2 Aa2e Hal Errata 012015

Chapter 1 | Accounting for Intercorporate Investments
19
Following are the required journal entries by the investor to record the initial investment and the
subsequent recognition of equity income and dividends received:
1. Equity investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240
(to record the purchase of the Equity Investment)
2. Equity investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
Equity income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
(to record the equity income 2 $30% of $300)
3. Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Equity investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
(to record the receipt of dividends of $30)
We have multiplied all of the previous journal entry amounts by 30%, the proportion of the investee
that the investor owns in this example. The investor initially records the Equity Investment at its
purchase price of $240, and subsequently recognizes the dividends received of $30 as a reduction of
that account. For the income recognition, when the investor owns less than 100% of the investee, it
can only record equity income equal to the proportion of the investee’s income that it owns. Since the
investee is reporting $300 of income in this case, the investor recognizes 30% of that amount ($90) in
its income statement as Equity Income.
The T-account for the Equity Investment illustrates these changes:
Equity Investment
Beginning balance 240
Equity income 90 30 Dividends received
Ending balance 300
The relation between the Equity Investment account on the investor’s balance sheet and the invest-
ee’s Stockholders’ Equity still holds. The investee reports Stockholders’ Equity of $1,000 at the end of
the year, and, since the 30% investment was acquired at book value, the investor reports an Equity Invest-
ment of $300, representing the 30% of the investee’s Stockholders’ Equity that it owns.
One final note: in the previous section we discuss the deferral of unrealized profit on intercom-
pany inventory sales. In that example, the investee sold inventory with a gross profit of $30 that the
investor deferred at the end of the year. The deferral of that profit when the investor owns less than
100% of the investee is handled in one of two ways:
1. Investor controls the investee—when the investor owns less than 100%, but still controls the
investee (say, for ownership levels in excess of 51% of the outstanding common stock), the inves-
tor defers all of the intercompany profit as described above, or 100% of the intercompany
2. Investor has a significant interest in the investee—when the investor has a significant interest profit for downstream sales
in the investee (say for ownership levels less than or equal to 50%), it defers only the proportion (i.e., the intercompany
inventory was sold by the
of the gross profit that it owns. For example, if the investor owns 30% of the investee, and the
parent to the subsidiary and it
gross profit on the intercompany sale is $30, the investor defers $9 ($30 3 30%) in the following is still held by the subsidiary at
journal entry:16 , regardless of whether the intercompany sale (and remaining the end of the period) or only
period-end inventory) is upstream or downstream. the portion of the gross profit
it owns for upstream sales (i.e.,
Equity income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 the intercompany inventory
Equity investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 was sold by the subsidiary to
(to record the deferral of gross profit on inventory sale in the period of sale) the parent and it is still held by
the parent at the end of the
period). Note that chapter 5
16
FASB ASC 323-10-35-9 through 35-11 indicates that proportionate elimination is only allowed if both of the following con- includes extensive discussion
ditions are met: (1) the investor does not control the investee and (2) the intercompany transactions are considered arm’s length. of the treatment of upstream
Otherwise, all of the intercompany transaction must be eliminated. versus downstream
intercompany profits.
Chapter 1 | Accounting for Intercorporate Investments 31
Book Values Fair Values
Investor Investee Investor Investee
Receivables & inventories . . . . . . . . . . . . . . . . . $120,000 $ 60,000 $108,000 $ 54,000

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240,000 120,000 360,000 180,000
Property & equipment . . . . . . . . . . . . . . . . . . . . 270,000 120,000 300,000 156,000
Trademarks & patents . . . . . . . . . . . . . . . . . . . . — — 180,000 96,000
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . $630,000 $300,000 $948,000 $486,000
Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $180,000 $ 96,000 $216,000 $114,000

Common stock ($1 par) . . . . . . . . . . . . . . . . . . . 36,000 20,000
Additional paid-in capital . . . . . . . . . . . . . . . . . . 324,000 172,000
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . 90,000 12,000
Total liabilities & equity . . . . . . . . . . . . . . . . . . . $525,000
$630,000 $300,000
$250,000
Net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $450,000 $204,000 $732,000 $372,000
17. Asset acquisition (market value is different from book value) LO1
Assume that the investor company issued 18,000 new shares of the investor company’s common stock AICPA
in exchange for all of the individually identifiable assets and liabilities of the investee company, in a Adapted
transaction that qualifies as a business combination. The financial information presented, above, was
prepared immediately before this transaction. Provide the Investor Company’s balance (i.e., on the
investor’s books, before consolidation) for “Goodwill” immediately following the acquisition of the
investee’s net assets:
a. $0
b. $6,000
c. $78,000
d. $174,000
18. Stock acquisition (market value is different from book value) LO1
Assume that the investor company issued 18,000 new shares of the investor company’s common stock AICPA
in exchange for 100% of the common stock of the investee company, in a transaction that qualifies as Adapted
a business combination. The financial information presented, above, was prepared immediately before
this transaction. Provide the Investor Company’s balance (i.e., on the investor’s books, before consoli-
dation) for “Investment in Investee” immediately following the acquisition of the investee’s common
stock:
a. $20,000
b. $192,000
c. $334,800
d. $378,000
Use the following facts for Multiple Choice problems 19 and 20 (each question is independent of the
other):
On January 1, 2013, an investor purchases 10,000 common shares of an investee at $9 (cash) per share. AICPA
The shares represent 20% ownership in the investee. The investee shares are not considered “market- Adapted
able” because they do not trade on an active exchange. On January 1, 2013, the book value of the
investee’s assets and liabilities equals $600,000 and $150,000, respectively. On that date, the appraised
fair values of the investee’s identifiable net assets approximated the recorded book values. During the
year ended December 31, 2013, the investee company reported net income equal to $22,500 and divi-
dends equal to $12,000.
19. Noncontrolling investment accounting (price equals book value) LO2,3
Assume the investor does not exert significant influence over the investee. Determine the balance in the AICPA
“Investment in Investee” account at December 31, 2013. Adapted
a. $2,400
b. $90,000
c. $92,100
d. $460,500
Chapter 3 | Consolidated Financial Statements Subsequent to the Date of Acquisition 113
Exhibit 3.3 Consolidation Spreadsheet at the End of the First Year Following Acquisition
Consolidation Entries
Parent Subsidiary Dr Cr Consolidated
Income statement:
Sales�� $10,000,000 $1,500,000 $11,500,000
Cost of goods sold�� (7,000,000) (900,000) (7,900,000)
Gross profit�� 3,000,000 600,000 3,600,000
Equity income�� 182,500 [C] 182,500 0
Operating expenses �� (1,900,000) (390,000) [D] 27,500 (2,317,500)
Net income �� $ 1,282,500 $ 210,000 $ 1,282,500
Statement of retained earnings:

BOY retained earnings �� $ 5,024,000 $ 775,000 [E] 775,000 $ 5,024,000
Net income �� 1,282,500 210,000 1,282,500
Dividends�� (256,500) (31,500) [C] 31,500 (256,500)
Ending retained earnings�� $ 6,050,000 $ 953,500 $ 6,050,000
Balance sheet:
Assets��
Cash �� $ 1,134,000 $ 404,500 $ 1,538,500
Accounts receivable �� 1,280,000 348,000 1,628,000
Inventory�� 1,940,000 447,000 2,387,000
Equity investment�� 1,651,000 [C] 151,000 0
[E] 1,000,000
[A] 500,000
PPE, net�� 9,373,350
9,332,000 785,650
827,000 [A] 200,000 [D] 10,000 10,349,000
Patent �� [A] 175,000 [D] 17,500 157,500
Goodwill �� [A] 125,000 125,000
$15,378,350
$15,337,000 $1,985,150
$2,026,500 $16,185,000
Liabilities and stockholders’ equity

Current liabilities�� 1,478,350
$ 1,437,000 $ 306,650
348,000 $ 1,785,000
Long-term liabilities�� 5,000,000 500,000 5,500,000
Common stock�� 1,635,000 100,000 [E] 100,000 1,635,000
APIC �� 1,215,000 125,000 [E] 125,000 1,215,000
Retained earnings�� 6,050,000 953,500 6,050,000
$15,378,350
$15,337,000 $1,985,150
$2,026,500 $16,185,000
own financial statements. However, because the parent controls the subsidiary, the parent cannot
issue financial statements to the public without first consolidating its subsidiary.8
The first four of our five C-E-A-D-I entries are designed to eliminate from the Equity Invest-
ment Income account the subsidiary’s reported net income, eliminate from the Equity Investment
account the book value of the subsidiary’s Stockholders Equity, reclassify the unamortized AAP
from the Equity Investment account into the appropriate individual identifiable net asset accounts
and Goodwill, and reclassify the amortized AAP from the Equity Investment Income account into
the appropriate income statement accounts (this example did not include the elimination of inter-
company transactions and balances; we will include that wrinkle in the next example).
As a result of these consolidation entries, the Equity Investment account (on the parent’s balance
sheet) and the Equity Income account (on the parent’s income statement) are both reduced to a zero bal-
8
The parent is allowed to issue supplemental unconsolidated parent-only or subsidiary-only financial statements if (and only
if) the parent also publishes consolidated financial statements in the same annual report. General Electric Co. is an example of
a company that regularly publishes audited parent and subsidiary financial statements with its audited consolidated statements.
You can download its financial statements from the SEC’s web site (http://www.sec.gov).
158 Chapter 3 | Consolidated Financial Statements Subsequent to the Date of Acquisition
LO4 44.A Consolidation when parent uses the cost method to account for its investment in the subsidiary
Assume that your company acquired a subsidiary on January 1, 2012, for $1,000,000. The purchase
price was $150,000 in excess of the subsidiary’s $850,000 book value of Stockholders’ Equity on the
acquisition date, and that excess was assigned to a Customer List that has a useful life of 10 years. Dur-
thetwo
ing the yearyears
ending December
ending 31, 2012,
December 31, 2013, the subsidiary reported net income totaling $476,000 and
paid dividends to the parent totaling $80,000.
The financial statements of the parent and its subsidiary for the year ended December 31, 2013, are
as follows:
Parent Subsidiary Parent Subsidiary
Income statement: Balance sheet:

Sales�� $6,860,000 $1,869,000 Assets
Cost of goods sold�� (4,939,200) (1,121,400) Cash �� $ 949,931 $ 481,579
Gross profit�� 1,920,800 747,600 Accounts receivable �� 1,756,160 433,608
Operating expenses �� (1,029,000) (485,940) Inventory �� 2,661,680 556,962
Dividend income�� 39,249 Equity investment�� 1,000,000
Net income �� $ 931,049 $ 261,660 Property, plant and equipment (PPE), net�� 7,315,504 1,030,442
$13,683,275 $2,502,591
BOY retained earnings �� $2,587,942 $ 965,650 Liabilities and stockholders’ equity
Net income �� 931,049 261,660 Accounts payable�� $ 1,004,304 $ 178,178
Dividends�� (186,210) (39,249) Accrued liabilities �� 1,193,640 233,002
Ending retained earnings�� $3,332,781 $1,188,061 Long-term liabilities�� 7,000,000 623,000
Common stock�� 373,800 124,600
APIC �� 778,750 155,750
Retained earnings�� 3,332,781 1,188,061
$13,683,275 $2,502,591
a. Compute the Equity Investment balance January 1, 2013, assuming that the parent had used the
equity method instead of the cost method.
b. Prepare the [ADJ] entry that is needed in order to bring the Equity Investment from its current
balance (using cost method) to the required balance (using the equity method) on January 1,
2013. [Hint: you computed this balance in part (a).]
c. Prepare the consolidation entries for the year ended December 31, 2013.
d. Prepare the consolidation spreadsheet for the year ended December 31, 2013.
e. Explain the function of the [ADJ] consolidation entry proposed in part (b).
f. Now, assume that the parent uses a hybrid equity method under which it reports its proportionate
share of the subsidiary’s net income, but doesn’t accrue any depreciation and amortization
expense on the [A] assets. Prepare the required [ADJ] consolidation entry.
Chapter 3 | Consolidated Financial Statements Subsequent to the Date of Acquisition 159
45.A Consolidation when parent uses the cost method to account for its investment in the subsidiary LO4
Assume that your company acquired a subsidiary on January 1, 2011, for $590,000. The purchase price
was $300,000 in excess of the subsidiary’s $290,000 book value of Stockholders’ Equity on the acquisi-
tion date, and that excess was assigned to a Patent that has a useful life of 10 years. During the three
two
years ending December 31, 2012,
2013, the subsidiary reported net income of $160,000 and paid dividends
to the parent totaling $20,000.
The financial statements of the parent and its subsidiary for the year ended December 31, 2013, are
as follows:

Sales�� $4,290,000 $645,000 Assets
Cost of goods sold�� (3,088,800) (387,000) Cash �� $ 694,756 $166,195
Gross profit�� 1,201,200 258,000 Accounts receivable �� 1,098,240 149,640
Operating expenses �� (643,500) (167,700) Inventory �� 1,664,520 192,210
Dividend income�� 13,545 Equity investment�� 590,000
Net income �� $ 571,245 $ 90,300 Property, plant and equipment (PPE), net�� 4,574,856 355,610
$8,622,372 $863,655
BOY retained earnings �� $ 893,110 $333,250 Liabilities and stockholders’ equity
Net income �� 571,245 90,300 Accounts payable�� $ 628,056 $ 61,490
Dividends�� (114,249) (13,545) Accrued liabilities �� 746,460 80,410
Ending retained earnings�� $1,350,106 $410,005 Long-term liabilities�� 5,500,000 215,000
Common stock�� 129,000 43,000
APIC �� 268,750 53,750
Retained earnings�� 1,350,106 410,005
$8,622,372 $863,655
a. Compute the Equity Investment balance as of January 1, 2013, assuming that the parent used the
equity method instead of the cost method.
b. Prepare the [ADJ] entry that is needed in order to bring the Equity Investment from its current
balance (using cost method) to the required balance (using the equity method) on January 1,
2013. [Hint: you computed this balance in part (a).]
c. Prepare the consolidation entries for the year ended December 31, 2013.
d. Prepare the consolidation spreadsheet for the year ended December 31, 2013.
e. Explain the function of the [ADJ] consolidation entry proposed in part (b).
f. Now, assume that the parent uses a hybrid equity method under which it reports its proportionate
share of the subsidiary’s net income, but doesn’t accrue any depreciation and amortization
expense on the [A] assets. Prepare the required [ADJ] consolidation entry.
46.C Consolidation subsequent to date of acquisition: pooling-of-interests method LO5
Assume that on January 1, 2010, the parent company acquires a 100% interest in its subsidiary by is-
suing common stock with a fair value that is $600,000 over the book value of the subsidiary’s Stock-
holders’ Equity. The parent accounted for the acquisition under the pooling-of-interest method. (Note:
pooling of interests is no longer acceptable for new acquisitions, except in the case of “common con-
trol” acquisitions.)
The financial statements of the parent and its subsidiary for the year ended December 31, 2013,
follow:
162 Chapter 3 | Consolidated Financial Statements Subsequent to the Date of Acquisition
Solution 3
$900,000 fair value of the subsidiary is less than the $1,000,000 book value of the Equity Investment
The $700,000
(i.e., the carrying value of the reporting unit); therefore, Goodwill is potentially impaired.
Fair value of the subsidiary�� $ 900,000

