ACC 401 Exam 2 Fall 2022 Solution

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University of Southern Mississippi *

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401CA

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Accounting

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Jun 8, 2024

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1 Name_________________ Section________________ ACC 401 Exam 2 Solution Fall 2022 The exam includes four sections. You must show your work to obtain credit. Point allocations are presented below: Maximum Points Points Earned Part 1 39 Part 2 8 Part 3 46 Part 4 16 Total Points 111 The exam time limit is 80 minutes. Exam scores will be scaled to count 100 points.

1 Part I. Basic Consolidation Problem 1 (39 points) On 1/1/X1, Big's book equity included $1,000,000 of capital stock and $800,000 retained earnings. On 1/1/X1, Big purchased 80% of Small for $1,200,000 when Small's book equity was $1,300,000 consisting of $700,000 capital stock and $600,000 retained earnings. An appraisal of Small's assets revealed that buildings and land were under-valued by $100,000 and $40, 000, respectively. Small's building has a 10- year life and is being depreciated using the S-L method. During year X1, Small reported a $200,000 net income and paid $50,000 of dividends. Big reported a $200,000 income from its own operations and paid $60,000 of dividends. 1. Calculate and allocate the differential. What is goodwill? (8) Show calculations. Small Stock (book value) 1,300,000 Allocation to Building (10 years) 100,000 P's 80% share 1,040,000 Allocation to Land 40,000 Small Stock Mkt Value 1,200,000 total Allocations 140,000 P's Differential 160,000 Total Differential 200,000 NCI's Differential 40,000 Unallocable Differential 60,000 Total Diff 200,000 Allocation to Building (10 years) 100,000 2. How much investment income should Big recognize in Year X1? Show calculations. (5) Depreciation =$100,000/10 =$10,000 per year Small’s reported Income $200,000 Less: Diff Amortization -10,000 S’s Adjusted income $190,000 Big’s 80% Share $152,000 (Investment Income) NCI’s 20% share $38,000 3. Calculate Consolidated Income and Consolidated Retained Earnings on 12/31/X1. (10) Consolidated NI = Big’s own NI +S’s Adjusted NI= $200,000 + $190,000 =$390,000 Consolidated Beg RE (=P’s RE) $800,000 Add P’S Share of Consol NI ($200,000+ $152,000) $352,000 Deduct P’s own Dividends -$60,000 Consolidated RE (12/31/X1) $1,092,000

2 4. Assume that pre-closing trial balances will be consolidated on 12/31/X1. Prepare the consolidation worksheet entries. Show supporting calculations. (16) Investment Income $152,000 Investment $112,000 Dividends $40,000 Retained Earnings: Small $600,000 Capital Stock: Small $700,000 Differential $200,000 Investment in Small $1,200,000 NCI $300,000 Building $90,000 Depreciation Expense $10,000 Land $40,000 Goodwill $60,000 Differential $200,000 Investment Income $152,000 Less: Dividends (.8*$50,000) $40,000 Net Investment Increase= $152,000-$40,000 =$112,000

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3 Part II. Conceptual Questions (8 pts) 1. Suppose that the parent (P) sells merchandise to its a subsidiary (S) during the year. How is consolidated income affected by the sale? Explain. (4) The effects depend on whether the units are sold to outsiders prior to period end. If S re-sells all merchandise to outsiders, then there is no effect on consolidated income and each company recognizes its own revenue and income from sales made during the year. However, if S fails to sell 100% of the merchandise, then P’s unrealized profit on the un-sold items in S’s inventory must be eliminated (deducted) from consolidated income. Accounting standards require that the differential (acquisition premium) should be allocated to the extent possible to misvalued assets. Why is such an allocation required? Explain. (4) The presence of a differential indicates that the acquiring firm has paid more than book value for the net assets of the other company. Such a differential exists because assets are under-valued on the books or there are synergies available when the two firms are managed jointly. Under GAAP, we want to determine whether assets have fair values that deviate from their book values and record the acquired assets at their fair value on the acquisition date. If the differential exceeds the amounts that can be allocated to mis-valued assets, then the firm must be expecting to generate synergies from the ability to coordinate the activities of the two firms. Goodwill represents the economic value of the synergies.

