CHAPTER 1

Chapter 7CONSOLIDATED FINANCIAL STATEMENTSOWNERSHIP PATTERNS AND INCOME TAXES Chapter OutlineI.Indirect subsidiary controlA. Control of subsidiary companies within a business combination is often of an indirect nature; one subsidiary possesses the stock of another rather than the parent having direct ownership.1. These ownership patterns may be developed specifically to enhance control or for organizational purposes.2. Such ownership patterns may also result from the parent company's acquisition of a company that already possesses subsidiaries.B. One of the most common corporate structures is the fathersongrandson configuration where each subsidiary in turn owns one or more subsidiaries.C. The consolidation process is altered somewhat when indirect control is present.1. The worksheet entries are effectively doubled by each corporate ownership layer but the concepts underlying the consolidation process are not changed.2. Calculation of the accrual-based income of a subsidiary recognizing the consolidated relationships is an important step in an indirect ownership structure.a. The determination of accrual-based income figures is needed for equity income accruals as well as for the computation of noncontrolling interest balances.b. Any company within the business combination that is in both a parent and a subsidiary position must recognize the equity income accruing from its subsidiary before computing its own income.

II. Indirect subsidiary control-connecting affiliationA. A connecting affiliation exists whenever two or more companies within a business combination hold an equity interest in another member of that organization.B. Despite this variation in the standard ownership pattern, the consolidation process is essentially the same for a connecting affiliation as for a fathersongrandson organization.C. Once again, any company in both a parent and a subsidiary position must recognize an appropriate equity accrual in computing its own income.

III.Mutual ownership A. A mutual affiliation exists whenever a subsidiary owns shares of its parent company.B. Parent shares being held by a subsidiary are accounted for by the treasury stock approach.1. The cost paid to acquire the parent's stock is reclassified within the consolidation process to a treasury stock account and no income is accrued. 2. The treasury stock approach is popular in practice because of its simplicity and is now required by the FASB Codification.

IV.Income tax accounting for a business combinationconsolidated tax returns A. A consolidated tax return can be prepared for all companies comprising an affiliated group. Any other companies within the business combination file separate tax returns.B. A domestic corporation may be included in an affiliated group if the parent company (either directly or indirectly) owns at least 80 percent of the voting stock of the subsidiary as well as 80 percent of each class of its nonvoting stock.C. The filing of a consolidated tax return provides several potential advantages to the members of an affiliated group.1. Intra-entity profits are not taxed until realized.2. Intra-entity dividends are not taxed (although these distributions are nontaxable for all members of an affiliated group whether a consolidated return or a separate return is filed).3. Losses of one affiliate can be used to reduce the taxable income earned by other members of the group.D.Income tax expenseeffect on noncontrolling interest valuation1. If a consolidated tax return is filed, an allocation of the total expense must be made to each of the component companies to arrive at the realized income figures that serve as a basis for noncontrolling interest computations.2. Income tax expense is frequently assigned to each subsidiary based on the amounts that would have been paid on separate returns.

V.Income tax accounting for a business combinationseparate tax returns A. Members of a business combination that are foreign companies or that do not meet the 80 percent ownership rule (as described above) must file separate income tax returns.B. Companies in an affiliated group can elect to file separate tax returns. Deferred income taxes are often recognized when separate returns are filed due to temporary differences stemming from unrealized gains and losses as well as intra-entity dividends.

VI.Temporary tax differences can stem from the creation of a business combinationA. The tax basis of a subsidiary's assets and liabilities may differ from their consolidated values (which is based on the fair value on the date the combination is created).B. If additional taxes will result in future years (for example, it the tax basis of an asset is lower than its consolidated value so that future depreciation expense for tax purposes will be less), a deferred tax liability is created by a combination.C. The deferred tax liability is then written off (creating a reduction in tax expense) in future years so that the net expense recognized (a lower number) matches the combination's book income (a lower number due to the extra depreciation of the consolidated value).

Vll.Operating loss carryforwardsA. Net operating losses recognized by a company can be used to reduce taxable income from the previous two years (a carryback) or for the future 20 years (a carryforward).B. If one company in a newly created combination has a tax carryforward, the future tax benefits are recognized as a deferred income tax asset.C. However, a valuation allowance must also be recorded to reduce the deferred tax asset to the amount that is more likely than not to be realized.

Answers to Questions

1. A fathersongrandson relationship is a specific type of ownership configuration often encountered in business combinations. The parent possesses the stock of one or more companies. At least one of these subsidiaries holds a majority of the voting stock of its own subsidiary. Each subsidiary controls other subsidiaries with the chain of ownership going on indefinitely. The parent actually holds control over all of the companies within the business combination despite having direct ownership in only its own subsidiaries.

2. In a business combination having an indirect ownership pattern, at least one company is in both a parent and a subsidiary position. To calculate the accrual-based income earned by that company, a proper recognition of the equity income accruing from its own subsidiary must initially be made. Structuring the income calculation in this manner is necessary to ensure that all earnings are properly included by each company.

3. Able100% of income accrues to the consolidated entity (as parent company).Baker70% (percentage of stock owned by Able).Carter56% (80% of stock owned by Baker multiplied by the 70% of Baker controlled by Able).Dexter33.6% (60% of stock owned by Carter multiplied by the 80% of Carter controlled by Baker multiplied by the 70% of Baker owned by Able).

4. When an indirect ownership is present, the quantity of consolidation entries will increase, perhaps significantly. An additional set of entries is included on the worksheet for each separate investment. Furthermore, the determination of realized income figures for each subsidiary must be computed in a precise manner. For any company in both a parent and a subsidiary position, equity income accruals are recognized prior to the calculation of that company's realized income. This realized income total is significant because it serves as the basis for noncontrolling interest calculations as well as the equity accruals to be recognized by that company's parent.

5. In a connecting affiliation, two (or more) companies within a business combination own shares in a third member. A mutual ownership, in contrast, exists whenever a subsidiary possesses an equity interest in its own parent.

6. In accounting for a mutual ownership, U.S. GAAP requires the treasury stock approach. The treasury stock approach presumes that the cost of the parent shares should be reclassified as treasury stock within the consolidation process. The subsidiary is being viewed, under this method, as an agent of the parent. Thus, the shares are accounted for as if the parent had actually made the acquisition.

7. According to present tax laws, an affiliated group can be comprised of all domestic corporations in which a parent holds 80 percent ownership. More specifically, the parent must own (directly or indirectly) 80 percent of the voting stock of the corporation as well as at least 80 percent of each class of nonvoting stock.

8. Several basic advantages are available to combinations that file a consolidated tax return. First, intra-entity profits are not taxed until realized. For companies with large amounts of intra-entity transactions, the deferral of unrealized gains causes a delay in the making of significant tax payments. Second, losses incurred by one company can be used to reduce or offset taxable income earned by other members of the affiliated group. In addition, intra-entity dividends are not taxable but that exclusion applies to the members of an affiliated group regardless of whether a consolidated or separate tax return is filed.

Members of a business combination may be forced to file separate tax returns. Foreign corporations, for example, must always file separately. Domestic companies that do not meet the 80 percent ownership rule are also required to file in this manner. Furthermore, companies that are in an affiliated group may still elect to file separately. If all companies within the combination are profitable and few intra-entity transactions are carried out, little advantage may accrue from preparing a consolidated return. With a separate filing, a subsidiary has more flexibility as to accounting methods as well as its choice of a fiscal yearend.

