income figures for a connecting affiliation)
UNREALIZED GROSS PROFIT:
Cleveland ($12,000 remaining inventory 25% markup) = $3,000
Wisconsin ($40,000 remaining inventory 30% markup) = $12,000
NONCONTROLLING INTERESTS:
CLEVELAND:
Operating income (sales minus cost of goods sold and
expenses) ........................................................................
Defer unrealized gross profit (above) ................................
Realized incomeCleveland .........................................
Outside ownership ...............................................................
Noncontrolling interest in Cleveland's net income .....
WISCONSIN:
Operating income (sales minus cost of goods sold and
expenses) ......................................................................
Defer unrealized gross profit (above) ..............................
Investment income (60% of Cleveland's realized income of
$57,000) ........................................................................
Realized incomeWisconsin ......................................
Outside ownership .............................................................
Noncontrolling interest in Wisconsin's net income ..
$60,000
(3,000)
$57,000
20%
$11,400
$110,000
(12,000)
34,200
$132,200
10%
$ 13,220
TOTAL NONCONTROLLING INTERESTS: $24,620 ($11,400 + $13,220)

CONSOLIDATION TOTALS
Sales = $1,590,000 (add the three book values and eliminate intra-entity
transfers of $40,000 and $100,000)
Cost of goods sold = $1,015,000 (add the three book values, eliminate intraentity transfers of $40,000 and $100,000, and defer [add] unrealized gains of
$3,000 and $12,000)
Expenses = $200,000 (add the three book values)
Dividend income = -0- (eliminated for consolidation purposes)
Consolidated net income = $375,000 (consolidated revenues less

consolidated cost of goods sold and expenses)
Net income attributable to noncontrolling interest = $24,620 (above)
Net income attributable to Baxter Company = $350,380 (consolidated net

income less noncontrolling interest share)
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18. (12 Minutes) (Acquisition accounting for a subsidiarys operating loss

carryforward)
a. Consideration transferred 1/1/14
$1,080,000
Fair value of identifiable assets acquired:
Software licensing agreements
$830,000
Deferred tax asset from NOL (.35 $155,000)
54,250
Fair value of net identifiable assets acquired
884,250
Goodwill
$195,750
b. Consideration transferred 1/1/14
$1,080,000
Fair value of identifiable assets acquired:
Software licensing agreements
$830,000
Deferred tax asset from NOL (.35 $155,000)
54,250
Valuation allowance for NOL
(54,250)
Fair value of net identifiable assets acquired
830,000
Goodwill
$250,000
19. (25 Minutes) (Tax expense with separate tax returns for a combination.)
a. CONSOLIDATED TOTALS
Sales = $790,000 (add the two book values and eliminate the $110,000 intraentity transfer)
Cost of goods sold = $340,000 (add the book values, eliminate intra-entity
transfers of $110,000, recognize [subtract] $30,000 deferred gain from 2014,
and defer [add] $40,000 intra-entity gain into 2015)
Operating expenses = $234,000 (add the two book values)
Dividend income = -0- (eliminated for consolidation purposes)
Consolidated net income = $216,000 (Revenues less expenses)
Net income attributable to noncontrolling interest = $18,000 (20 percent of
reported Income of $100,000 plus $30,000 gain deferred from 2014 less
$40,000 gain deferred into 2015)
Net income attributable to Up Company = $198,000
b. On separate returns, the unrealized gains are reported as taxable income.
Because Up owns 80 percent of Down's stock, the dividends are tax- free and no
deferred tax liability is necessary on the undistributed income.
DUE TO GOVERNMENT: (separate returns)
UP:
Income (without dividend income) ...............................
Tax rate ..........................................................................
Currently payable to government ...........................
$126,000
30%
$ 37,800
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19. (continued)
DOWN:
Reported income ............................................................
Tax rate ..........................................................................
Currently payable to government ...........................
$100,000
30%
$ 30,000
Total income tax payable: Current = $67,800 ($37,800 + $30,000)

Taxable income is not reduced by the unrealized gain. Therefore, the gain is
recognized for tax purposes but not for book purposes and this temporary
difference results in a deferred tax asset of $3,000 ($10,000 x 30%).
CONSOLIDATED INCOME TAX EXPENSE:
Income tax liability ($37,800 + $30,000 = $67,800) less deferred tax asset ($3,000)
= income tax expense $64,800.
Otherwise stated as: Up has a tax expense of $37,800 and Down has a tax
expense of $27,000 ($30,000 payable - $3,000 deferred tax asset). Income tax
expense on the consolidated income statement is $64,800.
20. (45 Minutes) (Computation of income tax expense and the related payable
balances)
a. $260,000 ($650,000 40%)
The affiliated group is taxed on its operating income of $650,000 ($500,000 $90,000 + $240,000: the net unrealized gross profit is deferred on a
consolidated return). The intra-entity income and dividends are not relevant
since a consolidated return is filed.
b. $260,000 ($650,000 40%)
The affiliated group is taxed on its operating income of $650,000 (the net
unrealized gross profit is deferred on a consolidated return). The intra-entity
income and dividends are not relevant if a consolidated return is filed. The
percentage ownership does not affect the figures on a consolidated return.
c. $296,000 ($96,000 + $200,000)
Rogers would pay $96,000 or 40% of its $240,000 operating income. Clarke
would pay $200,000 or 40% of its $500,000 operating income. The unrealized
gross profit is not deferred when separate returns are filed. Intra-entity
dividends are not taxable because the parties qualify as an affiliated group even
though separate returns are being filed. Answer (c.) differs from (a.) and (b.)
because tax on the $90,000 unrealized gross profit (40% or $36,000) is paid
immediately.
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20. (continued)
d. Clarkes operating income
Dividends received net of 80% deduction
($80,000 x 70% x 20%)
Taxable income
Tax rate
Clarkes income tax payable
Clarkes deferred taxes:
Unrealized gain
Tax rate
Clarkes deferred tax asset
$500,000
11,200
$511,200
40%
$204,480
$90,000
40%
$36,000
Rogers income before income tax