Fair value of the net assets exclusive of Goodwill �� 700,000
Implied fair value of Goodwill �� $ 200,000
Book value of Goodwill�� 300,000
Goodwill impairment�� $(100,000)
Goodwill is found to be impaired and must, therefore, be written off in part with the following journal entry:
Loss on write-down of Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000

Equity investment* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000
(to write down the book value of Goodwill)
*In the consolidated financial statements, this reduction in the Equity Investment account will appear as a
reduction in the balance of Goodwill.
Comprehensive Review Solution

Consolidation Entries

Income statement:
Sales�� $5,700,000 $480,000 $6,180,000
Cost of goods sold�� (3,990,000) (288,000) (4,278,000)
Gross profit�� 1,710,000 192,000 1,902,000
Equity income�� 47,200 [C] 47,200 0
Operating expenses �� (1,083,000) (124,800) [D] 20,000 (1,227,800)
Net income �� $ 674,200 $ 67,200 $ 674,200

BOY retained earnings �� $2,863,680 $248,000 [E] 248,000 $2,863,680
Net income �� 674,200 67,200 674,200
Dividends�� (134,840) (10,080) [C] 10,080 (134,840)
Ending retained earnings�� $3,403,040 $305,120 $3,403,040
Balance sheet:
Assets
Cash �� $ 354,870 $129,440 $ 484,310
Accounts receivable �� 729,600 111,360 840,960
Inventory�� 1,105,800 143,040 1,248,840
Equity investment�� 837,120 [C] 37,120 0
[E] 320,000
[A] 480,000
Property, plant and equipment (PPE), net�� 5,319,240 264,640 [A] 150,000 [D] 15,000 5,718,880
Customer list�� [A] 50,000 [D] 5,000 45,000
Goodwill �� [A] 280,000 280,000
$8,346,630 $648,480 $8,617,990

Current liabilities�� $ 819,090 $111,360 $ 930,450
Long-term liabilities�� 2,500,000 160,000 2,660,000
Common stock�� 931,950 32,000 [E] 32,000 931,950
APIC �� 692,550 40,000 [E] 40,000 692,550
Retained earnings�� 3,403,040 305,120 3,403,040
$8,346,630 $648,480 $8,617,990
Chapter 4 | Consolidated Financial Statements and Intercompany Transactions 189
Equity investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
Equity income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
(to record the equity method adjustment for equipment-gain-related income
recognized by the subsidiary)
Equity investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Equity income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
(to recognize the remaining deferred intercompany profit in income and remove
the previously deferred profit from the Equity Investment account)
When the parent uses the full equity method, the consolidating [C] entry will eliminate the gain
that corresponds to the income recognized in the subsidiary’s income statement and the consolidat-
ing [I] entry will reclassify the $30 of Income from Subsidiary into the consolidated Gain on Sale
of Equipment account. These consolidating entries for the year ended December 31, 2010 (i.e., the
financial statements that include the January 1, 2010 date of sale) are as follows:
[C] [C] Equity income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50.0

Consolidation entries Equity investment . . . . . . . . . . . . . . . . . . . . . . . . . 50.0
to eliminate changes
in the Equity
Investment account
during the year
[I] investment
[Igain] Equity income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30.0
Consolidation entry Gain on sale of equipment . . . . . . . . . . . . . . . . . . . 30.0
in the year of sale (to increase the Equity Investment account for the remaining
to an unaffiliated unconfirmed profit and recognize the deferred gain on the sale)
company
Again, the total gain reported in the consolidated income statement is $80 (i.e., $50 by the subsidiary
in its income statement and the recognition of the $30 deferred profit balance remaining on January
1, 2010).
One final point: if the sale to an unaffiliated party occurred after December 31, 2013, no consoli-
dating adjustment would have been necessary. That is, if the equipment is held by the subsidiary until
it is fully depreciated, the deferred gain will be fully amortized. Thus, the gain on sale reported on the
books of the subsidiary will be the only gain recognized in the consolidated income statement.
Upstream Intercompany Sale of Depreciable Assets In the case of

wholly owned subsidiaries, there is no difference in the [I] eliminating entries for upstream versus
downstream transactions involving intercompany (i.e., affiliated) transfers of depreciable assets among
commonly controlled companies (assuming we hold constant the parent company’s pre-consolidation
bookkeeping for the Equity Investment account). This is because all of the deferred profit must be
removed from the combined financial statements, regardless of the direction of the transaction.
If we consider the accounts affected and the amounts in the preceding example, the account rela-
tionships, [I] consolidating journal entries, and consolidated balances in Exhibits 4.14 and 4.16 are the
same in the upstream case. The only difference in the entries will relate to the [C] adjustment because
in the case of the upstream sale, the subsidiary would have recorded the gain in its income statement.
Thus the parent company would have recorded its equity method interest in the income of the subsid-
iary. In addition, the parent would make the same equity method adjustments to eliminate the deferred
intercompany profits that result from the sale.19 The following full-equity-method entries are recorded
by the parent company assuming an upstream sale instead of a downstream sale:
19
Again, we made some fairly big simplifying assumptions in this example. In particular, we assumed that there were no other
transactions or balances, except for the equipment-related items. Thus, the subsidiary’s only income would have been derived
from the upstream sale.
194 Chapter 4 | Consolidated Financial Statements and Intercompany Transactions
Com pr eh en s ive Re vi ew
A parent company acquired 100 percent of the stock of a subsidiary company on January 1, 2009, for
$555,000. On this date, the balances of the subsidiary’s stockholders’ equity accounts were Common
Stock, $292,500, and Retained Earnings, $67,500.
On January 1, 2009, the subsidiary’s recorded book values were equal to fair values for all items
except four: (1) accounts receivable had a book value of $82,500 and a fair value of $72,000, (2) prop-
erty, plant & equipment, net had a book value of $225,000 and a fair value of $252,000, (3) a previ-
ously unrecorded patent had a book value of $0 and a fair value of $45,000, and (4) notes payable had
a book value of $45,000 and a fair value of $37,500. Both companies use the FIFO inventory method
and sell all of their inventories at least once per year. The year-end net balance of trade receivables are
collected in the following year. On the acquisition date, the subsidiary’s property, plant & equipment,
net had a remaining useful life of 10 years, the patent had a remaining useful life of 4 years, and notes
payable had a remaining term of 5 years.
On January 1, 2012, the parent sold a building to the subsidiary for $120,000. On this date, the
building was carried on the parent’s books (net of accumulated depreciation) at $82,500. Both companies
estimated that the building has a remaining life of 10 years on the intercompany sale date, with no salvage
value.
Each company routinely sells merchandise to the other company, with a profit margin of 40 percent of
selling price (regardless of the direction of the sale). During 2013, intercompany sales amount to $75,000,
of which $20,000
$30,000 of merchandise remains in the ending inventory of the subsidiary. On December 31,
2013, $15,000 of these intercompany sales remained unpaid. Additionally, the parent’s December 31, 2012
$22,500 of merchandise purchased in the preceding year from the subsidiary. During
inventory includes $15,000
2012, intercompany sales amount to $60,000, and on December 31, 2012, $10,000 of these intercompany
sales remained unpaid.
The parent accounts for its investment in the subsidiary using the full equity method. Unconfirmed
profits are allocated pro rata. The pre-closing trial balances (and additional information) for the two
companies for the year ended December 31, 2013, are provided below:
Parent Subsidiary
Debits
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 87,120 $ 63,750
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121,500 90,000
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292,500 137,250
Property, plant & equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283,500 202,500
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128,250 225,000
Equity investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 660,000 —
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 648,000 243,000
Depreciation & amortization expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,000 21,600
Operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 339,000 81,150
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000 5,250
Dividends declared . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135,000 31,500
Total debits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,733,870 $1,101,000
Credits
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 252,000 $ 52,500
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121,470 45,000
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49,500 58,500
Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 540,000 292,500
Retained earnings (Jan. 1, 2013) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 640,350 247,500
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,080,000 405,000
Equity income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,550 —
Total credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,733,870 $1,101,000
Additional Information
Retained earnings (Dec. 31, 2013) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 609,900 $ 270,000
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 104,550 $ 54,000

Appendix 4B: Consolidation When the Parent Uses

the Partial Equity Method to Account
for Its Equity Investment
Given the tremendous volume of intercompany transactions for most affiliated groups of companies, the most
expedient accounting for intercompany transactions and deferred profit involves (1) ignoring intercompany
transactions and deferred profit adjustments in the parent’s pre-consolidation Equity Investment account and
(2) removing intercompany transactions and deferred profit during the consolidation process. Intercompany
transactions are generally assumed to create temporary differences between the Equity Investment account
and the Stockholders’ Equity of the subsidiary (i.e., they naturally reverse over time). Because consolidation
adjustments represent a process of “backing out” the parent’s investment account prior to summing the parents’
and subsidiaries’ financial statement information, adjusting the Equity Investment intercompany profits results
in more work that will ultimately be backed out in consolidation.20 Because it involves fewer steps during the
bookkeeping and consolidation process, the partial equity method arguably results in a reduced probability of
error in the consolidated financial statements.21 That is the justification for its use in practice.
To illustrate the consolidation process when the parent uses the partial equity method to account for its
Equity Investment in the subsidiary in the presence of intercompany sales of inventories, we will use the
same basic facts as the example in Appendix 4A.22 In that example, we assume that the parent acquired its
subsidiary on January 1, 2010, and we are preparing consolidated financial statements for the year ending
December 31, 2013. Assume the following facts (all amounts in $):
Original AAP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000

Unamortized AAP balance on January 1, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Annual depreciation/amortization of the AAP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
In addition, the subsidiary has sold inventories to its parent regularly since the acquisition. The inter-
company sales and profit for the prior and current period are as follows:
Year Ending Dec. 31, 2012 Dec. 31, 2013
Transfer price for inventory sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $150,000 $200,000

Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102,000 150,000
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 48,000 $ 50,000
Percentage of inventory remaining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25% 30%
Deferred intercompany profit (deferred profit) in ending inventory . . . . . . . . . $ 12,000 $ 15,000
Intercompany receivable/payable at end of period* . . . . . . . . . . . . . . . . . . . . $ 25,000 $ 30,000
* Paid at beginning of next period.
Exhibit 4B.1 presents the consolidation spreadsheet including the [ADJ] and C-E-A-D-I entries.
Because the parent, in this example, uses the partial equity method to account for its investment in the
subsidiary, the balance of the Equity Investment account at the end of the period is $831,000 as follows:
End of year stockholders’ equity (S) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $811,000

Unamortized AAP at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Cumulative understatement of Equity investment account . . . . . . . . . . . . . . . . . . . . . . $831,000
20
If the parent company wishes to publish supplementary “parent only” financial statements in addition to the consolidated
statements, then the Equity Investment account (and related Equity Investment Income account) must reflect the “fully ad-
justed” equity method (i.e., all intercompany profits must be eliminated).
21
Of course, ignoring deferred profit during the parent’s Equity Investment bookkeeping process means that the parent’s pre-
consolidation net income likely won’t equal consolidated net income. However, given the potentially high volume of intercom-
pany transactions during a given period, this is a small inconvenience for a more efficient consolidation process.
22
Because the parent is using a different method of investment account bookkeeping, some investment-related accounts will
have different balances from those included in Appendix 4A.
Exercises
LO1 26. Computing the amount of equity income and preparing [I] consolidation journal entries
Assume that a wholly owned subsidiary sells inventory to the parent company. The parent company,
ultimately, sells the inventory to customers outside of the consolidated group. You have compiled the
following data for the years ending 2012 and 2013:
Subsidiary Intercompany % Inventory

Net Inventory Gross Remaining at Receivable
Income Sales Profit % End of Year (Payable)
2013 . . . . . . . . . . . . . . . . . . . . $500,000 $75,000 32% 10% $25,000

2012 . . . . . . . . . . . . . . . . . . . . $400,000 $50,000 30% 9% $20,000
Assume that inventory not remaining at the end of the year was sold outside of the consolidated group
during the year. Assume the parent company uses the full equity method to account for its subsidiary.
a. How much Equity Income should the parent report in its pre-consolidation income statement the
year ending 2013 assuming that it uses the equity method of accounting for its Equity Investment?
b. Prepare the required [I] consolidation journal entries for 2013.
LO1 27. Computing the amount of equity income and preparing [I] consolidation journal entries
Assume that a parent company sells inventory to its wholly owned subsidiary. The subsidiary, ulti-
mately, sells the inventory to customers outside of the consolidated group. You have compiled the fol-
lowing data for the years ending 2012 and 2013:
Subsidiary Intercompany Gross Profit

Net Inventory on Unsold Receivable
Income Sales Inventories (Payable)
2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300,000 $50,000 $18,000 $20,000