4 Part III. Consolidation Problem 2 (46 points) P acquired 80% of S Company for $800,000 in cash. At the time, S’s equity consisted of $600,000 of capital stock, $400,000 of Retained Earnings, and $200,000 of 5% cumulative preferred stock. For year X1, S reported $400,000 of Revenue, $150,000 of COGS, and Other Expenses totaling $100,000. On 10/1/X1, S sold 1,000 units of merchandise costing $20,000 to P for $50,000. An inventory count revealed that 300 units purchased from S remained in P’s inventory on 12/31/X1. P reported $800,000 of Revenue, $200,000 of COGS, and $200,000 of operating expenses from its own operations in year X1. Neither company paid any dividends in year X1. 1. Calculate P’s investment income and consolidated income for year X1. (14) S’s Reported Income = $400,000-$150,000-$100,000 = $150,000 S’s Income avail to Common = $150,000 -$10,000 pfd Div = $140,000 S's Income avail to Common 140,000 % Un- realized Unrealized $ S's Unrealized Income (9,000) Internal Sales 50,000 30% 15,000 S's realized Income 131,000 COGS 20,000 30% 6,000 P's Investment Income 104,800 Internal profit 30,000 30% 9,000 NCI's 20% Share 26,200 P’s own Op Income = $800,000-$200,000-$200,000 =$400,000 Consolidated Income = P’s own Op Income + P’s Investment Income=$400,000+$131,000 =$531,000 2. Assume that pre-closing trial balances of P and S will be consolidated on 12/31/X1. Prepare the worksheet consolidation entries. Show supporting calculations. (18) Worksheet Entries Investment Income 104,800 Investment in S 104,800 Sales 15,000 COGS 6,000 Inventory 9,000 Retained Earning 400,000 Capital Stock 600,000 Preferred Stock 200,000 Investment in S 800,000 NCI: Pfd 200,000 NCI 200,000

5 3. How much consolidated Revenue and COGS will be reported in year X1? Show calculations. (8) S’s Reported Revenue $200,000 S’s reported COGS $150,000 -Unrealized Revenue $15, 000 -Unrealized COGS $6,000 S's Realized Revenue 385,00 0 S's Realized COGS 144,00 0 Add: P's Revenue 800,00 0 Add: P's COGS 200,00 0 Consolidated Revenue 1,185,00 0 Consolidated COGS 344,00 0 4. Assume that S reports $200,000 of income in year X2 and did not make any sales to P during year X2 nor did it pay any dividends in year X2. How much investment income should P recognize in year X2? Show supporting calculations. What is NCI’s share of Consolidated Income for year X2? (6) S's Reported X2 Income 200,00 0 Add: Unrealized X1 income 9, 000 S's Realized X2 income 209,00 0 Deduct: S’s Pfd Dividends -$10,000 S’s Realized Income Avail to CS $199,000 P’s 80% Share $159,200 NCI's 20% Share 39,80 0

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6 Part IV. Consolidation Problem 3 (16 points) On 1/1/X1, P purchased an 80% interest in Slim Company for $800,000. At the time, Slim had $100,000 of capital stock ($1 par), $500,000 of Additional Paid in Capital, and $400,000 of retained earnings. On 1/2/X1, Slim Company issued 10,000 additional shares at a price of $14 per share to provide funds for a major expansion. P did not purchase any of the new shares on that date but did make a $100,000 loan to Slim Company to provide additional funds for expansion. The two-year loan pays 4% interest annually and matures on 1/2/X3. Assume that the loan contract requires Slim to make a $40,000 total loan payment to P on 1/2/X2 (loan anniversary) and pay the remaining loan balance on 1/2/X3 when the loan matures. Required : 1. What entries if any should P make on 1/2/X1 in connection with Slim’s share issue and the loan? Show calculations. (10) Equity Before After Common Stock ($1 par) 100,00 0 110,00 0 Additional Paid in Capital 500,00 0 630,00 0 Retained Earnings 400,00 0 400,00 0 Common Equity 1,000,0 00 1,140,0 00 Shares Owned 80,000 80,000 Shares Outstanding 100,00 0 110,00 0 Ownership% 0.80 0.73 P's Share of Equity 800,00 0 829,09 1 Investment in Slim $29,09 1 Capital: P $29,09 1 Loan Receivable $100,0 00 Cash $100,0 00

7 2. Assume that you are consolidating pre-closing trial balances for P and Slim on 12/31/X1. Prepare the consolidation worksheet entries for the internal loan. You do not need to make any other worksheet entries. (6) Loan Payable $100,000 Loan Receivable $100,000 Interest Payable $4,000 Interest Income $4,000 Interest Receivable $4,000 Interest Expense $4,000