9. The allocation of income tax expense among the component companies of a business combination has a direct bearing on realized income totals and, therefore, noncontrolling interest calculations. Obviously, the more expense that is assigned to a particular company the less realized income is attributed to that concern. Income tax expense can be allocated based on the income totals that would have been reported by various companies if separate tax returns had been filed or on the portion of taxable income derived from each company.

10. In filing a separate tax return (assuming that the two companies do not qualify as members of an affiliated group), the parent must include as income the dividends received from the subsidiary. For financial reporting purposes, however, income is accrued based on the ownership percentage of the realized income of the subsidiary. Because income is frequently recognized by the parent prior to being received in the form of dividends (when it is subject to taxation), deferred income taxes must be recognized.

Either the parent or the subsidiary might also have to record deferred income taxes in connection with any unrealized intra-entity gain. On a separate tax return, such gains are reported at the time of transfer while for financial reporting purposes they are appropriately deferred until realized. Once again, a temporary difference is created which necessitates the recognition of deferred income taxes.

11. If the consolidated value of a subsidiarys assets exceeds their tax basis, depreciation expense in the future will be less on the tax return than is shown for external reporting purposes. The reduced expense creates higher taxable income and, thus, increases taxes. Therefore, the difference in values dictates an anticipated increase in future tax payments. This deferred liability is recognized at the time the combination is created. Subsequently, when actual tax payments do arise, the deferred liability is written off rather than recognizing expense based solely on the current liability. In this manner, the expense is shown at a lower figure, one that is matched with reported income (which is also a lower balance because of the extra depreciation).

Recognition of this deferred liability at date of acquisition also reduces the net amount attributed to the subsidiary's assets and liabilities in the initial allocation process. Therefore, the residual asset (goodwill) is increased by the amount of any liability that must be recognized.

12. A net operating loss carryforward allows the company to reduce taxable income for up to 20 years into the future. Thus, a benefit may possibly be derived from the carryforward but that benefit is based on Wilson (the subsidiary) being able to generate taxable income to be decreased by the carryforward. To reflect the potential tax reduction, a deferred income tax asset is recorded for the total amount of anticipated benefit. However, because of the uncertainty, unless the receipt of this benefit is more likely than not to be received, a valuation allowance must also be recorded as a contra account to the asset. The valuation allowance may be for the entire amount or just for a portion of the asset.

13. At the date of acquisition, the valuation allowance was $150,000. As a contra asset account, recognition of this amount reduced the net assets attributed to the subsidiary and, hence, increased the recording of goodwill (assuming that the price did not indicate a bargain purchase). If the valuation allowance is subsequently reduced to $110,000, the net assets have increased by $40,000. This change is reflected by a decrease in income tax expense.

Answers to Problems

1.D

2.B

3.D

4.C

5.C

6.C

7.DSapphire's accrual-based income:Operating income $210,000Defer unrealized gain (50,000)Sapphire's accrual-based income $160,000

Emerald's accrual-based income:Operating income $228,000Investment Income (90% of Sapphires accrual income) 144,000Emerald's accrual-based income $372,000

Diamond's accrual-based income:Operating income $348,000Investment income (80% of Emerald's accrual income) 297,600Diamond's accrual-based income $645,600

8.CCherry's accrual-based income:Operating income $280,000Defer unrealized gain (50,000)Cherry's accrual-based income $230,000Outside ownership 20%Net income attributable to noncontrolling interest$ 46,000

Beech's accrual-based income:Operating income $315,000Defer unrealized gain (19,000)Investment income (80% of Cherry's accrual-based income) 184,000Beech's accrual-based income $480,000Outside ownership 20%Net income attributable to noncontrolling interest $ 96,000

Total net income attributable to noncontrolling interest = ($46,000 + $96,000) = $142,000

9.A Stark's operating income$78,000Dividend income from Arryn 18,000Stark 's income $96,000Outside ownership 5%Noncontrolling interest $ 4,800

10. BEquity income (75% of $415,000) $311,250Dividend income (75% of $110,000) 82,500Tax difference $228,750Dividends received deduction upon eventual distribution (80%) (183,000)Temporary portion of tax difference $ 45,750Tax rate 40%Deferred income tax liability $ 18,300

11.CUnrealized Gross Profit:Total gross profit $30,000Portion still held 20%Unrealized gross profit $ 6,000Tax rate 25%Deferred tax asset $ 1,500

12.ARecognition of this gross profit is not required on a consolidated tax return.

13.ABecause fair value of the subsidiary's assets exceeds the tax basis by $144,000, a deferred tax liability of $57,600 (40%) must be recorded. Goodwill is then computed as follows:

Consideration transferred $450,000Fair value $454,000Deferred tax liability (57,600) 396,400Goodwill $ 53,600

14. (30 Minutes) (Series of reporting and consolidation questions pertaining to a fathersongrandson combination. Includes unrealized inventory gains)a.Consideration transferred (by Aspen) $288,000Noncontrolling interest fair value 72,000Birchs business fair value360,000Book value(300,000)Trade name$ 60,000Life 30 yearsAnnual amortization $ 2,000

14. (continued)

Consideration transferred for Cedar (by Birch) $104,000Noncontrolling interest fair value 26,000Cedars business fair value $130,000Book value(100,000)Trade name$30,000Life 30 yearsAnnual amortization $ 1,000

Investment in Birch $288,000 Birch's reported income-2012 $40,000 Amortization expense (2,000)Accrual-based income $38,000 Birchs percentage ownership 80%Equity accrual-2012 $30,400 Dividends received 2012 (8,000)Birch's reported income-2013 $60,000 Amortization expense (2,000)Income from Cedar [80% x ($10,000 - $1,000)] 7,200 Accrual-based income$65,200 Birchs percentage ownership 80%Equity accrual-2013 $52,160 Dividends received from Birch 2013 (16,000)Investment in Birch 12-31-13 $346,560

Note: Dividends declared by Cedar to Birch do not affect Aspens Investment account.b. Consolidated sales (total for the companies) $1,298,000 Consolidated expenses (total for the companies) (1,025,000)Total amortization expense (see a.) (3,000)Consolidated net income for 2014 $ 270,000 c. Noncontrolling interest in income of CedarRevenues less expenses$30,000 Excess amortization (1,000)Accrual-based income$29,000 Noncontrolling interest percentage 20%Noncontrolling interest in income of Cedar $5,800 Noncontrolling interest in income of Birch:Revenues less expenses$65,000 Excess amortization (2,000)Equity in Cedar income [(30,000-1,000) 80%] 23,200 Realized income of Birch2014$86,200 Outside ownership 20% $17,240 NCI share of 2014 consolidated income$23,040

14. (continued)d. 2013 Realized net income of Birch (prior to accounting for unrealized gross profit) (see a) $65,200 2012 Transfer-gross profit recognized in 2013 10,000 2013 Transfer-gross profit to be recognized in 2014 (16,000)2013 Realized net income - Birch $59,200 2014 Realized net income of Birch (prior to accounting for unrealized gross profit) (see c.) $86,200 2013 Transfer-gross profit recognized in 2014 16,000 2014 Transfer-gross profit to be recognized in 2015 (25,000)2014 Realized net incomeBirch $77,200

