Modern Advanced Accounting in Canada Canadian 7th Edition Hilton Solutions Manual 1

Solution Manual for Modern Advanced Accounting in
Canada Canadian 7th Edition Hilton Herauf

1259066487 9781259066481
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Chapter 5
Consolidation Subsequent to
Acquisition Date
Copyright © 2013 McGraw-Hill Ryerson Limited. All rights reserved.

Solutions Manual, Chapter 5 1
2 Modern Advanced Accounting in Canada, Seventh Edition
A brief description of the major points covered in each case and problem.
CASES
Case 5-1 In this case, students must discuss how to value employees and patentable products
and how these assets should be amortized or checked for impairment on an annual basis.
Case 5-2 (prepared by Peter Secord, Saint Mary’s University)

In this real life business combination, students are directed to identify all of the intangible assets
acquired and to discuss the valuation problems associated with them.
Case 5-3
In this case, adapted from a CA exam, students are asked to determine appropriate accounting
policies relating to a restructuring of a real estate company. A special purpose balance sheet
needs to be prepared that reports all assets and liabilities at fair value.
Case 5-4
In this case, adapted from a CA exam, students are asked to provide advice in managing a new
company providing warranties for new homes. Students must also recommend appropriate
accounting policies relating to revenue recognition, warranty obligations and a business
combination involving some unique factors in allocating the acquisition cost.
Case 5-5
In this real life case, students are asked to provide advice in resolving a salary dispute for a
hockey team. The owner of the hockey team states that he cannot afford the demands from the
union. However, consolidated statements are not being prepared for the combined operations of
the hockey team and Stadium, which is a subsidiary of the hockey team.
Case 5-6
In this case, adapted from a CA exam, management appears to be manipulating income to
minimize the payment required under a share-redemption agreement. Students are required to
apply special accounting policies when analyzing controversial accounting issues including the
valuation of inventory, capitalization policies, goodwill, and related party transactions.

PROBLEMS
Problem 5-1 (15 min.)

A fairly short problem requiring the calculation of consolidated net income attributable to the
controlling and non-controlling interest, and the equity method balance in the investment account.

This problem requires the preparation of journal entries under the cost method and equity method,
calculation of various amounts for the consolidated financial statements for the third year after
acquisition and calculation of the equity method balance in the investment account.

This problem requires the calculation of various consolidated amounts for the income statement
and balance sheet for the fifth year after acquisition and an indication of the impact of goodwill
impairment on key financial statement items.

The consolidated balance sheet as well as the balance sheet of a parent and its less than 100%-
owned subsidiary are presented. Students are required to answer four questions about the parent
and its subsidiary.

Selected information from the financial statements of a parent and its 85%-owned subsidiary for
a two-year period is given and the student is required to calculate the amounts for various items
that would appear in the consolidated statements during this period.

This is a tricky problem in which details of changes in the parent’s investment account over a
three-year period are given. The student is asked to calculate amounts from the subsidiary's
financial statements as well as amounts for certain items on the consolidated statements.
Problem 5-7 (30 min)

Consolidated financial statements and a calculation of consolidated retained earnings are
required for a parent and its 80%-owned subsidiary for the third year after acquisition. Non-
controlling interest is measured using the trading price of the subsidiary at the date of acquisition.

This problem requires the preparation of a consolidated income statement and retained earnings
statement for a parent and its 80%-owned subsidiary for the eighth year after acquisition.

A relatively straightforward question requiring the preparation of consolidated financial statements
one year after acquisition date.

This problem requires the preparation of consolidated financial statements four years after a
parent acquired 80% control in a subsidiary. Part of the acquisition cost is allocated to
unrecognised trademarks. Students must also assess the impact on two ratios of not allocating
any of the acquisition cost to the trademarks.

This problem requires the preparation of consolidated financial statements two and one-half years
after a parent acquired 80% control in a subsidiary. Also required are calculations of goodwill,
goodwill impairment and non-controlling interests under the parent company extension theory.
The parent uses the equity method for internal reporting.

Consolidated financial statements of a 75%-owned subsidiary, four years after acquisition is
required after impairment tests for goodwill and software have been performed. Also required are
calculations of goodwill impairment loss and non-controlling interests under the parent company
extension theory and an explanation of how the use of the parent company extension theory
would affect the debt to equity ratio.

The preparation of consolidated financial statements is required four and one-half years after the
acquisition of a 75%-owned subsidiary. Also required are calculations of goodwill, goodwill
impairment and non-controlling interests under the parent company extension theory.

Consolidated financial statements of a parent and its 80%-owned subsidiary four years after
acquisition are required.

This question requires the preparation of consolidated financial statements three years after
acquisition. The parent uses the equity method for internal reporting. Also required are
calculations of the investment account had the parent used the cost method and calculation and
interpretation of 3 key ratios under the three different reporting methods.
WEB-BASED PROBLEMS
Web Problem 5-1

The student answers a series of questions based on the 2011 financial statements of Thomson
Reuters, a Canadian company. The questions deal with different theories of consolidation, the
significance of non-controlling interests, goodwill impairment losses and the impact of
consolidation theory on certain ratios.
Web Problem 5-2

The student answers a series of questions based on the 2011 financial statements of BCE Inc.,
a Canadian company. The questions deal with different theories of consolidation, the
significance of non-controlling interests, goodwill impairment losses and the impact of
consolidation theory on certain ratios.
SOLUTIONS TO REVIEW QUESTIONS

1. There are two steps involved in testing the goodwill for impairment:
i) Compare the recoverable amount of each cash-generating unit with its carrying amount

(including goodwill). If the recoverable amount is the larger amount, there is no impairment
of goodwill. If the recoverable amount is the smaller amount the next step (ii) is performed.
ii) If the recoverable amount is less than the carrying amount, an impairment loss should be
recognized and should be allocated to reduce the carrying amount of the assets of the unit
(group of units) in the following order:
(a) first, to reduce the carrying amount of any goodwill allocated to the cash-generating
unit; and
(b) then, to the other assets of the unit pro rata on the basis of the carrying amount of
each asset in the unit. However, an entity shall not reduce the carrying amount of an
individual asset below the higher of its recoverable amount and zero. The amount of
the impairment loss that could not be allocated to an individual asset because of this
limitation shall be allocated pro rata to the other assets of the unit (group of units).
2. The process for testing for impairmentis essentially the same in that the assets are written
down to recoverable amount when they are less than the carrying amount. Recoverable
amount is defined as the higher of fair value less costs of disposal and value in use. The
write-down is called an impairment loss and is reported in net income unless the asset is
carried at revalued amount in accordance with another Standard (for example, in
accordance with the revaluation model in IAS 16). Any impairment loss of a revalued asset
should be treated as a revaluation decrease in accordance with that other Standard.
When the intangible assets must be tested for impairment is not the same for the different
types of intangible assets. Goodwill impairment tests must be conducted at least once a
year unless it is clear that there has been no impairment during the year and more often
than once a year when there is an indication that the cash-generating unit may be impaired.
For intangible assets with a definite useful live, the recoverable amount is only compared to
carrying amount if there is an indication that the asset may be impaired. Intangible assets
with indefinite useful lives must be checked for impairment on an annual basis and
whenever there is an indication that the intangible asset may be impaired.
3. The asset “Investment in subsidiary” on the balance sheet of the parent company is
removed and replaced with the individual assets and liabilities from the balance sheet of the
subsidiary (which are remeasured by the unamortized acquisition differential), and by the
non-controlling interests in the net assets of the subsidiary (in cases of less than 100%
ownership). The item of income “Investment income” on the income statement of the parent
company is removed and replaced with the income and expenses from the income
statement of the subsidiary (adjusted for the amortization of the acquisition differential), and
by the non-controlling interests in the net income of the subsidiary (in cases of less than
100% ownership). As well, any intercompany transactions such as payables and receivables
would be eliminated upon consolidation, whereas under the equity method they remain.
4. Under the equity method:

Cash 7,500
Investment in subsidiary 7,500
Under the cost method:
Cash 7,500
Dividend revenue 7,500
5. IFRS does not require either method for internal record keeping purposes because the
parent is required to prepare consolidated statements for external financial reporting
purposes, and these statements are identical regardless of the method that has been used
by the parent to record the investment. However, if the parent wants to issue separate entity
financial statements in accordance with GAAP, IAS 27 requires that the investment in
subsidiary on the separate entity financial statements shall be reported at cost or in
accordance with IAS 39, Financial Instruments: Recognition and Measurement (or IFRS 9,
Financial Instruments: Classification and Measurement if it is adopted early).
6. The dividends that appear in the retained earnings column in the consolidated statement of
changes in equity are those of the parent company only. The subsidiary’s dividends that
were paid outside the entity to the non-controlling shareholders would appear on a
statement of changes in non-controlling interests (if such a statement was prepared). The
subsidiary’s dividends that were paid to the parent do not appear on any consolidated
statement because no cash left the combined economic entity.
7. This statement is partially true. As long as the parent continues to control the subsidiary and
as long as the subsidiary continues to hold the land, this part of the acquisition differential
will be used to remeasure the land on all subsequent consolidated balance sheets. If the
land is sold by the subsidiary, the acquisition differential will in part be used to determine the
loss or gain for consolidated purposes and will no longer appear on the consolidated
balance sheet. If consolidation of this subsidiary ceases (due to loss of control) the
acquisition differential would become redundant since the acquisition differential only
appears within the consolidated financial statements.
8. What this statement means is that in addition to recording the investor’s share of net income
earned by the investee since acquisition, entries must also be made for the amortization of
the acquisition differential, and for the holdback and realization of any unrealized profits
regardless of whether the profit was recorded by the investee or the investor. The
calculations for these entries are identical to those that would be made when consolidating.
9. The unamortized acquisition differential was:

Investment account 120,000
Shareholders’ equity 125,000
75% 93,750
Parent’s share of unamortized acquisition differential (i.e. 75%) 26,250
Implied value of unamortized acquisition differential (26,250 / 75%) 35,000
(If equity method journal entries had been made to holdback unrealized profits, we would
not get this result.)
10. The elimination of intercompany receivables and payables has no effect on consolidated
shareholders’ equity or non-controlling interests.
11. Any fair value excess arising from the acquisition must be eliminated or amortized on
consolidation in the same way that a cost of an individual asset purchased directly by an
entity is eliminated or amortized. The matching principle states that the cost of an asset
should be expensed in the same period as the benefits received from using the asset. The
benefits are received over the useful life of an asset. Consequently, assets such as
property, plant and equipment should be amortized over their useful lives and assets such
as inventory should be expensed in the year they are sold.
12. The balance sheet accounts of the parent that have different balances are:
Investment in subsidiary, and
Retained earnings.

