Chapter 6 Exam 2

Total Equity at Acquisition = $690,000 + Equity Added by Stock Offering (10,000 × $15) $150,000 = Total Equity after Stock Offering $840,000 × 40,000 Parent / 60,000 Total = $560,000 Parent’s Investment Account

Intra-entity transfers of inventory do not involve any cash flow. These transfers represent movements of inventory between different entities within the same consolidated group. Since no cash is involved, they do not appear in the consolidated statement of cash flows.

The preferred stock being convertible means that it can be converted into common stock. This conversion would increase the number of outstanding shares and potentially dilute the earnings per share.

Variable interests refer to financial instruments or arrangements that have the potential to change in value based on certain factors. Guarantees of debt, lease residual value guarantees, participation rights, and asset purchase options are all examples of variable interests because their value can vary depending on the performance or outcome of certain events. However, stock options are not considered variable interests because their value is directly tied to the price of the underlying stock and does not change based on external factors.

The correct answer is C) Noncontrolling interest in net income of subsidiary would be added to net income. In a consolidated statement of cash flows, the noncontrolling interest in the net income of a subsidiary is added to the net income because it represents the portion of the subsidiary's income that belongs to the minority shareholders. This adjustment is necessary to reflect the true cash flows generated by the consolidated company.

A variable interest entity (VIE) is a legal entity that is created to hold a specific set of assets and liabilities. It is commonly used in situations where one company wants to have control over another entity without actually owning it. VIEs can take various forms, such as trusts, partnerships, joint ventures, and corporations. However, an estate is not a form that a VIE can take. An estate is typically used to describe the assets and liabilities left behind by a deceased person, and it is not structured in the same way as a VIE.

The correct answer is C) Consolidated net income divided by parent's number of shares outstanding. This is because consolidated earnings per share is calculated by dividing the consolidated net income (which includes the net income of both the parent and the subsidiary) by the number of shares outstanding for the parent company. Since the subsidiary has no convertible securities or warrants, its earnings per share is not factored into the calculation.

Feedback:
Subsidiary’s unamortized fair value of prior to new share issue
(12,000 × $56) $834,000
Parent's ownership 100%
Unamortized subsidiary fair value $834,000

Subsidiary unamortized fair value after issuing new
shares (above value plus 3,000 shares at $70 each) $1,044,000
Parent's ownership 12,000 ÷ 15,000 shares) 80%
Unamortized subsidiary fair value after stock issue $835,200

Investment in Odom increases by $1,200 ($835,200 less $834,000).

Feedback: Bond Acquisition Price $288,000 – Bonds carrying amount $265,000 = $23,000 R/E Reduction.
Intra-Entity Interest $29,000 - $25,000 = $4,000 R/E Increase
$23,000 - $4,000 = $19,000 R/E Reduction

Feedback: Sub’s income $140,000 × .30 = $42,000 NCI’s Portion of Income (gain or loss is assigned to the parent only)

Feedback: Bonds Purchase Price $19,000 – Bonds carrying amount ($20,000 + $2,000) =
$3,000 Gain to Consolidation Income

Feedback: Bonds Purchase Price $11,000 – Bonds carrying amount ($10,000 - $2,000) =
$3,000 Loss to Consolidation Income

When the parent acquires all the new shares of common stock at an amount greater than book value, it means that the parent is paying more than the recorded value of the subsidiary's assets and liabilities. This excess payment is considered goodwill and is recorded as an increase in the investment in subsidiary account on the parent's books. Therefore, the correct statement is that the investment in subsidiary will increase.

Feedback: $780,000 Net Income – Preferred Dividends (10,000 × $10) = $680,000 × .40 = $272,000 Noncontrolling Interest
$100,000 Preferred Dividends × .30 = $30,000 Noncontrolling Interest
$272,000 from Income + $30,000 Preferred Dividends = $302,000 Noncontrolling Interest in Income

The correct answer is E) Consolidated net income is not affected by a gain or loss on the debt transaction. This means that when an affiliate's debt instrument is acquired on the open market, the gain or loss from the transaction does not impact the consolidated net income of the parent company and its subsidiaries. Consolidated net income is determined by combining the individual net incomes of the parent company and its subsidiaries, but the gain or loss from this specific debt transaction does not factor into that calculation.

Feedback: Sub net income (300,000) – preferred divs(4,000) = $296,000 x 80% = 236,800 included in consolidated EPS. Parent net income (400,000)+ portion of sub net income = (400,000 + 236,800) / 100,000 shares = $6.37

Intra-entity transfers of inventory do not affect the preparation of a consolidated statement of cash flows because the consolidated balance sheet and income statement are used in preparing the statement. This means that no special elimination is required for these transfers. Therefore, option D is the correct answer.