Less: income tax (40%)
Rogers net income
Less: dividends paid
Undistributed income
Clarkes ownership percentage
Clarkes share of undistributed income
Less: dividends-received deduction (80%)
Income eventually taxable to Clarke
Tax rate
Clarkes deferred tax liability
Entry on Clarkes books:
Deferred Tax Asset
Income Tax Expense
Deferred Tax Liability
Tax Payable
$240,000
96,000
$144,000
80,000
$ 64,000
70%
$ 44,800
35,840
$ 8,960
40%
$ 3,584
36,000
172,064
3,584
204,480
Entry on Rogers books:

Income Tax Expense (40% x $240,000)
Tax Payable
96,000
96,000
Consolidated tax expense = $172,064 + $96,000 = $268,064

e. $204,480 (see part d. above) Clarke owes $200,000 on its operating income
($500,000 40%) because the unrealized gain cannot be deferred. Clarke also owes
$4,480 from the dividends received ($56,000 20% 40%). The difference between
the Clarkes $204,480 payment and the $172,064 tax expense in (d.) is created by
the premature payment of the tax (a deferred tax asset) on the unrealized gain
($90,000) less the deferred tax liability on the parent's equity accrual ($100,800) in
excess of dividends received ($56,000).
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21. (20 Minutes) (Comparison of income tax expense and payable on separate and
consolidated tax returns.)
a. Consolidated Return2014
Piranto income 2014 (sales less expenses) ......................................
Slinton income 2014 (sales less expenses) .......................................
2013 gain realized in 2014 ....................................................................
2014 deferred gain ................................................................................
Taxable income ...............................................................................
Tax rate ................................................................................................
Income tax payablecurrent .........................................................
$300,000
100,000
120,000
(150,000)
$370,000
40%
$148,000
Because no temporary differences exist in this problem, the income tax expense
would also be $148,000. The unrealized gain is not taxed until realized. Dividend
income is not important because a consolidated return is being filed.
b. Separate Returns2014
On its separate tax return, Piranto will report taxable income of $300,000the
unrealized gains cannot be deferred. The dividends would not be taxable
because Slinton still meets the criteria to be a member of an affiliated group. A
consolidated return is not a requirement for these dividends to be excluded.
Thus, income taxes payable by Piranto would be $120,000 ($300,000 40%).
To determine the income tax expense for Piranto, the two temporary differences
must be taken into account:
Taxable income ..............................................................
Gain taxed in 2013 although realized
in 2014 .......................................................................
Gain taxed in 2014 although not yet realized ...............
2014 realized income subject to taxation ....................
Tax rate ...........................................................................
Income tax expense .......................................................
$300,000
120,000
(150,000)
$270,000
40%
$108,000
The $12,000 difference between the expense and the payable is the tax effect on
the net unrealized gain ($30,000 40%).
Slinton will have an expense and payable of $40,000 ($100,000 40%).
Consolidated income tax expense is $148,000 ($108,000 + $40,000).
Consolidated income tax payable is $160,000 ($120,000 + $40,000).
7-15
Education.
22. (45 Minutes) (Comparison of income tax expense and payable on separate and
consolidated tax returns. Includes question on mutual ownership and the
conventional approach.)
a. Total income tax expense is $156,877. Because of the level of ownership,
separate returns must be filed. Unrealized gross profits are taxed immediately
as are intra-entity dividends. Because the unrealized gross profits are deferred
on the consolidated financial statements, Boxwood's expense would be $34,400
or 40% of $86,000 in realized income ($100,000 + $18,000 $32,000).
Lake's income subject to taxation includes its $300,000 in operating income
plus $30,960 in income accruing from its investment in Boxwood (60% of the
after-tax income of $51,600 [$86,000 $34,400]). Income tax expense for Lake is
computed as follows:
Operating income ..........................................................
Equity income ................................................................
Taxable portion ..............................................................
Income eventually subject to taxation .........................
Tax rate ............................................................................
Income tax expense Lake (rounded) .............................
Income tax expense Boxwood (above) .........................
Total income tax expense .............................................
-ORLakes operating income ................................................
Dividends received net of 80% deduction
($10,000 x 60% x 20%) ..................................................
Taxable income ...............................................................
Tax rate
Lakes income tax payable ........................................
Boxwoods income before income tax ..........................
Less: income tax (40%) ..................................................
Boxwoods net income ...................................................
Less: dividends paid ......................................................
Undistributed income .....................................................
Lakes ownership percentage ........................................
Lakes share of undistributed income ..........................
Less: dividends-received deduction (80%) ..................
Income eventually taxable to Lake ................................
Tax rate ............................................................................
Lakes deferred tax liability (rounded) .....................
Income tax expense Lake .........................................
Income tax expense Boxwood (above) ....................
Total income tax expense .............................................
$300,000
$30,960
20%
6,192
$306,192
40%
$122,477
34,400
$156,877
$300,000
1,200
$301,200
40%
$120,480
$ 86,000
34,400
$ 51,600
10,000
$ 41,600
60%
$ 24,960
19,998
$ 4,992
40%
$ 1,997
$122,477
34,400
$156,877
7-16
Education.
22. (continued)
Entry on Lakes books:
Income Tax Expense
Deferred Tax Liability
Tax Payable
122,477
1,997
120,480
Entry on Boxwoods books:

Income Tax Expense
Deferred Tax Asset
Tax Payable
34,400
5,600
40,000
b. Boxwood will pay $40,000 ($100,000 40%) because separate returns are filed.
Lake, however, will pay its taxes based on dividends received rather than on the
equity accrual. A deferred income tax liability would be established for the
difference. Lake's payment for the current year is computed as follows:
Operating income ...........................................................
Dividend income (60% $10,000) .................................
$6,000
Taxable portion (net of 80% dividends received deduction)
20%
Income currently taxable ...............................................
Tax rate ..........................................................................
Income tax payableLake ............................................
Income tax payableBoxwood (above) ......................
Total income tax payable current .................................
$300,000
1,200
$301,200
40%
$120,480
40,000
$160,480
The $3,603 difference between the expense in a. and the payable in b. is created
by the following two effects:
Deferred income tax liability on equity income accrual not yet taxed
($30,960 $6,000 = $24,960 20% 40%) ..................................
Deferred income tax asset on net unrealized gross profit
($32,000 $18,000 = $14,000 40%) ...........................................
Net decrease in expense ...................................................................
$1,997
5,600
$3,603
c. Because a consolidated tax return is filed, unrealized gross profits are deferred
as for external reporting purposes. Dividend income is not taxable.
Lake's operating income ...............................................
Boxwood's operating income .......................................
Prior year unrealized gross profit .................................
Current year unrealized gross profit ............................
Income subject to taxation (and currently taxable) .....
Tax rate ...........................................................................
$300,000
100,000
18,000
(32,000)
86,000
$386,000
40%
$154,400
7-17
Education.
23. (30 Minutes) (Computation of income tax expense and income tax payable on
consolidated and separate tax returns.)
a. Operating income ..........................................................
Tax rate ..........................................................................
Taxes to be paid .............................................................
$450,000
40%
$180,000
The affiliated group would be taxed on its operating income of $450,000 (the
$50,000 unrealized gain is deferred). Intra-entity income and dividends are not
relevant because a consolidated return is filed.
b. Total taxes to be paid are $200,000. Robertson would have to pay $80,000 or
40% of its $200,000 operating income. Garrison would pay $120,000 or 40% of
its $300,000 operating income. The unrealized gain is not deferred because
separate returns are being filed. Intra-entity dividends are not taxable because
the parties still qualify as an affiliated group even though separate returns are
being filed.
c. Robertson must report an income tax expense of $80,000 or 40% of its $200,000
operating income.
Garrison records its expense based on the revenue recognized during the
period. Thus, the expense is computed on an operating income of $250,000 (the
net unrealized gain is not recognized in this period) along with equity income
from Robertson of $84,000 (70% of that company's $120,000 after-tax income).
Garrison will record an income tax expense of $100,000 in connection with the
operating income ($250,000 40%) and $6,720 resulting from its equity income
($84,000 20% 40%). Total expense to be reported amounts to $186,720 for
Garrison and Robertson ($80,000 + $100,000 + $6,720).
d. Garrison will pay $120,000 in connection with its operating income ($300,000
40%) and $2,400 because of the dividends received from Robertson. Garrison
will receive $30,000 in dividends based on its 60% ownership. Of this total, only
$6,000 (20%) is taxable. Thus, at a 40% rate, the tax on the dividends would
amount to $2,400 ($6,000 40%). The total income taxes payable by Garrison is
$122,400 ($120,000 + $2,400).
7-18
Education.
24. (10 Minutes) (Impact on goodwill of assets with a different tax vs. book value.)
a. The assets and liabilities of Oxford (the subsidiary) will be consolidated at
their individual net fair values ($558,000). However, both the buildings and
equipment have a tax basis that is lower than fair value. Thus, for tax
purposes, future depreciation expense will be lower on the tax return so that
taxable income will exceed book income. The higher taxable income
(anticipated in the future) creates a deferred tax liability at the time the
combination is created.
Tax
Basis
$221,000
160,000
Buildings ...................................
Equipment .................................
Total temporary difference ......
Tax rate ......................................
Deferred tax liability .................
Fair
Value
$276,000
233,000
Temporary
Difference
$ 55,000
73,000
$128,000
40%
$ 51,200
b. Consequently, Oxford's accounts will be consolidated as follows:

(parentheses indicate a credit balance)
Accounts receivable .................................................
Inventory ...................................................................
Land ...........................................................................
Buildings ...................................................................
Equipment ..................................................................
Liabilities ....................................................................
Deferred tax liability .................................................
Assigned to specific accounts ................................
Acquisition consideration ........................................
c. Excess assigned to goodwill ...................................
$153,000
141,000
136,000
276,000
233,000
(281,000)
(51,200)
606,800
850,000
$243,200
7-19
Education.
25. (55 Minutes) (Consolidation worksheet for a father-son-grandson combination.