2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $200,000 $40,000 $13,500 $15,000
Assume that inventory not remaining at the end of the year was sold outside of the consolidated group.
a. How much Equity Income should the parent report in its pre-consolidation income statement
the year ending 2013 assuming that it uses the equity method of accounting for its Equity
Investment? Assume the parent company uses the full equity method to account for its subsidiary.
b. Prepare the required [I] consolidation journal entries for 2013.
LO2 28. Preparing the [I] consolidation journal entries for sale of land
Assume that during 2009 your subsidiary sells land that originally cost $100,000 to its parent for a sale
price of $130,000. The parent holds the land until it sells the land to an unaffiliated company on Decem-
ber 31, 2013. The parent uses the full equity method to account for its Equity Investment.
a. Prepare the required [I] consolidation journal entry in 2009.
b. Prepare the required [I] consolidation journal entry required at the end of each year 2010 through
2012.
c. Assume that the parent re-sells the land outside of the consolidated group for $190,000 on
December 31, 2013. Prepare the required [I] consolidation journal entry for 2013.
d. What will be the amount of gain reported in the consolidated income statement in 2013?
LO2 29. Preparing the [I] consolidation journal entries for sale of land
Assume that on June 15, 2006 a parent company sells land that originally cost $80,000 to its wholly-
owned subsidiary for a sale price of $120,000. The subsidiary holds the land until it sells the land to an
unaffiliated company on November 12, 2013. The parent uses the full equity method to account for its
Equity Investment.
a. Prepare the required [I] consolidation journal entry in 2006.
b. Prepare the required [I] consolidation journal entry required at the end of each year 2007 through
2012.
c. Assume that the subsidiary resells the land outside of the consolidated group for $175,000 on
November 12, 2013. Prepare the required [I] consolidation journal entry for 2013.
d. What will be the amount of gain reported in the consolidated income statement in 2013?
Chapter 4 | Consolidated Financial Statements and Intercompany Transactions 225
Year Ended December 31,
100% AAP Amortization – Dr (Cr) 2009 2010 2011 2012 2013
Accounts receivable . . . . . . . . . . . . . . . . . . . . . $(10,500) $ — $ — $ — $ —

Property, plant & equipment, net . . . . . . . . . . . . 2,700 2,700 2,700 2,700 2,700
Customer list . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,250 11,250 11,250 11,250 —
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500 1,500 1,500 1,500 1,500
Net amortization . . . . . . . . . . . . . . . . . . . . . . . . $ 4,950 $15,450 $15,450 $15,450 $4,200
December 31,
100% Unamortized AAP – Dr (Cr) Jan. 1, 2009 2009 2010 2011 2012 2013
Accounts receivable . . . . . . . . . . . . $ (10,500) $ — $ — $ — $ — $ —

Property, plant & equipment, net . . . 27,000 24,300 21,600 18,900 16,200 13,500
Customer list . . . . . . . . . . . . . . . . . . 45,000 33,750 22,500 11,250 — —
Notes payable . . . . . . . . . . . . . . . . . 7,500 6,000 4,500 3,000 1,500 —
Goodwill . . . . . . . . . . . . . . . . . . . . . 126,000 126,000 126,000 126,000 126,000 126,000
Net amortization . . . . . . . . . . . . . . . $195,000 $190,050 $174,600 $159,150 $143,700 $139,500
c. Intercompany depreciable asset sale:

One downstream asset sale.
Intercompany profit recognized on January 1, 2012: $120,000 2 $82,500 5 $37,500, 10-year remaining life
Profit confirmed each year: $37,500/10 5 $3,750
Downstream Upstream
Net intercompany profit deferred at January 1, 2013 . . . . . . . . . . . . . . . . . . . . . $33,750 $0

Less: Deferred intercompany profit recognized during 2013 . . . . . . . . . . . . . . . 3,750 0
Net intercompany profit deferred at December 31, 2013 . . . . . . . . . . . . . . . . . . $30,000 $0
Intercompany inventory transactions:

$75,000
Intercompany inventory sales during 2013: $50,000
Downstream Upstream
(in Sub’s (in Parent’s
inventory) inventory)
Intercompany profit in inventory on January 1, 2013 . . . . . . . . . . . . . . . . . . . . . $0 $9,000

Intercompany profit in inventory on December 31, 2013 . . . . . . . . . . . . . . . . . . $12,000 $0
Intercompany accounts receivables and payables at December 31, 2013: $15,000

d. The following is the general formula for computing the Equity Investment account (under the full
equity method) at any point in time when the parent company owns 100% of a subsidiary:
(1) Book value of the net assets of the subsidiary

Plus: (2) Unamortized AAP
Less: (3) Downstream deferred intercompany profits
Less: (4) Upstream deferred intercompany profits
Full equity method investment account
Equity Investment account balance at January 1, 2013:
Jan. 1, 2013
$540,000 (1) $292,500 1 $247,500
Plus: 143,700 (2) $74,350 (from part b.)
Less: (33,750) (3) $33,750 (from part c.)
Less: (9,000) (4) $9,000 (from part c.)
$640,950
Equity Investment account balance at December 31, 2013:
Dec. 31, 2013

$562,500 (1) $292,500 1 $270,000
Plus: 139,500 (2) $139,500 (from part b.)
Less: (30,000) (3) $30,000 (from part c.)
(12,000) (3) $12,000 (from part c.)
Less: 0 (4) none
$660,000
e. Full equity method investment accounting includes the following routine adjustments during any
given period: (1) recognition of p% of the subsidiary’s income, (2) amortization of the p% AAP, (3)
recognition of p% of the dividends declared by the subsidiary, (4) recognition of prior period deferred
intercompany profits that have been confirmed though either transactions with unaffiliated parties
or depreciation/amortization, and (5) deferral of intercompany profits newly originating during the
current period. With respect to the deferred intercompany profits, when the parent company owns
100% of a subsidiary, then 100% of the profit is deferred for downstream and upstream transactions.
Information for items (1) and (2) is available in the initial information, information for item (3) was
summarized in part b, and information for items (4) and (5) was summarized in part c. These items
are all reflected in the following completed T-account.
Equity Investment
January 1, 2013 640,950

(1) p% 3 net income of Sub. 5 100% 3 54,000 31,500 (2) p% 3 dividends of Sub. 5 100% 3
$54,000 $31,500
(4) p% 3 BOY upstream inventory profits 9,000 4,200 (3) p% AAP amortization (see part b)
recognized during 2013 5 100% 3
$9,000
(4) 100% 3 downstream building profits 3,750
3,700 12,000 (5) 100% 3 EOY downstream inventory
recognized via depreciation during profits deferred until year of sale to
2013 unaffiliated party
December 31, 2013 660,000
Consolidation Spreadsheet for the Year Ended December 31, 2013
Income statement:
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,080,000 $405,000 [Isales] $ 75,000 $1,410,000
Cost of goods sold . . . . . . . . . . . . . . . . (648,000) (243,000) [Icogs] 12,000 [Icogs] $ 9,000 (819,000)
[Isales] 75,000
Gross profit . . . . . . . . . . . . . . . . . . . . . . 432,000 162,000 591,000
Deprec. and amort. expense . . . . . . . . (27,000) (21,600) [D] 2,700 [Ideprec] 3,750
3,7500 (47,550)
Operating expenses . . . . . . . . . . . . . . . (339,000) (81,150) (420,150)
Interest expense . . . . . . . . . . . . . . . . . . (12,000) (5,250) [D] 1,500 (18,750)
Total expenses . . . . . . . . . . . . . . . . . . . . (378,000) (108,000) (486,450)
Equity income from subsidiary . . . . . . . 50,550 — [C] 50,550 —

Consolidated net income . . . . . . . . . . . 104,550 54,000 104,550
Retained earnings statement:

Beg. ret. earn.—parent . . . . . . . . . . . . . $640,350 $640,350
Beg. ret. earn.—subsidiary . . . . . . . . . . $247,500 [E] 247,500 —
Income attrib. to control. int. . . . . . . . . . 104,550 54,000 104,550
744,900 301,500 744,900
Dividends declared
Parent . . . . . . . . . . . . . . . . . . . . . . . . (135,000) (135,000)
Subsidiary . . . . . . . . . . . . . . . . . . . . . (31,500) [C] 31,500 —
Ending retained earnings . . . . . . . . . . . . $609,900 $270,000 $609,900
Balance sheet:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 87,120 $ 63,750 $150,870
Accounts receivable . . . . . . . . . . . . . . . 121,500 90,000 [Ipay] 15,000 196,500
Inventories . . . . . . . . . . . . . . . . . . . . . . 292,500 137,250 [Icogs] 12,000 417,750
Property, plant & equip., net . . . . . . . . . 283,500 202,500 [A] 16,200 [D] 2,700 469,500
[Ideprec] 3,750 [Iasset] 33,750
Other assets . . . . . . . . . . . . . . . . . . . . . 128,250 225,000 353,250
Patent . . . . . . . . . . . . . . . . . . . . . . . . . . — —
Equity investment . . . . . . . . . . . . . . . . . 660,000 [Icogs] 9,000 [C] 19,050 —
[Iasset] 33,750 [E] 540,000
[A] 143,700
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . [A] 126,000 126,000
Total assets . . . . . . . . . . . . . . . . . . . . . $1,572,870 $718,500 $1,713,870
Accounts payable . . . . . . . . . . . . . . . . . $252,000 $ 52,500 [Ipay] 15,000 $289,500

Notes payable . . . . . . . . . . . . . . . . . . . . 121,470 45,000 [A] 1,500 [D] 1,500 166,470
Other liabilities . . . . . . . . . . . . . . . . . . . . 49,500 58,500 108,000
Common stock
Parent . . . . . . . . . . . . . . . . . . . . . . . . 540,000 540,000
Subsidiary . . . . . . . . . . . . . . . . . . . . . 292,500 [E] 292,500 —
Retained earnings . . . . . . . . . . . . . . . . . 609,900 270,000 609,900
Total liabilities and equity . . . . . . . . . . $1,572,870 $718,500 $886,950 $886,950 $1,713,870
Chapter 5 | Consolidated Financial Statements with Less than 100% Ownership 239
($210,000 3 20% 5 $42,000), decreases by the amortization of the AAP assets attributable to the
noncontrolling shareholders ($40,000 3 20% 5 $8,000), and decreases by the dividends declared and
paid to the noncontrolling interests by the subsidiary ($4,200). The ending balance of Noncontrolling
Interests equity in the amount of $409,800 is reported separately in the Stockholders’ Equity section
of the consolidated balance sheet.
It is important to note that the noncontrolling shareholders have an interest only in the subsidiary
company. As a result, the amount of profit that is attributable to them is equal to the proportion of the
shares in the subsidiary that they own.10 Since the subsidiary reports net income of $210,000 in this
case, the profit attributable to the noncontrolling interests is equal to 20% of that amount, or $42,000.
In a similar manner, the noncontrolling interests are also allocated 20% of the amortization expense
related to the AAP assets, $8,000 ($40,000 3 20%) in this case.
As we discuss above, the $150,000 Goodwill asset was allocated $130,000 to the parent’s interest
and $20,000 to the noncontrolling interests. Neither the controlling nor the noncontrolling portions of
Goodwill are amortized. Instead, Goodwill is tested annually for impairment, and is written down if
found to be impaired. That charge, if realized, will be allocated to the parent’s shareholders and the
noncontrolling interests in proportion to the percentage of the Goodwill that has been allocated to
them, not in proportion to their respective ownership interests.
In Exhibit 5.3, we present our consolidation spreadsheet at the end of the year in the presence of
noncontrolling interests.
Our five basic C-E-A-D-I entries are a little more complex because of the noncontrolling interest.
However, they are fundamentally the same:
[C] Equity income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136,000 Eliminates all changes in the Equity Investment
Consol. NI attributable to NCI . . . . . . . . . . . . . . . . . . . . . . 34,000 and Noncontrolling Interest accounts during the
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,000 consolidation period. The NCI credit includes
Equity investment . . . . . . . . . . . . . . . . . . . . . . . . . . 119,200 the net income attributable to the NCI less the
dividends paid to the NCI.
Noncontrolling interest ($34,000 2 $4,200) . . . . . . 29,800
[E] Common stock @BOY . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000 Eliminates subsidiary Stockholders’ Equity

APIC @BOY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125,000 @ BOY. The credit to the Equity Investment
Retained earnings @BOY . . . . . . . . . . . . . . . . . . . . . . . . . 775,000 eliminates the BOY balance recognized in the
Equity investment 2 @BOY parent’s Equity Investment account. The credit
($1,000,000 3 80%) . . . . . . . . . . . . . . . . . . . . . . . . 800,000 to the Noncontrolling Interest equity account
Noncontrolling interest @BOY establishes its balance @ BOY.
($1,000,000 3 20%) . . . . . . . . . . . . . . . . . . . . . . . . 200,000
[A] PPE, net 2 @BOY (100% AAP) . . . . . . . . . . . . . . . . . . . . . 500,000 The debits recognize the BOY AAP ($950,000
Patent, net @BOY (100% AAP) . . . . . . . . . . . . . . . . . . . . . 300,000 @ BOY) on the consolidated balance sheet. The
Goodwill @ BOY (100% AAP) . . . . . . . . . . . . . . . . . . . . . . 150,000 credits eliminate the parent’s share of the BOY
(see footnote
Equity investment 2 @BOY ($950,000 9.)
3 80%) . . . 770,000 AAP from its Equity Investment account and
(see footnote
Noncontrolling interest ($950,000 9.)
3 20%) . . . . . . . 180,000 recognize the noncontrolling interests’ share of
the AAP in the NCI equity account. [Note that
the allocation of the 100% AAP is equal to the
footnote
split calculated in Exhibit 9.]
5.2.]
[D] Operating expenses (AAP amort) . . . . . . . . . . . . . . . . . . . 40,000 The debit to Operating Expenses recognizes
PPE, net (for 100% AAP amort) . . . . . . . . . . . . . . . 10,000 depreciation/amortization expense relating to
Patent, net (for 100% AAP amort) . . . . . . . . . . . . . 30,000 the identifiable AAP assets, and the credits to
PPE, net and Patent, net, adjust the balances to
reflect their correct end-of-year totals.
[I] Not applicable in this example (we cover this topic later in
the chapter)
10
If there are contractual arrangements that determine the attribution of earnings, such as a profit-sharing agreement, the attri-
bution specified by the arrangement should be considered. If there are no such contractual arrangements, the relative ownership
interests should be used if the parent’s ownership and the NCI’s ownership in the assets and liabilities are proportional. For
example, if the controlling interest owns 80%, and the NCI owns 20%, then 80% of the subsidiary’s earnings will be allocated
to the controlling interest and 20% to the NCI. If, however, the parties have a contractual arrangement specifying a 50/50 split
of the earnings, then 50% of the earnings would be allocated to the controlling interest and 50% to the noncontrolling interest,
regardless of the ownership percentage.
Because the long-term-notes-payable-related AAP has a credit balance, its amortization will decrease
interest expense by $2,000 (i.e., increase consolidated net income) in the consolidated income statement
each year through December 31, 2015 (i.e., the due date of the last payment on the note).
The following table summarizes the balances and activity for the 100% AAP through December
31, 2012:
Unamortized Fiscal Unamortized Fiscal Unamortized Fiscal Unamortized

