FA7e Ch12 Solutions 081922

Chapter 12
Reporting and Analyzing

Financial Investments
Learning Objectives – coverage by question

Mini- Cases
Exercises Problems
Exercises and Projects
LO1 – Explain and interpret the three

28-31, 33,
levels of investor influence over an
11 34, 41-43, 59, 61, 62 63-67
investee – passive, significant, and
45-50
controlling.
LO2 – Describe the term “fair value”

14 49 59, 61 66, 67
and the fair value hierarchy.
28-31, 33,
LO3 – Describe and analyze accounting
12, 13, 21-26 34, 36, 41- 59, 61 63-67
for passive investments.
43, 45-49
LO4 – Explain and analyze

accounting for investments with 15-17, 20 37-42, 49, 50 61, 62, 64 65-67
significant influence.
LO5 – Describe and analyze

32, 35, 44,
accounting for investments with 18-20, 27 60, 62 66
55, 56
control.
LO6 – Appendix 12A – Illustrate and

analyze accounting mechanics for 57 62
equity method investments.
LO7 – Appendix 12B – Apply

51-54, 56 60, 62
consolidation accounting mechanics.
LO8 – Appendix 12C – Discuss the

58
reporting of derivative securities.
©Cambridge Business Publishers, 2023

Solutions Manual, Chapter 12 12-1
QUESTIONS
Q12-1. (a) Trading securities are reported at their fair value in the balance sheet. (b)
Available-for-sale securities are reported at their fair value in the balance sheet.
(c) Held-to-maturity securities are reported at their amortized cost in the
balance sheet.
Q12-2. An unrealized holding gain (loss) is an increase (decrease) in the fair value of
an asset (in this case, an investment security) that is still owned. Investments
in equity securities should be reported at their fair value on the balance sheet,
with unrealized holding gains and losses reported in income in the period that
they occur. There is a provision for non-marketable securities to use when the
cost of estimating fair value is prohibitively expensive.
Q12-3. Unrealized holding gains and losses related to trading securities are reported in
the current-year income statement (and also retained earnings). Unrealized
holding gains and losses related to available-for-sale debt securities are
reported as a separate component of stockholders' equity called Other
Comprehensive Income (OCI).
Q12-4. Significant influence gives the owner of the stock the ability to significantly
influence the operating and financing activities of the company whose stock is
owned. Normally, this is accomplished with a 20% through 50% ownership of
the company's voting stock.
The equity method is used to account for investments with significant influence.
Such an investment is initially recorded at cost; the investment is increased by
the proportionate share of the investee company's net income, and equity
income is reported in the income statement; the investment account is
decreased by dividends received on the investment; and the investment
account is reported in the balance sheet at its book value. Unrealized
appreciation in the market value of the investment is not recognized.
Q12-5. Yetman Company's investment in Livnat Company is an investment with
significant influence, and should, therefore, be accounted for using the equity
method. At year-end, the investment should be reported in the balance sheet at
$206,400 [$200,000 + (40%  $64,000) - (40% x $48,000)].
Q12-6. A stock investment representing more than 50% of the investee company's
voting stock is generally viewed as conferring “control” over the investee
company. The investor and investee companies must be consolidated for
financial reporting purposes.
Q12-7. Consolidated financial statements attempt to portray the financial position,
operating results, and cash flows of affiliated companies as a single economic
unit so that the scope of the entire (whole) entity is more realistically conveyed.

12-2 Financial Accounting, 7th Edition
Q12-8. The $600,000 investment in Murray Company appearing in Finn Company's
balance sheet and the $240,000 common stock and $360,000 retained
earnings appearing on Murray Company's balance sheet are eliminated. The
two balance sheets (less the accounts eliminated) are then summed to yield the
consolidated balance sheet.
Q12-9.B The $150,000 accounts payable on Dee's balance sheet and the $150,000
accounts receivable on Bradshaw's balance sheet are eliminated. In a
consolidation, all intercompany items are eliminated so that the consolidated
statements show only the interests of outsiders.
Q12-10. Limitations of consolidated statements include the possibility that the
performances of poor companies in a group are "masked" in consolidation.
Likewise, rates of return, other ratios, and percentages calculated from
consolidated statements might prove deceptive because they are composites.
Consolidated statements also eliminate detail about product lines, divisional
operations, and the relative profitability of various business segments. (Some of
this information is likely to be available in the note disclosures relating to the
business segments of certain public firms.) Finally, shareholders and creditors
of subsidiary companies find it difficult to isolate amounts related to their legal
rights by inspecting only consolidated statements.

MINI EXERCISES
M12-11. (10 minutes)
LO 1
a. SI Griffin owns > 20% of Wright.
b. P Bond investments are always classified as passive.
c. P 2,000 shares of Alphabet is well below the number necessary to exert

influence
d. C Watts owns more than half of Zimmerman stock
e. SI Even though Shevlin owns less than 20% of Bowen, the fact that it buys 60%
of Bowen’s output means it is capable of exercising significant influence. This
is a case where the facts and circumstances override the guidance based on
strict percentage ownership.

LO 3
a. Available-for-sale securities are reported at fair value on the balance sheet. For
2020, this is equal to the amortized cost ($17,163 million) plus unrealized gains
($454 million) and less unrealized losses ($7 million), or $17,610 million.
b. Unrealized gains (and losses) on available-for-sale debt securities are reported as a

component of Accumulated Other Comprehensive Income (AOCI) in the
shareholders’ equity section of the balance sheet.

LO 3
Investments in equity securities must be reported at fair value, with all gains and losses
(realized and unrealized) recognized in income. Wu will report $11,050 of dividend
income plus income relating to the increase in the market price of the stock of $8,500
($13 - $12 price increase for 8,500 shares). Total investment income is $19,550.

LO 2
a. All of these investments are marked to fair value, but the determination differs. Level
1 fair values are determined by reference to an active market where identical assets
are traded. Level 2 fair values are determined by using a model (discounted cash
flow, prices of similar assets, etc.) for which the inputs and assumptions can be found
from observable value. Level 3 fair values are also determined by using a model, but
the inputs and assumptions are not observable except to the reporting company.
b. All are marked-to-fair-value, but only Level 1 investments are marked-to-market, the
others are marked-to-model. Level 1 values would be the most objective since they
come from an active market. Level 3 would be most subjective because they depend
significantly on management’s judgments.
c. Level 1 assets are most liquid, because they are traded in active markets. Level 3
assets are likely to be least liquid because their value depends significantly on
information that is not publicly available.

LO 4
a. Given the 30% ownership, “significant influence” is presumed and the investment
must be accounted for using the equity method. The year-end balance of the
investment account is computed as follows:
Beginning balance........................ $1,500,000

% Lang income earned................ 45,000 ($150,000  0.3)
% Dividends received................... (18,000) ($60,000  0.3)
Ending balance............................. $1,527,000
b. $45,000 ($150,000  0.3) - Equity earnings are computed as the reported net income
of the investee (Lang Company) multiplied by the percentage of the outstanding
common stock owned.
c. (1) In contrast to the market method, the equity method of accounting does not report
investments at market value. The unrealized gain of $300,000 is not reflected in
either the balance sheet or the income statement.

d.
Balance Sheet Income Statement
Cash Noncash Liabil- Contrib. Earned Net
Transaction Asset + Assets = ities + Capital + Capital Revenues - Expenses = Income
Purchase -1,500,000 +1,500,000 = - =
stock in Lang Cash Investment
Company.
Recognize +45,000 = +45,000 +45,000 - = +45,000

share of Lang Investment Retained Investment
income. Earnings Income
Receive +18,000 -18,000 = - =

dividend from Cash Investment
Lang.

LO 4
a.
1. Investment in Lang Company (+A) .................................................... 1,500,000
Cash (-A) ........................................................................................... 1,500,000
2. Investment in Lang Company (+A) ....................................................

