Collection

Prepared by:
Dr. Sameh Othman Mohamed Yassen
Ph.D. in Accounting
University of Bremen, Germany
Contents
Chapter 1: Business Combinations………………………………….3
Chapter 2: Consolidated Statements: Date of Acquisition………33
Chapter 3: Accounting for Branches………………………………...118
Chapter 4: Departmental Accounts………………………………......172

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 Chapter 1: Business Combinations

Introduction
When one company obtains control of one or more businesses, a
business combination has occurred. Some of the reasons for business
combinations are to
• defend a competitive position within a market segment or with a
particular customer;
• diversify into a new market and/or geographic region;

• gain access to new customers and/or partners;

• acquire new and/or complementary products or services;

• acquire new expertise or capabilities;

• accelerate time to market (for a product and/or service);

• improve the company's rate of innovation either by acquiring

new technology and/or intellectual property;
• gain control over a supplier; and

• position the company to benefit from industry consolidation.

Business combinations are frequent events throughout the world.

Hardly a week passes without some reference in the press to actual or
proposed takeovers and mergers. Among the examples of these events
are:
• Burger King Worldwide Inc.'s of the United States bought Tim

Hortons Inc. of Canada for US$11.3 billion.

• Repsol S.A. of Spain bought Talisman Energy Inc. of Canada for

US$13 billion.
• Caisse de depot et placement du Quebec participation in the
takeover of PetSmart Inc. of the United States was the biggest
foreign takeover involving a Canadian acquirer in 2014 for
US$8.6 billion.
• Encana Corporation of Canada's US$7.1 billion acquisition of

Athlon Energy Inc. of the United States was the biggest purchase
of a U.S. oil and gas producer by a Canadian company.
• Amaya Inc. of Canada purchased Oldford Group Limited of the

Isle of Man for US$4.9 billion in June, making it the largest

publicly held online gambling company in the world.
• BCE Inc. of Canada acquired the outstanding shares of Bell
Aliant Inc. of Canada that it did not already own for CAD$4.5
billion.

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 • The Manufacturers Life Insurance Company of Canada bought
Standard Life Financial Inc. and Standard Life Investments Inc.
of the United Kingdom for CAD$4.0 billion.

Business combinations can be described as either friendly or hostile.

Often a merger is initiated by one company submitting a formal tender
offer to the shareholders of another company. In a friendly combination,
the top management and the board of directors of the companies involved
negotiate the terms of the combination and then submit the proposal to
the shareholders of both companies along with a recommendation for
approval. An unfriendly combination occurs when the board of directors of
the target company recommends that its shareholders reject the tender
offer. The management of the target company will often employ defences
to resist the takeover. They include the following:
• Poison pill. This occurs when a company issues rights to its
existing shareholders, exercisable only in the event of a potential
takeover, to purchase additional shares at prices below market.
• Pac-man defence. This involves the target company making an
unfriendly countervailing takeover offer to the shareholders of the
company attempting to acquire it.
• White knight. In this case, the target company searches out
another company that will come to its rescue with a more
appealing offer for its shares.
• Selling the crown jewels. This involves selling certain desirable

assets to other companies so that the would-be acquirer loses

interest.

In the next section of this chapter, we define a business combination.

The discussion then proceeds to the accounting for business
combinations.

BUSINESS COMBINATIONS
A business combination is defined in International Financial
Reporting Standard 3 (IFRS 3) as a transaction or other event in which an
acquirer obtains control of one or more businesses. This definition has
two key aspects: control and businesses. We will discuss each aspect in
considerable depth, starting with businesses.

A business combination occurs when an acquirer obtains control of a

business.

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 A business is defined in IFRS 3, as an integrated set of activities and
assets that is capable of being conducted and managed for the purpose
of providing a return in the form of dividends, lower costs, or other
economic benefits directly to investors or other owners, members, or
participants.
IFRS 3 provides guidance to determine whether a business exists. A
business consists of inputs and processes applied to those inputs that
have the ability to create outputs. An input is any economic resource that
creates, or has the ability to create, outputs when one or more processes
are applied to it. Examples of inputs would include raw materials for a
manufacturing company, intellectual property of a hi-tech company, and
employees.
A business consists of inputs and processes applied to those inputs that have
the ability to create outputs.

A process is any system, standard, protocol, convention, or rule that,

when applied to an input or inputs, creates or has the ability to create
outputs. Examples include strategic management processes, operational
processes, and resource management processes. A workforce with the
necessary skills and experience following rules and conventions may
provide the necessary processes capable, when applied to inputs, of
creating outputs. An output is the result of inputs plus processes applied
to those inputs, which then provide or have the ability to provide a return.
Any product or service that is sold is obviously an example of an output.
The two essential elements of a business are inputs and processes
applied to those inputs. Although businesses usually have outputs,
outputs are not required for an integrated set of inputs and processes to
qualify as a business. As long as the inputs and processes have the ability
to produce outputs, the inputs and processes would qualify as a business.
A company in the development stage may have materials and processes
developed sufficiently that a prospective buyer could buy the company,
complete the development, and begin producing outputs for sale to
prospective customers. Alternatively, the buyer could integrate the seller’s
materials and processes with its own inputs and processes.
Determining whether a particular set of assets and activities is a
business should be based on whether a potential buyer will be able to
manage the integrated set as a business. In this evaluation, it is not
relevant whether a seller operated the set as a business or whether the
acquirer intends to operate the set as a business.

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 Buying a group of assets that do not constitute a business is a basket
purchase, not a business combination.

When a business combination does occur, the requirements of IFRS 3

must be applied. On the other hand, if an entity acquires all of the assets
of another entity but they do not meet the definition of a business, IFRS 3
would not be applicable. Instead, the assets acquired would be treated as
a basket purchase, and the total cost would be allocated to the individual
assets in proportion to their fair market values. Basket purchases were
studied in the property, plant, and equipment section of intermediate
accounting.
Let us now turn our attention to the other key aspect of a business
combination: control. Guidance for determining control is provided in IFRS
10.
IFRS 10 states that an investor controls an investee when it is exposed
or has rights to variable returns from its involvement with the investee,
and it has the ability to affect those returns through its power over the
investee. This definition contains the following three elements:
a) The investor has power over the investee.
b) The investor has exposure, or rights, to variable returns from its
involvement with the investee.
c) The investor has the ability to use its power over the investee to
affect the amount of the investor’s returns.
All three elements must be met for the investor to have control. If the
investor does have control over the investee, the investor is called the
parent and the investee is called the subsidiary. Let us now discuss each
element of control.

Power. An investor has power over an investee when the investor has
existing rights giving it the current ability to direct relevant activities, that
is, the activities that significantly affect the investee’s returns. Sometimes,
assessing power is straightforward, such as when power over an investee
is obtained directly and solely from the voting rights granted by equity
instruments such as shares and can be assessed by considering the
voting rights from those shareholdings. In other cases, the assessment
will be more complex and require consideration of more than one factor,
for example, when power results from one or more contractual
arrangements. An investor with the current ability to direct the relevant
activities has power, even if its rights to direct have yet to be exercised.
Evidence that the investor has been directing relevant activities can help
determine whether the investor has power, but such evidence is not, in

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itself, conclusive in determining whether the investor has power over an
investee. If two or more investors each have existing rights giving them
unilateral ability to direct different relevant activities, the investor with the
current ability that most significantly affects the returns of the investee has
power over the investee.
Control is the power to direct the relevant activities of the investee.

Returns. An investor is exposed or has rights to variable returns from

its involvement with the investee when those returns from its involvement
could vary as a result of the investee’s performance; the investor’s returns
can be only positive, only negative, or both positive and negative. An
investment in common shares is exposed to variable returns because the
common shareholders receive the residual returns in the company. If the
company is very profitable, the dividends to the shareholders or
appreciation in the price of common shares will be positive and can be
substantial. On the other hand, if the company is incurring losses, the
prospects for dividends or appreciation in the share price is minimal or
nonexistent.
The definition of control requires that the investor has exposure, or
rights, to variable returns from its involvement with the investee.

Link between power and returns. An investor controls an investee if

the investor not only has power over the investee and exposure or rights
to variable returns from its involvement with the investee, but the investor
also has the ability to use its power to affect his or her returns from its
involvement. A common shareholder usually has the power through
voting rights and exposure to variable returns. A preferred shareholder
may have exposure to a variable return. However, the preferred
shareholder typically does not have voting rights and, therefore, does
not have power over the relevant activities of the investee.
The definition of control requires that the investor has the ability to use its
power over the investee to affect the amount of the investor’s returns.

Let us now apply the elements of control to some practical situations.

If the means of paying for the business is cash or a promise to pay
cash in the future, the company making the payment is usually the one
obtaining control. If shares were issued as a means of payment, relative
holdings of voting shares of the combined company by shareholders of
the combining companies is key. In a combination involving two
companies, if one shareholder group holds more than 50% of the voting

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shares of the combined company, that company would usually have
control. If more than two companies are involved, the shareholder group
holding the largest number of voting shares would usually be identified as
the company with control.
Owning more than 50% of the voting shares usually, but not always, indicates
control.

Since the board of directors establishes the strategic policies of a

corporation, the ability to elect a majority of the members of the board
would generally be evidence of control. Therefore, the first element of
control is presumed to exist if the parent owns, directly or indirectly,
enough voting shares to elect the majority of the board of directors of a
subsidiary.
In most situations, more than 50% of the voting shares are required to
elect the majority of the board, and so the first element of control is
presumed to exist with greater than 50% ownership. However, we have to
look at all factors. For example, if D Company owns 60% of the voting
shares of E Company and F Company owns the other 40%, then we can
presume that D Company has power over the activities of E Company.
But if F Company owns convertible bonds of E Company or options or
warrants to purchase E Company shares, which, if converted or
exercised, would give F Company 62% of the outstanding shares of E
Company, then F Company, not D Company, would have power over the
activities of E Company.
There is also a general presumption that a holding of less than 50%
of the voting shares does not constitute control. This presumption can be
overcome if other factors clearly indicate control. For example, an
irrevocable agreement with other shareholders to convey voting rights to
the parent would constitute control, even if the parent owned less than
50% of the voting shares. A parent may also have power despite owning
less than 50% of the voting shares if its holdings of rights, warrants,
convertible debt, or convertible preferred shares would give it enough
voting power to control the board of directors of the subsidiary. Exercise
or conversion would not be necessary, only the right to exercise or convert
is.
It is also possible for a parent to have power without a majority share
ownership if it also has agreements in writing allowing it to dictate the
operating policies of the subsidiary, resulting in it receiving fees, royalties,
and profits from intercompany sales. For these situations, the parent
makes the key decisions, receives the majority of the benefits, and
absorbs most of the risk, even though the parent may own very few, if any,

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of the shares in the controlled company.
A company could have control with less than 50% of the voting shares when
contractual agreements give it control.

In another example, X Company owns 40% of Y Company, which is

the largest single block of Y Company’s outstanding shares. The other
60% is very widely held and only a very small proportion of the holders
appear at the annual meeting of Y Company. As a result, X Company has
had no trouble electing the majority of the board of directors. Thus, X
Company could be deemed to have control in this situation as long as the
other shareholders do not actively cooperate when they exercise their
votes so as to have more voting power than X Company.
Temporary control of an entity does not of itself change the fact that
control exists. During the time that control is held and until such time as
control ceases, the reporting requirements for controlled entities should
be applied.
The seizure of the company’s assets by a trustee in a receivership or
bankruptcy situation would be evidence that control has probably
ceased, as would the imposition of governmental restrictions over a
foreign company’s ability to pay dividends to its investor. However, when
a receiver seizes a specific asset in satisfaction of a default under a loan
agreement but permits the company to continue in business under the
direction of the parent, this is not a loss of control.
Normal business restrictions do not preclude control by the parent.

A reporting entity can control another entity, even though other parties
have protective rights relating to the activities of that other entity.
Protective rights are designed to protect the interests of the party holding
those rights, without giving that party control of the entity to which they
relate. They include, for example, the following:
a- Approval or veto rights granted to other parties that do not affect the
strategic operating and financing policies of the entity. Protective
rights often apply to fundamental changes in the activities of an
entity or apply only in exceptional circumstances. For example:
1- A lender might have rights that protect the lender from the risk that
the entity will change its activities to the detriment of the lender,
such as selling important assets or undertaking activities that
change the credit risk of the entity.
2- Non-controlling shareholders might have the right to approve
capital expenditures greater than a particular amount, or the right

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 to approve the issue of equity or debt instruments.
b- The ability to remove the party that directs the activities of the entity
in circumstances such as bankruptcy or on breach of contract by
that party.
c- Limitations on the operating activities of an entity. For example, a
franchise agreement for which the entity is the franchisee might
restrict the pricing, advertising, or other operating activities of the
entity but would not give the franchisor control of the franchisee.
Such rights usually protect the brand of the franchisor.
A parent can control a subsidiary, even though other parties have protective
rights relating to the subsidiary.

IFRS 10 provides extensive guidance to determine whether an entity

has control. Paragraph B3 states that the following factors may assist in
making the determination about control:
a- The purpose and design of the investee
b- What the relevant activities of the investee are and how decisions
about those activities are made
c- Whether the rights of the investor give it the current ability to direct
the relevant activities
d- Whether the investor is exposed, or has rights, to variable returns
from its involvement with the investee
e- Whether the investor has the ability to use its power over the
investee to affect the amount of the investor’s returns

The following example provides guidance in determining whether one

of the two investors has control of the investee or whether the two
investors each have joint control.
Two investors form an investee to develop and market a medical
product. One investor is responsible for developing and obtaining
regulatory approval of the medical product, a responsibility that includes
having the unilateral ability to make all decisions relating to the
development of the product and obtaining regulatory approval. Once the
regulator has approved the product, the other investor will manufacture
and market it. This investor has the unilateral ability to make all decisions
about the manufacture and marketing of the project. If all the activities—
developing and obtaining regulatory approval, as well as manufacturing
and marketing of the medical product—are relevant activities, each
investor needs to determine whether it is able to direct the activities that
most significantly affect the investee’s returns. Accordingly, each

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 investor needs to consider which of developing and obtaining regulatory
approval or manufacturing and marketing of the medical product is the
activity that most significantly affects the investor’s returns, and whether
it is able to direct that activity. In determining which investor has power,
the investors would consider the following:
a- Purpose and design of the investee
b- Factors that determine the profit margin, revenue, and value of the
investee, as well as the value of the medical product
c- Effect on the investee’s returns resulting from each investor’s
decision-making authority, with respect to the factors in (b)
d- Investors’ exposure to variability of returns.
In this particular example, the investors would also consider both of
these:
e- Uncertainty of, and effort required in, obtaining regulatory approval
(considering the investor’s record of successfully developing and
obtaining regulatory approval of medical products)
f- The investor who controls the medical product once the development
phase is successful
A key aspect of control is the ability to direct the activities that most
significantly affect the investor’s returns.

Let us now discuss the common forms of business combinations and

the reporting requirements for business combinations.

FORMS OF BUSINESS COMBINATIONS

Essentially, there are three main forms of business combinations.
One company can obtain control over the net assets of another company
by (1) purchasing its net assets, (2) acquiring enough of its voting shares
to control the use of its net assets, or (3) gaining control through a
contractual arrangement.

PURCHASE OF ASSETS OR NET ASSETS An obvious way to obtain

control over a business is by outright purchase of the assets that
constitute a business. In this case, the selling company is left only with the
cash or other consideration received as payment from the purchaser, and
the liabilities present before the sale. In other cases, the acquirer
purchases all the assets of the acquiree and assumes all its liabilities,
which together are referred to as net assets. In either case, the
shareholders of the selling company have to approve the sale, as well as
decide whether their company should be wound up or continue operations

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after the sale.
When purchasing assets or net assets, the transaction is carried out with the
selling company.

PURCHASE OF SHARES As an alternative to the purchase of assets or

net assets, the acquirer could purchase enough voting shares from the
acquiree’s shareholders to give it the power to determine the acquiree’s
strategic operating and financing policies. This is the most common form
of combination, and it is often achieved through a tender offer made by
the management of the acquirer to the shareholders of the acquiree.
These shareholders are invited to exchange their shares for cash or for
shares of the acquirer company.
When purchasing shares, the transaction is usually consummated with the
shareholders of the selling company.

The share-purchase form of combination is usually the least costly to

the acquirer because control can be achieved by purchasing less than
100% of the outstanding voting shares. In addition, there can be important
tax advantages to the vendor if shares rather than assets are sold.
Because the transaction is between the acquirer and the acquiree’s
shareholders, the acquiree’s accounting for its assets and liabilities is not
affected, and the company carries on as a subsidiary of the acquirer. The
acquirer becomes a parent company and, therefore, must consolidate its
subsidiary when it prepares its financial statements.
The acquired company makes no journal entries when the acquiring company
purchases shares.

CONTROL THROUGH CONTRACTUAL ARRANGEMENT A company

can get control of another company by signing an agreement with the
acquiree’s shareholders to give it control, without actually acquiring any
shares of the other company. Nevertheless, the company with control will
be deemed a parent and the controlled company will be a subsidiary.
Since there were no actual transactions between the parent and the
subsidiary for the transfer of control, there will be no entries made on the
subsidiary’s books to record this change in control. However, the parent
would have to consolidate this subsidiary when it prepares its financial
statements.
Control can be obtained through a contractual arrangement that does not
involve buying assets or shares.

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 All three forms of business combination result in the assets and
liabilities of the two companies being combined. If control is achieved by
purchasing net assets, the combining takes place in the accounting
records of the acquirer. If control is achieved by purchasing shares or
through contractual arrangement, the combining takes place when the
consolidated financial statements are prepared.

VARIATIONS One variation from the forms of business combinations

described above occurs when the companies involved agree to create a
new company, which either purchases the net assets of the combining
companies or purchases enough shares from the shareholders of the
combining companies to achieve control of these companies.
There are many different legal forms in which a business combination can be
consummated.

Another variation that can occur is a statutory amalgamation, whereby,

under the provisions of federal or provincial law, two or more companies
incorporated under the same Companies Act can combine and continue
as a single entity. The shareholders of the combining companies become
shareholders of the surviving company, and the non-surviving companies
are wound up. The substance of a statutory amalgamation indicates that
it is simply a variation of one of the basic forms. If only one of the
companies survives, it is essentially a purchase of net assets, with the
method of payment being shares of the surviving company.
A statutory amalgamation occurs when two or more companies combine to
form a single legal entity.

Exhibit 1.1 shows the intercompany shareholdings, both before and after
a business combination, under a variety of forms. Intercompany
shareholdings are often depicted in this manner. The arrow points from
the investor to the investee company, with the number beside the arrow
showing the number of shares owned by the investor. Mr. A and Mr. X
were the sole shareholders in A Co. and X Co. prior to the business
combination.

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EXHIBIT 1.1 Different Forms of Business Combinations

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ACCOUNTING FOR BUSINESS COMBINATIONS UNDER
ACQUISITION METHOD
IFRS 3 outlines the accounting requirements for business combinations.
The main principles are as follows:
• All business combinations should be accounted for by applying the

acquisition method.
• An acquirer should be identified for all business combinations.

• The acquisition date is the date the acquirer obtains control of the
acquiree.
• The acquirer should attempt to measure the fair value of the acquiree,

as a whole, as of the acquisition date. The fair value of the acquiree

as a whole is usually determined by adding together the fair value of
consideration transferred by the acquirer (i.e., the acquisition cost)
plus the value assigned to the non-controlling shareholders. In this
text, we will refer to the sum of the acquisition cost plus value assigned
to the non-controlling shareholders as total consideration given. The
value assigned to the non-controlling interest is measured as either
the fair value of the shares owned by the noncontrolling shareholders
or as the non-controlling interest’s proportionate share of the fair value
of the acquiree’s identifiable net assets. Business valuation
techniques would be used to measure the fair value of the business
acquired, especially if the parent acquired less than 100% of the
shares, if control is obtained without transferring any consideration or
if the consideration transferred does not represent the fair value of the
business acquired. Certain business valuation techniques are
referred to in IFRS 3 but are beyond the scope of this book.
• The acquirer should recognize and measure the identifiable assets
acquired and the liabilities assumed at fair value and report them
separately from goodwill.
• The acquirer should recognize goodwill, if any.

The acquisition method is required, and an acquirer must be identified for all
business combinations.

IDENTIFYING THE ACQUIRER AND DATE OF ACQUISITION The

acquirer is the entity that obtains control of one or more businesses in a
business combination. The concept of control and how to determine who
has control was discussed earlier in this chapter. It is important to
determine who has control because this determines whose net assets are
reported at carrying amount and whose assets are reported at fair value
at the date of acquisition. The date of acquisition is the date that one entity
obtains control of one or more businesses.

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ACQUISITION COST The acquisition cost is made up of the following:
• Any cash paid

• Fair value of assets transferred by the acquirer

• Present value of any promises by the acquirer to pay cash in the

future
• Fair value of any shares issued—the value of shares is based on the
market price of the shares on the acquisition date
• Fair value of contingent consideration

The acquisition cost is measured as the fair value of consideration given to

acquire the business.

The acquisition cost does not include costs such as fees for
consultants, accountants, and lawyers as these costs do not increase the
fair value of the acquired company. These costs should be expensed in
the period of acquisition.
Costs incurred in issuing debt or shares are also not considered part of
the acquisition cost. These costs should be deducted from the amount
recorded for the proceeds received for the debt or share issue; for
example, deducted from loan payable or common shares as applicable.
The deduction from loan payable would be treated like a discount on notes
payable and would be amortized into income over the life of the loan using
the effective interest method.
The acquisition cost does not include costs such as professional fees or costs
of issuing shares.

RECOGNITION AND MEASUREMENT OF NET ASSETS ACQUIRED

The acquirer should recognize and measure the identifiable assets
acquired and the liabilities assumed at fair value and report them
separately from goodwill. An identifiable asset is not necessarily one that
is presently recognized in the records of the acquiree company. For
example, the acquiree company may have patent rights that have a fair
value but are not shown on its balance sheet because the rights had been
developed internally.
Identifiable assets and liabilities should be recorded separately from goodwill.

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IAS 38 paragraph 12 defines an identifiable asset if it either
a- is separable, that is, is capable of being separated or divided from
the entity and sold, transferred, licensed, rented, or exchanged,
either individually or together with a related contract, identifiable
asset, or liability, regardless of whether the entity intends to do so;
or
b- arises from contractual or other legal rights, regardless of whether
those rights are transferable or separable from the entity or from
other rights and obligations.
To qualify for recognition, as part of applying the acquisition method,
the identifiable assets acquired, and liabilities assumed must meet the
definitions of assets and liabilities in the IASB’s The Conceptual
Framework for Financial Reporting at the acquisition date. For example,
costs that the acquirer expects but is not obliged to incur in the future to
effect its plan to exit an activity of an acquiree or to terminate the
employment of or to relocate an acquiree’s employees do not meet the
definition of a liability at the acquisition date. Therefore, the acquirer does
not recognize those costs as a liability at the date of acquisition. Instead,
the acquirer recognizes those costs in its post-combination financial
statements in accordance with other IFRS.
IFRS 3 provides guidance in identifying assets to be recognized
separately as part of a business combination.
There are some exceptions to the general principle in accounting for a
business combination that all assets and liabilities of the acquired entity
must be recognized and measured at fair value. One of the exceptions for
recognition pertains to contingent liabilities. For the acquired company,
following the usual standards in IAS 37 Provisions, Contingent Liabilities
and Contingent Assets, the contingent liability would only be recognized
in its separate entity financial statements if it were probable that an outflow
of resources would be required to settle the obligation. Under IFRS 3 an
exception is made, requiring the acquirer to recognize a contingent liability
if it is a present obligation that arises from past events and its fair value
can be measured reliably. Therefore, the acquirer recognizes the liability
even if it is not probable that an outflow of resources embodying economic
benefits will be required to settle the obligation.
Special requirements for recognition and measurement of financial
statement items at the date of acquisition also apply to employee benefits,
indemnification assets, reacquired rights, share-based payment awards,
and assets held for sale. Deferred income tax assets and liabilities are not
fair-valued and not carried forward. Instead, new amounts for deferred tax
assets and liabilities are determined at the date of acquisition.

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All of the acquiree’s identifiable assets and liabilities must be recognized and
most of these identifiable assets and liabilities would be measured at fair value
at the date of acquisition.

RECOGNITION OF GOODWILL If the total consideration given by the

controlling and non-controlling shareholders is greater than the fair value
of identifiable assets and liabilities acquired, the excess is recorded in the
acquirer’s financial statements as goodwill. Goodwill represents the
amount paid for excess earning power plus the value of other benefits that
did not meet the criteria for recognition as an identifiable asset.
Goodwill is the excess of total consideration given over the fair value of
identifiable assets and liabilities.

If the total consideration given is less than the fair value of the
identifiable net assets acquired, we have what used to be described as a
“negative goodwill” situation. This negative goodwill is now recognized as
a gain attributable to the acquirer on the acquisition date.
Negative goodwill could result in the reporting of a gain on purchase by the
acquiring company.

To illustrate the accounting involved using the acquisition method, we

will use the summarized balance sheets of two companies. Summarized
statements are used here so that we can focus completely on the broad
accounting concepts. In later examples, more detailed statements will be
used. Exhibit 1.2 presents the December 31, Year 1, balance sheets of
the two companies that are party to a business combination.

Exhibit 1.2
A COMPANY LTD. BALANCE SHEET
At December 31, Year 1
Assets $300,000
Liabilities $120,000
Shareholders' equity:
Common shares (Note 1) 100,000
Retained earnings 80,000
$300,000
Note 1: The shareholders of the 5,000 common shares issued and outstanding
are identified as Group X.

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 B CORPORATION BALANCE SHEET
At December 31, Year 1
Assets $88,000
Liabilities $30,000
Shareholders' equity:
Common shares (Note 2) 25,000
Retained earnings 33,000
$88,000

The fair values of B Corporation's identifiable assets and liabilities are as follows as at
December 31, Year 1:
Fair value of assets $ 109,000
Fair value of liabilities 29,000
Fair value of net assets $ 80,000
Note 2: The shareholders of the common shares of B Corporation are identified
as Group Y.
The actual number of shares issued and outstanding has been purposely omitted
because this number would have no bearing on the analysis required later.

Company A and Company B are separate legal entities.

Because the identification of an acquirer requires the analysis of

shareholdings after the combination, Notes 1 and 2 are presented in the
exhibit to identify the shareholders of each company as belonging to two
distinct groups.
A Company Ltd. will initiate the takeover of B Corporation. The first
two examples will involve the purchase of net assets with cash and the
issuance of shares as the means of payment. Later examples will have A
Company purchasing enough shares of B Corporation to obtain control
over that company’s net assets and will introduce the preparation of
consolidated statements.

Control through Purchase of Net Assets

In the following independent examples, A Company offers to buy all
assets and assume all liabilities of B Corporation. The management of B
Corporation accepts the offer.

19
EXAMPLE 1 Assume that on January 1, Year 2, A Company pays
$95,000 in cash to B Corporation for all of the net assets of that company,
and that no other direct costs are involved. Because cash is the means of
payment, A Company is the acquirer. Goodwill is determined as follows:
Acquisition cost $95,000
Fair value of net assets acquired 80,000
Goodwill $15,000
A Company would make the following journal entry to record the
acquisition of B Corporation’s net assets:
Assets (in detail) 109,000
Goodwill 15,000
Liabilities (in detail) 29,000
Cash 95,000
The acquiring company records the net assets purchased on its own
books at fair value.
A Company’s balance sheet after the business combination would
be as follows:

A COMPANY LTD. BALANCE SHEET

At January 1, Year 2

Assets (300,000 — 95,000* + 109,000) $314,000

Goodwill 15,000
$329,000
Liabilities (120,000 + 29,000) $149,000
Shareholders' equity:
Common shares 100,000
Retained earnings 80,000
$329,000
*Cash paid by A Company to B Corporation.
The acquiring company’s own assets and liabilities are not revalued when it
purchases the net assets of the acquired company.

While this example focuses on the balance sheet of A Company

immediately after the business combination, it is also useful to look at B
Corporation in order to see the effect of this economic event on that
company. B Corporation would make the following journal entry to record

20
the sale of its assets and liabilities to A Company:
Cash 95,000
Liabilities (in detail) 30,000
Assets (in detail) 88,000
Gain on sale of assets and liabilities 37,000

The selling company records the sale of its net assets on its own books.

The balance sheet of B Corporation immediately after the sale of all

of its net assets follows:

B CORPORATION BALANCE SHEET

At January 1, Year 2
Cash $95,000
Shareholders' equity:
Common shares $25,000
Retained earnings (33,000 + 37,000*) 70,000
$95,000
*The gain on sale of the net assets amounts to $37,000 (95,000 — [88,000 — 30,000].

The management of B Corporation must now decide the future of their

company. They could decide to invest the company’s cash in productive
assets and carry on in some other line of business. Alternatively, they
could decide to wind up the company and distribute the sole asset (cash)
to the shareholders.
After the sale of net assets, B Corporation’s sole asset is cash.
EXAMPLE 2 Assume that on January 1, Year 2, A Company issues 4,000
common shares, with a market value of $23.75 per share, to B Corporation
as payment for the company’s net assets. B Corporation will be wound up
after the sale of its net assets. Because the method of payment is shares,
the following analysis is made to determine which company is the
acquirer.
Shares of A Company
Group X now holds 5,000
Group Y will hold (when B Corporation is wound up) 4,000
9,000

21
 Group X will hold 5/9 (56%) of the total shares of A Company after the
combination, and Group Y will hold 4/9 (44%) of this total after the
dissolution of B Corporation. Because one shareholder group holds more
than 50% of the voting shares, that group will have power to make the key
decisions for A Company. Accordingly, A Company is identified as the
acquirer as Group X was the original shareholder of A Company.
The acquirer is determined based on which shareholder group controls A
Company after B Corporation is wound up.

Goodwill is determined as follows:

Acquisition cost (4,000 shares @ 23.75) $95,000
Fair value of net assets acquired 80,000
Goodwill $15,000
A Company would make the following journal entry to record the
acquisition of B Corporation’s net assets and the issuance of 4,000
common shares at fair value on January 1, Year 2:
Assets (in detail) 109,000
Goodwill 15,000
Liabilities (in detail) 29,000
Common shares 95,000
A Company’s balance sheet after the business combination would be as
follows:
A COMPANY LTD. BALANCE SHEET
At January 1, Year 2
Assets (300,000 + 109,000) $409,000
Goodwill 15,000
$424,000
Liabilities (120,000 + 29,000) $149,000
Shareholders' equity:
Common shares (100,000 + 95,000) 195,000
Retained earnings 80,000
$424,000
This balance sheet was prepared by combining the carrying amounts of A
Company’s assets and liabilities with the fair values of those of B
Corporation.

22
The recently purchased assets are recorded at fair value and A Company’s
old assets are retained at carrying amount.

B Corporation would make the following journal entry to record the sale of
its assets and liabilities to A Company:
Investment in shares of A Company 95,000
Liabilities (in detail) 30,000
Assets (in detail) 88,000
Gain on sale of assets and liabilities 37,000

The selling company records the sale of its net assets in exchange for shares
of the acquiring company.

B Corporation’s balance sheet immediately following the sale of its net

assets is given below:
B CORPORATION BALANCE SHEET
At January 1, Year 2
Investment in shares of A Company $95,000
Shareholders' equity:
Common shares $25,000
Retained earnings (33,000 + 37,000) 70,000
$95,000
After the sale of net assets, B Corporation’s sole asset is investment in shares
of A Company.
B Corporation’s sole asset is 4,000 of the issued shares of A
Company. This single block represents a voting threat to A Company’s
shareholders (Group X). A Company will likely insist that B Corporation
be wound up and distribute these 4,000 shares to its shareholders
(Group Y), who presumably will not get together to determine how to
vote them.
SUMMARY
A business combination takes place when one company gains control
over the net assets of a business. An investor controls an investee when
it is exposed, or has rights, to variable returns from its involvement with
the investee, and has the ability to affect those returns through its power
over the investee.

23
 A business combination can be achieved by purchasing the net assets
directly, by purchasing enough voting shares to gain control over the use
of the net assets, or through contractual arrangements. The acquisition
method must be used to report a business combination. The balance
sheet for the combined entity at the date of acquisition includes the assets
and liabilities of the acquirer at their carrying amounts and the identifiable
assets and liabilities of the acquiree at their fair value.
When a business combination is achieved by purchasing the net assets
directly, the acquirer records the purchased assets and assumed liabilities
in its own accounting records. Any excess of the total consideration given
over the fair value of the subsidiary’s identifiable assets and liabilities is
recorded as goodwill.

Self-Study Problem
On December 31, Year 1, the condensed balance sheets for ONT Limited
and NB Inc. were as follows:
ONT NB
Assets:
Cash $ 44,000 $ 80,000
Accounts receivable 480,000 420,000
Inventories 650,000 540,000
Property, plant, and equipment 2,610,000 870,000
Accumulated depreciation (1,270,000) (130,000)
$2,514,000 $1,780,000
Liabilities:
Current liabilities $ 660,000 $ 560,000
Bonds payable 820,000 490,000
1,480,000 1,050,000
Shareholders' equity:
Common shares 200,000 400,000
Retained earnings 834,000 330,000
1,034,000 730,000
$2,514,000 $1,780,000
The fair value of all of NB’s assets and liabilities were equal to their
carrying amounts except for the following:

24
 Asset Carrying Amount Fair Value
Inventories $540,000 $570,000
Property, plant, and equipment 740,000 790,000
Bonds payable 490,000 550,000
Required
Assume that on January 1, Year 2, ONT acquired all of NB’s net
assets by issuing new common shares with a fair value of $1,000,000.
This was the only transaction on this day.
1- Prepare the journal entry on ONT’s book to record the
purchase of NB’s net assets.
2- Prepare a balance sheet for ONT at January 1, Year 2, after
recording the purchase of NB’s net assets.
Solution to Self-Study Problem
(1)
Cash 80,000
Accounts receivable 420,000
Inventories 570,000
Property, plant, and equipment 790,000
Goodwill 250,000
Current liabilities 560,000
Bonds payable 550,000
Common shares 1,000,000
(2)
ONT LIMITED
BALANCE SHEET
At January 1, Year 2
Assets:
Cash (44,000 + 80,000) $ 124,000
Accounts receivable (480,000 + 420,000) 900,000
Inventories (650,000 + 570,000) 1,220,000
Property, plant, and equipment (2,610,000 + 790,000) 3,400,000
Accumulated depreciation (1,270,000 + 0) (1,270,000)
Goodwill 250,000
$4,624,000
Liabilities:
Current liabilities (660,000 + 560,000) $1,220,000

25
 Bonds payable (820,000 + 550,000) 1.370.000
2.590.000
Shareholders' equity:
Common shares (200,000 + 1,000,000) 1,200,000
Retained earnings 834,000
2,034,000
$4,624,000
PROBLEMS
Problem 1-1
The balance sheets of Abdul Co. and Lana Co. on June 30, Year 2, just
before the transaction described below, were as follows:
Abdul Lana
Cash and receivables $ 93,000 $20,150
Inventory 60,500 8,150
Plant assets (net) 236,000 66,350
$389,500 $94,650
Current liabilities $ 65,500 $27,600
Long-term debt 94,250 40,100
Common shares 140,500 40,050
Retained earnings (deficit) 89,250 (13,100)
$389,500 $94,650

On June 30, Year 2, Abdul Co. purchased all of Lana Co. assets
and assumed all of Lana Co. liabilities for $58,000 in cash. The carrying
amounts of Lana’s net assets were equal to fair value except for the
following:
Fair Value
Inventory $10,050
Plant assets 70,100
Long-term debt 33,800

Required
1. Prepare the journal entries for Abdul Co. and for Lana Co. to record
this transaction.
2. Prepare the balance sheets for Abdul Co. and Lana Co. at June 30,
Year 2 after recording the transaction noted above.

26
Problem 1-2
Three companies, A, L, and M, whose December 31, Year 5, balance
sheets appear below, have agreed to combine as at January 1, Year 6.
Each of the companies has a very small proportion of an intensely
competitive market dominated by four much larger companies. In order
to survive, they have decided to merge into one company. The merger
agreement states that Company A will buy the assets and liabilities of
each of the other two companies by issuing 27,000 common shares to
Company L and 25,000 common shares to Company M, after which the
two companies will be wound up.
Company A’s shares are currently trading at $5 per share. Company
A will incur the following costs:
Costs of issuing shares $ 8,000
Professional fees 20,000
$28,000
The following information has been assembled regarding the three
companies:
COMPANY A
Carrying Fair Value
Amount
Current assets $ 99,900 $102,000
Plant and equipment (net) 147,600 160,000
$247,500
Liabilities $ 80,000 75,000
Common shares (50,000 shares) 75,000
Retained earnings 92,500
$247,500
COMPANY L
Carrying Fair Value
Amount
Current assets $ 60,000 $ 65,000
Plant and equipment (net) 93,000 98,000
$153,000
Liabilities $ 35,000 36,000
Common shares (24,000 shares) 48,000
Retained earnings 70,000
$153,000

27
 COMPANY M
Carrying Fair Value
Amount
Current assets $ 52,000 $ 68,000
Plant and equipment (net) 115,000 120,000
$167,000
Liabilities $ 72,000 70,000
Common shares (33,000 shares) 60,000
Retained earnings 35,000
$167,000

Required
Prepare the balance sheet of Company A on January 2, Year 6, after
Company L and Company M have been wound up.