In addition, the following two income statement accounts differ in amount and their
description:
Dividend income (using the cost method)
Investment income (or equity earnings) (using the equity method)
13. This adjusts the parent's retained earnings under the cost method to what they would be
using the equity method. Under the equity method, the retained earnings of the parent
contain the parent's share of the subsidiary's net income since acquisition. Under the cost
method, the parent's retained earnings contain the parent's share of the subsidiary's
dividends since acquisition. Net income less dividends equals the change in retained
earnings. When we add the parent's share of the increase in the retained earnings of the
subsidiary to the retained earnings of the parent, the resultant amount now contains the
parent's share of the subsidiary's net income earned since acquisition.
14. The subsidiary’s revenue and expenses included in the consolidated income statement are
only those that have occurred since acquisition. Also, the non-controlling interest is based
on the subsidiary’s income earned subsequent to the date of acquisition.
*15.The initial entry adjusts the parent's investment account and retained earnings at the
beginning of the year to equity method balances. The investment account now reflects the
equity method balance at the beginning of the current year.
16. Under the cost method, the parent has recorded only its share of dividends received from
the subsidiary. It has not recorded its share of the subsidiary’s change in retained earnings
or its share of the amortization of the acquisition differential. Therefore, an entry or entries
must be made on the consolidation to record the parent’s share of the subsidiary’s change
in retained earnings and its share of the amortization of the acquisition differential. Since
the starting point for consolidation is the separate entity records of the parent and
subsidiary, a cumulative entry is required each year on consolidation to adjust the parent
company’s retained earnings to what it would be under the equity method. When the equity
method is used, the parent’s retained earnings already reflect its share of the subsidiary’s
retained earnings and its share of the amortization of the acquisition differential.
SOLUTIONS TO CASES
Case 5-1
a. None of the acquisition cost should be allocated to BIO’s skilled workers assuming that
the workers are not under contract. The skilled workers are not capable of being
separated or divided from the acquired enterprise and cannot be sold, transferred,
licensed, rented, or exchanged. Therefore, the value of the skilled workers would be
included as a part of goodwill.
b. Part of the acquisition cost should be allocated to patentable technology because this
technology has a value in the marketplace and it could be separated or divided from the
acquired enterprise and sold, transferred, licensed, rented, or exchanged. An appraiser
could be hired to estimate a value for the patentable technology. The technology would
be amortized over its expected useful life, which is likely to be short because of rapid
changes in technology. The technology would be checked for impairment whenever
events or changes in circumstances indicate that its carrying amount may not be
recoverable.
c. Goodwill is the difference between the acquisition cost and the fair value of identifiable
net assets. The goodwill can only be determined once all of the identifiable assets
including the patentable technology and identifiable liabilities have been measured at fair
value.
According to IAS 36, goodwill of a cash-generating unit should be tested for impairment
on an annual basis, unless all of the following criteria have been met:
(a) The assets and liabilities that make up the cash-generating unit have not changed
significantly since the most recent determination of recoverable amount.
(b) The most recent determination of recoverable amount resulted in an amount that
exceeded the carrying amount of the cash-generating unit by a substantial margin.
(c) Based on an analysis of events that have occurred and circumstances that have
changed since the most recent determination of recoverable amount, the
likelihood that today’s recoverable amount would be less than the current carrying
amount of the reporting unit is remote.
A two-step impairment test should be used to identify potential goodwill impairment and
measure the amount of a goodwill impairment loss to be recognized, if any:

(a) The recoverable amount of the cash-generating unit should be compared with its
carrying amount, including goodwill, in order to identify a potential impairment.
When the recoverable amount of a cash-generating unit exceeds its carrying
amount, goodwill of the reporting unit is considered not to be impaired and the
second step of the impairment test is unnecessary.
(b) When the recoverable amount is less than the carrying amount, an impairment
loss should be recognized and should be allocated to reduce the carrying amount
of the assets of the unit (group of units) in the following order:
(i) first, to reduce the carrying amount of any goodwill allocated to the cash-
generating unit; and
(ii) then, to the other assets of the unit pro rata on the basis of the carrying amount of
each asset in the unit. However, an entity shall not reduce the carrying amount of
an individual asset below the higher of its recoverable amount and zero. The
amount of the impairment loss that could not be allocated to an individual asset
because of this limitation shall be allocated pro rata to the other assets of the unit
(group of units).
Case 5-2
Valero - Ultramar Diamond Shamrock - Teaching Note
This case is concerned with the nature of the various intangible assets acquired in a business
combination, and their valuation in the consolidated financial statements pursuant to the
combination. The student is directed to devote attention to a variety of unrecorded intangible
assets, and should address their identification and then their valuation issues. Even though this
is an American Company, students are directed to basically treat it as a Canadian company as
far as financial reporting is concerned. Students need to recognize that IFRSs and US GAAP
are now almost identical in the accounting for business combinations.
The case mentions that the acquisition includes the extensive UDS refining, logistics, and retail
network operating under several brands, including Ultramar, Diamond Shamrock, Beacon, and
Total. The retail network is large, with 2,500 company-owned sites and supplying 2,500 further
sites. There are extensive brand support programs, and a large home heating oil business
(250,000 households).

IFRS 3 requires that the cost of the acquisition be allocated to identifiable assets acquired and
liabilities assumed in a business combination, whether or not recognized in the financial
statements of the acquired enterprise based on their fair values at the date of acquisition. An
intangible asset is identifiable and should be recognized apart from goodwill when:
• the asset results from contractual or other legal rights (regardless of whether those rights
are transferable or separable from the acquired enterprise or from other rights and
obligations); or
• the asset is capable of being separated or divided from the acquired enterprise and sold,
transferred, licensed, rented, or exchanged (regardless of whether there is an intent to do
so).
A sample memorandum follows:
To: CFO, Valero Energy Corp.

From: Advanced Accounting Candidate
Re: Intangible assets, UDS acquisition
This acquisition includes a variety of intangible assets, some of which should be segregated
from goodwill under the provisions of IFRS 3.
The overall amount to be allocated to intangible assets is determined in two stages. First, fair
values of the various tangible assets and liabilities, and those intangible assets, which can be
ascertained separately from goodwill, should be determined. After these amounts have been
provided for, the remainder of the acquisition cost is recognized as goodwill.
It is necessary to carefully identify and determine the value of intangible assets, which can be
recognized apart from goodwill. Although no separate value can be assigned to the workforce or
management team, intangible assets that can be recognized include:
• Intangible assets that arise from contractual or other legal rights, regardless of whether
the asset is transferable or separable from the acquired enterprise or from other rights
and obligations. This category of asset would include the legal rights associated with
leases, licences, and other items of that nature, as well as legally protected trademarks
and brand names.

• Intangible assets that are not legal or contractual rights but which are capable of being
separated or divided from the acquired enterprise and sold, transferred, licensed, rented,
or exchanged, whether or not it was the intent of management to perform any of these
actions and even when these assets are linked to particular tangible assets. This
category would include the network of dealerships, where individual locations or
territories could be sold separately. It would also include the customer lists such as the
proprietary credit cards and the home heating business household addresses, as well as
the related customer contracts and service agreements.
Estimates of fair value for these items should be based on the best information available,
including prices for similar items, independent appraisals, and the results of other valuation
techniques. Valuation techniques used would be consistent with the objective of measuring fair
value, and may include such approaches as earnings or revenues multiples and present value
techniques. Individual values for many of these intangible assets (such as individual retail
locations) may be difficult to determine, and would not be necessary for financial reporting
purposes. However, if the disposition of any part of any assets were contemplated, an allocation
of cost to this level of detail would be required to determine the gain or loss on disposition.
The amount to be assigned to goodwill is the residual value of all items which cannot be
separately identified and measured under the criteria suggested above, including the value of
the human resources of the acquired company. In short, the amount assigned to goodwill is the
total value of the acquisition, less all amounts that can be assigned to identifiable tangible and
intangible assets and liabilities, after those values have been objectively determined on the
basis of the best information available. Goodwill cannot be independently determined.
Subsequent to the date of acquisition, the intangible assets should be accounted for as follows:
• An intangible asset is not written down or written off in the period of acquisition, unless it
becomes impaired during this period.
• A recognized intangible asset should be amortized over its useful life to an enterprise,
unless the life is determined to be indefinite. When an intangible asset is determined to
have an indefinite useful life, it should not be amortized until its life is determined to be
no longer indefinite.

• The amortization method and estimate of the useful life of an intangible asset should be
reviewed annually. An intangible asset that is subject to amortization should be tested
for impairment in accordance with IAS 36. (That is, when the carrying amount exceeds
its recoverable amount, the excess should be charged to income.)
• An intangible asset that is not subject to amortization should be tested for impairment
annually, or more frequently if events or changes in circumstances indicate that the
asset might be impaired. The impairment test should consist of a comparison of the
asset’s recoverable amount with its carrying amount. When the carrying amount of the
intangible asset exceeds its recoverable amount, an impairment loss should be
recognized in an amount equal to the excess.
• Goodwill should be recognized on an enterprise's balance sheet at the amount initially

recognized, less any subsequent write-down for impairment.
Case 5-3
Memo to: Board of Directors of GIL
From: CA
Subject: Financial Accounting & Reporting Policies
As requested, I have prepared a report recommending appropriate accounting and reporting

policies related to GIL’s November 30, Year 3 financial statements.
Users and Needs
In determining appropriate accounting policies for GIL, I considered the users of GIL’s financial
statements and their information needs. There are many users, with varied and often conflicting
information needs. Accordingly, I have had to make assumptions when ranking the users in
order to determine the most appropriate policies.
The users of GIL’s financial statements are as follows:
• The bank will be concerned about liquidity and its security. Cash flow and current value
information would be useful for this purpose.

• Sam and Ida Growth will be concerned that the valuation of GIL’s net assets are
calculated fairly so that the redemption value of their preferred shares is fair. They will
also want information to evaluate the performance of GIL’s management since they still
have voting control.
• The common shareholders, the Growth children and Mario Thibeault, will be interested
in evaluating management’s performance and the performance of GIL’s investments.
Current value information is necessary for this purpose.
• The senior management of GIL will want to maximize income since it receives a bonus
based on net income.
• CRA requires historical cost information on realized gains and losses to assess income
taxes.
In my view, the most important users are Sam and Ida Growth, the preferred shareholders
because they have the most at stake in the company and could redeem their shares at any time
for fair value of GIL at November 30, Year 3. Thus, accounting policies have been chosen to
meet Sam and Ida’s objective of receiving a fair redemption value for their preferred shares and
of evaluating management. The valuation of the redemption creates a conflict. The common
shareholders will want the redemption value of the preferred shares to be as low as possible
while Sam and Ida will want the value to be high to maximize their cash flows when they
redeem their shares.
To satisfy the information needs of Sam and Ida for a one-time revaluation of the net assets of
GIL at November 30, Year 3, a special purpose balance sheet should be prepared. The
balance sheet will report all assets and liabilities at fair value. This will determine the
redemption value of, and the value assigned to, the preferred shares. The old common shares
will be cancelled. The new common shares will be valued at $400, the cash received on
issuance of these new shares.
The special purpose balance sheet will not comply with generally accepted accounting policies
(GGAP) because GAAP only allows for a comprehensive revaluation of net assets when there
has been a change in control. Since Sam and Ida controlled GIL both before and after the
reorganization, there has not been a change in control.
To satisfy the information needs of the other users for Year 3 and subsequent years, general