45,000
Investment income (+R, +SE) ........................................................... 45,000
3. Cash (+A) ..........................................................................................

18,000
Investment in Lang Company (-A) .................................................... 18,000
b.
+ Cash (A) - - Investment Income (R) +
1,500,000 1. 45,000 2.
3. 18,000
+ Investment in Lang Company (A) -

1. 1,500,000
2. 45,000
18,000 3.

LO 4
Equity income on this investment is computed as the investee company (Penno)

earnings multiplied by the percentage of the company owned. In this case, equity
earnings equal:
$720,000  40% = $288,000
Note that dividends are treated as a return of investment (reduce the investment
balance by $96,000, computed as $240,000  40%), and not as income. Also, the
investment is recorded at adjusted cost, not at market value, and unrealized gains
(losses) are neither recognized on the balance sheet nor in the income statement.

LO 5
The $480,000 investment in Hirst Company appearing on Philipich Company's balance

sheet and the $240,000 common stock and $360,000 retained earnings of Hirst
Company would be eliminated.
In addition, a $120,000 noncontrolling interest [20% of ($240,000 + $360,000)] would

appear on the consolidated balance sheet as part of shareholders equity.

LO 5
Benartzi Company consolidated net income............................. $1,050,000

Less: net income attributable to noncontrolling interests........... 21,000
Net income attributable to Benartzi Company shareholders...... $1,029,000

LO 4, 5
a. If DeFond purchases 100% of Verduzco’s common stock, then it must produce

consolidated reports.
DeFond
Company DeFond DeFond
(before Company Verduzco Eliminating Company
investment) (after investment) Company Entries (Consolidated)
Current assets $ 1,000 $ 625 $ 125 $ 750
Investment – 375 – (375) –
Noncurrent assets 2,500 2,500 1,125 3,625
Liabilities 2,750 2,750 875 3,625
Shareholders’ 750 750 375 (375) 750
Equity
b. If DeFond purchases 50% of the common stock of Lin Company, it uses the equity
method.
DeFond Company DeFond Company Lin

(before investment) (after investment) Company
Current assets $ 1,000 $ 625 $ 250
Investment – 375 –
Noncurrent assets 2,500 2,500 2,250
Liabilities 2,750 2,750 1,750
Shareholders’ Equity 750 750 750
c. If we compare DeFond’s consolidated balance sheet to the equity method balance

sheet, we can see that the total assets are higher and the liabilities are higher.
DeFond’s stockholders’ equity accounts are the same. So, the Debt-to-Equity ratio
will be higher if DeFond purchases the subsidiary rather than investing in the joint
venture. If reported profits are the same under either scenario, then purchasing the
subsidiary would produce a lower Return on Assets than the joint venture. Other
ratios would change as well (like the Current Ratio), but not in a predictable
direction.

LO 3

10/1/YR1 -874,800 + 874,800 = - =

Purchase Cash Investment
$500,000 of
Skyline bonds
at 97.
12/31/YR1 +15,750 = +15,750 +15,750 - = +15,750

Recognize Interest Retained Interest
interest Receivable Earnings Revenue
revenue.
12/31/YR1 +7,200 = +7,200 +7,200 - = +7,200

Record Investment Retained Unrealized
unrealized Earnings Gain
gain.
3/31/ +31,500 -15,750 = +15,750 +15,750 - = +15,750

YR2Recognize Cash Interest Retained Interest
income.
4/1/YR2 +886,140 -882,000 = +4,140 +4,140 - = +4,140

Sold Skyline Cash Investment Retained Realized
investment. Earnings Gain

LO 3
a. Year 1
10/1 Investment in Skyline, Inc. (+A) ........................................................
874,800
Cash (-A) .....................................................................................874,800
12/31 Interest receivable (+A) .....................................................................

15,750
Interest revenue (+R, +SE) ......................................................... 15,750

7,200
Unrealized gain (+R, +SE) .......................................................... 7,200
Year 2
3/31 Cash (+A) ........................................................................................
31,500
Interest receivable (-A) ................................................................ 15,750
4/1 Cash (+A) ........................................................................................

886,140
Realized gain (+R, +SE) ............................................................. 4,140
Investment in Skyline, Inc. (-A) .................................................... 882,000

b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of $7,200 in Skyline
Inc. bonds is closed to retained earnings in Year 1 increasing net income and
retained earnings.
+ Cash (A) - - Interest Revenue (R)

+
874,800 10/1/YR1 15,750 12/31/YR1
3/31/YR2 31,500 15,750 3/31/YR2
4/1/YR2 886,140
+ Investment in Skyline Bonds (A) - - Unrealized Gain (R)

+
10/1/YR1 874,800 7,200 12/31/YR1
12/31/YR1 7,200 882,000 4/1/YR2
+ Interest Receivable (A) - - Realized Gain (R)

+
12/31/YR2 15,750 15,750 3/31/YR2 4,140 4/1/YR2

LO 3

Cash Noncash Liabil Contrib. Earned Net
Transaction Asset + Assets = -ities + Capital + Capital Revenues - Expenses = Income
11/15 -256,800 +256,800 = =

10,000 shares
of Lane Inc
common.
12/22 +15,000 = +15,000 +15,000 = +15,000

Dividend Cash Retained Divdend
12/31 -24,300 = -24,300 +24,300 = -24,300

Decrease in Investment Retained Unrealized
Investment. Earnings Loss
1/20 +225,000 -232,500 = -7,500 +7,500 = -7,500

Sale of Lane Cash Investment Retained Realized
common. Earnings Loss

LO 3
a. Year 1
11/15 Investment in Lane, Inc. (+A) .................................................. 256,800
Cash (-A) ................................................................................. 256,800
12/22 Cash (+A) ................................................................................15,000

Dividend income (+R, +SE) ..................................................... 15,000
12/31 Unrealized loss (+E, -SE) ........................................................24,300

Investment in Lane, Inc. (-A) ................................................... 24,300
Year 2
1/20 Cash (+A) ..........................................................................................
225,000
Loss on sale of investment in Lane, Inc. (+E, -SE) ........................... 7,500
Investment in Lane, Inc. (-A) ............................................................. 232,
500
b. Assuming the firm’s fiscal year ends 12/31, the unrealized loss of $24,300 is closed
to the income summary in Year 1, reducing net income and retained earnings.
+ Cash (A) - + Investment in Lane Inc (A) -

12/22 15,000 256,800 11/15 11/15 256,800 24,300 12/31
1/20 225,000 232,500 1/20
+ Loss (E) -
1/20 7,500
+ Unrealized Loss (E) - - Dividend Income (R) +

12/31 24,300 15,000 12/22

LO 3

10/1/YR1 -874,800 + 874,800 = - =

$900,000 of
Skyline bonds
at 97.
12/31/YR1 +15,750 = +15,750 +15,750 - = +15,750

Recognize Interest Retained Interest
revenue.
12/31/YR1 +7,200 = +7,200 - =

Record Investment Unrealized
unrealized Gain-
gain. AOCI
3/31/YR2 +31,500 -15,750 = +15,750 +15,750 - = +15,750

Recognize Cash Interest Retained Interest
income.
4/1/YR2 +886,140 -882,000 = +11,340 +11,340 - = +11,340

Sold Skyline Cash Investment Retained Realized
investment. Earnings Gain
-7,200
Unrealized
Gain-
AOCI

LO 3
The main effect is to defer the gain in value experienced in Year 1 to the year Year 2.
a. Year 1
874,800
Cash (-A) .....................................................................................874,800
12/31 Interest receivable (+A) .....................................................................

15,750

7,200
Unrealized gain AOCI (+SE) ....................................................... 7,200
Year 2
3/31 Cash (+A) ........................................................................................
31,500
Interest receivable (-A) ................................................................ 15,750
4/1 Cash (+A) ........................................................................................