100% AAP Year 2011 100% AAP Year 2012 100% AAP Year 2013 100% AAP
100% AAP – Dr (Cr) 1/1/2011 Amortization 12/31/2011 Amortization 12/31/2012 Amortization 12/31/2013
Inventories . . . . . . . . . . . . $(40,000) $40,000 0 0 0

Land . . . . . . . . . . . . . . . . (90,000) (90,000) (90,000) (90,000)
Patents . . . . . . . . . . . . . . (60,000) 6,000 (54,000) $6,000 (48,000) $6,000 (42,000)
Long-term notes
payable . . . . . . . . . . . . (10,000) 2,000 (8,000) 2,000 (6,000) 2,000 (4,000)
Goodwill . . . . . . . . . . . . . 573,000 573,000 573,000 573,000
Net . . . . . . . . . . . . . . . . . . $373,000 $48,000 $421,000 $8,000 $429,000 $8,000 $437,000
$421,000
The 100% AAP is important to understand because it is necessary to determine account balances in
the consolidated financial statements. Understanding the AAP allocated to the controlling and noncon-
trolling interests is also necessary because (1) the controlling interest AAP is included in the parent
company’s pre-consolidation investment account and (2) the noncontrolling-interest share of the AAP
is reflected in the consolidated noncontrolling-interest-related accounts.
The controlling interest share of the AAP on January 1, 2011 equals $300,000, and is determined
by taking the fair value of the controlling interest on the acquisition date and subtracting the control-
ling interest share of the book value of net assets of the subsidiary on that same date: $1,400,000 2
(80% 3 $1,375,000) 5 $1,400,000 2 $1,100,000 5 $300,000. On the acquisition date, each of the
identifiable net assets is assigned a controlling-interest share of their respective AAP amounts. The
controlling-interest goodwill is then calculated as the residual controlling AAP that remains after fac-
toring in the controlling portions of the AAP assigned to the all of the identifiable net assets. In addi-
tion, similar to the 100% AAP, the controlling interest AAP is amortized for any of the identifiable net
assets subject to depreciation or amortization.
The following table summarizes the balances and activity for the controlling interest portion of
the AAP from the acquisition date through December 31, 2012:
Unamortized Fiscal Unamortized Fiscal Unamortized Fiscal Unamortized

Controlling Interest 80% AAP Year 2011 80% AAP Year 2012 80% AAP Year 2013 80% AAP
AAP – Dr (Cr) 1/1/2011 Amortization 12/31/2011 Amortization 12/31/2012 Amortization 12/31/2013
Inventories . . . . . . . . . . . . $(32,000) $32,000 0 0 0

Land . . . . . . . . . . . . . . . . (72,000) (72,000) (72,000)
(42,000) (72,000)
(42,000)
Patents . . . . . . . . . . . . . . (48,000) 4,800 (43,200) $4,800 (38,400) $4,800 (33,600)
Long-term notes
payable . . . . . . . . . . . . (8,000) 1,600 (6,400) 1,600 (4,800) 1,600 (3,200)
Goodwill . . . . . . . . . . . . . 460,000 460,000 460,000 460,000
Net . . . . . . . . . . . . . . . . . . $300,000 $38,400 $338,400 $6,400 $344,800 $6,400 $351,200
The noncontrolling interest share of the AAP on January 1, 2011 equals $73,000, and is determined
by taking the fair value of the noncontrolling interest on the acquisition date and subtracting the non-
controlling interest share of the book value of net assets of the subsidiary on that same date: $348,000
2 (20% 3 $1,375,000) 5 $348,000 2 $275,000 5 $73,000. On the acquisition date, each of the
identifiable net assets is assigned a noncontrolling-interest share of their respective AAP amounts. The
noncontrolling-interest goodwill is then calculated as the residual noncontrolling AAP that remains
after factoring in all of the noncontrolling portions of the AAP assigned to the identifiable net assets.
In addition, similar to the 100% AAP and the controlling interest AAP, the noncontrolling interest AAP
is amortized for any of the identifiable net assets subject to depreciation or amortization.
282 Chapter 5 | Consolidated Financial Statements with Less than 100% Ownership
LO3 17. Intercompany inventory transactions

AICPA Consolidated Revenues:
Adapted a. $2,400,000
b. $2,620,000
c. $2,720,000
d. $2,820,000
LO3 18. Intercompany inventory transactions and Acquisition Accounting Premium
AICPA Consolidated Expenses:
Adapted a. $1,600,000
b. $1,687,500
c. $1,760,000
d. $1,787,500
LO2, 3 19. Noncontrolling interest, upstream deferred intercompany inventory profits and Acquisition
AICPA Accounting Premium
Adapted Consolidated net income attributable to noncontrolling interest:
a. $26,500
b. $28,000
c. $30,500
d. $32,000
LO3 20. Intercompany inventory transactions
AICPA Current Assets:
Adapted a. $907,500
b. $900,000
c. $892,500
d. $875,000
LO3 21. Acquisition Accounting Premium
AICPA Noncurrent Assets:
Adapted a. $4,380,000
b. $4,360,000
c. $4,300,000
d. $4,280,000
LO3 22. Full equity method and consolidations
AICPA Retained Earnings:
Adapted a. $1,834,000
b. $1,794,000
c. $1,754,000
d. $1,594,000
LO2, 3 23. Noncontrolling interest, upstream deferred intercompany inventory profits and Acquisition
AICPA Accounting Premium
Adapted Noncontrolling Interest:
a. $58,500
b. $32,000
c. $24,000
d. $18,500
Use the following facts for Multiple Choice problems 24-28.

AICPA
Assume that on January 1, 2009, a parent company acquired a 90% interest in a subsidiary’s voting common
Adapted stock. On the date of acquisition, the fair value of the subsidiary’s net assets equaled their reported book val-
ues. On January 1, 2011, the subsidiary purchased a building for $480,000. The building has a useful life of
10 years and is depreciated on a straight-line basis with no salvage value. On January 1, 2013, the subsidiary
sold the building to the parent for $420,000. The parent estimated that the building had an eight year remaining
straight-line method of amortization. The
useful life and no salvage value. The parent also uses the straight-0line parent’s
For the year ending
December 31, 2013, the parent's “stand-alone” income (i.e., net income before recording any adjustments related to pre-consolidation invest-
ment accounting) is $500,000. The subsidiary’s recorded net income is $100,000.

Sales�� $3,380,000 $876,000 Assets
Cost of goods sold�� (2,433,600) (525,600) Cash �� $ 684,595 $ 243,272
Gross profit�� 946,400 350,400 Accounts receivable �� 591,500 376,680
Equity income (partial)�� 50,355 Inventory�� 878,800 481,800
Operating expenses �� (507,000) (227,760) PPE, net�� 3,400,280 902,280
Net income �� $ 489,755 $122,640 Equity investment�� 451,593
$6,006,768 $2,004,032
BOY retained earnings �� $1,812,627 $197,100 Liabilities and stockholders’ equity
Net income �� 489,755 122,640 Accounts payable�� $ 341,380 $ 155,928
Dividends�� (98,408) (17,520) Other current liabilities�� 402,220 201,480
EOY retained earnings�� $2,203,974 $302,220 Long-term liabilities�� 1,500,000 1,100,000
Common stock�� 186,914 108,624
APIC �� 1,372,280 135,780
$6,006,768 $2,004,032
a. Disaggregate and document the activity for the 100% Acquisition Accounting Premium (AAP),
the controlling interest AAP and the noncontrolling interest AAP.
b. Calculate and organize the profits and losses on intercompany transactions and balances.
c. Compute the pre-consolidation Equity Investment account beginning and ending balances
starting with the stockholders’ equity of the subsidiary.
d. Reconstruct the activity in the parent’s pre-consolidation Equity Investment T-account for the
year of consolidation.
e. Independently compute the owners’ equity attributable to the noncontrolling interest beginning
and ending balances starting with the owners’ equity of the subsidiary.
f. Independently calculate consolidated net income, controlling interest net income and
noncontrolling interest net income.
g. Complete the consolidating entries according to the C-E-A-D-I sequence and complete the
consolidation worksheet.
53. Consolidation subsequent to date of acquisition—loss on upstream intercompany equipment LO2, 3
sale
A parent company acquired its 80% interest in its subsidiary on January 1, 2010. On the acquisition
date, the total fair value of the controlling interest and the noncontrolling interest was $600,000 in ex-
cess of the book value of the subsidiary’s Stockholders’ Equity. $300,000 of that excess was assigned
to a Patent. The Patent has a zero recorded book value in the subsidiary’s financial statements, and has
a 10 year remaining economic life on the date of acquisition. Amortization is computed on a straight-
line basis. The remaining $300,000 of the purchase price was assigned to Goodwill. The Goodwill is
allocated to the parent and subsidiary in a 80:20 split, respectively.
OnJanuary
On January1, 1, 2012,
2011, the parent sold Equipment to the subsidiary
the subsidiary parent for a cash price of $87,500. The
parent had acquired the equipment at a cost of $175,000 and depreciated the equipment over its 10-year
subsidiary
useful life using the straight-line method (no salvage value). The parent had
The subsidiary depreciated
had depreciatedthe
the equipment
equipment
parent
for 3 years at the time of sale. The subsidiary retained the depreciation policy of the parent andand
subsidiary depreci-
depreci-
ated the equipment over its remaining 7 year useful life.
Following are financial statements of the parent and its subsidiary for the year ended December 31,
2013. The parent uses the full equity method to account for its Equity Investment.

Sales�� $8,920,000 $2,548,000 Assets
Cost of goods sold�� (6,422,400) (1,528,800) Cash �� $ 119,696 $ 508,056
Gross profit�� 2,497,600 1,019,200 Accounts receivable �� 1,561,000 1,095,640
Equity income (partial)�� 257,376 Inventory�� 2,319,200 1,401,400
Operating expenses �� (1,338,000) (662,480) PPE, net�� 8,973,520 2,624,440
Net income �� $1,416,976 $ 356,720 Equity investment�� 1,671,962
$14,645,378 $5,629,536
BOY retained earnings �� $4,944,470 $ 573,300 Liabilities and stockholders’ equity
Net income �� 1,416,976 356,720 Accounts payable�� $ 900,920 $ 453,544
Dividends�� (293,264) (50,960) Other current liabilities�� 1,061,480 586,040
EOY retained earnings�� $6,068,182 $ 879,060 Long-term liabilities�� 2,500,000 3,000,000
Common stock�� 493,276 315,952
APIC �� 3,621,520 394,940
$14,645,378 $5,629,536
a. Disaggregate and document the activity for the 100% Acquisition Accounting Premium (AAP),
the controlling interest AAP and the noncontrolling interest AAP.
b. Calculate and organize the profits and losses on intercompany transactions and balances.
c. Compute the pre-consolidation Equity Investment account beginning and ending balances
starting with the stockholders’ equity of the subsidiary.
d. Reconstruct the activity in the parent’s pre-consolidation Equity Investment T-account for the
year of consolidation.
e. Independently compute the owners’ equity attributable to the noncontrolling interest beginning
and ending balances starting with the owners’ equity of the subsidiary.
f. Independently calculate consolidated net income, controlling interest net income and
noncontrolling interest net income.
g. Complete the consolidating entries according to the C-E-A-D-I sequence and complete the
consolidation worksheet.
LO2, 3 54. Comprehensive consolidation subsequent to date of acquisition, noncontrolling interest, AAP
computation, goodwill, upstream and downstream intercompany inventory profits, downstream
intercompany depreciable asset gain
A parent company acquired 70 percent of the stock of a subsidiary company on January 1, 2009, for
$150,000. On this date, the balances of the subsidiary’s stockholders' equity accounts were Common
Stock, $130,000, and Retained Earnings, $14,000. On January 1, 2009, the market value for the 30% of
shares not purchased by the parent was $63,800.
On January 1, 2009, the subsidiary’s recorded book values were equal to fair values for all items
except four: (1) accounts receivable had a book value of $40,000 and a fair value of $36,000, (2) build-
ings and equipment, net had a book value of $35,000 and a fair value of $53,000, (3) the Licenses intan-
gible asset had a book value of $10,000 and a fair value of $52,000, and (4) notes payable had a book
value of $24,000 and a fair value of $18,000. Both companies use the FIFO inventory method and sell
all of their inventories at least once per year. The net balance of trade receivables are collected in the
following year. On the acquisition date, the subsidiary’s buildings and equipment, net had a remaining
useful life of 6 years, Licenses had a remaining useful life of 7 years, and notes payable had a remaining
term of 4 years.
On January 1, 2012, the parent sold a building to the subsidiary for $65,000. On this date, the
building was carried on the subsidiary's
parent's books (net of accumulated depreciation) at $50,000. Both com-
panies estimated that the building has a remaining life of 6 years on the intercompany sale date, with no
salvage value.
Each company routinely sells merchandise to the other company, with a profit margin of 25 per-
cent of selling price (regardless of the direction of the sale). During 2013, intercompany sales amount to
Equity Investment account balance at January 1, 2013:
Jan. 1, 2013
$270,000 (1) 75% 3 ($195,000 1 $165,000)
Plus: 74,350 (2) $74,350 (from part b.)
Less: (22,500) (3) 100% 3 $22,500 (from part c.)
Less: (4,500) (4) 75% 3 $6,000 (from part c.)
$317,350
Equity Investment account balance at December 31, 2013:
Dec. 31, 2013

$281,250 (1) 75% 3 ($195,000 1 $180,000)
Plus: 72,250 (2) $74,350 (from part b.)
Less: (20,000) $20,000 (from part c.)
(3) 100% 3 $22,500
(8,000) (4) 100% 3 $8,000 (from part c.)
Less: 0 (4) none
$325,500
e. Full equity method Equity Investment accounting includes the following routine adjustments during
any given period: (1) recognition of p% of the subsidiary’s income, (2) amortization of the p% AAP,
(3) recognition of p% of the dividends declared by the subsidiary, (4) recognition of prior period
deferred intercompany profits that have been confirmed though either transactions with unaffiliated
parties or depreciation/amortization, and (5) deferral of intercompany profits newly originating during
the current period. With respect to the deferred intercompany profits, the effect on the Equity Invest-
ment account is 100% for downstream transactions and p% for upstream transactions. Information for
items (1) and (2) is available in the initial information, information for item (3) was summarized in
part b, and information for items (4) and (5) was summarized in part c. These items are all reflected
in the following completed T-account.
Equity Investment
January 1, 2013 317,350
(1) p% 3 net income of Sub. 5 75% 27,000 15,750 (2) p% 3 dividends of Sub. 5 75%
3 $36,000 3 $21,000
(4) p% 3 BOY upstream inventory 4,500 2,100 (3) p% AAP amortization
profits recognized during 2013 5 (see part b)
75% 3 $6,000
(4) 100% 3 downstream equipment 2,500 8,000 (5) 100% 3 EOY downstream
profits recognized via depreciation inventory profits deferred until year of
during 2013 sale to unaffiliated party
December 31, 2013 325,500
f. The following is the general formula for computing the noncontrolling interest in consolidated equity
at any point in time:
(1) nci% 3 book value of the net assets of the subsidiary