purpose financial statements should be prepared in accordance with ASPE. The net assets of
GIL will be retained at their carrying value. Accordingly, the value assigned to the preferred
shares will be equal to the carrying value of the common shareholders’ equity prior to the
reorganization. The new common shares will be valued at $400, the cash received on issuance
of these new shares.
In the ensuing discussion, I will indicate the accounting and reporting requirements for both the
special purpose balance sheet and the general-purpose financial statements.
Special Purpose Balance Sheet
The special purpose balance sheet will show the fair value of Sam and Ida preferred shares at
the date of the reorganization. This value will be used as the base for future dividend
distribution. This balance sheet will not be updated on an annual basis.
Fair value is defined in IFRS 13: Fair Value Measurement as the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between market participants at
the measurement date (i.e. an exit price). It would reflect the highest and best use for the asset.
The various properties should be valued at appraised value regardless of whether the appraised
value is higher or lower than carrying value. The non-interest bearing note receivable should be
discounted at current market rates to reflect the true value. Assuming an interest rate of 10%
(based on current five-year mortgage interest rates), the present value of the receivable is
$1,895,000 (500,000 x 3.79).
GIL’s outstanding debt bears varying interest rates. These liabilities should also be discounted
at current market rates to reflect their true value.
In revaluing the assets and liabilities of GIL, we must consider the tax effects of the revaluation.
Selling costs should be deducted in determining the fair value of these assets and liabilities.
Then, future income taxes should be set up to reflect the tax that would be payable or
receivable if these assets and liabilities were sold or paid off at their fair value.
There would be no benefit in capitalizing the real estate taxes and interest on the debt incurred
to finance the raw land purchases since the land is being revalued to its fair value. If these
costs were capitalized, the land would be reported at a value in excess of its fair value.
A professional appraiser should appraise the apartment building that is planned to be converted
to a condominium. The appraised value should reflect the likelihood of conversion and the
potential profits from the conversion.
GIL should record the benefits of the low lease payments ($100,000 versus $220,000 per year)
as an asset at the time of reorganization because the new shareholders will benefit from the
leasing decision made by the previous owners. Using a discount rate of 10% for 14 years, the
remaining term of the lease, the reduced payments have a value of $884,400 (120,000 x 7.37).
The investment in the joint venture should be valued at fair value by valuing the net assets
owned by the joint venture at fair value and multiplying by GIL’s 50% interest.
The likely amount of contingent consideration to be received from the sale of the office building
should be included in the redemption value of the shares since the decision to sell the building
was made by Sam and Ida.
General Purpose Financial Statements
The general-purpose financial statements will be prepared in accordance with ASPE and will be
prepared on an annual basis. Unless otherwise noted below, the assets and liabilities of GIL
will not be revalued to fair value on the date of the reorganization.
The non-interest bearing note receivable should be valued at $1,895,000, as calculated above,
on the date of the sale of the building. The difference between the face value and the present
value of the note, $605,000, represents deferred interest revenue. It should be reported as a
deferred credit on the balance sheet and amortized into income over the five-year term of the
receivable. The $605,000 of interest revenue will reduce the amount of gross profit recognized
on the sale. Only $500,000 of the note receivable should be reported as a current asset. The
remainder should be reported as a long-term asset.
The real estate taxes and interest on debt incurred to finance the raw land purchase should be
added to the cost of the land. These are costs of getting the land ready for sale or ready for
use. These costs will be recovered through future sales.
The increase in value of the building due to conversion to condominium status will not be
reflected in the financial statement on conversion. The gain will be reported if and when the
building is sold.
GIL should report a gain as a result of the sale to the joint venture partner of one-half of its
interest in the land on which the shopping center is being built as this portion was deemed to be
sold to an arm’s length party.
GIL has an accounting policy choice to report its investment in the joint venture using the cost
method, equity method or proportionate consolidation. The equity method or proportionate
consolidation both reflect GIL’s share of the income in the joint venture as the income is earned
by the joint venture. The cost method is easier to account for but doesn’t reflect income until it is
received as a dividend from the joint venture. The details of the joint venture arrangement
should be disclosed including its significant commitment to the construction company.
The sales agreement for the office building contains a contingent fee clause. Any additional
sums received are really a part of the selling price of the building. These additional amounts
should be added to the selling price once they are measurable. Since new leases have already
been signed, no uncertainty exists regarding at least a portion of the contingent consideration.
GIL is currently using the same depreciation rates and methods for tax purposes and
accounting purposes. However, the rates used for tax purposes do not necessarily reflect the
true economic lives of the assets. GIL should review all its depreciation rates and ensure that
they properly represent the actual usage of the assets over time.
According to paragraph .23 of section 3856 of Part II in the CICA Handbook, an entity that
issues preferred shares in a tax planning arrangement should present the shares at par, stated
or assigned value as a separate line item in the equity section of the balance sheet, with a
suitable description indicating that they are redeemable at the option of the holder. When
redemption is demanded, the issuer shall reclassify the shares as liabilities and measure them
at the redemption amount. Any adjustment shall be recognized in retained earnings. Extensive
note disclosure will be required of the share exchange and the conditions of the preferred share
issue.

(CICA adapted)
Case 5-4
REPORT ON MANAGEMENT ASSISTANCE AT TOTAL PROTECTION LIMITED
We have been engaged to provide you with recommendations that will assist you in managing
Total Protection Limited (TPL or the Company) profitably on a long-term basis. The key
decisions that TPL will be making concern pricing, cost control, and cash management and
investment. Our report offers advice intended to assist the Company with these decisions, as
they are the determinants of future profitability.
(Candidates were expected to identify the key decision needs facing this company. Few
candidates did this.)
Pricing
There appears to be no rationale for pricing other than charging what the market will bear. It is
important to set prices for each builder that will more than offset the costs of warranty repairs
and price guarantees if long-term profitability is to be achieved. The attached accounting
policies report discusses the problems with estimating warranty costs, so the discussion is not
repeated here.
I have done an analysis of warranty revenues and costs by builder (see Appendix I). No undue
reliance should be placed on the data, given the condition of the Company's records. However,
some problems seem apparent:
1. The prices being charged for the warranties and repair costs incurred vary widely among
the builders.
2. Warranty revenues charged by Kings Road and Safe-Way Builders are low in
comparison to those of the other builders and are unlikely to cover future warranty costs.
3. Repair costs bear no relationship to the price of the warranties. Not surprisingly,
warranties for houses built by the companies using lower cost materials are experiencing
higher repair cost claims. These builders are also charging only the minimum amount for
the upfront fees.
4. Safe-Way has the highest repair cost per warranty sold of the shareholder participants
and is, therefore, probably the least qualified to do the warranty repairs.
5. Kings Road has the smallest margin between cost and revenues and given the length of
the warranty, its costs will soon exceed its revenues.
6. Repair costs based on experience to date are highest for the builders that are not
shareholders in the Company, and they may be using the warranties to increase their
own profits.
All these problems suggest that a major overhaul of the pricing structure is in order to allow
flexibility for homes of different quality. Although the current commission structure helps
maximize the price that is received for the warranties sold, it does not motivate the builders to
minimize the repair costs incurred as a result of using lower quality materials.
The minimum premiums for Kings Road, Safe-Way Builders, and the other builders will all have
to be increased substantially to cover repair costs adequately and ensure fairness to all
shareholder participants in the Company. At present, the better-quality builders are subsidizing
the lower-quality builders. Perhaps a large deductible should be imposed on each repair claim
to reduce the amount of this differential, or some other variation of pricing structure should be
considered that relates price to cost history.
Larkview, Towne and Granite have sold warranties at reasonably high prices and have relatively
low repair costs, perhaps as a result of the higher-quality construction they undertake. Little
change in their pricing structure is needed at this time for these builders.
(Candidates were expected to identify the pricing problem and recognize that it was a critical
issue for long-term profitability. Marks were heavily awarded for interpretation of quantitative
analysis. No marks were awarded to candidates who performed the quantitative analysis but did
not use it in their responses.)
(Candidates recognized the need for a better internal control system but failed to identify the
pricing problem as the critical issue for long-term profitability. Failing to charge an adequate
amount for the warranties will lead to the ultimate failure of the business as warranty costs are
incurred.)
Cost control of warranty work
Safe-Way Builders are currently performing all the repair work on warranties. There is a problem
in having any shareholder solely responsible for the repair work. The motivation for any builder
will be to maximize the price of the repair work in order to increase its own profits. TPL should
therefore institute certain controls to ensure that all repair work performed is in fact required and
that it is performed at the best price to TPL.
Standards should be developed for hourly rates and the number of hours required for the
various types of repairs.
An approval process for repairs should be introduced whereby another shareholder must
approve the warranty work of a given builder. A system of reporting should also be
implemented, requiring TPL to report the various repair claims it undertakes to each of the
shareholders and to include an analysis of the variances from standard,
Hiring independent staff and increasing the segregation of duties in the Company may help
improve controls over warranty claims and will reduce the need for involvement by the
shareholders in the future.
(Candidates were expected to provide recommendations to resolve the cost control and conflict-
of-interest problems. Candidates could have considered other recommendations.)
(Candidates failed to recognize the need to control work performed by Safe-Way. Most
candidates did not identify the conflict-of-interest position that Safe-Way is in.)
Cash management and investment
As warranty costs are usually incurred in the future while the warranty revenue (initial fee) is
received currently, TPL will always have excess cash balances that must be invested.
Investments in low risk government/corporate bonds and other investments typically used for
trusts would be the most appropriate. A cash budget should be completed, and the terms to
maturity of such investments should coincide with the requirements identified in the cash
budgets. A large portion of the investments should be highly liquid because the future cash
flows cannot be estimated with a high degree of certainty.
Real estate investments can be illiquid and risky in cyclical markets and should be avoided. The
acquisition of the local construction company was probably not a good idea at this time because
you are likely going to need the cash for warranty work in the near future. You should seriously
consider divesting of this investment unless you need the construction company to carry out the
warranty work.
Dividends should not be declared and management fees should not be charged by the
participants until the Company has more experience with warranty repair claims.
(Candidates were expected to respond to the comments of the president of Safe-Way regarding

the disposition of excess cash balances. The recommendations given above are not exhaustive;
however, candidates should have addressed liquidity of the investments and timing of cash
flows.)
(Candidates generally recognized the need to maintain some amount of short-term investments
in order to meet repair costs as they become due.)
REPORT ON ACCOUNTING POLICIES
There are a number of users of the financial statements of TPL, each with different interests:
1. The shareholders/builders will use the financial statements to assess the profitability of the
Company and to determine what cash, if any, should be distributed.
2. Safe-Way will calculate its royalties on the basis of the revenue-recognition policies adopted
by the Company.
3. Customers may use the statements to determine the liquidity and viability of the Company
before purchasing a warranty.
4. Other builders may rely on the statements before participating in the warranty programs.
Their reputations are at stake.
5. The government may use the statements as part of its review of the Company's operations
from time to time.
(The selection of accounting policies cannot be done in a vacuum. Candidates had to recognize
the different users of the financial statements and their information needs in determining the
usefulness of the accounting policies selected.)
(Candidates recognized the needs of the owners and, in particular, Safe-Way.)
Accordingly, policies for accruals of future warranty costs will be of great importance to all the
users and will affect the long-term viability of TPL. Given the number of users and high levels of
assurance each requires, statements should be prepared in accordance with generally accepted
accounting principles, with the appropriate disclosures.
Since TPL is a private company, it can choose to use IFRSs or ASPE. Assuming that the five
shareholders are also private companies and assuming that they all use ASPE, it would be
appropriate for TPL to also use ASPE.
The most significant accounting policies that must be developed are for warranty liabilities and
expenses, revenue recognition and business combinations.
Matching the revenues and expenses is the critical issue because the largest portion of cash
from warranty sales is received up front and expenditures will be made on warranty repairs
unevenly over the following ten years.
To the extent that cash reserves are in place to meet future contingencies, interest will be
earned on those funds. Policies should be re-evaluated from year to year according to repair
experience and potential increases in reserves from investment income.
Warranty liabilities and expenses
Future warranty expenses are difficult to estimate because few warranties of 10 years have
been offered in the marketplace. Accordingly, data on repair history for warranties longer than
one year are not available in the industry. Further complicating estimations is the fact that new
builders do not use materials and construction techniques of identical quality, and there are no
controls over the builders participating in the plan.
The market-decline provision due to faulty construction is unique in this industry, so no

comparable information is available to determine the extent of the risk arising from this
coverage.
Despite the problems with warranty cost estimation, an attempt must be made to quantify the
estimated future liability by reviewing the repair history of each builder participating in the plan
and the nature of the repairs incurred to date. Otherwise, revenue cannot be recognized until
the end of the warranty period.
Historical repair data from each builder should be reviewed to properly estimate the current
portion of the warranty liability at the balance-sheet date. This is particularly important in light of
the Company's liquidity objective.
(Candidates were expected to recognize that the uncertainty of the warranty liability was the
critical element affecting the choice of financial accounting policies.)
(Many candidates failed to recognize the necessity of estimating the warranty liability in order to
recognize any revenue.)
Revenue recognition
Revenue can be recognized in several ways:

1. Recognize all revenues from warranties sold, including discounted maintenance payments
(at the time the contract is signed).
This method is appropriate if the total warranty costs can be estimated and if the collection of all
maintenance fees is assured. The method provides information to the shareholders and other
users on the expected profitability from yearly sales. It is unlikely that the estimations required
by this method can be made with sufficient certainty.
2. Defer all revenues until the end of the warranty period (year ten).
This method is the most conservative and implicitly recognizes that warranty cost estimation is
impossible and that income should, therefore, not be recognized until the critical event takes
place - that is, the expiration of the warranty period. Thus, revenues could be recognized only to
the extent that costs were incurred.
This method is of limited usefulness to the shareholders because profitability is not assessed
(although regulators would likely be most satisfied with this treatment because of its
conservative nature).
3. Recognize the initial warranty fee and annual maintenance fees on a cash basis.
A percentage of total warranty costs is expensed in the same proportion as the income
recognized. The problems with estimating total warranty costs have been discussed previously.
Using the cash basis of revenue recognition avoids the problem of estimating the collection of
future maintenance fees.
This method provides the shareholders with information on cash flows and estimated future
liabilities that are required to determine dividend payments.
4. Recognize revenues on a percentage-of-completion basis, based on estimated warranty

expenditures throughout the ten-year warranty period.
This is similar to the previous method except that warranty costs drive revenue recognition.
Warranty-cost estimation is still very subjective and is not an appropriate basis on which to
recognize revenue.
5. Amortize the initial payment received for the warranties equally over the ten-year life and
recognize maintenance fees as received.
This method assumes that the initial fee represents the present value of future cash flows.
Again, warranty expenses must still be estimated and are unlikely to be incurred equally
throughout the life of the warranty, resulting in a mismatch of revenues and expenses in most
years.
(Candidates were not expected to discuss all these methods but should nevertheless have
presented some alternative accounting treatments.)
I recommend recognizing revenues and expenses on a cash basis because this method
recognizes the reality of warranties for homes (i.e. that the majority of claims will occur in the
first two years). If there is a problem with construction, it is much more likely to become
apparent in the first year than in later years. The cash method recognizes more revenues and
expenses in the first year, and the maintenance payments should cover repairs that may be
made in subsequent periods.
(Some assumptions have been made here. Candidates could have made other
recommendations as long as they were supported by the analysis they presented.)
(Candidates covered the revenue-recognition alternatives adequately. However, candidates

generally discussed the initial fee and maintenance fees in isolation rather than considering
revenues in total and therefore the allocation of total revenues over the entire warranty period.)
Business combinations
By purchasing 100% of the shares of Gainery Construction Ltd. (Gainery), TPL has obtained
control over Gainery. Under ASPE, TPL can report its investment in Gainery on a consolidated
basis or by using the cost method or equity method. The cost method is the simplest but only
reports income as dividends are received. Given that Gainery probably needs its cash for
operating purposes, it may be more meaningful to use the equity method or consolidation
method. Both methods will report the same amount of income. As indicated in Appendix II, the
amount paid by TPL for Gainery appears to be less than the fair value of the identifiable net
assets. You will need to verify that these fair values are realistic. If they are realistic, then TPL
could report a gain on purchase in the amount of $280,868 on the consolidated income
statement for Year 1. However, when the homes under construction and undeveloped land are
sold, the acquisition differential for these assets will have to be expensed. This will reduce the
gains reported on the consolidated income statement. The acquisition differential pertaining to
the equipment should be amortized over the life of the equipment. This will reduce depreciation
expense reported on the consolidated income statement.
Other accounting issues

Commission expense should be recognized on the same basis as the revenue-recognition
policy selected. To the extent that cash commission payments differ from the expense recorded,
prepaid commissions will be recorded on the balance sheet.
The repairs and rent charged by Safe-Way to TPL and the royalties received by Safe-Way from
the Company are related party transactions. Details of these transactions must be fully
disclosed in the financial statements.
APPENDIX I
Warranty Revenues and Repair Costs*
Larkview Towne Granite Kings Safe-Way Others Total
Number of warranties 50 85 190 250 175 465 1,215
Warranty revenue $120,000 $165,000 $395,000 $90,000 $160,000 $705,000

$1,635,000
Per warranty 2,400 1,941 2,079 360 914 1,516 1,346
Repair costs 6,000 9,000 21,000 42,000 39,000 107,000 224,000
Per warranty 120 106 111 168 223 230 184
* Readers should be cautioned that these figures have not been independently verified.
APPENDIX II
Determination and Allocation of Acquisition cost
Present value of amounts paid to Mr. Gainery (Note 1) $1,391,632
Less: amount attributable to consulting services provided by Mr. Gainery (Note 2) (22,500)
Amount paid for acquisition of shares of Gainery 1,369,132
Fair value of identifiable net assets (4,120,000 – 2,470,000) 1,650,000
Gain on purchase $ 280,868
Notes:
1. Assuming an incremental borrowing rate of 8%, annuity of $500,000 per year for 3
years.
2. Assuming that consulting services are worth $50 per hour: $50 x (300 + 150)
Case 5-5
(a)
It appears that Mr. Slim is trying to hide profits of the hockey operations by funnelling the profits
of the Stadium through a separate company and not disclosing the results of the Stadium’s
operations as part of the salary negotiations. Furthermore, the price for the use of the Stadium
may be inflated to transfer profits from the Club to the Stadium.
Since the Club owns 90% of the Stadium, it controls the Stadium and it would normally prepare
consolidated financial statements to present the financial situation for the combined economic
entity. Furthermore, since the Stadium is used primarily by the Oilers, it would be appropriate to
incorporate the Club’s share of the Stadium’s income when considering the Club’s ability to pay
increased salaries to the players.
The consolidated income statement for the Club would appear as follows:
Revenues
Tickets $3,000,000
Concessions 1,200,000
Parking 100,000
Total revenues 4,300,000
Expenses
Cost of concessions 400,000
Player salaries 600,000
Staff salaries 1,200,000
Depreciation of stadium 500,000
Advertising 200,000
Total expenses 2,800,000
Net income $1,400,000
Attributable to:
Shareholders of the Club $1,220,000
Non-controlling interest (10% x 1,800,000) 180,000
$1,400,000
The consolidated net income attributable to the shareholders of the Club of $1,220,000 presents
a much different situation than the net loss of $400,000 presented by the Club on its separate
entity income statement. The consolidated financial statement is the more relevant figure as it
presents the overall picture of the hockey operations.
To determine what a fair salary increase is for the players, the following additional information is
required:
• What did the owner pay for the Club and what is a fair return on this investment?
• What was the cost of the Stadium and over what period is the Stadium being amortized?
• Who owns the other 10% of the Stadium and what is the relationship to Mr. Slim?
• How much of the staff salaries are paid to Mr. Slim and parties related to Mr. Slim?
If Mr. Slim were not willing to provide answers to these questions, it would be very difficult to
determine a fair salary. It would create a lack of trust in his leadership and could have negative
impacts on the players’ willingness to perform at a high level for the team.
(b)
Since Mr. Slim owns the Stadium, GAAP would not require that consolidated financial
statements be prepared for the Club and the Stadium since the Club does not control the
Stadium. Since the Club has no financial interest in the Stadium, one could argue that the
employees and players of the Club should not expect to share in any of the profits earned by the
Stadium. However, employees and players of the Club would expect that a fair price be paid for
use of the Stadium. If the Stadium were owned by a non-related party, a fair price would likely
be negotiated between the Club and the Stadium.
Since the Club and Stadium are both owned by Mr. Slim, these two companies are related. Any
transactions between the two companies can be used to manipulate the profits of the individual
companies. To ensure that a fair salary is paid by the owners, I would want to determine
whether the price paid for the use of the Stadium is fair. To make this determination, I would
like to see the financial statements for the Stadium and get answers to questions presented in
(a) above.

Case 6
MEMO TO PARTNER
Memo to: Partner

From: CA
Subject: Share-redemption price, Gerry's Fabrics Ltd.
My initial assessment of the Preferred Share Agreement (the Agreement), suggests that the
policies listed lean towards recognizing revenue as early as possible while also delaying
recognition of expenses as long as possible. Therefore, in reviewing the policies used in Year
5 we must ensure that they conform to the policies specified in the Agreement or are
consistent with the intent of the Agreement (Clause 1). Further, parties to the Agreement had
reason to assume that policies in effect in Year 1 (when the Agreement was signed) but not
specifically referred to in the Agreement would remain the same.
One point to note is that the figure for income before tax of $895,420 is unaudited and was
prepared by the vice-president of finance of GFL. The validity of this figure will need to be
established before a share-redemption price is calculated.
It appears from a review of the disputed items that GFL has been trying to minimize its
revenues and maximize its expenses. This bias is understandable since it is in GFL's best
interests to minimize the amount it has to pay the shareholder. The preferred shareholder had
to notify GFL by January Year 5 of his intention to redeem his shares. After this date, GFL
entered into transactions and changed certain policies; these actions tend to confirm a bias on
GFL's part since they lower the redemption price.
The above factors will need to be taken into consideration when determining the share-
redemption price.
ANALYSIS OF TRANSACTIONS
J. Ltd.

Allocating the difference between acquisition cost and carrying amount to goodwill may not
conform to the Agreement if other assets should have been debited instead. Identifiable assets
and liabilities acquired should have been recorded at their fair values at the time of acquisition.
By choosing to debit goodwill instead of debiting the appropriate asset, GFL may or may not
achieve a low-income figure for Year 5. For example, if GFL had debited an asset such as
inventory in Year 4, the inventory would have been expensed in Year 4. In turn, the Year 5
income figure would have been higher because it would not contain the amortization of
goodwill or the cost of goods sold. Conversely, if GFL had debited a larger amount to an asset
that was not sold until Year 5, the fair value excess would be expensed in Year 5. The fair
value excess would likely have been higher than the amortization of goodwill, which would
cause a lower income than what was reported. Similarly, if GFL had assigned a value greater
than carrying amount to an asset with a physical life of more than 10 years, income would be
higher than what was reported since the amortization on the capital asset would be less than
the amortization of the goodwill. Overall, the value of each asset and liability will have to be
examined to determine whether the correct amount was recorded initially. If adjustments are
needed the share-redemption price will be affected.
Even though the Agreement does not refer to intangible assets, Clause C can be used for
guidance on the goodwill component of the purchase (whether the goodwill figure is changed
or not). Clause C refers, however, to the physical life of an asset, and an intangible asset by
definition, does not have a physical life. Although the Agreement specifies that physical life be
used regardless of the useful life of the asset, perhaps in this instance the use of useful life can
be justified.
Goodwill should not be amortized on an annual basis. Instead, it should only be written down if
there is impairment. Furthermore, only the impairment for Year 5 should be reported in Year 5.
Impairment tests will have to be performed at the end of Year 4 and end of Year 5 to determine
the amount of impairment for Year 5.
Goodwill is impaired when the recoverable amount is less than carrying amount. Recoverable
amount is the higher of fair value less costs of disposal and value in use, which is defined as
the present value of future cash flows. J Ltd. does not need to use fair value because the value
in use is higher than fair value. An impairment loss must be reported because the value in use
is less than carrying amount. The amount of the impairment is dependent on whether the
discount rate is 6 percent or 3 percent. 6 percent would be most appropriate because it reflects
J Ltd.’s borrowing rate. At 6 percent, the impairment loss would be $0.9 million and the overall
loss for the year would be $0.8 million.
If the assumed debt pushes GFL's debt-to-equity ratio beyond the 1: 1 ratio required under
Clause E, then additional interest above the ratio should be added back to income for the
purpose of calculating the share-redemption price.
Volume discounts
One could argue that since Clause A2 prohibits the setting up of an allowance for returns, no
allowance should be set up for volume discounts. Or, it could be argued that a discount is
similar to an adjustment and, therefore, should be recorded in the year to which it relates, in
accordance with Clause F. Accordingly, if the volume to which the discount applies was to be
reached after year-end, it can be argued that it should not be accrued. On the other hand, if the
volume to which the discount applies is reached before year-end, then the discount should be
accrued. More information is needed to determine how to account for the discount, but the
intent of the agreement to delay expenses suggests that the discount should not be accrued.
Standard costing
Standard costing variances are not specifically mentioned in the Agreement, but expensing all
variances seems inconsistent with its intent. The variance allocation likely does not result in
inventory being costed with its full share of all designated overhead expenditures as required in
Clause B1. Since the current policy was introduced in Year 4, it is possible that income reflects
the actual costs of the inventory, but only if opening and closing inventories were constant.
Inventory, and hence cost of goods sold, should be adjusted to reflect the actual production
costs; no adjustment may be necessary if Year 4 variances offset Year 5 variances.
Incentives
Compensation is to be in accordance with levels used in Year 1 adjusted by the Consumer