Includes intra-entity inventory transfers.)
The following computations are needed before the consolidation worksheet is
prepared: calculation of the deferred gross profits in beginning and ending
inventory.
Beginning Unrealized Gross Profit (Wilson)
(January 1, 2014 Inventory
Transfer Price (goods remaining) =
Balance)
Cost + .25 Cost
$60,000 = 1.25 Cost
$48,000 = Cost
$12,000 is Unrealized gross profit
Ending Unrealized Gross Profit (Wilson)
(December 31, 2014 Inventory
Transfer Price (goods remaining) =
Balance)
Cost + .25 Cost
$90,000 = 1.25 Cost
$72,000 = Cost
$18,000 is Unrealized gross profit
CONSOLIDATION ENTRIES
Entry *G
Retained Earnings, 1/1/14 (Wilson) .........................
12,000
Cost of Goods Sold ..............................................
12,000
(To recognize income on intra-entity inventory transfers made in previous
year but not resold until current year as per above computation.)
Entry *C
Retained Earnings, 1/1/14 (House) ...............................
11,200
Investment in Wilson ..........................................
11,200
(To convert investment account from partial equity method to equity method.
Unrealized gross profit shown in Entry *G is not properly reflected by parent
under partial equity method [12,000 70% = $8,400 income decrease] nor would
be the $2,800 in amortization expense for 20122013. Thus, a reduction of
$11,200 is required. Because Cuddy is a current year acquisition, no prior
conversion to equity method is required for the investment.)
Entry S1
Common Stock (Cuddy) ................................................
150,000
Retained Earnings, 1/1/14 (Cuddy) ...............................
150,000
Investment in Cuddy (80%) .......................................
240,000
Noncontrolling Interest in Cuddy Common Stock (20%)
60,000
(To eliminate Cuddy's stockholders' equity against the corresponding
investment balance and to recognize noncontrolling interest in common stock.)
7-20
Education.
25. (continued)
Entry S2
Common Stock (Wilson) ...............................................
310,000
Retained Earnings, 1/1/14 (Wilson)
(adjusted by Entry *G) ..............................................
578,000
Investment in Wilson (70%) ................................
621,600
Noncontrolling Interest in Wilson (30%) ...........
266,400
(To eliminate Wilson's stockholders' equity against corresponding investment
balance and to recognize noncontrolling interest.)
Entry A
Buildings .........................................................................
54,000
Franchise Contracts ......................................................
32,000
Goodwill ...........................................................................
140,000
Equipment .................................................................
10,000
Investment in Wilson ................................................
151,200
Noncontrolling Interest in Wilson ............................
64,800
(To allocate excess payment made in connection with purchase of Wilson
shown above. Amortization for 2012 and 2013 has been taken into account in
determining the January 1, 2014 value for each account.)
Entry I1
Income of Cuddy ......................................................
56,000
Investment in Cuddy ...........................................
56,000
(To eliminate intra-entity income accrued by both House and Wilson during
the year.)
Entry I2
Income of Wilson ......................................................
91,000
Investment in Wilson ..........................................
91,000
(To eliminate intra-entity income accrued by House during the year.)
Entry D1
Investment in Cuddy ...............................................
40,000
Dividends declared (80%) (Cuddy) ....................
(To eliminate effects of intra-entity dividend payments.)
Entry D2
Investment in Wilson ...............................................
67,200
Dividends declared (70%) (Wilson) ....................
(To eliminate effects of intra-entity dividend payments.)
40,000
67,200
7-21
Education.
25. (continued)
Entry E
Operating Expenses .................................................
2,000
Equipment ...............................................................
5,000
Franchise Contracts ...........................................
4,000
Buildings ...............................................................
3,000
(To record 2014 amortization on excess payment made in connection with
acquisition of Wilson Company.)
Entry TI
Sales and Other Revenues ......................................
200,000
(To eliminate intra-entity inventory sales for the current year.)
Entry G
Cost of Goods Sold ...................................................
Inventory ...............................................................
18,000
(To defer unrealized gross profit in ending inventory.)
200,000
18,000
Noncontrolling Interest in Net Income of Cuddy:

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

Reported operating income
Equity income of Cuddy ($70,000 40%) ...................................
Excess amortization .....................................................................
Recognition of 2013 gross profit (Entry *G)
Deferral of 2014 unrealized gross profit (Entry G)
Realized net income
Outside ownership
Noncontrolling interest in net income of Wilson
$130,000
28,000
(2,000)
12,000
(18,000)
$150,000
30%
$ 45,000
7-22
Education.
25. (continued)
HOUSE CORPORATION AND CONSOLIDATED SUBSIDIARIES
Consolidation Worksheet
December 31, 2014
Accounts
Sales and other revenue
Cost of goods sold
House
Corp.
Cuddy
Company
Consolidation EntriesNoncontrollingConsolidated
Debit
Credit
Interest
Balance
(900,000)
(700,000)
(300,000) (TI) 200,000
551,000
300,000
140,000 (G) 18,000
270,000
90,000 (E)
2,000
(I2) 91,000
(I1) 56,000
(70,000)
Operating expenses
219,000
Income of Wilson Company
(91,000)
Income of Cuddy Company
(28,000)
Net income
(249,000)
Net income attributable to
noncontrolling interest (Wilson)
Net income attributable to
noncontrolling interest (Cuddy)
Net income attributable to House Corporation
Retained earnings, 1/1/14:
House Corporation
(820,000)
Wilson Company
Cuddy Company
Net Income
Dividends declared
House Corporation
Wilson Company
Cuddy Company
Retained earnings, 12/31/14
Wilson
Company
(249,000)
(28,000)
(158,000)
(1,700,000)
(*G) 12,000
(TI) 200,000
797,000
581,000
-0-0(322,000)
(590,000)
(158,000)
(45,000)
45,000
(14,000)
14,000
(263,000)
(*C) 11,200
(*G) 12,000
(S2)578,000
(150,000) (S1)150,000
(70,000)
(808,800)
-0-0(263,000)
100,000
96,000
(969,000)
(652,000)
50,000
(170,000)
(D2) 67,200
(D1) 40,000
28,800
10,000
7-23
Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
100,000
-0-0(971,800)
25. (continued)
Accounts
House
Corp.
Wilson
Company
Cuddy
Company
Debit
Credit
Interest
Balance
Cash and receivables

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

88,000 (E)
5,000
16,000
(A) 140,000
(A) 32,000
418,000
Liabilities
Noncontrolling interest in Cuddy
Noncontrolling interest in Wilson
Noncontrolling interest in
subsidiary companies
Common stock
Retained earnings (above)
Total liabilities and equities
(632,000)
67,000
103,000
(D2) 67,200
(570,000)
(G)
(*C)
(S2)
(I2)
(A)
(S1)
(I1)
(E)
(A)
(E)
(310,000)
(969,000)
(2,421,000)
(652,000)
(1,532,000)
-0900,000
523,000
496,000
140,000
28,000
3,503,200
4,000
(98,000)
(1,300,000)
(S1) 60,000
(S2) 266,400
(A) 64,800
(820,000)
621,000
795,200
-0-
18,000
11,200
621,600
91,000
151,200
240,000
56,000
3,000
10,000
(150,000) (S1) 150,000