15. (15 minutes) (Income and noncontrolling interest with mutual ownership.)

a.Consideration transferred by Uncle $500,000Noncontrolling interest fair value 125,000Nephews business fair value $625,000Book value 600,000Intangible assets $25,000Life 10 yearsAmortization expense (annual) $2,500

Net income reported by Nephew2014$50,000Amortization expense (above) (2,500)Accrual-based income47,500Uncle's ownership percentage 80%Net income of subsidiary recognized by Uncle $38,000

b.To the outside owners, the $6,000 intra-entity dividends ($20,000 30%) declared by Uncle are viewed as income because the book value of Nephew increases. Thus, the noncontrolling interest's share of income is computed as follows:

Nephews accrual-based income (above) $47,500Dividends declared by Uncle to Nephew6,000Income to outside owners$53,500Noncontrolling interest percentage20% Noncontrolling interest share of Nephews net income$10,700

16. (35 Minutes) (Consolidated net income for a fatherson-grandson combination.)

a.Mesa's operating income $250,000 Butte's operating income 98,000 Valley's operating income 140,000 Amortization expenseMesa's investment in Butte (22,500)Amortization expenseButte's investment in Valley (8,000)Consolidated net income $457,500

b.Valley's operating income $140,000 Amortization expense (on Butte's investment) (8,000)Valley's accrual-based net income $132,000 Outside ownership 45%Noncontrolling interest in Valley's income $59,400 Butte's operating income $ 98,000 Amortization expense (on Mesa's investment) (22,500)Equity accrual from ownership of Valley ($132,000 55%) 72,600 Butte's accrual-based net income $148,100 Outside ownership 20%Noncontrolling interest in Butte's net income $29,620 Total net income attributable to noncontrolling interests $89,020

Reconciliation:Mesas operating income$250,000 Mesas share of Buttes operating income (80% $98,000)78,400Mesas share of Valleys operating income (80% 55% $140,000)61,600Mesas share of Buttes excess amortization (80% $22,500)(18,000) Mesas share of Valleys excess amortization (80% 55% $8,000)(3,520) Controlling interest in consolidated net income $368,480 Net income attributable to noncontrolling interest 89,020 Consolidated net income$457,500

17. (30 Minutes) (Consolidated net income figures for a connecting affiliation)UNREALIZED GROSS PROFIT:Cleveland ($12,000 remaining inventory 25% markup) =$3,000Wisconsin ($40,000 remaining inventory 30% markup) =$12,000

NONCONTROLLING INTERESTS:CLEVELAND:Operating income (sales minus cost of goods sold andexpenses) $60,000Defer unrealized gross profit (above) (3,000)Realized incomeCleveland $57,000Outside ownership 20%Noncontrolling interest in Cleveland's net income $11,400

WISCONSIN:Operating income (sales minus cost of goods sold andexpenses) $110,000Defer unrealized gross profit (above) (12,000)Investment income (60% of Cleveland's realized income of$57,000) 34,200Realized incomeWisconsin $132,200Outside ownership 10%Noncontrolling interest in Wisconsin's net income $ 13,220

TOTAL NONCONTROLLING INTERESTS: $24,620 ($11,400 + $13,220)

CONSOLIDATION TOTALS Sales = $1,590,000 (add the three book values and eliminate intra-entity transfers of $40,000 and $100,000) Cost of goods sold = $1,015,000 (add the three book values, eliminate intra-entity transfers of $40,000 and $100,000, and defer [add] unrealized gains of $3,000 and $12,000) Expenses = $200,000 (add the three book values) Dividend income = 0 (eliminated for consolidation purposes) Consolidated net income = $375,000 (consolidated revenues less consolidated cost of goods sold and expenses) Net income attributable to noncontrolling interest = $24,620 (above) Net income attributable to Baxter Company = $350,380 (consolidated net income less noncontrolling interest share)

18. (12 Minutes) (Acquisition accounting for a subsidiarys operating loss carryforward)

a.Consideration transferred 1/1/14$1,080,000Fair value of identifiable assets acquired:Software licensing agreements$830,000Deferred tax asset from NOL (.35 $155,000) 54,250Fair value of net identifiable assets acquired884,250Goodwill$195,750

b.Consideration transferred 1/1/14$1,080,000Fair value of identifiable assets acquired:Software licensing agreements$830,000Deferred tax asset from NOL (.35 $155,000)54,250Valuation allowance for NOL (54,250)Fair value of net identifiable assets acquired830,000Goodwill$250,000

19. (25 Minutes) (Tax expense with separate tax returns for a combination.)

a.CONSOLIDATED TOTALS Sales = $790,000 (add the two book values and eliminate the $110,000 intra-entity transfer) Cost of goods sold = $340,000 (add the book values, eliminate intra-entity transfers of $110,000, recognize [subtract] $30,000 deferred gain from 2014, and defer [add] $40,000 intra-entity gain into 2015) Operating expenses = $234,000 (add the two book values) Dividend income = 0 (eliminated for consolidation purposes) Consolidated net income = $216,000 (Revenues less expenses) Net income attributable to noncontrolling interest = $18,000 (20 percent of reported Income of $100,000 plus $30,000 gain deferred from 2014 less $40,000 gain deferred into 2015) Net income attributable to Up Company = $198,000

b. On separate returns, the unrealized gains are reported as taxable income. Because Up owns 80 percent of Down's stock, the dividends are tax- free and no deferred tax liability is necessary on the undistributed income.

DUE TO GOVERNMENT: (separate returns)UP:Income (without dividend income) $126,000Tax rate 30%Currently payable to government $ 37,800

19. (continued)

DOWN:Reported income $100,000Tax rate 30%Currently payable to government $ 30,000

Total income tax payable: Current = $67,800 ($37,800 + $30,000)Taxable income is not reduced by the unrealized gain. Therefore, the gain is recognized for tax purposes but not for book purposes and this temporary difference results in a deferred tax asset of $3,000 ($10,000 x 30%).

CONSOLIDATED INCOME TAX EXPENSE:

Income tax liability ($37,800 + $30,000 = $67,800) less deferred tax asset ($3,000) = income tax expense $64,800.

Otherwise stated as: Up has a tax expense of $37,800 and Down has a tax expense of $27,000 ($30,000 payable - $3,000 deferred tax asset). Income tax expense on the consolidated income statement is $64,800.20. (45 Minutes) (Computation of income tax expense and the related payable balances)

a.$260,000($650,000 40%)The affiliated group is taxed on its operating income of $650,000 ($500,000 - $90,000 + $240,000: the net unrealized gross profit is deferred on a consolidated return). The intra-entity income and dividends are not relevant since a consolidated return is filed.

b.$260,000($650,000 40%) The affiliated group is taxed on its operating income of $650,000 (the net unrealized gross profit is deferred on a consolidated return). The intra-entity income and dividends are not relevant if a consolidated return is filed. The percentage ownership does not affect the figures on a consolidated return.

c.$296,000($96,000 + $200,000)Rogers would pay $96,000 or 40% of its $240,000 operating income. Clarke would pay $200,000 or 40% of its $500,000 operating income. The unrealized gross profit is not deferred when separate returns are filed. Intra-entity dividends are not taxable because the parties qualify as an affiliated group even though separate returns are being filed. Answer (c.) differs from (a.) and (b.) because tax on the $90,000 unrealized gross profit (40% or $36,000) is paid immediately.