Price Index (CPI), under Clause G. It is reasonable to assume that incentives form part of
compensation.
GFL must determine the average compensation per employee at Year 1 and adjust it
according to the CPI. This figure should then be multiplied by the number of employees to
determine how much compensation can be charged for the year.
Changing investment from equity to cost
The cost method recognizes dividends that GFL receives as income whereas the equity
method recognizes GFL's share (based on its percentage ownership) of the investment’s
earnings. The change in policy from equity to cost could be an attempt by GFL to manipulate
net income if dividends were low compared to its proportional share of earnings. This
manipulation could have an even greater effect if GFL can influence the amount of dividends
distributed during GFL's Year 5 fiscal year.
The equity method reflects Clause F better than the cost method since the adjustment under
the equity method causes an increase in the carrying amount on GFL's books and is closer to
the change in the value of the investment.
If GFL owned the investment in Year 1, we should determine how it was accounted for then,
since that was what was expected at the time the Agreement was signed. We should also
investigate whether there have been any significant changes in the investment since Year 1
that warrant changing the accounting method used.
New plant costs
Clause D1 states that expenditures should be capitalized as assets unless their useful life is
limited to the current financial period. Accordingly, all costs of constructing the plant should be
capitalized. These construction costs are necessary for the long-term operations of a plant,
and thus their useful life is longer than one year. Further, although it is difficult to state exactly
when construction has been completed, it is hard to justify calling it completed just because
some form of manufacturing began. It would seem that both parties are satisfied with
capitalizing construction costs since GFL did capitalize the costs until manufacturing activities
began. In this case, capitalizing costs until economic production levels are attainable is
reasonable i.e., until the plant is able to produce what it was built to produce.
From a procedural standpoint, we need to assess how much manufacturing occurred in

relation to what the manufacturing capacity will be when the plant is completed. It can be
argued that the proportion related to the area completed should be expensed and the rest
capitalized as construction costs.
On the other side of this issue is revenue recognition. It would make sense to argue that
revenue recognition should be delayed while costs are still being capitalized since there is no
expense to offset revenue. The Agreement, however, recognizes revenue up-front (Clause A –
when production is completed or items are shipped). If revenue is recognized up-front,
perhaps expenses associated with the production should be accrued.
It would be useful to determine which expenditures create future income since we could then
infer that the life of those expenditures was greater than one year. If any expenditure can be
shown to benefit GFL over a period longer than the Year 5 fiscal period, they should be
capitalized and amortized over their useful life, regardless of whether manufacturing activity
has begun. Some amortization should occur in the period related to the space that was used
for production.
Land for development
If the land can legitimately be considered inventory, Clause B of the Agreement should be
followed. Clause B does not mention writing down the asset; it specifies only that all
expenditures needed to make the inventory available for use must be included. If the land was
unjustifiably reclassified as inventory, Clause D applies, since there was no change in GFL's
handling of the property. Clause D states that assets should be recorded at cost; like Clause B,
Clause D does not refer to writing down an asset's value.
If a write down can be justified under Clause F (all changes in value should be attributed to
the year to which the error or adjustment relates), then only the decline in value that occurred
in Year 5 should be charged against income of the period. There should be a write down only
if the decline in value is felt to be permanent. However, only the change in value during Year
5 should be charged to income in Year 5.
Deferred payment on capital asset sale
Regular sales are not recognized on a cash basis for purposes of the Agreement but rather
when inventory is shipped (Clause A). The only reason for deferring recognition of the income
from the sale of assets might be the possibility that the purchaser will not pay. However, in
Clause A2 the Agreement specifically states that no allowances should be made for returned
merchandise. If the same line of reasoning is followed, then no allowance for uncollectible
amounts should be set up. Therefore, the full gain on the sale of the asset should be recorded
for the benefit of the preferred shareholder.
It could be counter-argued that selling of property, plant and equipment does not fall under
Clause, A which deals with revenue from the sale of inventory. If so, then the intent of the
Agreement to recognize revenue early and delay expenses becomes applicable. Thus the
previous recommendation still applies.
The deferral of payment (and hence deferral of revenue recognition) may be a deliberate
attempt on the part of GFL to decrease income. The deal was entered into in March, at which
time GFL would have known that the shareholder was cashing in his preferred shares based
on the financial statements of fiscal Year 5.
New pension benefits
Pension benefits are probably considered part of compensation and hence should be
measured as prescribed in Clause G. If these pension benefits are not considered part of
compensation, then we must determine what basis was used for determining the charges that
were made against income. Actuarial reports may contain some of this information.
If the costs relate to past service, then the expense should be charged to the year that it
relates to (Clause F of the Agreement). However, Clause F could also be interpreted to mean
that since the adjustment in pension was made in Year 5, the increase in expenses should be
charged to Year 5.
DGR transactions
Sales to DGR must be recorded at fair value since it is a related party, in accordance with
Clause G of the Agreement. An adjustment would increase the redemption price by $475,000
($380,000 x 1.25).

Accrual of legal fees
Under Clause F of the Agreement, legal costs should be applied to the year in which the patent
infringement occurred. We must examine legal documentation to find out when the infringement
occurred.
Another question is whether Clause F will apply if in the future there is an award (fine) in the
case. If the answer is yes, then a recalculation will need to be made at that time.
CONCLUSION
It is evident from the preceding analysis that some of the accounting policies used in GFL's
March 31, Year 5 financial statements do not comply with the Agreement. Policies that have
changed since the Agreement was signed to accommodate operational changes do not lead to
suspicions about GFL's intent. However, when circumstances have not changed, GFL's sole
reason for making the change may have been to lower the redemption price.
SOLUTIONS TO PROBLEMS
Problem 5-1
(a)
Net income Pill – Year 1 (cost method) 25,000
Less: Dividends from Sill (85%  9,000) 7,650
17,350
Net income of Sill – Year 1 40,000
Less: Goodwill impairment loss 1,500
38,500
85% 32,725
Consolidated net income attributable to Pill’s shareholders – Year 1 50,075
(b)
Consolidated net income attributable to non-controlling interests – Year 1
[15%  (40,000 – 1,500)] 5,775

(c)
Investment in Sill – Dec. 31, Year 1 (cost method) 238,000
Income from Sill 32,725
270,725
Less: Dividends from Sill 7,650
Investment in Sill – Dec. 31, Year 1 - equity method 263,075
Problem 5-2
Cost of 75% investment 600,000
Implied cost of 100% investment 800,000
Carrying amount of Small’s net assets = Carrying amount of Small’s shareholders’ equity
Ordinary shares 400,000
Retained earnings 100,000
500,000
Acquisition differential – Jan. 1, Year 1 300,000
Allocated:
Inventory 40,000
Patents (70,000) (30,000)
Balance – goodwill 330,000
Balance Balance
Jan. 1 Amortization Dec. 31
Year 1 Yr 1 & 2 Year 3 Year 3
Inventory 40,000 40,000
Patents (70,000) (28,000) (14,000) (28,000)
Goodwill 330,000 0 19,300 310,700
300,000 12,000 5,300 282,700
PART A
Year 1 Year 2 Year 3
Investment in Small 600,000
Cash 600,000
Cash 18,750 7,500 30,000
Dividend income 18,750 7,500 30,000

PART B
(i) Goodwill 310,700
(ii) Small’s ordinary shares 400,000
Small’s retained earnings (100,000+80,000-25,000-35,000-10,000+90,000
-40,000) 160,000
560,000
Unamortized acquisition differential 282,700
842,700
NCI’s share (25%) 210,675
(iii) Large’s retained earnings 500,000
Small’s retained earnings (100,000+80,000-25,000-35,000
-10,000) 110,000
Small’s retained earnings, date of acquisition 100,000
Change since acquisition 10,000
Less: cumulative amortization of acquisition differential 12,000
Adjusted change since acquisition (2,000)
Large’s share (75%) (1,500)
Consolidated retained earnings 498,500
(iv) Large’s profit 200,000
Less: dividends from Small (40,000 x75%) (30,000)
170,000
Small’s profit 90,000
Less: amortization of acquisition differential 5,300
84,700
Large’s share (75%) 63,525
Consolidated profit attributable to Large’s shareholders 233,525
(v) NCI on income statement (84,700 x 25%) 21,175
PART C
(i) Year 1 Year 2 Year 3
Investment in Small 600,000
Cash 600,000
Investment in Small (75% x Small’s profit) 60,000 (26,250) 67,500
Investment income 60,000 (26,250) 67,500
Cash (75% x Small’s dividends) 18,750 7,500 30,000

Investment in Small 18,750 7,500 30,000
Investment income (75% x amortization of PD) 19,500 (10,500) 3,975
Investment in Small 19,500 (10,500) 3,975
(ii) Investment in Small under cost method 600,000

Small’s retained earnings, end of year 160,000
Small’s retained earnings, date of acquisition 100,000
42,700
Large’s share (75%) 32,025
Investment in Small under equity method 632,025
Problem 5-3
Carrying amount of Petite’s net assets = Carrying amount of Petite’s shareholders’ equity
Petite Common shares 35,000
60,000
Acquisition differential – Jan. 1, Year 2 60,000
Allocated:
Inventory 10,000
Equipment 20,000 30,000
Balance - goodwill 30,000
Non-controlling interest (30% x 120,000) 36,000 (1)
Balance Amortization Balance
Jan. 1 & Impairment Dec. 31
Year 2 Yrs 2 to 5 Year 6 Year 6
Inventory 10,000 10,000
Equipment 20,000 8,000 2,000 10,000
Goodwill 30,000 0 2,000 28,000
60,000 18,000 4,000 38,000

(a)
Inventory (150,000 + 80,000) 230,000
Equipment, net (326,000 + 160,000 + 10,000) 496,000
Goodwill 28,000
Gros’s retained earnings 270,000

Petite’s retained earnings 50,000
Petite’s retained earnings, date of acquisition 25,000
3,000
Gros’s share (70%) 2,100
Consolidated retained earnings 272,100
Non-controlling interest on balance sheet (Method 1)

Petite’s common shares 35,000
85,000
123,000
NCI’s share (30%) 36,900
Non-controlling interest on balance sheet (Method 2)

Non-controlling interest – date of acquisition (1) 36,000
Petite’s retained earnings, date of acquisition 25,000
3,000
NCI’s share (30%) 900
Non-controlling interest –December 31, Year 6 36,900
Cost of goods purchased (500,000 + 450,000) 950,000

Change in inventory (20,000 + 12,000) 32,000
Amortization expense (35,000 + 20,000 + 2,000) 57,000
Non-controlling interest on income statement

Petite’s net income 48,000
44,000
NCI’s share (30%) 13,200
Net income
Gros’s net income 90,000
Less: dividends from Petite (10,000 x 70%) (7,000)
83,000
Petite’s net income 48,000
44,000
Consolidated net income 127,000
Dividends paid 30,000

(b) If goodwill at December 31, Year 6 was $8,000 rather than $28,000, then:
(i) Consolidated net income attributable to Gros’ shareholders would decrease by $14,000
(70% x (28,000 – 8,000))
(ii) Consolidated retained earnings would decrease by $14,000 (70% x (28,000 – 8,000))
(iii) Non-controlling interest in net income would decrease by $6,000 (30% x (28,000 – 8,000))
Problem 5-4
(a)
Non-controlling interest 280,000/ (600,000+800,000) = 20%

Therefore Corner owns 80% of Brook.
(b)
Net income of Brook – Year 4 140,000
80%
112,000
Net loss of Corner – Year 4 60,000
Consolidated net income attributable to Corner’s shareholders – Year 4 52,000
(c)
Consolidated retained earnings – Dec. 31, Year 4 180,000
Consolidated net income – Year 4 52,000
Corner's retained earnings Dec. 31, Year 3 (equity) 128,000
(d)
640,000 / 80% is shareholders' equity of Brook 800,000
Common shares – Brook 600,000
Retained earnings – Brook – date of acquisition 200,000
Problem 5-5
Carrying amount of Silk’s net assets = Carrying amount of Silk’s shareholders’ equity
Silk Common shares 500,000
600,000
Acquisition differential – Dec. 31, Year 1 160,000
Allocated:
Inventory 70,000
Balance – patents 90,000
Non-controlling interest (15% x 760,000) 114,000 (a)
Balance Balance
Dec. 31 Amortization Dec. 31
Year 1 Year 2 Year 3 Year 3
Inventory 70,000 70,000
Patents 90,000 9,000 9,000 72,000
160,000 79,000 9,000 72,000
(a)
Non-controlling interest in profit
Year 2 15%  (30,000 – 79,000) - 7,350