Problem 1-3
The statement of financial position of Bagley Incorporated as at July 31,
Year 4, is as follows:
BAGLEY INCORPORATED
STATEMENT OF FINANCIAL POSITION
At July 31, Year 4
Carrying
Amount Fair Value
Plant and equipment—net $ 913,000 $1,056,000
Patents — 81,000
Current assets 458,000 510,000
$1,371,000
Ordinary shares $ 185,000
Retained earnings 517,000
Long-term debt 393,000 419,000
Current liabilities 276,000 276,000
$1,371,000

On August 1, Year 4, the directors of Bagley considered a takeover

offer from Davis Inc., whereby the corporation would sell all of its assets
and liabilities. Davis’s costs of investigation and drawing up the merger

28
 agreement would amount to $21,000.
Required
a- Assume that Davis made a $1,090,600 cash payment to Bagley
for its net assets. Prepare the journal entries in the accounting
records of Davis to record the business combination.
b- Assume that Davis issued 133,000 ordinary shares, with a market
value of $8.20 per share, to Bagley for its net assets. Legal fees
associated with issuing these shares amounted to $6,800 and
were paid in cash. Davis had 153,000 shares outstanding prior to
the takeover.
1- Prepare the journal entries in the records of Davis to record the
business combination.
2- Prepare the statement of financial position of Bagley
immediately after the sale.

Problem 1-4
D Ltd. and H Corporation are both engaged in the manufacture of
computers. On July 1, Year 5, they agree to a merger, whereby D will
issue 300,000 shares with a current market value of $9 each for the net
assets of H.
Summarized balance sheets of the two companies prior to the
merger are presented below:
BALANCE SHEET
At June 30, Year 5
D Ltd. H Corporation
Carrying Amount Carrying Amount Fair Value
Current assets $ 450,000 $ 500,000 $ 510,000
Non-current assets (net) 4,950,000 3,200,000 3,500,000
$5,400,000 $3,700,000
Current liabilities $ 600,000 $ 800,000 800,000
Long-term debt 1,100,000 900,000 920,000
Common shares 2,500,000 500,000
Retained earnings 1,200,000 1,500,000
$5,400,000 $3,700,000
In determining the purchase price, the management of D Ltd. noted that
H Corporation leases a manufacturing facility under an operating lease
that has terms that are favorable relative to market terms. However, the
lease agreement explicitly prohibits transfer of the lease (through either

29
sale or sublease). An independent appraiser placed a value of $60,000
on this favorable lease agreement.
Required
Prepare the July 1, Year 5, balance sheet of D, after the merger.

Problem 1-5
The following are summarized statements of financial position of three
companies as at December 31, Year 3:
Company X Company Y Company Z
Assets $400,000 $300,000 $250,000
Ordinary shares (note 1) $ 75,000 $ 48,000 $ 60,000
Retained earnings 92,500 70,000 35,000
Liabilities 232,500 182,000 155,000
$400,000 $300,000 $250,000
Note 1: Shares outstanding 50,000 12,000 16,500
The fair values of the identifiable assets and liabilities of the three
companies as at December 31, Year 3, were as follows:
Company X Company Y Company Z
Assets $420,000 $350,000 $265,000
Liabilities 233,000 180,000 162,000
On January 2, Year 4, Company X will purchase the assets and assume
the liabilities of Company Y and Company Z. It has been agreed that
Company X will issue common shares to each of the two companies as
payment for their net assets as follows:
To Company Y—13,500 shares
To Company Z—12,000 shares
The shares of Company X traded at $15 on December 31, Year 3.
Company X will incur the following costs associated with this
acquisition:
Costs of registering and issuing shares $12,000
Other professional fees associated with the takeover 30,000
$42,000
Company Y and Company Z will be wound up after the sale.
Required
a) Prepare a summarized pro forma statement of financial position of
Company X as at January 2, Year 4, after the purchase of net
assets from Company Y and Company Z.

30
 b) Prepare the pro forma statements of financial position of Company
Y and Company Z as at January 2, Year 4, after the sale of net
assets to Company X and prior to being wound up.

Problem 1-6
Myers Company Ltd. was formed 10 years ago by the issuance of 34,000
common shares to three shareholders. Four years later, the company
went public and issued an additional 30,000 common shares.
The management of Myers is considering a takeover in which Myers
would purchase all of the assets and assume all of the liabilities of Norris
Inc. Two alternative proposals are being considered:
PROPOSAL 1
Myers would offer to pay $446,400 cash for the Norris net assets, to be
financed by a $446,400 bank loan due in five years. In addition, Myers
would incur legal, appraisal, and finders’ fees for a total cost of $6,200.
PROPOSAL 2
Myers would issue 62,000 shares currently trading at $7.20 each for the
Norris net assets. Other costs associated with the takeover would be as
follows:
Legal, appraisal, and finders' fees $ 6,200
Costs of issuing shares 8,200
$14,400
Norris shareholders would be offered five seats on the 10-member board
of directors of Myers, and the management of Norris would be absorbed
into the surviving company.
Balance sheet data for the two companies prior to the combination are as
follows:

31
 Myers Norris Norris
Carrying Amount Carrying Amount Fair Value
Cash $ 152,000 $ 64,500 $ 64,500
Accounts receivable 179,200 73,450 68,200
Inventory 386,120 122,110 148,220
Land 437,000 87,000 222,000
Buildings (net) 262,505 33,020 36,020
Equipment (net) 90,945 29,705 27,945
$1,507,770 $409,785
Current liabilities $ 145,335 $ 53,115 53,115
Non-current liabilities — 162,000 167,000
Common shares 512,000 112,000
Retained earnings 850,435 82,670
$1,507,770 $409,785
Required
a) Prepare the journal entries of Myers for each of the two proposals
being considered.
b) Prepare the balance sheet of Myers after the takeover for each of
the proposals being considered.

32
 Chapter 2: Consolidated Statements: Date of Acquisition

The preceding chapter dealt with business combinations that are

accomplished as asset acquisitions. The net assets of an entire company
are acquired and recorded directly on the books of the acquiring company.
Consolidation of the two companies is automatic because all subsequent
transactions are recorded on a single set of books.
A company will commonly acquire a large enough interest in another
company’s voting common stock to obtain control of operations. The
company owning the controlling interest is termed the parent, while the
controlled company is termed the subsidiary. Legally, the parent company
has only an investment in the stock of the subsidiary and will only record
an investment account in its accounting records. The subsidiary will
continue to prepare its own financial statements. However, accounting
principles require that when one company has effective control over
another, a single set of consolidated statements must be prepared for the
companies under common control. The consolidated statements present
the financial statements of the parent and its subsidiaries as those of a
single economic entity. Worksheets are prepared to merge the separate
statements of the parent and its subsidiary(s) into a single set of
consolidated statements.
This chapter will show how to combine the separate statements of a
parent and its subsidiaries. The theory of acquisition accounting,
developed in Chapter 1, is applied in the consolidation process. In fact,
the consolidated statements of a parent and its 100% owned subsidiary
look exactly like they would have had the net assets been acquired. This
chapter contains only the procedures necessary to prepare consolidated
statements on the day that the controlling investment is acquired.

LEVELS OF INVESTMENT
The purchase of the voting common stock of another company
receives different accounting treatments depending on the level of
ownership and the amount of influence or control caused by the stock
ownership. The ownership levels and accounting methods can be
summarized as follows:

33
 Level of Ownership Initial Recording Recording of Income
Passive—generally under 20% At cost including Dividends as declared (except stock
ownership. brokers' fees. dividends).
Influential—generally 20% to At cost including Ownership share of income (or loss) is
50% ownership. brokers' fees. reported. Shown as investment income on
financial statements. (Dividends declared
are distributions of income already
recorded; they reduce the investment
account.)
Controlling—generally over At cost. Ownership share of income (or loss).
50% ownership. Accomplished by consolidating the
subsidiary income statement accounts
with those of the parent in the
consolidation process.

To illustrate the differences in reporting the income applicable to the

common stock shares owned, consider the following example based on
the reported income of the investor and investee (the company whose
shares are owned by investor):
Account Investor* Investee
Sales $500,000 $300,000
Less: Cost of goods sold 250,000 180,000
Gross profit $250,000 $120,000
Less: Selling and administrative expenses 100,000 80,000
Net income $150,000 $40,000
*Does not include any income from investee.
Assume that the investee company paid $10,000 in cash dividends.
The investor would prepare the following income statements, depending
on the level of ownership:
10% 30% 80%
Level of Ownership
Passive Influential Controlling
Sales
$500,000 $500,000 $800,000
Less: Cost of goods sold
250,000 250,000 430,000
Gross profit
$250,000 $250,000 $370,000
Less: Selling and administrative
100,000 100,000 180,000
expenses
Operating income $150,000
Dividend income (10% x $10,000 $150,000
dividends) 1,000
Investment income (30% x $40,000
reported income) 12,000
Net income $151,000 $162,000 $190,000
Distribution of income:
Noncontrolling interest (20% x $40,000 $8,000
reported income)
Controlling interest (100% of investor's $182,000
$150,000 + 80% of investee's $40,000)

34
 With a 10% passive interest, the investor included only its share of
the dividends declared by the investee as its income. With a 30%
influential ownership interest, the investor reported 30% of the investee
income as a separate source of income. With an 80% controlling interest,
the investor (now termed the parent) merges the investee’s (now a
subsidiary) nominal accounts with its own amounts. Dividend and
investment income no longer exist. A single set of financial statements
replaces the separate statement of the entities. If the parent owned a
100% interest, net income would simply be reported as $190,000. Since
this is only an 80% interest, the net income must be shown as distributed
between the noncontrolling and controlling interests. The noncontrolling
interest is the 20% of the subsidiary that is not owned by the parent. The
controlling interest is the parent income plus 80% of the subsidiary
income.

Notes
• An influential investment (generally over 20% ownership) requires
recording, as a single line-item amount, the investor's share of the
investee's income as it is earned.
• A controlling investment (generally over 50% ownership) requires
that subsidiary income statement accounts be combined with
those of the parent company.
• The essence of consolidated reporting is the portrayal of the
separate legal entities as a single economic entity.

FUNCTION OF CONSOLIDATED STATEMENTS

Consolidated financial statements are designed to present the results
of operations, cash flow, and the balance sheet of both the parent and its
subsidiaries as if they were a single company. Generally, consolidated
statements are the most informative to the stockholders of the controlling
company. Yet, consolidated statements do have their shortcomings. The
rights of the noncontrolling shareholders are limited to only the company
they own, and, therefore, they get little value from consolidated
statements. They really need the separate statements of the subsidiary.
Similarly, creditors of the subsidiary need its separate statements
because they may look only to the legal entity that is indebted to them for
satisfaction of their claims. The parent’s creditors should be content with
the consolidated statements, since the investment in the subsidiary will
produce cash flows that can be used to satisfy their claims.
Consolidated statements have been criticized for being too
aggregated. Unprofitable subsidiaries may not be very obvious because,
when consolidated, their performance is combined with that of other
affiliates. However, this shortcoming is easily overcome. One option is to

35
 prepare separate statements of the subsidiary as supplements to the
consolidated statements. The second option, which may be required, is to
provide disclosure for major business segments. When subsidiaries are
in businesses distinct from the parent, the definition of a segment may
parallel that of a subsidiary.
Criteria for Consolidated Statements
Under U.S. GAAP, there are two models that determine when
consolidation of financial statements is required. The most common model
is based on control of a voting interest entity. That is an entity with
common stock where the investor company owns over 50% of the voting
common shares. That ownership interest is referred to as a ‘‘Controlling
Interest.’’ There are, however, exceptions where control may also exist
with a lesser percentage of ownership such as when there is control via
contract, lease, agreement with other shareholders, or by court decree.
The Securities and Exchange Commission (SEC) also requires
consolidation where an affiliate is not majority owned. The situations
where this could apply are:
1. The company financed the affiliate directly or indirectly.
2. The company owns securities that upon exercise or conversion would
create majority ownership.
3. The company will compensate the affiliate for incurred start-up losses.
The second FASB model applies to variable interest entities (VIE). The
definition of a VIE is based on an entity meeting one of four requirements:
1. The possible investor and its related companies participate significantly in
the design of the entity. The entity cannot be a joint venture or a
franchisee.
2. The entity is designed such that almost all of its activities include or are
for the benefit of the investor.
3. The investor and its related companies provide over 50% of the equity,
subordinated debt, or other subordinated financial support of the entity.
This test is based on the fair value of the entity.
4. The entity’s activities are mainly financial in nature involving
securitizations, asset-backed financing, or leasing benefiting the investor.
The unique consolidation procedures for VIEs are covered in an
appendix to this chapter.
Consolidation may also be required when a not-for-profit (NFP) entity
has a controlling interest in another NFP. Control can be based on
ownership of a majority interest or if there are an economic interest and a
majority voting interest.

36
 Notes
• The combining of the statements of a parent and its subsidiaries into
consolidated statements is required when parent ownership exceeds 50%
of the controlled firm's shares.
• Consolidation is required for any company that is controlled, even in cases
where less than 51% of the company's shares is owned by the parent.

TECHNIQUES OF CONSOLIDATION
This chapter builds an understanding of the techniques used to
consolidate the separate balance sheets of a parent and its subsidiary
immediately subsequent to the acquisition.
Chapter 1 emphasized that there are two means of achieving control
over the assets of another company. A company may directly acquire the
assets of another company, or it may acquire a controlling interest in the
other company’s voting common stock. In an asset acquisition, the
company whose assets were acquired is dissolved. The assets acquired
are recorded directly on the books of the acquirer, and consolidation of
balance sheet amounts is automatic. Where control is achieved through a
stock acquisition, the acquired company (the subsidiary) remains as a
separate legal entity with its own financial statements. While the initial
accounting for the two types of acquisitions differs significantly, a 100%
stock acquisition and an asset acquisition have the same effect of creating
one larger single reporting entity and should produce the same
consolidated balance sheet. There is, however, a difference if the stock
acquisition is less than 100%. Then, there will be a noncontrolling interest
in the consolidated balance sheet. This is not possible when the assets
are purchased directly.
In the following discussion, the recording of an asset acquisition and a
100% stock acquisition are compared, and the balance sheets that result
from each type of acquisition are studied. Then, the chapter deals with the
accounting procedures needed when there is less than a 100% stock
ownership and a noncontrolling equity interest exists.

Reviewing an Asset Acquisition

Illustration 2-1 demonstrates an asset acquisition of Company S by
Company P for cash. Part A of the exhibit presents the balance sheets of
the two companies just prior to the acquisition. Part B shows the entry to
record Company P’s payment of $500,000 in cash for the net assets of
Company S. The book values of the assets and liabilities acquired are
assumed to be representative of their fair values, and no goodwill is
acknowledged. The assets and liabilities of Company S are added to
those of Company P to produce the balance sheet for the combined
company, shown in Part C. Since account balances are combined in

37
 recording the acquisition, statements for the single combined reporting
entity are produced automatically, and no consolidation process is
needed.

Illustration 2-1 Asset Acquisition

Part A. Balance sheets of Companies P and S prior to acquisition:
Company P Balance Sheet
Assets Liabilities and Equity
Cash ...................... $800,000 Current liabilities ....... $150,000
Accounts receivable 300,000 Bonds payable .......... 500,000
Inventory ................ 100,000 Common stock .......... 100,000
Equipment (net) ..... 150,000 Retained earnings..... 600,000
Total .................... $1,350,000 Total .................... $1,350,000

Company S Balance Sheet

Assets Liabilities and Equity
Accounts receivable $200,000 Current liabilities .... $100,000
Inventory ................ 100,000 Common stock ....... 200,000
Equipment (net) ..... 300,000 Retained earnings.. 300,000
Total ............... $600,000 Total ............... $600,000

Part B. Entry on Company P's books to record acquisition of the net assets of
Company S by Company P:
Accounts Receivable 200,000
Inventory 100,000
Equipment 300,000
Current Liabilities 100,000
Cash 500,000

Part C. Balance sheet of Company P (the combined company) subsequent to asset

acquisition:
Company P Balance Sheet
Assets Liabilities and Equity
Cash $300,000 Current liabilities $250,000
Accounts receivable 500,000 Bonds payable 500,000
Inventory 200,000 Common stock 100,000
Equipment (net) 450,000 Retained earnings 600,000
Total $1,450,000 Total $1,450,000

Consolidating a Stock Acquisition

In a stock acquisition, the acquiring company deals only with existing
shareholders, not the company itself. Assuming the same facts as those
used in Illustration 2-1, except that Company P will acquire all the
outstanding stock of Company S from its shareholders for $500,000,
Company P would make the following entry:

38
 Investment in Subsidiary S .................................... 500,000
Cash ……………….……………………………………500,000
This entry does not record the individual underlying assets and
liabilities over which control is achieved. Instead, the acquisition is
recorded in an investment account that represents the controlling
interest in the net assets of the subsidiary. If no further action was
taken, the investment in the subsidiary account would appear as a long-
term investment on Company P’s balance sheet. However, such a
presentation is permitted only if consolidation were not required (i.e., when
control does not exist).
Assuming consolidated statements are required (i.e., when control does
exist), the balance sheet of the two companies must be combined into a
single consolidated balance sheet. The consolidation process is separate
from the existing accounting records of the companies and requires
completion of a worksheet. No journal entries are actually made to the
parent’s or subsidiary’s books, so the elimination process starts anew
each year.
The first example of a consolidated worksheet, Worksheet 2-1, appears
later in the chapter on page 74. (The icon in the margin indicates the
location of the worksheet at the end of the chapter.) The first two columns
of the worksheet include the trial balances (balance sheet only for this
chapter) for Companies P and S. The trial balances and the consolidated
balance sheet are presented in single columns to save space. Credit
balances are shown in parentheses. Obviously, since there are no
nominal accounts listed, the income statement accounts have already
been closed to Retained Earnings.
The consolidated worksheet requires elimination of the investment
account balance because the two companies will be treated as one. (How
can a company have an investment in itself?) Similarly, the subsidiary’s
stockholders’ equity accounts are eliminated because its assets and
liabilities belong to the parent, not to outside equity owners. In general
journal form, the elimination entry is as follows:

(EL) Common Stock, Company S ......................... 200,000

Retained Earnings, Company S ................................ 300,000
Investment in Company……………………..……….. 500,000

Note that the key (EL) will be used in all future worksheets. Keys,
once introduced, will be assigned to all similar items throughout the text.
For quick reference, a listing of these keys is provided on the inside front
cover of this text. The balances in the Consolidated Balance Sheet column
(the last column) are exactly the same as in the balance sheet prepared
for the preceding asset acquisition example—as they should be for a
100% stock acquisition.

39
 Notes
• Consolidation when a parent owns 100% of the subsidiary's voting
common stock produces the same balance sheet that would result in an
asset acquisition.
• Consolidated statements are derived from the individual statements of the
parent and its subsidiaries.

ADJUSTMENT OF SUBSIDIARY ACCOUNTS

In the last example, the price paid for the investment in the subsidiary
was equal to the net book value of the subsidiary (which means the price
was also equal to the subsidiary’s stockholders’ equity). In most
acquisitions, the price will exceed the book value of the subsidiary’s net
assets. Typically, fair values will exceed the recorded book values of
assets. The price may also reflect unrecorded intangible assets, including
goodwill. Let us revisit the last example and assume that instead of paying
$500,000 cash, Company P paid $700,000 cash for all the common stock
shares of Company S and made the following entry for the purchase:

Investment in Subsidiary S ................................. 700,000

Cash ……………………………………………… 700,000

Use the same Company S balance sheet as in Illustration 2-1, with

the following additional information on fair values:

Company S Book and Estimated Fair Values December 31, 2015

Liabilities and
Assets Book Value Fair Value Equity Book Value Fair Value
Accounts
$200,000 $200,000 Current liabilities $100,000 $100,000
receivable
Inventory Market value of
100,000 120,000
Equipment (net) net assets (assets
300,000 400,000
— liabilities) $620,000
Total assets $600,000 $720,000

If this were an asset acquisition, the identifiable assets and liabilities

would be recorded at fair value and goodwill at $80,000. This is the price
paid of $700,000 minus the $620,000 ($720,000 total assets — $100,000
total liabilities) fair value of net assets. Adding fair values to Company P’s
accounts, the new balance sheet would appear as follows:

40
 Company P
Consolidated Balance Sheet December 31,2015
Assets Liabilities and Equity
Current assets: Current liabilities $250,000
Cash $100,000 Bonds payable 500,000
Accounts receivable 500,000 Total liabilities $750,000
Inventory 220,000
Total current assets $820,000
Long-term assets: Stockholders' equity:
Equipment (net) $550,000 Common stock $100,000
Goodwill 80,000 Retained earnings 600,000
Total long-term
630,000 Total equity 700,000
assets
Total assets $1,450,000 Total liabilities and equity $1,450,000

As before, the consolidated worksheet should produce a consolidated

balance sheet that looks exactly the same as the preceding balance sheet
for an asset acquisition. Worksheet 2-2, on page 75, shows how this is
accomplished.
• The (EL) entry is the same as before: $500,000 of subsidiary equity is
eliminated against the investment account.
• Entry (D) distributes the remaining cost of $200,000 to the acquired assets
to bring them from book to fair value and to record goodwill of $80,000.

In general journal entry form, the elimination entries are as follows:

(EL) Common Stock, Company S ................................................. 200,000

Retained Earnings, Company S ............................................ 300,000
Investment in Company S……………………………… 500,000

(D1) Inventory (to increase from $100,000 to $120,000) ............... 20,000

(D2) Equipment (to increase from $300,000 to $400,000)………….100,000
(D3) Goodwill ($700,000 price minus $620,000 fair value
assets)............................................................................................... 80,000
(D) Investment in Company S ($700,000 price minus
$500,000 book value eliminated above) ............................................ …….. 200,000

The Consolidated Balance Sheet column of Worksheet 2-2 includes the

subsidiary accounts at full fair value and reflects the $80,000 of goodwill
included in the purchase price. The formal balance sheet for Company P,
based on the worksheet, would be exactly the same as shown above for
the asset acquisition.
Acquisition of a subsidiary at a price in excess of the fair values of the
subsidiary equity is as simple as the case just presented, especially where
there are a limited number of assets to adjust to fair value. For more
involved acquisitions, where there are many accounts to adjust and/or the

41
 price paid is less than the fair value of the net assets, a more complete
analysis is needed. We will now proceed to develop these tools.

Analysis of Complicated Purchases—100% Interest

The previous examples assumed the purchase of the subsidiary for
cash. However, most acquisitions are accomplished by the parent issuing
common stock (or, less often, preferred stock) in exchange for the
subsidiary common shares being acquired. This avoids the depletion of
cash and, if other criteria are met, allows the subsidiary shareholders to
have a tax-free exchange. In most cases, the shares are issued by a
publicly traded parent company that provides a readily determinable
market price for the shares issued. The investment in the subsidiary is
then recorded at the fair value of the shares issued. Less frequently, a
nonpublicly traded parent may issue shares to subsidiary shareholders. In
these cases, the fair values are determined for the net assets of the
subsidiary company, and the total estimated fair value of the subsidiary
company is recorded as the cost of the investment.
In order to illustrate the complete procedures used to record the
investment in and the consolidation of a subsidiary, we will consider the
acquisition of a 100% interest in Sample Company. The book and fair
values of the net assets of Sample Company on December 31, 2015,
when Parental, Inc., acquired 100% of its shares, were as follows:

Book Market Book Market

Assets Value Value Liabilities and Equity Value Value
Accounts receivable $20,000 $20,000 Current liabilities ............ $40,000 $40,000
Inventory ............... 50,000 55,000 Bonds payable ............. 100,000 100,000
Land ....................... 40,000 70,000 Total liabilities ........... $140,000 $140,000
Buildings ............... 200,000 250,000
Accumulated
depreciation (50,000) Stockholders' equity:
Equipment ............ 60,000 60,000 Common stock ($1 par) . $10,000
Accumulated (20,000) Paid-in capital in excess 90,000
depreciation of par .............................
Copyright .............. 50,000 Retained earnings ........ 60,000
Total equity ................ $160,000
Total assets .......... $300,000 $505,000 Net assets .................... $160,000 $365,000

Assume that Parental, Inc., issued 20,000 shares ofits$1 par value
common stock for 100% (10,000 shares) of the outstanding shares of
Sample Company. The fair value of a share of Parental, Inc., stock is $25.
Parental also pays $25,000 in accounting and legal fees to accomplish
the purchase. Parental would make the following entry to record the
purchase:

42
Investment in Sample Company
(20,000 shares issued x $25 fair value) 500,000
Common Stock ($1 par value) (20,000 shares x $1 par) 20,000
Paid-In Capital in Excess of Par ($500,000 — $20,000 par value) 480,000

Parental would record the costs of the acquisition as follows:

Acquisition Expense (closed to Retained Earnings since only balance sheets
are being examined).................................................. 25,000
Cash………………………………..…………….. 25,000
A value analysis schedule has been designed to compare the fair value
of the company acquired with the fair value of the net assets. In this case,
the fair value of the company is based on the value of the shares
exchanged by Parental, Inc. The schedule includes a column for a
noncontrolling interest (NCI) for later cases when the parent does not
acquire a 100% interest.
Company
Implied Fair Parent Price NCI Value
Value Analysis Schedule Value (100%) (0%)
Company fair value ........................ $500,000 $500,000 N/A
Fair value of net assets excluding
goodwill .......................................... 365,000 365,000
Goodwill ....................................... $135,000 $135,000
Gain on acquisition ........................ N/A N/A

Notice the following features of the value analysis:

• In this case, the company fair value exceeds the fair value of the net
assets. This means that all subsidiary accounts will be adjusted to fair
value, and goodwill of $135,000 will be shown on the consolidated
balance sheet.
• If the company fair value was less than the fair value of the net assets, all
of the subsidiary accounts would still be adjusted to fair value and a gain
on the acquisition would be recorded.
Reflection
• The value analysis schedule determines if there will be goodwill or a gain
as a result of consolidating the subsidiary with the parent.

DETERMINATION AND DISTRIBUTION OF EXCESS SCHEDULE

The determination and distribution of excess (D&D) schedule is
used to compare the company fair value with the recorded book value of
the subsidiary. It also schedules the adjustments that will be made to all
subsidiary accounts in the consolidated worksheet process. The D&D
schedule below is for a 100% interest but is built to accommodate an NCI
in later examples.

43
 Determination and Distribution of Excess Schedule
Company
Implied Parent Price NCI
Fair Value (100%) Value (0%)
Fai Fair value of subsidiary .................... $500,000 $500,000 N/A
Less book value of interest acquired:
Common stock ($1 par)............ $10,000
Paid-in capital in excess of par 90,000
Retained earnings .................... 60,000
Total stockholders' equity .. $160,000 $160,000
Interest acquired ...................... 100%
Book value ....................................... $160,000
Excess of fair value over book value $340,000 $340,000

Adjustment of identifiable accounts:

Adjustment Worksheet Key
Inventory ($55,000 fair — $50,000 book value) $5,000 debit D1
Land ($70,000 fair — $40,000 book value) 30,000 debit D2
Buildings ($250,000 fair — $150,000 net book value) 100,000 debit D3
Equipment ($60,000 fair — $40,000 net book value) 20,000 debit D4
Copyright ($50,000 fair — $0 book value) 50,000 debit D5
Goodwill .......................................... 135,000 debit D6
Total............................................... $340,000

Note the following features of the above D&D schedule:

♦ Since this is a 100% interest, the parent price and the implied value
of the subsidiary are equal.
♦ The total adjustment that will have to be made to subsidiary net
assets on the worksheet is $340,000.
♦ The schedule shows the adjustments to each subsidiary account.
Recall that in Chapter 1, we recorded the entire value of the subsidiary
accounts in the acquisition entry. Now the subsidiary assets are already
listed on the worksheet at book value, and they only need to be adjusted
to fair value.

The D&D schedule provides complete guidance for the worksheet

eliminations. Study Worksheet 2-3 on page 76 and note the following:
♦ Elimination (EL) eliminated the subsidiary equity purchased (100%
in this example) against the investment account as follows:
(EL) Common Stock ($1 par)—Sample ............................................... 10,000
Paid-In Capital in Excess of Par—Sample .......................................... 90,000
Retained Earnings—Sample ............................................................... 60,000
Investment in Sample Company……………………………………. 160,000
♦ The (D) series eliminations distribute the $340,000 excess to the
appropriate accounts, as indicated by the D&D schedule. A valuable
check is to be sure that the investment account is now eliminated. If it has

44
 not been eliminated, there has been an error in the balances entered into
the Balance Sheet columns of the worksheet. Worksheet eliminations are
as follows:
(D1) Inventory ............................................................ 5,000
(D2) Land ................................................................. 30,000
(D3) Buildings ......................................................... 100,000
(D4) Equipment ........................................................ 20,000
(D5) Copyright .......................................................... 50,000
(D6) Goodwill ......................................................... 135,000
(D) Investment in Sample Company [remaining excess after (EL)]… 340,000

The amounts that will appear on the consolidated balance sheet are
shown in the final column of Worksheet 2-3. Notice that we have
consolidated 100% of the fair values of subsidiary accounts with the
existing book values of parent company accounts.
Formal Balance Sheet
The formal consolidated balance sheet resulting from the 100% purchase
of Sample Company, in exchange for 20,000 Parental shares, has been
taken from the Consolidated Balance Sheet column of Worksheet 2-3.
Parental, Inc.
Consolidated Balance Sheet December 31,2015
Assets Liabilities and Equity
Current assets: Current liabilities $120,000
Cash $84,000 Bonds payable 300,000
Accounts receivable 92,000 Total liabilities $420,000
Inventory 135,000
$311,000 Stockholders' equity:
Total current assets Common stock ($1 par) $40,000
Long-term assets: $170,000 Paid-in capital in excess 680,000
Land 800,000 of par
Buildings Retained earnings 456,000
Accumulated (130,000)
depreciation 1,176,000
320,000 Total controlling equity
Equipment
Accumulated (60,000)
depreciation 50,000
Copyright (net) 135,000
Goodwill (net)
Total long-term assets. 1,285,000
Total liabilities and equity
Total assets $1,596,000 $1,596,000

Bargain Purchase
A bargain purchase refers to an acquisition at a price that is less than the
fair value of the subsidiary net identifiable assets. Let us change the prior
example to assume that Parental, Inc., issued only 12,000 shares of its
stock. The entry to record the purchase would be as follows.

45
 Investment in Sample Company (12,000 shares issued x $25 fair value) 300,000
Common Stock ($1 par value) (12,000 shares x $1 par) ............... .……12,000
Paid-In Capital in Excess of Par ($300,000 — $12,000 par value)…...288,000

The entry to record the costs of the acquisition would be as follows:

Acquisition Expense (closed to Retained Earnings since only balance sheets are being
examined) 25,000
Cash 25,000

The value analysis schedule would compare the price paid with the fair
value of the subsidiary net identifiable assets as follows:
Company
Implied Fair Parent Price NCI Value
Value Analysis Schedule Value (100%) (0%)
Company fair value ............... $300,000 $300,000 N/A
Fair value of net assets excluding 365,000 365,000
goodwill
Goodwill ................................ N/A N/A
Gain on acquisition ............. $(65,000) $(65,000)
The D&D schedule would be as follows for the $300,000 price:
Determination and Distribution of Excess/Schedule
NCI
Company Implied Parent Price Value
Fair Value (100%) (0%)
Fair value of subsidiary ............... $300,000 $300,000 N/A
Less book value of interest acquired:
Common stock ($1 par) ........... $10,000
Paid-in capital in excess of par 90,000
Retained earnings ................... 60,000
Total equity .............................. $160,000 $160,000
Interest acquired ...................... 100%
Book value .................................. $160,000
Excess of fair value over book value $140,000 $140,000
Adjustment of identifiable accounts:
Worksheet
Adjustment Key
Inventory ($55,000 fair — $50,000 book value) $5,000 debit D1
Land ($70,000 fair — $40,000 book value) 30,000 debit D2
Buildings ($250,000 fair — $150,000 net book
value) ...................................... debit D3
100,000
Equipment ($60,000 fair — $40,000 net book
value) ...................................... 20,000 debit D4
Copyright ($50,000 fair — $0 book value) 50,000 debit D5
Gain on acquisition .................. (65,000) credit D7
Total ......................................... $140,000

Note the following features of the above D&D schedule:

46
 ♦ All identifiable net assets are still adjusted to full fair value even
though it was a bargain purchase.
♦ A gain will be distributed to the parent on the worksheet.

The D&D schedule provides complete guidance for the worksheet

eliminations. Study Worksheet 2-4 on page 78 and note the following:
♦ Elimination (EL) eliminated the subsidiary equity purchased (100%
in this example) against the investment account as follows:
(EL) Common Stock ($1 par)—Sample……….. 10,000
Paid-In Capital in Excess of Par—Sample...90,000
Retained Earnings—Sample………………. 60,000
Investment in Sample Company………. ..................... 160,000
♦ The (D) series eliminations distribute the $100,000 excess to the
appropriate accounts, as indicated by the D&D schedule. Worksheet
eliminations are as follows:
(D1) Inventory .................................................... 5,000
(D2) Land ......................................................... 30,000
(D3) Buildings ................................................ 100,000
(D4) Equipment ................................................ 20,000
(D5) Copyright.................................................. 50,000
(D7) Retained Earnings—Parental* …………… 65,000
(D) Investment in Sample Company [remaining excess
after (EL)] ................................................................... …………… 140,000

*Since only a balance sheet is being prepared, the gain on the acquisition
is closed directly to Parental Retained Earnings.
The amounts that will appear on the consolidated balance sheet are
shown in the final column of Worksheet 2-4. Notice that 100% of the fair
values of subsidiary accounts has been consolidated with the existing
book values of parent company accounts.
There could be an unusual situation where the price paid by the parent
is less than the book value of the subsidiary net assets. For example, if
the price paid by the parent was only $150,000, the value analysis
schedule would be as follows:

Company Implied Parent Price NCI Value

Value Analysis Schedule Fair Value (100%) (0%)
Company fair value ................ $150,000 $150,00 N/A
Fair value of net assets excluding
365,000 365,000
goodwill
Goodwill ................................. N/A N/A
Gain on acquisition ............. $(215,000) $(215,000)

47
 The D&D schedule would be as follows for the $150,000 price:
Determination and Distribution of Excess Schedule
Company
Implied Parent Price NCI Value
Fair Value (100%) (0%)
Fair value of subsidiary ............. $150,000 $150,000 N/A
Less book value of interest
acquired:
Common stock ($1 par) ......... $10,000
Paid-in capital in excess of par
.............................................. 90,000
Retained earnings ................. 60,000
Total equity .......................... $160,000 $160,000
Interest acquired .................... 100%
Book value ................................ $160,000
Excess of fair value over book $(10,000)
$(10,000)
value .........................................
Adjustment of identifiable accounts:
Adjustment Worksheet Key
Inventory ($55,000 fair — $50,000 book value) $5,000 debit D1
Land ($70,000fair — $40,000 book value) 30,000 debit D2
Buildings ($250,000 fair — $150,000 book value) 100,000 debit D3
Equipment ($60,000 fair — $40,000 book value) 20,000 debit D4
Copyright ($50,000 fair — $0 book value) 50,000 debit D5
Gain on acquisition* ............... (215,000) credit D7
Total ...................................... $(10,000)
*Agrees with total (company) gain in the value analysis schedule.

The eliminations on the worksheet would be as follows:

♦ Elimination (EL) eliminated the subsidiary equity purchased (100% in this
example) against the investment account as follows:
(EL) Common Stock ($1 par)—Sample ............................................. 10,000
Paid-In Capital in Excess of Par—Sample ................................ 90,000
Retained Earnings—Sample ..................................................... 60,000
Investment in Sample Company……………………………….. 160,000
• The (D) series eliminations distribute the $10,000 negative excess to the
appropriate accounts, as indicated by the D&D schedule. Worksheet
eliminations are as follows:
(D1) Inventory .................................................... 5,000
(D2) Land ......................................................... 30,000
(D3) Buildings ................................................ 100,000
(D4) Equipment ................................................ 20,000
(D5) Copyright .................................................. 50,000
(D7) Retained Earnings—Parental*.......... ………… 215,000
(D) Investment in Sample Company [remaining excess after
(EL)] ............................................................................. 10,000

48
*Since only a balance sheet is being prepared, the gain on the acquisition
is closed directly to Parental Retained Earnings.
A worksheet, in this case, would debit the investment account $10,000 to
cure the distribution of adjustments to subsidiary accounts that exceed the
amount available for distribution.
Notes
• The D&D schedule compares the price paid for the investment in the
subsidiary with subsidiary book values and schedules the adjustments to
be made on the worksheet.
• The worksheet adjusts the subsidiary accounts to fair values and
adds them to the parent accounts to arrive at a consolidated balance
sheet.

