Chapter 7 Exam 3

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Chapter 7 Exam 3 - Quiz

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Questions and Answers
  • 1. 

    1. Buckette Co. owned 60% of Shuvelle Corp. and 40% of Tayle Corp., and Shuvelle owned 35% of Tayle. When Buckette prepares consolidated financial statements, it should include

    • A.

      A) Shuvelle but not Tayle.

    • B.

      B) Tayle but not Shuvelle.

    • C.

      C) Either Shuvelle or Tayle.

    • D.

      D) Shuvelle and Tayle.              

    • E.

      E) Neither Shuvelle nor Tayle.

    Correct Answer
    D. D) Shuvelle and Tayle.              
    Explanation
    Buckette Co. owns 60% of Shuvelle Corp. and 40% of Tayle Corp. Additionally, Shuvelle Corp. owns 35% of Tayle Corp. When preparing consolidated financial statements, Buckette should include both Shuvelle and Tayle because it has a controlling interest in both companies. Consolidated financial statements combine the financial information of a parent company and its subsidiaries into one set of financial statements. In this case, Buckette has a controlling interest in Shuvelle and Tayle, so their financial information should be included in the consolidated statements.

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  • 2. 

    2-      Evanston Co. owned 60% of Montgomery Corp.  Montgomery owned 75% of Noir Inc., and Noir owned 15% of  Montgomery.  This pattern of ownership would be called…

    • A.

      A) Mutual ownership.     

    • B.

      B) Direct control.

    • C.

      C) Indirect control.

    • D.

      D) An affiliated group.

    • E.

      E) A connecting affiliation.

    Correct Answer
    A. A) Mutual ownership.     
    Explanation
    The pattern of ownership described in the question is mutual ownership because Evanston Co. owns 60% of Montgomery Corp., Montgomery Corp. owns 75% of Noir Inc., and Noir Inc. owns 15% of Montgomery Corp. This means that there is a mutual ownership relationship between the three companies, as each company owns a portion of the other companies involved in the ownership chain.

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  • 3. 

    3-     Prescott Corp. owned 90% of Bell Inc., while Bell owned 10% of the outstanding common shares of Prescott.  No              goodwill or other allocations were recognized in connection with either of these acquisitions.  Prescott reported net             income of $266,000 for 2018 whereas Bell recognized $98,000 during the same period.  No investment income was        included within either of these income totals.         On a consolidated income statement, what is the net income attributable to the noncontrolling interest?

    • A.

      A) $  9,800.                 

    • B.

      B) $13,692.

    • C.

      C) $10,836.

    • D.

      D) $12,460.

    • E.

      E) $11,214.

    Correct Answer
    A. A) $  9,800.                 
    Explanation
     Bell’s net income ($98,000) × Noncontrolling interest (10 %) = $9,800

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  • 4. 

    4-      Jastoon Co. acquired all of Wedner Co. for $588,000 cash in a tax-free transaction.  On that date, the subsidiary had          net assets with a $560,000 fair value but a $420,000 book value and income tax basis.  The income tax rate was          30%.  What amount of goodwill should have been recognized on the date of the acquisition?

    • A.

      A) $  70,000.

    • B.

      B) $  28,000.

    • C.

      C) $ (14,000).

    • D.

      D) $  19,600.

    • E.

      E) $  65,000.

    Correct Answer
    A. A) $  70,000.
    Explanation
    Feedback: FV ($560,000) – Tax Basis ($420,000) = Temporary Tax Difference ($140,000) × .30 = Deferred Tax Liability ($42,000) + [Cash Paid ($588,000) – FV Assets ($560,000)] $28,000 = Goodwill ($70,000)

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  • 5. 

    5-   Beagle Co. owned 80% of Maroon Corp.  Maroon owned 90% of Eckston Inc.  Separate company net incomes for  2018 are shown below; these figures contained no investment income.  Amortization expense was not required by any of these acquisitions.  Included in Eckston's operating income was a $56,000 gross profit on intra-entity transfers to Maroon.       The accrual-based net income of Eckston Inc. is calculated to be

    • A.

      A) $234,000.

    • B.

      B) $211,000.

    • C.