886,140
Unrealized gain – AOCI (-SE) 7,200
Realized gain (+R, +SE) ............................................................. 11,340
Investment in Skyline, Inc. (-A) .................................................... 882,000
b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of $7,200 in Skyline
Inc. bonds is closed to retained earnings in Year 1 increasing net income and
retained earnings.
+ Cash (A) - - Interest Revenue (R) +

874,800 10/1/ 15,750 12/31/YR1
YR1
3/31/YR2 31,500 15,750 3/31/YR2
4/1/YR2 886,140
+ Investment in Skyline Bonds (A) - - Unrealized Gain (AOCI) +

10/1/YR1 874,800 7,200 12/31/YR1
12/31/YR1 7,200 882,000 4/1/YR2 4/1/YR2 7,200
+ Interest Receivable (A) - - Realized Gain (R) +

12/31/YR1 15,750 15,750 3/31/ 11,340 4/1/YR2
YR2
Note that most of the gain occurred in Year 1, but was not recognized on the income
statement until management decided to sell the securities in Year 2.

LO 5
Halen Inc. now owns all of Jolson. The company reports will be consolidated. The total
in the consolidated stockholder’s equity section on 1/1 is the stockholders’ equity
section of the parent company, determined as follows:
Common stock $480,000
Retained earnings 248,000
Total Equity $728,000
Jolson’s equity accounts are eliminated in the consolidation process.

EXERCISES
E12-28. (30 minutes)

LO 1, 3
a.
1. Purchase bonds for -610,000 +610,000 = =
$610,000 Cash Investment
2. Receive interest +12,000 = +12,000 +12,000 = +12,000

payment of $12,000 Cash Retained Interest
Earnings Income
3. Year-end market +6,000 = +6,000 +6,000 = +6,000
price of bonds is Investment Retained Unrealized
$616,000 Earnings Holding
Gain
4a. Receive interest +12,000 = +12,000 +12,000 = +12,000
payment of $12,000 Cash Retained Interest
Earnings Income
4b. Sell bonds for +612,000 -616,000 = -4,000 +4,000 = -4,000
$612,000 Cash Investment Retained Realized
Earnings Holding
Loss
b.

1. Purchase bonds -610,000 +610,000 = =

for $610,000 Cash Investment
+12,000
2. Receive interest +12,000 = +12,000 = +12,000
Retained
payment of Cash Interest
Earnings
$12,000 Income
+6,000
3. Year-end +6,000 = =
AOCI
market price of Investment
bonds is
$616,000
+12,000
4a. Receive +12,000 = +12,000 = +12,000
Retained
interest Cash Interest
Earnings
payment of Income
$12,000
+2,000
4b. Sell bonds for +612,000 -616,000 = +2,000 = +2,000
Retained
$612,000 Cash Investment Realized
Earnings
Holding
-6,000 Gain
AOCI

LO 1, 3
a. Trading securities
(i.)
1. Investment in US Treasury bonds (+A) ......................................... 610,000

Cash (-A) ...................................................................................... 610,000
2. Cash (+A) ......................................................................................12,000

Interest income (+R, +SE) ............................................................ 12,000
3. Investment in US Treasury bonds.................................................. 6,000

Unrealized holding gain (+R, +SE) ............................................... 6,000
4a Cash (+A) ......................................................................................12,000

.
Interest income (+R, +SE)............................................................. 12,000
4b Cash (+A) ......................................................................................

612,000
.
Realized loss on sale of investment (+E, -SE) ..............................
4,000
Investment in US Treasury bonds (-A)...........................................616,000
(ii.)
+ Cash (A) - + Investment in US T. Bonds (A) -

2. 12,000 610,000 1. 1. 610,000
4a. 12,000 3. 6,000 616,000 4b.
4b 612,000
- Interest Income (R) +

12,000 2.
12,000 4a.
+ Unrealized Gain (R) - + Realized Loss on Sale (E) -

3. 6,000 4b. 4,000

b. Available-for-Sale Securities
(i.)
1. Investment in US Treasury bonds (+A) 610,000

Cash (-A) 610,000
2. Cash (+A) 12,000

Interest income (+R, +SE) 12,000
3. Investment in US Treasury bonds 6,000

Unrealized holding gain - AOCI (+SE) 6,000
4a. Cash (+A) 12,000

Interest income (+R, +SE) 12,000
4b. Cash (+A) 612,000

Unrealized holding gain – AOCI (-SE) 6,000
Investment in US Treasury bonds (-A) 616,000
Realized holding gain (+R, +SE) 2,000
(ii.)
+ Cash (A) - + Investment in US T. Bonds (A) -

2. 12,000 610,000 1. 1. 610,000
4a. 12,000 3. 6,000 616,000 4b.
4b. 612,000
- Interest Income (R) +

12,000 2.
12,000 4a.
- Unrealized Gain AOCI (SE) + - Realized Gain (R) +

4b. 6,000 6,000 3. 2,000 4b.

LO 1, 3
1. Ohlson Co. -96,000 +96,000 = - =
purchases 6,000 Cash Investment
common shares
of Freeman Co.
at $16 cash per
share.
2. Ohlson Co. +7,500 = +7,500 +7,500 - = +7,500

receives a cash Cash Retained Dividend
dividend of Earnings Income
$1.25 per
common share
from Freeman.
3. Year-end market +9,000 = +9,000 +9,000 - = +9,000

price of Freeman Investment Retained Unrealized
common stock is Earnings Gain
$17.50 per share.
4. Ohlson Co. sells +103,680 -105,000 = + -1,320 - +1,320 = -1,320

all 6,000 common Cash Investment Retained Loss
shares of Earnings
Freeman for
$103,680 cash.

LO 1, 3
a. Equity investments measured at fair value, with all gains/losses recognized in

income.
1. Investment in Freeman, Co. (+A) ............................................96,000

Cash (-A) ................................................................................. 96,000
2. Cash (+A) ................................................................................ 7,500

Dividend income (+R, +SE) ..................................................... 7,500
3. Investment in Freeman, Co. (+A) ............................................ 9,000

Unrealized gain (+R, +SE) ....................................................... 9,000
4. Cash (+A) ................................................................................

103,680
Loss on sale of investment (+E, -SE) ...................................... 1,320
Investment in Freeman, Co. (-A).................................... 105,000

b.
+ Cash (A) - + Investment in Freeman (A) -
2. 7,500 96,000 1. 1. 96,000
4. 103,680 3. 9,000 96,000 4.
- Dividend Income (R) +

7,500 2.
- Unrealized Gain (R) + + Loss on Sale (E) -

9,000 3. 4. 1,320

LO 5
a. The annual growth rates in revenues are (110,360/96,571)-1 = 14.3% for 2018 and
(96,571/91,154)-1 = 5.9% for 2017. The cumulative average growth rate (CAGR) is
(110,360/91,154)^0.5 - 1 = 10.0%.
b. Microsoft’s acquisition of LinkedIn was completed in December 2016, and it was at

that point that Microsoft began to include LinkedIn’s revenues in its income
statement. Let’s say December 31, 2016 just to be concrete. As a result, 2016’s
revenue included a full year of Microsoft’s revenues, 2017’s revenues included a full
year of Microsoft’s revenues plus a half year of LinkedIn’s revenues, and 2018’s
revenues included a full year of each of Microsoft’s and LinkedIn’ revenues.
As a result, the growth trends over this period intermix the “organic growth” of these
companies with the “acquisition growth.” The former is likely to continue, while the
latter is dependent on acquisitions of other companies.
c. The disclosure information provides revenues for 2016 and 2017 as if Microsoft and
LinkedIn had been one organization over this period. That is, the “acquisition
growth” can be set aside to focus on the “organic growth.” In this case, the revised
growth rates would be the following:
The annual growth rates in revenues are (110,360/98,291)-1 = 12.3% for 2018 and
(98,291/94,490)-1 = 4.0% for 2017. The cumulative average growth rate (CAGR) is
((110,360/94,490)^0.5) - 1 = 8.1%. So “acquisition growth” added about 2% to the
growth pattern in reported revenue.