Plus: (2) Unamortized nci% AAP
Less: (3) nci% 3 upstream deferred intercompany profits
Full equity method Equity Investment account
The balance of noncontrolling interest in consolidated equity at January 1, 2013:
Jan. 1, 2013
$ 90,000 (1) 25% 3 ($195,000 1 $165,000)
Plus: 21,450 (2) $21,450 (from part b.)
Less: (1,500) (3) 25% 3 $6,000 (from part c.)
$109,950
The balance of noncontrolling interest in consolidated equity at December 31, 2013:
Jan. 1, 2013
$ 93,750 (1) 25% 3 ($195,000 1 $180,000)
Plus: 20,750 (2) $20,750 (from part b.)
Less: 0 (3) none at December 31, 2013 (from part c)
$114,500
g.
Incremental Computation of Consolidated Net Income for the Year Ended December 31, 2013
Parent’s stand-alone net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $36,000 ($59,900 2 $23,900)

Plus: 100% realized downstream deferred profits . . . . . . . . . . . . . . . . 2,500 (see part c)
Less: 100% unrealized downstream deferred profits . . . . . . . . . . . . . (8,000) (see part c)
Parent’s adjusted stand-alone net income . . . . . . . . . . . . . . . . . . . . . $30,500
Subsidiary’s stand-alone net income . . . . . . . . . . . . . . . . . . . . . . . . . . . $36,000 (see facts)
Plus: 100% realized upstream deferred profits . . . . . . . . . . . . . . . . . . 6,000 (see part c)
Less: 100% unrealized upstream deferred profits . . . . . . . . . . . . . . . . 0 (see part c)
Less: 100% AAP amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,800) (see part b)
Subsidiary’s adjusted stand-alone net income . . . . . . . . . . . . . . . . . $39,200
Consolidated net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $69,700
Incremental Computation of Consolidated Net Income Attributable to the Controlling Interest for the
Year Ended December 31, 2013
Parent’s stand-alone net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $36,000 ($59,900 2 $23,900)

Plus: 100% realized downstream deferred profits . . . . . . . . . . . . . . . . 2,500 (see part c)
Less: 100% unrealized downstream deferred profits . . . . . . . . . . . . . (8,000) (see part c)
Parent’s adjusted stand-alone net income . . . . . . . . . . . . . . . . . . . . . $30,500
75% 3 subsidiary’s stand-alone net income (75% 3 $36,000) . . . . . . . $27,000 (see facts)
Plus: 75% realized upstream deferred profits (75% 3 $6,000) . . . . . . 4,500 (see part c)
Less: 75% AAP amortization (from schedule) . . . . . . . . . . . . . . . . . . . (2,100) (see part b)
75% of the Subsidiary’s adjusted stand-alone net income . . . . . . . . $29,400
Consolidated net income attributable to the controlling interest . . . $59,900
Incremental Computation of Consolidated Net Income Attributable to the Noncontrolling Interest for
the Year Ended December 31, 2013
25% 3 subsidiary’s stand-alone net income (25% 3 $36,000) . . . . . . . . . . $9,000 (see facts)
Plus: 25% realized upstream deferred profits (25% 3 $6,000) . . . . . . . . . 1,500 (see part c)
Less: 25% AAP amortization (from schedule) . . . . . . . . . . . . . . . . . . . . . . 0 (see part c)
Less: 25% AAP amortization (from schedule) . . . . . . . . . . . . . . . . . . . . . . (700) (see part b)
Consolidated net income attributable to the noncontrolling interest . . $9,800
Chapter 6 | Consolidation of Variable Interest Entities and Other Intercompany Investments 319
Exhibit 6.2 Comprehensive Consolidation Model in FASB ASC 810
No ❶ Does the company have a variable

Do not consolidate
interest in the legal entity?
Yes
Yes Apply other GAAP

❷ Does a general scope exception
apply? (not FASB ASC 810)
No
❸ Does the business-related scope

Yes exception apply?
No
❹ Is the legal entity a Variable Interest Entity?
No Yes
❺ Does the company own ❻ Is the company the

(either directly or indirectly)
primary beneficiary of the
more than 50% of the voting
Variable Interest Entity?
shares of the entity?
Yes No Yes No
Consolidate Do not consolidate Consolidate Do not consolidate
departments, branches, and pools of assets.11 Further, it is applied to majority-owned subsidiaries of

other reporting entities that are legal entities separate from their parents.
Step ❶ also suggests that the consolidation model in ASC 810 (and that we discuss in preceding
chapters) is only applied if the reporting company holds a variable interest in the legal entity. This
step explicitly includes voting common stock as a variable interest. If we look ahead to Step ❺ ❻, you’ll
notice that the voting common stock variable interest can actually result in evaluation for consolidation
via the evaluation of majority voting interest.
General Scope Exceptions to the Comprehensive Consolidation

Model in FASB ASC 810 As soon as we know we are evaluating a legal entity for
consolidation on the basis of its variable interests, we proceed to Step ❷ in which FASB ASC 810
provides numerous scope exceptions that might preclude application of its consolidation guidance.
For example, the following entities/arrangements are considered outside the scope of FASB ASC 810:
11
One possible exception to this general restriction relates to “silos” within VIEs. FASB ASC 810-10-25-57 and -58
describe a silo as specified assets of a VIE that are essentially the only source of payment for specified liabilities or speci-
fied other interests. In certain cases, silos can be separately evaluated as VIEs. Note that this really isn’t an exception
whole-legal-entity requirement because silos are only separately evaluated as VIEs if the overall legal entity holding the
“siloed” asset has been determined to be, in its entirety, a VIE.
Chapter 6 | Consolidation of Variable Interest Entities and Other Intercompany Investments 351
a. Assume that Reporting Company B borrowed from an unaffiliated bank $40,000 of its $56,000
capital contribution. What is the maximum amount of expected losses that the Legal Entity can
expect to sustain without being considered a variable interest entity (VIE)? Why?
b. Assume that the Chairman of the Board of Directors of Reporting Entity A paid $40,000 to
Reporting Company B for consulting services. What is the maximum amount of expected
losses that the Legal Entity can expect to sustain without being considered a variable interest
entity (VIE)? Why?
47. Determination of whether a legal entity is a variable interest entity LO1
Assume a Legal Entity’s capital structure consists of the following accounts:
General partner capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40,000

Limited partner capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 360,000
Total capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $400,000
A Reporting Company is the sole general partner of the Legal Entity. The limited partnership capi-
tal was contributed by unaffiliated individual investors recruited by a regional boutique investment
bank. The Reporting Company is paid a $30,000 management fee. The limited partners expect the
partnership to be highly successful over the next five years. The investment bank estimated that the
distribution of income to these investors should be at least $50,000 during that time period. What is
the maximum amount of expected losses that the Legal Entity can expect to sustain without being
considered a variable interest entity (VIE)? Why?
Assume that a limited partnership is formed to perform research and development. The general part-
ner acquires a 1% interest in the limited partnership, and its investment is considered an equity
investment at risk. The 99% limited partner interests are also considered substantive at-risk equity.
As is customary in a limited partnership, the general partner makes day-to-day decisions about the
activities of the limited partnership that most significantly impact the entity’s economic performance.
The limited partners have only protective rights, and do not have the ability to make decisions about
the activities of an entity that most significantly impact the entity’s economic performance. There are
no other variable interest holders in the partnership (e.g., a lender) that have participating rights. As-
sume that the equity at risk is sufficient to absorb all expected future losses. Is the limited partnership
a variable interest entity (VIE) on the basis of the power test? Explain your answer.
Assume that a Legal Entity owns and operates a real estate development and property management
company. The decisions that significantly impact the performance of the Legal Entity include mak-
ing capital investments, such as incurring capital expenditure for new developments to continue to
attract tenants. The Legal Entity typically funds it capital investments via a mix of equity and debt
financing. However, all capital investment decisions involving new property developments need the
lender’s approval (one party). There are no other variable interest holders in the Legal Entity (e.g.,
a lender) that have participating rights. Assume that the equity at risk is sufficient to absorb all ex-
pected future losses of the partnership. Is the limited partnership a variable interest entity (VIE) on
the basis of the power test? Explain your answer.
Assume that a limited partnership is formed to perform research and development. None of the part-
nership interests have voting rights, but one partner, a pharmaceutical company, makes all significant
decisions for the partnership under the terms of a service agreement entered into at inception of the
entity. The pharmaceutical company isisnot requiredtotohave
required have aa substantive equity investment at risk as
long as it provides services pursuant to the service agreement. Assume the service agreement is a
variable interest. There are no other variable interest holders in the partnership (e.g., a lender) that
have participating rights. Assume that the equity at risk is sufficient to absorb all expected future
losses of the partnership. Is the limited partnership a variable interest entity (VIE) on the basis of the
power test? Explain your answer.
374 Chapter 7 | Accounting for Foreign Currency Transactions and Derivatives
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195,000
Accounts payable (d150,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195,000
(to record the purchase of inventories for €150,000 when the exchange rate is
$1.30:€1)
The inventories are recorded at their $US equivalent of $195,000 (10,000 units 3 €15/unit 3 $1.30/€).
The payable is also recorded at the $US equivalent of $195,000; however, it is important to understand
that this $US recorded value is only an approximation of the $US amount we expect to pay to settle
the €150,000 account payable. The account payable never actually becomes a payable denominated
in $US; it’s just that our accounting system can only record transactions in one currency (i.e., in this
case, $US).
The fundamental principle underlying foreign-currency-denominated transactions (i.e. FASB ASC
830-20-35) is that any foreign-currency-denominated receivables or payables must be remeasured to
the current spot rate on each balance sheet date and on the settlement date. On December 31, 2012,
our company issues its financial statements, and the assumed exchange rate is now $1.40:€1. If we
were to make payment on that date, our company would have to sell $210,000 (€150,000 3 $1.40/€)
to purchase the €150,000 required for payment. As a result our company’s cash flow would be reduced
by $15,000 ($210,000 2 $195,000) at current exchange rates. We are required to accrue this estimated
transaction loss of $15,000 on the December 31, 2012, balance sheet date.4 This is accomplished with
the following journal entry:
Foreign currency transaction loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000

Accounts payable (C150,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000
(to record the increase in accounts payable due to a decline in the $US from
$1.30:€1 to $1.40:€1)
The account payable is now correctly reported on our balance sheet at its current $US-equivalent value
of $210,000 and the increase in the recorded liability is reflected as a foreign currency transaction loss
in our income statement for the period ended December 31, 2012.
Now, assume that on February 15, 2013 (i.e., the date payment is made), the $US further declines
in value to $1.45:€1. The journal entry to record the payment is as follows:
Accounts payable (C150,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210,000

Foreign currency transaction loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,500
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217,5005
(to record the payment of €150,000 when the exchange rate is $1.45:€1)
To settle its €150,000 liability, our company must sell $217,500 to purchase Euros. Because the
account payable is reported at $210,000 on the payment date, we must recognize the additional liability
as a foreign exchange transaction loss.
4
FASB ASC 830-20-25-1 prescribes that “At the date a foreign currency transaction is recognized, each asset, liability,
revenue, expense, gain, or loss arising from the transaction shall be recorded in the functional currency of the recording
entity.” And FASB ASC 830-25-35-1 recognizes a subsequent change from the initial recognized amount in income:
“A change in exchange rates between the functional currency and the currency in which a transaction is denominated
increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction. That
increase or decrease in expected functional currency cash flows is a foreign currency transaction gain or loss that gener-
ally shall be included in determining net income for the period in which the exchange rate changes.”
5
To simplify exposition we credit the cash account. In practice, we would first have the intermediate step to acquire the
Euros:
Investment in euros . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217,500
202,500
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217,500
202,500
and, then, record the settlement of the payable:
Accounts
Accounts payable
payable ((C150,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . 210,000
€ 150,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210,000
Foreign currency transaction gain . . . . . . . . . . . . . . . .
Foreign currency transaction loss . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . 7,500 7,500
Investment in euros . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202,500
Investment in euros . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217,500
continued
Practice Insight
the simplicity of this method and its obvious financial benefits, the FASB has set strict requirement
for its use. These requirements are detailed in ASC 815-20-25-104 to 106 and include three core
requirements:
a. Interest rate risk must be the only risk identified as the hedged risk.
b. The hedging instrument involves an interest rate swap
c. The hedge must involve a recognized interest-bearing financial asset or liability.
The critical terms match approach. If the critical terms of the hedging instrument and of the entire
hedged asset or liability or hedged forecasted transaction are the same, the entity could conclude
that changes in fair value or cash flows attributable to the risk being hedged are expected to com-
pletely offset at inception and on an ongoing basis. Critical terms can be assumed to match if
1) The forward contract is for purchase of the same quantity of the same commodity at the same
time and location as the hedged forecasted purchase.
2) The fair value of the forward contract at inception is zero.
3) Either of the following criteria is met:
a) The change in the discount or premium on the forward contract is excluded from the
assessment of effectiveness and included directly in earnings
b) The change in expected cash flows on the forecasted transaction is based on the forward
price for the commodity. (FASB ASC 815-20-25-84)
In this abbreviated method, the entity may forego performing a detailed effectiveness assessment
in each period.
The FASB provides a number of examples of the determination of hedge effectiveness in ASC 815-
25-55 and 815-30-55.
■■ Documentation and ongoing effectiveness assessment. In order to qualify for the special hedge
accounting, there must be formal documentation of the hedged item (or hedgeable risk), the hedging
instrument, and how effectiveness will be assessed and how ineffectiveness will be measured.
The formal documentation must be made with enough specificity and clarity that an independent
third party could understand and identity
identify the hedging relationship and re-perform the effectiveness
tests and measurement of ineffectiveness. All documentation must be contemporaneous—that is
the documentation must be completed at the time the hedge is created. The following items must
be documented:
❍❍ The risk management objective and strategy
❏❏ The nature of the risk being hedged
❏❏ How the hedging instrument (derivative) is expected to reduce the risk exposure
❍❍ The hedging relationship
❏❏ Hedged risk, hedged item, and hedging instrument
❍❍ How effectiveness will be assessed and the method to measure ineffectiveness
Exhibit 7.1 presents a graphical depiction of questions that must be answered in order for an
investment in a financial derivative to be qualified for hedge accounting. If the conditions for hedge
accounting are met, a derivative may be designated as a fair value hedge, a cash flow hedge, or a
hedge of a foreign currency exposure and hedge accounting can be employed.9 Note that application
of hedge accounting does not change the fundamental requirement in ASC 815: All derivatives must
always be measured and reported in the balance sheet at fair value at every interim and annual
financial statement date. Instead, hedge accounting is a system of recognition and measurement that
minimizes the net income volatility of mark-to-market accounting for derivatives. We now discuss the
application of hedge accounting for derivatives.
9
FASB ASC 815-20-25-43 prohibits hedge accounting for the following (partial list): (1) an investment accounted for by
the equity method, (2) an equity investment in a consolidated subsidiary, (3) a held-to-maturity security, (4) the risk of
changes in its fair value attributable to interest rate risk, and (5) an asset or liability that is remeasured with the changes
in fair value attributable to the hedged risk reported currently in earnings.
Problems
LO2 26.B Use of futures contracts to hedge cotton inventory—fair value hedge
On December 1, 2012, a cotton wholesaler purchases 10 million pounds of cotton inventory at an average
cost of 37 cents per pound. To protect the inventory from a possible decline in cotton prices, the company
sells cotton futures contracts for 10 million pounds at 67 cents a pound for delivery on June 1, 2013, to
coincide with its expected physical sale of its cotton inventory. The company designates the hedge as a
fair value hedge (i.e., the company is hedging changes in the inventory’s fair value, not changes in cash
flows from anticipated sales). The cotton spot price on December 1 is 75 cents per pound.
On December 31, 2012, the company’s fiscal year-end, the June cotton futures price has fallen
to 57 cents a pound, and the spot price has fallen to 66 cents a pound. On June 1, 2013, the company
closes out its futures contracts by entering into an offsetting contract in which it agrees to buy June
2013 cotton futures contracts at 48 cents a pound, the spot rate on that date. Finally, the company sells
its cotton for $0.48 per pound on June 1, 2013.
Following are futures and spot prices for the relevant dates:
Date Spot Futures
December 1, 2012�� 75¢ 67¢