      C) $221,000.

    • D.

      D) $224,000.

    • E.

      E) $246,000.

    Correct Answer
    D. D) $224,000.
    Explanation
    Feedback: Net income ($280,000) – deferral of gross profit from intra-entity transfers ($56,000) = Accrual-based
    net income $224,000

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  • 6. 

    6-   Hardford Corp. held 80% of Inglestone Inc., which, in turn, owned 80% of Jade Co.  Excess amortization expense was not required by any of these acquisitions. Separate net income figures (without investment income) as well as upstream intra-entity gross profits (before deferral) included in the income for the current year follow:         The accrual-based net  income of Jade Co. is calculated to be

    • A.

      A) $193,000.

    • B.

      B) $189,000.

    • C.

      C) $196,000.     

    • D.

      D) $201,000.

    • E.

      E) $144,000.

    Correct Answer
    C. C) $196,000.     
    Explanation
    Feedback: Separate net income ($280,000) – intra-entity gross profit to be deferred ($84,000) = Accrual-based net
    income $196,000

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  • 7. 

    7- .  When indirect control is present, which of the following statements is true?

    • A.

      A) At least one company within the consolidated entity holds a parent and a subsidiary relationship.

    • B.

      B) The parent company owns a percent of subsidiary and subsidiary owns a percent of the parent.

    • C.

      C) Consolidated financial statements are required for only one subsidiary.

    • D.

      D) Recognition of income for an indirectly owned subsidiary is ignored.

    • E.

      E) Only dividend income is recognized for an indirectly owned subsidiary.

    Correct Answer
    A. A) At least one company within the consolidated entity holds a parent and a subsidiary relationship.
    Explanation
    When indirect control is present, it means that there is a chain of ownership between the parent company and the subsidiary, with one or more intermediate companies in between. In this scenario, at least one company within the consolidated entity must hold a parent and a subsidiary relationship. This means that there is a direct ownership relationship between at least one company and another company within the consolidated entity. Therefore, option A is the correct statement.

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  • 8. 

    8.  Which of the following statements is false concerning a father-son-grandson configuration?

    • A.

      A) This type of ownership pattern does not significantly alter the worksheet process.

    • B.

      B) Most worksheet entries are simply made twice.

    • C.

      C) The doubling of entries may seem overwhelming.

    • D.

      D) The individual consolidation procedures remain unaffected.

    • E.

      E) Consolidated financial statements are required for only the father and son companies.

    Correct Answer
    E. E) Consolidated financial statements are required for only the father and son companies.
    Explanation
    In a father-son-grandson configuration, consolidated financial statements are required for all the companies involved, including the father, son, and grandson companies. Therefore, statement E is false.

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  • 9. 

    9.  Which of the following statements is true regarding a subsidiary's investment in the parent company's stock?

    • A.

      A) The treasury stock approach focuses on the parent’s control over its subsidiary.

    • B.

      B) For consolidation, both the parent and subsidiary must defer gross profit on remaining inventory from intra-entity transfers.

    • C.

      C) In consolidation, the parent’s retained earnings will not be reduced by the dividends it paid to the subsidiary.

    • D.

      D) This corporate combination is known as mutual ownership.

    • E.

      E) All of these answer choices are true statements.

    Correct Answer
    E. E) All of these answer choices are true statements.
  • 10. 

    10.  Which of the following statements is true regarding the filing of income taxes for an affiliated group?

    • A.

      A) Domestic subsidiaries greater than 50% ownership must file a consolidated tax return.

    • B.

      B) Domestic subsidiaries greater than 60% ownership must file a consolidated tax return.

    • C.

      C) Domestic subsidiaries greater than 80% ownership must file a consolidated tax return.

    • D.

      D) Domestic subsidiaries greater than 80% ownership may file a consolidated tax return.

    • E.

      E) Foreign subsidiaries must file a consolidated tax return.

    Correct Answer
    D. D) Domestic subsidiaries greater than 80% ownership may file a consolidated tax return.
  • 11. 

    11.  The benefits of filing a consolidated tax return include all of the following except

    • A.

      A) Gross profits from intra-entity transfers are not taxed until such amounts are recognized for financial statement reporting purposes.