(S2) 310,000
(170,000)
(418,000)
1,916,400
(60,000)
(331,200)
(411,400)
1,916,400
Parentheses indicate a credit balance.
7-24
(411,400)
(820,000)
(971,800)
(3,503,200)
26. (20 Minutes) (Consolidation entries for a mutual holding business combination)
a. Acquisition Allocation and Amortization
Consideration transferred ............................................
Lowlys business fair value ...........................................
Book value acquired .......................................................
Trademarks .....................................................................
Annual amortization (20-year life) .................................
$420,000
280,000
700,000
(600,000)
$100,000
$ 5,000
Entry *C
Investment in Lowly .................................................
117,000
Retained Earnings, 1/1/14 (Mighty) ....................
117,000
(To accrue income to parent during the previous years as measured by
increase in book value [$200,000 60%] and amortization expense of $3,000
[$5,000 60%] for the previous year.)
Entry S1
Common Stock (Lowly) ............................................
300,000
Retained Earnings, 1/1/14 (Lowly) ...........................
500,000
Investment in Lowly (60%) .................................
480,000
Noncontrolling Interest in Lowly 1/1/14 (40%) ..
320,000
(To eliminate subsidiary stockholders' equity accounts against investment
account and to recognize noncontrolling interest ownership.)
Entry S2
Treasury Stock ..........................................................
240,000
Investment in Mighty ...........................................
(To reclassify cost of parent shares as treasury stock.)
240,000
Entry A
Trademarks ...............................................................
95,000
Investment in Lowly ............................................
57,000
Noncontrolling Interest in Lowly 1/1/14 (40%) ..
38,000
(To recognize unamortized portion of acquisition-date excess fair value.)
Entry E
Amortization Expense ..............................................
Trademarks ..........................................................
(To record trademarks amortization expense for 2014.)
5,000
5,000
Net income attributable to noncontrolling interest = $14,000

[40% ($40,000 - $5,000)]
7-25
Education.
27. (80 Minutes) (Prepare consolidation worksheet for a father-son-grandson

combination. Also asks about income taxes paid on both a separate and a
consolidated return)
a. Acquisition-Date Allocation and Amortization
The January 1, 2013 book values are determined by removing the 2013 income
from the January 1, 2014 book values (based on equity accounts).
Consideration transferred for Stookey .........................
Stookey business fair value ..........................................
Stookey book value .......................................................
Customer List ..................................................................
Life ..................................................................................
$344,000
86,000
$430,000
(380,000)
$ 50,000
10 Years
$ 5,000
Consideration transferred for Yarrow ...........................

Yarrow business fair value ...........................................
Yarrow book value ..........................................................
Copyright ........................................................................
Life ..................................................................................
$720,000
80,000
$800,000
740,000
$ 60,000
15 Years
$ 4,000
Entry *G
Retained Earnings, 1/1/14 (Stookey) .......................
7,680
7,680
(To give effect to unrealized gross profit from 2013. Amount is calculated
based on normal 48% markup [found from Income Statement] multiplied by
$16,000 retained inventory [20% of $80,000])
Entry *C1
Investment in Stookey .............................................
85,856
Retained Earnings, 1/1/14 (Yarrow) ...................
85,856
(To recognize equity income accruing from Yarrow's investment in Stookey
during 2013. Because the initial value method is applied and no dividends
declared, no income has been recognized in connection with the 2013
ownership of Stookey. Reported income of $120,000 [2013] less unrealized
gain of $7,680 deferred above indicates income of $112,320. Based on 80%
ownership, an $89,856 accrual is needed, which is reduced by the $4,000
amortization (80% $5,000) for that year.
7-26
Education.
27. (continued)
Entry *C2
Investment in Yarrow ...............................................
217,670
Retained Earnings, 1/1/14 (Travers) ..................
217,670
(To recognize equity income accruing from Travers' investment in Yarrow
during 2013. Because the initial method is applied and no dividends
declared, income has not been recognized in connection with the 2013
ownership of Yarrow. Income of $245,856 is calculated based on reported
income of $160,000 [2013] plus the $85,856 accrual recognized in Entry *C1.
Ownership of 90% dictates a $221,270 accrual that is then reduced to
$217,670 by the $3,600 [90% $4,000] amortization applicable to 2013.)
Entry S1
Common Stock (Stookey) ........................................
200,000
Retained Earnings, 1/1/14 (Stookey, as adjusted
by Entry *G) .........................................................
292,320
Investment in Stookey (80%) ........................
393,856
Noncontrolling Interest in Stookey (20%) ....
98,464
(To eliminate stockholders' equity accounts of subsidiary [Stookey] against
corresponding balance in investment account and to recognize
noncontrolling interest ownership.)
Entry S2
Common Stock (Yarrow) ..........................................
300,000
Retained Earnings, 1/1/14 (Yarrow, as adjusted
by Entry *C1) ........................................................
685,856
Investment in Yarrow (90%) ..........................
887,270
Noncontrolling Interest in Yarrow (10%) ......
98,586
(To eliminate stockholders equity accounts of subsidiary Yarrow against
corresponding balance in investment account and to recognize
noncontrolling interest ownership.)
Entry A1
Customer List ............................................................
Investment in Stookey ........................................
Noncontrolling Interest in Stookey (20%) .........
45,000
36,000
9,000
(To recognize January 1, 2014 unamortized portion of acquisition price

assigned to Stookeys customer list.)
7-27
Education.
27. (continued)
Entry A2
Copyright ...................................................................
56,000
Investment in Yarrow . .........................................
50,400
Noncontrolling Interest in Yarrow ......................
5,600
(To recognize January 1, 2014 unamortized portion of acquisition price
assigned to copyright.)
Entry E
9,000
Customer List .......................................................
5,000
Copyright ..............................................................
4,000
(To recognize amortization expense for 2014$5,000 in connection with
Travers' investment and $3,000 in connection with Yarrow's investment.)
Entry Tl
Sales ..........................................................................
100,000
(To eliminate intra-entity inventory transfers made during 2014.)
100,000
Entry G
9,600
Inventory (current assets) ..................................
9,600
(To defer unrealized gross profit on ending inventory$20,000 48%
markup.)
Noncontrolling Interest in Stookey's Net Income
2014 Reported net income ............................................
Customer list amortization ............................................
Realization of 2013 deferred gross profit (*G) .............
Deferral of 2014 unrealized gross profit (G) ................
Realized income 2014 ....................................................
Outside ownership .........................................................
Noncontrolling interest in Stookey's net income ........
Noncontrolling Interest in Yarrow's Net Income
2014 Reported net income ............................................
Copyright amortization ..................................................
Accrual of Stookey's income (80% of $93,080
realized income [computed above]) ........................
Realized income2014 .................................................
Noncontrolling interest in Yarrow's net income ..........
$100,000
(5,000)
7,680
(9,600)
$93,080
20%
$18,616
$200,000
(4,000)
74,464
$270,464
10%
$ 27,046
7-28
Education.
27. (continued)
Accounts
TRAVERS COMPANY AND CONSOLIDATED SUBSIDIARIES