CONSOLIDATING WITH A NONCONTROLLING INTEREST

Consolidation of financial statements is required whenever the parent
company controls a subsidiary. In other words, a parent company could
consolidate far less than a 100% ownership interest. If a parent company
owns 80% of the common stock of a company, the remaining 20% interest
is noncontrolling interest. Several important ramifications may arise when
less than 100% interest is consolidated.
♦ The parent’s investment account is eliminated against only its
ownership percentage of the underlying subsidiary equity accounts. The
NCI is shown on the consolidated balance sheet in total and is not broken
into par, paid-in capital in excess of par, and retained earnings. The NCI
must be shown as a component of stockholders’ equity. In the past, the
NCI has also been displayed on the consolidated balance sheet as a
liability, or in some cases has appeared between the liability and equity
sections of the balance sheet. These alternatives are no longer allowed.
♦ The entire amount of every subsidiary nominal (income statement)
account is merged with the nominal accounts of the parent to calculate
consolidated income. The noncontrolling interest is allocated its
percentage ownership times the reported income of the subsidiary only.
In the past, this share of income has often been treated as an other
expense in the consolidated income statement. FASB ASC 810-10-65-1
requires that it not be shown as an expense but, rather, as a distribution
of consolidated income.
♦ Subsidiary accounts are adjusted to full fair value regardless of the
controlling interest percentage. Prior to 2009, subsidiary accounts would
only be adjusted to the controlling interest percentage ownership interest.
For example, assume that the parent owns an 80% interest in the
subsidiary. Further assume that the book value of equipment is $100,000
and that its fair value is $150,000. Past practice would have been to adjust
the asset by $40,000 (80% ownership interest x $50,000 fair value-book

49
 value difference). The new requirement is that the asset will be adjusted
for the full $50,000 difference no matter what size the controlling interest
is.

Analysis of Complicated Purchase with a Noncontrolling Interest

We will illustrate consolidation procedures using the 80% acquisition
of Sample Company by Parental, Inc. Presented below are the balance
sheet amounts and the fair values of the assets and liabilities of Sample
Company as of December 31, 2015.

Book Market Book Market

Assets Value Value Liabilities and Equity Value Value
Accounts
receivable $20,000 $20,000 Current liabilities $40,000 $40,000
Inventory 50,000 55,000 Bonds payable 100,000 100,000
Land 40,000 70,000 Total liabilities $140,000 $140,000
Buildings 200,000 250,000
Accumulated
depreciation (50,000) Stockholders' equity:
Equipment 60,000 60,000 Common stock ($1 par) $10,000
Accumulated Paid-in capital in excess of
depreciation (20,000) par 90,000
Copyright 50,000 Retained earnings 60,000
Total equity $160,000
Total assets $300,000 $505,000 Net assets $160,000 $365,000

Assume that Parental, Inc., issued 16,000 shares of its $1 par value
common stock for 80% (8,000 shares) of the outstanding shares of
Sample Company. The fair value of a share of Parental, Inc., stock is $25.
Parental also pays $25,000 in accounting and legal fees to accomplish
the purchase. Parental would make the following entry to record the
purchase:
Investment in Sample Company (16,000 shares issued x $25 fair value) 400,000
Common Stock ($1 par value) (16,000 shares x $1 par) .............. …………16,000
Paid-In Capital in Excess of Par ($400,000 — $16,000 par value)………..384,000

Parental would record the costs of the acquisition as follows:

Acquisition Expense (closed to Retained Earnings since only balance sheets are being
examined)…………………………………………………………..25,000
Cash ………………………………………………………………………... 25,000

50
 The following value analysis would be prepared for the 80% interest:
Company Parent
Implied Fair Price NCI Value
Value Analysis Schedule Value (80%) (20%)
Company fair value ............... $500,000 $400,000 $100,000
Fair value of net assets excluding goodwill 365,000 292,000 73,000
Goodwill ............................... $135,000 $108,000 $27,000
Gain on acquisition ............... N/A N/A

Several assumptions went into the above calculation.

♦ Company fair value—It is assumed that if the parent would pay $400,000
for an 80% interest, then the entire subsidiary company is worth $500,000
($400,000/80%). We will refer to this as the ‘‘implied value’’ of the
subsidiary company. Assuming this to be true, the NCI is worth 20% of
the total subsidiary company value (20% x $500,000 = $100,000). This
approach assumes that the price the parent would pay is directly
proportional to the size of the interest purchased. We will later study the
situation where this presumption is defeated. Unless otherwise stated,
exercises and problems in this text will assume the value of the NCI
is ‘‘implied’’ by the price the parent pays for the controlling interest.
♦ Fair value of net assets excluding goodwill ($365,000)—The fair
values of the subsidiary accounts are from the comparison of book and
fair values. All identifiable assets and all liabilities will be adjusted to 100%
of fair value regardless of the size of the controlling interest purchased.
♦ Goodwill—The total goodwill is the excess of the ‘‘company fair value’’
over the fair value of the subsidiary net assets. It is proportionately
allocated to the controlling interest and NCI.

Determination and Distribution of Excess Schedule

The D&D schedule that follows revalues the entire entity, including the NCI.
Determination and Distribution of Excess Schedule
Company
Implied Parent Price NCI Value
Fair Value (80%) (20%)
Fair value of subsidiary $500,000 $400,000 $100,000
Less book value of interest acquired:
Common stock ($1 par) . $10,000
Paid-in capital in excess of par 90,000
Retained earnings ......... 60,000
Total equity ...................... $160,000 $160,000 $160,000
Interest acquired .............. 80% 20%
Book value ....................... $128,000 $32,000
Excess of fair value over book value $340,000 $272,000 $68,000

51
 Adjustment of identifiable accounts:
Adjustment Worksheet Key
Inventory ($55,000 fair — $50,000 book value) $5,000 debit D1
Land ($70,000 fair — $40,000 book value) 30,000 debit D2
Buildings ($250,000 fair — $150,000 net book value) 100,000 debit D3
Equipment ($60,000 fair — $40,000 net book value) 20,000 debit D4
Copyright ($50,000 fair — $0 book value) 50,000 debit D5
Goodwill ($500,000 fair — $365,000 book value) 135,000* debit D6
Total ................................................ $340,000
*Agrees with total (company) goodwill in the value analysis schedule.

Note the following features of a D&D schedule for a less than 100%
parent ownership interest:
♦ The ‘‘fair value of subsidiary’’ line contains the implied value of the
entire company, the parent price paid, and the implied value of the NCI
from the above value analysis schedule.
♦ The total stockholders’ equity of the subsidiary (equal to the net assets
of the subsidiary at book value) is allocated 80/20 to the controlling
interest and the NCI.
♦ The excess of fair value over book value is shown for the company,
the controlling interest, and the NCI. This line means that the entire
adjustment of subsidiary net assets will be $340,000. The controlling
interest paid $272,000 more than the underlying book value of subsidiary
net assets. This is the excess that will appear on the worksheet when the
parent’s 80% share of subsidiary stockholders’ equity is eliminated
against the investment account.
Finally, the NCI share of the increase to fair value is $68,000.
• All subsidiary assets and liabilities will be increased to 100% of fair
value, just as would be the case for a 100% purchase.
The D&D schedule provides complete guidance for the worksheet
eliminations. Study Worksheet 2-5 on page 80 and note the following:
• Elimination (EL) eliminated the subsidiary equity purchased (80% in
this example) against the investment account as follows:
(EL) Common Stock ($1 par)—Sample ............................................. 8,000
Paid-In Capital in Excess of Par—Sample ................................ 72,000
Retained Earnings—Sample ..................................................... 48,000
Investment in Sample Company ................................................. 128,000

• The (D) series eliminations distribute the excess applicable to the

controlling interest plus the increase in the NCI [labeled (NCI)] to the
appropriate accounts, as indicated by the D&D schedule. The
adjustment of the NCI is carried to subsidiary retained earnings.
Recall, however, that only the total NCI will appear on the
consolidated balance sheet. Worksheet eliminations are as follows:

52
 (D1) Inventory 5,000
(D2) Land 30,000
(D3) Buildings 100,000
(D4) Equipment 20,000
(D5) Copyright 50,000
(D6) Goodwill 135,000
(D) Investment in Sample Company [remaining excess after (EL)] 272,000
(NCI) Retained Earnings Sample (NCI share of fair market adjustment) 68,000

Worksheet 2-5 has an additional column, the NCI column. The

components of the NCI are summed and presented as a single amount in
this balance sheet column. Notice that 100% ofthe fair values of subsidiary
accounts has been consolidated with the existing book values of parent
company accounts. The amounts that will appear on the consolidated
balance sheet are shown in the final column of Worksheet 2-5. The
Balance Sheet columns of the worksheet will show the components of
controlling equity (par, paid-in capital in excess of par, and retained
earnings) and the total NCI.

Formal Balance Sheet

The formal consolidated balance sheet resulting from the 80% purchase
of Sample Company, in exchange for 16,000 Parental shares, has been
taken from the Consolidated Balance Sheet column of Worksheet 2-5.
Recall, this is the date of acquisition.
Parental, Inc.
Consolidated Balance Sheet December 31,2015
Assets Liabilities and Equity
Current assets: Current liabilities $120,000
Cash ................. $84,000 Bonds payable.......... 300,000
Accounts receivable 92,000 Total liabilities ........ $420,000
Inventory ........... 135,000
Total current assets $311,000
Long-term assets: Stockholders' equity:
Common stock ($1 par)
Land................... $170,000 .............................. $36,000
Paid-in capital in excess
Buildings ............ 800,000 of par 584,000
Accumulated depreciation (130,000) Retained earnings 456,000
Total controlling equity
Equipment ........ 320,000 .............................. 1,076,000
Accumulated depreciation (60,000) Noncontrolling interest 100,000
Copyright ........... 50,000 Total equity .......... $1,176,000
Goodwill ............. 135,000
Total long-term assets 1,285,000
Total assets .......... $1,596,000 Total liabilities and equity $1,596,000
.................................

53
 Adjustment of Goodwill Applicable to NCI
The NCI goodwill value can be reduced below its implied value if there is
evidence that the implied value exceeds the real fair value of the NCI’s
share of goodwill. This could occur when a parent pays a premium to
achieve control, which is not dependent on the size of the ownership
interest.
The NCI share of goodwill could be reduced to zero, but the NCI share
of the fair value of net tangible assets is never reduced. The total NCI
can never be less than the NCI percentage of the fair value of the net
assets (in this case, it cannot be less than 20% x $365,000 = $73,000).
If the fair value of the NCI was estimated to be $90,000 ($10,000 less
than the value implied by parent purchase price), the value analysis would
be modified as follows (changes are boldfaced):

Company Implied Fair Parent Price NCI Value

Value Analysis Schedule Value (80%) (20%)
Company fair value .................... $490,000 $400,000 $90,000
Fair value of net assets excluding goodwill 365,000 292,000 73,000
..................................................
Goodwill ..................................... $125,000 $108,000 $17,000
Gain on acquisition...................... N/A N/A

Several assumptions went into the above calculation.

♦ Company fair value—This is now the sum of the price paid by the
parent plus the newly estimated fair value of the NCI.
♦ Fair value of net assets excluding goodwill—The fair values of the
subsidiary accounts are from the comparison of book and fair values.
These values are never less than fair value.
♦ Goodwill—The total goodwill is the excess of the ‘‘company fair
value’’ over the fair value of the subsidiary net assets.

The revised D&D schedule with changes (from the previous example) in
boldfaced type would be as follows.

54
 Determination and Distribution of Excess Schedule
Company
Implied Parent Price NCI Value
Fair Value (80%) (20%)
Fair value of subsidiary .... $490,000 $400,000 $90,000
Less book value of interest acquired:
Common stock ($1 par) . $10,000
Paid-in capital in excess of par 90,000
Retained earnings.......... 60,000
Total equity ................. $160,000 $160,000 $160,000
Interest acquired ............ 80% 20%
Book value ....................... $128,000 $32,000
Excess of fair value over book value $330,000 $272,000 $58,000

Adjustment of identifiable accounts: Adjustment Worksheet Key

Inventory ($55,000 fair — $50,000 book value) $5,000 debit D1
Land ($70,000 fair — $40,000 book value) 30,000 debit D2
Buildings ($250,000 fair — $150,000 book value) 100,000 debit D3
Equipment ($60,000 fair — $40,000 book value) 20,000 debit D4
Copyright ($50,000 fair — $0 book value) 50,000 debit D5
Goodwill ($490,000 fair — $365,000 book value) 125,000* debit D6
Total $330,000
*Agrees with total (company) goodwill in the value analysis schedule.

If goodwill becomes impaired in a future period, the impairment

charge would be allocated to the controlling interest and the NCI
based on the percentage of total goodwill each equity interest
received on the D&D schedule. In the original example, where goodwill
on the NCI was assumed to be proportional to that recorded on the
controlling interest, the impairment charge would be allocated 80/20 to the
controlling interest and NCI. In the above example, where goodwill was
not proportional, a new percentage would be developed as follows:
Percentag
Value e of Total
Goodwill applicable to parent from value analysis schedule $108,000 86.4%
Goodwill applicable to NCI from value analysis schedule 17,000 13.6%
Total goodwill .............................................. $125,000

IASB Perspectives
• The IRRS has a single model to define control for all entities. Control
exists when the investor has the power to direct the entities activities and
has the exposure or rights to variable returns. The investor must have the
ability to exercise its power to affect its returns on its investment. Power
may exist with less than a majority ownership position.

55
 No Goodwill on the Noncontrolling Interest
Currently, International Accounting Standards provide a choice in
accounting for the noncontrolling interest. The NCI can be recorded at fair
value, which would result in goodwill applicable to the NCI, as
demonstrated above. The other choice is to record the NCI at the NCI
percentage of the fair value of the net identifiable assets only, with no
goodwill on the NCI. Under the non- NCI goodwill model, the preceding
example would be modified to appear as shown below.
If the fair value of the NCI is estimated to be $73,000 (20% x $365,000
fair value of subsidiary company net identifiable assets), the value
analysis would be modified as follows (changes are boldfaced):
Company Implied Parent Price NCI Value
Value Analysis Schedule Fair Value (80%) (20%)
Company fair value ................ $473,000 $400,000 $73,000
Fair value of net assets excluding goodwill 365,000 292,000 73,000
Goodwill ................................ $108,000 $108,000 $0
Gain on acquisition ................ N/A N/A

Several assumptions went into the calculation on page 55.

♦ Company fair value—This is now the sum of the price paid by the parent
plus the NCI share of net identifiable assets.
♦ Fair value of net assets excluding goodwill—The fair values of the
subsidiary accounts are from the comparison of book and fair values.
These values are never less than fair value.
♦ Goodwill—The only goodwill recorded is that applicable to the
controlling interest.
The revised D&D schedule with changes (from the previous example)
in boldfaced type would be as follows:
Determination and Distribution of Excess Schedule
Company Implied Parent Price NCI Value
Fair Value (80%) (20%)
Fair value of subsidiary .... $473,000 $400,000 $73,000
Less book value of interest acquired:
Common stock ($1 par) . $10,000
Paid-in capital in excess of par 90,000
Retained earnings ......... 60,000
Total equity.................. $160,000 $160,000 $160,000
Interest acquired ........... 80% 20%
Book value ....................... $128,000 $32,000
Excess of fair value over book value $313,000 $272,000 $41,000

56
 Adjustment of identifiable accounts:
Worksheet
Adjustment Key
Inventory ($55,000 fair — $50,000 book value) $5,000 debit D1
Land ($70,000 fair — $40,000 book value) 30,000 debit D2
Buildings ($250,000 fair — $150,000 book value) 100,000 debit D3
Equipment ($60,000 fair — $40,000 book value) . 20,000 debit D4
Copyright ($50,000 fair — $0 book value) 50,000 debit D5
Goodwill ($473,000 fair — $365,000 book value) 108,000* debit D6
Total ............................................... $313,000
*Agrees with total (company) goodwill in the value analysis schedule.

If goodwill becomes impaired in a future period, the impairment

charge would apply only to the controlling interest.

Gain on Purchase of Subsidiary

Let us now study the same example, except that the price paid by the
parent will be low enough to result in a gain. Assume that Parental, Inc.,
issued 10,000 shares of its $1 par value common stock for 80% of the
outstanding shares of Sample Company. The fair value of a share of
Parental, Inc., stock is $25. Parental also pays $25,000 in accounting and
legal fees to complete the purchase. Parental would make the following
journal entry to record the purchase:
Investment in Sample Company (10,000 shares issued x $25 fair value) 250,000
Common Stock ($1 par value) (10,000 shares x $1 par) .................... ……. 10,000
Paid-In Capital in Excess of Par ($250,000 — $10,000 par value)………..240,000

Parental would record the costs of the acquisition as follows:

Acquisition Expense (closed to Retained Earnings since only balance sheets are being
examined)………………………………………………………….25,000
Cash………………………………………………………………… 25,000
Refer back to the prior comparison of book and fair values for the
subsidiary. The following value analysis would be prepared for the 80%
interest:
Company Implied Parent Price NCI Value
Value Analysis Schedule Fair Value (80%) (20%)
Company fair value ............... $323,000 $250,000 $73,000
Fair value of net assets excluding goodwill 365,000 292,000 73,000
Goodwill ................................ N/A N/A
Gain on acquisition ............. $(42,000) $(42,000)

Several assumptions went into the above calculation.

• Company fair value—It is assumed that if the parent would pay
$250,000 for an 80% interest, then the entire subsidiary company is
worth $312,500 ($250,000/80%). We will refer to this as the ‘‘implied

57
 value’’ of the subsidiary company. Assuming this to be true, the NCI
is worth 20% of the total subsidiary company value (20% x $312,500
= $62,500). The NCI value, however, can never be less than its
share of net identifiable assets ($73,000). Thus, the NCI share of
company value is raised to $73,000 (replacing the $62,500).
• Fair value of net assets excluding goodwill—The fair values of the
subsidiary accounts are from the comparison of book and fair
values.
• Goodwill—There can be no goodwill when the price paid is less than
the fair value of the parent’s share of the fair value of net identifiable
assets.
• Gain on acquisition—The only gain recognized is that applicable to
the controlling interest.

The following D&D would be prepared:

Determination and Distribution of Excess Schedule
Company
Implied Parent Price NCI Value
Fair Value (80%) (20%)
Fair value of subsidiary..... $323,000 $250,000 $73,000
Less book value of interest acquired:
Common stock ($1 par) $10,000
Paid-in capital in excess of par 90,000
Retained earnings . 60,000
Total equity ..... $160,000 $160,000 $160,000
Interest acquired ..... 80% 20%
Book value........................ $128,000 $32,000
Excess of fair value over book value $163,000 $122,000 $41,000

Adjustment of identifiable accounts:

Worksheet
Adjustment Key
Inventory ($55,000 fair — $50,000 book value) $5,000 debit D1
Land ($70,000 fair — $40,000 book value) 30,000 debit D2
Buildings ($250,000 fair — $150,000 book value). 100,000 debit D3
Equipment ($60,000 fair — $40,000 book value) 20,000 debit D4
Copyright ($50,000 fair — $0 book value) 50,000 debit D5
Gain (only applies to controlling interest)... (42,000) credit D7
Total .............................................. $163,000

Worksheet 2-6 on page 82 is the consolidated worksheet for the

$250,000 price. The D&D schedule provides complete guidance for the
worksheet eliminations.
♦ Elimination (EL) eliminated the subsidiary equity purchased (80% in

58
 this example) against the investment account as follows:
(EL) Common Stock ($1 par) ............................ 8,000
Paid-In Capital in Excess of Par ................ 72,000
Retained Earnings ..................................... 48,000
Investment in Sample Company ...................... 128,000

♦ The (D) series eliminations distribute the excess applicable to the

controlling interest plus the increase in the NCI [labeled (NCI)] to the
appropriate accounts as indicated by the D&D schedule. Worksheet
eliminations are as follows:
(D1) Inventory............................................................ 5,000
(D2) Land ................................................................ 30,000
(D3) Buildings ........................................................ 100,000
(D4) Equipment ....................................................... 20,000
(D5) Copyright ......................................................... 50,000
(D7) Gain on Purchase of Subsidiary (since we are dealing only with a balance
sheet, this would be credited to Controlling Retained Earnings) 42,000
(D) Investment in Sample Company [remaining excess after (EL)] 122,000
(NCI) Retained Earnings—Sample (NCI share of fair market adjustment) 41,000

Valuation Schedule Strategy

Here are steps to valuation that will always work if prepared in the order
shown below.
Step 1: Enter ownership percentages in C2 and D2. Then enter fair
value of net assets of acquired company in B4, and multiply by ownership
percentages to fill C4 and D4.
A B C D
Company Implied Fair
1. Value Analysis Schedule Value Parent Price NCI Value
2. Ownership percentages 80% 20%
3. Company fair value
4. Fair value of net assets excluding goodwill 365,000 292,000 73,000
5. Goodwill
6. Gain on bargain acquisition

Step 2: Enter the price paid by the parent in C3. Then, enter value of
NCI in D3. Normally, this is proportionate to price paid by parent. It can be
a separate value, but never less than D4. This would happen when the
parent pays a control premium. B3 is sum of C3 and D3.

59
 A B C D
Company Parent
1. Value Analysis Schedule Implied Fair Price NCI Value
2. Ownership percentages Value 80% 20%
3. Company fair value 525,000 420,000 105,000
4. Fair value of net assets excluding goodwill 365,000 292,000 73,000
5. Goodwill
6. Gain on bargain acquisition
Step 3: Compare company fair value (B3) with fair value of net assets,
excluding goodwill (B4). If B3 is greater than B4, follow Step 3A (Goodwill).
If B3 is less than B4, follow Step 3B (Gain).
Step 3A (Goodwill): Calculate goodwill for B5-D5 by subtracting line 4
from line 3 in columns B—D.
A B C D
Company Parent NCI
1. Value Analysis Schedule Implied Fair Price Value
2. Ownership percentages Value 80% 20%
3. Company fair value 525,000 420,000 105,000
4. Fair value of net assets excluding goodwill 365,000 292,000 73,000
5. Goodwill 160,000 128,000 32,000
6. Gain on bargain acquisition
Step 3B (Gain): Enter the new values for line 3. The NCI value cannot
be less than D4 and normally will be equal to D4. (An exception where it
exceeds D4 follows.) B4 is the sum of C4 and D4. Calculate and enter C6.
It is C4 minus C3. No other cells are filled.
A B C D
Company Parent NCI
1. Value Analysis Schedule Implied Fair Price Value
2. Ownership percentages Value 80% 20%
3. Company fair value 323,000 250,000 73,000
4. Fair value of net assets excluding goodwill 365,000 292,000 73,000
5. Goodwill
6. Gain on bargain acquisition (42,000)
Step 3B (Gain) Exception for NCI: This exception is for a situation
where the NCI value exceeds its share of fair value of net assets,
excluding goodwill.
Enter new Value for D3. Then calculate and enter values for C6 and
D6. B6 is sum of C6 and D6.

60
 A B C D
Company Parent NCI
1. Value Analysis Schedule Implied Fair Price Value
2. Ownership percentages Value 80% 20%
3. Company fair value 340,000 250,000 90,000
4. Fair value of net assets excluding goodwill 365,000 292,000 73,000
5. Goodwill
6. Gain on bargain acquisition (25,000) (42,000) 17,000

The entry to distribute the excess on the worksheet would be as follows:

Investment in Subsidiary ................................. 42,000
NCI .................................................……… 17,000
Gain on Acquisition of Subsidiary ...………. 25,000

Parent Exchanges Noncash Assets for Controlling Interest

The parent must bring to fair value any assets, other than cash, that it
exchanges for the controlling interest. If those assets are retained and
used by the subsidiary company, the gain must be eliminated in the
consolidation process.
Assets transferred would be retained by the subsidiary when either:
1. The assets are transferred to the former shareholders of the
subsidiary company and the shareholders sell the assets to the
subsidiary company, or
2. The assets are transferred directly to the subsidiary company in
exchange for newly issued shares or treasury shares.

Notes
♦ A less than 100% interest requires that value analysis be applied to
the entire subsidiary.
♦ Subsidiary accounts are adjusted to full fair value regardless of the
controlling percentage ownership.
♦ The noncontrolling interest shares in all asset and liability fair value
adjustments.
♦ The noncontrolling interest does not share a gain on the acquisition
(when applicable).
♦ The noncontrolling share of subsidiary equity appears as a single line-item
amount within the equity section of the balance sheet.

61
 PREEXISTING GOODWILL
If a subsidiary is purchased and it has goodwill on its books, that
goodwill is ignored in the value analysis. The only complication caused by
existing goodwill is that the D&D schedule will adjust existing goodwill,
rather than only recording new goodwill. Let us return to the example
involving the 80% acquisition of Sample Company on pages 42 and 43
and change only two facts: assume Sample has goodwill of $40,000 and
its retained earnings is $40,000 greater. The revised book and fair values
would be as follows:
Book Market Book Market
Assets Value Value Liabilities and Equity Value Value
Accounts receivable.. $20,000 $20,000 Current liabilities ........ $40,000 $40,000
Inventory .................. 50,000 55,000 Bonds payable ......... 100,000 100,000
Land......................... 40,000 70,000 Total liabilities ....... $140,000 $140,000
Buildings .................. 200,000 250,000 Stockholders' equity:
Accumulated depreciation (50,000) Common stock ($1 par) $10,000
Paid-in capital in excess of
Equipment ............... 60,000 60,000 par. 90,000
Accumulated depreciation (20,000) Retained earnings ..... 100,000
Copyright ................. 50,000 Total equity ............... $200,000
Goodwill .................. 40,000 Total liabilities and equity $340,000
Total assets ............. $340,000 $505,000 Net assets ................ $365,000

Assume that Parental, Inc., issued 16,000 shares of its $1 par value
common stock for 80% (8,000 shares) of the outstanding shares of
Sample Company. The fair value of a share of Parental, Inc., stock is $25.
Parental also pays $25,000 in accounting and legal fees to accomplish
the purchase. Parental would make the following entry to record the
purchase:

Investment in Sample Company (16,000 shares issued x $25 fair value) 400,000
Common Stock ($1 par value) (16,000 shares x $1 par) 16,000
Paid-In Capital in Excess of Par ($400,000 — $16,000 par value) 384,000

Parental would record the costs of the acquisition as follows:

Acquisition Expense (closed to Retained Earnings since only balance sheets
are being examined)………………………………………………. 25,000
Cash ................................................................................................. 25,000

The value analysis schedule is unchanged. The fair value of the Sample
Company net assets does not include goodwill.

62
 Company Implied Parent Price NCI Value
Value Analysis Schedule Fair Value (80%) (20%)
Company fair value..................... $500,000 $400,000 $100,000
Fair value of net assets excluding goodwill 365,000 292,000 73,000
...................................................
Goodwill .................................... $135,000 $108,000 $27,000
Gain on acquisition

The D&D schedule differs from the earlier one only to the extent that:
*The Sample Company retained earnings is $40,000 greater.
*The implied goodwill of $135,000 is compared to existing goodwill of
$40,000.
Determination and Distribution of Excess Schedule
Company Parent NCI
Implied Fair Price Value
Value (80%) (20%)
Fair value of subsidiary ... $500,000 $400,000 $100,000
Less book value of interest acquired:
Common stock ($1 par) $10,000
Paid-in capital in excess of par 90,000
Retained earnings . 100,000
Total equity ....... $200,000 $200,000 $200,000
Interest acquired .... 80% 20%
Book value ...................... $160,000 $40,000
Excess of fair value over book value $300,000 $240,000 $60,000

Adjustment of identifiable accounts:

Worksheet
Adjustment Key
Inventory ($55,000 fair — $50,000 book value) $5,000 debit D1
Land ($70,000 fair — $40,000 book value) 30,000 debit D2
Buildings ($250,000 fair — $150,000 net book value) 100,000 debit D3
Equipment ($60,000 fair — $40,000 net book value) 20,000 debit D4
Copyright ($50,000 fair — $0 book value) 50,000 debit D5
Goodwill ($135,000 fair — $40,000 book value) 95,000 debit D6
Total ................................................ $300,000

The D&D schedule provides complete guidance for the worksheet

eliminations. Changes from Worksheet 2-5 are in boldface. Study
Worksheet 2-7 on page 84 and note the following:
♦ Elimination (EL) eliminated the subsidiary equity purchased (80% in
this example) against the investment account as follows:

(EL) Common Stock ($1 par)—Sample .................. 8,000

Paid-In Capital in Excess of Par—Sample ...... 72,000
Retained Earnings—Sample ........................... 80,000
Investment in Sample Company……………... 160,000

63
♦ The (D) series eliminations distribute the excess applicable to the
controlling interest plus the increase in the NCI [labeled (NCI)] to the
appropriate accounts, as indicated by the D&D schedule. The adjustment
of the NCI is carried to subsidiary retained earnings.
(D1) Inventory ................................................................... 5,000
(D2) Land 30,000
(D3) Buildings ............................................................... 100,000
(D4) Equipment ............................................................... 20,000
(D5) Copyright................................................................. 50,000
(D6) Goodwill ($135,000 - $40,000 book value) ............. 95,000
(D) Investment in Sample Company [remaining excess after (EL)] 240,000
(NCI) Retained Earnings Sample (NCI share of fair market adjustment) 60,000

The Consolidated Balance Sheet column of Worksheet 2-7 is the same

as those for Worksheet 2-5 and the resulting balance sheet.

Note
• Where the acquired firm already has goodwill on its books, the D&D adjusts
from the recorded goodwill to the goodwill calculated in the valuation
schedule.

OWNERSHIP OF A PRIOR NONCONTROLLING INTEREST

The acquirer may already own a noncontrolling investment (less than
50%) interest in a company. It may then decide to buy additional shares
of common stock to achieve a controlling interest. The previously owned
shares are adjusted to fair value and a gain or loss is recorded on the
investment. The fair value of the shares is then added to the price paid for
the new shares. The prior plus new interest is treated as one price paid
for a controlling interest. Normally, the fair value of the previously owned
shares is based on the price paid for the controlling interest.
For example, assume Company P owns a 10% interest (10,000
shares) in Company S that Company P purchased at a prior date for $20
per share. At a later date, Company P purchases another 50,000 shares
(50% interest) for $30 per share.
The 10,000 previously purchased shares would be adjusted to fair
value as follows:

Investment in Company S shares (10,000 shares x $10increase) 100,000

Unrealized Gain on Revaluation of Investments 100,000

This entry would increase the carrying value of the 10,000 previously
owned shares to $300,000. The acquisition price for the controlling 60%
interest would be calculated as follows:

64
 Fair value of previously owned 10% interest ...................................... $300,000
Acquisition of 50,000 shares at $30 .................................................. 1,500,000
Total acquisition cost .......................................................................... $1,800,000

Assuming cash is paid for the 50,000 shares, the acquisition entry
would be as follows:
Investment in Subsidiary Company S ……………………………1,800,000
Cash (50,000 shares at $30) ........................................................... 1,500,000
Investment in Company S (10,000 shares x $30)............................ 300,000

Value analysis and the D&D schedule would be constructed for a single
60% interest with an acquisition price of $1,800,000.
Two observations that should be made about the prior investment that
is rolled into the total acquisition cost are as follows:
1. The above investment was a passive investment and was not an
influential investment accounted for under the equity method. Most
likely, it would have been an ‘‘Available for Sale’’ investment. It
would have been adjusted to fair value on prior balance sheet dates
with the adjustment going to ‘‘Other Comprehensive Income’’ (OCI).
That portion of the portfolio and OCI adjustment attributable to this
investment would be included in future portfolio valuations. It is
unlikely, but possible, that the investment could have been a
‘‘Trading Investment.’’ In that case, prior portfolio adjustments were
recorded as unrealized gains or losses and were included in net
income. The above investment would no longer be included in the
future portfolio adjustments.
2. The previously owned interest may be large enough to be accounted
for under the equity method (typically greater than a 20% interest).
If that is the case, the investment will be carried at equity-adjusted
cost. It will be adjusted to fair value on the date of the later acquisi-
tion that creates control.

Note
• Any previously owned interest in the acquiree is adjusted to fair value
based on the price paid for the later interest that creates control.

PUSH-DOWN ACCOUNTING
Thus far, it has been assumed that the subsidiary’s statements are
unaffected by the parent’s purchase of a controlling interest in the
subsidiary. None of the subsidiary’s accounts is adjusted on the
subsidiary’s books. In all preceding examples, adjustments to reflect fair
value are made only on the consolidated worksheet. This is the most
common but not the only accepted method.

65
 Some accountants object to the inconsistency of using book values in
the subsidiary’s separate statements while using fair value-adjusted
values when the same accounts are included in the consolidated
statements. They would advocate push-down accounting, whereby the
subsidiary’s accounts are adjusted to reflect the fair value adjustments. In
accordance with the new basis of accounting, retained earnings are
eliminated, and the balance (as adjusted for fair value adjustments) is
added to paid-in capital. It is argued that the purchase of a controlling
interest gives rise to a new basis of accountability for the interest traded,
and the subsidiary accounts should reflect those values.
If the push-down method were applied to the example of a 100%
purchase for $500,000 on pages 42 and 43, the following entry would be
made by the subsidiary on its books:
Inventory.................................................................... 5,000
Land ........................................................................ 30,000
Buildings ................................................................ 100,000
Equipment ............................................................... 20,000
Copyright ................................................................. 50,000
Goodwill................................................................. 135,000
Paid-In Capital in Excess of Par ................ …………… 340,000

This entry would raise the subsidiary equity to $500,000. The $500,000
investment account would be eliminated against the $500,000 subsidiary
equity with no excess remaining. All accounts are adjusted to full fair
value, even if there is a noncontrolling interest. The SEC staff has adopted
a policy of requiring push-down accounting, in some cases, for the
separately published statements of a subsidiary. The existence of any
significant noncontrolling interests (usually above 5%) and/or significant
publicly held debt or preferred stock generally eliminates the need to use
push-down accounting. Note that the consolidated statements are
unaffected by this issue. The only difference is in the placement of the
adjustments from the determination and distribution of excess schedule.
The conventional approach, which is used in this text, makes the adjust-
ments on the consolidated worksheet. The push-down method makes the
same adjustments directly on the books of the subsidiary. Under the push-
down method, the adjustments are already made when consolidation
procedures are applied. Since all accounts are adjusted to reflect fair
values, the investment account is eliminated against subsidiary equity with
no excess. The difference in methods affects only the presentation on the
subsidiary’s separate statements.

66
 Notes
• Push-down accounting revalues subsidiary accounts directly on the
books of the subsidiary based on adjustments indicated in the D&D
schedule.
• Since assets are revalued before the consolidation process starts,
no distribution of excess (to adjust accounts) is required on the
consolidated worksheet.

APPENDIX: REVERSE ACQUISITION

A reverse acquisition occurs when a usually larger firm, that is not publicly
traded, wishes to acquire a controlling interest in a usually smaller
company, which does not have publicly traded common stock. The
‘‘reverse’’ nature of the transaction concerns the common shares used in
the exchange. So far, we have assumed that the potential controlling
company issues its common stock shares to make the acquisition. In a
‘‘reverse acquisition,’’ the shares of the ‘‘to be’’ acquired publicly traded
company are used for the exchange. The intent is to end up with a con-
solidated company that has easily tradable stock.
The following example is taken from FASB ASC 805-40-55-4 to allow
the reader additional information on the process. Prior to the acquisition,
assume that Private Company (the acquirer) and Public Company (the
acquiree) have the following balance sheets:
Private Company (the acquirer, but the company receiving public shares)
Balance Sheet December 31,2015
Assets Liabilities and Equity
Current assets ......... $700 Long-term liabilities......... $1,700
Fixed assets ........... 3,000 Common stock (60 shares) ($1 par) 60
Paid-in capital in excess of par 540
Retained earnings .......... 1,400
Total assets .......... $3,700 Total liabilities and equity $3,700

Public Company (the acquiree, but the company issuing public shares) Balance Sheet
December 31,2015
Book Fair Book Fair
Assets Value Value Liabilities and Equity Value Value
Current assets $500 $500 Long-term liabilities $700 $700
Common stock (100 shares)
Fixed assets . 1,300 1,500 ($1 par) 100
Paid-in capital in excess of par 200
Retained earnings 800
Total assets. $1,800 $2,000 Total liabilities and equity $1,800

Public Company will issue 150 new shares to Private Company

shareholders in exchange for their 60 outstanding shares of Private

67
Company. Assuming that the fair value of a Public Company share is $16,
the transaction would be recorded by Public Company as follows:
Investment in Private Company (150 shares x $16) .......................... 2,400
Common Stock ($1 par) (150 shares x $1 par)……………………… 150
Paid-In Capital in Excess of Par ($2,400 - $150 par)………………. 2,250

The following diagram depicts the change in ownership:

December 31, 2015
Prior to Exchange

Private Company Public Company

60 shares outstanding 100 shares outstanding

After Exchange

Public Company
Private Company
250 shares outstanding
60 shares outstanding
Investment in Private Company, $2,400

After the exchange, all of the shares of Private Company are owned by
Public Company. In most cases, Public Company will distribute Public
Company shares to the former Private Company shareholders. However,
the 150 shares of Public Company are owned by the former Private
Company shareholders. The former Private Company shareholders now
own 60% of the 250 total Public Company shares. They, collectively, now
have control of Public Company.
Since control of Public Company has been transferred, the company is
considered to have been sold. Thus, it is the Public Company assets and
liabilities that must be adjusted to fair value. Since the fair value per share
of Public Company is $16, it is assumed that Public Company was worth
$1,600 (100 shares x $16) prior to the transfer.
Because the shareholders of Private Company are the controlling
interest, Private Company cannot revalue its assets to fair value. The
controlled company is Public Company; thus, it is the company that must
have its net assets adjusted to fair value. This means that value analysis
is only applied to Public Company.
The following value analysis would be prepared for Public Company.
The fair value analysis would apply to only those assets present just prior
to the acquisition. The fair value of Public Company at the time of the
acquisition can be calculated as $1,600 (100 shares x $16 market value).