20.(continued)

d.Clarkes operating income$500,000Dividends received net of 80% deduction ($80,000 x 70% x 20%)11,200Taxable income$511,200Tax rate40% Clarkes income tax payable$204,480Clarkes deferred taxes:Unrealized gain$90,000Tax rate40% Clarkes deferred tax asset$36,000

Rogers income before income tax$240,000Less: income tax (40%)96,000Rogers net income$144,000Less: dividends paid80,000Undistributed income$ 64,000Clarkes ownership percentage70%Clarkes share of undistributed income$ 44,800Less: dividends-received deduction (80%)35,840Income eventually taxable to Clarke$ 8,960Tax rate40% Clarkes deferred tax liability$ 3,584

Entry on Clarkes books:Deferred Tax Asset36,000Income Tax Expense172,064Deferred Tax Liability3,584Tax Payable204,480

Entry on Rogers books:Income Tax Expense (40% x $240,000)96,000Tax Payable96,000Consolidated tax expense = $172,064 + $96,000 = $268,064

e.$204,480 (see part d. above) Clarke owes $200,000 on its operating income ($500,000 40%) because the unrealized gain cannot be deferred. Clarke also owes $4,480 from the dividends received ($56,000 20% 40%). The difference between the Clarkes $204,480 payment and the $172,064 tax expense in (d.) is created by the premature payment of the tax (a deferred tax asset) on the unrealized gain ($90,000) less the deferred tax liability on the parent's equity accrual ($100,800) in excess of dividends received ($56,000).

21. (20 Minutes) (Comparison of income tax expense and payable on separate and consolidated tax returns.)

a.Consolidated Return2014

Piranto income 2014 (sales less expenses) $300,000Slinton income 2014 (sales less expenses) 100,0002013 gain realized in 2014120,0002014 deferred gain(150,000)Taxable income $370,000Tax rate 40%Income tax payablecurrent $148,000

Because no temporary differences exist in this problem, the income tax expense would also be $148,000. The unrealized gain is not taxed until realized. Dividend income is not important because a consolidated return is being filed.

b.Separate Returns2014On its separate tax return, Piranto will report taxable income of $300,000the unrealized gains cannot be deferred. The dividends would not be taxable because Slinton still meets the criteria to be a member of an affiliated group. A consolidated return is not a requirement for these dividends to be excluded. Thus, income taxes payable by Piranto would be $120,000 ($300,000 40%).

To determine the income tax expense for Piranto, the two temporary differences must be taken into account:

Taxable income $300,000Gain taxed in 2013 although realizedin 2014 120,000Gain taxed in 2014 although not yet realized(150,000)2014 realized income subject to taxation $270,000Tax rate 40%Income tax expense $108,000

The $12,000 difference between the expense and the payable is the tax effect on the net unrealized gain ($30,000 40%).

Slinton will have an expense and payable of $40,000 ($100,000 40%).

Consolidated income tax expense is $148,000 ($108,000 + $40,000).

Consolidated income tax payable is $160,000 ($120,000 + $40,000).

22.(45 Minutes) (Comparison of income tax expense and payable on separate and consolidated tax returns. Includes question on mutual ownership and the conventional approach.)

a.Total income tax expense is $156,877. Because of the level of ownership, separate returns must be filed. Unrealized gross profits are taxed immediately as are intra-entity dividends. Because the unrealized gross profits are deferred on the consolidated financial statements, Boxwood's expense would be $34,400 or 40% of $86,000 in realized income ($100,000 + $18,000 $32,000).

Lake's income subject to taxation includes its $300,000 in operating income plus $30,960 in income accruing from its investment in Boxwood (60% of the aftertax income of $51,600 [$86,000 $34,400]). Income tax expense for Lake is computed as follows:

Operating income $300,000Equity income $30,960Taxable portion 20% 6,192Income eventually subject to taxation $306,192Tax rate 40%Income tax expense Lake (rounded)$122,477Income tax expense Boxwood (above) 34,400Total income tax expense $156,877-OR-Lakes operating income$300,000Dividends received net of 80% deduction ($10,000 x 60% x 20%)1,200Taxable income$301,200Tax rate40% Lakes income tax payable$120,480Boxwoods income before income tax$ 86,000Less: income tax (40%)34,400Boxwoods net income$ 51,600Less: dividends paid10,000Undistributed income$ 41,600Lakes ownership percentage60%Lakes share of undistributed income$ 24,960Less: dividends-received deduction (80%)19,998Income eventually taxable to Lake$ 4,992Tax rate40% Lakes deferred tax liability (rounded)$ 1,997Income tax expense Lake$122,477Income tax expense Boxwood (above) 34,400Total income tax expense $156,877

22. (continued)

Entry on Lakes books:Income Tax Expense122,477Deferred Tax Liability1,997Tax Payable120,480

Entry on Boxwoods books:Income Tax Expense 34,400Deferred Tax Asset5,600Tax Payable40,000b.Boxwood will pay $40,000 ($100,000 40%) because separate returns are filed. Lake, however, will pay its taxes based on dividends received rather than on the equity accrual. A deferred income tax liability would be established for the difference. Lake's payment for the current year is computed as follows:

Operating income$300,000Dividend income (60% $10,000) $6,000Taxable portion (net of 80% dividends received deduction) 20% 1,200Income currently taxable $301,200Tax rate 40%Income tax payableLake $120,480Income tax payableBoxwood (above) 40,000Total income tax payable current $160,480

The $3,603 difference between the expense in a. and the payable in b. is created by the following two effects:

Deferred income tax liability on equity income accrual not yet taxed($30,960 $6,000 = $24,960 20% 40%)$1,997Deferred income tax asset on net unrealized gross profit($32,000 $18,000 = $14,000 40%) 5,600Net decrease in expense$3,603

c.Because a consolidated tax return is filed, unrealized gross profits are deferred as for external reporting purposes. Dividend income is not taxable.

Lake's operating income $300,000Boxwood's operating income 100,000Prior year unrealized gross profit 18,000Current year unrealized gross profit (32,000) 86,000Income subject to taxation (and currently taxable)$386,000Tax rate 40%Income tax expense $154,40023. (30 Minutes) (Computation of income tax expense and income tax payable on consolidated and separate tax returns.)

a.Operating income $450,000Tax rate 40%Taxes to be paid $180,000

The affiliated group would be taxed on its operating income of $450,000 (the $50,000 unrealized gain is deferred). Intra-entity income and dividends are not relevant because a consolidated return is filed.

b.Total taxes to be paid are $200,000. Robertson would have to pay $80,000 or 40% of its $200,000 operating income. Garrison would pay $120,000 or 40% of its $300,000 operating income. The unrealized gain is not deferred because separate returns are being filed. Intra-entity dividends are not taxable because the parties still qualify as an affiliated group even though separate returns are being filed.

c.Robertson must report an income tax expense of $80,000 or 40% of its $200,000 operating income.