The correct answer is E) To Regency because Regency is the controlling party in the business combination. In an intra-entity transaction, the controlling party is responsible for any gains or losses that arise from the transaction. Since Regency Corp. acquired the bonds of Safire Co., it is considered the controlling party in this scenario. Therefore, any loss resulting from the acquisition of the bonds should be attributed to Regency.

The potential losses or returns of a variable interest entity are related to financial outcomes such as residual profits, increases in asset fair value, honoring a debt guarantee, or honoring a guarantee related to a leased asset. However, receiving shares of common stock is not a potential loss or return as it represents ownership in a company rather than a financial outcome.

The correct answer is E) 1, 2, 3, and 4. This means that all of the statements concerning variable interest entities (VIEs) are true. Statement 1 suggests that the role of VIE equity investors can be minor. Statement 2 states that a VIE may be created to benefit the business enterprise with low-cost financing. Statement 3 mentions that VIE governing agreements often limit activities and decision-making. Statement 4 indicates that VIEs usually have a well-defined and limited business activity.

Feedback: Shares Outstanding 50,000 × .80 = 40,000 Parent’s Shares
50,000 + 30,000 = 80,000 New Outstanding Shares
40,000 + 30,000 = 70,000 Parent’s Shares after New Issue
70,000 / 80,000 = 87.5% New Ownership Percentage

Feedback: $50,000 + Depreciation $14,000 ($170,000 - $156,000) + Amortization $2,000 ($18,000 -$16,000) – A/R $21,000 ($75,000 - $54,000) – Inventory $11,000 ($100,000 - $89,000) + A/P $9,000 ($60,000 - $51,000) = $43,000 Net Consolidated Cash Flow from Operations

When new bonds are issued from a parent to its subsidiary, any premium or discount on bonds payable is exactly offset by a premium or discount on bond investment. This means that there will be $0 net gain or loss on the bond transaction, as stated in option B. Additionally, interest expense needs to be eliminated on the consolidated income statement, as stated in option C. Similarly, interest revenue needs to be eliminated on the consolidated income statement, as stated in option D. Therefore, the only statement that is false is option E, which states that a net gain or loss on the bond transaction will be reported.

When a subsidiary issues new shares of common stock at an amount below book value and outsiders buy all of these shares, it means that the shares are being sold at a discount. This discount is considered a loss for the parent company, resulting in a decrease in the parent's additional paid-in capital. Therefore, the correct answer is D) The parent's additional paid-in capital will be decreased.

Feedback: FV Common Stock $62,000,000 + FV Preferred Stock $8,000,000 = $70,000,000 × .10 = $7,000,000 Noncontrolling Interest

Feedback: Common Stock Noncontrolling Interest at Acquisition = $1,850,000 / .80 = $2,312,500
Preferred Stock Noncontrolling Interest at Acquisition = $750,000 / .30 = $2,500,000
$2,312,500 + $2,500,000 = $4,812,500 FV of Sub at Acquisition
$1,850,000 + $462,500 + $750,000 + $1,750,000 = $4,812,500

Dividends paid by a subsidiary to the parent company do not appear in the consolidated statement of cash flows. The reason for this is that dividends are considered a return of investment and not an operating, investing, or financing activity. Instead, dividends are typically reported separately in the notes to the financial statements or in a supplemental schedule of noncash investing and financing activities.

Dividends paid to the noncontrolling interest of a subsidiary are considered as a distribution of profits to the owners of the subsidiary. As a result, these dividends are categorized as cash flows from financing activities on the consolidated statement of cash flows. This is because financing activities involve transactions with owners or investors, and the payment of dividends to noncontrolling interests falls under this category.

Feedback: Land Sale of $5,000 Reduces Net Income as Operating Activity in Cash Flows

Feedback: No Adjustment is made to the APIC of the Parent as a Result of Sub’s Stock Issue because the same Level of Ownership Interest is Maintained

Feedback: Parent $400,000 + Sub $250,000 – Intra-Entity $50,000 – Increase in A/R $10,000 ($120,000 - $130,000) = $590,000

The correct answer is D) The difference is treated as a gain from the extinguishment of the debt. When Riley Corp. acquired the outstanding bonds of its subsidiary for a purchase price lower than the carrying value, it resulted in a gain. This gain is recognized in the consolidated financial statements as a gain from the extinguishment of the debt.