The value analysis schedule for Public Company would be as follows:

68
 Company
Implied Parent Price
Value Analysis Schedule Fair Value (100%) NCI Value
Company fair value ......................... $1,600 $1,600
Fair value of assets excluding goodwill ($1,100 net
book value + $200 adjustment to fixed assets) 1,300 1,300
Goodwill ......................................... $300 $300
Gain on acquisition .......................... N/A N/A
The determination and distribution of excess schedule would be prepared
as follows:
Determination and Distribution of Company Implied Parent Price
Excess Schedule Fair Value (100%) NCI Value
Fair value of subsidiary $1,600 $1,600
Less book value of interest acquired:
Common stock ($1 par) ......... $100
Paid-in capital in excess of par 200
Retained earnings ................. 800
Total equity.......................... $1,100 $1,100
Interest acquired ................... 100%
Book value ............................... $1,100
Excess of fair value over book value $500 $500
.................................................
Adjustment of identifiable accounts:
Fixed assets ............................. $200
Goodwill .................................. 300
Total ........................................ $500

Worksheet 2A-1 on page 86 includes the consolidation procedures that

may be used for the acquisition on the acquisition date. The first step is to
eliminate the investment account against the increase in Public Company
equity recorded at the time of the acquisition as follows:

(EL) Common Stock ($1 par)—Public Company (150 shares x $1) 150
Paid-In Capital in Excess of Par—Public Company (150 shares x $15) 2,250
Investment in Private Company................................. …………………. 2,400

The assets of Public Company are then adjusted to fair value on the
acquisition date, using the information from the above determination and
distribution of excess schedule. The total adjustment is credited to Public
Company retained earnings.
(D1) Fixed Assets 200
(D2) Goodwill 300
(D) Retained Earnings—Public Company 500

Then, the Private Company par and paid-in capital in excess of par
amounts are transferred to the par and paid-in value of the public shares.

69
 The retained earnings of the acquired, Public Company, are also
transferred to the paid-in capital in excess of par account of Public
Company as follows:

(Trans) Common Stock ($1 par)—Private Company 60

Paid-In Capital in Excess of Par—Private Company. 540
Retained Earnings—Public Company (as adjusted by''D'') 1,300
Common Stock ($1par)—Public Company (150 shares x $1) 150
Paid-In Capital in Excess of Par—Public Company ($1,900 $150) 1,750

The consolidation steps can be summarized as follows:

(EL) Remove the investment account and the additions to paid-in capital
that occurred on the purchase date.
(D) Bring the acquired company’s assets and liabilities to fair value on the
acquisition date. (Trans) Assign all remaining equity account values,
except the controlling interest share of retained earnings, to paid-in capital
accounts ofthe publicly traded company. The only retained earnings that
can emerge from the combination are that of the controlling interest.
The following balance sheet results:
Public Company and Subsidiary Private Company
Balance Sheet
December 31,2015
Assets Liabilities and Equity
Current assets ....... $1,200 Long-term liabilities ..... $2,400
Fixed assets ......... 4,500
Goodwill ............... 300 Equity: $250
Common stock ($1 par) 1,950
Paid-in capital in excess of par. Retained earnings 1,400
Total controlling interest $3,600
Total assets $6,000 Total liabilities and equity $6,000

There are alternative procedures that could be used on the worksheet,

but the end result is that the controlling equity can only include the retained
earnings of the acquiring company. In this case, that is the original $1,400
attributable to Private Company. The total paid-in capital can be confirmed
as follows:
Total equity of acquired Public Company ($100 + $200 + $800) $1,100
Adjustment of Public Company to fair value 500
Total paid-in capital of Private Company ($60 + $540) 600
Total paid-in capital of consolidated Public Company $2,200

Reverse Acquisition with Noncontrolling Interest

A portion of the acquiring company shareholders may choose not to
exchange their shares for the company being acquired. Let us change the
prior example to assume that only 80% or 48 Private Company shares

70
participate in the exchange. The 20% or 12 Private Company shares
become a noncontrolling interest in Private Company.
Public Company will issue 120 new shares to the Private Company
shareholders in exchange for their 48 outstanding shares of Private
Company. Assuming that the fair value of a Public Company share is $16,
the transaction would be recorded by Public Company as follows:

Investment in Private Company (120 shares x $16) 1,920

Common Stock ($1 par) (120 shares x $1 par) 120
Paid-In Capital in Excess of Par ($1,920 - $120 par) 1,800

The following diagram depicts the change in ownership:

December 31,2015
Prior to Exchange

Private Company Public Company

60 shares outstanding 100 shares outstanding

After Exchange

Public Company
Private Company
220 shares outstanding
60 shares outstanding
Investment in Private Company, $1,920

After the exchange, 80% of the shares of Private Company are owned
by Public Company. However, the 120 shares of Public Company are
owned by former Private Company shareholders. The former Private
Company shareholders now own 54.5% of the 220 total Public Company
shares. They, collectively, now have control of Public Company.
Since the control of Public Company has been transferred, the company
is considered to have been sold. Thus, it is the Public Company assets
and liabilities that must be adjusted to fair value. Since the fair value per
share of Public Company is $16, it is assumed that Public Company was
worth $1,600 (100 shares x $16) prior to the transfer.
There is no change in the value analysis or the determination and
distribution of excess schedule. Since the noncontrolling interest is
applicable to Private Company, it does not share in the revaluation.
Worksheet 2A-2 on page 87 includes the consolidation procedures that
may be used for the acquisition on the acquisition date. The first step is to
eliminate the investment account against the increase in Public Company

71
equity recorded at the time of the acquisition as follows:

(EL) Common Stock ($1 par)—Public Company (120 shares x $1) 120
Paid-In Capital in Excess of Par—Public Company (120 shares x $15). 1,800
Investment in Public Company 1,920

The assets of Public Company are then adjusted to fair value on the
acquisition date, using the information from the above determination and
distribution of excess schedule. The total adjustment is credited to Public
Company retained earnings.

(D1) Fixed Assets 200

(D2) Goodwill 300
(D) Retained Earnings—Public Company 500

Then, the Private Company par and paid-in capital in excess of par
amounts are transferred to the par and paid-in value of the public shares.
The retained earnings of the acquired, Public Company, are also
transferred to the paid-in capital in excess of par account of Public
Company as follows:

(Trans) Common Stock ($1 par)—Private Company ($60 x 80%) 48

Paid-In Capital in Excess of Par—Private Company ($540 x 80%) 432
Retained Earnings—Public Company (as adjusted by''D'') 1,300
Common Stock ($1 par)—Public Company (120 shares x $1) 120
Paid-In Capital in Excess ofPar—Public Company ($1,780-$120) 1,660

The following balance sheet results:

Public Company and Subsidiary Private Company Balance Sheet December
31,2015
Assets Liabilities and Equity
Current assets $1,200 Long-term liabilities .... $2,400
Fixed assets .. 4,500 Equity:
Goodwill ........ 300 Common stock ($1 par) $220
Paid-in capital in excess of par 1,860
Retained earnings 1,120
Total controlling interest $3,200
Noncontrolling interest 400
Total equity $3,600
Total assets $6,000 Total liabilities and equity $6,000
There are alternative procedures that could be used on the worksheet,
but the end result is that the controlling equity can only include the retained
earnings of the acquiring company. In this case, that is $1,120 (80% x
$1,400) attributable to the Private Company controlling interest. The total
paid-in capital can be confirmed as follows:

72
Public Company equity ($100 + $200 + $800) $1,100
Fair value adjustment 500
80% of Private Company paid-in capital (80% x $600) 480
Total paid-in capital in excess of par, Public Company $2,080

73
100% Interest; Price Equals Book Value
Company P and Subsidiary Company S Worksheet for Consolidated Balance Sheet December 31, 2015
Worksheet 2-1 (see page 39)
Eliminations & Consolidated
Trial Balance
Adjustments Balance
Company P Company S Dr. Cr. Sheet
1 Cash 300,000 300,000 1
2 Accounts Receivable 300,000 200,000 500,000 2
3 Inventory 100,000 100,000 200,000 3
4 Investment in Company S 500,000 (EL) 500,000 4
5 5
6 Equipment (net) 150,000 300,000 450,000 6
7 Goodwill 7
8 Current Liabilities (150,000) (100,000) (250,000) 8
9 Bonds Payable (500,000) (500,000) 9
10 Common Stock—Company S (200,000) (EL) 200,000 10
11 Retained Earnings—Company S (300,000) (EL) 300,000 11
12 Common Stock—Company P (100,000) (100,000) 12
13 Retained Earnings—Company P (600,000) (600,000) 13
14 Totals 0 0 500,000 500,000 0 14

Eliminations and Adjustments:

(EL) Eliminate the investment in the subsidiary against the subsidiary equity accounts.

74
100% Interest; Price Exceeds Book Value
Company P and Subsidiary Company S Worksheet for Consolidated Balance Sheet December 31,2015
Worksheet 2-2 (see page 41)
Trial Balance Eliminations & Adjustments Consolidated
Balance
Company P Company S Dr. Cr.
Sheet
1 Cash 100,000 100,000 1
2 Accounts Receivable 300,000 200,000 500,000 2
3 Inventory 100,000 100,000 (D1) 20,000 220,000 3
4 Investment in Company S 700,000 (EL) 500,000 4
5 (D) 200,000 5
6 Equipment (net) 150,000 300,000 (D2) 100,000 550,000 6
7 Goodwill (D3) 80,000 80,000 7
8 Current Liabilities (150,000) (100,000) (250,000) 8
9 Bonds Payable (500,000) (500,000) 9
10 Common Stock—Company S (200,000) (EL) 200,000 10
11 Retained Earnings—Company S (300,000) (EL) 300,000 11
12 Common Stock—Company P (100,000) (100,000) 12
13 Retained Earnings—Company P (600,000) (600,000) 13
14 Totals 0 0 700,000 700,000 0 14
Eliminations and Adjustments:
(EL) Eliminate the investment in the subsidiary against the subsidiary equity accounts. (■>) Distribute $200,000
excess of costover book value as follows:
(D1) Inventory, $20,000.
(D2) Eq uipment, $100,000.
(D3) Goodwill, $80,000.

75
100% Interest; Price Exceeds Market Value of Identifiable Net Assets
Parental, Inc. and Subsidiary Sample Company Worksheet for Consolidated Balance Sheet December 31,2015
Worksheet 2-3 (see page 44)
(Credit balance amounts are in Consolidated
Balance Sheet Eliminations & Adjustments
parentheses.) Balance
Parental Sample Dr. Cr. Sheet
1 Cash 84,000 84,000 1
2 Accounts Receivable 72,000 20,000 92,000 2
3 Inventory 80,000 50,000 (D1) 5,000 135,000 3
4 Land 100,000 40,000 (D2) 30,000 170,000 4
5 Investment in Sample Company 500,000 (EL) 160,000 5
6 (D) 340,000 6
7 Buildings 500,000 200,000 (D3) 100,000 800,000 7
8 Accumulated Depreciation (80,000) (50,000) (130,000) 8
9 Equipment 240,000 60,000 (D4) 20,000 320,000 9
10 Accumulated Depreciation (40,000) (20,000) (60,000) 10
11 Copyright (D5) 50,000 50,000 11
12 Goodwill (D6) 135,000 135,000 12
14 Current Liabilities (80,000) (40,000) (120,000) 14
13 Bonds Payable (200,000) (100,000) (300,000) 13
14 Common Stock—Sample (10,000) (EL) 10,000 14
15 Paid-In Capital in Excess of Par—Sample (90,000) (EL) 90,000 15
16 Retained Earnings—Sample (60,000) (EL) 60,000 16
17 Common Stock—Parental (40,000) (40,000) 17
18 Paid-In Capital in Excess of Par—Parental (680,000) (680,000) 18
19 Retained Earnings—Parental (456,000) (456,000) 19
20 Totals 0 0 500,000 500,000 0 20

76
Eliminations and Adjustments:
(EL) Eliminate 100% subsidiary equity against investment account.
(D) Distribute remaining excess in investment account plus NCI adjustment to:
(D1) Inventory.
(D2) Land.
(D3) Buildings (recorded cost is increased without removing accumulated depreciation).
The alternative is to debit Accumulated Depreciation for $50,000 and Buildings for $50,000.
(D4) Equipment (recorded cost is increased without removing accumulated depreciation).
The alternative is to debit Accumulated Depreciation for $20,000.
This would also restate the net asset at fair value.
(D5) Copyright.
(D6) Goodwill.
This would also restate the net asset at fair value.

77
100% Interest; Price Exceeds Fair Value of Net Identifiable Assets
Parental, Inc. and Subsidiary Sample Company Worksheet for Consolidated Balance Sheet December 31,2015
Worksheet 2-4 (see page 47)
(Credit balance amounts are in Eliminations & Consolidated
Balance Sheet
parentheses.) Adjustments Balance
Parental Sample Dr. Cr. Sheet
1 Cash 84,000 84,000 1
2 Accounts Receivable 72,000 20,000 92,000 2
3 Inventory 80,000 50,000 (D1) 5,000 135,000 3
4 Land 100,000 40,000 (D2) 30,000 170,000 4
5 Investment in Sample Company 300,000 (EL) 160,000 5
6 (D) 140,000 6
7 Buildings 500,000 200,000 (D3) 100,000 800,000 7
8 Accumulated Depreciation (80,000) (50,000) (130,000) 8
9 Equipment 240,000 60,000 (D4) 20,000 320,000 9
10 Accumulated Depreciation (40,000) (20,000) (60,000) 10
11 Copyright (D5) 50,000 50,000 11
12 Goodwill 12
13 Current Liabilities (80,000) (40,000) (120,000) 13
14 Bonds Payable (200,000) (100,000) (300,000) 14
15 Common Stock—Sample (10,000) (EL) 10,000 15
16 Paid-In Capital in Excess of Par—Sample (90,000) (EL) 90,000 16
17 Retained Earnings—Sample (60,000) (EL) 60,000 17
18 Common Stock—Parental (32,000) (32,000) 18
19 Paid-In Capital in Excess of Par—Parental (488,000) (488,000) 19
20 Retained Earnings—Parental (456,000) (D7) 65,000 (521,000) 20
21 Totals 0 0 365,000 365,000 0 21

78
Eliminations and Adjustments:
(EL) Eliminate 100% subsidiary equity against investment account.
(D) Distribute remaining excess in investment account plus NCI adjustment to:
(D1) Inventory.
(D2) Land.
(D3) Buildings (recorded cost is increased without removing accumulated depreciation).
The alternative is to debit Accumulated Depreciation for $50,000 and
Buildings for $50,000. This would also restate the net asset at fair value.
(D4) The alternative is to debit Accumulated Depreciation for $20,000.
This would also restate the net asset at fair value.
(D5) Copyright.
(D7) Gain on acquisition (close to Parental's Retained Earnings since balance sheet only worksheet).
Equipment (recorded cost is increased without removing accumulated depreciation).

79
80% Interest; Price Exceeds Fair Value of Net Identifiable Assets
Parental, Inc. and Subsidiary Sample Company Worksheet for Consolidated Balance Sheet December 31,2015
Worksheet 2-5 (see page 52)
(Credit balance amounts are in Consolidat
Balance Sheet Eliminations & Adjustments NCI
parentheses.) ed Balance
Parental Sample Dr. Cr. Sheet
1 Cash 84,000 84,000 1
2 Accounts Receivable 72,000 20,000 92,000 2
3 Inventory 80,000 50,000 (D1) 5,000 135,000 3
4 Land 100,000 40,000 (D2) 30,000 170,000 4
5 Investment in Sample Company 400,000 (EL) 128,000 5
6 (D) 272,000 6
7 Buildings 500,000 200,000 (D3) 100,000 800,000 7
8 Accumulated Depreciation (80,000) (50,000) (130,000) 8
9 Equipment 240,000 60,000 (D4) 20,000 320,000 9
10 Accumulated Depreciation (40,000) (20,000) (60,000) 10
11 Copyright (D5) 50,000 50,000 11
12 Goodwill (D6) 135,000 135,000 12
13 Current Liabilities (80,000) (40,000) (120,000) 13
14 Bonds Payable (200,000) (100,000) (300,000) 14
15 Common Stock—Sample (10,000) (EL) 8,000 (2,000) 15
16 Paid-In Capital in Excess of Par—Sample (90,000) (EL) 72,000 (18,000) 16
17 Retained Earnings—Sample (60,000) (EL) 48,000 (NCI) 68,000 (80,000) 17
18 Common Stock—Parental (36,000) (36,000) 18
19 Paid-In Capital in Excess of Par—Parental (584,000) (584,000) 19
20 Retained Earnings—Parental (456,000) (456,000) 20
21 Totals 0 0 468,000 468,000 21
22 NCI (100,000) (100,000) 22
23 Totals 0 23

80
Eliminations and Adjustments:
(EL) Eliminate 80% subsidiary equity against investment account.
(NCI) Adjust NCI to fair value (credit to Sample's Retained Earnings].
(D) Distribute remaining excess in investment account plus NCI adjustment to:
(D1) Inventory.
(D2) Land.
(D3) Buildings (recorded cost is increased without removing accumulated depreciation).
The alternative is to debit Accumulated Depreciation for $50,000 and Buildings for $50,000. This would also
restate the net asset at fair value.
(D4) Equipment (recorded cost is increased without removing accumulated depreciation).
The alternative is to debit Accumulated Depreciation for $20,000.
This would also restate the net asset at fair value.
(D5) Copyright.
(D6) Goodwill.

81
 80% Interest; Price Is Less Than Fair Value of Net Identifiable Assets
Parental, Inc. and Subsidiary Sample Company Worksheet for Consolidated Balance Sheet December 31,2015
Worksheet 2-6 (see page 58)
(Credit balance amounts are in Consolidat
Balance Sheet Eliminations & Adjustments NCI
parentheses.) ed
Balance
Parental Sample Dr. Cr.
Sheet
1 Cash 254,000 254,000 1
2 Accounts Receivable 72,000 20,000 92,000 2
3 Inventory 80,000 50,000 (D1) 5,000 135,000 3
4 Land 100,000 40,000 (D2) 30,000 170,000 4
5 Investment in Sample Company 250,000 (EL) 128,000 5
6 (D) 122,000 6
7 Buildings 500,000 200,000 (D3) 100,000 800,000 7
8 Accumulated Depreciation (80,000) (50,000) (130,000) 8
9 Equipment 240,000 60,000 (D4) 20,000 320,000 9
10 Accumulated Depreciation (40,000) (20,000) (60,000) 10
11 Copyright (D5) 50,000 50,000 11
12 Goodwill 12
13 Current Liabilities (80,000) (40,000) (120,000) 13
14 Bonds Payable (200,000) (100,000) (300,000) 14
15 Common Stock—Sample (10,000) (EL) 8,000 (2,000) 15
16 Paid-In Capital in Excess of Par—Sample (90,000) (EL) 72,000 (18,000) 16
17 Retained Earnings—Sample (60,000) (EL) 48,000 (NCI) 41,000 (53,000) 17
18 Common Stock—Parental (36,800) (36,800) 18
19 Paid-In Capital in Excess of Par—Parental (603,200) (603,200) 19
20 Retained Earnings—Parental (456,000) (D7) 42,000 (498,000) 20
21 Totals 0 0 333,000 333,000 21
22 NCI (73,000) (73,000) 22
23 Totals 0 23

82
Eliminations and Adjustments:
(EL) Eliminate 80%subsidiary equity against investment account.
(NCI) Adjust NCI to fair value (credit to Sample's Retained Earnings).
(D) Distribute remaining excess in investment account plus NCI adjustment to:
(Dl) Inventory.
(D2) Land.
(D3) Buildings (recorded cost is increased without removing accumulated depreciation).
The alternative is to debit Accumulated Depreciation for $50,000 and Buildings for $50,000.
(D4) Equipment (recorded cost is increased without removing accumulated depreciation).
This would also restate the net asset at fair value.
(D5) Copyright.
(D7) Gain on acquisition (close to Parental's Retained Earnings since balance- sheet-only worksheet).
This would also restate the net asset at fair value.
The alternative is to debit Accumulated Depreciation for $20,000.

83
 80% Interest; Price Exceeds Fair Value of Net Identifiable Assets Preexisting Goodwill
Parental, Inc. and Subsidiary Sample Company Worksheet for Consolidated Balance Sheet December 31, 2015
Worksheet 2-7 (see page 63)
(Credit balance amounts are in Consolidat
Balance Sheet Eliminations & Adjustments NCI
parentheses.) ed Balance
Parental Sample Dr. Cr. Sheet
1 Cash 84,000 84,000 1
2 Accounts Receivable 72,000 20,000 92,000 2
3 Inventory 80,000 50,000 (D1) 5,000 135,000 3
4 Land 100,000 40,000 (D2) 30,000 170,000 4
5 Investment in Sample Company 400,000 (EL) 160,000 5
6 (D) 240,000 6
7 Buildings 500,000 200,000 (D3) 100,000 800,000 7
8 Accumulated Depreciation (80,000) (50,000) (130,000) 8
9 Equipment 240,000 60,000 (D4) 20,000 320,000 9
10 Accumulated Depreciation (40,000) (20,000) (60,000) 10
11 Copyright (D5) 50,000 50,000 11
12 Goodwill 40,000 (D6) 95,000 135,000 12
13 Current Liabilities (80,000) (40,000) (120,000) 13
14 Bonds Payable (200,000) (100,000) (300,000) 14
15 Common Stock—Sample (10,000) (EL) 8,000 (2,000) 15
16 Paid-In Capital in Excess of Par—Sample (90,000) (EL) 72,000 (18,000) 16
17 Retained Earnings—Sample (100,000) (EL) 80,000 NCI 60,000 (80,000) 17
18 Common Stock—Parental (36,000) (36,000) 18
19 Paid-In Capital in Excess of Par—Parental (584,000) (584,000) 19
20 Retained Earnings—Parental (456,000) (456,000) 20
21 Totals 0 0 460,000 460,000 21
22 NCI (100,000) (100,000) 22
23 Totals 0 23

84
Eliminations and Adjustments:
(EL) Eliminate 80% subsidiary equity against investment account.
(NCI) Adjust NCI to fair value (credit to Sample's Retained Earnings).
(D) Distribute remaining excess in investment account plus NCI adjustment to:
(D1) Inventory.
(D2) Land.
(D3) Building (recorded cost is increased without removing accumulated depreciation).
The alternative is to debit Accumulated Depreciation for $50,000 and Buildings for $50,000.
(D4) Equipment (recorded cost is increased without removing accumulated depreciation).
The alternative is to debit Accumulated Depreciation for $20,000.
This would also restate the net asset at fair value.
(D5) Copyright.
(D6) Goodwill.
This would also restate the net asset at fair value.

85
 Reverse Acquisition
Public Company and Subsidiary Private Company Worksheet for Consolidated Balance Sheet December 31,
2013 Worksheet 2A-1 (see page 69)
(Credits are in parentheses.) Balance Sheet Eliminations & Adjustments NCI Consolidated
Balance
Private Public Dr. Cr.
Sheet
1 Current Assets 700 500 1,200 1
2 Investment in Private Company 2,400 2
3 (EL) 2,400 3
4 Fixed Assets 3,000 1,300 (D1) 200 4,500 4
5 Goodwill (D2) 300 300 5
6 Long-Term Liabilities (1,700) (700) (2,400) 6
7 Common Stock—Private (60) (Trans) 60 7
8 Paid-In Capital in Excess of Par—Private (540) (Trans) 540 8
9 Retained Earnings—Private (1,400) (1,400) 9
10 Common Stock—Public (100 + 150) (250) (EL) 150 (Trans) 150 (250) 10
11 Paid-In Capital in Excess of Par—Public (200 + 2,250) (2,450) (EL) 2,250 (Trans) 1,750 (1,950) 11
12 Retained Earnings—Public (800) (Trans) 1,300 (D) 500 12
13 Totals 0 0 4,800 4,800 0 13
14 NCI 0 0 14
15 Totals 0 15
Eliminations and Adjustments:
(EL) Eliminate investment account and entries to Public equity made to record the acquisition.
(D) Distribute fair market value adjustment to Public Company retained earnings as of the acquisition date.
(D1) Increase fixed assets from $1,300 to $1,500.
(D2) Record goodwill.
(Trans) Transfer Private paid-in equity and Public retained earnings into value assigned to newly issued Public
shares.

86
 Reverse Acquisition with Noncontrolling Interest in the Private Company
Public Company and Subsidiary Private Company Worksheet for Consolidated Balance Sheet December
31,2015 Worksheet 2A-2 (see page 71)
(Credits are in parentheses.) Balance Sheet Eliminations & Adjustments NCI Consolidated
Private Public Dr. Cr. Balance Sheet
1 Current Assets 700 500 1,200 1
2 Investment in Private Company 1,920 2
3 (EL) 1,920 3
4 Fixed Assets 3,000 1,300 (D1) 200 4,500 4
5 Goodwill (D2) 300 300 5
6 Long-Term Liabilities (1,700) (700) (2,400) 6
7 Common Stock—Private (60) (Trans) 48 (12) 7
8 Paid-In Capital in Excess of Par—Private (540) (Trans) 432 (108) 8
9 Retained Earnings—Private (1,400) (280) (1,120) 9
10 Common Stock—Public (100 + 120) (220) (EL) 120 (Trans) 120 (220) 10
11 Paid-In Capital in Excess of Par—Public (200 + 1,800) (2,000) (EL) 1,800 (Trans) 1,660 (1,860) 11
12 Retained Earnings—Public (800) (Trans) 1,300 (D) 500 12
13 Totals 0 0 4,200 4,200 0 13
14 NCI (400) (400) 14
15 Totals 0 15
Eliminations and Adjustments:
(EL) Eliminate investment account and entries to Public equity made to record the acquisition.
(D) Distribute fair market value adjustment to Public Company retained earnings as of the acquisition date.
(D1) Increase fixed assets from $1,300 to $1,500.
(D2) Record goodwill.
(Trans) Roll Private paid-in equity and Public retained earnings into value assigned to newly issued Public shares.

87
Exercises & Problems

1. Jacobson Company is considering an investment in the common

stock of Biltrite Company. What are the accounting issues
surrounding the recording of income in future periods if Jacobson
purchases:
a) 15% of Biltrite's outstanding shares.
b) 40% of Biltrite's outstanding shares.
c) 100% of Biltrite's outstanding shares.
d) 80% of Biltrite's outstanding shares.

2. What does the elimination process accomplish?

3. Paulos Company purchases a controlling interest in Sanjoy

Company. Sanjoy had identifiable net assets with a book value of
$500,000 and a fair value of $800,000. It was agreed that the total
fair value of Sanjoy's common stock was $1,200,000. Use value
analysis schedules to determine what adjustments will be made to
Sanjoy's accounts and what new accounts and amounts will be
recorded if:
a) Paulos purchases 100% of Sanjoy's common stock for $1,200,000.
b) Paulos purchases 80% of Sanjoy's common stock for $960,000.

4. Pillow Company is purchasing a 100% interest in the common stock

of Sleep Company. Sleep's balance sheet amounts at book and fair
values are as follows:
Account Book Value Fair Value
Current Assets ......... $200,000 $250,000
Fixed Assets ............. 350,000 800,000
Liabilities .................. (200,000) (200,000)

Use valuation analysis schedules to determine what adjustments to

recorded values of Sleep Company's accounts will be made in the
consolidation process (including the creation of new accounts), if the price
paid for the 100% is:
a) $1,000,000.
b) $500,000.

88
 5. Pillow Company is purchasing an 80% interest in the common stock
of Sleep Company. Sleep's balance sheet amounts at book and fair
values are as follows:
Account Book Value Fair Value
Current Assets ......... $200,000 $250,000
Fixed Assets ............. 350,000 800,000
Liabilities .................. (200,000) (200,000)

Use valuation analysis schedules to determine what adjustments to

recorded values of Sleep Company's accounts will be made in the
consolidation process (including the creation of new accounts), if the price
paid for the 80% is:
a) $800,000.
b) $600,000.

6. Pillow Company is purchasing an 80% interest in the common stock

of Sleep Company for $800,000. Sleep's balance sheet amounts at
book and fair value are as follows:
Account Book Value Fair Value
Current Assets ......... $200,000 $250,000
Fixed Assets ............. 350,000 800,000
Liabilities .................. (200,000) (200,000)

Use a valuation analysis schedule to determine what will be the amount

of the noncontrolling interest in the consolidated balance sheet and how
will it be displayed in the consolidated balance sheet.

89
Exercise 1 Investment recording methods. Santos Corporation is
considering investing in Fenco Corporation, but is unsure about what level
of ownership should be undertaken. Santos and Fenco have the following
reported incomes:
Santos Fenco
Sales .......................... $700,000 $450,000
Cost of goods sold ... 300,000 300,000
Gross profit ............... $400,000 $150,000
Selling and administrative
expenses 120,000 80,000
Net income .............. $280,000 $70,000

Fenco paid $15,000 in cash dividends to its investors. Prepare a pro

forma income statement for Santos Corporation that compares income
under 10%, 30%, and 80% ownership levels.

Exercise 2 Asset compared to stock purchase. Glass Company is

thinking about acquiring Plastic Company. Glass Company is considering
two methods of accomplishing control and is wondering how the
accounting treatment will differ under each method. Glass Company has
estimated that the fair values of Plastic’s net assets are equal to their book
values, except for the equipment, which is understated by $20,000. The
following balance sheets have been prepared on the date of acquisition:
Assets Glass Plastic
Cash .......................... $540,000 $20,000
Accounts receivable. 50,000 70,000
Inventory ................... 50,000 100,000
Property, plant, and equipment (net) 230,000 270,000
Total assets ............ $870,000 $460,000

Liabilities and Equity

Current liabilities ...... $140,000 $80,000
Bonds payable .......... 250,000 100,000
Stockholders' equity:
Common stock ($100 par) 200,000 150,000
Retained earnings .. 280,000 130,000
Total liabilities and equity $870,000 $460,000

90
1- Assume Glass Company purchased the net assets directly from
Plastic Company for $530,000.
a) Prepare the entry that Glass Company would make to record the
purchase.
b) Prepare the balance sheet for Glass Company immediately
following the purchase.
2- Assume that 100% of the outstanding stock of Plastic Company is
purchased from the former stockholders for a total of$530,000.
a) Prepare the entry that Glass Company would make to record the
purchase.
b) State how the investment would appear on Glass’s unconsolidated
balance sheet prepared immediately after the purchase.
c) Indicate how the consolidated balance sheet would appear.

91
Exercise 3 Simple value analysis. Flom Company is considering the
cash purchase of 100% of the outstanding stock of Vargas Company. The
terms are not set, and alternative prices are being considered for
negotiation. The balance sheet of Vargas Company shows the following
values:
Assets Liabilities and Equity
Cash equivalents $60,000 Current liabilities ...... $60,000
Inventory 120,000 Common stock ($5 par) 100,000
Land 100,000 Paid-in capital in excess of par 150,000
Building (net) 200,000 Retained earnings .... 170,000
Total assets $480,000 Total liabilities and equity $480,000

Appraisals reveal that the inventory has a fair value of $160,000 and that
the land and building have fair values of $120,000 and $300,000,
respectively.
1. Above what price will goodwill be recorded?
2. Below what price will a gain be recorded?

Exercise 4 Recording purchase with goodwill. Woolco, Inc., purchased

all the outstanding stock of Paint, Inc., for $980,000. Woolco also paid
$10,000 in direct acquisition costs. Just before the investment, the two
companies had the following balance sheets:
Assets Woolco, Inc. Paint, Inc.
Accounts receivable ...... $900,000 $500,000
Inventory ......................... 600,000 200,000
Depreciable fixed assets (net) 1,500,000
600,000
.........................................
Total assets .................. $3,000,000 $1,300,000

Liabilities and Equity

Current liabilities ............ $950,000 $400,000
Bonds payable ............... 500,000 200,000
Common stock ($10 par) 400,000 300,000
Paid-in capital in excess of par 500,000 380,000
Retained earnings ......... 650,000 20,000
Total liabilities and equity $3,000,000 $1,300,000

92
 Appraisals for the assets of Paint, Inc., indicate that fair values differ
from recorded book values for the inventory and for the depreciable fixed
assets, which have fair values of $250,000 and $750,000, respectively.
1. Prepare the entries to record the purchase of the Paint, Inc.,
common stock and payment of acquisition costs.
2. Prepare the value analysis and the determination and distribution
of excess schedule for the investment in Paint, Inc.
3. Prepare the elimination entries that would be made on a
consolidated worksheet.

Exercise 5 Purchase with a gain. Libra Company is purchasing 100% of

the outstanding stock of Genall Company for $700,000. Genall has the
following balance sheet on the date of acquisition:

Assets Liabilities and Equity

Accounts receivable .... $300,000 Current liabilities ......... $250,000
Inventory ..................... 200,000 Bonds payable ............ 200,000
Property, plant, and equipment Common stock ($5 par) 200,000
(net) ............................. 500,000
Paid-in capital in excess of par 300,000
Computer software ...... 125,000 Retained earnings ...... 175,000
Total assets .............. $1,125,000 Total liabilities and equity $1,125,000

Appraisals indicate that the following fair values for the assets and
liabilities should be acknowledged:
Accounts receivable ................................... $300,000
Inventory ...................................................... 215,000
Property, plant, and equipment .................... 700,000
Computer software ...................................... 130,000
Current liabilities .......................................... 250,000
Bonds payable ............................................. 210,000
1. Prepare the value analysis schedule and the determination and
distribution of excess schedule.
2. Prepare the elimination entries that would be made on a
consolidated worksheet prepared on the date of purchase.

93
Exercise 6 80% purchase, alternative values for goodwill. Quail Com-
pany purchases 80% of the common stock of Commo Company for
$800,000. At the time of the purchase, Commo has the following balance
sheet:
Assets Liabilities and Equity
Cash equivalents $120,000 Current liabilities ...... $200,000
Inventory 200,000 Bonds payable ......... 400,000
Common stock ($5
Land 100,000 par) ............................. 100,000
Paid-in capital in
Building (net) 450,000 excess of par 150,000
Equipment (net) 230,000 Retained earnings .... 250,000
Total liabilities and
Total assets $1,100,000 $1,100,000
equity .......................

The fair values of assets are as follows:

Cash equivalents ...................................................... $120,000
Inventory .................................................................... 250,000
Land ........................................................................... 200,000
Building ...................................................................... 650,000
Equipment .................................................................. 200,000

1- Prepare the value analysis schedule and the determination and

distribution of excess schedule under three alternatives for valuing
the NCI:
a) The value of the NCI is implied by the price paid by the parent for
the controlling interest.
b) The market value of the shares held by the NCI is $45 per share.
c) The international accounting option, which does not allow goodwill
to be recorded as part of the NCI, is used.
2- Prepare the elimination entries that would be made on a
consolidated worksheet prepared on the date of purchase under
the three alternatives for valuing the NCI:
a) The value of the NCI is implied by the price paid by the parent for
the controlling interest.
b) The market value of the shares held by the NCI is $45 per share.
c) The international accounting option, which does not allow goodwill
to be recorded as part of the NCI, is used.

94
Exercise 7 80% purchase with a gain and preexisting goodwill. Venus
Company purchases 8,000 shares of Sundown Company for $64 per
share. Just prior to the purchase, Sundown Company has the following
balance sheet:

Assets Liabilities and Equity

Cash ..............................
$20,000 Current liabilities ......... $250,000
Common stock ($5 par)
Inventory ...................... 280,000 ...................................... 50,000
Property, plant, and Paid-in capital in excess
equipment (net). 400,000 of par............................. 130,000
Goodwill ....................... 100,000 Retained earnings........ 370,000
Total assets .................. Total liabilities and
$800,000 $800,000
equity ............................

Venus Company believes that the inventory has a fair value of

$400,000 and that the property plant, and equipment is worth $500,000.
1. Prepare the value analysis schedule and the determination and
distribution of excess schedule.
2. Prepare the elimination entries that would be made on a
consolidated worksheet prepared on the date of acquisition.

