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Chapter 7
(A) Intercompany Profits in

Depreciable Assets
(B) Intercompany Bondholdings
Copyright © 2013 McGraw-Hill Ryerson Limited. All rights reserved.

Solutions Manual, Chapter 7 1
A brief description of the major points covered in each case and problem.
CASES
Case 7-1
In this case, students are asked to compare the accounting for an intercompany transaction
depending on whether the investee company was a controlled entity, a significantly influenced
entity, or a related party.
Case 7-2
In this case, students are asked to discuss how a loss on intercompany bondholdings should be
allocated to the parent and/or to the subsidiary.
Case 7-3
In this real life case, students are asked to determine the economic benefits of transferring a
machine from the subsidiary to the parent in order to increase the tax savings from depreciation
expense. The case also requires a discussion of various alternatives for reporting the tax savings
on the consolidated income statement.
Case 7-4
In this case taken from a CA exam, students are asked to prepare a memo for the partner to
address the accounting implications and disclosure requirements for transactions involving
convertible debentures and spin off of a division from a subsidiary to the parent and then to a newly
created subsidiary.
Case 7-5
In this case taken from a CA exam, students are asked to prepare a statement of loss to support an
insurance claim and to prepare an analysis of accounting issues involving nonmonetary
transactions, asset impairments and lease termination payments.
Case 7-6
In this case taken from a CA exam, students are asked to prepare a memo for the partner to
address the accounting issues for a new client in the waste management business. The accounting
issues include intercompany transactions in capital assets, revenue recognition, contingencies and
capitalization of expenditures.

2 Modern Advanced Accounting in Canada, Seventh Edition
PROBLEMS
Problem 7-1 (15 min.)
This is a relatively short problem requiring the reconstruction of the investment account when the
parent used the equity method. Unrealized profit transactions in depreciable assets made by both
companies are involved.

This question requires the preparation of a consolidated income statement when the parent has
used the cost method and where the realization of an unrealized profit in depreciable assets is
involved.

This problem consists of two-year consolidated income statements that have been incorrectly
prepared and require correcting. Intercompany transactions and unrealized intercompany profits in
depreciable assets have been overlooked.

This problem focuses on a single transaction involving the intercompany sale of equipment. It
contrasts the differences between an upstream and downstream transaction. It also compares the
results when reporting under cost, equity, and consolidated bases.

The preparation of a consolidated balance sheet and consolidated retained earnings statement
when the parent has used the cost method is required. There are unrealized profits in inventories
and land involved as well as intercompany bondholdings, which are accounted for using the
effective-interest method. The question also requires the preparation of the year’s equity method
journal entries, an explanation of why deferred income taxes arise with the elimination of
intercompany bondholdings and an explanation as to how the parent company extension theory
would affect the debt to equity ratio.

The preparation of a consolidated income statement is required when the parent has used the
equity method of accounting. Unrealized profits in depreciable and nondepreciable assets as well
as inventories are involved. Every line on the income statement requires adjustment in the
consolidation process. The preparation of the parent’s income statement under the cost method is
also required.

The preparation of a consolidated statement of financial position is required when the parent has
used the equity method and there are intercompany bondholdings and intercompany profits in a
depreciable asset. NCI is measured at the date of acquisition using the fair value as determined by
an independent business valuator.

A comprehensive problem that involves all of the consolidation adjustments taken to the end of
Chapter 7.

This is another problem from a CMA exam that involves unrealized profits in inventories and other
assets when the parent has used the cost method. The calculation of selected items from the
consolidated balance sheet is required as well as the calculation of total income of the parent
company for the year if the equity method had been used. It also compares the straight-line and
effective-interest method for bond amortization.

This problem involves equity method journal entries and the calculation of selected accounts when
there are intercompany bondholdings, which are accounted for using the effective-interest method.

This problem requires the preparation of a consolidated income statement when the parent has
used the cost method and there are intercompany bondholdings.

This problem involves equity method journal entries and the calculation of selected accounts when
there are intercompany bondholdings.

This is a problem from a CGA exam that involves unrealized profits in inventories and building when
the parent has used the equity method. It involves the preparation of a consolidated income
statement, the calculation of selected items from the consolidated balance sheet, and an
explanation of the difference if the parent had used the cost method.

In this fairly difficult problem, selected trial balance accounts from the records of a parent and its
90%–owned subsidiary are given. The parent has used the equity method and there are
intercompany bonds and unrealized gains on land. The preparation of a consolidated income
statement and a consolidated retained earnings statement is required.

In this comprehensive problem, the parent has used the cost method and there are unrealized
profits in land, depreciable assets, and inventory. The preparation of the three consolidated financial
statements is required along with an explanation of how the historical cost principle supports the
elimination of unrealized profits. It also involves the calculation of goodwill, NCI (using the market
price of the subsidiary’s shares at the date of acquisition) and return on equity under the parent
company extension theory.