LO 1, 3

11/1 -511,500 +511,500 = - =

Buy $500,000 Cash Investment
Joos bonds
@102.
12/31 +7,500 = +7,500 +7,500 - = +7,500

Accrue Interest Retained Interest
interest. Receivable Earnings Revenue
12/31 -9,000 = -9,000 - +9,000 = -9,000

Recognize Investment Retained Unrealized
decline in Earnings Loss
value of
bonds.
4/30 +22,500 -7,500 = +15,000 +15,000 - = +15,000

Receive Cash Interest Retained Interest
interest. Receivable Earnings Revenue
5/1 Sold +501,500 -502,500 = -1,000 - +1,000 = -1,000

Joos bonds. Cash Investment Retained Loss
Earnings

LO 1, 3
a. Year 1
11/1 Investment in Joos, Inc. (+A) ............................................... 511,500
Cash (-A) ............................................................................. 511,500
12/31 Interest receivable (+A) ....................................................... 7,500

Interest revenue (+R, +SE) ................................................. 7,500
12/31 Unrealized loss (+E, -SE) .................................................... 9,000

Investment in Joos, Inc. (-A) ................................................ 9,000
Year 2
4/30 Cash (+A) ............................................................................ 22,500
Interest receivable (-A) ........................................................ 7,500
Interest revenue (+R, +SE) ................................................. 15,000
5/1 Cash (+A) ............................................................................ 501,500

Loss on sale of investments (+E, -SE) ................................ 1,000
Investment in Joos, Inc. (-A)................................................. 502,500

b.
+ Cash (A) - + Investment in Joos Inc. (A) -
4/30 22,500 511,500 11/1 11/1 511,500 9,000 12/31
5/1 501,500 502,500 5/1
+ Unrealized Loss (E) - + Interest Receivable (A) -

12/31 9,000 12/31 7,500 7,500 4/30
- Interest Revenue (R) + + Loss on Sale of Investments (E) -

7,500 12/31 5/1 1,000
15,000 4/30

LO 5
Baylor Company now owns 75% of Reed. The company reports will be consolidated. The
total in the consolidated stockholders’ equity section on 1/1 is determined as follows:
Common stock………………………………………… 720,000

Retained earnings………………………………….…. 352,000
Baylor Company shareholders’ equity $1,072,000
Noncontrolling interests 160,000
Total equity $1,232,000

LO 3
a. The fixed-maturity (debt) investment portfolio is reported in the balance sheet at its
current fair value of $44,631 million. The cost of the portfolio is $38,953 million, there
are $5,795 million in unrealized gains, $77 million of unrealized losses, and $40 in the
allowance for credit losses.
b. For the fixed-maturity (debt) investments accounted for as available-for-sale,

unrealized gains (losses) on investments are reported in Accumulated Other
Comprehensive Income (AOCI), rather than current income. The investments are
reported on the balance sheet at current market value on the statement date. Note that
there are no unrealized gains or losses related to the fixed maturity securities classified
as trading for CNA Financial. However, if there were unrealized gains or losses
reported, they would be recognized in current income.

c. An allowance for credit losses has been established on fixed maturity securities that
reduces the value of the investment on the balance sheet. Changes in the allowance
are reflected in current income. Gains and losses realized from the sale of securities
are recognized in current income. A reclassification adjustment is required in Other
Comprehensive Income. Because the gains and losses from the sale of securities will
be recognized in current income (and retained earnings), they need to be removed
from AOCI to avoid double-counting the gains and losses in stockholders’ equity.

LO 4

1. Buy 30% of -162,000 +162,000 = - =

Barth stock. Cash Investment
2. Receive +22,500 -22,500 = - =

dividend. Cash Investment
3. Recognize +36,000 = +36,000 +36,000 - = +36,000

share of net Investment Retained Investment
income of Earnings Income
Barth.
4. Sold Barth +180,500 -175,500 = +5,000 +5,000 - = +5,000

investment. Cash Investment Retained Gain
Earnings

LO 4
a Investment in Barth Co. (+A) .............................................................

162,000
. 1.
Cash (-A) ...........................................................................................162,000
2. Cash (+A) ..........................................................................................

22,500
Investment in Barth Co. (-A) .............................................................. 22,500
3. Investment in Barth Co. (+A) .............................................................

36,000
Investment income (+R, +SE) ........................................................... 36,000
4. Cash (+A) ..........................................................................................

180,500
Gain on sale of investment (+R, +SE) ............................................... 5,000
Investment in Barth Co. (-A) ..............................................................175,500

b.
+ Cash (A) - + Investment in Barth (A) -
2. 22,500 162,000 1. 1. 162,000 22,500 2.
4. 180,500 3. 36,000 175,500 4.
- Gain (R) + - Investment Income (R) +

5,000 4. 36,000 3.

LO 4

1. Buy 25% -240,000 +240,000 = - =

of Palepu Cash Investment
stock.
2. Receive +24,000 -24,000 = - =

dividend. Cash Investment
3. Recognize +60,000 = +60,000 +60,000 - = +60,000

share of Investment Retained Investment
net income Earnings Income
of Palepu.
4. Sold +280,000 -276,000 = +4,000 +4,000 - = +4,000

Palepu Cash Investment Retained Gain
investment. Earnings

LO 4
a.
1 Investment in Palepu Co. (+A) ..................................................
240,000
.
Cash (-A) ................................................................................... 240,000
2 Cash (+A) ..................................................................................24,000

.
Investment in Palepu Co. (-A) ................................................... 24,000
3 Investment in Palepu Co. (+A) ..................................................60,000

.
Investment income (+R, +SE) ................................................... 60,000
4 Cash (+A) ..................................................................................

280,000
.
Gain on sale of investment (+R, +SE) ....................................... 4,000
Investment in Palepu Co. (-A) ................................................... 276,000
b.
+ Cash (A) - + Investment in Palepu (A) -
2. 24,000 240,000 1. 1. 240,000 24,000 2.
4. 280000 3. 60,000 276,000 4.
- Gain (R) + - Investment Income (R) +

4,000 4. 60,000 3.

LO 1, 3, 4
a.
1. Purchase -75,000 +75,000 = - =

Common Cash Investment
shares.
2. No entry. = - =
3. Received +5,500 = +5,500 +5,500 - = +5,500

a cash Cash Retained Dividend
dividend of Earnings Income
$1.10 per
common
share.
4. Recognize +20,000 = +20,000 +20,000 - = +20,000

increase in Investment Retained Unrealized
investment Earnings Gain
value at
year end .
b.
1. Purchase -75,000 +75,000 = - =

Common Cash Investment
shares.
2. Recognize +12,000 = +12,000 +12,000 - = +12,000

30% Investment Retained Investment
portion of Earnings Income
Leftwich
net
income.
3. Received +5,500 -5,500 = - =

a cash Cash Investment
dividend
of $1.10
per
common
share.
4. No entry. = - =

LO 1, 3, 4
a. Fair Value Method

i.
1. Investment in Leftwich Co. (+A) ..................................... 75,000
Cash (-A) ........................................................................ 75,000
2. No entry
3. Cash (+A)........................................................................ 5,500

Dividend income (+R, +SE) ........................................... 5,500
4. Investment in Leftwich Co. (+A) ..................................... 20,000

Unrealized gain (+R, +SE) ............................................. 20,000
ii.
+ Cash (A) - + Investment in Leftwich (A) -
3. 5,500 75,000 1. 1. 75,000
4. 20,000
- Unrealized Gain (R) + - Dividend Income (R) +

20,000 4. 5,500 3.
b. Equity Value Method

i.
1. Investment in Leftwich Co. (+A) ..................................................................
75,000
Cash (-A) .....................................................................................................
75,000
2. Investment in Leftwich Co. (+A) ..................................................................