95
 Exercise 8 Prior investment, control with later acquisition. Barns
Corporation purchased a 10% interest in Delta Company on January 1,
2015, as an available- for-sale investment for a price of $42,000.
On January 1, 2020, Barns Corporation purchased 7,000 additional
shares of Delta Company from existing shareholders for $350,000. This
purchase raised Barns’s interest to 80%. Delta Company had the following
balance sheet just prior to Barns’s second purchase:

Assets Liabilities and Equity

Current assets
................................. $165,000 Liabilities ...................... $65,000
Buildings (net)
................................. 140,000 Common stock ($10 par) 100,000
Equipment (net) Retained earnings ...... 240,000
................................. 100,000
Total assets Total liabilities and equity
$405,000 $405,000
................................. ......................................

At the time of the second purchase, Barns determined that Delta’s

equipment was understated by $50,000 and had a 5-year remaining life.
All other book values approximated fair values. Any remaining excess was
attributed to goodwill.
1. Prepare the value analysis and the determination and distribution
of excess schedule for the 2020 purchase.
2. Record the investment made by Barns on January 1, 2020, and
any required adjustment of the prior 10% interest.

96
 Exercise 9 Push-down accounting. On January 1, 2021, Knight
Corporation purchases all the outstanding shares of Craig Company for
$950,000. It has been decided that Craig Company will use push-down
accounting principles to account for this transaction. The current balance
sheet is stated at historical cost.
The following balance sheet is prepared for Craig Company on January
1, 2021:

Assets Liabilities and Equity

Current assets: Current liabilities Long-
Cash ........................ $80,000 term liabilities:
Accounts receivable 260,000 Bonds payable ...... $300,000 $90,000
Deferred taxes ....... 50,000 350,000
Prepaid expenses .... 20,000 $360,000 Stockholders' equity:
Property, plant, and Common stock ($10 par) $300,000
equipment: $200,000 Retained earnings 420,000 720,000
Building
Land (net) .......... 600,000 800,000
...................................
Total assets.............. $1,160,000 Total liabilities and equity $1,160,000
................................
Knight Corporation receives the following appraisals for Craig
Company’s assets and liabilities:
Cash ...................................................... ……………..$80,000
Accounts receivable ................................................... 260,000
Prepaid expenses ........................................................ 20,000
Land ........................................................................... 250,000
Building (net) .............................................................. 700,000
Current liabilities ........................................................... 90,000
Bonds payable ........................................................... 280,000
Deferred tax liability ...................................................... 40,000

1. Record the investment.

2. Prepare the value analysis schedule and the determination and
distribution of excess schedule.
3. Record the adjustments on the books of Craig Company.
4. Prepare the entries that would be made on the consolidated
worksheet to eliminate the investment.

97
 Exercise 10 Reverse acquisition. Small Company acquired a controlling
interest in Big Company. Private Company had the following balance
sheet on the acquisition date:

Small Company (the acquirer)

Balance Sheet
December 31,2015
Assets Liabilities and Equity
Current assets .... $1,000 Long-term liabilities .....
Fixed assets ........ 5,000 Common stock ($1 par)
(100 shares) $2,000
Paid-in capital in excess 100
of par ............................. 900
Retained earnings ........ 3,000
Total liabilities and
Total assets...... $6,000 $6,000
equity .........................

Big Company had the following book and fair values on the acquisition
date:
Assets Book Value Fair Value Liabilities and Equity Book Value Fair Value
Current assets $1,000 $1,000 $1,000 $1,000
..................... Long-term liabilities
Fixed assets 2,000 3,000 Common stock ($1 par) 200
(200 shares)
Paid-in capital in excess 800
of par ............
Retained earnings 1,000
Total assets $3,000 $4,000 Total liabilities and $3,000
equity
The shareholders of Small Company requested 300 Big Company
shares in exchange for all of their 100 shares. This was an exchange ratio
of 3 to 1. The fair value of a share of Big Company was $25.
Prepare an appropriate value analysis and a determination and
distribution of excess schedule.

98
Problems
Problem 2-1 100% purchase, goodwill, consolidated balance sheet.
On July 1, 2016, Roland Company exchanged 18,000 of its $45 fair value
($1 par value) shares for all the outstanding shares of Downes Company.
Roland paid acquisition costs of $40,000. The two companies had the
following balance sheets on July 1, 2016:

Assets Roland Downes

Other current assets ...... $50,000 $70,000
Inventory ......................... 120,000 60,000
Land................................. 100,000 40,000
Building (net) .................. 300,000 120,000
Equipment (net) .............. 430,000 110,000
Total assets..................... $1,000,000 $400,000

Liabilities and Equity

Current liabilities ............ $180,000 $60,000
Common stock ($1 par) . 40,000 20,000
Paid-in capital in excess of par 360,000 180,000
Retained earnings .......... 420,000 140,000
Total liabilities and equity $1,000,000 $400,000

The following fair values applied to Downes’s assets:

Other current assets…………………………………………………………..$70,000
Inventory ................................................................................................. 80,000
Land ........................................................................................................ 90,000
Building…………………………………………………………………………150,000
Equipment………………………………………………………………………100,000

1. Record the investment in Downes Company and any other entry

necessitated by the purchase.
2. Prepare the value analysis and the determination and distribution of
excess schedule.
3. Prepare a consolidated balance sheet for July 1, 2016, immediately
subsequent to the purchase.

99
 Problem 2-2 80% purchase, goodwill, consolidated balance sheet.
Using the data given in Problem 2-1, assume that Roland Company
exchanged 14,000 of its $45 fair value ($1 par value) shares for 16,000 of
the outstanding shares of Downes Company.
1. Record the investment in Downes Company and any other purchase-
related entry.
2. Prepare the value analysis schedule and the determination and distribution
of excess schedule.
3. Prepare a consolidated balance sheet for July 1, 2016, immediately
subsequent to the purchase.

Problem 2-3 100% purchase, bargain, elimination entries only.

On March 1, 2015, Carlson Enterprises purchases a 100% interest in
Entro Corporation for $400,000. Entro Corporation has the following
balance sheet on February 28, 2015:

Entro Corporation Balance Sheet February 28, 2015

Assets Liabilities and Equity
Accounts receivable .. $60,000 Current liabilities ........ $50,000
Inventory ..................... 80,000 Bonds payable ........... 100,000
Land ............................ 40,000 Common stock ($5 par) 50,000
Buildings .................... 300,000 Paid-in capital in excess of par 250,000
Accumulated depreciation-building (120,000) Retained earnings ...... 70,000
Equipment ................. 220,000
Accumulated depreciation-equipment (60,000)
Total assets ................ $520,000 Total liabilities and equity $520,000
Carlson Enterprises receives an independent appraisal on the fair
values of Entro Corporation’s assets and liabilities. The controller has
reviewed the following figures and accepts them as reasonable:
Accounts receivable $60,000
Inventory ................. 100,000
Land.......................... 40,500
Building ................... 202,500
Equipment ............... 162,000
Current liabilities ..... 50,000
Bonds payable ........ 95,000

1. Record the investment in Entro Corporation.

2. Prepare the value analysis and the determination and distribution of
excess schedule.
3. Prepare the elimination entries that would be made on a consolidated
worksheet prepared on the date of acquisition.

100
 Problem 2-4 80% purchase, bargain, elimination entries only. On
March 1, 2015, Penson Enterprises purchases an 80% interest in
Express Corporation for $320,000 cash. Express Corporation has the
following balance sheet on February 28, 2015:

Express Corporation Balance Sheet February 28, 2015

Assets Liabilities and Equity
Accounts receivable ...... $60,000 Current liabilities .......... $50,000
Inventory ........................ 80,000 Bonds payable .............. 100,000
Land ................................. 40,000 Common stock ($10 par) 50,000
Buildings ........................ 300,000 Paid-in capital in excess of par 250,000
Accumulated depreciation-
buildings (120,000) Retained earnings ....... 70,000
Equipment ...................... 220,000
Accumulated depreciation-
(60,000)
equipment
Total assets .................. $520,000 Total liabilities and equity $520,000

Penson Enterprises receives an independent appraisal on the fair

values of Express Corporation’s assets and liabilities. The controller has
reviewed the following figures and accepts them as reasonable:
Accounts receivable ........................... …………….. $60,000
Inventory ................................................................... 100,000
Land............................................................................. 50,000
Buildings ................................................................... 200,000
Equipment................................................................. 162,000
Current liabilities ........................................................ 50,000
Bonds payable ............................................................ 95,000

1. Record the investment in Express Corporation.

2. Prepare the value analysis schedule and the determination and
distribution of excess schedule.
3. Prepare the elimination entries that would be made on a consolidated
worksheet prepared on the date of acquisition.

101
 Problem 2-5 100% purchase, goodwill, push-down accounting. On
March 1, 2015, Collier Enterprises purchases a 100% interest in Robby
Corporation for $480,000 cash. Robby Corporation applies push-down
accounting principles to account for this acquisition.
Robby Corporation has the following balance sheet on February 28,
2015:
Robby Corporation Balance Sheet February 28, 2015
Assets Liabilities and Equity
Accounts receivable ........ $60,000 Current liabilities ...... $50,000
Inventory .......................... 80,000 Bonds payable .......... 100,000
Land ................................. 40,000 Common stock ($5) .. 50,000
Buildings ......................... 300,000 Paid-in capital in excess of par 250,000
Accumulated depreciation-buildings (120,000) Retained earnings ... 70,000
Equipment ...................... 220,000
Accumulated depreciation-
(60,000)
equipment
Total assets ................... $520,000 Total liabilities and equity $520,000

Collier Enterprises receives an independent appraisal on the fair values

of Robby Corporation’s assets and liabilities. The controller has reviewed
the following figures and accepts them as reasonable:
Accounts receivable .................................................................................. $60,000
Inventory ..................................................................................................... 100,000
Land............................................................................................................. 55,000
Buildings ..................................................................................................... 200,000
Equipment................................................................................................... 150,000
Current liabilities ........................................................................................ 50,000
Bonds payable ............................................................................................ 98,000

1. Record the investment in Robby Corporation.

2. Prepare the value analysis schedule and the determination and
distribution of excess schedule.
3. Give Robby Corporation’s adjusting entry.

102
 Problem 2-6 100% purchase, goodwill, worksheet. On December 31,
2015, Aron Company purchases 100% of the common stock of Shield
Company for $450,000 cash. On this date, any excess of cost over book
value is attributed to accounts with fair values that differ from book values.
These accounts of Shield Company have the following fair values:

Cash………………………………………………………………………………….$40,000
Accounts receivable ...................................................................................... 30,000
Inventory…………………………………………………………………………….140,000
Land................................................................................................................. 45,000
Buildings and equipment…………………………………………………………225,000
Copyrights ...................................................................................................... 25,000
Current liabilities ............................................................................................ 65,000
Bonds payable……………………………………………………………………...105,000

The following comparative balance sheets are prepared for the two
companies immediately after the purchase:

Aron Shield
Cash .................................. $185,000 $40,000
Accounts receivable ........ 70,000 30,000
Inventory ........................... 130,000 120,000
Investment in Shield Company 450,000
Land................................... 50,000 35,000
Buildings and equipment 350,000 230,000
Accumulated depreciation (100,000) (50,000)
Copyrights ........................ 40,000 10,000
Total assets ...................... $1,175,000 $415,000
Current liabilities .............. $192,000 $65,000
Bonds payable ..................
100,000
Common stock ($10 par)—Aron 100,000
Common stock ($5 par)—Shield 50,000
Paid-in capital in excess of par 250,000 70,000
Retained earnings ............ 633,000 130,000
Total liabilities and equity $1,175,000 $415,000
1. Prepare the value analysis schedule and the determination and
distribution of excess schedule for the investment in Shield Company.
2. Complete a consolidated worksheet for Aron Company and its
subsidiary Shield Company as of December 31, 2015.

103
 Problem 2-7 80% purchase, goodwill, worksheet. Using the data given
in Problem 2-6, assume that Aron Company purchases 80% of the
common stock of Shield Company for $320,000 cash.
The following comparative balance sheets are prepared for the two
companies immediately after the purchase:
Aron Shield
Cash ................................ $315,000 $40,000
Accounts receivable ...... 70,000 30,000
Inventory ......................... 130,000 120,000
Investment in Shield Company 320,000
Land ................................ 50,000 35,000
Buildings and equipment 350,000 230,000
Accumulated depreciation (100,000) (50,000)
Copyrights ...................... 40,000 10,000
Total assets .................... $1,175,000 $415,000
Current liabilities ............ $192,000 $65,000
Bonds payable................ 100,000
Common stock ($10 par)—Aron 100,000
Common stock ($5 par)—Shield 50,000
Paid-in capital in excess of par 250,000 70,000
Retained earnings .......... 633,000 130,000
Total liabilities and equity $1,175,000 $415,000

1. Prepare the value analysis and the determination and distribution of

excess schedule for the investment in Shield Company.
2. Complete a consolidated worksheet for Aron Company and its
subsidiary Shield Company as of December 31, 2015.

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 Use the following information for Problems 2-8 through 2-11:
In an attempt to expand its operations, Palto Company acquires Saleen
Company on January 1, 2015. Palto pays cash in exchange for the
common stock of Saleen. On the date of acquisition, Saleen has the
following balance sheet:

Saleen Company Balance Sheet January 1,2015

Assets Liabilities and Equity
Accounts receivable ...... $20,000 Current liabilities .................. $40,000
Inventory ......................... 50,000 Bonds payable ..................... 100,000
Land ................................ 40,000 Common stock ($1 par) ....... 10,000
Buildings ........................ 200,000 Paid-in capital in excess of par 90,000
Accumulated depreciation (50,000) Retained earnings ............... 60,000
Equipment ...................... 60,000
Accumulated depreciation (20,000)
Total assets .................... $300,000 Total liabilities and equity ... $300,000

An appraisal provides the following fair values for assets:

Accounts receivable $20,000

Inventory ................. 60,000
Land ........................ 80,000
Buildings ................ 320,000
Equipment .............. 60,000
Copyright ................ 50,000

Problem 2-8 100% purchase, goodwill, worksheet. Use the preceding

information for Palto’s purchase of Saleen common stock. Assume Palto
purchases 100% of the Saleen common stock for $500,000 cash. Palto
has the following balance sheet immediately after the purchase:
Palto Company Balance Sheet January 1,2015
Assets Liabilities and Equity
Cash ......................... $61,000 Current liabilities ........ $80,000
Accounts receivable 65,000 Bonds payable .......... 200,000
Inventory ................. 80,000 Common stock ($1 par) 20,000
Investment in Saleen 500,000 Paid-in capital in excess of par 180,000
Land .......................... 100,000 Retained earnings ...... 546,000
Buildings ................. 250,000
Accumulated depreciation (80,000)
Equipment ............... 90,000
Accumulated depreciation (40,000)
Total assets ............ $1,026,000 Total liabilities and equity $1,026,000

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 1. Prepare the value analysis schedule and the determination and
distribution of excess schedule for the investment in Saleen.
2. Complete a consolidated worksheet for Palto Company and its
subsidiary Saleen Company as of January 1, 2015.

Problem 2-9 100% purchase, bargain, worksheet. Use the preceding

information for Palto’s purchase of Saleen common stock. Assume Palto
purchases 100% of the Saleen common stock for $400,000 cash. Palto
has the following balance sheet immediately after the purchase:
Palto Company Balance Sheet January 1,2015
Assets Liabilities and Equity
Cash.......................... $161,000 Current liabilities ..... $80,000
Accounts receivable 65,000 Bonds payable ($1 par) 200,000
Inventory .................. 80,000 Common stock ......... 20,000
Investment in Saleen 400,000 Paid-in capital in excess of par 180,000
Land .......................... 100,000 Retained earnings ... 546,000
Buildings .................. 250,000
Accumulated depreciation (80,000)
Equipment ................ 90,000
Accumulated depreciation (40,000)
Total assets ............ $1,026,000 Total liabilities and equity $1,026,000

1. Prepare the value analysis schedule and the determination and

distribution of excess schedule for the investment in Saleen.
2. Complete a consolidated worksheet for Palto Company and its
subsidiary Saleen Company as of January 1, 2015.

106
 Problem 2-10 80% purchase, goodwill, worksheet. Use the preceding
information for Palto’s purchase of Saleen common stock. Assume Palto
purchases 80% of the Saleen common stock for $400,000 cash. The
shares of the noncontrolling interest have a fair value of $46 each. Palto
has the following balance sheet immediately after the purchase:
Palto Company Balance Sheet January 1,2015
Assets Liabilities and Equity
Cash ......................... $161,000 Current liabilities ...... $80,000
Accounts receivable 65,000 Bonds payable ......... 200,000
Inventory .................. 80,000 Common stock ($1 par) 20,000
Investment in Saleen 400,000 Paid-in capital in excess of par 180,000
Land .......................... 100,000 Retained earnings .... 546,000
Buildings ................. 250,000
Accumulated depreciation (80,000)
Equipment ............... 90,000
Accumulated depreciation (40,000)
Total assets ........... $1,026,000 Total liabilities and equity $1,026,000

1. Prepare the value analysis schedule and the determination and

distribution of excess schedule for the investment in Saleen.
2. Complete a consolidated worksheet for Palto Company and its
subsidiary Saleen Company as ofJanuary 1, 2015.

107
 Problem 2-11 80% purchase, bargain, purchase, worksheet. Use the
preceding information for Palto’s purchase of Saleen common stock.
Assume Palto purchases 80% of the Saleen common stock for $300,000
cash. Palto has the following balance sheet immediately after the
purchase:
Palto Company Balance Sheet January 1,2015
Assets Liabilities and Equity
Cash .......................... $261,000 Current liabilities ..... $80,000
Accounts receivable 65,000 Bonds payable ......... 200,000
Inventory .................. 80,000 Common stock ($1 par) 20,000
Investment in Saleen 300,000 Paid-in capital in excess of par 180,000
Land .......................... 100,000 Retained earnings .. 546,000
Buildings .................. 250,000
Accumulated depreciation (80,000)
Equipment ................ 90,000
Accumulated depreciation (40,000)
Total assets ........... $1,026,000 Total liabilities and equity $1,026,000
1. Prepare the value analysis and the determination and distribution of
excess schedule for the investment in Saleen.
2. Complete a consolidated worksheet for Palto Company and its
subsidiary Saleen Company as of January 1, 2015.

108
 Use the following information for Problems 2-12 through 2-15:
Purnell Corporation acquires Sentinel Corporation on December 31, 2015.
Sentinel has the following balance sheet on the date of acquisition:
Sentinel Corporation Balance Sheet December 31,2015
Assets Liabilities and Equity
Accounts receivable $50,000 Current liabilities ..... $90,000
Inventory ................ 120,000 Bonds payable ........ 200,000
Land ....................... 100,000 Common stock ($1 par) 10,000
Buildings ............... 300,000 Paid-in capital in excess of par 190,000
Accumulated depreciation (100,000) Retained earnings ... 140,000
Equipment ............ 140,000
Accumulated depreciation (50,000)
Patent ..................... 10,000
Goodwill ................ 60,000
Total assets ........ $630,000 Total liabilities and equity $630,000
An appraisal is performed to determine whether the book values of
Sentinel’s net assets reflect their fair values. The appraiser also
determines that intangible assets exist, although they are not recorded.
The following fair values for assets and liabilities are agreed upon:

Accounts receivable……………………………… $50,000

Inventory ............................................................. 100,000
Land..................................................................... 200,000
Buildings ............................................................. 400,000
Equipment........................................................... 200,000
Patent .................................................................. 150,000
Computer software............................................... 50,000
Current liabilities .................................................. 90,000
Bonds payable .................................................... 210,000

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 Problem 2-12 100% purchase, goodwill, several adjustments,
worksheet. Use the preceding information for Purnell’s purchase of
Sentinel common stock. Assume Purnell exchanges 22,000 shares of its
own stock for 100% of the common stock of Sentinel. The stock has a
market value of $50 per share and a par value of $1. Purnell has the
following trial balance immediately after the purchase:
Purnell Corporation Trial Balance December 31,2015
Cash............................. 20,000
Accounts Receivable . 300,000
Inventory ..................... 410,000
Investment in Sentinel 1,100,000
Land ............................. 800,000
Buildings ..................... 2,800,000
Accumulated Depreciation (500,000)
Equipment ................... 600,000
Accumulated Depreciation (230,000)
Current Liabilities ....... (150,000)
Bonds Payable ............ (300,000)
Common Stock ($1 par) (95,000)
Paid-In Capital in Excess of Par (3,655,000)
Retained Earnings ..... (1,100,000)
Total ............................ 0

1. Prepare the value analysis schedule and the determination and

distribution of excess schedule for the investment in Sentinel.
2. Complete a consolidated worksheet for Purnell Corporation and its
subsidiary Sentinel Corporation as of December 31, 2015.

110
 Problem 2-13 100% purchase, bargain, several adjustments, work-
sheet. Use the preceding information for Purnell’s purchase of Sentinel
common stock. Assume Purnell exchanges 16,000 shares of its own stock
for 100% of the common stock of Sentinel. The stock has a market value
of $50 per share and a par value of $1. Purnell has the following trial
balance immediately after the purchase.

Purnell Corporation Trial Balance December 31,2015

Cash .............................................. 20,000
Accounts Receivable ................... 300,000
Inventory ....................................... 410,000
Investment in Sentinel .................. 800,000
Land................................................ 800,000
Buildings ....................................... 2,800,000
Accumulated Depreciation .......... (500,000)
Equipment ..................................... 600,000
Accumulated Depreciation .......... (230,000)
Current Liabilities .......................... (150,000)
Bonds Payable............................... (300,000)
Common Stock ($1 par) ................ (89,000)
Paid-In Capital in Excess of Par ... (3,361,000)
Retained Earnings ........................ (1,100,000)
Total ............................................... 0
1. Prepare the value analysis schedule and the determination and
distribution of excess schedule for the investment in Sentinel.
2. Complete a consolidated worksheet for Purnell Corporation and its
subsidiary Sentinel Corporation as of December 31, 2015.

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 Problem 2-14 80% purchase, goodwill, several adjustments,
worksheet. Use the preceding information for Purnell’s purchase of
Sentinel common stock. Assume Purnell exchanges 19,000 shares of its
own stock for 80% of the common stock of Sentinel. The stock has a
market value of $50 per share and a par value of $1. Purnell has the fol-
lowing trial balance immediately after the purchase:
Purnell Corporation Trial Balance December 31,2015
Cash ............................................. 20,000
Accounts Receivable .................. 300,000
Inventory ...................................... 410,000
Investment in Sentinel ................ 950,000
Land.............................................. 800,000
Buildings ...................................... 2,800,000
Accumulated Depreciation ......... (500,000)
Equipment .................................... 600,000
Accumulated Depreciation ......... (230,000)
Current Liabilities ........................ (150,000)
Bonds Payable............................. (300,000)
Common Stock ($1 par) .............. (92,000)
Paid-In Capital in Excess of Par . (3,508,000)
Retained Earnings ...................... (1,100,000)
Total ............................................. 0
1. Prepare the value analysis schedule and the determination and
distribution of excess schedule for the investment in Sentinel.
2. Complete a consolidated worksheet for Purnell Corporation and its
subsidiary Sentinel Corporation as of December 31, 2015.

112
 Problem 2-15 80% purchase, bargain, several adjustments,
worksheet. Use the preceding information for Purnell’s purchase of
Sentinel common stock. Assume Purnell exchanges 10,000 shares of its
own stock for 80% of the common stock of Sentinel. The stock has a
market value of $50 per share and a par value of $1. Purnell has the fol-
lowing trial balance immediately after the purchase:
Purnell Corporation Trial Balance December 31,2015
Cash ............................................. 20,000
Accounts Receivable .................. 300,000
Inventory ...................................... 410,000
Investment in Sentinel ................ 500,000
Land.............................................. 800,000
Buildings ...................................... 2,800,000
Accumulated Depreciation ......... (500,000)
Equipment .................................... 600,000
Accumulated Depreciation ......... (230,000)
Current Liabilities ........................ (150,000)
Bonds Payable............................. (300,000)
Common Stock ($1 par) .............. (83,000)
Paid-In Capital in Excess of Par (3,067,000)
Retained Earnings ...................... (1,100,000)
Total.............................................. 0

1. Prepare the value analysis schedule and the determination and

distribution of excess schedule for the investment in Sentinel.
2. Complete a consolidated worksheet for Purnell Corporation and its
subsidiary Sentinel Corporation as of December 31, 2015.

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 Problem 2-16 Reverse acquisition On January 1, 2016, the
shareholders of Unknown Company request 6,000 Famous shares in
exchange for all oftheir 5,000 shares. This is an exchange ratio of 1.2 to
1. The fair value of a share of Famous Company is $60. The acquisition
occurs when the two companies have the following balance sheets:
Unknown Company (the acquirer) Balance Sheet December 31,2015
Assets Liabilities and Equity
Current assets... $10,000 Long-term liabilities . $5,000
Building (net) .... 150,000 Common stock ($1 par) (5,000 shares) 5,000
Equipment (net) 100,000 Paid-in capital in excess of par 115,000
Retained earnings .... 135,000
Total assets ....... $260,000 Total liabilities and equity $260,000

Famous Company (the acquiree) Balance Sheet December 31,2015

Fair
Assets Book Value Value Liabilities and Equity Book Value Fair Value
Current assets . $5,000 $5,000 Long-term liabilities $10,000 $10,000
Common stock ($1 par) (4,000
Building (net) ... 100,000 200,000 shares) 4,000
Equipment (net) 20,000 40,000 Paid-in capital in excess of par 96,000
Retained earnings .. 15,000
Total assets ... .. $125,000 $245,000 Total liabilities and equity $125,000

1. Prepare an appropriate value analysis and a determination and

distribution of excess schedule.
2. Complete a consolidated worksheet for Unknown Company and its
subsidiary, Famous Company, as of January 1, 2016.

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 CASE Consolidating a Bargain Purchase
Your client, Great Value Hardware Stores, has come to you for assistance
in evaluating an opportunity to purchase a controlling interest in a
hardware store in a neighboring city. The store under consideration is a
closely held family corporation. Owners of 60% of the shares are willing
to sell you the 60% interest, 30,000 common stock shares in exchange for
7,500 of Great Value shares, which have a fair value of $40 each and a
par value of $10 each.
Your client sees this as a good opportunity to enter a new market. The
controller of Great Value knows, however, that all is not well with the store
being considered. The store, Al's Hardware, has not kept pace with the
market and has been losing money. It also has a major lawsuit against it
stemming from alleged faulty electrical components it supplied that
caused a fire. The store is not insured for the loss. Legal counsel advises
that the store will likely pay $300,000 in damages.
The following balance sheet was provided by Al's Hardware as of
December 31, 2015:
Assets Liabilities and Equity
Cash ................................ $180,000 Current liabilities .. $425,000
Accounts receivable ...... 460,000 8% Mortgage payable 600,000
Inventory ........................ 730,000 Common stock ($5 par) 250,000
Paid-in capital in excess of 750,000
Land ................................. 120,000 par
Building ......................... 630,000 Retained earnings (80,000)
Accumulated depreciation-building (400,000)
Equipment ..................... 135,000
Accumulated depreciation-equipment (85,000)
Goodwill ......................... 175,000
Total assets .................. $1,945,000 Total liabilities and equity $1,945,000

Your analysis raises substantial concerns about the values shown. You
have gathered the following information:
1. Aging of the accounts receivable reveals a net realizable value of
$350,000.
2. The inventory has many obsolete items; the fair value is $600,000.
3. Appraisals for long-lived assets are as follows:
Land ..................................................................... $100,000
Building ................................................................. 300,000
Equipment ............................................................. 100,000
4. The goodwill resulted from the purchase of another hardware store that
has since been consolidated into the existing location. The goodwill was
attributed to customer loyalty.
5. Liabilities are fairly stated except that there should be a provision for the
estimated loss on the lawsuit.

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 On the basis of your research, you are convinced that the statements
of Al's Hardware are not representative and need major restatement. Your
client is not interested in being associated with statements that are not
accurate.
Your client asks you to make recommendations on two concerns:
1. Does the price asked seem to be a real bargain? Consider the fair value
of the entire equity of Al's Hardware; then decide if the price is reasonable
fora 60% interest.
2. If the deal were completed, what accounting methods would you
recommend either on the books of Al's Hardware or in the consolidation
process? Al's Hardware would remain a separate legal entity with a
substantial noncontrolling interest.

116
117
 Chapter 3: Accounting for Branches
Introduction:
As a business enterprise grows, it may establish one or more branches
to market its products over a large district (territory). Although branches of
an enterprise are not separate legal entities, they are separate economic
and accounting entities whose special features necessitate accounting
procedures tailored for those features, such as reciprocal ledger
accounts.
The term branch is used to describe a business unit located at some
distance from the home office. This unit carries merchandise obtained
from the home office, makes sales, approves customers’ credit, and
makes collections from its customers.
A branch may obtain goods solely from the home office, or a portion
may be purchased from outside suppliers. The cash receipts of the branch
often are deposited in a bank account belonging to the home office; the
branch expenses then are paid from an imprest cash fund or a bank
account provided by the home office. As the imprest cash fund is depleted,
the branch submits a list of cash payments supported by vouchers and
receives a check or an electronic or wire transfer from the home office to
replenish the fund.
The use of an imprest cash fund gives the home office considerable
control over the cash transactions of the branch. Nevertheless, it is
common practice for a large branch to maintain its own bank account. The
extent of autonomy (independency) and responsibility of a branch varies,
even among different branches of the same business enterprise.
A segment of a business enterprise also may be operated as a
division, which generally has more autonomy than a branch. The
accounting procedures for a division not organised as a separate
corporation (subsidiary company) are similar to those used for
branches. When a business segment is operated as a separate
corporation, consolidated financial statement are generally required.

Accounting System for A Branch

The accounting system of one business enterprise with branches may
provide for a complete set of accounting records at each branch; policies
of another such enterprise may keep all accounting records in the home
office. For example, branches of drug and grocery chain stores submit
daily reports and business documents to the home office, which enters all
transactions by branches in computerized accounting records kept in a
central location. The home office may not even conduct operations of its
own; it may serve only as an accounting and control centre for the
branches.

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 A branch may maintain a complete set of accounting records consisting
of journals, ledgers, and a chart of accounts similar to those of an
independent business enterprise. Financial statements are prepared by
the branch accountant and forwarded to the home office. The number and
types of ledger accounts, the internal control structure, the form and
content of the financial statements, and the accounting policies generally
are prescribed (imposed) by the home office.
This section on a branch operation that maintains a complete set of
accounting records. Transactions recorded by a branch should include all
controllable expenses and revenue for which the branch manager is
responsible. If the branch manager has responsibility over all branch
assets, liabilities, revenue, and expenses, the branch accounting records
should reflect this responsibility. Expenses such as depreciation often are
not subject to control by a branch manager; therefore, both the branch
plant assets and the related depreciation ledger accounts generally are
maintained by the home office.

Reciprocal Ledger Accounts:

The accounting records maintained by a branch include a Home Office
ledger account that is credited for all merchandise, cash, or other assets
provided by the home office; it is debited for all cash, merchandise, or
other assets sent by the branch to the home office or to other branches.
The Home Office account is similar to ownership equity account that
shows the net investment by the home office in the branch. At the end of
an accounting period when the branch closes its accounting records, the
Income Summary account is closed to the Home Office account. A net
income increases the credit balance of the Home Office account; a net
loss decreases this balance.
In the home office accounting records, a reciprocal ledger account
with a title such as Investment in Branch is maintained. This noncurrent
asset account is debited for cash, merchandise, and services provided to
the branch by the home office, and for net income reported by the branch.
It is credited for cash or other assets received from the branch, and for net
losses reported by the branch. Thus, the Investment in Branch account
reflects the equity method of accounting. A separate investment account
generally is maintained by the home office for each branch. If there is only
one branch, the account title is likely to be Investment in Branch; if there
are numerous branches, each account title includes a name or number to
identify each branch.

Expenses Incurred by Home Office and Allocated to Branches

In practice, some business enterprises follow a policy of notifying each
branch of expenses incurred by the home office on the branch’s behalf.

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 As stated previously, plant assets located at a branch generally are
carried in the home office accounting records. If a plant asset is acquired
by the home office for the branch, the journal entry for the acquisition is a
debit to an appropriate asset account such as Equipment: Branch and a
credit to Cash or an appropriate liability account. If the branch acquires
a plant asset, it debits the Home Office ledger account and credits
Cash or an appropriate liability account. The home office debits an
asset account such as Equipment: Branch and credits Investment in
Branch.
The home office also usually acquires insurance, pays property and
other taxes, and arranges for advertising that benefits all branches.
Obviously, such expenses as depreciation, property taxes, insurance, and
advertising must be considered in determining the profitability of a branch.
A policy decision must be made as to whether these expense data are to
be retained at the home office or are to be reported to the branches so
that the income statement prepared for each branch will give a complete
picture of its operations. An expense incurred by the home office and
allocated to a branch is recorded by the home office by a debit to
Investment in Branch and a credit to an appropriate expense ledger
account; the branch debits an expense account and credits Home Office.
If the home office does not make sales, but functions only as an
accounting and control centre, most or all of its expenses may be allocated
to the branches. To facilitate comparison of the operating results of the
various branches, the home office may charge each branch interest on
the capital invested in that branch. Such interest expense recognised by
the branches would be offset by interest revenue recognized by the home
office and would not be displayed in the combined income statement of
the business enterprise as a whole.

Alternative Methods of Billing Merchandise Shipments to

Branches:
Practically, three methods are available to the home office for billing
merchandise shipped to its branches. The shipments may be billed:
(1) At home office cost.
(2) At a percentage above home office cost.
(3) At the branch’s retail selling price.
The shipment of merchandise to a branch does not constitute a sale,
because ownership of the merchandise does not change.
1- Billing at home office cost. It is the simplest procedure and is widely
used. It avoids the complication of unrealized gross profit in inventories
and permits the financial statements of branches to give a meaningful
picture of operations. However, billing merchandise to branches at home
office cost attributes all gross profits of enterprise to the branches, even

120
though some of the merchandise may be manufactured by the home
office. Under these circumstances, home office cost may not be the most
realistic basis for billing shipments to branches.
2- Billing at a percentage above home office cost. Adopting this
method (such as 110% of cost) may be intended to allocate a reasonable
gross profit to the home office. When merchandise is billed to a branch at
a price above home office cost, the net income reported by the branch
is understated and the ending inventories are overstated for the
enterprise as a whole. Adjustments must be made by the home office to
eliminate the excess of billed prices over cost (intracompany profits) in
the preparation of combined financial statements for the home office and
the branch.
3- Billing at branch retail selling prices. Billing shipments to a branch
at branch retail selling prices may be based on a desire to strengthen
internal control over inventories. The inventories ledger account of the
branch shows the merchandise received and sold at retail selling prices.
As a result, the account will show the ending inventories that should be
on hand at retail prices. The home office record of shipments to a branch,
when considered along with sales reported by the branch, provides a
perpetual inventory stated at selling prices. If the physical inventories
taken periodically at the branch do not agree with the amounts thus
computed, an error or theft may be indicated and should be investigated
promptly.

Separate Financial Statements for Branch and for Home Office

Logically, a separate income statement and balance sheet should be
prepared for a branch in order that management of the enterprise may
review the operating results and financial position of the branch. The
branch’s income statement has no unusual features if merchandise is
billed to the branch at home office cost. However, if merchandise is billed
to the branch at branch retail selling prices, the branch’s income statement
will show a net loss approximating the amount of operating expenses. The
only unusual aspect of the balance sheet for a branch is the use of the
Home Office ledger account instead of the ownership equity accounts for
a separate business enterprise. The separate financial statements
prepared for a branch may be revised at the home office to include
expenses incurred by the home office allocable to the branch and to show
the results of branch operations after elimination of any intracompany
profits on merchandise shipments.
Additionally, separate financial statements also may be prepared for
the home office so that management will be able to appraise the results
of its operations and its financial position. Nevertheless, it is important to
emphasize that separate financial statements of the home office and of

121
the branch are prepared for internal use only; they do not meet the
needs of investors or other external users of financial statements.

Illustration 3.1:
Illustrative Journal Entries for Operations of a Branch:
Egypt Company bills merchandise to Qena Branch at home office cost
and that Qena Branch maintains complete accounting records and
prepares financial statements. Both the home office and the branch
use the perpetual inventory system. Equipment used at the branch is
carried in the home office accounting records. Certain expenses, such as
advertising and insurance, incurred by the home office on behalf of the
branch, are billed to the branch. Transactions and events during the first
year (2014) of operation of Qena Branch are summarized below:
1. Cash of L.E.1000 was forwarded by the home office to Qena Branch.
2. Merchandise with a home office cost of L.E.60000 was shipped by the
home office to Qena Branch.
3. Equipment was acquired by Qena Branch for L.E.500, to be carried in
the home office accounting records. (other plant assets for Qena Branch
generally are acquired by the home office.
4. Credit sales by Qena Branch amounted to L.E.80000; the branch’s cost
of the merchandise sold was L.E.45000.
5. Collections of trade accounts receivable by Qena Branch amounted to
L.E.62000.
6. Payments for operating expenses by Qena Branch totalled L.E.20000.
7. Cash of L.E.37500 was remitted by Qena Branch to the home office.
8. Operating expenses incurred by the home office and charged to Qena
Branch totalled L.E.3000.
Instructions:
Record these transactions and events in the accounting records of home
office and Qena Branch.