Year 3 15%  (52,000 – 9,000) 6,450
(b)
Year 2 Year 3
Profit (loss) Pen 28,000 (45,000)
Dividends from Silk
Year 2 0
Year 3 (85%  15,000) (12,750)
28,000 (57,750)
Share of Silk’s profit
85%  (30,000 – 79,000) (41,650)
85%  (52,000 – 9,000) _ 36,550_
Consolidated profit (loss) attributable to Pen’s shareholders (13,650) (21,200)
(c)
Retained earnings Pen – Dec. 31, Year 3 (cost method) 91,000
Retained earnings Silk – Dec. 31, Year 3
(100,000 + 30,000 + 52,000 – 15,000) 167,000
Acquisition retained earnings 100,000
Increase since acquisition 67,000
Less: acq. diff. amort. to date (79,000 + 9,000) 88,000
Adjusted increase since acquisition - 21,000 (a)
85% - 17,850
Consolidated retained earnings – Dec. 31, Year 3 73,150
(d)
Method 1:
Silk – Common shares 500,000
Retained earnings Dec. 31, Year 3 167,000
667,000
739,000
15%
Non-controlling interest – Dec. 31, Year 3 110,850
Method 2:
Non-controlling interest – date of acquisition (a) 114,000
(100,000 + 30,000 + 52,000 – 15,000) 167,000
- 21,000
NCI’s share 15% - 3,150
(e)
Cost of investment 646,000
(100,000 + 30,000 + 52,000 – 15,000) 167,000
- 21,000
85% - 17,850
Invest. account – equity method as at Dec. 31, Year 3 628,150
(f)
See amortization schedule above.
Alternative calculation:
Invest. account – equity Dec. 31, Year 3 628,150

Implied value of 100% (628,150 / 85%) 739,000

Silk – Common shares 500,000
667,000
Balance unamortized acq. diff. – Patents 72,000
Problem 5-6
(a) Cherry’s Year 4 dividends were $40,000 (28,000 / 70%)
(b)Cherry’s Year 5 dividends were $50,000 (35,000 / 70%)
Therefore, the Year 5 reported profit of Cherry was $100,000 (50,000 / 50%)
(c) Investment in Cherry at Dec. 31, Year 6 (70% interest) 739,900

Imputed value of 100% 1,057,000
Non-controlling interests on consolidated
statement of financial position (30%) 317,100
Investment income for year 6 (70% share) 78,400

Imputed value of 100% 112,000
Non-controlling interests on consolidated income statement (30%) 33,600
(d) Cost of 70% investment 651,000

Implied value of 100% investment 930,000
Carrying amount of Cherry’s shareholders’ equity, Jan. 1, Year 4 900,000
Acquisition differential 30,000
Allocated (FV – CA) –0–
Goodwill at acquisition 30,000
Because the entire acquisition differential was recognized as goodwill, and because we know
the equity method balance in the investment account as at December 31, Year 6 we can use it
to calculate goodwill on that date as follows:
Investment account Dec. 31, Year 6 (equity) 739,900
Imputed value of 100% carrying amount of investment 1,057,000
Shareholders’ equity — Cherry
Balance, January 1, Year 4 900,000
Less: dividends for Years 4 to 6
(28,000 + 35,000 + 42,000) / 70% (150,000)

Plus: profit for Years 4 to 6 (twice the dividends) 300,000
Balance, December 31, Year 6 1,050,000
Balance of unamortized acquisition differential — goodwill 7,000
There must have been impairment losses totalling $23,000 since the date of acquisition. The
parent’s share of these impairment losses is $16,100 (23,000 x 70%)
Problem 5-7
Grant NCI
Cost of 80% Interest in Lee 70,000
Fair value of NCI’s Interest in Lee (7 x 2,000 shares) 14,000
Carrying amount of Lee’s net assets = Carrying amount of Lee’s shareholders’ equity
Common shares 25,000
55,000
Shareholders’ interest 44,000 11,000
Acquisition differential 26,000 3,000
Allocated:
Fv – CA
Inventory 5,000 4,000 1,000
Patent 10,000 8,000 2,000
Goodwill 14,000 -0-
Bal Amortization Bal

Jan. 1/Yr4 To Dec. 31/Yr5 Yr6 Dec.31/Yr6
Inventory 5,000 5,000
Patent 10,000 4,000 2,000 4,000
Goodwill* 14,000 4,000 10,000
29,000 9,000 6,000 14,000
* all pertaining to Grant’s 5 ownership
(a)
Calculation of consolidated retained earnings – Dec 31, Year 6

Retained earnings – Grant 300,000
Retained earnings – Lee 65,000
Acquisition 30,000
Increase 35,000
80% 28,000
Less: Acq. diff. amort.
[(9,000 + 2,000) x 80% + 4,000] (12,800)
315,200
Calculation of Year 6 net income attributable to Grant’s Shareholders
Net income Grant 230,000
Net income Lee 23,000
Grant’s % interest 80%
18,400
Less: Grant’s share of amortization of acq. diff.
(2,000 x 80% + 4,000) 5,600
12,800
242,800
(b) Grant Corporation
Consolidated Income Statement
Year ended December 31, Year 6
Sales (900,000 + 360,000) 1,260,000
Cost of goods sold (340,000 + 240,000) 580,000
Gross margin 680,000
Distribution expense (30,000 + 25,000 + 2,000) 57,000
Other expenses (180,000 + 56,000 + 4,000) 240,000

Income taxes (120,000 + 16,000) 136,000
Total 433,000
Net income 247,000
Attributable to:
Grant’s shareholders 242,800
Non-controlling interest [20% x (23,000 – 2,000)] 4,200
247,500
Grant Corporation
Consolidated Balance Sheet – December 31, Year 6
Cash ( 5,000 + 18,000) 23,000
Accounts receivable (185,000 + 82,000 – 30,000) 237,000
Inventory (310,000 + 100,000) 410,000
Equipment (230,000 + 205,000) 435,000
Patent (0 + 2,000 + 4,000) 6,000
Goodwill 10,000
1,121,000
Accounts payable (190,000 + 195,000 – 30,000) 355,000
Other accrued liabilities (60,000 + 50,000) 110,000
Income taxes payable (80,000 + 72,000) 152,000
Non-controlling interests (Note 1) 18,800
1,121,000
Note 1:
Non-controlling interests (Method 1)
Lee’s shareholders’ equity 90,000
Unamortized acquisition differential on identifiable net assets 4,000
94,000
NCI’s share @20% 18,800
Non-controlling interests (Method 2)
NCI, date of acquisition (7 x 2,000 shares) 14,000
Change in Lee’s retained earnings (a) 35,000
Amort. of acq. diff. on identifiable net assets 11,000
24,000
NCI’s share at 20% 4,800
Problem 5-8
(a) Calculation of consolidated net income attributable to Paris’ shareholders
Net income – Paris 160,000

Less: Dividends from Slater (75,000  80%) 60,000
100,000
Income of Slater 120,000
Acq. diff. amort. (100,000 / 10 years) 10,000
110,000
80% 88,000
Consolidated net income attributable to Paris’ shareholders 188,000
Paris Corporation
for the Year Ended December 31
Sales (900,000 + 500,000) 1,400,000

Cost of sales (600,000 + 300,000) 900,000
Operating expenses (200,000 + 80,000 +10,000) 290,000
Total 1,190,000
Net income 210,000
Attributable to:
Paris’ shareholders 188,000
Non-controlling interest [20% x 110,000)] 22,000
210,000
(b) Calculation of consolidated retained earnings – Jan. 1
Retained earnings Paris Jan. 1 301,000

Retained earnings Slater – Jan. 1 584,000
Less: Acq. diff. amort. (7 years10,000) 70,000
461,000
80% 368,800
Consolidated retained earnings – Jan. 1 669,800
Paris Corporation
Consolidated Retained Earnings Statement
for the Year Ended December 31
Balance January 1 669,800

Net income 188,000
857,800
Dividends 150,000
Balance December 31 707,800
Proof
Paris retained earnings 311,000
Retained earnings Slater 629,000
Retained earnings Slater – Acquisition date 53,000
Increase 576,000
Less: Acq. Diff. amort. to date (8 years x 10,000) 80,000
496,000
80% 396,800
707,800

Problem 5-9
(a)
Implied value of 100% 152,600
Carrying amount of Little’s net assets = Carrying amount of Little’s shareholders’ equity
– July 1, Year 5
86,400
Allocated: FV – CA
Government contract 50,000
Equipment – 21,600
28,400
Amortization Schedule
July 1 year ending June 30
Year 5 June 30, Year 6 Year 6
Equipment (8 years) –21,600 –2,700 –18,900
Government contract (5 years)50,000 10,000 40,000
Goodwill 37,800 17,800 20,000
66,200 25,100 41,100
The government contract should be recognized as an identifiable asset because it can meet the
separability test. It can be sold separately and provides future economic benefits.
(b) Calculation of consolidated net income attributable to Big’s shareholders – Year 6

Income of Big 109,620
Less: dividends from Little (13,500  80%) 10,800
98,820
Income of Little 39,420
Less: acquisition differential amortization 25,100
14,320

80% 11,456
110,276
Big
for the Year Ended June 30, Year 6
Sales (270,000 + 162,000) 432,000

Cost of sales (140,100 + 94,380) 234,480
Misc. expense (31,080 + 28,200 – 2,700 + 10,000) 66,580
Goodwill impairment loss 17,800
318,860
Net income 113,140
Attributable to:
Big’s shareholders 110,276
Non-controlling interest [20%  (39,420 – 25,100)] 2,864

113,140
Big
for the Year Ended June 30, Year 6
Balance July 1, Year 5 459,000
Net income 110,276
569,276
Dividends 32,400
Balance June 30, 2006 536,876
Calculation of non-controlling interest – June 30, Year 6
Little – Common shares 54,000

112,320

153,420
20%
30,684
Big
Consolidated Balance Sheet
June 30, Year 6
Miscellaneous assets (835,940 + 128,820) 964,760

Equipment (162,000 + 95,600 - 21,600 – 20,000) 216,000
Accumulated depreciation (60,000 + 50,000 - 20,000 - 2,700) (87,300)
Government contract 40,000
Goodwill 20,000
1,153,460
Liabilities (253,800 + 62,100) $315,900

Non-controlling interest 30,684
1,153,460
(c) Changes in non-controlling interest
Bal. July 1, Year 5 [20%  (86,400 + 66,200)] 30,520

Allocation of entity net income 2,864
33,384
Dividends (20%  13,500) 2,700
Balance June 30, 2006 30,684
Problem 5-10
Cost of 80% of Storm 310,000
Implied value of 100% 387,500
Carrying amount of Storm’s net assets
= Carrying amount of Storm’s shareholders’ equity

260,000
Plant assets 40,000
Trademarks 24,000 64,000
Goodwill 63,500
Bal Amortization Loss Bal
Dec. 31/Yr2 to Dec.31/Yr5 Yr6 Yr6 Dec. 31/Yr6
Plant assets 40,000 15,000 5,000 20,000
Trademarks 24,000 6,000 2,000 2,250 13,750
Goodwill 63,500 ----- ------ 13,500 50,000
127,500 21,000 7,000 15,750 83,750
Calculation of consolidated profit attributable to Palm’s shareholders

Palm profit 96,000
Less: Dividend income (80% x 20,000) 16,000
80,000
Storm profit 50,000
Acq. diff. amort. (7,000 + 15,750) 22,750
27,250
80% 21,800
101,800
(a) Palm Inc.
Year ended December 31, Year 6
Sales (870,000 + 515,000) 1,385,000

Interest income (34,000 – 16,000 + 2,000) 20,000
1,405,000
Cost of sales (638,000 + 360,000) 998,000
Selling expenses (22,000 + 35,000 + 7,000) 64,000
Other expenses (148,000 + 72,000 + 15,750) 235,750