12,000
Investment income (+R, +SE) .....................................................................
12,000
3. Cash (+A) ....................................................................................................

5,500
Investment in Leftwich Co. (-A) ...................................................................5,500
4. No entry
ii.
+ Cash (A) - + Investment in Leftwich (A) -
3. 5,500 75,000 1. 1. 75,000 5,500 3.
2. 12,000
- Investment Income (R) +

12,000 2.

LO 1, 3
a. The amounts reported for all these separately-identifiable assets and liabilities must
be fair values at the date of the acquisition. So, any property, plant and equipment
would be reported at what we would expect to get for it, rather than historical cost.
Any financial liabilities would be estimated at the value required to discharge them at
the date of the acquisition. In the fair value hierarchy, most of these amounts will be
determined using Level 2 or Level 3 approaches.
b. Goodwill is equal to the amount of consideration given for the transaction minus the
fair value of the net assets acquired. Other than goodwill, the asset fair value is
$8,432 million and the fair value of liabilities is $3,970 million. So, the fair value of
separately-identifiable net assets is $4,462 million (= $8,432 million - $3,970 million).
As a result, the goodwill is $9,501 million (= $13,963 million - $4,462 million). This
amount would not be amortized in the future, but Amazon would have to assess its
value annually for impairment. If the goodwill value is impaired, the goodwill asset is
reduced and a charge is recognized in income.
c. Investors are likely to prefer acquisitions of identifiable net assets (even if

intangible), rather than vaguely-defined “synergy effects.” When the acquired
company goes to the highest bidder, there is a real risk that the highest bidder was
the one that most overestimated the potential for future synergies. When purchase
price allocations are disclosed subsequent to the acquisition, stock prices respond
favorably (unfavorably) to the disclosure that less (more) goodwill was acquired

LO 5
a. The amounts reported for all these separately-identifiable assets and liabilities must
be fair values at the date of the acquisition. So, any inventory would be reported at
what we would expect to get for it, rather than historical cost. Any financial liabilities
would be estimated at the value required to discharge them at the date of the
acquisition. In the fair value hierarchy, most of these amounts will be determined
using Level 2 or Level 3 approaches. Indeed, Gilead states that the Liability Related
to Future Royalties in this instance is computed using the real options method and
that the inputs used for valuation are unobservable and considered Level 3 under
the fair value measurement and disclosure guidance.
b. Goodwill is equal to the amount of consideration given for the transaction minus the
fair value of the net assets acquired. In this case, the acquisition price is $20.6
billion and the identifiable assets are $16.6 billion so the Goodwill is $4 billion. Under
current GAAP, this amount would not be amortized in the future, but Gilead would
have to assess its value annually for impairment. If the goodwill value is impaired,
the goodwill asset is reduced and a charge is recognized in income.

c. Investors are likely to prefer acquisitions of identifiable net assets (even if
intangible), rather than vaguely-defined “synergy effects.” When the acquired
company goes to the highest bidder, there is a real risk that the highest bidder was
the one that most overestimated the potential for future synergies. When purchase
price allocations are disclosed subsequent to the acquisition, stock prices respond
favorably (unfavorably) to the disclosure that less (more) goodwill was acquired.

LO 1, 3

11/15 -121,350 +121,350 = =

7,500 shares
of Core Inc
common.
12/22 +9,375 = +9,375 +9,375 = +9,375

Dividend Cash Retained Dividend
12/31 +9,900 = +9,900 +9,900 = +9,900

Increase in Investment Retained Unrealized
Investment. Earnings Gain
1/20 +129,600 -131,250 = -1,650 +1,650 = -1,650

Sale of Core Cash Investment Retained Loss
common. Earnings on Sale

LO 1, 3
a. Year 1:
11/15 Investment in Core, Inc. (+A) ................................................ 121,35
0
Cash (-A) .............................................................................. 121,350
12/22 Cash (+A) .............................................................................9,375

Dividend income (+R, +SE) .................................................. 9,375
12/31 Investment in Core, Inc. (+A) ................................................9,900

Unrealized gain (+R, +SE) .................................................... 9,900
Year
2:
1/20 Cash (+A) .............................................................................
129,60
0
Loss on sale of investment (+E, -SE) ...................................1,650
Investment in Core, Inc. (-A) ................................................. 131,250
b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of 9,900 increases
net income and retained earnings in Year 1.
+ Cash (A) - + Investment in Core Inc (A) -

12/22/YR1 9,375 121,350 11/15/YR1 11/15/YR1 121,350
1/20/YR2 129,600 12/31/YR1 9,900 131,250 1/20/YR2
+ Loss on Sale of Investment (E) -

1/20/YR2 1,650
- Unrealized Gain (R) + - Dividend Income (R) +

9,900 12/31/YR1 9,375 12/22/YR1

E12-47 (30 minutes)
LO 1, 3
a.
11/15
Purchase
-121,350 +121,350
7,500 shares = - =
Cash Investment
of Core Inc
common.
12/20 +9,375 +9,375

+9,375
Dividend = Retained Dividend - = +9,375
Cash
12/31
+9,900 +9,900
Increase in = - =
Investment AOCI
Investment.
1/20 +129,600 -131,250 = -1,650 - =

Sale of Core Cash Investment AOCI
common.
b. Some companies complained that marking equity investments to fair value and
reporting fair value changes in the income statement did not fit their business model.
They wanted to make smaller investments in companies with whom they had a
strategic relationship or a continuing interest, but falling short of the significant
influence needed for the equity method. These companies said that they were not
interested in the possible holding gains that they might achieve. So, the IASB
allowed IFRS companies to make an irrevocable choice at the time of investment. If
they chose FVOCI, all holding gains and losses will end up in AOCI and never go
through the income statement.

E12-48 (20 minutes)
LO 1, 3
a. Year 1:
11/15 Investment in Core, Inc. (+A) ................................................ 121,35

0
Cash (-A) .............................................................................. 121,350
12/22 Cash (+A) .............................................................................9,375

Dividend income (+R, +SE) .................................................. 9,375
12/31 Investment in Core, Inc. (+A) ................................................9,900

AOCI (+SE) .......................................................................... 9,900
Year 2:
1/20 Cash (+A) .............................................................................
129,60
0
AOCI (-SE) ……………………………………….. 1,650
Investment in Core, Inc. (-A) ................................................. 131,250
b.
+ Cash (A) - + Investment in Core Inc (A) -

12/22/YR1 9,375 121,350 11/15/YR1 11/15/YR1 121,350
1/20/YR2 129,600 12/31/YR1 9,900 131,250 1/20/YR2
- AOCI + - Dividend Income (R) +

1/20/YR2 1,650 9,900 12/31/YR1 9,375 12/22/YR1

LO 1, 2, 3, 4
a. The trading stock investments will be reported at $337,950. This amount is computed
using their market values at year-end; specifically, $97,950 + $240,000, or $337,950.
b. The available-for-sale debt investments will be reported at $520,050. This amount is

computed using their market values at year-end; specifically, $288,000 + 232,050, or
$520,050.
c. The equity method stock investments will be reported at $354,000. This amount is
computed using their equity method value at year-end; specifically, $150,000 +
$204,000, or $354,000.

d. Unrealized holding losses of $7,800 will appear in the income statement. These losses
relate to the trading securities; specifically— Barth: $102,000 - $97,950 = $4,050;
Foster: $243,750 - $240,000 = $3,750; total of $4,050 + $3,750 = $7,800.
e. Unrealized holding losses of $10,950 will appear in the stockholders' equity section of
the December 31 balance sheet under other comprehensive income. These losses
relate to the available-for-sale debt securities; specifically— 30-Year Treasury Bond:
$295,500 - $288,000 = $7,500; 10-Year Treasury Note: $235,500 - $232,050 = $3,450;
total of $7,500 + $3,450 = $10,950.