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 Solution:
Home Office Accounting Records Qena Branch Accounting Records
Journal Entries Journal Entries
(1) Investment in Qena Branch 1000 Cash 1000
Cash 1000 Home Office 1000

(2) Investment in Qena Branch 60000 Inventories 60000

Inventories 60000 Home Office 60000

(3) Equipment: Qena Branch 500 Home Office 500

Investment in Qena Branch 500 Cash 500

(4) None Trade Accounts Receivable 80000

Sales 80000

Cost of Goods Sold 45000

Inventories 45000

(5) None Cash 62000

Trade Accounts Receivable 62000

(6) None Operating Expenses 20000

Cash 20000

(7) Cash 37500 Home Office 37500

Investment in Qena Branch 37500 Cash 37500

(8) Investment in Qena Branch 3000 Operating Expenses 3000

Operating Expenses 3000 Home Office 3000

On the other hand, if a branch obtains merchandise from outsiders as

well as from the home office, the merchandise acquired from the home
office may be recorded in a separate Inventories from Home Office
ledger account.
In the home office accounting records, the Investment in Quena Branch
ledger account has a debit balance of L.E.26000 [before the accounting
records are closed and the branch net income of L.E.12000 (L.E.8000 –
L.E.45000 – L.E.20000 – L.E.3000 = L.E.12000) is transferred to the
Investment in Quena Branch ledger account], as illustrated below
(Reciprocal Ledger Account in Accounting Records of Home Office Prior
to Equity-Method Adjusting Entry).

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 Investment in Qena Branch
Date Explanation Debit Credit Balance
2014 Cash sent to branch 1000 1000 dr
Merchandise billed to branch at home office cost 60000 61000 dr
Equipment acquired by branch, carried in home office
accounting records 500 60500 dr
Cash received from branch 37500 23000 dr
Operating expenses billed to branch 3000 26000 dr

In the accounting records of Qena Branch, the Home Office ledger

account has a credit balance of L.E.26000 (before the accounting records
are closed and the net income of L.E.12000 is transferred to the Home
Office account), as shown below [Reciprocal Ledger Account in
Accounting Records of Qena Branch Prior to Closing Entry].
Home Office
Date Explanation Debit Credit Balance
2014 Cash received from home office 1000 1000 cr
Merchandise received from home office 60000 61000 cr
Equipment acquired 500 60500 cr
Cash sent to home office 37500 23000 cr
Operating expenses billed by home office 3000 26000 cr

Combined Financial Statements for Home Office and Branch

A balance sheet for distribution to creditors, stockholders, and
government agencies must show the financial position of a business
enterprise having branches as a single entity. A convenient starting point
in the preparation of a combined balance sheet consists of the adjusted
trial balances of the home office and of the branch. A working paper for
the combination of these trial balances is illustrated on the following
pages.
The assets and liabilities of the branch are substituted for the
Investment in Branch ledger account included in the home office trial
balance. Similar accounts are combined to produce a single total amount
for cash, trade accounts receivable, and other assets and liabilities of the
enterprise as a whole.
In the preparation of a combined balance sheet, reciprocal ledger
accounts are eliminated because they have no significance when the
branch and home office report as a single entity. The balance of the Home
Office account is offset against the balance of the Investment in Branch
account; in addition, any receivables and payables between the home
office and the branch (or between two branches) are eliminated.
The operating results of the enterprise (the home office and all
branches) are shown by an income statement in which the revenue and
expenses of the branches are combined with corresponding revenue and

124
expenses for the home office. Any intracompany profits or losses are
eliminated.
Working Paper for Combined Financial Statements:
A working paper for combined financial statements has three purposes:
(1) to combine ledger account balances for like revenue, expenses,
assets, and liabilities;
(2) to eliminate any intracompany profits or losses, and
(3) to eliminate the reciprocal accounts.
Assume that the perpetual inventories of L.E.15000 (L.E.60000 –
L.E.45000 =15000) at the end of 2014 for Qena Branch had been verified
by a physical count. The following working paper for Egypt Company is
based on the transactions and events of Illustration 2.1 above and
additional assumed data for the home office trial balance. All the routine
year-end adjusting entries (except the home office entries on presented
next) are assumed to have been made, and the working paper is begun
wit the adjusted trial balances of the home office and Qena Branch.

125
 EGYPT COMPANY
Working Paper for Combined Financial Statements of Home Office
and Qena Branch
For Year Ended December 31, 2014
(Perpetual Inventory System: Billing at Cost)
Adjusted Trial
Balances
Home Qena
Office Branch Eliminations Combined
Dr (Cr) Dr (Cr) Dr (Cr) Dr (Cr)
Income Statement
Sales (400000) (80000) (480000)
Cost of goods sold 235000 45000 280000
Operating expenses 90000 23000 113000
Net income (to statement of retained earnings
below) 75000 12000 87000
Totals -0000- -0000- -0000-
Statement of Retained Earnings
Retained earnings, beginning of year (70000) (70000)
Net (income) (from income statement above) (75000) (12000) (87000)
Dividends declared 40000 40000
Retained earnings, end of year (to balance sheet 117000
below)
Totals -0000-
Balance Sheet
Cash 25000 5000 30000
Trade accounts receivable (net) 39000 18000 57000
Inventories 45000 15000 60000
Investment in Qena Branch 26000 (a) (26000)
Equipment 150000 150000
Accumulated depreciation of equipment (10000) (10000)
Trade accounts payable (20000) (20000)
Home office (26000) (a) 26000
Common stock,L.E.10 par (150000) (150000)
Retained earnings (from statement of retained
earnings above) (117000)
Totals -0000- -0000- -0000- -0000-
(a) To eliminate reciprocal ledger account balances.

Note that the L.E.26000 debit balance of the Investment in Qena Branch
ledger account and the L.E.26000 credit balance of the Home Office
account are the balances before the respective accounting records are
closed, that is, before the L.E.12000 net income of Qena Branch is
entered in these two reciprocal accounts. In the Elimination column,
elimination (a) offsets the balance of the Investment in Qena Branch
account against the balance of the Home Office account. This
elimination appears in the working paper only; it is not entered in the

126
accounting records of either the home office or Qena Branch because its
only purpose is to facilitate the preparation of combined financial
statements.

Illustrating Combined Financial Statements:

The above working paper provides the information for the combined
financial statements of Egypt Company as follows:
EGYPT COMPANY
Income Statement
For Year Ended December 31, 2014
Sales L.E. 480000
Cost of goods sold 280000
Gross margin on sales 200000
Operating expenses 113000
Net income 87000
Basic earnings per share of common stock 5.80
EGYPT COMPANY
Statement of Retained Earnings
For Year Ended December 31, 2014
Retained earnings, beginning of year L.E. 70000
Add: Net Income 87000
Subtotal 157000
Less: Dividends (L.E.2.67 per share) 40000
Retained earnings, end of year 117000

EGYPT COMPANY
Balance Sheet
December 31, 2014
Assets L.E.
Cash 30000
Trade accounts receivable (net) 57000
Inventories 60000
Equipment L.E.150000
Less: Accumulated depreciation 10000 140000
Total assets
287000
Liabilities and Stockholders’ Equity L.E.
Liabilities
Trade accounts payable 20000
Stockholders’ equity
Common stock, L.E.10 par, 15000 shares
authorized, issued and outstanding
L.E.150000
Retained earnings 117000 267000
Total liabilities and stockholders’ equity 287000

127
 Home Office Adjusting and Closing Entries and Branch Closing
Entries
The home office’s equity-method adjusting and closing entries for branch
operating results and the branch’s closing entries on December 31, 2014,
are as follows:
Home Office Accounting Records
Adjusting and Closing Entries
(Perpetual Inventory System)
Investment in Qena Branch 12000
Income: Qena Branch 12000

Income: Qena Branch 12000

Income Summary 12000

Qena Branch Accounting Records

Closing Entries
(Perpetual Inventory System)
Sales 80000
Income Summary 80000

Income Summary 68000

Cost of Goods Sold 45000
Operating Expenses 23000

Income Summary 12000

Home Office 12000

Billing of Merchandise to Branches at Prices Above Home Office

Cost
Previously, it was stated that the home offices of some business
enterprises bill merchandise shipped to branches at home office cost plus
a markup percentage (or alternatively at branch retail selling prices).
Because both these methods involve similar modifications of accounting
procedures, a single example illustrates the key points involved.
Illustration 3.2:
The prior illustration (3.1) for Egypt Company, will be used with one
changed assumption: the home office bills merchandise shipped to Qena
Branch at a markup of 50% above home office cost, or 33⅓% of billed
price.
Notice: Billed price = cost + 0.50 cost; therefore, markup on billed price
is
0.50/ (1 + 0.50) or 33⅓%.
In other words, billed price = cost + markup on cost.
Markup on billed price
= markup on cost/cost + markup on cost

128
 Under this assumption, the journal entries for the first year’s events and
transactions by the home office and Qena Branch are the same as those
presented previously (Illustration 2.1), except for the journal entries for
shipments of merchandise from the home office to Qena Branch. These
shipments (L.E.60000 cost + 50% markup on cost = L.E.90000) are
recorded under the perpetual inventory system as follows:
Home Office Accounting Records
Journal Entries
(2) Investment in Qena Branch 90000
Inventories 60000
Allowance for Overvaluation of Inventories: Qena Branch
30000
Qena Branch Accounting Records
Journal Entries
(2) Inventories 90000
Home Office 90000

In the accounting records of the home office, the Investment in Qena

Branch ledger account prepared previously (Illustration 2.1), now has a
debit balance of L.E.56000 before the accounting records are closed and
the branch net income or loss is entered in the Investment in Qena Branch
account. This account is L.E.30000 larger than the L.E.26000 balance in
the prior illustration (2.1). The increase represents the 50% markup over
cost (L.E.60000) of the merchandise shipped to Qena Branch, as
illustrated below (Reciprocal Ledger Account in Accounting Records of
Home Office Prior to Equity-Method Adjusting Entry).
Investment in Qena Branch
Date Explanation Debit Credit Balance
2014 Cash sent to branch 1000 1000 dr
Merchandise billed to branch at markup
of 50% over home office cost, or 33⅓%
of billed price 90000 91000 dr
Equipment acquired by branch, carried
in home office accounting records 500 90500 dr
Cash received from branch 37500 53000 dr
Operating expenses billed to branch 3000 56000 dr

In the accounting records of Qena Branch, the Home Office ledger

account now has a credit balance of L.E.56000, before the accounting
records are closed and the net income or loss is entered in the Home
Office account, as shown below [Reciprocal Ledger Account in
Accounting Records of Qena Branch Prior to Closing Entry].

129
 Home Office
Date Explanation Debit Credit Balance
2014 Cash received from home office 1000 1000 cr
Merchandise received from home office 90000 91000 cr
Equipment acquired 500 90500 cr
Cash sent to home office 37500 53000 cr
Operating expenses billed by home office 3000 56000 cr

Qena Branch recorded the merchandise received from the home office
at billed prices of L.E.90000; the home office recorded the shipment by
credits of L.E.60000 to Inventories and L.E.30000 to Allowance for
Overvaluation of Inventories: Qena Branch. Use of the allowance account
enables the home office to maintain a record of the cost of merchandise
shipped to Qena Branch as well as the amount of unrealized gross profit
on the shipments.
At the end of the accounting period, Qena Branch reports its
inventories (at billed prices) at L.E.22500. The cost of these inventories is
L.E.15000 (L.E.22500 ÷ 1.50 = L.E.15000). In the home office accounting
records, the required balance of the Allowance for Overvaluation of
Inventories: Qena Branch ledger account is L.E.7500 (L.E.22500 –
L.E.15000 = L.E.7500); therefore, this account balance must be reduced
from its present amount of L.E.30000 to L.E.7500. The reason for this
reduction is that the 50% markup of billed prices over cost has
become realized gross profit to the home office with respect to the
merchandise sold by the branch. Consequently, at the end of the year
the home office reduces its allowance for overvaluation of the branch
inventories to the L.E.7500 excess valuation contained in the ending
inventories. The debit adjustment of L.E.22500 in the allowance account
is offset by a credit to the Realized Gross Profit: Qena Branch Sales
account, because it represents additional gross profit of the home office
resulting from sales by the branch.
Working Paper When Billings to Branches Are at Prices above Cost.
When a home office bills merchandise shipments to branches at prices
above home office cost, preparation of the working paper for combined
financial statements is facilitated by an analysis of flow of merchandise to
a branch, such as the following for Qena Branch of Egypt Company:

130
 Egypt Company
Flow of Merchandise for Qena Branch
During 2014
Billed Brice Home Office Cost Mark-up (50% of Cost;
L.E. L.E. 33⅓% of Billed Price)
Beginning inventories
Add: Shipments from home
office 90000 60000 30000
Available for sale 90000 60000 30000
Less: Ending inventories 22500 15000 7500
Cost of goods sold 67500 45000 22500
The Markup column in the foregoing analysis provides the information
needed for the Eliminations column in the working paper for combined
financial statements below:
EGYPT COMPANY
Working Paper for Combined Financial Statements of Home Office
and Qena Branch
For Year Ended December 31, 2014
(Perpetual Inventory System: Billings above Cost)
Adjusted Trial
Balances
Home Qena
Office Branch Eliminations Combined
Dr (Cr) Dr (Cr) Dr (Cr) Dr (Cr)
Income Statement
Sales (400000) (80000) (480000)
Cost of goods sold 235000 67500 (a) (22500) 280000
Operating expenses 90000 23000 113000
Net income (loss) (to statement of retained
earnings below) 75000 (10500) (b) 22500 87000
Totals -0000- -0000- -0000-
Statement of Retained Earnings
Retained earnings, beginning of year (70000) (70000)
Net (income) loss (from income statement
above) (75000) 10500 (b) (22500) (87000)
Dividends declared 40000 40000
Retained earnings, end of year (to balance
sheet below) 117000
Totals -0000-
Balance Sheet
Cash 25000 5000 30000
Trade accounts receivable (net) 39000 18000 57000
Inventories 45000 22500 (a) (7500) 60000
Investment in Qena Branch 56000 (c) (56000)
Allowance for overvaluation of inventories:
Qena Branch (30000) (a) 30000
Equipment 150000 150000
Accumulated depreciation of equipment (10000) (10000)

131
Trade accounts payable (20000) (20000)
Home office (56000) (c) 56000
Common stock, L.E.10 par (150000) (150000)
Retained earnings (from statement of
retained earnings above) (117000)
Totals -0000- -0000- -0000- -0000-
(a) To reduce ending inventories and cost of goods sold of branch to cost,
and to eliminate unadjusted balance of Allowance of Overvaluation of
Inventories: Qena Branch ledger account.
(b) To increase income of home office by portion of merchandise markup
that was realized by branch sales.
(c) To eliminate reciprocal ledger account balances.

The foregoing working paper differs from the previous working paper
by the inclusion of an elimination to restate the ending inventories of the
branch to cost. Also, the income reported by the home office is adjusted
by the L.E.22500 of merchandise markup that was realized as a result of
sales by the branch. The amounts in the Eliminations column appear only
in the working paper. The amounts represent a mechanical step to aid in
the preparation of combined financial statements and are not entered in
the accounting records of either the home office or the branch.
Combined Financial Statements
Because the amounts in the Combined column of the working paper
above are the same as in the working paper prepared when the
merchandise shipments to the branch were billed at home office cost, the
combined financial statements are identical to those illustrated previously.
Home Office Adjusting and Closing Entries and Branch Closing
Entries
The December 31, 2014, adjusting and closing entries of the home office
are illustrated below:
Home Office Accounting Records
Adjusting and Closing Entries
Income: Qena Branch 10500
Investment in Qena Branch 10500
To record net loss reported by branch.

Allowance for Overvaluation of Inventories: Qena Branch 22500

Realized Gross Profit: Qena Branch Sales 22500
To reduce allowance to amount by which ending inventories of branch
exceed cost.
Realized Gross Profit: Qena Branch Sales 22500
Income: Qena Branch 10500
Income Summary 12000
To close branch net loss and realized gross profit to Income Summary
ledger account.

132
 After the foregoing journal entries have been posted, the ledger
accounts in the home office general ledger used to record branch
operations are as follows:

Investment in Qena Branch

Date Explanation Debit Credit Balance
2014 Cash sent to branch 1000 1000 dr
Merchandise billed to branch at mark-up of 50% over
home office cost, or 33⅓% of billed price 90000 91000 dr
Equipment acquired by branch, carried in home
office accounting records 500 90500 dr
Cash received from branch 37500 53000 dr
Operating expenses billed to branch 3000 56000 dr
Net loss for 2014 reported by branch 10500 45500 dr

Allowance for Overvaluation of Inventories: Qena Branch

Date Explanation Debit Credit Balance
2014 Mark-up on merchandise shipped to branch during
2014 (50% of cost) 30000 30000 cr
Realization of 50% mark-up on merchandise sold by
branch during 2014 22500 7500 cr

Realized Gross Profit: Qena Branch

Date Explanation Debit Credit Balance
2014 Realization of 50% mark-up on merchandise sold by
branch during 2014 22500 22500 cr
Closing entry 22500 -0000-
Income: Qena Branch
Date Explanation Debit CreditBalance
2014 Net loss for 2014 reported by branch 10500 10500 dr
Closing entry 10500 -0000-

In the separate balance sheet for the home office, the L.E.7500 credit
balance of the Allowance of Overvaluation of Inventories: Qena Branch
account is deducted from the L.E.45500 debit balance of the Investment
in Qena Branch account, thus reducing the carrying amount of the
investment account to a cost basis with respect to shipments of
merchandise to the branch. In the separate income statement for the
home office, the L.E.22500 realized gross profit on Qena Branch sales
may be displayed following gross margin on sales, L.E.165000
(L.E.400000 – L.E.235000 cost of goods sold = L.E.165000).
The closing entries for branch at the end of 2014 are as follows:

133
 Qena Branch Accounting Records
Closing Entries
(Perpetual Inventory System)
Sales 80000
Income Summary 80000

Income Summary 90500

Cost of Goods Sold 67500
Operating Expenses 23000
To close revenue and expense ledger accounts.

Home Office 10500

Income Summary 10500
To close the net loss in the Income Summary account to
the Home Office account.

Accordingly, after these closing entries have been posted by the

branch, the following Home Office ledger account in the accounting
records of Qena Branch has a credit balance of L.E.45500, the same debit
balance of the Investment in Qena Branch account in the accounting
records of the home office:

Home Office
Date Explanation Debit Credit Balance
2014 Cash received from home office 1000 1000 cr
Merchandise received from home office 90000 91000 cr
Equipment acquired 500 90500 cr
Cash sent to home office 37500 53000 cr
Operating expenses billed by home office 3000 56000 cr
Net loss for 2014 10500 45500 cr

134
Treatment of Beginning Inventories Priced Above Cost
The foregoing working paper shows how the ending inventories and
the related allowance for overvaluation of inventories were handled.
However, because 2014 was the first year of operations for Qena Branch,
no beginning inventories were involved.
Perpetual Inventory System
Under the perpetual inventory system, no special problems arise when
the beginning inventories of the branch include an element of unrealized
gross profit. The working paper eliminations would be similar to those
illustrated previously.
Periodic Inventory System
The illustration of a second year of operations (2015) of Egypt Company
demonstrates the handling of beginning inventories carried by Qena
Branch at an amount above home office cost.
Illustration 3.3
Assume that both the home office and Qena Branch adopted the periodic
inventory system in 2015. when the periodic inventory system is used, the
home office credits Shipments to Branch (an offset account to
Purchases) for the home office cost of merchandise shipped and
Allowance for Overvaluation of Inventories for the markup over home
office cost. The branch debits Shipments from Home Office (analogous
to a Purchases account) for the billed price of merchandise received.
The beginning inventories for 2015 were carried by Qena Branch at
L.E.22500, or 150% of the cost of L.E.15000 (L.E.15000 × 1.50 =
L.E.22500). Assume that during 2015 the home office shipped
merchandise to Qena Branch that cost L.E.80000 and was billed at
L.E.120000, and that Qena Branch sold for L.E.150000 merchandise that
was billed at L.E.112500. The journal entries to record the shipments and
sales under the periodic inventory system are illustrated below (Journal
Entries for Shipments to Branch at a Price above Home Office Cost,
Periodic Inventory System):
Home Office Accounting Records
Journal Entries
Investment in Qena Branch 120000
Shipments to Qena Branch 80000
Allowance for Overvaluation of Inventories: Qena Branch 40000
Qena Branch Accounting Records
Journal Entries
Shipment from Home Office 120000
Home Office 120000

Cash (or Trade Accounts Receivable) 150000

Sales 150000

135
 The branch inventories at the end of 2014 amounted to L.E.30000
(L.E.22500 + L.E.120000 – L.E.112500 = L.E.30000) at billed prices,
representing cost of L.E.20000 plus a 50% markup on cost (L.E.20000 ×
1.50 = L.E.30000). The flow of merchandise for Qena Branch during 2015
is summarizes below:
Egypt Company
Flow of Merchandise for Qena Branch
During 2015
Billed Home Office Mark-up (50% of Cost;
Brice L.E. Cost L.E. 33⅓% of Billed Price)
Beginning inventories 22500 15000 7500
Add: Shipments from home office 120000 80000 40000
Available for sale 142500 95000 47500
Less: Ending inventories (30000) (20000) (10000)
Cost of goods sold 112500 75000 37500

The activities of the branch for 2015 and end-of-period adjusting and
closing entries are reflected in the four home office ledger accounts below.
Investment in Qena Branch
Date Explanation Debit Credit Balance
2015 Balance, Dec 31, 2014 45500dr
Merchandise billed to branch at mark-up of 50% 120000 165500dr
over home office cost, or 33⅓% of billed price
Cash received from branch 113000 52500dr
Operating expenses billed to branch 4500 57000dr
Net income for 2015 reported by branch 10000 67000dr

Allowance for Overvaluation of Inventories: Qena Branch

Date Explanation Debit Credit Balance
2015 Balance, Dec. 31, 2014 7500cr
Mark-up on merchandise shipped to branch during
2015 (50% of cost) 40000 47500cr
Realization of 50% mark-up on merchandise sold by
branch during 2015 37500 10000cr

Realized Gross Profit: Qena Branch

Date Explanation Debit Credit Balance
2015 Realization of 50% mark-up on merchandise sold by
branch during 2015 37500 37500cr
Closing entry 37500 -0000-
Income: Qena Branch
Date Explanation Debit Credit Balance
2015 Net income for 2015 reported by branch 10000 10000cr
Closing entry 10000 -0000-

136
 In the accounting records of the home office at the end of 2015, the
balance required in the Allowance for Overvaluation of Inventories: Qena
Branch ledger account is L.E.10000, that is, the billed price of L.E.30000
less cost of L.E.20000 for merchandise in the branch’s ending inventories.
Therefore, the allowance account balance is reduced from L.E.47500 to
L.E.10000. This reduction of L.E.37500 represents the 50% markup on
merchandise above cost that was realized by Qena Branch during 2015
and is credited to the Realized Gross Profit: Qena Branch Sales account.
The Home Office account in the branch general ledger shows the
following activity and closing entry for 2015:
Home Office
Date Explanation Debit Credit
Balance
2015 Balance, Dec. 31, 2015 45500cr
Merchandise received from home office 120000 165500cr
Cash sent to home office 113000 52500cr
Operating expenses billed by home office 4500 57000cr
Net income for 2015 10000 67000cr

The working paper for combined financial statements under the

periodic inventory system, which reflects pre-adjusting and pre-closing
balances for the reciprocal ledger accounts and the Allowance for
Overvaluation of Inventories: Qena Branch account, is shown as below:

137
 EGYPT COMPANY
Working Paper for Combined Financial Statements of Home Office
and Qena Branch
For Year Ended December 31, 2015
(Periodic Inventory System: Billings above Cost)
Adjusted Trial
Balances
Home Qena
Office Branch Eliminations Combined
Dr (Cr) Dr (Cr) Dr (Cr) Dr (Cr)
Income Statement
Sales (500000) (150000) (650000)
Inventories, Dec.31, 2014 45000 22500 (b) (7500) 60000
Purchases 400000 400000
Shipments to Qena Branch (80000) (a) (80000)
Shipments from Home Office 120000 (a) (120000)
Inventories, Dec. 31, 2015 (70000) (30000) (c) 10000 (90000)
Operating expenses 120000 27500 147500
Net income (to statement of retained earnings
below) 85000 10000 (d) 37500 132500
Totals -0000- -0000- -0000-
Statement of Retained Earnings
Retained earnings, beginning of year (117000) (117000)
Net (income) (from income statement above) (85000) (10000) (d) (37500) (132500)
Dividends declared 60000 60000
Retained earnings, end of year (to balance
sheet below) 189500
Totals -0000-
Balance Sheet
Cash 30000 9000 39000
Trade accounts receivable (net) 64000 28000 92000
Inventories 70000 30000 (c) (10000) 90000
Investment in Qena Branch 57000 (e) (57000)
Allowance for overvaluation of inventories: (a) 40000
Qena Branch (47500) (b) 7500
Equipment 158000 158000
Accumulated depreciation of equipment (15000) (15000)
Trade accounts payable (24500) (24500)
Home office (57000) (e) 57000
Common stock, L.E.10 par (150000) (150000)
Retained earnings (from statement of retained
earnings above) (189500)
Totals -0000- -0000- -0000- -0000-
(a) To eliminate reciprocal ledger accounts for merchandise shipments.
(b) To reduce beginning inventories of branch to cost.
(c) To reduce ending inventories of branch to cost.
(d) To increase income of home office by portion of merchandise markup
that was realized by branch sales.

138
 (e) To eliminate reciprocal ledger account balances.

Reconciliation of Reciprocal Ledger Accounts

Practically, at the end of an accounting period, the balance of the
Investment in Branch ledger account in the accounting records of the
home office may not agree with the balance of the Home Office account
in the accounting records of the branch because certain transactions may
have been recorded by one office but not by the other. The situation is
comparable to that of reconciling the ledger account for Cash in Bank with
the balance in the monthly bank statement. The lack of agreement
between the reciprocal ledger account balances causes no difficulty
during an accounting period, but at the end of each period the reciprocal
account balances must be brought into agreement before combined
financial statements are prepared.
Illustration 3.4
As an illustration of the procedure for reconciling reciprocal ledger account
balances at year-end, assume that the home office and branch accounting
records of Misr Company on December 31, 2014, contain the data below.
Investment in Aswan Branch
(in Home Office Accounting Records)
Date Explanation Debit Credit Balance
2014
Nov. 30 Balance 62,500dr
Dec. 10 Received cash from branch 20,000 42,500dr
27 Collection of branch trade accounts receivable 1,000 41,500dr
29 Shipment of merchandise 8,000 49,500dr
Home Office (in Aswan Branch Accounting Records)
Date Explanation Debit Credit Balance
2014
Nov. 30 Balance 62,500cr
Dec. 7 Cash sent to home office 20,000 42,500cr
28 Acquired equipment 3,000 39,500cr
30 Collection of home office trade accounts receivable 2,000 41,500cr

Instructions
a. Prepare a working paper to reconcile the reciprocal ledger accounts of
Misr Company’s home office and Aswan Branch to the corrected balances
on December 31, 2014.
b. Prepare journal entries on December 31, 2014, for the (1) home office
and (2) Aswan Branch of Misr Company to bring the accounting records
up to date. Both the home office and the branch use the perpetual
inventory system.

139
Solution
Comparison of the two reciprocal ledger accounts discloses four
reconciling items, described as below:
1. A debit of L.E.8,000 in the Investment in Aswan Branch ledger
account without a related credit in the Home Office account.
On December 29, 2014, the home office shipped merchandise costing
L.E.8,000 to the branch. The home office debits its reciprocal ledger
account with the branch on the date merchandise is shipped, but the
branch credits its reciprocal account with the home office when the
merchandise is received a few days later. The required journal entry on
December 31, 2014, in the branch accounting records, assuming use
of the perpetual inventory system, appears as follows:
Branch Journal Entry for Merchandise in Transit from Home Office
Inventories in Transit 8,000
Home Office 8,000
To record shipment of merchandise in transit from home office.

In taking a physical inventory on December 31, 2014, the branch

personnel must add to the inventories on hand the L.E.8,000 of
merchandise in transit. When the merchandise is received in 2015, the
branch debits Inventories and credits Inventories in Transit.
2. A credit of L.E.1,000 in the Investment in Aswan Branch ledger
account without a related credit in the Home Office account.
On December 27, trade accounts receivable of the branch were
collected by the home office. The collection was reported by the home
office by a debit to Cash and a credit to Investment in Aswan Branch. No
journal entry had been made by Aswan Branch; therefore, the following
journal entry is required in the accounting records of Aswan Branch on
December 31, 2014:
Branch Journal Entry for Trade Accounts Receivable Collected by
Home Office
Home Office 1,000
Trade Accounts Receivable 1,000
To record collection of accounts receivable by home office.

3. A debit of L.E.3,000 in the Home Office ledger account without a

related credit in the Investment in Aswan Branch account.
On December 28, 2014, the branch acquired equipment for L.E.3,000.
Because the equipment used by the branch is carried in the accounting
records of the home office, the journal entry made by the branch was a
debit to Home Office and a credit to Cash. No journal entry had been made
by the home office; therefore, the following journal entry is required on
December 31, 2014, in the accounting records of the home office:
Home Office Journal Entry for Equipment Acquired by Branch

140
 Equipment: Aswan Branch 3,000
Investment in Aswan Branch 3,000
To record equipment acquired by branch.

4. A credit of L.E.2,000 in the Home Office ledger account without a

related debit in the Investment in Aswan Branch account.
On December 30, 2014, trade accounts receivable of the home office
were collected by Aswan Branch. The collection was recorded by Aswan
Branch by a debit to Cash and a credit to Home Office. No journal entry
had been made by the home office; therefore, the following journal entry
is required in the accounting records of the home office on December
31, 2014:
Home Office Journal Entry for Trade Accounts Receivable
Collected by Branch
Investment in Aswan Branch 2,000
Trade Accounts Receivable 2,000
To record collection of accounts receivable by Aswan Branch.
The effect of the foregoing end-of-period journal entries is to update
the reciprocal ledger accounts, as shown by the following reconciliation:
MISR COMPANY-HOME OFFICE AND ASWAN BRANCH
Reconciliation of Reciprocal Ledger Accounts
December 31, 2014
Investment in Home Office
Aswan Branch Account (in
Account (in home branch
office accounting accounting
records) records)
Balances before adjustments L.E.49,500 dr L.E.41,500 cr
Add: (1) Merchandise shipped to branch by home office 8,000
(4) Home office trade accounts receivable
collected by branch 2,000
Less: (2) Branch trade accounts receivable collected by
home office (1,000)
(3) Equipment acquired by branch (3,000)
Adjusted balances L.E.48,500 dr L.E.48,500 cr

Transactions between Branches

Efficient operations may on occasion require that merchandise or other
assets be transferred from one branch to another. Generally, a branch
does not carry a reciprocal ledger account with another branch but records
the transfer in the Home Office ledger account. For instance, if Sohag
Branch ships merchandise to Assiut Branch, Sohag Branch debits Home
Office and credits Inventories (assuming that the perpetual inventory
system is used). On receipt of the merchandise, Assiut Branch debits
Inventory and credits Home Office. The home office records the transfer

141
 between branches by a debit to Investment in Assut Branch and a credit
to Investment in Sohag Branch.
The transfer of merchandise from one branch to another does not
justify increasing the carrying amount of inventories by the freight costs
incurred because of the indirect routing (dispatch). The amount of freight
costs properly included in inventories at a branch is limited to the cost of
shipping the merchandise directly from the home office to its present
location. Excess freight costs are recognized as expenses of the home
office.
Illustration 3.5
In order to illustrate the accounting for excess freight costs on inter-branch
transfers of merchandise, assume the data below.
The home office shipped merchandise costing L.E.6,000 to Red Sea
Branch and paid freight costs of L.E.400. Subsequently, the home office
instructed Red Sea Branch to transfer this merchandise to Menia Branch.
Freight costs of L.E.300 were paid by Red Sea Branch to carry out this
order. If the merchandise had been shipped directly for the home office to
Menia Branch, the freight costs would have been L.E.500.
Instructions
Pass the journal entries required in the three sets of accounting records
(assuming that the perpetual inventory system is used).
Solution
In Accounting Records of Home Office:
Investment in Red Sea Branch 6,400
Inventories 6,000
Cash 400
To record shipment of merchandise and payment of freight costs.

Investment in Menia Branch 6,500

Excess Freight Expense-Interbranch Transfers 200
Investment in Red Sea Branch 6,700
To record transfer of merchandise from Red Sea Branch to Menia Branch
under instruction of home office. Interbranch freight of L.E.300 paid by Red
Sea Branch caused total freight costs on this merchandise to exceed direct
shipment costs by L.E.200 (L.E.400 + L.E.300 – L.E.500 = 200).

142
 In Accounting Records of Red Sea Branch:
Freight in (or Inventories) 400
Inventories 6,000
Home Office 6,400
To record receipt of merchandise from home office with freight costs paid in
advance by home office.

Home Office 6,700

Inventories 6,000
Freight in (or Inventories) 400
Cash 300
To record transfer of merchandise to Menis Branch under instruction of
home office and payment of freight costs of L.E.300.

In Accounting Records of Menia Branch:

Freight in (or Inventories) 500
Inventories 6,000
Home Office 6,500
To record receipt of merchandise from Red Sea Branch under instruction of
home office and normal freight costs billed by home office.

Recognizing excess freight costs on merchandise transferred from one

branch to another as expenses of the home office is an example of the
accounting principle that expenses and losses should be given prompt
recognition. The excess freight costs from such shipments generally result
from inefficient planning of original shipments and should not be included
in inventories.
In recognizing excess freight costs of interbranch transfers as
expenses attributable to the home office, the assumption was that the
home office makes the decisions directing all shipments. If branch
managers are given authority to order transfers of merchandise between
branches, the excess freight costs are recognized as expenses
attributable to the branches whose managers authorized the transfers.

143
 Exercises and Practical Problems
Exercises:
(Exercise 3.1)
Select the best answer for each of the following multiple-choice questions:
1. May the Investment in Branch ledger account of a home office be
accounted for by the:
Cost Method of Accounting? Equity Method of Accounting?
a. Yes Yes
b. Yes No
c. No Yes
d. No No

2. Which of the following generally is not a method of billing merchandise

shipments by a home office to a branch?
a. Billing at cost.
b. Billing at a percentage below cost.
c. Billing at a percentage above cost.
d. Billing at retail selling prices.

3. A branch journal entry debiting Home Office and crediting Cash may be
prepared for:
a. The branch’s transmittal of cash to the home office only.
b. The branch’s acquisition for cash of plant assets to be carried in the
home office accounting records only.
c. Either a or b.
d. Neither a nor b.

4. A home office’s Allowance for Overvaluation of Inventories: Branch

ledger account, which has a credit balance, is:
a. An asset valuation account.
b. A liability account.
c. An equity Account.
d. A revenue account.

144
 5. Does a branch use a Shipments from Home Office ledger account
under the:
Perpetual Inventory System? Periodic Inventory System?
a. Yes Yes
b. Yes No
c. No Yes
d. No No

6. A journal entry debiting Cash in Transit and crediting Investment in

Branch is required for:
a. The home office to record the mailing of a check to the branch early in
the accounting period.
b. The branch to record the mailing of a check to home office early in the
accounting period.
c. The home office to record the mailing of a check by the branch on the
last day of the accounting period.
d. The branch to record the mailing of a check to the home office on the
last day of the accounting period.

7. For a home office that uses the periodic inventory system of accounting
for shipments of merchandise to the branch, the credit balance of
Shipments to Branch ledger account is displayed in the home office’s
separate:
a. Income statement as an offset to Purchases.
b. Balance sheet as an offset to Investment in Branch.
c. Balance sheet as an offset to Inventories.
d. Income statement as revenue.

8. If the home office maintains accounts in its general ledger for a branch’s
plant assets, the branch debits its acquisition of office equipment to:
a. Home Office.
b. Office Equipment.
c. Payable to Home Office.
d. Office Equipment Carried by Home Office.

145
9. In a working paper for combined financial statements of the home office
and the branch of a business enterprise, an elimination that debits
Shipments to Branch and credits Shipments from Home Office is required
under:
a. The periodic inventory system only.
b. The perpetual inventory system only.
c. Both the periodic inventory system and the perpetual inventory system.
d. Neither the periodic inventory system nor the perpetual inventory
system.