Consolidation Worksheet
December 31, 2014
Travers
Yarrow
Stookey
Company
Company
Company
Debit
Credit
Interest
Balances
Sales and other revenues

Cost of goods sold
(900,000)
480,000
(600,000)
320,000
(500,000)
260,000
(Tl)
(G)
Operating expenses
Separate company net income
Net income attributable to NCI (Yarrow)
Net income attributable to NCI (Stookey)
Net income attributable to Travers Company
Retained earnings, 1/1/14:
Travers Company
Yarrow Company
Stookey Company
100,000
(320,000)
80,000
(200,000)
140,000
(100,000)
(E)
Net Income (above)

Dividends declared
Retained earnings, 12/31/14
(320,000)
128,000
(892,000)
(200,000)
444,000
720,000
380,000
Current assets
Investment in Yarrow Company
(700,000)
(600,000)
(300,000)
329,000
(800,000)
280,000
(*C1)
1,560,000
(G)
217,670 (S2)
(A2)
85,856 (S1)
(A1)
9,600
887,270
50,400
393,856
36,000
1,094,400
-0-0-
45,000 (E)
56,000 (E)
2,305,000
40,000
52,000
3,491,400
5,000
4,000
800,000
(721,000)
(500,000)
(460,000)
(300,000)
(200,000)
(200,000)
Retained earnings, 12/31/14 (above)

NCI interest in Stookey, 1/1/14
(892,000)
(800,000)
(400,000)
(2,113,000)
(917,670)
-0-0-
520,000
(A1)
(A2)
2,113,000
217,670
85,856
(1,560,000)
(800,000)
(609,080)
27,046
18,616
(563,418)
(563,418)
128,000
(1,353,088)
(*C2)
836,000
(*C2)
685,856 (*C1)
7,680
292,320
(400,000)
344,000
949,000
(S2)
(*G)
(S1)
(100,000)
Liabilities
Common stock
Noncontrolling interest in Yarrow, 1/1/14

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

Land, buildings, & equipment (net)
Customer list
Copyright
Total assets
100,000
9,600 (*G)
(TI)
9,000
(1,381,000)
(S1)
(S2)
200,000
300,000
(S1)
(A1)
(S2)
(A2)
2,008,982
98,464
9,000
98,586
5,600
(500,000)
(1,353,088)
(107,464)
(104,186)
(257,312)
2,008,982
7-29
(257,312)
(3,491,400)
27. (continued)
b. Travers' reported pre-tax income .......................................................
Yarrow's reported pre-tax income ......................................................
Dividend income (none collected) ......................................................
Intra-entity gains (no transfers) ..........................................................
Amortization expense ..........................................................................
Taxable income ....................................................................................
Tax rate .................................................................................................
Income tax payable ..............................................................................
$320,000
200,000
-0-0(9,000)
$511,000
45%
$229,950
c. Stookey's reported pre-tax income ....................................................

(Unrealized gains are not deferred on a separate
tax return.)
Tax rate .................................................................................................
Income tax payable ..............................................................................
$100,000
45%
$45,000
d. (1) Because Yarrow owns 80% of Stookey's stock, intra-entity dividends are
nontaxable. Thus, no temporary difference is created by Stookey's failure to
pay a dividend.
(2) Stookey's unrealized gains are recognized in one time period for financial
reporting purposes and in a different time period for tax purposes. This
temporary increases taxable income by $1,920 over reported income:
2014 Unrealized gross profit taxed in 2014 ........................................
2013 Unrealized gross profit taxed previously in 2013......................
Increase in taxable income .................................................................
Tax rate .................................................................................................
Deterred income tax asset ..................................................................
$9,600
(7,680)
$1,920
45%
$ 864
Income Tax Expense:

Travers and Yarrowpayable (part b) ..........................................
Stookeypayable (part c) ..............................................................
Total taxes to be paid2014 ..........................................................
Prepayment (asset) (above) ...........................................................
Income tax expense 2014................................................................
$229,950
45,000
$274,950
(864)
$274,086
Because a single rate is used, income tax expense can also be computed by
taking consolidated net income (prior to noncontrolling interest reduction) of
$609,080 (part a.) and multiplying by the 45% tax rate to obtain $274,086.
Income tax expensecurrent .......................................
Deferred income taxasset ..........................................
Income tax payable ..................................................
274,086
864
274,950
7-30
Education.
28. (40 Minutes) (Series of questions about a business combination and its income
tax reporting)
a. Partial equity method. "Income of Soludan" is 80% of Soludan's reported total.
b. $12,000. Reduction is evidenced by a $338,000 figure reported for consolidated
inventory rather than the $350,000 total for the two companies.
c. $37,500. Consolidated operating expenses have increased by $2,500, evidently
the annual amortization. Because a 15-year life is assumed by the combination,
the amount originally allocated to trademarks must have been $37,500.
d. $120,000. Decrease shown in consolidated sales account.
e. Upstream. " Net income attributable to the noncontrolling interest" is $18,700.
Because this amount is not equal to 20% of Soludan's reported net income less
excess amortization ($100,000 $2,500), realized net income must have been
adjusted for unrealized gross profits. Subsidiary net income is only adjusted to
show the effects of upstream transfers.
f. $20,000. For both receivables and liabilities, the consolidated total is $20,000
less than the sum of the two companies.
g. $8,000. Consolidated cost of goods sold is decreased by $120,000 (to $780,000)
in eliminating intra-entity sales. The increase of $12,000 created by the ending
unrealized gross profit (see part b.) would then leave a $792,000 balance.
Because $784,000 is the ending balance reported for consolidated cost of goods
sold, an $8,000 unrealized gross profit must have been deferred from the
previous year.
7-31
Education.
28. (continued)
h. Because the trademarks balance now stands at $32,500, amortization expense
of $2,500 has been recognized, $2,500 in the previous year. In addition, an
$8,000 unrealized gross profit from the prior year (see part g.) is recognized.
Amortization expenseprior year 80% .....................
Unrealized gross profitupstream effect on
parent's retained earnings is $8,000 80% .............
Adjustment to parents beginning retained earnings ..
$2,000
6,400
$8,400
i. This figure is computed as follows:

Book value of subsidiary1/1 ......................................
$370,000
Unrealized gross profit in beginning inventory (see above)
Realized book value ....................................................
$362,000
Excess allocation at 1/1..................................................
35,000
Subsidiary valuation basis 1/1 ......................................
397,000
Noncontrolling interest percentage ..............................
20%
Noncontrolling interest 1/1 ...........................................
Noncontrolling interest in Soludan's income
(as reported) ..............................................................
Noncontrolling interest in Soludan's dividends
($20,000 20%) .........................................................
Ending noncontrolling interest .....................................
(8,000)
$79,400
18,700
(4,000)
$94,100
j. For a consolidated return, unrealized gross profit are deferred as in the

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

Sales .............................................................................................. $1,280,000
Cost of Goods Sold .......................................................................
(784,000)
Operating expenses .....................................................................
(202,500)
Taxable income ....................................................................... $ 293,500
k. On a separate return, Politan would report its operating income of $200,000
leading to a tax expense and payable of $80,000. Because of the level of
ownership, intra-entity dividend (or investment) income is omitted.
Income Tax Expense .....................................................
Income Tax Payable .................................................
80,000
80,000
7-32
Education.
28. k. (continued)
On a separate return, Soludan would report $100,000 operating income for a
payable of $40,000. The unrealized gross profits are accounted for in different
time periods in the financial statements, thus, a temporary difference is created.
The beginning inventory gross profit of $8,000 was taxed in the previous year
rather than currently. The current unrealized gross profit of $12,000 is taxed
now rather than next year; the tax paid this year on the net $4,000 ($1,600) is a
prepayment.
Income Tax Expense .....................................................
Deferred Income Tax Asset ............................................
Income Tax Payable .................................................
38,400
1,600
Soludan's entry can also be computed as follows:

Reported income ............................................................................
Unrealized gross profit from previous period realized currently
Deferral of current unrealized gross profit ...................................
Realized income .............................................................................
Tax rate
.....................................................................................
Income tax expense .......................................................................
Taxes payable ..................................................................................
Deferred tax asset ................................................................................
40,000
$100,000
8,000
(12,000)
$96,000
40%
$38,400
40,000
$ 1,600
29. (45 Minutes) Develop worksheet entries that were used to consolidate the
financial statements of a father-son-grandson combination.
Entry *G
Retained Earnings, 1/1/14 (Delta) ............................
15,000
15,000
(To recognize gross profit that was unrealized in 2013 [amount provided].)
Entry *C1
Retained Earnings, 1/1/14 (Delta) ............................
7,000
Investment in Omega Company .........................
7,000
(To recognize amortization expense from Deltas acquisition for 2013.)
7-33
Education.
29. (continued)
Entry *C2
Retained Earnings, 1/1/14 (Alpha) ...........................
27,600
Investment in Delta Company ............................
27,600
To recognize accrual adjustments for excess amortization
and inventory deferral as follows:
Excess amortization from Delta acquisition
(80% $6,250 2 years)........................................
$10,000
Deltas share of excess amortization from Omega acquisition
(80% [70% $10,000] 1 year) ..........................
5,600
Inventory profit deferral at 1/1/14 (80% $15,000) .
12,000
*C2 adjustment ..........................................................
$27,600
Entry S1
Common Stock (Omega) ..........................................
100,000
Retained Earnings, 1/1/14 (Omega) .........................
100,000
Investment in Omega (70%) ................................
140,000
Noncontrolling Interest in Omega (30%) ...........
60,000
(To eliminate stockholders' equity accounts of Omega against parent's
Investment account and to recognize outside ownership.)
Entry S2
Common Stock (Delta) .............................................
120,000
Retained Earnings, 1/1/14 (Delta, as adjusted) ......
378,000
Investment in Delta (80%) ...................................
398,400
Noncontrolling Interest in Delta (20%) ..............
99,600
(To eliminate stockholders' equity accounts of Delta [as adjusted as Entry *G
and Entry *C1] against corresponding balance in Investment account and to
recognize outside ownership.)
Entry A
Copyrights .................................................................
222,500
Investment in Delta .............................................
90,000
Investment in Omega ..........................................
77,000
Noncontrolling Interest in Delta ..........................
22,500
Noncontrolling Interest in Omega ......................
33,000
(To recognize January 1, 2014 unamortized copyrights, 2 years amortization
recorded on first investment but only one year for second.)
Entry I1
Income of Subsidiary ...............................................
144,000
Investment in Delta .............................................
144,000
(To eliminate intra-entity income accrual found on Alpha's records.)
7-34
Education.
29. (continued)
Entry I2
Income of Subsidiary ...............................................
49,000
Investment in Omega ..........................................
49,000
(To eliminate intra-entity income accrual found on Delta's records.)
Entry D1
Investment in Delta ...................................................
Dividends Declared (Delta) .................................
(To eliminate intra-entity dividends.)
Entry D2
Investment in Omega ...............................................
Dividends Declared (Omega) .............................
(To eliminate intra-entity dividends.)
32,000
32,000
35,000
35,000
Entry E
16,250
Copyrights ...........................................................
16,250
(Current year amortization, $6,250 on first acquisition and $10,000 on
second.)
Entry Tl
Sales ..........................................................................
(To eliminate intra-entity inventory transfer.)
200,000
200,000
Entry G
22,000
Inventory ...............................................................
(To defer ending unrealized gross profit on intra-entity transfers.)
Noncontrolling Interest in Omega's Income:
Reported income ............................................................
Excess fair value amortization ......................................
Accrual-based income....................................................
Net income attributable to noncontrolling interest .....
22,000
$70,000
(10,000)
60,000
30%
$18,000
7-35
Education.
29. (continued)
Noncontrolling Interest in Delta's Net Income:
Reported operating income ..........................................
Equity income investment in Omega (70% $60,000)
Amortization expense ....................................................
2013 Unrealized income realized in 2014 ......................
2014 Unrealized income realized in 2014 .....................
Accrual-based incomeDelta (2014) ...........................
Net income attributable to noncontrolling interest ......
Noncontrolling interest in Delta Company ...................
Noncontrolling interest, 1/01/14 (Entry S2) .............
Noncontrolling interest, 1/01/14 (Entry A) ...............
Noncontrolling interest in Deltas income (above) .
Dividends declared to noncontrolling interest
($40,000 20%) .......................................................
Noncontrolling interest in Delta, 12/31/14 ..........
$131,000
42,000
(6,250)
15,000
(22,000)
$159,750
20%
$ 31,950
$99,600
22,500
31,950
(8,000)
$146,050
Noncontrolling interest in Omega Company ................