LO 1, 4
(Entries in $ millions)
a. Record share of income:
Investment in affiliates (+A)……………………………. 95

Income from affiliates (+R, +SE)…………... 95
b. Record receipt of cash dividends:
Cash (+A)………………………………………………… 133

Investment in affiliates (-A)…………………… 133
c. The ending balance should be $3,695 million + $95 million - $133 million = $3,657
million. The actual balance, $1,780 million, was $1,877 million lower. The
difference could be due to dispositions (offset by additional investments), foreign
currency changes, impairments, or other adjustments besides the ones described
above.

E12-51.B (30 minutes)
LO 7
1. & 2.
Consolidating
Healy Miller Adjustments Consolidated
Current assets $1,360,000 $96,000 $ 1,456,000
Investment in Miller 400,000 $(400,000) 0
Plant assets............................... 2,400,000 328,000 12,000 2,740,000
Goodwill..................................... _________ ________ 36,000 36,000
Total assets................................ $4,160,000 $424,000 $ 4,232,000
Liabilities.................................... $ 560,000 $ 72,000 $632,000

Contributed capital..................... 2,800,000 320,000 (320,000) 2,800,000
Retained earnings...................... 800,000 32,000 (32,000) 800,000
Total liabilities & stockholders’
equity...................................... $ 4,160,000 $ 424,000 $4,232,000
3.
1/1 -400,000 = -320,000 - =
To consolidate Investment Miller
Healy & Miller. in Miller Contributed
+36,000 Capital
Goodwill -32,000
+12,000 Miller
Plant Retained
Assets Earnings

LO 7
a. Miller contributed capital (-SE) ............................................................

320,000
Miller retained earnings (-SE)..............................................................
32,000
Plant assets (+A) ................................................................................
12,000
Goodwill (+A) ......................................................................................
36,000
Investment in Miller Co. (-A) .............................................................. 400,000
b.
+ Investment in Miller Co. (A) - + Goodwill (A) -
400,000 1/1 1/1 36,000
- Miller Contributed Capital (SE) +

1/1 320,000
+ Plant Assets (A) - - Miller Retained Earnings (SE) +

1/1 12,000 1/1 32,000

LO 7
1. & 2.
Rayburn Company purchased all of Kanodia Company's common stock for cash on
January 1, after which the separate balance sheets of the two corporations appeared
as follows:
Consolidating
Rayburn Kanodia Adjustments Consolidated
Investment in Kanodia................ $ 480,000 (480,000) $ 0
Other assets............................... 1,840,000 $560,000 16,000 2,416,000
Goodwill..................................... . . 32,000 32,000
Total assets................................ $2,320,000 $560,000 $2,448,000
Liabilities.................................... $ 720,000 $128,000 $848,000
Contributed capital..................... 1,120,000 240,000 (240,000) 1,120,000
equity...................................... $2,320,000 $560,000 $2,448,000

3.
1/1 -480,000 = -240,000 =
To Investment in Kanodia
consolidate Kanodia Contributed
Rayburn & +32,000 Capital
Kanodia. Goodwill -192,000
+16,000 Kanodia
Other Assets Retained
Earnings

LO 7
a. Kanodia contributed capital (-SE) .......................................................

240,000
Kanodia retained earnings (-SE) ........................................................
192,000
Other assets (+A) ...............................................................................
16,000
Goodwill (+A) ......................................................................................
32,000
Investment in Kanodia Co. (-A)..........................................................480,000
b.
+ Investment in Kanodia Inc. (A) - + Goodwill (A) -
480,000 1/1 1/1 32,000
- Kanodia Contributed Capital (SE) +

1/1 240,000
+ Other Assets (A) - - Kanodia Retained Earnings (SE) +

1/1 16,000 1/1 192,000

LO 5
a. The investment is initially recorded on Engel’s balance sheet at the purchase price of
$23.5 million, including $9.2 million of goodwill. Because the fair value of Ball is less
than the carrying amount of the investment on Engel’s balance sheet, the goodwill is
deemed to be impaired. To determine impairment, the imputed value of the goodwill is
determined to be 17.5 million - $14.3 million = $3.2 million.
b. Goodwill must be written down by $6.0 ($23.5 - $17.5) million. The write-down will
reduce the carrying amount of goodwill by this amount, and the write-down will be
recorded as a loss in Engel’s consolidated income statement, thereby reducing
retained earnings by that amount.

E12-56B (60 minutes)
LO 5, 7
a.
Cash paid........................................................................... $252,000
Fair market value of shares issued.................................... 216,000
Purchase price.................................................................. 468,000
Less: Book value of Harris................................................. 336,000
Excess payment................................................................. $132,000
Excess payment assigned to specific accounts based on fair market value:

Buildings............................................................................ 48,000
Patent................................................................................ 36,000
Goodwill............................................................................. $ 48,000
$132,000
b.
Consolidation Consolidated
Accounts Easton Company Harris Co. Entries Totals
Cash $100,800 $48,000 148,800
Receivables 192,000 108,000 300,000
Inventory 264,000 156,000 420,000
Investment in Harris 468,000 [S] $(336,000) -
[A] (132,000)
Land 120,000 72,000 192,000
Buildings, net 480,000 132,000 [A] 48,000 660,000
Equipment, net 144,000 60,000 204,000
Patent 0 --- [A] 36,000 36,000
Goodwill - -- [A] 48,000 48,000
Totals $1,768,800 $576,000 $2,008,800
Accounts payable $192,000 $36,000 $ 228,000

Long-term liabilities 456,000 204,000 660,000
Common stock 600,000 48,000 [S] (48,000) 600,000
Additional paid-in capital 88,800 - 88,800
Retained earnings 432,000 288,000 [S] (288,000) 432,000
Totals $1,768,800 $ 576,000 $2,008,800
c. The tangible assets are accounted for just like any other acquired asset. The
receivables are removed when collected, inventories affect future cost of goods sold,
and depreciable assets are depreciated over their estimated useful lives. Intangible
assets with a determinable life are amortized (depreciated) over that useful life. Finally,
intangible assets with an indeterminate useful life (such as goodwill) are not amortized,
but are either tested annually for impairment, or more often if circumstances require.
(However, note, FASB is re-considering the post-acquisition treatment of goodwill and
may move to an amortization with impairment method in the future.)

E12-57.A (20 minutes)
LO 6
a. Investment in Harris Company (+A) ....................................................

34,560
Equity in earnings of Harris Company (-SE) ....................................... 34,560
The equity in earnings of Harris Company is calculated as follows:
40% x [$96,000 – ($48,000  20) – ($36,000  5)] = $34,560
b. $187,200 + $34,560 – 40% x $48,000 = $202,560.
E12-58.C (20 minutes)

LO 8
a. Companies use derivative securities in order to mitigate risks, such as commodity price
risks, risks relating to foreign exchange fluctuations, or risks relating to fluctuations in
interest rates.
b. Derivatives are reported on the balance sheet as are the assets or liabilities to which
they relate. Generally, derivatives and the related assets/liabilities are reported on the
balance sheet at their fair market value.
c. The unrealized gains (losses) on HPE’s derivatives are reported in the Accumulated
Other Comprehensive Income section of its stockholders’ equity. This reporting
indicates that the underlying item being hedged has not yet affected HPE’s profits.
Once the underlying item appears in income, these unrealized gains (losses) will be
removed from AOCI and transferred into current income.

PROBLEMS
P12-59. (50 minutes)

LO 1, 2, 3
a. Available-for-sale investments are reported at market value on the balance sheet.