    • B.

      B) Recognition of gross profits from intra-entity transfers is deferred for income tax recognition purposes.

    • C.

      C) The issuance of dividends between related entities are not taxable.

    • D.

      D) Losses incurred by an affiliated company can be used to reduce taxable income earned by other members to that affiliated group.

    • E.

      E) Gross profits on intra-entity transfers are taxed before they are recognized for financial statement reporting purposes in the year of the transfer, but any such losses are deferred.

    Correct Answer
    E. E) Gross profits on intra-entity transfers are taxed before they are recognized for financial statement reporting purposes in the year of the transfer, but any such losses are deferred.
    Explanation
    The correct answer is E) Gross profits on intra-entity transfers are taxed before they are recognized for financial statement reporting purposes in the year of the transfer, but any such losses are deferred. This means that while the profits from intra-entity transfers are subject to immediate taxation, any losses incurred from these transfers are not recognized for tax purposes until a later date. This is the opposite of the benefits of filing a consolidated tax return, which typically allow for the deferral of recognition of gross profits from intra-entity transfers for income tax purposes.

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  • 12. 

    12.  Which of the following statements is true regarding goodwill?

    • A.

      A) For accounting purposes, goodwill may be amortized over a period not to exceed 40 years.

    • B.

      B) For accounting purposes, goodwill may be amortized over a period not to exceed 20 years.

    • C.

      C) For tax purposes, goodwill amortization cannot be deductible.

    • D.

      D) For tax purposes, goodwill amortization may be deductible over a 20-year period.

    • E.

      E) For tax purposes, goodwill amortization may be deductible over a 15-year period.

    Correct Answer
    E. E) For tax purposes, goodwill amortization may be deductible over a 15-year period.
  • 13. 

    13-  Chase Company owns 80% of Lawrence Company and 40% of Ross Company.  Lawrence Company also owns 30% of Ross Company.  Separate company net incomes for 2018 of Chase, Lawrence, and Ross are $450,000, $300,000, and $250,000, respectively.  Each company also defers a $20,000 intra-entity gain in its current income figures. Excess annual amortization expense of $15,000 is assigned to Chase’s investment in Lawrence and another $15,000 is assigned to Lawrence’s investment in Ross.       Compute the  net income attributable to the noncontrolling interest in Ross for 2018.

    • A.

      A) $92,000.

    • B.

      B) $77,400.

    • C.

      C) $75,000.

    • D.

      D) $64,500.                              

    • E.

      E) $69,000.

    Correct Answer
    D. D) $64,500.                              
    Explanation
    $250,000 - $20,000 - $15,000 = $215,000 × .30 = $64,500

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  • 14. 

    14-     White Company owns 60% of Cody Company.  Separate tax returns are required.  For 2017, White's operating income (excluding taxes and any income from Cody) was $300,000 while Cody reported a pretax income of  $125,000.  During the period, Cody declared total dividends of $25,000; $15,000 (60%) to White and $10,000 to the noncontrolling interest. White declared dividends of $180,000.  The income tax rate for both companies is 30%.   Compute the income tax liability of Cody for 2018.

    • A.

      A) $33,000.

    • B.

      B) $34,500.

    • C.

      C) $37,500.

    • D.

      D) $30,000.

    • E.

      E) $22,500.

    Correct Answer
    C. C) $37,500.
    Explanation
    Feedback: Separate tax return calculation: Cody’s operating income $125,000 × .30 = $37,500 Cody’s income tax
    liability

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  • 15. 

    15-  Which of the following statements is true concerning connecting affiliations and mutual ownerships?

    • A.

      A) In a mutual ownership, at least two companies in the consolidated group own portions of a third company.

    • B.

      B) There are at least four companies in a connecting affiliation.

    • C.

      C) In a connecting affiliation, at least one subsidiary owns stock in the parent company.

    • D.

      D) In a mutual ownership, the subsidiary owns a portion of the parent’s stock.

    • E.

      E) There are only two companies in a connecting affiliation.