Noncontrolling interest, 1/01/14 (Entry S1) .............
$60,000
Noncontrolling interest in Omegas income (above)
18,000
Noncontrolling interest, 1/01/14 (Entry A) ...............
33,000
Dividends declared to noncontrolling interest ($50,000 30%) (15,000)
Noncontrolling interest in Omega, 12/31/14.......
$96,000
7-36
Education.
Chapter 7 Excel Case Solution
Summit
Treeline
Basecamp
Operating
income
$345,000
$280,000
$175,000
Ownership percentages
Summit-->Treeline
Treeline-->Basecamp
Dividends
declared
$150,000
$100,000
$40,000
Excess
amortizations
$20,000
$25,000
90%
70%
Treeline's share of Basecamp net income:

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

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

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

net income = -0-
7-37
Education.
RESEARCH CASE: CONSOLIDATED TAX EXPENSE

At www.thecoca-colacompany.com the annual 10-K Note 14 provides detailed footnote
disclosures for consolidated income tax. The excerpt below shows a portion of the
footnote relating to deferred tax assets, liabilities, and carryforwards.
From Note 14: Income Taxes
The tax effects of temporary differences and carryforwards that give rise to deferred tax
assets and liabilities consist of the following (in millions):
December 31,
2012
2011
Deferred tax assets:
Property, plant and equipment
$
89
$ 224
Trademarks and other intangible assets
77
68
Equity method investments (including translation adjustment) 209
278
Derivative financial instruments
116
43
Other liabilities
1,178
1,257
Benefit plans
1,808
2,022
Net operating/capital loss carryforwards
782
818
Other
320
418
Gross deferred tax assets
4,579
5,128
Valuation allowances
(487)
(859)
1,2
Total deferred tax assets
$ 4,092
$ 4,269
Deferred tax liabilities:
Property, plant and equipment
$ (2,204) $ (2,039)
Trademarks and other intangible assets
(4,133)
(4,201)
Equity method investments (including translation adjustment) (712)
(816)
Derivative financial instruments
(140)
(129)
Other liabilities
(144)
(129)
Benefit plans
(495)
(445)
Other
(929)4
(753)
Total deferred tax liabilities3
$ (8,757) $ (8,512)
Net deferred tax liabilities
$ (4,665) $ (4,243)
1
Noncurrent deferred tax assets of $ 403 million and $243 million were included in the line item
other assets in our consolidated balance sheets as of December 31, 2012 and 2011, respectively.
2
Current deferred tax assets of $244 million and $227 million were included in the line item
prepaid expenses and other assets in our consolidated balance sheets as of December 31, 2012
and 2011, respectively.
3
Current deferred tax liabilities of $ 331 million and $19 million were included in the line item
accounts payable and accrued expenses in our consolidated balance sheets as of December 31,
2012 and 2011, respectively.
As of December 31, 2012 and 2011, we had $70 million of net deferred tax assets and
$491 million of net deferred tax liabilities located in countries outside the United States.
As of December 31, 2012, we had $6,494 million of loss carryforwards available to reduce
future taxable income. Loss carryforwards of $ 279 million must be utilized within the
next five years, and the remainder can be utilized over a period greater than five years..
7-38
Education.

Consolidated Financial Statements - Ownership Patterns and Income Taxes

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Consolidated Financial Statements - Ownership Patterns and Income Taxes

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Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Indirect subsidiary control

II. Indirect subsidiary control-connecting affiliation

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

IV. Income tax accounting for a business combinationconsolidated tax returns

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Emerald's accrual-based income:

Diamond's accrual-based income:

8. C Cherry's accrual-based income:

Beech's accrual-based income:

Total net income attributable to noncontrolling interest =

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

9. A Stark's operating income................................................................

10. B Equity income (75% of $415,000) ..................................................

11. C Unrealized Gross Profit:

14. (30 Minutes) (Series of reporting and consolidation questions pertaining to a

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Note: Dividends declared by Cedar to Birch do not affect Aspens Investment

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

2014 Realized net income of Birch (prior to accounting

b. To the outside owners, the $6,000 intra-entity dividends ($20,000 30%)

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

16. (35 Minutes) (Consolidated net income for a father-son-grandson combination.)

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

TOTAL NONCONTROLLING INTERESTS: $24,620 ($11,400 + $13,220)

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

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

Consolidated net income = $375,000 (consolidated revenues less

Net income attributable to noncontrolling interest = $24,620 (above)

Net income attributable to Baxter Company = $350,380 (consolidated net

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

18. (12 Minutes) (Acquisition accounting for a subsidiarys operating loss

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Total income tax payable: Current = $67,800 ($37,800 + $30,000)

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Rogers income before income tax

Entry on Rogers books:

Consolidated tax expense = $172,064 + $96,000 = $268,064

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Entry on Boxwoods books:

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

b. Consequently, Oxford's accounts will be consolidated as follows:

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

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

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Noncontrolling Interest in Net Income of Cuddy:

Noncontrolling Interest in Net Income of Wilson:

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

(300,000) (TI) 200,000

140,000 (G) 18,000

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Cash and receivables

Investment in Cuddy Company

144,000 (A) 54,000

(150,000) (S1) 150,000