Garrison records its expense based on the revenue recognized during the period. Thus, the expense is computed on an operating income of $250,000 (the net unrealized gain is not recognized in this period) along with equity income from Robertson of $84,000 (70% of that company's $120,000 after-tax income). Garrison will record an income tax expense of $100,000 in connection with the operating income ($250,000 40%) and $6,720 resulting from its equity income ($84,000 20% 40%). Total expense to be reported amounts to $186,720 for Garrison and Robertson ($80,000 + $100,000 + $6,720).

d.Garrison will pay $120,000 in connection with its operating income ($300,000 40%) and $2,400 because of the dividends received from Robertson. Garrison will receive $30,000 in dividends based on its 60% ownership. Of this total, only $6,000 (20%) is taxable. Thus, at a 40% rate, the tax on the dividends would amount to $2,400 ($6,000 40%). The total income taxes payable by Garrison is $122,400 ($120,000 + $2,400).

24.(10 Minutes) (Impact on goodwill of assets with a different tax vs. book value.)

a. The assets and liabilities of Oxford (the subsidiary) will be consolidated at their individual net fair values ($558,000). However, both the buildings and equipment have a tax basis that is lower than fair value. Thus, for tax purposes, future depreciation expense will be lower on the tax return so that taxable income will exceed book income. The higher taxable income (anticipated in the future) creates a deferred tax liability at the time the combination is created.

TaxFairTemporaryBasis Value DifferenceBuildings $221,000$276,000 $ 55,000Equipment 160,000233,000 73,000Total temporary difference $128,000Tax rate 40%Deferred tax liability $ 51,200

b. Consequently, Oxford's accounts will be consolidated as follows: (parentheses indicate a credit balance)

Accounts receivable $153,000Inventory 141,000Land 136,000Buildings 276,000Equipment233,000Liabilities(281,000)Deferred tax liability (51,200)Assigned to specific accounts 606,800Acquisition consideration 850,000c. Excess assigned to goodwill $243,200

25.(55 Minutes) (Consolidation worksheet for a fathersongrandson combination. Includes intra-entity inventory transfers.)

The following computations are needed before the consolidation worksheet is prepared: calculation of the deferred gross profits in beginning and ending inventory.Beginning Unrealized Gross Profit (Wilson)(January 1, 2014 InventoryTransfer Price (goods remaining) =Balance)Cost + .25 Cost$60,000 = 1.25 Cost$48,000 = Cost$12,000 is Unrealized gross profitEnding Unrealized Gross Profit (Wilson)(December 31, 2014 InventoryTransfer Price (goods remaining) = Balance)Cost + .25 Cost $90,000 = 1.25 Cost$72,000 = Cost$18,000 is Unrealized gross profitCONSOLIDATION ENTRIESEntry *GRetained Earnings, 1/1/14 (Wilson) 12,000Cost of Goods Sold12,000(To recognize income on intra-entity inventory transfers made in previous year but not resold until current year as per above computation.)

Entry *CRetained Earnings, 1/1/14 (House) 11,200Investment in Wilson 11,200(To convert investment account from partial equity method to equity method. Unrealized gross profit shown in Entry *G is not properly reflected by parent under partial equity method [12,000 70% = $8,400 income decrease] nor would be the $2,800 in amortization expense for 20122013. Thus, a reduction of $11,200 is required. Because Cuddy is a current year acquisition, no prior conversion to equity method is required for the investment.)

Entry S1Common Stock (Cuddy) 150,000Retained Earnings, 1/1/14 (Cuddy) 150,000Investment in Cuddy (80%)240,000Noncontrolling Interest in Cuddy Common Stock (20%)60,000 (To eliminate Cuddy's stockholders' equity against the corresponding investment balance and to recognize noncontrolling interest in common stock.)

25.(continued)

Entry S2Common Stock (Wilson) 310,000Retained Earnings, 1/1/14 (Wilson)(adjusted by Entry *G) 578,000Investment in Wilson (70%) 621,600Noncontrolling Interest in Wilson (30%) 266,400(To eliminate Wilson's stockholders' equity against corresponding investment balance and to recognize noncontrolling interest.)

Entry ABuildings54,000Franchise Contracts 32,000Goodwill140,000Equipment 10,000Investment in Wilson 151,200Noncontrolling Interest in Wilson64,800(To allocate excess payment made in connection with purchase of Wilson shown above. Amortization for 2012 and 2013 has been taken into account in determining the January 1, 2014 value for each account.)

Entry I1Income of Cuddy 56,000Investment in Cuddy 56,000(To eliminate intra-entity income accrued by both House and Wilson during the year.)Entry I2Income of Wilson 91,000Investment in Wilson 91,000(To eliminate intra-entity income accrued by House during the year.)

Entry D1Investment in Cuddy 40,000Dividends declared (80%) (Cuddy) 40,000(To eliminate effects of intra-entity dividend payments.)

Entry D2Investment in Wilson 67,200Dividends declared (70%) (Wilson) 67,200(To eliminate effects of intra-entity dividend payments.)

25.(continued)

Entry EOperating Expenses 2,000Equipment 5,000Franchise Contracts 4,000Buildings3,000(To record 2014 amortization on excess payment made in connection with acquisition of Wilson Company.)

Entry TISales and Other Revenues 200,000Cost of Goods Sold200,000(To eliminate intra-entity inventory sales for the current year.)

Entry GCost of Goods Sold18,000Inventory18,000(To defer unrealized gross profit in ending inventory.)

Noncontrolling Interest in Net Income of Cuddy:

Reported net income $70,000Outside ownership 20%Noncontrolling interest in Cuddy net incomecommon $14,000

Noncontrolling Interest in Net Income of Wilson:

Reported operating income $130,000Equity income of Cuddy ($70,000 40%)28,000Excess amortization(2,000)Recognition of 2013 gross profit (Entry *G)12,000Deferral of 2014 unrealized gross profit (Entry G) (18,000)Realized net income $150,000Outside ownership 30%Noncontrolling interest in net income of Wilson $ 45,000

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income TaxesChapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

Chapter 07 - Consolidated Financial StatementsOwnership Patterns and Income Taxes

7-1Copyright 2015 McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-28Copyright 2015 McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-27Copyright 2015 McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.25. (continued)HOUSE CORPORATION AND CONSOLIDATED SUBSIDIARIESConsolidation WorksheetDecember 31, 2014

AccountsHouseWilsonCuddyConsolidation EntriesNoncontrollingConsolidatedCorp.CompanyCompanyDebit CreditInterestBalance

Sales and other revenue (900,000)(700,000)(300,000) (TI) 200,000(1,700,000)Cost of goods sold 551,000300,000140,000(G) 18,000(*G) 12,000797,000(TI) 200,000Operating expenses 219,000270,00090,000(E) 2,000581,000Income of Wilson Company (91,000)(I2) 91,000-0-Income of Cuddy Company (28,000)(28,000) (I1) 56,000-0-Net income (249,000)(158,000)(70,000)Consolidated net income(322,000)Net income attributable to noncontrolling interest (Wilson) (45,000)45,000Net income attributable to noncontrolling interest (Cuddy)(14,000) 14,000Net income attributable to House Corporation(263,000)Retained earnings, 1/1/14:House Corporation(820,000)(*C) 11,200(808,800)Wilson Company (590,000)(*G) 12,000-0-(S2)578,000Cuddy Company (150,000)(S1)150,000-0-Net Income (249,000)(158,000)(70,000)(263,000)Dividends declared House Corporation 100,000100,000Wilson Company 96,000 (D2) 67,20028,800-0-Cuddy Company 50,000(D1) 40,00010,000 -0-Retained earnings, 12/31/14(969,000)(652,000)(170,000)(971,800)

25. (continued)