This comprehensive problem originally appeared on a CMA national examination. It involves an
intercompany loss on a building and unrealized gains on equipment and inventories when the
parent has used the cost method. The preparation of a consolidated income statement and retained
earnings statement is required along with an explanation of the rationale for not always eliminating
intercompany losses in depreciable assets. It also compares the straight-line and effective-interest
method for bond amortization.

This problem appeared on a CGA national examination. It involves unrealized profits in inventory
and equipment. The preparation of a consolidated income statement and retained earnings
statement is required along with an explanation of how the historical cost principle supports
consolidation adjustments. It also involves the calculation of goodwill impairment loss and NCI
under the parent company extension theory.

This problem involves an intercompany sale of equipment when both the parent and subsidiary use
the revaluation model to account for equipment. The student must calculate account balance for
selected account for the separate entity statements of the parent and subsidiary and for the
consolidated statements.
WEB-BASED PROBLEMS
Web Problem 7-1
The student answers a series of questions based on the 2011 financial statements of Barrick Gold
Corporation, a Canadian company. The questions deal with accounting policies for tangible and
intangible long-term assets and the impact of changes in accounting policies on certain financial
ratios.
Web Problem 7-2

The student answers a series of questions based on the 2011 financial statements of RONA inc., a
Canadian company. The questions deal with accounting policies for tangible and intangible long-
term assets and the impact of changes in accounting policies on certain financial ratios.
SOLUTIONS TO REVIEW QUESTIONS
1. A $2,700 intercompany gain recorded by a constituent company is held back in the

preparation of the consolidated income statement by showing no gain on the statement.
Income tax expense is reduced by the amount of income tax that the selling company
recorded on this gain in the year of sale. In subsequent years, the intercompany gain is
realized in the preparation of consolidated income statements by reducing depreciation
expense. This reduction in expense increases consolidated net income and thus realizes a
portion of the gain in before-tax dollars. Income tax expense is increased each year by the
depreciation expense reduction multiplied by the tax rate used on the original gain
transaction. This results in a portion of the gain being realized in after-tax dollars. Over the
life of the asset, the reduction in depreciation exactly offsets the gain that had been
eliminated.

2. The realization of an intercompany inventory profit is accomplished by decreasing
consolidated cost of goods sold by the amount of the profit. The resultant cost of goods
sold is stated at historical cost to the entity. The realization of an intercompany depreciable
asset profit is accomplished by decreasing consolidated depreciation expense. The
resultant depreciation expense is stated at historical cost to the entity.
3. Yes. The realization of the intercompany profit through the adjustment to consolidated
depreciation is considered to be in effect an indirect sale of a portion of the equipment to
customers outside the consolidated entity. Further, if a depreciable asset is sold to a third
party, the remaining intercompany profit is then realized.
4. No. The only time an adjustment of this kind affects the non-controlling interest calculation
is when the subsidiary was the selling company in the transaction that created the original
intercompany gain.
5. As long as the purchaser continues to depreciate the depreciable asset an adjustment will
be required on consolidation to change depreciation expense to what it would have been
had the intercompany sale not taken place.
6. As the purchaser uses the depreciable asset and earns a profit by selling its own goods
and services to outsiders, a portion of the previously unrecognized gain is considered to be
realized from a consolidation viewpoint. As each year passes, the amount of unrealized
gain is reduced and, in turn, the adjustment of beginning retained earnings is reduced.
7. Rather than simply eliminating the unrealized gain from the purchaser’s cost of the asset,
both the cost of the asset and accumulated depreciation are adjusted to the amounts that
would have been reported by the seller had the intercompany transaction not occurred.
This usually means that the cost and accumulated amortization are both increased i.e.
grossed up to get to the target amount.
*8. The consolidated financial statements should report account balances as if the
intercompany transaction has not occurred. The transfer from cumulative other
comprehensive income to retained earnings should be reversed on consolidation. In turn,
the equipment should be remeasured to fair value with the adjustment to fair value being
added to/subtracted from cumulative other comprehensive income.
*9. This statement is true. There should never be a gain on the consolidated income statement
from an intercompany sale of equipment regardless of whether the companies are using
the historical cost model or the fair value model to value the equipment because there has
not been a transaction with outsiders. However, there could be a gain or loss on the
separate entity income statement for the selling entity because the transaction may occur
at a point in time when the financial statements have not been updated to the most recent
fair value for the equipment. For example, the equipment may have been updated to fair
value at the end of the previous period but the sale took place late in the current year when
the fair value was higher than previously reported.
10. The four approaches are as follows:

(a) The purchasing affiliate acted as an agent for the issuing affiliate; therefore gains or
losses are allocated to the issuer.
(b) Gains or losses are allocated to the purchasing affiliate because it made the open
market purchase of the bonds.
(c) Gains or losses are allocated to the parent company because it controls the actions
of the affiliates.
(d) Gains or losses are allocated to both the purchasing and the issuing affiliates.
Approach (d) is conceptually superior because each affiliate will actually record the gain
(loss) so allocated when it amortizes the premiums or discounts that caused the
consolidated gains (losses) in the first place. As a result, the eliminations in consolidated
statements mirror the entries made by both the purchaser and the issuer.
11. An "interest elimination loss" is created in the preparation of a consolidated income

statement as a result of the unequal elimination of interest revenue and expense. When
the elimination of interest revenue is greater than the elimination of interest expense, a
reduction of the entity's before-tax net income results. This "loss" does not appear as a
separate item in the consolidated income statement.
12. The holdback of an intercompany asset gain results in the creation of a deferred tax asset
in the preparation of the consolidated balance sheet because, although the selling affiliate
has recorded the tax in its income statement, it will not be an expense of the entity until the
asset is sold to outsiders. The adjustment in the preparation of a consolidated income
statement creating a gain on bond retirement results in a deferred tax liability in the
consolidated balance sheet because none of the constituent affiliates has paid (or recorded)
the tax on the gain, but will do so in future periods when they amortize the premiums or
discounts that caused the gain.
13. Gains (losses) on the intercompany sales of assets are realized for consolidated purposes
when the assets have been used up or sold outside the entity. This event occurs in periods
that are subsequent to the period in which the selling affiliate recorded the gain.
Gains (losses) resulting from the elimination of intercompany bondholdings are realized for
consolidation purposes in the period in which the intercompany acquisition takes place.
The affiliates' share of the gain (loss) is recorded in subsequent periods when the
discounts or premiums that caused the gain (loss) are amortized by each affiliate.
14. Gains should be recognized when they are realized i.e., when there has been a transaction
with outsiders and consideration has been given/received. When the parent acquires the
subsidiary’s bonds for cash in the open market, it is transacting with an outsider and giving
cash as consideration. From the separate entity perspective, the parent is investing in
bonds. However, from a consolidated point of view, the parent is retiring the bonds of the
subsidiary when it purchases the bonds from the outside entity. Therefore, when the
investment in bonds is offset against the bonds payable on consolidation, any difference in
the carrying amounts is recorded as a gain or loss on the deemed retirement of the bonds.
15. The matching principle requires that expenses be matched to revenues. When
intercompany bondholdings are eliminated, a gain or loss on the deemed retirement of the
bonds is recognized on the consolidated financial statements. In turn, the income tax on
the gain or loss must be recognized to match to the gain or loss. Since the income tax is
not currently payable or receivable but deferred until the temporary differences reverse, it
is set up as deferred income tax.
SOLUTIONS TO CASES
Case 7-1
1. If Enron controlled LIM2, Enron did overstate its earnings by reporting a profit of $67 million
on a transaction with LIM2. When consolidated financial statements are prepared, the
intercompany transaction between Enron and LIM2 would be eliminated and the fibre optic
cable would be remeasured to the carrying value of this asset prior to the sale. The profit on
the fibre optic cable would only be recognized on the consolidated income statement when
LIM2 sells this cable to outsiders or through reduced depreciation expense over the useful
life of this asset.
2. If Enron only had significant influence over LIM2, it would use the equity method to report its
investment. Since Enron does not control LIM2, it would not be able to dictate the selling
price of the cable. Since Enron only has significant influence, the interests’ of the other
shareholders would have to be considered in setting the price. It would be similar to Enron
selling to outsiders. IAS 28 states that profit pertaining to the other shareholders’ interest
would be considered realized and need not be eliminated; only the investor’s percentage
interest in the investee times the profit must be eliminated. The unrealized profit would be
eliminated from investment income.
3. IAS 24 does not deal with the measurement of related party transactions. It only deals with
the disclosure requirements for related party transactions.
If the transaction were to be reported at carrying amount, Enron would not report the gain. If
the transaction were to be reported at exchange amount under IAS 24, Enron would be able
to report the gain.
In most of the situations considered in this question, Enron should not have reported the gain.
Gains from intercompany transactions are typically eliminated and not reported on the seller’s
financial statement. Gains are typically not reported until they are realized in a transaction with
a non-related party. This requirement applies to consolidated financial statements and
investments reported under the equity method but does not necessarily apply under related
party transactions.
Case 7-2
(a)
This case is designed to give life to a theoretical accounting issue discussed within the chapter: If a
subsidiary's debt is retired, should the resulting gain or loss be assigned to the parent or to the