Thus, Met Life’s bond investments are reported at:
$354,809 million as of 2020

$327,820 million as of 2019
b. Net unrealized gains (losses) at the end of 2020 are:
$44,079 million ($45,519 million - $1,440 million)
Net unrealized gains (losses) at the end of 2019 are:
$30,132 million ($31,812 million - $1,680 million)
Because the investments are accounted for as available-for-sale, these unrealized

gains (losses) did not affect reported income for 2020 and 2019. (Note: Had these
investments been accounted for as trading securities, those unrealized gains
(losses) would have affected reported income.)
c. Realized gains (losses) are gains (losses) that occur as a result of sales of
securities. These are reported in the income statement and affect reported income.
Unrealized gains (losses) reflect the difference between the current market price of
the security and its acquisition cost. Only unrealized gains (losses) from trading
securities are reported in income. If MetLife had sold all of the AFS securities on
which it had gains, its pre-tax income would have increased by $45,519 million.
d. The evaluation of investment performance is difficult as companies have discretion

over the timing of realized investment gains (losses) and can, thereby, affect
reported income. By including unrealized gains (losses) in the analysis, we are able
to get a clearer picture of overall investment performance—albeit, with an
understanding that these gains and losses are not yet realized. These returns could
then be compared with those of competitors and market rates in general for
investments of comparable risk. We believe this reporting metric provides useful
insights as noted.

P12-60.B (30 minutes)
Consolidating
Gem Alpine Adjustments Consolidated
Current assets............................ $322,500 $200,000 $ 522,500
Investment in Alpine................... 490,000 - $(490,000) -
Plant assets (net) ...................... 331,250 575,000 906,250
Total assets................................ $1,143,750 $775,000 $ 1,428,750
Liabilities.................................... $62,500 $75,000 137,500

Common stock........................... 875,000 525,000 (525,000) 875,000
Noncontrolling interest............... 210,000 210,000
equity...................................... $1,143,750 $775,000 $1,428,750
P12-61. (40 minutes)

LO 1, 2, 3, 4
a. The trading security investments will be reported at $562,950. This value is computed
using their market values at year-end; specifically, $157,950 + $405,000.
b. The available-for-sale investments will be reported at $538,500. This value is

computed using their market values at year-end; specifically, $298,500 + $240,000.
c. The held-to-maturity bond investments will be reported at $355,800. This value is

computed using their amortized cost value at year-end; specifically, $151,800 +
$204,000.
d. Unrealized holding gains of $15,600 will appear in the income statement. These gains
relate to the trading securities; specifically— Ling: $157,950 - $153,600 = $4,350 gain;
Wren: $405,000 - $393,750 = $11,250; total of $4,350 + $11,250 = $15,600. The
calculation is only possible because this is the first year the bonds have been held.
Therefore, the entire price difference occurred this year.
e. Unrealized holding gains of $12,000 will appear in the stockholders' equity section
of the December 31 balance sheet under accumulated other comprehensive
income (AOCI). These losses relate to the available-for-sale securities; specifically
— Olanamic: $298,500 - $295,500 = $3,000; Fossil: $240,000 - $231,000 = $9,000;
total of $3,000 + $9,000 = $12,000.

P12-62.A,B (60 minutes)
LO 1, 4, 5, 6, 7
a. Yes, each individual company (e.g., parent and subsidiary) maintains its own
financial statements (and their own underlying books and records). This approach is
necessary to identify and maintain a record of the activities of the individual units
and to report to the respective stakeholders of each unit (division heads, minority
owners, etc).
The purpose of consolidation is to combine these separate statements to more

clearly reflect the operations and financial condition of the combined (whole) entity
and after eliminating intercompany transactions.
b. The Investment in Financial Services is reported on the parent’s (Equipment

Operations) balance sheet at $5,345 million.
This amount is the same balance as reported for stockholders’ equity of the
Financial Services subsidiary.
This relation will always exist when the investment is organic, meaning that the
parent created and funded the subsidiary.
c. The consolidated balance sheet more clearly reflects the actual assets and liabilities
of the combined company relative to the information revealed by the equity method
of accounting. That is, it better reflects operations as one entity as far as investors
and creditors are concerned.
The equity method of accounting that is used by the parent company to account for
its investment in a subsidiary reflects only its proportionate share of the investee
company stockholders’ equity and does not report the individual assets and liabilities
comprising that equity.
d. The consolidating adjustments generally accomplish three objectives:
(i) They eliminate the equity method investment on the parent’s balance sheet and
replace it with the actual assets and liabilities of the investee company to which it
relates.
(ii) They record any additional assets that are included in the investment balance
that may not be reflected on the subsidiary’s balance sheet, like goodwill, for
example.
(iii) They eliminate any intercompany sales and receivables/payables.

e. The consolidated stockholders’ equity and the stockholders’ equity of the parent
company are equal. This equality will always be the case. The consolidation process
replaces the investment account with the assets and liabilities to which it relates.
Thus, stockholders’ equity remains unaffected.
f. Consolidated net income will equal the net income of the parent company. The
reason for this result is that the parent reflects the income of the subsidiary via the
equity method of accounting for its investment. The consolidation process merely
replaces the equity income account with the actual and individual sales and
expenses to which it relates. Net income is unaffected.
g. The equity method of accounting reports investments at adjusted cost (beginning

balance plus equity earnings and less dividends received)—this contrasts with the
market method. Unrealized gains for a subsidiary are, therefore, not reflected on the
consolidated balance sheet and income statement. Instead, the subsidiary is
reflected on the balance sheet at its purchase price net of depreciation and
amortization, just like any other asset. The consolidation process merely replaces
the investment account with the actual assets and liabilities to which it relates. Thus,
there can exist substantial unrealized gains subsequent to the acquisition that are
not reflected in the consolidated financial statements when consolidation is required
(nor when using the equity method of accounting at the parent company).

CASES
C12-63. (60 minutes)

LO 1, 3
a. Return on assets:
$57,411 + (1 – 0.25)*$2,873
ROA = = 0.180 or 18.0%
($323,888 + $338,516)/2
b. Return on net operating assets

$57,411 – ($803 x (1 – 0.25))
RNOA = = 1.736 or 173.6%
($23,961 + $41,481)/2
RNOA above 174% is a very high number. One factor contributing to this return is
Apple’s well-known use of contract manufacturers. Apple concentrates on the product
design, but they let other companies do much of the manufacturing. This means there
are relatively fewer assets on the balance sheet. Another factor is that Apple develops
much of its intellectual property in-house, which means that it doesn’t show up on the
balance sheet. Apple reports no goodwill asset in its balance sheet and no intangible
assets., This reduces the company’s reported assets. Finally, Apple has issued a
non-trivial amount of debt (borrowed money) over time. All of these factors yield a
relatively low net asset amount in the denominator of the RNOA ratio. The small
denominator results in a higher ratio, that is a higher RNOA. In other words, Apple
earns a high return per dollar of net operating asset employed.
c. Apple is using the available-for-sale method to account for its fixed-income

investments. The value that will be used on the balance sheet is the fair value at the
end of the fiscal year. The unrealized gains and losses are reported in the
accumulated other comprehensive income section of the shareholders’ equity.
d. Return on financial assets: The return on financial assets is measured as the income
from interest and dividends divided by the average balance of financial assets (which
Apple refers to as marketable securities).
(1 – 0.25) x $3,763
Return on Financial Assets = = 0.0182 or 1.82%
($153,814 + $157,054)/2
Apple’s return on its financial assets is much lower than its return on its operating
assets. This differential is reasonable because interest rates are low and also Apple
earns very high returns on its products. However, the interest and dividend income in
the income statement do not tell the whole story because these are available-for-sale
assets and thus the unrealized holding gains and losses are not in the income
statement but in AOCI. Apple’s disclosures show that they have net unrealized gains
of $3,320 million as well (but again, these are unrealized).