10. The appropriate journal entry for the home office to recognize the
branch’s expenditure of L.E.1,000 for equipment to be carried in the home
office accounting records is:
a. Equipment 1,000
Investment in Branch 1,000
b. Home Office 1,000
Equipment 1,000
c. Investment in Branch 1,000
Cash 1,000
d. Equipment: Branch 1,000
Investment in Branch 1,000

11. On January 31, 2014, East Branch of Cairo Company, which uses the
perpetual inventory system, prepared the following journal entry:
Inventories in Transit 10,000
Home Office 10,000
To record shipment of merchandise in transit from home office.
When the merchandise is received on February 4, 2014, East Branch
should:
a. Prepare no journal entry.
b. Debit Inventories and credit Home Office, L.E.10,000
c. Debit Home Office and credit Inventories in Transit, L.E.10,000.
d. Debit Inventories and credit Inventories in Transit, L.E.10,000.

146
12. If a home office bills merchandise shipments to the branch at a markup
of 20% on cost, the markup on billed price is:
a. 16⅔%
b. 20%
c. 25%
d. Some other percentage.

13. The appropriate journal entry in the accounting records of the home
office to record a L.E.10,000 cash remittance in transit from the branch at
the end of an accounting period is:
a. Cash 10,000
Cash in Transit 10,000
b. Cash in Transit 10,000
Investment in Branch 10,000
c. Cash 10,000
Home Office 10,000
d. Cash in Transit 10,000
Cash 10,000

147
 (Exercise 3.2)
On September 1, 2014, Edfina Company established a branch in Sinai.
Following are the first three transactions between the home office and
Sinai Branch of Edfina Company:
Sept. 1 Home office sent L.E.10,000 to the branch for an imprest bank account.
Sept. 2 Home office shipped merchandise costing L.E.60,000 to the branch,
billed a mark-up of 20% on billed price.
Sept. 3 Branch acquired office equipment for L.E.3,000, to be carried in the
home office accounting records.
Both the home office and the Sinai branch of Edfina Company use the
perpetual inventory system.
Prepare journal entries for the foregoing transactions:
a. In the accounting records of the home office.
b. In the accounting records of the Sinai branch.

(Exercise 3.3)
On September 1, 2014, Western Company established the Eastern
Branch. Separate accounting records were set up for the branch. Both the
home office and the Eastern Branch use the periodic inventory system.
Among the intracompany transactions were the following:
Sept. 1 Home office mailed a check for L.E.50,000 to the branch. The check
was received by the branch on September 3.
Sept. 4 Home office shipped merchandise costing L.E.95,000 to the branch,
at a billed price of L.E.125,000. The branch received the merchandise on
September 8.
Sept. 11 the branch acquired a truck for L.E.34,200. The home office maintains
the plant assets of the branch in its accounting records.
Prepare journal entries for the foregoing intracompany transactions:
a. In the accounting records of the home office.
b. In the accounting records of the Eastern Branch.

148
 (Exercise 3.4)
Among the journal entries of the home office of Wally Corporation for the
month of January 2014, were the following:
2014 Explanation L.E. dr L.E. cr
Jan 2 Investment in Luxor Branch 100,000
Inventories 80,000
Allowance for Overvaluation of Inventories: Luxor
Branch 20,000
To record merchandise shipped to branch.

Equipment: Luxor Branch 5,000

18 Investment in Luxor Branch 5,000
To record acquisition of equipment by branch for cash.

31 Investment in Luxor Branch 8,000

Operating Expenses 8,000
To record allocation of operating expenses to branch.

Prepare related journal entries for the Luxor Branch of Wally Corporation:
the branch uses the perpetual inventory system.

149
 (Exercise 3.5)
Among the journal entries for business transactions and events of the
Hoover Street of Tanta Company during January 2014, were the following:
201 Explanation L.E. dr L.E. cr
4
Jan. Inventories 60,000
Home Office 60,000
12 To record the receipt of merchandise shipped Jan.
10 from the home office and billed at a mark-up of
20% on billed price.

25 Cash 25,000
Home Office 25,000
To record collection of trade accounts receivable of
home office.

31 Operating Expenses 18,000

Home Office 18,000
To record operating expenses allocated by home
office.

Prepare appropriate journal entries for the home office of Tanta Company.

150
 (Exercise 3.6)
Among the journal entries of the home office of Turbo Company for the
month ended August 31, 2014, were the following:
2014 Explanation L.E. dr L.E. cr
Aug. 6 Investment in Nido Branch 10,000
Cash 10,000
To record payment of account payable of branch.

14 Cash 6,000
Investment in Nido Branch 6,000
To record collection of trade account receivable of
branch.

22 Equipment: Nido Branch 20,000

Investment in Nido Branch 20,000
To record branch acquisition of equipment for cash,
to be carried in home office accounting records.
Prepare appropriate journal entries for Nido Branch of Turbo Company.

(Exercise 3.7)
Prepare journal entries in the accounting records of both the home office
and the Alexandria Branch of World Company to record each of the
following transactions or events:
a. Home office transferred cash of L.E.5,000 and merchandise (at home
office cost) of L.E.10,000 to the branch. Both the home office and the
branch use the perpetual inventory system.
b. Home office allocated operating expenses of L.E.1,500 to the branch.
c. Alexandria Branch informed the home office that it had collected
L.E.416 on a note payable to the home office. Principal amount of the note
was L.E.400.
d. Alexandria Branch made sales of L.E.12,500, terms 2/10, n/30, and
incurred operating expenses of L.E.2,500. The cost of goods sold was
L.E.8,000, and the operating expenses were paid in cash.
e. Alexandria Branch had a net income of L.E.500. (Debit Income
Summary in the accounting records of the branch.)

151
(Exercise 3.8)
Newland Company has a policy of accounting for all plant assets of its
branches in the accounting records of the home office. Contrary to this
policy, the accountant for Dhab Branch prepared the following journal
entries for the equipment acquired by Dhab Branch at the direction of the
home office:
2014
Aug. 1 Equipment 20,000
Cash 20,000
To record acquisition of equipment with an economic life of 10 years and
a residual value of L.E.2,000.
Dec. 31 Depreciation Expenses 750
Accumulated Depreciation
of equipment 750
To recognize depreciation of equipment by the straight-line method
(L.E.18,000 × 5/120).
Prepare appropriate journal entries for Dhab Branch and the home
office on December 31, 2014, the end of the fiscal year, assuming that the
home office had prepared no journal entries for the equipment acquired
by the Dhab Branch on August 1, 2014. Neither set of accounting records
has been closed.

(Exercise 3.9)
The home office of Port Said Company ships merchandise to the Nile-Star
Branch at a billed price that includes a mark-up on home office cost of
25%. The Inventories ledger account of the branch, under the perpetual
inventory system, showed a December 31, 2013, debit balance,
L.E.120,000; a debit for a shipment received January 16, 2014,
L.E.500,000; total credits for goods sold during January 2014,
L.E.520,000; and a January 31, 2014, debit balance, L.E.100,000 (all
amounts are home office billed prices).
Prepare a working paper for the home office of Port Said Company to
analyse the flow of merchandise to Nile-Star Branch during January 2014.
(Check Figure: Mark-up in cost of goods sold, L.E.104,000).

152
 (Exercise 3.10)
The flow of merchandise from the home office of Sharm El-Sheikh
Company to its Rafah Branch during the month of April 2014, may be
analysed as follows:
Sharm El-Sheikh Company
Flow of Merchandise for Rafah Branch
For Month of April 2014
Billed
Price Cost Markup
Beginning inventories L.E. 180,000 150,000 30,000
Add: Shipment from home office (Apr. 16) 540,000 450,000 90,000
Available for sale 720,000 600,000 120,000
Less: Ending inventories 120,000 100,000 20,000
Cost of goods sold L.E. 600,000 500,000 100,000

From the foregoing information, reconstruct a three-column ledger

account Allowance for Overvaluation of Inventories: Rafah Branch for the
home office of Sharm El-Sheikh Company, beginning with the March 31,
2014, balance, L.E.30,000 credit.
(Check Figure: Apr. 30 balance L.E.20,000 credit).

(Exercise 3.11)
On May 31, 2014, Green Branch of Garden Company reported a net
income of L.E.80,000 for May 2014, and a L.E.240,000 ending inventory
at billed price of merchandise received from the home office at a 25%
mark-up on billed. Prior to adjustment, the May 31, 2014, balance of the
home office’s Allowance for Overvaluation of Inventories: Green Branch
was L.E.200,000 credit.
Prepare journal entries on May 31, 2014, for the home office of Garden
Company to reflect the foregoing facts.

153
(Exercise 3.12)
Superman Textile Company has a single branch in South Valley. On
March 1, 2014, the home office accounting records included an Allowance
for Overvaluation of Inventories: South Valley Branch ledger account with
a credit balance of L.E.32,000. During March, merchandise costing
L.E.36,000 was shipped to the South Valley Branch and billed at a price
representing a 40% mark-up on the billed price. On March 31, 2014, the
branch prepared an income statement indicating a net loss of L.E.11,500
for March and ending inventories at billed prices of L.E.25,000.
Instructions
a. Prepare a working paper to compute the home office cost of the branch
inventories on March 1, 2014, assuming a uniform markup on all
shipments to the branch.
b. Prepare a journal entry to adjust the Allowance for Overvaluation of
Inventories: South Valley Branch ledger account on March 31, 2014, in
the accounting records of the home office.
(Check Figure: b. Debit allowance for overvaluation of inventories,
L.E.46,000).

(Exercise 3.13)
The home office of Oasis Company, which uses the perpetual inventory
system, bills shipments of merchandise to the Yellow Branch at a mark-
up of 25% on the billed price. On August 31, 2014, the credit balance of
the home office’s Allowance for Overvaluation of Inventories: Yellow
Branch ledger account was L.E.60,000. On September 17, 2014, the
home office shipped merchandise to the branch at a billed price of
L.E.400,000. the branch reported an ending inventory, at billed price, of
L.E.160,000 on September 30, 2014.
Prepare journal entries involving the Allowance for Overvaluation of
Inventories: Yellow Branch ledger account of the home office of Oasis
Company on September 17 and 30, 2014. Show supporting computations
in the explanations for the entries.
(Check Figure: Sept. 30, credit realized gross profit, L.E.120,000).

154
(Exercise 3.14)
On January 31, 2014, the unadjusted credit balance of the Allowance for
Overvaluation of Inventories: Red Branch of the home office of Mountain
Company was L.E.80,000. The branch reported a net income of
L.E.60,000 for January 2014 and an ending inventory on January 31,
2014, of L.E.81,000, at billed prices that included a mark-up of 50% on
home office cost.
Prepare journal entries for the home office of Mountain Company on
January 31, 2014, for the foregoing facts.

(Exercise 3.15)
The home office of Gerga Company bills its only branch at a markup of
25% above home office cost for all merchandise shipped to that Bardees
Branch. Both the home office and the branch use the periodic inventory
system. During 2014, the home office shipped merchandise to the branch
at a billed price of L.E.30,000. Bardees Branch inventories for 2014 were
as follows:
Jan. 1 Dec. 31
Purchased from home office (at billed price) 15,000 19,500
Purchased from outsiders 6,800 8,670

Prepare journal entries (including adjusting entry) for the home office
of Gerga Company for 2014 to reflect the foregoing information.
(Check Figure: Credit realized gross profit, L.E.5,100).

155
(Exercise 3.16)
On May 31, 2014, the unadjusted balances of the Investment in Toy
Branch ledger account of the home office of Argentina Company and the
Home Office account of the Toy Branch of Argentina Company were
L.E.380,000 debit and L.E.140,000 credit, respectively.
Additional Information
1. On May 31, 2015, the home office had shipped merchandise to the
branch at a billed price of L.E.280,000; the branch did not receive the
shipment until June 3, 2014. Both the home office and the branch use the
perpetual inventory system.
2. On May 31, 2014, the branch had sent a L.E.10,000 “dividend” to the
home office, which did not receive the check until June 2, 2014.
3. On May 31, 2014, the home office had prepared the following journal
entry, without notifying the branch:
Cash 50,000
Investment in Toy Branch 50,000
To record collection of a trade account receivable of branch.

Prepare journal entries on May 31, 2014, for (a) the home office and
(b) the Toy Branch of Argentina Company to reconcile the reciprocal
ledger accounts.

156
Problems
(Problem 3.1)
Strongman, Inc., established Reno Branch on January 2, 2014. During
2014, Strongman’s home office shipped merchandise to Reno Branch that
cost L.E.300,000. Billings were made at prices marked up 20% above
home office cost. Freight costs of L.E.15,000 were paid by the home
office. Sales by the branch were L.E.450,000, and branch operating
expenses were L.E.96,000, all for cash. On December 31, 2014, the
branch took a physical inventory that showed merchandise on hand of
L.E.72,000 at billed prices. Both the home office and the branch use the
periodic inventory system.
Instructions
Prepare journal entries for Reno Branch and the home office of
Strongman, Inc., to record the foregoing transactions and events, ending
inventories, and adjusting and closing entries on December 31, 2014.
(Allocate a proportional amount of freight costs to the ending inventories
of the branch.)

157
 (Problem 3.2)
Included in the accounting records of the home office and Solo Branch,
respectively, of Logo Company were the following ledger accounts for the
month of January 2014:
Investment in Solo Branch
(in Home Office Accounting Records)
Date Explanation Debit Credit Balance
2014
Jan. 1 Balance 39,200dr
9 Shipment of merchandise 4,000 43,200dr
21 Receipt of cash 1,600 41,600dr
27 Collection of branch trade accounts
receivable 1,100 40,500dr
31 Shipment of merchandise 6,000 46,500dr
31 Payment of branch trade accounts payable 2,000 48,500dr
Home Office (in Solo Branch Accounting Records)
Date Explanation Debit Credit Balance
2014
Jan. 1 Balance 39,200cr
10 Receipt of merchandise 4,000 43,200cr
19 Remittance of cash 1,600 41,600cr
28 Acquisition of furniture 1,200 40,400cr
30 Return of merchandise 2,200 38,200cr
31 Remittance of cash 2,500 35,700cr

Instructions
a. Prepare a working paper to reconcile the reciprocal ledger accounts of
Logo Company’s home office and Solo Branch to the corrected balances
on January 31, 2014.
b. Prepare journal entries on January 31, 2014, for the (1) home office and
(2) Solo Branch of Logo Company to bring the accounting records up to
date. Both the home office and the branch use the perpetual inventory
system.
(Check Figure: Adjusted balances L.E.42,600.)

158
(Problem 3.3)
The home office of Grand Corporation operates a branch to which it bills
merchandise at prices marked up 20% above home office cost. The
branch obtains merchandise only from the home office and sells it at
prices averaging mark-ups 10% above the prices billed by the home
office. Both the home office and the branch maintain perpetual inventory
records, and both close their accounting records on December 31.
On March 10, 2014, a fire at the branch destroyed a part of the
inventories. Immediately after the fire, a physical inventory of merchandise
on hand and not damaged amounted to L.E.16,500 at branch retail selling
prices. On January 1, 2014, the inventories of the branch at billed prices
had been L.E.18,000. Shipments from the home office during the period
January 1 to March 10, 2014, were billed to the branch in the amount of
L.E.57,600. The accounting records of the branch show that net sales
during this period were L.E.44,880.
Instructions
Prepare journal entries on March 10, 2014, to record the uninsured loss
from fire in the accounting records of (a) the branch and (b) the home
office of Grand Company. Show supporting computations for all amounts.
Assume that the loss was reported at billed prices by the branch to the
home office and that it was recorded in the intracompany reciprocal ledger
accounts.
(Check Figure: a. Debit loss from fire, L.E.19,800; b. Debit loss from fire,
L.E.16,500.)

159
 (Problem 3.4)
On December 31, 2014, the Investment in Lion Branch ledger account in
the accounting records of the home office of Zoo Company shows a debit
balance of L.E.55,500. You ascertain the following facts in analysing this
account:
1. On December 13, 2014, merchandise billed at L.E.5,800 was in transit
from the home office to the branch. The periodic inventory system is used
by both the home office and the branch.
2. The branch had collected a home office trade account receivable of
L.E.560 on December 30, 2014; the home office was not notified.
3. On December 29, 2014, the home office had mailed a check for L.E.2,000
to the branch, but the accountant for the home office had recorded the
check as a debit to the Charitable Contributions ledger account; the
branch had not received the check as of December 31, 2014.
4. Branch net income for December 2014 was recorded erroneously by the
home office at L.E.840 instead of L.E.480 on December 31, 2014. The
credit was recorded by the home office in the Income: Lion Branch ledger
account.
5. On December 28, 2014, the branch had returned supplies costing L.E.220
to the home office; the home office had not recorded the receipt of the
supplies. The home office records acquisitions of supplies in the Inventory
of Supplies ledger account.

Instructions
a. Assuming that all other transactions and events have been recorded
properly, prepare a working paper to compute the unadjusted balance of
the Home Office ledger account in the accounting records of Zoo
Company’s Lion Branch on December 31, 2014.
b. Prepare journal entries for the home office of Zoo Company on December
31, 2014, to bring its accounting records up to date. Closing entries have
not been made.
c. Prepare journal entries for Lion Branch of Zoo Company on December 31,
2014, to bring its accounting records up to date.
d. Prepare a reconciliation on December 31, 2014, of the Investment in Lion
branch ledger account in the accounting records of the home office and
the Home Office account in the accounting records of Lion Branch of Zoo
Company. Use a single column for each account and start with the
unadjusted balances.
(Check Figures: a. Unadjusted balance, L.E.49,680; d. Adjusted Balance,
L.E.57,480.)

160
(Problem 3.5)
Luxor Company’s home office bills shipments of merchandise to its Savoy
Branch at 140% of home office cost. During the first year after the branch
was opened, the following were among the transactions and events
completed:
1. The home office shipped merchandise with a home office cost of
L.E.110,000 to Savoy Branch.
2. Savoy Branch sold for L.E.80,000 cash merchandise that was billed by the
home office at L.E.70,000 and incurred operating expenses of L.E.16,500
(all paid in cash).
3. The physical inventories taken by Savoy Branch at the end of the first year
were L.E.82,460 at billed prices from the home office.

Instructions
a. Assuming that the perpetual inventory system is used both by the home
office and by Savoy Branch, prepare for the first year:
(1) All journal entries, including closing entries, in the accounting records
of Savoy Branch of Luxor Company.
(2) All journal entries, including the adjustment of the Inventories
Overvaluation account, in the accounting records of the home office of
Luxor Company.
b. Assuming that the periodic inventory system is used both by the home
office and by Savoy Branch, prepare for the first year:
(1) All journal entries, including closing entries, in the accounting records
of Savoy Branch of Luxor Company.
(2) All journal entries, including the adjustment of the Inventories
Overvaluation account, in the accounting records of the home office of
Luxor Company.

161
(Problem 3.6)
You are making an audit for the year ended December 31, 2014, of the
financial statements of Marina Company, which carries on merchandise
operations at both a home office and branch. The unadjusted trial
balances of the home office and the branch are shown below:

MARINA COMPANY
Unadjusted Trial Balances
December 31, 2014
Home Office Dr (Cr) Branch Dr (Cr)
Cash L.E. 22,000 10,175
Inventories, Jan. 1, 2014 23,000 11,550
Investment in branch 60,000
Allowance for overvaluation of
branch inventories, Jan. 1, 2014 (1,000)
Other assets (net) 197,000 48,450
Current liabilities (35,000) (8,500)
Common stock, L.E.2.50 par (200,000)
Retained earnings, Jan. 1, 2014 (34,000)
Dividends declared 15,000
Home office (51,000)
Sales (169,000) (144,700)
Purchases 190,000
Shipments to branch (110,000)
Shipments from home office 104,500
Freight-in from home office 5,225
Operating expenses 42,000 24,300
Totals -0000- -0000-

The audit for the year ended December 31, 2014, disclosed the following:
1. The branch deposits all cash receipts in a local bank for the account of the
home office. The audit working papers for the cash cutoff include the
following:
Date Deposited Date recorded
Amount By Branch By Home Office
L.E.1,050 Dec. 27, 2014 Dec. 31, 2014
1,100 Dec. 30, 2014 Not recorded
600 Dec. 31, 2014 Not recorded
300 Jan. 2, 2015 Not recorded
2. The branch pays operating expenses incurred locally from an imprest
cash account that is maintained with a balance of L.E.2,000. Checks are
drawn once a week on the imprest cash account, and the home office is

162
 notified of the amount needed to replenish the account. On December 31,
2014, a L.E.1,800 reimbursement check was in transit from the home
office to the branch.
3. The branch received all its merchandise from the home office. The home
office bills the merchandise shipments at a mark-up of 10% above home
office cost. On December 31, 2014, a shipment with a billed price of
L.E.5,500 was in transit to the branch. Freight costs of common carriers
typically are 5% of billed price. Freight costs are considered to be
inventoriable costs. Both the home office and the branch use the periodic
inventory system.
4. Beginning inventories in the trial balance are shown at the respective costs
to the home office and to the branch. The physical inventories on
December 31, 2014, were as follows:
Home office, at cost L.E.30,000
Branch, at billed price (excluding
Shipment in transit and freight) 9,900

Instructions
a. Prepare journal entries to adjust the accounting records of the home office
of Marina Company on December 31, 2014.
b. Prepare journal entries to adjust the accounting records of Marina
Company’s branch on December 31, 2014.
c. Prepare a working paper for combined financial statements of Marina
Company. Compute the amounts in the adjusted trial balances for the
home office and the branch by incorporating the journal entries in (a) and
(b) with the amounts in the unadjusted trial balances.
(Check Figure: c. Combined net income, L.E.63,120.)

163
(Problem 3.7)
On January 4, 2014, Solo Company opened its first branch, with
instructions to the branch manager to perform the functions of granting
credit, billing customers, accounting for receivables, and making cash
collections. The branch paid its operating expenses by checks drawn on
its bank account. The branch obtained merchandise solely from the home
office; billings from these shipments were at cost to the home office.
The adjusted trial balances for the home office and the branch on
December 31, 2014, were as follows:

SOLO COMPANY
Adjusted Trial Balances
December 31, 2014
Home Office Dr (Cr) Branch Dr (Cr)
Cash L.E. 46,000 14,600
Notes receivable 7,000
Trade accounts receivable (net) 80,400 37,300
Inventories, Jan. 1, 2014 95,800 24,200
Investment in branch 82,700
Furniture and equipment (net) 48,100
Trade accounts payable (41,000)
Common stock, L.E.2 par (200,000)
Retained earnings, Dec. 31, (25,000)
2013 Dividends declared 30,000
Home office (82,700)
Sales (394,000) (101,100)
Cost of goods sold 200,500 85,800
Operating expenses 69,500 21,900
Totals -0000- -0000-
The physical inventories on December 31, 2014, were in agreement
with the perpetual inventory records of the home office and the branch.

Instructions
a. Prepare a four-column working paper for combined financial statements of
the home office and branch of Solo Company for the year ended
December 31, 2014.
b. Prepare closing entries on December 31, 2014, in the accounting records
of the branch of Solo Company.
c. Prepare adjusting and closing entries pertaining to branch operations on
December 31, 2014, in the accounting records of the home office of Solo
Company.
(Check Figure: a. Combined net income, L.E.117,400.)

164
(Problem 3.8)
The unadjusted general ledger trial balances on December 31, 2014, for
Sinai Cola Corporation’s home office and its only branch are shown below:
SINAI COLA COMPANY
Unadjusted Trial Balances
December 31, 2014
Home Office Dr (Cr) Branch Dr (Cr)
Cash L.E. 28,000 23,000
Trade accounts receivable (net) 35,000 12,000
Inventories, Jan. 1, 2014 (at cost to
home office) 70,000 15,000
Investment in branch 30,000
Equipment (net) 90,000
Trade accounts payable (46,000) (13,500)
Accrued liabilities (14,000) (2,500)
Home office (19,000)
Common stock, L.E.10 par (50,000)
Retained earnings, Jan. 1, 2014 (48,000)
Dividends declared 10,000
Sales (450,000) (100,000)
Purchases 290,000 24,000
Shipments from home office 45,000
Operating expenses 55,000 16,000
Totals -0000- -0000-

Your audit disclosed the following:

1. On December 10, 2014, the branch manager acquired equipment for
L.E.500, but failed to notify the home office. The branch accountant,
knowing that branch equipment is carried in the home office ledger,
recorded the proper journal entry in the branch accounting records. It is
Sinai Cola’s policy not to recognise depreciation on equipment acquired
in the last half of a year.
2. On December 27, 2014, Moro, Inc., a customer of the branch, erroneously
paid its account of L.E.2,000 to the home office. The accountant made the
correct journal entry in the home office accounting records but did not
notify the branch.
3. On December 30, 2014, the branch remitted to the home office cash of
L.E.5,000, which had not been received by the home office as of
December 31, 2014.
4. On December 31, 2014, the branch accountant erroneously recorded the
December allocated expenses from the home office as L.E.500 instead of
L.E.5,000.

165
5. On December 31, 2014, the home office shipped merchandise billed at
L.E.3,000 to the branch; the shipment had not received by the branch as
of December 31, 2014.
6. The inventories on December 31, 2014, excluding the shipment in transit,
were: home office-L.E.60,000 (at cost); branch-L.E.20,000 (consisting of
L.E.18,000 from home office at billed price and L.E.2,000 from suppliers).
Both the home office and the branch use the periodic inventory system.
7. The home office erroneously billed shipments to the branch at a markup
of 20% above home office cost, although the billing should have been at
cost. The Sales ledger account was credited for the invoices’ price by the
home office.

Instructions
a. Prepare journal entries for the home office of Sinai Cola Company on
December 31, 2014, to bring the accounting records up to date and to
correct any errors. Record ending inventories by an offsetting credit to the
Income Summary ledger account. Do not prepare other closing entries.
b. Prepare journal entries for the branch of Sinai Cola Company on
December 31, 2014, to bring the accounting records up to date and to
correct any errors. Record ending inventories at cost to the home office
by an offsetting credit to the Income Summary ledger account. Do not
prepare other closing entries.
c. Prepare a working paper to summarize the operations of Sinai Company
for the year ended December 31, 2014. Disregard income taxes and use
the following column headings:
Revenue & Expenses Home Office Branch Combined

(Check Figure: c. Combined net income, L.E.107,000.)

166
 (Problem 3.9)
The following reciprocal ledger accounts were included in the accounting
records of the home office and the Senzo Branch of Spinneys Company
on April 30, 2014. you have been retained by Spinneys to assist it with
some accounting work preliminary to the preparation of financial
statements for the quarter ended April 30, 2014.

Investment in Senzo Branch

Date Explanation Debit Credit Balance
2014
Feb. 1 Balance 124,630dr
6 Shipment of merchandise 160 units @ L.E.49 7,840 132,470dr
17 Note receivable collected by branch 2,500 134,700dr
Mar. 31 Cash deposited by branch 2,000 132,970dr
Apr. 2 Merchandise returned by branch 450 132,520dr
26 Loss on disposal of branch equipment 780 133,300dr
28 Operating expenses charged to branch 1,200 134,500dr
29 Corrected loss on disposal of branch
equipment from L.E.780 to L.E.250 530 133,970dr
Home Office
Date Explanation Debit Credit Balance
2014
Feb. 1 Balance 124,620cr
8 Merchandise from home office, 160 units @
L.E.49 7,480 132,110cr
14 Received shipment directly from supplier,
invoice to be paid by home office 2,750 134,860cr
15 Note receivable collected for home office 2,500 137,360cr
Mar30 Deposited cash in account of home office 2,000 135,360cr
31 Returned merchandise to home office 450 134,910cr
Apr 29 Paid repair bill for home office 375 134,535cr
30 Excess merchandise returned to home office
(billed at cost) 5,205 129,330cr
30 Preliminary net income for quarter (before any
required corrections) 13,710 143,040cr

Additional Information
1. Branch equipment is carried in the accounting records of the home office;
the home office notifies the branch periodically as to the amount of
depreciation applicable to equipment used by the branch. Gains or loss
on disposal of branch equipment are reported to the branch and included
in the income statement of the branch.

167
2. Because of the error in recording the shipment from the home office on
February 8, 2014, the sale of the 160 units has been debited improperly
by the branch to cost of goods sold at L.46.75 a unit.
3. On April 30, 2014, the branch collected trade accounts receivable of
L.E.350 belonging to the home office, but the branch employee who
recorded the collection mistakenly treated the trade accounts receivable
as belonging to the branch.
4. The branch accountant recorded the preliminary net income of L.E.13,710
by a debit to Income Summary and a credit to Home Office, although the
revenue and expense ledger accounts had not been closed.
Instructions
a. Reconcile the reciprocal ledger accounts of the home office and Senzo
Branch of Spinneys Company to the correct balances on April 30, 2014.
Use a four-column working paper (debit and credit columns for the
Investment in Senzo Branch account in the home office accounting
records and a debit and credit columns for the Home Office account in the
branch accounting records). Start with the unadjusted balances on April
30, 2014, and work to corrected balances, including explanations of all
adjusting or correcting items.
b. Prepare journal entries for Senzo Branch of Spinneys Company on April
30, 2014, to bring its accounting records up to date, assuming that
corrections still may be made to revenue and expense ledger accounts.
The branch uses the perpetual inventory system. Do not prepare closing
entries.
c. Prepare journal entries for the home office of Spinneys Company on April
30, 2014, to bring its accounting records up to date. The home office uses
the perpetual inventory system and has not prepared closing entries. Do
not prepare closing entries.
(Check Figure: b. Adjusted balances, L.E.143,390.)

168
 (Problem 3.10)
Stars, a single proprietorship owned by Egyptians, sells merchandise
at both its home office and a branch. The home office bills merchandise
shipped to the branch at 125% of home office cost and is the only supplier
for the branch. Shipments of merchandise to the branch have been
recorded improperly by the home office by credits to Sales for the billed
price. Both the home office and the branch use the perpetual inventory
system.
Stars has engaged you to audit its financial statements for the year
ended December 31, 2014. This is the first time the proprietorship has
retained an independent accountant. You were provided with the following
unadjusted trial balances.

STARS
Unadjusted Trial Balances
December 31, 2014
Home Office Dr (Cr) Branch Dr (Cr)
Cash L.E. 31,000 13,000
Trade accounts receivable (net) 20,000 22,000
Inventories 40,000 8,000
Investment in branch 45,000
Equipment (net) 150,000
Trade accounts payable (23,000)
Accrued liabilities (2,000)
Note payable, due 2017 (51,000)
Home office (10,000)
Egyptians, capital, Jan. 1, 2014 (192,000)
Egyptians drawing 50,000
Sales (390,000) (160,000)
Purchases 250,000 93,000
Operating expenses 70,000 36,000
Totals -0000- -0000-

Additional Information
1. On January 1, 2014, inventories of the home office amounted to
L.E.25,000 and inventories of the branch amounted to L.E.6,000. During
2014, the branch was billed for L.E.105,000 for shipments from the home
office.
2. On December 28, 2014, the home office billed the branch for L.E.12,000,
representing the branch’s share of operating expenses paid by the home
office. This billing had not been recorded by the branch.

169
3. All cash collections made by the branch were deposited in a local bank to
the bank account of the home office. Deposits of this nature included in
the following:
Date Deposited Date recorded
Amount by Branch By Home Office
L.E.5,000 Dec. 28, 2014 Dec. 31, 2014
3,000 Dec. 30, 2014 Not recorded
7,000 Dec. 31, 2014 Not recorded
2,000 Jan. 2, 2015 Not recorded
4. Operating expenses incurred by the branch were paid from an imprest
bank account that was reimbursed periodically by the home office. On
December 30, 2014, the home office had mailed a reimbursement check
in the amount of L.E.3,000, which had not been received by the branch as
of December 31, 2014.
5. A shipment of merchandise from the home office to the branch was in
transit on December 31, 2014.
Instructions
a. Prepare journal entries to adjust the accounting records of home office on
December 31, 2014. Establish an allowance for overvaluation of branch
inventories.
b. Prepare journal entries to adjust the accounting records the branch on
December 31, 2014.
c. Prepare a working paper for combined financial statements of Stars on
December 31, 2014. Compute the amounts for the adjusted trial balances
for the home office and the branch by incorporating the journal entries in
(a) and (b) with the amounts in the unadjusted trial balances.
d. After the working paper in (c) is completed, prepare all required adjusting
and closing entries on December 31, in the accounting records of Stars’
home office.
(Check Figure: c. Combined net income, L.E.86,600.)

170
171
 CHAPTER 4: DEPARTMENTAL ACCOUNTS

4.1 Introduction:
In the real world, a business may have a number of Departments each

dealing in a different type of goods. for instance, one department may

be dealing in furniture, the other may be dealing in textile, still another

may be dealing in gifts and so on. Hence and in order to determine the

net profit or loss made by each Department, it will be advisable to

prepare separately Trading and Profit & Loss Account of each

Department at the end of the accounting year. To a great extent,

preparation of such Departmental Accounts is helpful to the business

regarding the following respects:

(1) It enables the business to compare the performance of one

Department with that of another.

(2) It helps the business in formulating proper policies relating to the

expansion of the business. Accordingly, new profitable lines of

production or trading can be taken up while the existing lines of

production or trading which are giving a loss can be closed down.

(3) It helps in appropriate rewarding or penalising the Departmental

employees on the basis of the results implemented by them.

172
4.2 Maintenance of Columnar Subsidiary
Books:
Practically, the preparation of Departmental Trading and Profit & Loss

Account requires maintenance of proper subsidiary books having

appropriate columns for different departments. For example, if an

enterprise has three department, namely A, B and C, the subsidiary

books such as Purchase Book, Purchase Returns Book, Sales Book,

Sales Returns Book, etc, should have separate columns for each of the

departments. Cash book may also have columns for recording cash

sales of each of the departments separately in case the volume of cash

sales is quite large. The pro forma of a Purchases Book having columns

for different Departments is shown below:

Purchase Book
Date Particulars Deptt. A Deptt. B Deptt. C

The same design of rulings can be followed in case of other

subsidiary books also.

173
4.3 Departmentalization of Expenses:
Logically and in order to ascertain the net profit or loss made by each

department, it is necessary that each department is charged with a

proper share of the various business expenses. The following basis may

be adopted for departmentalization of such expenses:

1- Expenses incurred specifically for a particular department should

be directly charged to that department. For instance, salaries

payable to each of the departmental managers will be charged to

the respective departments. Similarly, if there are separate

electricity meters for each of the departments, the electricity

expenses should be charged to each of the departments on the

basis of the electricity bills received for each one of them.

2- Expenses which have been incurred for the business as a whole

but capable of being apportioned over different departments on a

suitable basis should be charged to the different departments, on

such basis. Of course, there are no hard and fast rules as regards

the basis to be applies for apportionment of such expenses.

Nevertheless, the following basis for apportionment may be

adopted: (a) Departmental wages. Expenses which

174
 directly vary with the departmental wages can be apportioned on

this basis. For example, premium for work persons’

compensation, insurance, etc may be apportioned on this basis.

(b)Capital value of the assets. Expenses such as depreciation of

buildings, plants and machinery, fire insurance premiums regarding

this assets etc, may be apportioned on this basis.

(c) Floor area. Expenses such as lighting (unless metered

separately), rent and rates, wages of night watchmen etc, may be

apportioned on this basis.

(d) Number of workers employed. Expenses of workers’ canteen,

welfare, personnel and time keeping departments etc, may be

apportioned on this basis.

(e) Production hours of direct labour. Works manager’s

remuneration, general over-time expenses, cost of inter-

departmental transport should be charged to the various departments

in the ratio which the Departmental Direct Labour Hours bear to the

Total Factory Direct Labour Hours.

(f)Technical estimate. Advice of the technical personnel may also

be useful for the apportionment of certain expenses. For example,

175
the cost of the central conditioning consumed by a particular

department, may be estimated on the basis of the engineer’s

estimate.

3- Expenses which cannot be allocated or apportioned over different

departments in a reasonable manner, should be charged to the

total profit of all the departments taken together. For this purpose,

the profit shown by the different departments should be brought

down in one account which will be termed as the General Profit

& Loss Account and all such expenses should be charged there.

General Manager’s salary, Directors’ fees, Auditors’

remuneration, financial interest etc. are some of the expenses

which fall in this category.

176
4.4 Types of Problems:
The common problems relating to departmental accounts can be put in

the following categories:

(1) Problems relating to Departmentalization of Expenses.

(2) Problems relating to Computation of Departmental Costs.

(3) Problems relating to Inter-departmental Transfers:

(a) When such transfers are at cost.

(b) When such transfers are at a price higher than the cost.

In the following pages, practical illustrations will be given in respect

of each of these types of problems.

(1) Departmentalization of Expenses:

Illustration 4.1:
Elmasrya Auto Garage have three departments: Cars and Trucks, Two

wheelers, and Servicing. The former two sell spare parts and occupy a

godown-showroom. The servicing department uses a garage and

additional site.

The following particular ended are extracted from the books of the

business for the year ended 31st of December 2014, from which you are

required to prepare:

(a) A departmental Trading and Profit and Loss Account.