    Correct Answer
    D. D) In a mutual ownership, the subsidiary owns a portion of the parent’s stock.
    Explanation
    In a mutual ownership, the subsidiary owns a portion of the parent's stock. This means that the subsidiary company has invested in the parent company by purchasing some of its shares. This creates a direct financial relationship between the two companies, with the subsidiary having a stake in the ownership and performance of the parent company.

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  • 16. 

    16. Which of the following is true concerning the treasury stock approach in accounting for a subsidiary’s investment in parent company stock?

    • A.

      A) The original cost of the subsidiary’s investment reduces long-term liabilities.

    • B.

      B) The cost of parent shares is treated as if the shares are no longer outstanding.

    • C.

      C) The existence of intra-entity gross profit remaining in ending inventory.

    • D.

      D) Transfers of inventory at a transfer price above cost.

    • E.

      E) There is no difference between U.S. GAAP and tax accounting rules for dividends paid to a parent by an 85%-owned subsidiary.

    Correct Answer
    A. A) The original cost of the subsidiary’s investment reduces long-term liabilities.
    Explanation
    The correct answer is A) The original cost of the subsidiary's investment reduces long-term liabilities. This means that when a subsidiary purchases stock in its parent company, the original cost of that investment is deducted from the subsidiary's long-term liabilities. This reduces the subsidiary's overall debt and can improve its financial position.

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  • 17. 

    18.      How is goodwill amortized?

    • A.

      A) It is not amortized for reporting purposes or for tax purposes.

    • B.

      B) It is not amortized for reporting purposes, but is amortized over a 5-year life for tax purposes.

    • C.

      C) It is not amortized for tax purposes, but is amortized over a 5-year life for reporting purposes.

    • D.

      D) It is not amortized for tax purposes, but is amortized over a 15-year life for reporting purposes.

    • E.

      E) It is not amortized for reporting purposes, but is amortized over a 15-year life for tax purposes.

    Correct Answer
    E. E) It is not amortized for reporting purposes, but is amortized over a 15-year life for tax purposes.
    Explanation
    Goodwill is an intangible asset that represents the value of a company's brand, reputation, and customer relationships. It is not amortized for reporting purposes because it is considered to have an indefinite useful life. However, for tax purposes, goodwill is amortized over a 15-year life. This means that for tax calculations, the cost of acquiring goodwill is spread out over a 15-year period, reducing the taxable income each year. This treatment allows the company to receive tax benefits over time for the acquisition of goodwill.

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  • 18. 

    19-   Delta Corporation owns 90 percent of Sigma Company, and Sigma owns 90 percent of Pi, Inc., all of which are domestic corporations.  There are no excess amortizations associated with any of the acquisitions. Information for the three companies for the year ending December 31, 2018 follows:         Which of the following statements is true?

    • A.

      A) Delta and Sigma must file a consolidated income tax return, but must exclude Pi from the consolidated return.

    • B.

      B) Delta, Sigma, and Pi must file a consolidated income tax return.

    • C.

      C) Delta, Sigma, and Pi must file separate income tax returns because the ownership of Sigma and Pi is less than 100%.

    • D.

      D) Delta, Sigma, and Pi will probably not file a consolidated income tax return.

    • E.

      E) Delta, Sigma, and Pi may file separate income tax returns or a consolidated income tax return.

    Correct Answer
    E. E) Delta, Sigma, and Pi may file separate income tax returns or a consolidated income tax return.
  • 19. 

    20-   Horse Corporation acquires all of Pony, Inc. for $300,000 cash.  On that date, Pony has net assets with fair value of $250,000 but a book value and tax basis of $200,000.  The tax rate is 40 percent.  Prior to this date, neither Horse nor Pony has reported any deferred income tax assets or liabilities.  What amount of goodwill should be recognized on the date of the acquisition?

    • A.

      A) $           0.

    • B.

      B) $  50,000.

    • C.

      C) $  70,000.

    • D.

      D) $100,000.

    • E.

      E) $150,000.

    Correct Answer
    C. C) $  70,000.
    Explanation
    Feedback:
    Consideration transferred (cash) $300,000
    to net assets at fair value $250,000
    to deferred tax liability on net
    assets [($250,000 − $200,000) × 40%] (20,000) 230,000
    Goodwill $70,000

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