1,297,750
Profit 107,250
Attributable to:
Palm’s shareholders
101,800
Non-controlling interest [20% x (50,000 – 7,000 – 15,750)] 5,450

107,250
Calc. of consolidated retained earnings December 31, Year 6

Palm retained earnings Dec. 31, Year 6 110,000
Storm retained earnings Dec. 31, Year 6 150,000
Less: Acquisition retained earnings 60,000
Increase 90,000
Less: Acq. Diff. Amortization & impairment to Dec. 31, Year 6 43,750
Adjusted change since acquisition 46,250 (a)
80% 37,000
147,000
Palm Inc.
Consolidated Statement of Financial Position
December 31, Year 6
Plant assets (230,000 + 160,000 + 20,000) 410,000

Trademarks 13,750
Goodwill 50,000
Investments (82,000 + 22,000) 104,000
Notes receivable 10,000
Inventory (100,000 + 180,000) 280,000
Accounts receivable (88,000 + 160,000) 248,000
Cash (20,000 + 30,000) 50,000
1,165,750

Non-controlling interest [20% x (350,000 + 83,750)] 86,750
Notes payable (130,000 + 100,000) 230,000
Other current liabilities (10,000 + 50,000) 60,000
Accounts payable (80,000 + 62,000) 142,000
1,165,750
(b) If none of the acquisition differential had been allocated to trademarks, the schedule to
amortize the acquisition differential would have been as follows:
Bal Amortization Loss Bal
Dec. 31/Yr2 to Dec.31/Yr5 Yr6 Yr6 Dec. 31/Yr6
Plant assets 40,000 15,000 5,000 20,000
Goodwill 87,500 ----- ------ 37,500 50,000
127,500 15,000 5,000 37,500 70,000
(i) The return on equity would decrease because net income would decrease by $19,750 i.e.
the change in amortization and impairment of the acquisition differential for Year 6 and
total shareholders’ equity would only decrease by $13,750 i.e. the change in unamortized
acquisition differential at the end of the year.
(ii) The debt to equity ratio would increase because debt would not change but total
shareholders’ equity would decrease.
Problem 5-11
Cost of 80% investment – July 1, Year 4 543,840
Carrying amount of Bondi’s net assets
Assets 936,000
Liabilities 307,200
628,800
Accounts receivable 24,004
Inventory 48,000
Plant assets - 90,000
Bonds payable 13,466 - 4,530
Bond Carrying
Cash Interest Premium Amount
Date Paid Expense Amortization of Bonds
July 1/ Year 4 $186,534
Dec 31/ Year 4 $6,0001 $7,4612 $1,4613 187,9954
June 30, Year 5 6,000 7,520 1,520 189,515
Dec 31/ Year 5 6,000 7,580 1,580 191,095
June 30, Year 6 6,000 7,644 1,644 192,739
Dec 31/ Year 6 6,000 7,710 1,710 194,449
1 2
$200,000 x 6% x 6/12 = $6,000 $186,534 x 4% = $7,461
3
$7,461 – $6,000 = $1,461 4
$186,534 + $1,461 = $187,995

July 1 Dec. 31 Dec. 31 Dec. 31 Dec. 31
YR 4 YR 4 YR 5 YR 6 YR 6
Accounts receivable 24,004 24,004
Inventory 48,000 48,000
Plant assets – 90,000 – 3,000 – 6,000 – 6,000 – 75,000
Bonds payable 13,466 1,461 3,100 3,354 5,551
Goodwill 55,530 – 8,329 5,553 41,648
51,000 22,465 53,429 2,907 –27,801
Calculation of consolidated profit attributable to NCI – Year 6

Profit Bondi 8,400
Less: Acquisition differential amortization 2,907
5,493
20%
1,099
Calculation of non-controlling interest – Dec. 31, Year 6 (Method 1)

Ordinary shares Bondi 120,000
Unamortized acquisition differential - 27,801
650,399
20%
130,080
NCI, date of acquisition (20% x [543,840 / .80]) 135,960
Adjusted change in Bondi’s retained earnings (a) -29,401
NCI’s share at 20% -5,880
(a)
Aaron Co.
Consolidated Financial Statements
December 31, Year 6
Income Statement
Sales (1,261,000 + 1,200,000) 2,461,000

Income – other investments 25,000
2,486,000
Raw materials used (880,000 + 1,005,000) 1,885,000
Change in inventory (-40,000 + 15,000) (25,000)
Depreciation (60,000 + 54,000 – 6,000) 108,000
Interest (37,000 + 26,400 + 3,354) 66,754
Other (227,000 + 91,200) 318,200
Goodwill impairment 5,553
2,358,507
Profit 127,493
Attributable to:
Aaron’s shareholders (= profit under equity method) 126,394

127,493
Statement of Financial Position
Plant assets (net) (720,000 + 540,000 - 75,000) 1,185,000

Other investments 250,666
Goodwill 41,648
Inventory (300,000 + 276,000) 576,000
Cash (120,000 + 84,000) 204,000
2,551,314

Retained earnings 1,295,185
Bonds payable (315,000 + 200,000 – 5,551) 509,449
Current liabilities (180,200 + 135,800) 316,000
2,551,314
(b)
Goodwill impairment loss – entity theory 5,553
Less: NCI’s share @20% 1,111
Goodwill impairment loss – parent company extension theory 4,442
NCI – entity theory 1,099
NCI’s share of goodwill impairment loss 1,111
NCI – parent company extension theory 2,210
(c)
Goodwill– entity theory 41,648

Goodwill– parent company extension theory 33,318
NCI’s share of goodwill 8,330

Problem 5-12
Total Rabb NCI
100% 75% 25%
Consideration given for share ownership 152,000 117,000 35,000
Carrying amount of Rabb’s net assets
= Carrying amount of Rabb’s shareholders’ equity
Carrying amount of Rabb – common shares 50,000
retained earnings 30,000
80,000 60,000 20,000
Acquisition differential 72,000 57,000 15,000
Allocated: FV –CA
Inventory -11,000
Equipment 24,000
Software 15,000
28,000 21,000 7,000
Goodwill 44,000 36,000 8,000
Bal Amortization Impairment Bal

Jan. 1/Yr3 to Dec.31/Yr5 Yr6 Loss/Yr6 Dec.31/Yr6
Inventory - 11,000 - 11,000
Equipment 24,000 12,000 4,000 8,000
Software 15,000 4,500 1,500 1,000 8,000
28,000 5,500 5,500 1,000 16,000
Goodwill – parent 36,000 19,636 16,364
NCI 8,000 4,364 3,636
72,000 5,500 5,500 25,000 36,000
(a)
Calculation of consolidated net income attributable to Foxx’s shareholders – Year 6
Net income Foxx 120,000

Less Dividends from Rabb (.75 x 20,000) 15,000
105,000
Net income Rabb 48,000

Foxx’s share @75% 36,000
141,000
Less: Acq. Diff. Amortization
Identifiable assets [5,500 + 1,000] x 75% - 4,875
Goodwill impairment loss - 19,636
116,489
Calculation of consolidated net income attributable to NCI – Year 6
Net income Rabb 48,000

NCI’s share @25% 12,000
Less: Acq. Diff. Amortization
Identifiable assets [5,500 + 1,000] x 25% - 1,625
Goodwill impairment loss - 4,364
6,011
Foxx Corp.
Year 6 Consolidated Income Statement
Sales (821,000 + 320,000) 1,141,000
Investment income (15,000 – 15,000 + 3,600) 3,600
1,144,600
Cost of sales (480,000 + 200,000) 680,000
Administrative expenses (40,000 + 12,000 + 5,500) 57,500
Miscellaneous expense (116,000 + 31,600 + 1,000 + 19,636 +4,364) 172,600
Income tax (80,000 + 32,000) 112,000
1,022,100
Net income 122,500
Attributable to:
Foxx’s shareholders 116,489

122,500
Calculation of consolidated retained earnings January 1, Year 6

Foxx retained earnings 153,000
Rabb retained earnings 92,000
Rabb retained earnings – acquisition date 30,000
Less: Amortization of acq. diff. 5,500
56,500
Foxx’s share 75% 42,375
195,375
Year 6 Consolidated Retained Earnings Statement

Balance January 1 195,375
Net income 116,489
311,864
Less: Dividends 30,000
Balance December 31 281,864
Consolidated Balance Sheet – December 31, Year 6
Cash 10,000
Notes receivable (0 + 40,000 – 40,000) 0
Inventory (66,000 + 44,000) 110,000
Equipment (220,000 + 76,000 + 8,000) 304,000
Land (150,000 + 30,000) 180,000
Software 8,000
Goodwill 20,000
702,000
Bank indebtedness 90,000

Notes payable (40,000 + 0 – 40,000) 0

Non-controlling interest [.25 x (170,000 + 16,000) + 3,636] 50,136
702,000
(b)
Goodwill impairment loss – entity theory 19,636 + 4,364) 24,000
Less: NCI’s share 4,364
(c)
If Foxx had used the parent company extension theory rather than the entity theory, the debt to
equity ratio would have increased because shareholders’ equity would have decreased due to
the decrease in non-controlling interests while debt would remain the same.
Problem 5-13
Cost of 75% investment 2,400,000

Implied value of 100% 3,200,000
Carrying amount of Silver’s net assets = Carrying amount of Silver’s shareholders’ equity
Common shares 1,600,000
2,000,000
Acquisition differential 1,200,000
Allocated:
Inventory (30%) 360,000
Equipment (40%) 480,000 840,000
Balance – goodwill (30%) 360,000
NCI (25% x 3,200,000) 800,000 (a)
July 1 Dec. 31 Dec. 31 Dec. 31 Dec. 31
Year 2 Year 2 Years 3 to 5 Year 6 Year 6
Inventory 360,000 360,000
Equipment 480,000 30,000 180,000 60,000 210,000
Goodwill 360,000 70,000 20,000 270,000
1,200,000 390,000 250,000 80,000 480,000
Calculation of consolidated net income attributable to Pearl’s shareholders – Year 6
Net income Pearl 1,000,000

Less: Dividends from Silver (200,000  75%) 150,000
850,000
Net income Silver 400,000
Less: Acquisition differential amortization 80,000
320,000
75% 240,000
1,090,000
Calculation of consolidated retained earnings Jan. 1, Year 6

Retained earnings Pearl – Jan. 1 2,900,000
Retained earnings Silver – Jan.1 800,000
Less: Acq. diff. amort. to end of Year 5
(390,000 + 250,000) 640,000
- 240,000
75% - 180,000
2,720,000
Calculation of non-controlling interest – Dec. 31, Year 6

Silver – Common shares 1,600,000
2,600,000

3,080,000
25%
770,000
(a)
Pearl Company
for the Year Ended December 31, Year 6
Sales (4,000,000 + 1,000,000) 5,000,000

Cost of sales (2,500,000 + 400,000 + 60,000) 2,960,000
Miscellaneous expense (320,000 + 70,000) 390,000
Admin expense (80,000 + 10,000 + 20,000) 110,000
Income tax (250,000 + 120,000) 370,000
3,830,000
Net income 1,170,000
Attributable to:
Pearl’s shareholders 1,090,000
1,170,000
Pearl Company
Balance Jan. 1 2,720,000

Net income 1,090,000
3,810,000
Dividends 500,000
Balance Dec. 31 3,310,000
Pearl Company
December 31, Year 6
Cash (300,000 + 100,000) 400,000

Accounts receivable (200,000 – 75,000) 125,000
Inventory (2,000,000 + 420,000) 2,420,000
Plant and equipment (3,000,000 + 2,690,000 + 480,000 – 60,000) 6,110,000
Accumulated depreciation (750,000 + 310,000 + 270,000 – 60,000) (1,270,000)
Goodwill 270,000
8,055,000
Liabilities (900,000 + 300,000 – 75,000) 1,125,000

Common shares 2,850,000
8,055,000
(b)
Goodwill impairment loss – entity theory 20,000
(c)
Goodwill– entity theory 270,000

Goodwill – parent company extension theory
202,500
NCI’s share of goodwill 67,500