AccountsHouseWilsonCuddyConsolidation EntriesNoncontrollingConsolidatedCorp.CompanyCompanyDebit CreditInterestBalance

Cash and receivables220,000334,00067,000621,000Inventory 390,200320,000103,000(G) 18,000795,200Investment in Wilson Company 807,800(D2) 67,200(*C) 11,200-0-(S2) 621,600(I2) 91,000(A) 151,200Investment in Cuddy Company 128,000128,000(D1) 40,000(S1)240,000-0-(I1) 56,000Buildings 385,000320,000144,000(A) 54,000(E) 3,000900,000Equipment 310,000130,00088,000(E) 5,000(A) 10,000523,000Land 180,000300,00016,000496,000Goodwill (A) 140,000140,000Franchise Contracts (A) 32,000(E) 4,000 28,000Total assets2,421,0001,532,000418,0003,503,200Liabilities (632,000)(570,000)(98,000)(1,300,000)Noncontrolling interest in Cuddy(S1) 60,000(60,000)Noncontrolling interest in Wilson (S2) 266,400Noncontrolling interest in (A) 64,800(331,200)subsidiary companies (411,400)(411,400)Common stock (820,000)(310,000)(150,000)(S1) 150,000(820,000)(S2) 310,000Retained earnings (above) (969,000) (652,000)(170,000) (971,800)Total liabilities and equities (2,421,000)(1,532,000)(418,000)1,916,4001,916,400 (3,503,200)Parentheses indicate a credit balance.

26. (20 Minutes) (Consolidation entries for a mutual holding business combination)

a.Acquisition Allocation and Amortization Consideration transferred $420,000Noncontrolling interest fair value 280,000Lowlys business fair value700,000Book value acquired (600,000)Trademarks$100,000Annual amortization (20-year life)$ 5,000

CONSOLIDATION ENTRIESEntry *CInvestment in Lowly 117,000Retained Earnings, 1/1/14 (Mighty) 117,000(To accrue income to parent during the previous years as measured by increase in book value [$200,000 60%] and amortization expense of $3,000 [$5,000 60%] for the previous year.)

Entry S1Common Stock (Lowly) 300,000Retained Earnings, 1/1/14 (Lowly) 500,000Investment in Lowly (60%) 480,000Noncontrolling Interest in Lowly 1/1/14 (40%) 320,000(To eliminate subsidiary stockholders' equity accounts against investment account and to recognize noncontrolling interest ownership.)

Entry S2Treasury Stock 240,000Investment in Mighty 240,000(To reclassify cost of parent shares as treasury stock.)

Entry ATrademarks 95,000Investment in Lowly 57,000Noncontrolling Interest in Lowly 1/1/14 (40%) 38,000 (To recognize unamortized portion of acquisition-date excess fair value.)

Entry EAmortization Expense 5,000Trademarks 5,000(To record trademarks amortization expense for 2014.)

Net income attributable to noncontrolling interest = $14,000[40% ($40,000 - $5,000)]

27.(80 Minutes) (Prepare consolidation worksheet for a fathersongrandson combination. Also asks about income taxes paid on both a separate and a consolidated return)

a.Acquisition-Date Allocation and AmortizationThe January 1, 2013 book values are determined by removing the 2013 income from the January 1, 2014 book values (based on equity accounts).

Consideration transferred for Stookey$344,000Noncontrolling interest fair value 86,000Stookey business fair value $430,000Stookey book value (380,000)Customer List$ 50,000Life 10 YearsAnnual amortization $ 5,000

Consideration transferred for Yarrow$720,000Noncontrolling interest fair value 80,000Yarrow business fair value $800,000Yarrow book value 740,000Copyright $ 60,000Life 15 YearsAnnual amortization $ 4,000

CONSOLIDATION ENTRIES

Entry *GRetained Earnings, 1/1/14 (Stookey) 7,680Cost of Goods Sold7,680(To give effect to unrealized gross profit from 2013. Amount is calculated based on normal 48% markup [found from Income Statement] multiplied by $16,000 retained inventory [20% of $80,000])

Entry *C1Investment in Stookey 85,856Retained Earnings, 1/1/14 (Yarrow) 85,856(To recognize equity income accruing from Yarrow's investment in Stookey during 2013. Because the initial value method is applied and no dividends declared, no income has been recognized in connection with the 2013 ownership of Stookey. Reported income of $120,000 [2013] less unrealized gain of $7,680 deferred above indicates income of $112,320. Based on 80% ownership, an $89,856 accrual is needed, which is reduced by the $4,000 amortization (80% $5,000) for that year.

27.(continued)

Entry *C2Investment in Yarrow 217,670Retained Earnings, 1/1/14 (Travers) 217,670(To recognize equity income accruing from Travers' investment in Yarrow during 2013. Because the initial method is applied and no dividends declared, income has not been recognized in connection with the 2013 ownership of Yarrow. Income of $245,856 is calculated based on reported income of $160,000 [2013] plus the $85,856 accrual recognized in Entry *C1. Ownership of 90% dictates a $221,270 accrual that is then reduced to $217,670 by the $3,600 [90% $4,000] amortization applicable to 2013.)

Entry S1Common Stock (Stookey) 200,000Retained Earnings, 1/1/14 (Stookey, as adjustedby Entry *G) 292,320Investment in Stookey (80%) 393,856Noncontrolling Interest in Stookey (20%) 98,464(To eliminate stockholders' equity accounts of subsidiary [Stookey] against corresponding balance in investment account and to recognize noncontrolling interest ownership.)

Entry S2Common Stock (Yarrow) 300,000Retained Earnings, 1/1/14 (Yarrow, as adjustedby Entry *C1) 685,856Investment in Yarrow (90%) 887,270Noncontrolling Interest in Yarrow (10%) 98,586(To eliminate stockholders equity accounts of subsidiary Yarrow against corresponding balance in investment account and to recognize noncontrolling interest ownership.)

Entry A1Customer List45,000Investment in Stookey 36,000Noncontrolling Interest in Stookey (20%) 9,000

(To recognize January 1, 2014 unamortized portion of acquisition price assigned to Stookeys customer list.)

27. (continued)

Entry A2Copyright 56,000Investment in Yarrow .50,400Noncontrolling Interest in Yarrow5,600(To recognize January 1, 2014 unamortized portion of acquisition price assigned to copyright.)

Entry EOperating Expenses 9,000Customer List5,000Copyright4,000(To recognize amortization expense for 2014$5,000 in connection with Travers' investment and $3,000 in connection with Yarrow's investment.)

Entry TlSales 100,000Cost of Goods Sold100,000(To eliminate intra-entity inventory transfers made during 2014.)

Entry GCost of Goods Sold9,600Inventory (current assets) 9,600(To defer unrealized gross profit on ending inventory$20,000 48% markup.)