(b) A general Profit and Loss Account, and

177
 (c) A Balance Sheet.
Stock 1/1/014 L.E.
Cars and Trucks 100,000
Two-wheelers 27,500
Purchases:
Cars and Trucks 350,000
Two-Wheelers 110,000
Sales:
Cars and Trucks 600,000
Two-Wheelers 300,000
Servicing 100,000
Wages of counter-salespersons
Cars and Trucks 30,000
Two-wheelers 12,000
Wages of garage labour 10,800
Office salaries and wages 12,000
Godown and showroom rent 24,000
Land and Garage Building 272,000
Office Expenses 36,000
Garage Equipment 100,000
Showroom Furniture 70,000
Office Van 24,000
Sundry Debtors 12,000
Sundry Creditors 60,000
Bank Overdraft 17,200
Power and Lighting 36,000
Bank Interest 1,000
Cash in hand 900
Drawings A/c 12,000
Proprietor’s Capital Account 163,000

178
The following further information is also available:

(1) Included in “Land and Garage Building” is cost of site used by

the servicing department L.E.200,000.

(2) Closing stock on 31/12/2014 at the departments: Cars and

Trucks L.E.90,000. Two-wheelers L.E.32,500.

(3) 50% of power and lighting is to be charged to servicing

Department, the balance equally to the other departments.

(4) Rates for depreciation are: Building 5%; Garage Equipment

15%; Showroom furniture 10% and Office Van 20%.

(5) Outstanding expenses were: Interest L.E.150 and Office

expenses L.E.2,000.

(6) Interest and all expenses relating to the office are to considered

common and charged to the General Profit and Loss A/c.

(7) The departments using the showroom share the space and

furniture equally.

179
 Solution:
Elmasrya Auto Garage
Departmental Trading and Profit and Loss Account
For the Year ending December 31st, 2014
Particulars Cars & Two Servicing Particulars Cars & Two Servicing
Trucks Wheelers Trucks Wheeler
s L.E.
L.E. L.E. L.E. L.E. L.E.
Opening stock 100000 27500 Sales 600000 300000 100000
Purchases 350000 110000 Closing
Wages 30000 12000 10800 Stock 90000 32500
Gross Profit c/d 210000 183000 89200
Totals 690000 332500 100000 Totals 690000 332500 100000
Godown & 12000 12000 Gross
Showroom Rent 9000 9000 18000 Profit b/d 210000 183000 89200
Power & Lighting
Depreciation: 3600
Building 15000
Garage 3500 3500
Equipment 185500 158500 52600
Furniture
Net Profit c/d
Totals 210000 183000 89200 Totals 210000 183000 89200

General Profit & Loss Account

For the Year ending December 31st, 2014
Office Salaries & 12000 Profit b/d:
Wages Cars & Truck 185500
Office Expenses 38000 Dept. 158500
36000 4800 Two wheelers 52600
Outstanding Dept.
2000 1150 Servicing Dept.
Depreciation on 340650
Van
Bank interest
1000
Outstanding
150
Net Profit
Totals 396600 Totals 396600
Balance Sheet
Assets As at December 31st, 2014 Liabilities
Current Assets: Bank Overdraft
Cash-in-Hand 900 Outstanding 17200
sundry Debtors 12000 Expenses:
Stock in trade: Interest
Cars & Trucks 150
90000 122500 Office 2150
Two Wheelers Expenses 2000
32500 200000 Sundry Creditors 60000
Fixed Assets: Capital
Land 68400 163000
Garage Building Net Profit
72000 85000 340650
491650

180
Less: Depreciation
3600 63000 503650
Garage Equip. Less: Drawings
100000 19200 12000
Less: Depreciation
15000
Show Room
Furniture
70000
Less: Depreciation
7000
Office Van
24000
Less: Depreciation
4800
Totals 571000 Totals
571000

181
(2) Computation Departmental Costs:
Illustration 4.2:
The following purchases were made by a business entity having three

departments:

Department A 1,000 units, B 2,000 units, and C 2,000 units; all at a

total cost of L.E.100,000.

Stock on 1st of January were: Department A 120 units, Department

B 80 units and department C 152 units. The sales were: Department A

1,020 units at L.E.20 each. Department B 1,920 units at L.E.22.50 each.

Department C 2,496 units at L.E.25 each.

The rate of gross profit is the same in each case. Prepare

Departmental Trading Account.

182
 Solution:
In order to determine the rate of Gross Profit, it is assumed that all units

purchased have been sold away.

Sales: Dept. A 1,000 units × L.E.20 = L.E. 20,000

Dept. B 2,000 units × L.E.22.50 = L.E. 45,000
Dept. C 2,400 units × L.E.26 = L.E. 60,000
Total Sales L.E. 125,000
Less Cost of Purchases 100,000
Gross Profit 25,000
Gross Profit as a percentage =
25000/125000 × 100 = 20%

Cost Price of units purchased for each department can now be ascertained as

follows:

Selling Price Gross Profit Cost

Dept. A L.E.20 L.E.4 L.E.16
Dept. B 22.50 4.50 18
Dept. C 25 5 20
Units of closing sock Opening stock + Purchases - Sales
Dept. A 120 + 1000 - 1020 =100
Dept. B 80 + 2000 - 1920 =160
Dept. C 152 + 2400 - 2496 = 56

Departmental Trading Account can now be prepared as follows:

Departmental Trading Account

Particulars Dept A Dept B Dept C Particulars Dept A Dept B Dept C
Opening stock Sales 20400 43200 62400
Purchases 1920 1440 3040 Closing
Gross Profit 16000 36000 48000 stock 1600 2880 1120

4080 8640 12480

Totals 22000 46080 63520 Totals 22000 46080 63520

183
Illustration 4.3:
Adam sells two products manufactured in his own factory. The goods

are made in two Departments, A and B for which separate sets of

accounts are kept. Some of the manufactured goods of Department A

are used as Raw Material by Department B and vice versa.

From the following data, you are required to ascertain the total cost of

goods manufactured in Department A and B.

Particulars Dept. A Dept. B

Total units manufactured 1000000 500000
Total cost of manufacture (excluding 10000 5000
inter-departmental transfers)

Department A transferred 250000 units to Department B and the

latter transferred 100000 units to the former.

184
Solution:
Suppose a is the total cost of department A and b is the total cost of

department B.

a = L.E.10000 + 1/5 b
b = L.E.5000 + ¼ a
or a = L.E.10000 + 1/5 (5000 + ¼ a )
a = L.E.10000 + 1000 + 1/20 a
a = L.E.11000 + 1/20 a
or 20 a = L.E.220000 + a
or 19 a = 220000 or a = L.E.11579
Now b = L.E.5000 + ¼ a
= L.E.5000 + ¼ × L.E.11579
= L.E.5000 + 2895 = L.E.7895.

Total Cost of Goods Manufactured

Particulars Dept. A L.E. Dept. B L.E.
Cost as determined above 11579 7895
Less: Transfer to department ( ¼ and 1/5 ) 2895 1579
8684 6316

185
(3) Inter-Departmental Transfers:
Actually, transfers of goods or services may take place from one

department to another. While preparing the Departmental Trading and

Profit and Loss Account, the department receiving the goods or

services should be debited with the value of the goods or services so

supplied and department providing such goods or services should be

credited with the same amount.

The transfer of goods from one department to another is usually at

cost. However, if such transfer is at a profit, the profit or loss of each

department should be ascertained on the basis of the transfer price

itself. Nevertheless, if the goods transferred by one department to

another at a profit, still remain unsold with the transferee department,

an appropriate reserve for unrealized profit will have to be created by

means of the following journal entry.

General Profit & Loss Account Dr

To Stock Reserve Account Cr

In case the transferee department has also some stock in the

beginning of the accounting year, including some unrealized profit,

against which stock reserve was created last year, such reserve will also

186
be transferred to the General Profit & Loss Account by preparing the

following journal entry.

Stock Reserve Account Cr

To General Profit & Loss Account Dr

Alternatively, a single journal entry may be prepared for the

unrealized profit on the basis of the difference between unrealized

profit included in the opening and closing stocks. This will be clear

with the help of the following detailed illustration.

187
Illustration 4.4:
From the following Trial Balance, you are required to prepare

Departmental Trading and Profit and Loss Account for the year ending

31st December, 2014 and the Balance Sheet as at that date.

L.E.
Stock Jan. 1 A Department 1700000
B Department 1450000
Purchases A Department 3540000
B Department 3020000
Sales A Department 6080000
B Department 5125000
Wages A Department 820000
B Department 270000
Rent, Rates, Taxes and Insurance 939000
Sundry Expenses 360000
Salaries 300000
Lighting and Heating 210000
Discount allowed 222000
Discount received 65000
Advertising 368000
Carriage Inward 234000
Furniture and Fittings 300000
Machinery 2100000
Sundry Debtors 606000
Sundry Creditors 1860000
Capital Account 4766000
Drawings 450000
Cash at Bank 1007000

The following additional information is also available:

1- Internal transfer of goods from A to B Department L.E.42,000.
2- The items Rent, Rates and Taxes and insurance, Sundry Expenses, Lighting
and Heating, Salaries and carriage are to be apportioned 2/3rd to A Department
and 1/3rd to B Department.
3- Advertising is to apportioned equally.
4- Discount allowed and received are to be apportioned on the basis of
Departmental Sales and Purchases (excluding Transfers).
5- Depreciation at 10 per cent annually on Furniture and Fittings and on
Machinery is to charged 3/4th to A Department and 1/4th to B Department.
6- Services rendered by B Department to A Department are included in its wages
L.E.50,000.
7- Stock on 31st of December, 2014 in A Department was worth L.E.1,674,000
and in B Department was worth L.E.1,205,000.

188
Solution:
Departmental Trading & Profit & Loss Account
For the year ending 31st December, 2014
Particulars Dept A Dept B Particulars Dept A Dept B
Opening 1700000 1450000 Sales 6080000 5125000
stock 3540000 3020000 Transfers 42000 50000
Purchases 820000 270000 Closing 1674000 1205000
Wages 50000 42000 stock
Transfer 156000 78000
Carriage 1530000 1520000
inward
Gross Profit
Totals 7796000 6380000 Totals 7796000 6380000
Salaries 200000 100000 Gross 1530000 1520000
Rent, Rates, Profit
Taxes & 625000 313000 Discount 35000 30000
Insur. 240000 120000 Received 126000 ------
Sundry 140000 70000 Net Loss
expenses 184000 184000
Lighting,
Heating 158000 52000
Advertising 22000 8000
Depreciation: 121000 101000
Machinery ------ 602000
Furniture
Discount All.
Net Profit
Totals 1691000 1550000 Totals 1691000 1550000

Balance Sheet
As on 31st December, 2014
Assets L.E. Liabilities L.E.
Machinery Capital
2100000 1890000 4766000
Less: Depr. (+): Profit
210000 270000 476000 4792000
Furniture 2879000 1860000
300000 606000 5242000
Less: Depr. 1007000 (-) Drawings
30000 450000
Stock in trade Sundry
Sundry Debtors Creditors
Cash at Bank
Totals 6652000 Totals 6652000

189
Illustration 4.5:
Peace Hotel prepares separate Departmental Profit and Loss Accounts.

The nature of their operations require frequent supply of

articles/services from one department to another. The Hotel consisted

of three departments: Apartments, Boarding and Restaurant. It had

been decided that the Apartments Department will charge, for service

supplied to other departments the cost thereof plus 10% thereon. The

same, Boarding Department was to charge the other departments cost

plus 20% thereof in respect of supplies to them. The Restaurant

Department supplies to the other departments were charged at the

prevailing rates applicable to outsiders. The Accounts for the year

ended on December 31, 2014 had been closed without taking into

account interdepartmental debits and credits. From the following

figures, you are required to show the net variation in the Departmental

Profit & Loss Accounts as a result of such adjustments.

(1) Cost of Apartments services extended to: L.E.

Boarding Staff 8400
Restaurant 4500
(2) Cost of supplies made by Boarding Department to:
Apartments Staff 29800
Restaurant Staff 5400
(3) Values of supplies made by the Restaurant to:
Apartments Staff 400
Boarding Staff 5600

190
 Additionally, the following are the charges to be made for Inter-

change of staff from one department to another for temporary periods

during the year:

Boarding staff lent to Apartments Dept 4400

Apartments staff lent to Boarding Dept 1100

191
 Solution:
Profit and Loss (Adjustment) Account
Particulars Apartment A L.E Boarding B Restaurant R Particulars Apar Board Restaura
L.E. L.E. tmen ing B nt R
t A L.E. L.E.
L.E
Rent of Apartments Apartment
Boarding Charges ----- 9240 4950 rents from:
Restaurant Expenses B 9240
Charge in respect of staff 35760 ------ 6480 R 4950 1419 ----- ------
borrowed Boarding 0
Increase of dept profit or 400 5600 ----- charges
decrease in dept loss from:
A 35760
R 6480 42240 ------
4400 1100 ----- Restaurant ----
sales:
A 400
B 5600 ----- 6000
----- 30700 ----- Recoveries -----
in respect of
staff lent 4400 ------
Decrease in
dept profit or 1100
increase in
dept loss ------ 5430

2527
0
Totals 40560 46640 11430 Totals 4056 46640 11430
0

Notes: 10% has been added to costs of Apartments services to find out

transfer price to Boarding and Restaurant. 20% has been added to costs

of Boarding Department to find out transfer price for Apartment and

Restaurant.

192
Illustration 4.6:
From the following balances extracted from the books of an enterprise,

prepare Departmental Trading Account and General Profit and Loss

Account for the year ended December 31st, 2014 and a Balance Sheet

as on that date after adjusting the unrealized departmental profits if any.

Particulars Dr. L.E. Cr. L.E.

1. Capital
2. Land and Building 300000
3. Furniture 125000
4. Opening Stock Dept A
Dept B 25000
5. Purchases Dept A
Dept B 30000
6. Sales Dept A
Dept B 40000
7. General Expenses 2000000
8. Sundry Debtors 1000000
9. Sundry Creditors 3200000
10. Drawings 1500000
11. Cash and Bank
100000
1400000
200000
-------
--
280000
1000000
Totals
5600000 5600000

193
Additional Information:
1- Closing Stock of Dept. A L.E.130000 including goods from Dept. B

L.E.40000 at cost to Dept. A. Dept. B L.E.260000 including goods

from Dept. A L.E.90000 at cost to Dept. B.

2- Sales of Dept. A includes transfer of goods to Dept. B of the value

of L.E.200000 and sales of Dept. B includes transfer of goods to Dept.

A of the value of L.E.300000, both at market price to transferor Dept.

3- Opening Stock of Dept. A and Dept. B includes goods of the value

of L.E.10000 and L.E.15000 taken from Dept. B and Dept A

respectively at cost to transferor Depts.

4- Depreciate land and building by 5% and furniture by 10% annually.

194
Solution:
Departmental Trading account and General Profit and Loss
Account
For the year ended 31/12/2014
Particulars Dept Dept B Total Particula Dept Dept B Total
AL.E. L.E. L.E. rs A L.E. L.E. L.E.
Opening Sales 18000 29000 47000
Stock Transfer 00 00 00
Purchases* 30000 40000 70000 s -------
Transfers 13000 20000 Closing 20000 30000
Gross 70000 00 00 Stock 0 0
Profit 0 ------- 39000
20000 30200 0
30000 0 00 13000 26000
0 19200 0 0
11000 00
00
Totals 21300 34600 50900 Totals 21300 34600 50900
00 00 00 00 00 00
General Gross
Expenses 14000 Profit:
Depreciati 00 Dept A 11000
on: Dept B 00 30200
Building 6250 19200 00
Furniture 00
Reserve on 2500 8750
Closing
Stock:**
Transfers
From: A
From: B
Net Profit 49500
73500
24000 15377
50
Totals 30200 30200
00 00
*Excluding inter-department transfers.
**Since inter-department transfers in opening stocks are at costs, no stock reserve
for opening stock has been created.
Note: The unrealized profit on inter-department transfers determined as follows:
Transfers included in Closing Stock × Gross Profit/Sales + Transfers
Dept. A = 40000 × 1920000/3200000 = 24000
Dept. B = 90000 × 1100000/2000000 = 49500

195
 Balance Sheet
As at 31st December, 2014
Land & Buildings Capital:
Balance Balance
125000 300000
Less: Depr. 118750 Add: Profit
6250 1537750 155775
Furniture 0
25000 22500 1837750
Less: Depr. Less: Drawings 100000
2500 280000
Stock Sundry Creditors
390000 316500
Less: Stock
Reserve 200000
73500 100000
Sundry Debtors 0
Cash and Bank
Total 165775 Totals 165775
0 0

196
Illustration 4.7:
An Enterprise has a factory which includes two manufacturing

Departments X and Y. Part of the output of X Department is transferred

to Y Department for further processing and the balance is directly

transferred to the Selling Department. The entire production of Y

Department is transferred to the Selling Department. Inter-

departmental stock transfers are made as follows:

X Department to Y Department of 33⅓% over-departmental cost.

X Department to Selling Department of 50% over departmental cost.
Y Department to Selling Department of 25% over departmental cost.
The following information is given for the year ending 31st December,

2014.

Particulars Department X Department Selling

Y Department
MT L.E. MT L.E. MT L.E.
Opening Stock 60 60000 145000
Raw Material Consumption 20 40000 50
Labor Charges 90 100000
Sales -- 50000 --
Closing Stock -- --- 20 20000 -- 500000
30 --- -- -- --
-- 80000
-- 60
50 --

Out of the total production in X Department 30 MT were for transfer

to the Selling Department. Apart from these stocks which were

transferred during the year, the balance output and the entire opening

197
and closing stocks of X Department were for transfer to Y Department.

The per tone material and labor consumption in X Department on

production to be transferred directly to the selling Department is 300%

of the labor and material consumption on production meant for Y

Department.

Required: Prepare Departmental Trading and Profit and Loss Account

and General Profit and Loss Account; ignoring material wastages.

198
 Solution:

Departmental Trading and Profit And Loss Account

Dept. X Dept. Y Selling Dept. Dept. X Dept. Y Selling Dept.
Qty Amount Qty Amount Qty Amount Qty Amount Qty Amount Qty Amount
Opening 60 60000 20 40000 50 145000 Sales 100 500000
Stock* Stock
Raw 90 100000 20 20000 transfer 120 255000* 80 200000
Material 50000 80000 Closing
Consumed Stock 30 30000 50 100000 60 180000
Labor 90 120000 30 135000
Charge
Stock 80 200000
transferred 75000 40000 200000
from X
Dept.
Stock
transferred
from Y
Dept.
Gross
Profit
Totals 150 285000 130 300000 160 680000 150 285000 130 300000 160 680000
* 90 tones L.E.120000
30 tones L.E.135000
120 tones L.E.255000
General Profit and Loss Account
Stock Reserve (increase Gross Profit
required): from: 75000
Y Dept. 8182 X Dept. 40000
Selling Dept. 11160 Y Dept. 200000
Net Profit 295658 Selling Dept.
Totals 315000 Totals 315000
Working Notes:

Value of goods transferred

1- X Department MT Amount
Qty. and value of production* 210 210000
Transferred to Selling Dept. 90 90000
Balance meant for transfer to Y Dept.1 120 120000
Closing stock of Dept. X 30 30000
Actual transfer to Y Dept. 90 90000
Add Profit of 33⅓% 30000
Total Qty. and value of goods transferred
To Y Department 90 120000
Cost of goods transferred to Selling

199
Department 30 90000
Add: Profit of 50% 45000
Quantity and value of goods transferred
to Selling Department 30 135000
Total transfer 120000 + 135000= 255000
from Dept. X
*The proportion of cost between output meant for Dept. Y and Selling Dept. is
1:3. Thus, the output of 30 units meant for Selling Dept. is equivalent to 90 units
of Dept. Y.

2- Department Y
Qty. and value of production 130 260000
Less: Closing stock of Y Dept. 50 100000
Cost of goods transferred to selling
Dept. 80 160000
Add: Profit of 25% 40000
Quantity and value of goods transferred
to Selling Department 80 200000
Stock Reserve for unrealized profit of
Y Department.
Transfer from X Dept. 120000
Own cost (Raw material and labor) 100000
220000
Increase in Closing Stock (100000-40000) 60000
Prop. Of X Dept. 60000 × 120000/220000 32727
Unrealized profit (33⅓% of cost) on 25%
on Transfer Price 8182
3- Selling Department
Transfer directly from X Dept. 135000
Total transfers from Depts. X and Y 335000
Share in increase of unsold stock
135000/335000 × 35000 = 14104
Profit charged by X Dept.
(50% on cost or 33⅓% on 14104) 4701 (1)
Transfer from Y Dept. to Selling Dept. 200000
Share of increase in unsold stock
transferred from Y Dept.
200000/335000 × 35000 = 20896
Profit charged by Y Dept.
(25% on cost or 2o% on L.E.20896) 4179 (2)
Cost of Dept. Y of goods transferred to
Selling Dept. 20896 – 4179) 16717
Share of goods transferred from Dept.

200
X to Dept. Y in L.E.16717 =
16717 × 120000/220000 = 9118
Profit charged by Dept. X on goods
transferred to Dept. Y (33⅓% on cost
or ¼ of L.E.9118) 2280 (3)
Total unrealized profit in closing stock
with Selling Dept. (4701 + 4179 + 2280)= L.E.11160

201
4.5 Questions and Practical Problems:
1. State whether each of the following statements is ‘True’ or
‘False’.
a. If the rate of gross profit of the departments is the same, the
cost price of these departments will be in the ratio of their
respective sales price.
b. The fire insurance on building is allocated on the basis of
floor area occupied by each department.
c. Depreciation on plant is divided equally over the different
departments.
d. Bad debts are charged to the General Profit and Loss since
there is no proper basis for their apportionment.
e. Management expenses are charged to the General Profit
and Loss Account.
f. Stock Reserve for unrealized profit for inter-departmental
transfer of goods is charged to General Profit and Loss
Account.
g. In Departmental Accounts, Work-Persons’ Compensation
Insurance should be apportioned on the basis of the number
of workers in each department.

202
2. Choose the best answer for each of the following:
(1) Non-departmental items of expenses are:
a- charged to Departments on the basis of total sales.
b- charged to the General Profit and Loss Account.
c- charged to departments according to the fixed assets
employed.
(2) Repair to machinery is apportioned over different
departments according to:
a- the number of machines in each department.
b- value of machinery.
c- floor area occupied by each machine.
(3) In case goods are transferred from department A to
department B at a price so as to include a profit of 25% on
the cost, the amount of stock reserve on a closing stock of
L.E.6000 in department B will be:
a- L.E.1200.
b- L.E.1500.
c- L.E.2000.
(4) The cost of electric power should be apportioned over
different departments according to:
a- Horse Power of Motors.
b- Number of light points.
c- Horse Power X Machine Hours.

203
Practical Problems:
DEPARTMENTALIZATION OF
EXPENSES
1. The Trading and Profit and Loss Account of Egyptian
Electronics for the year ending 31st of December, 2014 is as
below:
Details L.E. Details L.E.
Purchases: Sales:
Transistors (X) 160000 Transistors (X)
Tape Recorders 125000 Tape Recorders 175000
(Y) (Y)
Spare Parts for Servicing and 140000
servicing and 80000 repair jobs (Z)
repairs jobs (Z) 48000 Stock 31/12/2014: 35000
Salaries and 10800 Transistors (X)
Wages 11000 Tape Recorders 60100
Rent 40200 (Y) 20300
Sundry Expenses Spare parts for
Profit servicing and
repairs jobs (Z) 44600
Totals 475000 Totals
475000
Prepare Departmental Accounts for each of the three
Departments X, Y and Z mentioned above after taking into
consideration the following:
(1) Transistors and Tape Recorders are sold at the Showroom,
Servicing and Repairs are carried out at the Workshop.
(2) Salaries and Wages comprise as follows: Showroom ¾ths.
Workshop ¼th. It was decided to allocate the showroom
salaries and wages in ratio 1:2 between Departments X and
Y.
(3) The workshop rent is L.E.500 per month. The rent of the
showroom is to be divided equally between the Departments
X and Y.
(4) Sundry Expenses are to be allocated on the basis of the

204
 turnover of each Department.
(Ans. Net Profit: Dept. X L.E.55200; Dept. Y L.E.4500; Net
Loss Dept. Z L.E.19500.)
[Answer Key: Opening Balance of Suspense Account (Dr
L.E.17,200)].

2. Samsung Brothers are Leading paper merchants and

booksellers. Their Wholesale business is in paper and their
retail show room conducts business in stationery, books and
magazines. The following balances are extracted from their
books as at the end of their financial year 31st December,
2014:
Particulars L.E.
Capital 300000
Stock: January 1st, 2014:
Paper 200000
Stationery 50000
Books 100000
Magazines 25000
Purchases:
Paper 800000
Stationery 300000
Books 350000
Magazines 300000
Sales:
Paper 1000000
Stationery 360000
Books 420000
Magazines 420000
Rent 60000

205
 Lighting 24000
Showroom maintenance 18000
Showroom fittings 180000
Sundry Debtors (for paper) 100000
Sundry creditors 150000
Salaries:
Showroom staff 36000
Wholesale business staff 12000
Showroom cashier 12000
General Office Salaries 11000
General Office Expenses 44000
Cash and Bank Balances 8000
You are required by the firm to prepare their Departmental
Trading and Profit and Loss Account for the financial year
under reference with the help of the following additional
information:
(1) Closing stock at the end of the year in the various
departments were:
Paper L.E.180000. Stationery L.E.40000. Books
L.E.120000. Magazines L.E.30000
(2) Rent and lighting are for premises taken on lease, General
office accommodation is negligible. Wholesale department
uses 1500 sq. feet. The balance of 1500 sq. feet is occupied
by the showroom with equal division among stationery,
books and magazines.
(3) Showroom fittings are to be depreciated by 10% annually.
(Ans. Net Profit Paper L.E.101000, Stationer L.E.600, Books
L.E.36700 and Magazines L.E.71700.)

206
3. The following is the trial balance of Automatic Motors and
Garage on 31st December, 2014:
Particulars L.E. L.E.
Capital Account
Drawings 8500 76250
Opening Stocks:
Petrol and oil 1650
Spare parts and tires 5500
Tools 2200
Hire cars 72000
Purchases:
Tools 4000
Spare parts and tires 32000
Petrol and oil 41250
Advertising Expenses 4500
Rent, Rates and Taxes 12000
Insurance premium:
On hire cars 4000
Fire, theft and burglary cases 425
Wages:
Drivers 12000
Repairs Department 16500
Office 7500
Garage 1000
Sales:
Petrol and oil
Spare parts and tires
Garage Receipts 23000
Repairs Department
Hire Receipts 37000
License fees and permit fees for
hire cars 3000 4000
Office Expenses 4000
Sundry Debtors 400 1000
Sundry Creditors
Commission received on cars 70000
sold
Loans 2000
Cash in hand and at Bank

1200

207
 5000

4000
Totals 234450
234450
The following additional information is also provided to you:
(1) The loan was taken on 1st of October, 2014 on which
interest at 12% is to be paid.
(2) Stocks on hand on 31st December, 2014 were as follows:
Tools L.E.5000, Petrol and oil L.E.4300 and Spare parts and
tires L.E.10000.
(3) Petrol and oil whose value was L.E.15600 and L.E.1800
were used by hire cars and repairs department respectively.
Besides, the owner of the garage drew petrol and oil worth
L.E.3000 for his personal car.
(4) Repairs department performed work during the year as
under:
On owner’s car L.E.600 and on hire cars L.E.7500.
(5) Spare parts used by the Repairs Department in the year
cost L.E.4000 and by the hire carsL.E.750.
(6) Depreciation on hire cars to be provided at 30% annually.
(7) Licenses and taxes amounting to L.E.200 on owner’s car
have been paid and included in Rent, Rates and Taxes.
(8) Rent, Rates and Taxes to be distributed as below:
a. Repairs Department ½. b. Spare parts ¼.
c. Garage ⅛. d. Office ⅛.
You are required to prepare a Departmental Trading Account,

208
 a Profit and Loss Account for the year ended 31st December,
2014 and a balance Sheet as at that date.
[ Answer Key: Profit; Garage L.E.1525, Petrol & Oil L.E.4775,
Spare parts L.E.11300. Hire Cars L.E.5550, Repairs (Loss)
L.E.7300, Net Business Profit L.E.2830, B/S Total
L.E.72100].

4. Cairo Limited has three departments X, Y and Z. From the

particulars given below, compute:

a. The values of stock as on 31st of December, 2014 and

b. The departmental trading results.

Particulars Dept. X Dept. Y Dept. Z
(1) L.E. L.E. L.E.
Stock as on 1st Jan. 2014 24000 36000 12000
Purchases 48000
Actual Sales 146000 124000 74600
Gross Profit on normal
selling prices 172500 159400 33⅓%
(2) During the year certain
items were sold at discount 20% 25%
and these discounts were
reflected in the value of
sales shown above. The
items sold at discount
were: 1000
Sales at normal prices 600
Sales at actual prices 10000 3000
7500 2400
[Answer: Gross Profit Dept. X L.E.32500, Dept. Y L.E.39400 and
Dept. Z L.E.24600.]

209
ASCERTAINMENT OF DEPARTMENTAL
COSTS
5. Kamal Nayle purchased goods for his three departments as
follows:

Dept. A 2000 pieces

Dept. B 14000 pieces Total cost L.E.51000

Dept. C 4000 pieces

Sales of three departments were as follows: Dept. A 1800

pieces at L.E.15 per piece. Dept. B 15000 pieces at L.E.18 per
piece. Dept. C 4500 pieces at L.E.6 per piece.

Other information about stock in the beginning was as follows:

Dept. A 1000 pieces .

Dept. B 4000 pieces.

Dept. C 600 pieces.

Kamal informs you that the rate of gross profit is the same in
all departments. You are required to prepare trading account
for the three departments.

[ Answer Key: Gross Profit: A Dept. L.E.22500 B Dept.

L.E.225000, C Dept. L.E.22500].

210
INTER-DEPT. TRANSFERS

6. A firm had two departments, cloth and ready made clothes.

The clothes were made by the firm itself out of cloth supplied
by the cloth department at its selling price. From the following
figures, prepare Departmental Trading and Profit and Loss
Account for the year 2014.
Particulars Cloth Readymade
Department Clothes
Opening Stock 300000 50000
1/1/2014 2000000 15000
Purchases 2200000 450000
Sales
Transfer to Readymade 300000 ……..
Cloth Department
Expenses: 60000
Manufacturing 20000 6000
Selling 200000 60000
Stock on 31/12/2014
The stocks in the readymade clothes department may be
considered as consisting of 75% cloth and 25% other
expenses. The cloth department earned gross profit at the rate
of 15% in 2013. General expenses of the business as a whole
came to L.E.110000.
[ Answer Key: Net Profit: Cloth Dept. L.E.380000; Readymade
Clothes Dept. L.E.79000, Total Net Profit of the business
L.E.347425. Hint: Increase in Stock Reserve by L.E.1575].

211
7. Qena Highway Garage consists of three departments: Spares,
Service and Repairs. Each department is managed by a
departmental manager whose commission is respectively 5%,
10% and 10% of the respective departmental profit, subject,
however, to a minimum of L.E.3000 in each case. Inter-
departmental transfers take place at ‘loaded’ price as follows:
From Spares to Service 5% above cost
From Spares to Repairs 10% above cost
From Repairs to Service 10% above cost
In respect of the year ended on December 31st, 2014, the firm
had already prepared and closed the departmental trading and
profit and loss account. Subsequently it was discovered that the
closing stocks of various departments had included inter-
departmentally transferred goods at ‘loaded’ price instead of the
correct cost price. From the following information you are
required to prepare a statement recomputing the departmental
profit or loss.
Particulars Spares Services Repairs
L.E. L.E. L.E.
Final Net Profit/Loss 19000 25200 36000
(loss) (profit) (profit)
Inter-departmental ….. 32500 2100
transfers included at (10500 (from
‘loaded’ price in the from Spares)
departmental stocks Spares
and
22000
from
Repairs)

[Answer: Real Net Profit (loss): Spares L.E.(19691); Service

212
 L.E.25200 and Repairs L.E.34200]

8. Alexandria Ltd. has three departments A, B & C. The following

information is given:
Particulars A B C
Opening Stock 3000 4000 6000
Consumption of direct 8000 12000 ……
materials 5000 10000 ……
Wages 4000 14000 8000
Closing Stock ……. ……. 34000
Sales
Stocks of each department are valued at cost to the
department concerned. Stocks of A department are transferred
to B at a margin of 50% above departmental cost. Stocks of B
department are transferred to C department at a margin of 10%
above departmental cost.

Other expenses were:

Salaries L.E.2000

Printing & Stationery L.E.1000

Rent L.E.6000

Interest paid L.E.4000

Depreciation L.E.3000

Allocate expenses in the ratio of departmental gross profits.

Opening figures of reserves for unrealized profits on
Departmental Stocks were:

213
 Department B L.E.1000

Department C L.E.2000

Required: Prepare Departmental Trading and Profit and Loss

Account.

[Answer: Net Loss Dept. A L.E.2000; Dept. B L.E.1000; Dept. C

L.E.1000, Total Net loss after adjustment for stock reserves
L.E.4918.]

214
 9. Messrs G.B.T. carried on business as Drapers and Tailors.
The partners, G, B and T were in charge of the departments
X, Y and Z respectively. The partners are entitled to a
remuneration equal to 50% of the profits (without taking the
partner’s remuneration into consideration) of the respective
Departments of which they are in charge and the balance of
the profits are to be divided among G, B and T in the ratio of
5:3:2. The following are the balances of the Revenue Item in
the books for the year 31st December, 2014.
Opening Stock: L.E. L.E.
Department X 75780 Salaries and wages 96000
Y 48000 Advertising 4500
Z 40000 Rent 21600
Purchases: Discount Allowed 27000
Department X 281400 Discount Received 1600
Y 161200 Sundry expenses 24300
Z 88800 Depreciation on
Sales: Furniture and 1500
Department X 360000 Fittings
Y 270000
Z 180000
Closing Stock:
Department X 90160
Y 34960
Z 43180
Instructions:
a. Prepare the Departmental accounts for each of the three

Departments in a columnar form.

b. Show the distribution of Profits amongst the Partners after

taking into account the following:

(1) Goods having a transfer price of L.E.21400 and L.E.1200

were transferred from Department X and Y respectively to

215
Department Z. The inter-departmental transfers are made at
125% of the cost.

(2) The various items shall be apportioned among the three

Departments in the following proportion:
Particulars Dept. X Dept. Y Dept. Z
Rent 2 2 5
Salaries 1 1 1
Depreciation 1 1 1
Discount 8 5 3
received
All the other expenses: on the basis of the sales (excluding inter-
departmental transfers) of each department.

(3) The opening stock of Department Z does not include any

goods transferred from other departments, but the closing stock
includes L.E.17100 valued at the inter-departmental transfer
prices.

[Answer: Net Profit, Dept. X L.E.63880, Dept. Y L.E.49660, Dept.

Z L.E.20580]

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 10. X Ltd. has a factory which has two manufacturing
Departments A and B. Part of the output of A Dept. is
transferred to B Dept. for further processing and balance is
directly transferred to the Selling Department. The entire
production of B Department is transferred to the Selling
Department. Inter department stock transfers are made as
follows:

A Dept. to B Dept. at 20% over departmental cost.

A Department to Selling Department at 30% over departmental

cost.

B Department to Selling Department at 25% over departmental

cost.

The following information is given for the year ending 31st

December 2014.
Particulars Department A Department Department
B C.
M.T. L.E. M.T. L.E. M.T. L.E.
Opening Stock 60 60000 20 4000 50 16000
Raw material 0 0
consumption 100 110000 30
Labor Charges 60000 3000
Sales 0
Closing Stock 40 60 8000 60 60000
0 0
Out of production in A Department 30 M.T were for transfer to
the Selling Department and the balance to B Department. The
per tone material and labor consumption in A Department on
production to be transferred directly to the Selling Department is
200% of the labor and material consumption on production

217
meant for B Department. Prepare Department Profit and Loss
Account.

[Answer: Profit: Dept. A L.E.44640, Dept. B L.E.50490, Selling

Dept. L.E.281286].

(Hint. Closing Stock (FIFO) Dept. A L.E.44000, Dept. B

L.E.81960, Selling Dept. L.E.190456). It is assumed that no work
has been done on the units in closing stock in Dept. A. In Dept.
B the closing stock is a mixture of material introduced directly
and those transferred from Dept. B i.e., 60/120 of L.E.166920.
Closing stock of Selling Dept. is 60/110 of L.E.349170. The other
assumption could be that the closing stocks are out of the
finished output of the concerned department.

{Answers: [1. True or False (a) T (b) T (c) F (d) F (e) T (f) T (g) F
]. [2. (1) b (2) b (3) a (4) c.]}

218
219
References

Fischer, P. M., Taylor, W. J., & Cheng, R. H. Advanced Accounting (12th

Edition). USA: Cengage Learning.
Herauf, D., & Hilton, M. W. Modern Advanced Accounting in Canada
(Eighth Edition). Canada: McGraw-Hill.
Rawy, A. A. Contemporary Accounting Issues (2020). Egypt: South Valley
University.

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