LO 1, 3, 4
a.
1/2/22 -588,000 +588,000 = - =

Buy 28,000 Cash Investment
shares of
Dye.
12/31/22 +22,400 = +22,400 +22,400 - = +22,400

Declare Dividend Retained Dividend
dividend Receivable Earnings Income
$.8/share.
12/31/22 -84,000 = -84,000 - +84,000 = -84,000

Recognize Investment Retained Unrealized
decline in Earnings Loss
investment.
1/18/23 +22,400 -22,400 = - =

Receipt of Cash Dividend
dividend. Receivabl
e
b.
1/2/22 -588,000 +588,000 = - =
Buy 20,000 Cash Investment
shares of
Dye.
12/31/22 +22,400 = - =
Declare Dividend
dividend Receivable
$.8/share.
-22,400
Investment
12/31/22 +156,800 = +156,800 +156,800 - = +156,800

Recognize Investment Retained Investment
income from Earnings Income
investment.
1/18/23 +22,400 -22,400 = - =

Receipt of Cash Dividend
dividend. Receivabl
e

LO 1, 3, 4
a.
i. Year 1:
1/2 Investment in Dye, Inc. (+A) ..............................................................
588,000
Cash (-A) ...........................................................................................
588,000
12/31 Dividend receivable (+A) ...................................................................

22,400
Dividend income (+R, +SE) ...............................................................
22,400
12/31 Unrealized loss (+E, -SE) ..................................................................

84,000
Investment in Dye, Inc. (-A) ...............................................................
84,000
Year
2:
1/18 Cash (+A) ..........................................................................................
22,400
Dividend receivable (-A) .................................................................... 22,400
ii.
+ Cash (A) - + Investment in Dye Inc. (A) -
1/18/23 22,400 588,000 1/2/22 1/2/22 588,000 84,000 12/31/22
+ Dividend Receivable (A) -

12/31/22 22,400 22,400 1/18/23
+ Unrealized Loss (E) - - Dividend Income (R) +

12/31/22 84,000 22,400 12/31/22

b.
i. 2022:
588,000
Cash (-A) ...........................................................................................
588,000
12/31 Dividend receivable (+A) ...................................................................

22,400
Investment in Dye, Inc. (-A) ...............................................................22,400

156,800
Investment income (+R, +SE) ...........................................................156,800
2023:
1/18 Cash (+A) ..........................................................................................
22,400
Dividend receivable (-A) ....................................................................22,400
ii.
+ Cash (A) - + Investment in Dye Inc. (A) -
1/18/23 22,400 588,000 1/2/22 1/2/22 588,000
12/31/22 156,800 22,400 12/31/22
- Investment Income (R) + + Dividend Receivable (A) -

156,800 12/31/22 12/31/22 22,400 22,400 1/18/23

LO 1, 2, 3, 4, 5
a. Consolidated statements present the total assets and liabilities of all firms in which
the reporting firm has more than a fifty percent ownership with intercompany
accounts and transactions eliminated.
b. Demski, Inc. has a controlling interest in Asare and Demski Finance. Therefore, all
of Asare’s and Demski Finance’s assets and liabilities are added to those of Demski
Inc. for the presentation of the consolidated balance sheet. Demski, Inc. does not
have a controlling interest in Knechel. Therefore, it must show its investment in
Knechel Inc. as a financial asset (and use the equity method of accounting for that
investment).
c. This excess is the amount paid to Asare in excess of the net book value of Asare’s
assets (assets less liabilities assumed) when Asare was acquired by Demski. The
amount is known more commonly as Goodwill and reflects the fact that Demski
believed the company was worth more than the net book value of its assets.
d. The amount represents the outside ownership claim on Asare’s net assets, which
are aggregated in the balances of Demski’s accounts. In other words, Demski only
owns 75% of Asare; other investors own the remaining 25%. The non-controlling
interest represents the equity of the 25% owners. (Recall 100% of the assets and
liabilities of Asare are on Demski’s balance sheet.)

LO 1, 2, 3, 4
a. While the approach recommended by Doug is not disallowed by a specific

accounting standard, it is not consistent with the intent of GAAP. Certainly from a
position of representational faithfulness, it specifically does not represent how
management regards the investment or intends to treat it in the future. The approach
recommended is a flagrant attempt to violate the spirit of GAAP in order to manage
earnings.
Such practice may get by the firm’s auditors once or twice, but failure to be
consistent in the accounting treatment over time is unlikely to be tolerated under
SOX and the increased scrutiny applied by the SEC.
Further, such practice can lead to lawsuits by investors who can argue that
management was not accounting truthfully.
b. We believe the suggested approach to be highly unethical.


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Chapter 12

Reporting and Analyzing

Learning Objectives – coverage by question

LO1 – Explain and interpret the three

LO2 – Describe the term “fair value”

LO4 – Explain and analyze

LO5 – Describe and analyze

LO6 – Appendix 12A – Illustrate and

LO7 – Appendix 12B – Apply

LO8 – Appendix 12C – Discuss the

©Cambridge Business Publishers, 2023

©Cambridge Business Publishers, 2023

©Cambridge Business Publishers, 2023

M12-11. (10 minutes)

a. SI Griffin owns > 20% of Wright.

b. P Bond investments are always classified as passive.

c. P 2,000 shares of Alphabet is well below the number necessary to exert

d. C Watts owns more than half of Zimmerman stock

M12-12. (10 minutes)

b. Unrealized gains (and losses) on available-for-sale debt securities are reported as a

M12-13. (15 minutes)

©Cambridge Business Publishers, 2023

M12-15. (15 minutes)

Beginning balance........................ $1,500,000

©Cambridge Business Publishers, 2023

Recognize +45,000 = +45,000 +45,000 - = +45,000

Receive +18,000 -18,000 = - =

M12-16. (10 minutes)

2. Investment in Lang Company (+A) ....................................................

3. Cash (+A) ..........................................................................................

+ Investment in Lang Company (A) -

©Cambridge Business Publishers, 2023

Equity income on this investment is computed as the investee company (Penno)

M12-18. (10 minutes)

The $480,000 investment in Hirst Company appearing on Philipich Company's balance

In addition, a $120,000 noncontrolling interest [20% of ($240,000 + $360,000)] would

M12-19. (10 minutes)

Benartzi Company consolidated net income............................. $1,050,000

©Cambridge Business Publishers, 2023

a. If DeFond purchases 100% of Verduzco’s common stock, then it must produce

DeFond Company DeFond Company Lin

c. If we compare DeFond’s consolidated balance sheet to the equity method balance

©Cambridge Business Publishers, 2023

Balance Sheet Income Statement

10/1/YR1 -874,800 + 874,800 = - =

12/31/YR1 +15,750 = +15,750 +15,750 - = +15,750

12/31/YR1 +7,200 = +7,200 +7,200 - = +7,200

3/31/ +31,500 -15,750 = +15,750 +15,750 - = +15,750

4/1/YR2 +886,140 -882,000 = +4,140 +4,140 - = +4,140

M12-22. (30 minutes)

12/31 Interest receivable (+A) .....................................................................

12/31 Investment in Skyline, Inc. (+A) ........................................................

4/1 Cash (+A) ........................................................................................

©Cambridge Business Publishers, 2023

+ Cash (A) - - Interest Revenue (R)

+ Investment in Skyline Bonds (A) - - Unrealized Gain (R)

+ Interest Receivable (A) - - Realized Gain (R)

M12-23. (20 minutes)

Balance Sheet Income Statement

11/15 -256,800 +256,800 = =

12/22 +15,000 = +15,000 +15,000 = +15,000

12/31 -24,300 = -24,300 +24,300 = -24,300

1/20 +225,000 -232,500 = -7,500 +7,500 = -7,500