Noncontrolling Interest in Stookey's Net Income2014 Reported net income $100,000Customer list amortization (5,000)Realization of 2013 deferred gross profit (*G) 7,680Deferral of 2014 unrealized gross profit (G) (9,600)Realized income 2014 $93,080Outside ownership 20%Noncontrolling interest in Stookey's net income $18,616

Noncontrolling Interest in Yarrow's Net Income2014 Reported net income $200,000Copyright amortization (4,000)Accrual of Stookey's income (80% of $93,080realized income [computed above]) 74,464Realized income2014 $270,464Outside ownership 10%Noncontrolling interest in Yarrow's net income $ 27,046

.27. (continued)TRAVERS COMPANY AND CONSOLIDATED SUBSIDIARIESConsolidation WorksheetDecember 31, 2014TraversYarrowStookeyConsolidation EntriesNoncontrollingConsolidated AccountsCompanyCompanyCompanyDebit CreditInterestBalancesSales and other revenues (900,000) (600,000)(500,000)(Tl) 100,000(1,900,000)Cost of goods sold 480,000320,000260,000(G) 9,600(*G)7,680 961,920(TI)100,000Operating expenses 100,00080,000140,000(E) 9,000329,000Separate company net income (320,000)(200,000)(100,000)Consolidated net income (609,080)Net income attributable to NCI (Yarrow) (27,046)27,046Net income attributable to NCI (Stookey) (18,616) 18,616Net income attributable to Travers Company(563,418)Retained earnings, 1/1/14:Travers Company (700,000)(*C2)217,670(917,670)Yarrow Company (600,000) (S2)685,856(*C1) 85,856-0-Stookey Company (300,000)(*G)7,680-0-(S1) 292,320Net Income (above) (320,000)(200,000)(100,000)(563,418)Dividends declared 128,000 128,000Retained earnings, 12/31/14 (892,000) (800,000)(400,000)(1,353,088)

Current assets 444,000 380,000 280,000(G) 9,6001,094,400Investment in Yarrow Company 720,000(*C2) 217,670(S2)887,270-0-(A2)50,400Investment in Stookey Company344,000(*C1) 85,856(S1) 393,856-0-(A1)36,000Land, buildings, & equipment (net) 949,000836,000520,0002,305,000Customer list (A1)45,000(E) 5,00040,000Copyright (A2)56,000(E) 4,000 52,000 Total assets2,113,0001,560,000800,000 3,491,400

Liabilities (721,000) (460,000)(200,000)(1,381,000)Common stock (500,000)(300,000)(200,000)(S1)200,000(S2)300,000(500,000)Retained earnings, 12/31/14 (above) (892,000) (800,000)(400,000)(S1) 98,464(1,353,088)NCI interest in Stookey, 1/1/14(A1)9,000(107,464)(S2) 98,586Noncontrolling interest in Yarrow, 1/1/14(A2) 5,600(104,186)Noncontrolling interests in subsidiaries (257,312) (257,312)Total liabilities and equities (2,113,000)(1,560,000)(800,000)2,008,9822,008,982(3,491,400)

27.(continued)

b.Travers' reported pre-tax income $320,000Yarrow's reported pre-tax income 200,000Dividend income (none collected) -0-Intra-entity gains (no transfers) -0-Amortization expense (9,000)Taxable income $511,000Tax rate 45%Income tax payable $229,950

c.Stookey's reported pre-tax income $100,000(Unrealized gains are not deferred on a separatetax return.)Tax rate 45%Income tax payable $45,000

d.(1)Because Yarrow owns 80% of Stookey's stock, intra-entity dividends are nontaxable. Thus, no temporary difference is created by Stookey's failure to pay a dividend.

(2)Stookey's unrealized gains are recognized in one time period for financial reporting purposes and in a different time period for tax purposes. This temporary increases taxable income by $1,920 over reported income:

2014 Unrealized gross profit taxed in 2014$9,6002013 Unrealized gross profit taxed previously in 2013 (7,680)Increase in taxable income $1,920Tax rate 45%Deterred income tax asset $ 864

Income Tax Expense:Travers and Yarrowpayable (part b) $229,950Stookeypayable (part c) 45,000Total taxes to be paid2014$274,950Prepayment (asset) (above) (864)Income tax expense 2014$274,086

Because a single rate is used, income tax expense can also be computed by taking consolidated net income (prior to noncontrolling interest reduction) of $609,080 (part a.) and multiplying by the 45% tax rate to obtain $274,086.

Income tax expensecurrent 274,086Deferred income taxasset 864Income tax payable 274,950

28. (40 Minutes) (Series of questions about a business combination and its income tax reporting)

a.Partial equity method. "Income of Soludan" is 80% of Soludan's reported total.

b.$12,000. Reduction is evidenced by a $338,000 figure reported for consolidated inventory rather than the $350,000 total for the two companies.

c.$37,500. Consolidated operating expenses have increased by $2,500, evidently the annual amortization. Because a 15year life is assumed by the combination, the amount originally allocated to trademarks must have been $37,500.

d.$120,000. Decrease shown in consolidated sales account.

e.Upstream. " Net income attributable to the noncontrolling interest" is $18,700. Because this amount is not equal to 20% of Soludan's reported net income less excess amortization ($100,000 $2,500), realized net income must have been adjusted for unrealized gross profits. Subsidiary net income is only adjusted to show the effects of upstream transfers.

f.$20,000. For both receivables and liabilities, the consolidated total is $20,000 less than the sum of the two companies.

g.$8,000. Consolidated cost of goods sold is decreased by $120,000 (to $780,000) in eliminating intra-entity sales. The increase of $12,000 created by the ending unrealized gross profit (see part b.) would then leave a $792,000 balance. Because $784,000 is the ending balance reported for consolidated cost of goods sold, an $8,000 unrealized gross profit must have been deferred from the previous year.

28.(continued)

h.Because the trademarks balance now stands at $32,500, amortization expense of $2,500 has been recognized, $2,500 in the previous year. In addition, an $8,000 unrealized gross profit from the prior year (see part g.) is recognized.

Amortization expenseprior year 80%$2,000Unrealized gross profitupstream effect onparent's retained earnings is $8,000 80% 6,400Adjustment to parents beginning retained earnings$8,400

i.This figure is computed as follows:Book value of subsidiary1/1 $370,000Unrealized gross profit in beginning inventory (see above) (8,000)Realized book value $362,000Excess allocation at 1/1 35,000Subsidiary valuation basis 1/1 397,000Noncontrolling interest percentage 20%Noncontrolling interest 1/1 $79,400Noncontrolling interest in Soludan's income(as reported) 18,700Noncontrolling interest in Soludan's dividends($20,000 20%) (4,000)Ending noncontrolling interest $94,100

j.For a consolidated return, unrealized gross profit are deferred as in the consolidated statements. At a 40% rate, both the expense and payable would be $117,400.

Income tax expense 117,400Income tax payable 117,400

Consolidated Taxable Income:Sales $1,280,000Cost of Goods Sold(784,000)Operating expenses (202,500)Taxable income $ 293,500

k.On a separate return, Politan would report its operating income of $200,000 leading to a tax expense and payable of $80,000. Because of the level of ownership, intra-entity dividend (or investment) income is omitted.

Income Tax Expense 80,000Income Tax Payable 80,000

28.k. (continued)

On a separate return, Soludan would report $100,000 operating income for a payable of $40,000. The unrealized gross profits are accounted for in different time periods in the financial statements, thus, a temporary difference is created. The beginning inventory gross profit of $8,000 was taxed in the previous year rather than currently. The current unrealized gross profit of $12,000 is taxed now rather than next year; the tax paid this year on the net $4,000 ($1,600) is a prepayment.