December 31, 2012�� 66¢ 57¢
June 1, 2013�� 48¢ n/a
Required
Prepare the journal entries to record the following:
a. Purchase of cotton
b. Sale of cotton futures contract
c. Adjusting entry at December 31
d. Sale of cotton on June 1
LO2 27.B Use of futures contracts to hedge a forecasted transaction—cash flow hedge
As of January, our company plans to purchase 100,000 lbs. of copper on May 31 at the prevailing spot
rate. To hedge this forecasted transaction, we purchase May futures contracts in January for 100,000
lbs. of copper at the futures price of $1.57/lb. On May 31, we close out our futures contracts by enter-
ing into an offsetting contract in which we agree to buy 100,000 lbs. of May copper futures contracts at
$1.83/lb., the spot rate on that date. We also purchase 100,000 lbs. of copper at $1.83/lb. on that date.
Finally, we sell the inventory in June for $2.05/lb. Our company operates on a calendar year and issues
financial statements quarterly.
Following are futures and spot prices for the relevant dates:
Date Spot Futures
January�� $1.43 $1.57

March 31�� $1.51 $1.66
May 31,
June 2013
1, 2013�� $1.83 n/a
Required
a. Purchase of copper futures contract in January
b. Adjusting entry at March 31
c. Purchase of copper on May 31
d. Sale of copper on June 1
LO2 33. Use of futures contracts to hedge a receivable denominated in a foreign currency—fair value
hedge
In May, our company sells $675,000 of inventory to a customer in France. The customer demands that
the invoice be stated in Euros (€). The exchange rate on the date of sale is $1.35:€1. Accordingly, the
invoice is written for €500,000, and payment is due in 60 90 days. Our company feels that the $US has
been over-sold and is likely to rebound during the next 90 days, thus lowering the $US equivalent of the
receivable. The current futures price for 90-day delivery of $1.30 reflects our view. Since we feel that
the $US is likely to strengthen even more, we purchase a forward contract to sell Euros at $1.30 after 90
days. When the receivable is collected in 90 days, the exchange rate at that date is $1.27: €1.
Assume the following data relating to the spot and forward rates for the $US vis-à-vis the Euro:
Spot Rate Forward Rate
May�� $1.35:€1 $1.30:€1

June 30�� $1.30:€1 $1.28:€1
July �� $1.27:€1 n/a
Required
a. Account receivable and sale (ignore cost of goods sold)
b. Adjusting entries on June 30
c. Collection of the account receivable in July
LO2 34. Use of forward exchange contracts to hedge a firm commitment to pay foreign currency
On September 30, our company has executed a purchase order for new equipment to be purchased from a
supplier
supplier in
in Germany for aa purchase
Germany for purchase price
price of
of €5 million.The
€5 million. Theterms
equipment
of theispurchase
deliverable onmeet
order Marchthe31. In or-of
criteria
Underline indicates der to hedge the commitment
an unrecognized to pay The
firm commitment. €5 million,
equipment we enter into a forward
is deliverable exchange
and payment contract on
is required on September
March 31. In
change made. 30 to receive
order to hedge million
€5the on June 30
commitment to at
payan€5
exchange rateenter
million, we of $0.72:€1.
into a forward exchange contract on September
30 toAssume
receive the following
€5 million exchange
on March rates:
31 at an exchange rate of $0.72:€1.
Assume the following exchange rates:
Date Spot Rates March 31, 2013

June 30,
September 30 �� $0.65:€1 $0.72:€1

December 31 �� $0.66:€1 $0.71:€1
March 31, 2013 �� $0.69:€1 n/a
Required
a. Execution of the purchase order and forward contract
b. Adjusting entries at December 31
c. Receipt of equipment and payment to equipment supplier on March 31
LO2 35.B Use of a forward-exchange contract to hedge the foreign-currency fair value risk of an
available-for-sale security
On September 30, our company purchases a foreign-currency-denominated debt security for €100,000.
The security is classified as available-for-sale (AFS). We decide to hedge the risk of the currency fluc-
tuations of this available-for-sale security over the next three months and enter into a forward contract
to sell €100,000 on December 31, at an exchange contract rate of €1 5 $1.49.
Assume the following exchange rates:
Forward Exchange Rate Fair Value of

Spot Exchange Rate to 12/31/13 AFS Security
September 30 . . . . . . . . . . . . . . . €1 5 U.S. $1.50 €1 5 U.S. $1.49 €100,000

December 31 . . . . . . . . . . . . . . . . €1 5 U.S. $1.30 €1 5 U.S. $1.30 €110,000
434 Chapter 8 | Consolidation of Foreign Subsidiaries
Exhibit 8.10 Financial Data of Foreign Subsidiary in Remeasurement Example

Year Ended December 31, 2011 2012 Year Ended December 31, 2011 2012
Beginning inventory�� € 310,417 € 372,500 Statement of retained earnings:

Purchases�� 812,083 974,500 BOY retained earnings �� € 630,000 € 787,500
Ending inventory�� (372,500) (447,000) Net income �� 175,000 210,000
Cost of goods sold�� € 750,000 € 900,000 Dividends�� (17,500) (21,000)
Ending retained earnings�� € 787,500 € 976,500

Land �� € 326,800 € 326,800
Building�� 360,000 360,000
Accum. deprec.—building�� (30,000) (60,000)
Equipment�� 280,000 280,000 Balance sheet:
Accum. deprec.—equipment �� (40,000) (80,000) Assets
Property, plant and equipment (PPE), net�� € 896,800 € 826,800 Cash �� € 159,200 € 426,900
Accounts receivable �� 290,000 348,000
Inventory�� 372,500 447,000
Depreciation expense—building�� € 30,000 € 30,000
Property, plant and
Depreciation expense—equipment�� 40,000 40,000
equipment (PPE), net�� 896,800 826,800
Depreciation expense�� € 70,000 € 70,000
Total assets�� €1,718,500 €2,048,700
Income statement:
Sales�� €1,250,000 €1,500,000
Cost of goods sold�� (750,000) (900,000)
Current liabilities�� € 212,000 € 254,400
Gross profit�� 500,000 600,000 Long-term liabilities �� 494,000 592,800
Operating expenses �� (255,000) (320,000) Common stock�� 100,000 100,000
Depreciation �� (70,000) (70,000) APIC �� 125,000 125,000
Retained earnings�� 787,500 976,500
Net income �� € 175,000 € 210,000 Total liabilities and equity �� €1,718,500 €2,048,700
Financial data for the subsidiary for the two most recent years (in Euros) is provided in Exhibit
8.10. The subsidiary’s net monetary assets (i.e., monetary assets less monetary liabilities) at December
31, 2011 and 2012 are as follows:
Net Monetary Assets Dec. 31, 2011 Dec. 31, 2012
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . € 159,200 € 426,900

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290,000 348,000
Current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (212,000) (254,400)
Long-term liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (494,000) (592,800)
€(256,800) € (72,300)
As is typical of many companies, while our subsidiary reports a positive net asset position (see earlier
example), it also reports a negative net monetary position. This is because monetary liabilities are usually
greater than monetary assets, primarily because of the inclusion of long-term debt as a monetary liabil-
ity. As a result, when the $US weakens, as it does in this example, remeasurement losses result. This is
analogous to the losses that result from a foreign-currency-denominated account payable or long-term
debt when the $US weakens (see Chapter 6).
The remeasurement of our subsidiary from Euros to $US is provided in Exhibit 8.11. Remeasure-
ment of our subsidiary’s Euro-denominated financial statements into the $US functional currency for
the years ended December 31, 2011 and 2012 involves the following steps. These steps are conceptu-
ally similar to the steps we applied in our translation example.
1. Remeasurement
Translation usingusing exchange
exchange rates: rates:
■■ Monetary assets (cash and accounts receivable) and monetary liabilities (current liabilities
and long-term debt) are remeasured at the EOY exchange rate.
■■ Nonmonetary assets are remeasured at the exchange rates in effect when those assets were
purchased.
■■ Common Stock and APIC are remeasured at the exchange rate in effect when the stock was
purchased by the parent.
484 Chapter 9 | Government Accounting: Fund-Based Financial Statements
revenue until collected in the subsequent fiscal year. In this case, the taxes levied would be recognized
as deferred revenue in the current year.
The entry to recognize property tax revenue for the portion that is expected to be collected within
60 days and to defer revenue recognition for the remaining amount is as follows:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxx

Property tax revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxx
Deferred revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxx
(to recognize revenues for the portion of taxes receivable expected to be
collected within 60 days from the end of the fiscal year and to defer revenue
recognition for the remaining amount)
Deferred revenues are recognized as revenue in the subsequent year when collected with a debit to
Deferred Revenues and a credit to Property Tax Revenues for the amount of revenue recognized.
Revenue Recognition in the Presence of Eligibility Requirements

for Grants and Other Subsidies Local governments often receive aid from the state
or federal government in the form of grants and other subsidies. These grants often contain conditions
that must be met in order for the local government to use the funds. Following are typical conditions:
a. Required characteristics of recipients. The recipient has the characteristics specified by the pro-
vider (state grants to be used only in support of school districts would be an example).
b. Time requirements. Time requirements specified by enabling legislation or the provider have been
met (such as the period during which the resources are required to be used).
c. Reimbursements. The provider offers resources on a reimbursement (“expenditure-driven”) basis
and the recipient has incurred allowable costs under the applicable program.
d. Contingencies (applies only to voluntary nonexchange transactions). The provider’s offer of
resources is contingent upon a specified action of the recipient and that action has occurred (for
example, the recipient is required to raise a specific amount of resources from third parties or to
dedicate its own resources for a specified purpose and has complied with those requirements).
Governments recognize receivables (or a decrease in liabilities) and revenues (net of estimated uncol-
lectible amounts), when all applicable eligibility requirements, including time requirements, are met.
Resources received before the eligibility requirements are met should be reported as deferred revenues
(GASB ASC N50.117-.118).
Revenue and Expense Recognition for Proprietary and Fiduciary

Funds Proprietary (business-type activities) and Fiduciary (trust) Funds are accounted for differ-
ently from the Governmental Fund that we describe above. Revenues and expenses for Proprietary and
Fiduciary Funds should be recognized on the accrual basis (i.e., revenues should be recognized in the
accounting period in which they are earned and become measurable; expenses should be recognized in
the period incurred, if measurable).4 We discuss the measurement focus of Proprietary and Fiduciary
Funds later in the chapter.
Summary of Fund Types, Accounting Approaches, and Required

Financial Statements
Exhibit 9.3 provides a summary of the types of Funds, the accounting approach utilized for each, and
the required financial statements (GASB 34, Table B-2). We provide examples of each of these financial
statements later in the chapter.
4
The Statement of Net Assets (Proprietary Funds) and the Statement of Fiduciary Net
Net Position Assets (Fiduciary Funds) are prepared
Net Position
using the economic resources measurement focus. “Economic resources” are broader than the “Financial Resources” measure-
ment focus that we use in the preparation of the Governmental Funds financial statements. The economic resources measure-
ment focus includes long-term assets and liabilities as well as current financial resources. We discuss the economic resources
measurement focus in our discussion of Proprietary and Fiduciary Funds, later in this chapter, and in more depth in Chapter 10
in our discussion of government-wide financial statements.
Chapter 9 | Government Accounting: Fund-Based Financial Statements 485
Exhibit 9.3 Summary of Fund Types, Accounting Approaches, and Required Financial Statements
General Measurement Focus and Basic Financial
Fund Type Specific Fund Types Basis of Accounting Statements
Governmental general current financial resources balance sheet

special revenue measurement focus statement of revenues, expenditures,
capital projects modified accrual basis of accounting and changes in fund balances
debt service
permanent
Proprietary enterprise economic resources measurement focus statement of
statement ofnet
netposition
assets or balance
internal service accrual basis of accounting sheet
statement of revenues, expenses, and
changes ininfund
changes fundnet
netposition
assets or fund
equity
statement of cash flows
Fiduciary pension (and other employee economic resources measurement focus statement of fiduciary net assets
position
benefit) trust funds accrual basis of accounting statement of changes in fiduciary net
investment trust funds position
assets
private-purpose trust funds
agency funds
We now turn to a discussion of the mechanics of fund accounting.
Fund Accounting Journal Entries