Problem 5-14
Carrying amount of Bach’s net assets = Carrying amount of Bach’s shareholders’ equity
230,000
Inventory (50,000 – 20,000) 30,000
Land (45,000 – 25,000) 20,000
Equipment (78,000 – 60,000) 18,000
Misc. intangibles (42,000 – 0) 42,000 110,000
Goodwill 0
Non-controlling interest (20% x 340,000) 68,000 (a)
Acquisition Differential Amortization Schedule

Jan. 1 Dec. 31 Dec. 31 Dec. 31
Year 1 Years 1, 2, and 3 Year 4 Year 4
Inventory 30,000 30,000
Land 20,000 20,000
Equipment 18,000 3,600 1,200 13,200
Misc. intangibles 42,000 6,300 2,100 33,600
110,000 39,900 3,300 66,800
Calculation of consolidated net income attributable to Albeniz’s shareholders – Year 4
Net income Albeniz 29,700

Less: Dividends from Bach (8,000  80%) 6,400
23,300
Net income Bach 17,500
Less: Acq. diff. amort. 3,300

14,200
80% 11,360
34,660
Calculation of consolidated retained earnings Dec. 31, Year 4

Retained earnings Albeniz 170,000
Retained earnings Bach 163,500
Less: acq. diff. amortization (39,900 + 3,300) 43,200
Adjusted increase since acquisition 90,300 (b)
80% 72,240
242,240

Bach – Common shares 200,000
363,500
430,300
20%
86,060
NCI, date of acquisition (a) 68,000
Adjusted change in Bach’s retained earnings (b) 90,300
NCI’s share at 20% 18,060
(a) Albeniz Company

Sales (600,000 + 400,000) 1,000,000
Interest income 6,700
1,006,700
Cost of goods sold (334,000 + 225,000) 559,000
Distribution expense (20,000 + 70,000 + 1,200 + 2,100) 93,300
Selling and admin. (207,000 + 74,000) 281,000
Financing expense (1,700 + 6,000) 7,700
Income taxes (20,700 + 7,500) 28,200
969,200
Net income 37,500
Attributable to:
Albeniz’s shareholders 34,660

37,500
(b)
Albeniz Company
December 31, Year 4
Cash (40,000 + 21,000) 61,000

Inventories (56,000 + 45,000) 101,000
Land (20,000 + 60,000 + 20,000) 100,000
Plant and equipment (200,000 + 700,000 - 240,000 + 18,000) 678,000
Accumulated deprec. (80,000 + 350,000 – 240,000 + 4,800) (194,800)
Miscellaneous intangibles 33,600
954,800

Advances payable (0 + 100,000 – 100,000) 0
954,800

Problem 5-15
Cost of 80% investment 4,120,000

Implied value of 100% investment 5,150,000
Carrying amount of Partridge’s net assets
= Carrying amount of Partridge’s shareholders’ equity
Ordinary shares 2,000,000
4,500,000
Allocated: FV - CA
Inventory 200,000
Patents 500,000
Bonds payable - 300,000 400,000
Jan. 2 Dec. 31 Dec. 31 Dec. 31
Year 1 Years 1 & 2 Year 3 Year 3
Inventory 200,000 200,000
Patents 500,000 100,000 50,000 350,000
Bonds payable - 300,000 - 60,000 - 30,000 - 210,000
Goodwill 250,000 25,000 12,500 212,500
650,000 265,000 32,500 352,500
Brady Ltd.
Sales (10,000,000 + 5,000,000) 15,000,000
Cost of goods purchased (6,930,000 + 2,890,000) 9,820,000
Change in inventory (70,000 + 110,000) 180,000

Depreciation expense (900,000 + 400,000) 1,300,000
Patent amortization (100,000 + 50,000) 150,000
Interest expense (480,000 + 300,000 – 30,000) 750,000
Other expense (680,000 + 850,000) 1,530,000
Goodwill impairment loss 12,500
Income tax (600,000 + 150,000) 750,000
14,492,500
Profit 507,500
Attributable to:
Brady’s shareholders = profit under equity method 474,000
507,500
Calculation of non-controlling interest – Dec. 31, Year 3
Partridge – Ordinary shares 2,000,000

5,100,000
5,452,500
20%
1,090,500
Brady Ltd.
Consolidated Statement of Financial Position
December 31, Year 3
Plant and equipment (8,000,000 + 5,000,000) 13,000,000
Patents (700,000 + 350,000) 1,050,000
Goodwill 212,500
Inventory (4,600,000 + 1,900,000) 6,500,000
Accounts receivable (1,000,000 + 1,300,000) 2,300,000
Cash (400,000 + 600,000) 1,000,000
24,062,500
Ordinary shares 5,000,000

Retained earnings (= retained earnings under equity method) 6,362,000
Non-controlling interest 1,090,500
Bonds payable (4,000,000 + 3,000,000 + 210,000) 7,210,000
Accounts payable (3,000,000 + 1,400,000) 4,400,000
24,062,500
(b)
Only retained earnings and investment in Partridge would be different.
The investment in Partridge would be $4,120,000, which is the original acquisition cost of the
investment. This represents a decrease of $242,000 (4,362,000 – 4,120,000) from the balance
under the equity method.
Retained earnings under the cost method would also be decreased by $242,000. It would change
from $6,362,000 under the equity method to $6,120,000 (6,362,000 – 242,000) under the cost
method.
(in 000s) Equity Cost Consolidation
Current assets 6,000 6,000 9,800
Current liabilities 3,000 3,000 4,400
Current ratio 2.00 2.00 2.23
Total debt 7,000 7,000 11,610

Total equity 11,362 11,120 12,452.5
Debt-to-equity ratio 0.62 0.63 0.93
Net income 474 420* 507.5

Total shareholders’ equity 11,362 11,120 12,452.5
Return on equity 4.2% 3.8% 4.1%
* 474 – investment income of 134 + dividend income of 100 x 80% = 420

(d)
• The consolidation method shows the highest liquidity because it had the highest current
ratio.
• The consolidation method shows the highest risk of insolvency because it had the highest
debt-to-equity ratio.

• The equity method and consolidation method report the highest profitability because they
had the highest return on equity
SOLUTIONS TO WEB-BASED PROBLEMS

Web Problem 5-1
The following answers were determined using the 2011 financial statements of Thomson Reuters
Corporation.
(a) As per note 27 to the consolidated financial statements, Thomson Reuters reports 100%
of the goodwill of its subsidiaries at the date of acquisition. Therefore, Thomson Reuters
is using the entity theory of consolidation to value the non-controlling interest at the date
of acquisition.
(b) Approximately 0.1% (2 / 1,392) of the company’s loss is represented by non-controlling
interest as per the consolidated income statement.
(c) The portion of additions to other intangible assets arising from acquisitions was 100%
(503 / 503) and the portion arising from direct purchases was 0% (0 / 503). This was
determined based on the disclosures contained in notes 16 and 27 to the consolidated
financial statements.
(d) The goodwill impairment loss for 2011 was $3,010 as per note 17 to the consolidated
financial statements. The primary reason for the loss, as per note 17, was weaker than
expected performance by the company’s Markets CGU both in terms of income
generation as determined by future cash flows as well as by a comparison of EBITDA
multiples of comparable benchmark companies.
(e) The performance bonuses will be reduced in the current year due to the immediate
effect of the impairment loss on net income. However, the performance bonuses in
future years may be improved because there is less goodwill to be written down.
(f) The discount rates incorporate the risk associated with future cash flows; the higher the
uncertainty of future cash flows, the higher the discount rate. According to note 17 to the
consolidated financial statements, lower discount rates were applied to CGUs whose
cash flows are expected to be less volatile due to factors such as the maturity of the
market they serve and their market position; higher discount rates were applied to CGUs
whose cash flows are expected to be more volatile due to competition or participation in
less stable geographic markets. When the discount rates increase, the present value of
future cash flows decrease, which would cause a decrease in the recoverable amount of
the goodwill and thus the recognition of an impairment loss.
(g) The return on total shareholders’ equity would have increased for the first year after the
date of acquisition if the company used the parent company extension theory for valuing
non-controlling interest. Net income would have been higher due to a lower goodwill
impairment loss but shareholders’ equity would have been lower since non-controlling
interest would be lower.
Web Problem 5-2

The following answers were determined using the 2011 financial statements of BCE Inc.
(a) As per note 4 to the consolidated financial statements, BCE reports 100% of the goodwill
of its subsidiaries at the date of acquisition. Therefore, BCE is using the entity theory of
consolidation to value the non-controlling interest at the date of acquisition.
(b) Approximately 9.1% (234 / 2,574) of the company’s net earnings is represented by non-
controlling interest as per the consolidated income statements.
(c) The portion of additions to intangible assets arising from acquisitions was 78.2% (2,062 /
[574 + 2,062]) and the portion arising from direct purchase was 21.8% (574 / [574 +
2,062]). This was determined based on the disclosures contained in note 14 to the
consolidated financial statements.
(d) The goodwill impairment loss for 2011 was $17 as per notes 8 and 16 to the
consolidated financial statements. The only reason for the loss, as cited in note 8, was
on account of a CGU within Bell Wireline that will cease operations in 2012.
(e) The performance bonuses will be reduced in the current year due to the immediate
effect of the impairment loss on net income. However, the performance bonuses in
future years may be improved because there is less goodwill to be written down.
(f) The discount rates incorporate the risk associated with future cash flows; the higher the
uncertainty of future cash flows, the higher the discount rate. According to the
impairment of non-financial assets policy as disclosed in note 2 to the consolidated
financial statements, the discount rates used by BCE ranged from 8.7% to 9.1%. When
the discount rates increase, the present value of future cash flows decrease, which
would cause a decrease in the recoverable amount of the goodwill and thus the
recognition of an impairment loss.
(g) The return on total shareholders’ equity would have increased for the first year after the

date of acquisition if the company used the parent company extension theory for valuing
non-controlling interest. Net income would have been higher due to a lower goodwill
impairment loss and shareholders’ equity would have been lower since non-controlling
interest would be lower.


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Case 5-2 (prepared by Peter Secord, Saint Mary’s University)

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Problem 5-1 (15 min.)

Problem 5-2 (30 min.)

Problem 5-3 (25 min.)

Problem 5-4 (15 min.)

Problem 5-5 (25 min.)

Problem 5-6 (40 min.)

Problem 5-7 (30 min)

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Problem 5-8 (20 min.)

Problem 5-9 (40 min.)

Problem 5-10 (60 min.)

Problem 5-11 (50 min.)

Problem 5-12 (55 min.)

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Problem 5-14 (55 min.)

Problem 5-15 (50 min.)

Web Problem 5-1

Web Problem 5-2

SOLUTIONS TO REVIEW QUESTIONS

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4. Under the equity method:

9. The unamortized acquisition differential was:

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A sample memorandum follows:

To: CFO, Valero Energy Corp.

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• Goodwill should be recognized on an enterprise's balance sheet at the amount initially

As requested, I have prepared a report recommending appropriate accounting and reporting

Users and Needs

The users of GIL’s financial statements are as follows:

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Special Purpose Balance Sheet

General Purpose Financial Statements

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REPORT ON MANAGEMENT ASSISTANCE AT TOTAL PROTECTION LIMITED

Cost control of warranty work

Cash management and investment

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REPORT ON ACCOUNTING POLICIES

(Candidates recognized the needs of the owners and, in particular, Safe-Way.)

Warranty liabilities and expenses

The market-decline provision due to faulty construction is unique in this industry, so no

Revenue can be recognized in several ways:

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4. Recognize revenues on a percentage-of-completion basis, based on estimated warranty

(Candidates covered the revenue-recognition alternatives adequately. However, candidates

Other accounting issues

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Warranty Revenues and Repair Costs*

Larkview Towne Granite Kings Safe-Way Others Total

Number of warranties 50 85 190 250 175 465 1,215

Warranty revenue $120,000 $165,000 $395,000 $90,000 $160,000 $705,000

Per warranty 2,400 1,941 2,079 360 914 1,516 1,346

Repair costs 6,000 9,000 21,000 42,000 39,000 107,000 224,000