Income Tax Expense 38,400Deferred Income Tax Asset1,600Income Tax Payable 40,000

Soludan's entry can also be computed as follows:Reported income $100,000Unrealized gross profit from previous period realized currently 8,000Deferral of current unrealized gross profit (12,000)Realized income $96,000Tax rate 40%Income tax expense $38,400Taxes payable 40,000Deferred tax asset $ 1,600

29.(45 Minutes) Develop worksheet entries that were used to consolidate the financial statements of a father-son-grandson combination.

Entry *GRetained Earnings, 1/1/14 (Delta) 15,000Cost of Goods Sold15,000(To recognize gross profit that was unrealized in 2013 [amount provided].)

Entry *C1Retained Earnings, 1/1/14 (Delta) 7,000Investment in Omega Company 7,000(To recognize amortization expense from Deltas acquisition for 2013.)

29. (continued)

Entry *C2Retained Earnings, 1/1/14 (Alpha) 27,600Investment in Delta Company 27,600To recognize accrual adjustments for excess amortization and inventory deferral as follows:Excess amortization from Delta acquisition (80% $6,250 2 years)$10,000Deltas share of excess amortization from Omega acquisition (80% [70% $10,000] 1 year)5,600Inventory profit deferral at 1/1/14 (80% $15,000) 12,000*C2 adjustment$27,600Entry S1Common Stock (Omega) 100,000Retained Earnings, 1/1/14 (Omega) 100,000Investment in Omega (70%) 140,000Noncontrolling Interest in Omega (30%) 60,000(To eliminate stockholders' equity accounts of Omega against parent's Investment account and to recognize outside ownership.)

Entry S2Common Stock (Delta) 120,000Retained Earnings, 1/1/14 (Delta, as adjusted) 378,000Investment in Delta (80%) 398,400Noncontrolling Interest in Delta (20%) 99,600(To eliminate stockholders' equity accounts of Delta [as adjusted as Entry *G and Entry *C1] against corresponding balance in Investment account and to recognize outside ownership.)

Entry ACopyrights 222,500Investment in Delta 90,000Investment in Omega 77,000Noncontrolling Interest in Delta22,500Noncontrolling Interest in Omega33,000(To recognize January 1, 2014 unamortized copyrights, 2 years amortization recorded on first investment but only one year for second.)

Entry I1Income of Subsidiary 144,000Investment in Delta 144,000(To eliminate intra-entity income accrual found on Alpha's records.)

29. (continued)

Entry I2Income of Subsidiary 49,000Investment in Omega 49,000(To eliminate intra-entity income accrual found on Delta's records.)

Entry D1Investment in Delta 32,000Dividends Declared (Delta) 32,000(To eliminate intra-entity dividends.)

Entry D2Investment in Omega 35,000Dividends Declared (Omega) 35,000(To eliminate intra-entity dividends.)

Entry EOperating Expenses 16,250Copyrights 16,250(Current year amortization, $6,250 on first acquisition and $10,000 on second.)

Entry TlSales200,000Cost of Goods Sold200,000(To eliminate intra-entity inventory transfer.)

Entry GCost of Goods Sold22,000Inventory22,000(To defer ending unrealized gross profit on intra-entity transfers.)

Noncontrolling Interest in Omega's Income:Reported income $70,000Excess fair value amortization (10,000)Accrual-based income60,000Outside ownership 30%Net income attributable to noncontrolling interest $18,000

29. (continued)

Noncontrolling Interest in Delta's Net Income:Reported operating income $131,000Equity income investment in Omega (70% $60,000) 42,000Amortization expense (6,250)2013 Unrealized income realized in 201415,0002014 Unrealized income realized in 2014 (22,000)Accrual-based incomeDelta (2014) $159,750Outside ownership 20%Net income attributable to noncontrolling interest$ 31,950

Noncontrolling interest in Delta CompanyNoncontrolling interest, 1/01/14 (Entry S2)$99,600Noncontrolling interest, 1/01/14 (Entry A)22,500Noncontrolling interest in Deltas income (above)31,950Dividends declared to noncontrolling interest ($40,000 20%) (8,000)Noncontrolling interest in Delta, 12/31/14$146,050

Noncontrolling interest in Omega CompanyNoncontrolling interest, 1/01/14 (Entry S1)$60,000Noncontrolling interest in Omegas income (above)18,000Noncontrolling interest, 1/01/14 (Entry A)33,000Dividends declared to noncontrolling interest ($50,000 30%) (15,000)Noncontrolling interest in Omega, 12/31/14$96,000

Chapter 7 Excel Case Solution

OperatingDividendsExcess income declared amortizationsSummit$345,000$150,000Treeline$280,000$100,000$20,000Basecamp$175,000$40,000$25,000Ownership percentagesSummit-->Treeline90%Treeline-->Basecamp 70%Treeline's share of Basecamp net income:Basecamp operating income$175,000 Excess amortization (25,000)Accrual based income$150,000 Treeline ownership percentage70%Equity income from Basecamp$105,000 Summit's share of Treeline income:Treeline operating income$280,000 Equity income from Basecamp105,000 Excess amortization (20,000)Treeline adjusted income$365,000 Summit ownership percentage90%Summit's share of reported net income$328,500 Controlling interest in net incomeSummit's operating income$345,000 Equity earnings in Treeline and Basecamp328,500 Summits net income$673,500 ComparisonConsolidated net income (operating incomes less amortizations)$755,000Net income attributable to noncontrolling interests (30% $150,000 plus 10% $365,000) 81,500Net income attributable to Summit Company$673,500

Difference between Summits net income and controlling interest in consolidated net income = -0-

RESEARCH CASE: CONSOLIDATED TAX EXPENSE

At www.thecoca-colacompany.com the annual 10-K Note 14 provides detailed footnote disclosures for consolidated income tax. The excerpt below shows a portion of the footnote relating to deferred tax assets, liabilities, and carryforwards.

From Note 14: Income TaxesThe tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consist of the following (in millions): December 31,20122011Deferred tax assets:Property, plant and equipment$ 89$ 224Trademarks and other intangible assets7768Equity method investments (including translation adjustment)209278Derivative financial instruments11643Other liabilities1,1781,257Benefit plans1,8082,022Net operating/capital loss carryforwards782818Other 320 418Gross deferred tax assets 4,5795,128Valuation allowances (487) (859)Total deferred tax assets1,2$ 4,092$ 4,269Deferred tax liabilities:Property, plant and equipment$ (2,204)$ (2,039)Trademarks and other intangible assets(4,133)(4,201)Equity method investments (including translation adjustment)(712)(816)Derivative financial instruments(140)(129)Other liabilities(144)(129)Benefit plans(495)(445)Other (929)4 (753)Total deferred tax liabilities3$ (8,757)$ (8,512)Net deferred tax liabilities$ (4,665)$ (4,243)1 Noncurrent deferred tax assets of $ 403 million and $243 million were included in the line item other assets in our consolidated balance sheets as of December 31, 2012 and 2011, respectively.2 Current deferred tax assets of $244 million and $227 million were included in the line item prepaid expenses and other assets in our consolidated balance sheets as of December 31, 2012 and 2011, respectively.3 Current deferred tax liabilities of $ 331 million and $19 million were included in the line item accounts payable and accrued expenses in our consolidated balance sheets as of December 31, 2012 and 2011, respectively.

As of December 31, 2012 and 2011, we had $70 million of net deferred tax assets and $491 million of net deferred tax liabilities located in countries outside the United States.

As of December 31, 2012, we had $6,494 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 279 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years..