Fund accounting focuses on the sources and uses of current financial resources. Its primary objective L O 4 Describe fund
is to insure that managers do not overspend the monies that have been appropriated by the taxpayers, accounting journal
entries
and its focus is on current financial resources. The focus on current financial resources means, for
example, that we will record the purchase of PPE as an “expenditure” (essentially, cash-out) rather
than as an asset like we would in the corporate world, and we will recognize the proceeds of long-term
debt as Other Financing Sources (cash-in) rather than as a long-term liability. The omission of long-
term assets and liabilities limits the usefulness of fund financial statements for the evaluation of the
solvency of the governmental body and, thus, provides some of the impetus for the government-wide
financial statements that we discuss in Chapter 10.
We begin our discussion of fund accounting with the initial journal entry to record the current
year’s budget, the first entry of the fiscal year.
Budget Entry In its FY2011 Town meeting, the Town of Acton residents approved total appro-
priations in the General Fund amounting to $79,589,189 (to simplify the exposition, we assume that
budgeted amounts are equal to those reported in the town’s financial statements that we reproduce later
in the chapter). This dollar amount was the result of a long and, sometimes contentious, process of public
hearings. The process began with an estimate of the total amount of funds that the Town would receive
from the state and federal governments in the form of grants and subsidies, interest income and depart-
mental income from fees. Then, Town administrators faced the daunting task of determining simultane-
ously how much would be spent on municipal services, like public safety and education, and how much
would have to be raised in the form of taxes on Town residents. Although much of the municipal and
education expenditures budget is fixed (e.g., salaries and benefits), discretionary expenditures are typi-
cally met with strong opposition from overburdened taxpayers.
The final budget appropriated $79,589,189 for municipal and education expenditures, employee
benefits, debt service and capital outlays. To fund these projected outflows, the Town estimated that it
would receive $65,003,456 in taxes on real estate, $2,702,506 in taxes on automobiles, $11,450,403 in
grants from the State of Massachusetts, and miscellaneous other inflows of $1,948,944. These receipts,
together with an estimated $442,785 in inflows from Other Financing Sources, would result in an
estimated budget surplus of $1,958,905. This budgeted surplus would increase the General Fund from
a balance of $10,293,477 at the beginning of the year to $12,252,382 at year-end.
Fund Financial Statements

L O5 Describe the The pre-closing trial balance reflects all of the journal entries that we discuss above. We then use this
preparation of fund to prepare the fund financial statements in the same way that we use the pre-closing trial balance to
financial statements
prepare the income statement and balance sheet for a corporation.
We prepare a different set of financial statements for each type of Fund (GASB ASC 2200.105b):
1. Governmental funds
a. Balance sheet
b. Statement of revenues, expenditures, and changes in fund balances
2. Proprietary funds
position
a. Statement of net assets
position
b. Statement of revenues, expenses, and changes in fund net assets
c. Statement of cash flows
3. Fiduciary funds (and component units that are fiduciary in nature)
position
a. Statement of fiduciary net assets
b. Statement of changes in fiduciary net assets
position
In addition to differences in the required financial statements by fund category, it is also important to
keep in mind that these financial statements are also prepared using a different measurement focus as
we discuss above and in subsequent sections of this chapter:
■■ Government Funds are prepared using current financial resources measurement focus and the
modified accrual basis of accounting,
■■ Proprietary and Fiduciary Funds are prepared using the economic resources measurement
focus and the accrual basis of accounting.
We now present and discuss the financial statements for each of the general fund types listed above.
Financial Statements for Governmental Funds

We present the fiscal year 2011 Balance Sheet for the Town of Acton in Exhibit 9.4. Fund financial
statements should present the financial information of each major fund in a separate column. Nonma-
jor funds should be aggregated and displayed in a single column. The reporting government’s main
operating fund (i.e., the general fund) should always be reported as a major fund. Other funds are
designated as major funds, and reported in separate columns in the fund financial statements, if the
following requirements are met:
a. Total assets, liabilities, revenues, or expenditures/expenses are at least 10% of the corresponding
total for all funds of the fund’s type (i.e., a specific enterprise fund whose total assets are greater
than 10% of the total assets of all enterprise funds), and
b. Total assets, liabilities, revenues, or expenditures/expenses of the individual governmental fund or
enterprise fund are at least 5% of the corresponding total for all governmental and enterprise funds
combined (i.e., a governmental fund whose total assets are greater than 5% of the total assets for
all governmental and enterprise funds combined) (GASB 34, ¶76).18
The Town of Acton reports two major funds: the General Fund and the Community Preservation Fund
(a special revenue fund used to account for the accumulation of resources to purchase open space,
provide for affordable housing, or preservation of historical property under the guidelines of the Com-
munity Preservation Act of the Massachusetts General Laws). All other funds are aggregated in the
Nonmajor Funds columns because they do not meet the size tests referenced above.
Receivables include taxes on real estate and personal property, together with penalties and interest
on delinquent taxes. The Town takes the position that delinquent taxes are fully collectible since they
are secured by liens on the related real estate and prior experience does not reveal collection losses.
18
Governments may also report a fund as a major fund, even if it does not meet these financial thresholds, if the fund is deemed
to be important because of public interest or consistency with prior fund financial statements.
The footnotes to the financial statements of the Town of Acton describe the Enterprise Funds as follows:
Proprietary Funds. The Town of Acton, Massachusetts maintains three proprietary (enterprise)
fund types. Enterprise funds are used to report the same functions presented as business-type
activities in the government-wide financial statements. The Town of Acton, Massachusetts uses
enterprise funds to account for its sanitation, nursing services and sewer operations.
Proprietary funds provide the same type of information as the government-wide financial
statements, only in more detail. The proprietary fund financial statements provide separate infor-
mation for each enterprise fund. All three funds are considered to be major funds of the Town of
Acton, Massachusetts.
Financial Statements for Proprietary Funds The financial statements for Proprietary Funds
include the following:
■■ Statement of Net Assets
Position
1919
■■ Statement of Revenues, Expenses, and Changes in Fund Net Assets
Position
■■ Statement of Cash Flows
These financial statements are similar to those for commercial enterprises in their use of accrual basis
accounting and the presentation of a Statement of Cash Flows, and are similar to those prepared for
position.
governmental funds in their reference to net assets.
The Statement of Net Assets reports assets in order of liquidity and liabilities in order of maturity
Net Position
like the balance sheet for a business. Since a government does not have shareholders, we replace Stock-
holders’ Equity with Net
NetPosition.
Assets. This section is divided into Net Assets Invested in Capital Assets, net
of related debt, Restricted, and Unrestricted. We discuss these components in Chapter 10 as this is the
reporting of Net Assets that is required for the Government-Wide Statement of Net Assets.
Net Position Position.
The Statement of Revenues, Expenses, and Changes in Fund Net Assets is similar to the income
Net Position
statement that businesses report. Revenues and expenses are recognized on the accrual basis, includ-
ing depreciation of the long-term depreciable assets. Finally, the Statement of Cash Flows is prepared
similarly to that which we use for businesses.
Accounting for Proprietary Funds The basis of accounting for Enterprise Funds is different from
that used for Governmental Funds. The business-like activities of Proprietary Funds are accounted for
using the economic resources measurement focus and the accrual basis of accounting (GASB ASC
1300.102b). “Economic resources” are broader than the “Financial Resources” measurement focus that
we use in the preparation of the Governmental Funds financial statements. The economic resources
measurement focus includes long-term assets and liabilities as well as current financial resources. And,
under the accrual accounting that we use for Proprietary Funds, we recognize revenues when earned
(and expenses when incurred), not just when they are available to finance current period expenditures,
the criterion we use to recognize revenues for governmental fund financial statements.
We use the Town of Acton’s Sewer Enterprise Fund to illustrate the typical journal entries for a
Proprietary Fund (the entries correspond with the fund financial statements which we present in the
next section).
1. To record the sale of sewer services to residents and to other departments of the Town of
Acton.
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,387,686

Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,387,686
19
Notice the use of the word expenses in place of expenditures to reflect the use of accrual accounting.
Notice also that the "Net Assets" referenced in the Town of Acton's 2011 financial statements is now called "Net Position."
Exhibit 9.6 Statement of Net Assets for the Town of Acton Proprietary Funds
Town of Acton, Massachusetts
Proprietary Funds
Statement of Net Assets
June 30, 2011
Sanitation Sewer Nursing Total
Assets
Current:
Cash and cash investments�� $3,590,926 $ 4,174,109 $141,197 $ 7,906,232
Accounts receivable, net of allowance for uncollectibles:
User charges �� — 92,658 65,724 158,382
Special assessments�� — 714,088 — 714,088
Tax liens�� — 59,452 — 59,452
Noncurrent:
Accounts receivable:
Deferred special assessments�� — 14,721,932 — 14,721,932
Other post employment benefit net asset�� 2,454 — — 2,454
Assets not being depreciated �� 435,300 99,469 — 534,769
Assets being depreciated, net�� 609,530 19,137,282 — 19,746,812
Total assets�� 4,638,210 38,998,990 206,921 43,844,121
Liabilities
Current:
Warrants payable�� 1,400 38,827 5,433 45,660
Accrued wages payable �� 4,970 2,278 13,916 21,164
Unearned income �� — 90,811 — 90,811
Accrued interest payable�� — 133,379 — 133,379
Bonds payable�� — 734,600 — 734,600
Noncurrent:
Bonds payable�� — 18,312,800 — 18,312,800
Compensated absences�� 6,198 1,394 19,105 26,697
Other post-employment benefit obligations �� — 39,830 96,948 136,778
Total liabilities �� 12,568 19,353,919 135,402 19,501,889
Net assets
Invested in capital assets, net of related debt�� 1,044,830 349,125 — 1,393,955
Restricted for:
Debt service�� — 17,830,622 — 17,830,622
Unrestricted�� 3,580,812 1,465,324 71,519 5,117,655
Total net assets�� $4,625,642 $19,645,071 $ 71,519 $24,342,232
Financial Statements for Fiduciary Funds The financial statements for Fiduciary Funds include
the following:
Position
■■ Statement of Fiduciary Net Assets
■■ Statement of Changes in Fiduciary Fund Net Assets
Position
The Statement of Fiduciary Net Net Position

Assets reports the Assets, Liabilities and Net
Net Position Assets by fund
type. The Statement of Changes in Fiduciary Fund Net Assets is prepared using the accrual basis of
Net Position
accounting. The terms “Additions” and “Deductions” are used in place of revenues and expenses, and
the activities of Agency Funds are not included in this statement.
b. Internal service funds—to report any activity that provides goods or services to other funds,
departments, or agencies of the primary government and its component units, or to other
governments, on a cost-reimbursement basis.
5. Fiduciary Funds are used to monitor resources that are required to be held in trust for others.
a. Pension (and other employee benefit) trust funds—to report resources that are required to
be held in trust for the members and beneficiaries of defined benefit pension plans, defined
contribution plans, other postemployment benefit plans, or other employee benefit plans.
b. Investment trust funds—to report the external portion of investment pools reported by the
sponsoring government.
c. Private-purpose trust funds—to report all other trust arrangements under which principal
and income benefit individuals, private organizations, or other governments.
d. Agency funds—to report resources held by the reporting government in a purely custodial
capacity.
Under fund accounting, we recognize revenues and expenditures using the current financial resources
measurement focus and the modified accrual basis of accounting
1. Current financial resources measurement focus refers to what is being reported. The words
current financial resources mean resources that can be consumed in the near future.
2. Modified accrual basis of accounting refers to when the transaction is recognized.
a. Revenues are recognized in the accounting period in which they become both measurable
and available to finance expenditures. “Available” means collectible within the current period
or soon enough thereafter to be used to pay liabilities of the current period.
b. Expenditures should be recognized in the accounting period in which the fund liability is
incurred.
We prepare a different set of financial statements for each type of Fund:
1. Governmental funds
a. Balance sheet
b. Statement of revenues, expenditures, and changes in fund balances
2. Proprietary funds
a. Statement of net assets
position
b. Statement of revenues, expenses, and changes in fund net assets
position
c. Statement of cash flows
3. Fiduciary funds (and component units that are fiduciary in nature)
a. Statement of fiduciary net assets
position
b. Statement of changes in fiduciary net assets
position
■■ Government Funds are prepared using current financial resources measurement focus and the
modified accrual basis of accounting,
■■ Proprietary and Fiduciary Funds are prepared using the economic resources measurement
focus and the accrual basis of accounting.
Compr ehen s ive Revi e w

Part 1:
Prepare journal entries in the General Fund for each of the following events relating to the City of Santa
Rosa (all amounts in $1,000s).
Required
a. The citizens approve the following budget for the year:
Estimated revenues�� $22,888

Estimated other financing sources�� 2,000
Appropriations �� (22,409)
Budgetary fund balance�� $ 2,479
Chapter 9 | Government Accounting: Fund-Based Financial Statements 515
is desirable in order to maintain management control and accountability over the library. What type of
fund should King establish in order to meet their measurement objectives?
a. Special revenue fund
b. General fund
c. Internal service fund
d. Enterprise fund
26. Financial statements LO5
Which of the following statements are required to be presented for special-purpose governments en- AICPA
gaged only in business-type activities (such as utilities)? Adapted
a. Statement of net assets only
b. Management’s Discussion and Analysis (MD&A) and Required Supplementary Information
(RSI) only
c. The financial statements required for governmental funds, including MD&A
d. The financial statements required for enterprise funds, including MD&A and RSI
27. Other financing uses LO4
Brandon County’s general fund had the following transactions during the year: AICPA
Adapted
Transfer to a debt service fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000
Payment to a pension trust fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000
Purchase of equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
What amount should Brandon County report for the general fund as other financing uses in its govern-
mental funds statement of revenues, expenditures, and changes in fund balances?
a. $100,000
b. $400,000
c. $800,000
d. $900,000
28. Encumbrances LO4
Carlson City’s fiscal year ends December 31. On August 1, the city issued a purchase order for new AICPA
vehicles to be delivered at the rate of two per month beginning October 15. Twelve vehicles were Adapted
delivered as scheduled and payments of $264,000 were made upon delivery. If these were the only
transactions made by the city, which of the following balances would appear on the balance sheet as of
December 31?
a. Encumbrances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132,000
Budgetary
Reserve for fund balance - Reserved
encumbrances . . . . . . . . for
. . . encumbrances
.................... 132,000
b. Fund balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132,000

Budgetary
Reserve forfund balance - Reserved
. . .encumbrances
.................... 132,000
Budgetary
c. Reserve for fund balance - Reserved for encumbrances
encumbrances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264,000
Fund balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264,000
d. Encumbrances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264,000
Budgetary
Reserve for fund balance - Reserved
. . . encumbrances
.................... 264,000
29. Property taxes LO4

During the current year, Wythe County levied $2,000,000 property taxes, 1% of which is expected to be AICPA
uncollectible. During the year, the county collected $1,800,000 and wrote off $15,000 as uncollectible. Adapted
What amount should Wythe County report as property tax revenue in its government-wide statement of
activities for the current year?
a. $1,800,000
b. $1,980,000
c. $1,985,000
d. $2,000,000
544 Chapter 10 | Government Accounting: Government-Wide Financial Statements
The cost of normal maintenance and repairs that do not add to the value of the assets or materially
extend asset lives are not capitalized and are treated as expenses when incurred. Improvements
are capitalized.
■■ Interfund Receivables and Payables. Transactions of a buyer/seller nature between and within
governmental funds are eliminated from the governmental activities in the statement of position.
Any residual balances outstanding between the governmental activities and business-type activi-
ties are reported in the statement of net assets as “internal balances.”
■■ Interfund Transfers. Operating transfers between and within governmental funds are elimi-
nated from the governmental activities in the statement of net position.
assets. Any residual balances
outstanding between the governmental activities and business-type activities are reported in the
statement of activities as “Transfers, net”.
■■ Deferred Revenue. Deferred revenue at the governmental fund financial statement level repre-
sents billed receivables that do not meet the available criterion in accordance with the current finan-
cial resources measurement focus and the modified accrual basis of accounting. Deferred revenue is
recognized as revenue in the conversion to the government-wide (full accrual) financial statements.
■■ Noncurrent Liabilities. Long-term debt is reported as liabilities in the government-wide and
proprietary fund statement of net assets. Material bond premiums and discounts are deferred
and amortized over the life of the bonds using the effective interest method. Bonds payable are
reported net of the applicable bond premium or discount.
■■ Landfill Closure Liability. The Town’s estimated liability for closure and post-closure care
costs for the landfill is $60,651 as of June 30, 2011. The Town will be responsible for post-closure
monitoring of the site for thirty years once the landfill is capped. The $60,651 as of June 30, 2011
reported as landfill closure and post-closure liability at June 30, 2011, is based on what it would
cost to perform all closure and post-closure care at June 30, 2011. Actual costs may be higher due
to inflation, changes in technology or changes in regulations.
■■ Net Position. Net Position is classified into three components:
a. Net investment in capital assets—consists of capital assets including restricted capital assets,
net of accumulated depreciation and reduced by the outstanding balances of any bonds,
mortgages, notes, or other borrowings that are attributable to the acquisition, construction, or
improvement of those assets.
b. Restricted—Consists of net assets with constraints placed on the use either by (1) external
groups such as creditors, grantors, contributors, or laws or regulations of other governments;
or (2) law through constitutional provisions or enabling legislation. Net assets have been
“restricted” for the following:
• Streets represent amounts committed by the State of Massachusetts for the repair and/or
construction of streets.
• Permanent funds—expendable represents amounts held in trust for which the expenditures
are restricted by various trust agreements.
• Permanent funds—nonexpendable represents amounts held in trust for which only invest-
ment earnings may be expended.
• Other specific purposes represent restrictions placed on assets from outside parties.
c. Unrestricted—All other net assets that do not meet the definition of “restricted” or “net
investment in capital assets”.
Landfill Liability Management of solid waste disposal is an important governmental activity.

Typically, solid waste is transported to a disposal facility where it is buried. The municipality incurs
labor and equipment costs to manage the facility while it is operational.12 When the site is filled, the
municipality, then, incurs costs to “cap” the landfill (i.e., to cover the landfill site and make it ready
for its long-term post-closure use).
12
Capital assets that will be used exclusively for a landfill and that are excluded from the calculation of the estimated total cur-
rent cost of closure and post-closure care should be fully depreciated by the date that the landfill stops accepting solid waste
(GASB ASC L10.108).
564 Chapter 10 | Government Accounting: Government-Wide Financial Statements
Comprehensive Review Solution
Governmental Governmental
Government-Wide Financial Statements Spreadsheet Activities DR CR Activities
Statement of Net Assets

Current:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,971 $ 5,971
Receivables
Real estate & personal property . . . . . . . . . . . . . . . . . . 414 414
Intergovernmental . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,281 4,281
Non-current:
Receivables
Capital assets, net of accumulated depreciation . . . . . 1 32,752 33,079
2 327
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,666 $43,745
Payables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $490 $490

Accrued interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 53 53
Bond and notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 7,000 8,300
4 1,300
absences
Compensated advances . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 688 688
Landfill closure and postclosure care costs . . . . . . . . . . . . 9 901 901
Deferred revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,709 5 4,485 0
6 224
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,199 10,432
Net assets:
Fund balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,467 5,467
Adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 7,000 1 32,752 28,661
7 655 5 4,485
8 20
9 901
Net income adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . below (815) (815)
33,313
$10,666 $43,745
Statement of Revenues, Expenditures, and Changes in

Fund Balances
Total revenues—fund financial statements . . . . . . . . . . . . . $18,300 $18,300

Adjustments:
Deferred revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 224 224
Total revenues—statement of activities . . . . . . . . . . . . . . 18,524
Total expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,398 18,398

Adjustments:
Debt principal payments . . . . . . . . . . . . . . . . . . . . . . . . . 4 700 (700)
Depreciation expense/capital outlay . . . . . . . . . . . . . . . . 2 1,638 2 1,965 (327)
Compensated absences . . . . . . . . . . . . . . . . . . . . . . . . . 7 33 33
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 33 33
Total expenses—statement of activities . . . . . . . . . . . . . 17,437
Misc. adjustments:
Proceeds from bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 4 2,000 0
Net change in fund balances/change in net assets . . . . . . $ 1,902 3,704 2,889 $ 1,087
Chapter 12 | Segment Disclosures and Interim Financial Reporting 597
Corporate and Unallocated operating income includes a variety of miscellaneous items, such as
corporate investment gains and losses, certain derivative gains and losses, certain insurance−related
gains and losses, certain litigation and environmental expenses, corporate restructuring charges and
certain under− or over−absorbed costs (e.g. pension, stock−based compensation) that the Company
may choose not to allocate directly to its business segments. Because this category includes a vari-
ety of miscellaneous items, it is subject to fluctuation on a quarterly and annual basis…
Segment assets for the operating business segments (excluding Corporate and Unallocated)
primarily include accounts receivable; inventory; property, plant and equipment—net; goodwill and
intangible assets; and other miscellaneous assets. Assets included in Corporate and Unallocated prin-
cipally are cash, cash equivalents and marketable securities; insurance receivables; deferred income
taxes; certain investments and other assets, including prepaid pension assets. Corporate and unallo-
cated assets can change from year to year due to changes in cash, cash equivalents and marketable
securities, changes in prepaid pension benefits, and changes in other unallocated asset categories.
3M discloses financial data relating to Sales, Operating Income, Assets, Depreciation and Amortiza-
tion, and Capital Expenditures. These disclosure categories are typical. 3M also provides a reconcilia-
tion of the segment totals to the consolidated totals in the Corporate and Unallocated row in each cate-
gory. The “Total Company” row equals the amounts reported in the consolidated financial statements.
Quantitative Thresholds SFAS 131 requires disclosure for all segments that exceed any
of the quantitative thresholds for revenues (sales), profit, and assets.
Revenues All business segments
All operating segments exceeding 10% of combined revenue, internal and external, of
all operating segments must be separately disclosed. We do not have data on the internal revenues as
these have been eliminated in the consolidation process. For external revenues, the threshold is 10% of
$29,164 million ($29,611 million 2 $447 million), or $2,916.4 million. All of the reported segments
exceed that threshold as we would expect.
Profit
Profit All
All operating
profitablesegments
business for which the
segments absolute10%
exceeding valueofofcombined
segment profit
profitorofabsolute value of
all profitable segment
operating
loss exceedsand
segments, 10 percent
all loss of the greater
business of the absolute
segments exceedingvalue
10%of of
aggregate
combined segment
loss ofprofit (for profitable
all profitable operating
operating Underline indicates
segments,segments) or absolutedisclosed.
must be separately value of aggregate
These aresegment losses tests,
two separate (for unprofitable
one for thesegments).
category ofAllallofprofit-
3M's
change made.
segments are profitable, and the threashold is 10% of $6,700 million ($6,178 million + $522 million),
able segments and the other for all loss segments. All of 3M’s segments are profitable, and the thresh- or $670
million. All of the reported segments exceed the profit threshold.
old is 10% of $6,700 million ($6,178 million 1 $522 million), or $670 million. All of the reported
segments exceed the profit threshold.
Assets AllAlloperating
businesssegments
segments with assets exceeding 10% of combined assets for all operating seg-
ments must be separately disclosed. All of 3M’s segments, except Consumer & Office and Electro &
Communications, exceed the asset threshold of 10% of $24,437 million ($31,616 million 2 $7,179
million), or $2,443.7 million.
Other Disclosures In addition to the financial data presented above, 3M also provides the
following required disclosure relating to the concentration of its sales, income and assets by geographi-
cal area:
Property, Plant and

Net Sales Operating Income Equipment, Net
(Millions) 2011 2010 2009 2011 2010 2009 2011 2010
United States $10,028 $9,210 $8,509 $1,629 $1,636 $1,640 $3,979 $3,888
Asia Pacific 9,108 8,259 6,120 2,523 2,400 1,528 1,887 1,605
Europe, Middle East and Africa 7,076 6,259 5,972 1,150 1,112 1,003 1,271 1,239
Latin America and Canada 3,411 2,950 2,516 896 797 631 529 547
Other Unallocated (12) (16) 6 (20) (27) 12 — —
Total Company $29,611 $26,662 $23,123 $6,178 $5,918 $4,814 $7,666 $7,279
SFAS 131 requires two disclosure categories: the U.S and outside of the U.S. 3M’s disclosure of the
U.S. and several geographic areas outside of the U.S. is typical.

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Chapter 1 | Accounting for Intercorporate Investments

1. Equity investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240

Book Values Fair Values

Investor Investee Investor Investee

Receivables & inventories . . . . . . . . . . . . . . . . . $120,000 $ 60,000 $108,000 $ 54,000

Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $180,000 $ 96,000 $216,000 $114,000

Net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $450,000 $204,000 $732,000 $372,000

Parent Subsidiary Dr Cr Consolidated

Statement of retained earnings:

Liabilities and stockholders’ equity

Parent Subsidiary Parent Subsidiary

Income statement: Balance sheet:

Parent Subsidiary Parent Subsidiary

Income statement: Balance sheet:

Fair value of the subsidiary���������������������������������������������������������������� $ 900,000

Loss on write-down of Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000

Comprehensive Review Solution

Parent Subsidiary Dr Cr Consolidated

Statement of retained earnings:

Liabilities and stockholders’ equity

[C] [C] Equity income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50.0

Upstream Intercompany Sale of Depreciable Assets In the case of

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 104,550 $ 54,000

Appendix 4B: Consolidation When the Parent Uses

Original AAP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000

Year Ending Dec. 31, 2012 Dec. 31, 2013

Transfer price for inventory sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $150,000 $200,000

* Paid at beginning of next period.

End of year stockholders’ equity (S) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $811,000

Subsidiary Intercompany % Inventory

2013 . . . . . . . . . . . . . . . . . . . . $500,000 $75,000 32% 10% $25,000

Subsidiary Intercompany Gross Profit

2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300,000 $50,000 $18,000 $20,000

Year Ended December 31,

100% AAP Amortization – Dr (Cr) 2009 2010 2011 2012 2013

Accounts receivable . . . . . . . . . . . . . . . . . . . . . $(10,500) $ — $ — $ — $ —

Accounts receivable . . . . . . . . . . . . $ (10,500) $ — $ — $ — $ — $ —

c. Intercompany depreciable asset sale:

Net intercompany profit deferred at January 1, 2013 . . . . . . . . . . . . . . . . . . . . . $33,750 $0

Intercompany inventory transactions:

Intercompany profit in inventory on January 1, 2013 . . . . . . . . . . . . . . . . . . . . . $0 $9,000

Intercompany accounts receivables and payables at December 31, 2013: $15,000

(1) Book value of the net assets of the subsidiary

Equity Investment account balance at January 1, 2013:

Equity Investment account balance at December 31, 2013:

Dec. 31, 2013

January 1, 2013 640,950

Consolidation Spreadsheet for the Year Ended December 31, 2013

Parent Subsidiary Dr Cr Consolidated

Equity income from subsidiary . . . . . . . 50,550 — [C] 50,550 —

Retained earnings statement:

Accounts payable . . . . . . . . . . . . . . . . . $252,000 $ 52,500 [Ipay] 15,000 $289,500

[E] Common stock @BOY . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000 Eliminates subsidiary Stockholders’ Equity

Unamortized Fiscal Unamortized Fiscal Unamortized Fiscal Unamortized

Inventories . . . . . . . . . . . . $(40,000) $40,000 0 0 0

Unamortized Fiscal Unamortized Fiscal Unamortized Fiscal Unamortized

Inventories . . . . . . . . . . . . $(32,000) $32,000 0 0 0

LO3 17. Intercompany inventory transactions

Fair value of the subsidiary�� $ 900,000

Appendix 4B: Consolidation When the Parent Uses

December 1, 2012�� 75¢ 67¢

January�� $1.43 $1.57

May�� $1.35:€1 $1.30:€1

September 30 �� $0.65:€1 $0.72:€1

Beginning inventory�� € 310,417 € 372,500 Statement of retained earnings:

Ending retained earnings�� € 787,500 € 976,500