subsidiary? The case attempts to illustrate that no clear-cut solution to this question can be found.
This lack of an absolute answer makes financial accounting both intriguing and frustrating. Interesting
class discussion can be generated from this issue.
Students should note that the decision as to assignment only becomes necessary because of the
presence of the non-controlling interest. Regardless of the level of ownership all intercompany
balances are eliminated on consolidation. Not until the time that the non-controlling interest
computations are made does the identity of the specific party become important.
All financial and operating decisions are assumed to be made in the best interest of the business
entity as a whole. This debt would not have been retired unless corporate officials believed that
Penston/Swansan would benefit from the decision. Thus, a strong argument can be made against any
assignment to either separate party.
(b)
Students should be required to pick one method and justify its use. Discussion usually centers on the
following issues:
• Parent company officials made the actual choice that created the loss. Therefore, assigning the
$300,000 to the subsidiary directs the impact of their reasoned decision to the wrong party. In
effect, the subsidiary had nothing to do with this transaction (as indicated in the case) so that its
financial records should not be affected by the $300,000 loss.
• The debt was that of the subsidiary. Because the subsidiary's debt is being retired, all of the
$300,000 should be attributed to that party. Financial records measure the results of
transactions and the retirement simply culminates an earlier transaction made by the subsidiary.
The parent is doing no more than acting as an agent for the subsidiary (as indicated in the
case). If the subsidiary had acquired its own debt, for example, no question as to the
assignment would have existed. Thus, changing that assignment simply because the parent
chose to be the acquirer is not justified.
• Both parties were involved in the transaction so that some allocation of the loss is required. If, at
the time of repurchase, a discount existed within the subsidiary's accounts, this figure would
have been amortized to interest expense (if the debt had not been retired). Thus, the $300,000
loss was accepted now in place of the later amortization. This reasoning then assigns this
portion of the loss to the subsidiary. Because the parent was forced to pay more than face
value, that remaining portion is assigned to the buyer.

Case 7-3
(a) The following amounts would be reported on the separate-entity financial statements:
Slum’s books Plum’s books

Years 1 + 2 Years 3 through 6
Amortization per year 84,000 / 6 = 14,000 100,000 / 4 = 25,000
Tax Rate 30% 40%
Tax savings per year 4,200 10,000
Gain on Sale at end of Year 2

Proceeds on sale 100,000
Carrying amount (84,000 x 4/6) 56,000
Gain on sale 44,000
Income tax (@30%) 13,200
The consolidated entity paid taxes of $13,200 at the end of year 2 and gained a tax saving of
$10,000 - $4,200 = $5,800 per year in years 3 through 6. In nominal terms, it gained $5,800 x 4
- $13,200 = $10,000. In present value terms, it realized a return of nearly 30%. Therefore, the
intercompany sale was a good financial decision.
(b) 40% of Slum’s after-tax gain on the sale of the machine would now be credited to the non-
controlling interest i.e., ($44,000 - $13,200) x 40% = $12,320. Since this amount is
greater than the overall tax saving of $10,000, Plum would realize an overall loss of
$2,320 on the intercompany transaction. From Plum’s perspective, it is not a good
financial decision.
(c) As a result of the intercompany transaction, amortization expense has increased from
$14,000 to $25,000 per year. The extra $11,000 must be eliminated on consolidation so
that only $14,000 of amortization expense is reported on the consolidated income
statement. Income tax on the $11,000 must also be eliminated. Three alternatives are
presented below for the elimination of tax on the excess amortization for each of Years 3
to 6:

Controller Manager Other
Excess amortization $11,000 $11,000 $11,000
Proposed tax rate 30% 40% 52.727%
Tax saving eliminated 3,300 4,400 5,800
Tax saving before adjustment 10,000 10,000 10,000
Tax saving after adjustment 6,700 5,600 4,200
The controller’s suggestion of 30% can be supported on the basis that the total tax eliminated
over 4 years will be $13,200 which is equal to the tax paid by Slum when the gain was reported
for tax purposes. This results in reporting a tax saving of $6,700 on amortization expense of
$14,000 on the consolidated income statement. This is $2,500 per year more than Slum’s tax
saving of $4,200 per year before it sold the machine to Plum. This fairly presents the actual
situation because Plum is achieving an incremental tax benefit of $2,500 per year (i.e. $10,000
overall gain spread over 4 years) as a result of the intercompany transaction.
The other option can initially be supported on the basis that it would report a tax saving of
$4,200 on amortization expense of $14,000 on the consolidated income statement which is
consistent with what was reported before the intercompany transaction occurred. However, it
would eliminate a total of $23,200 of tax over 4 years, which is $10,000 more than the tax paid
on the original sale of the machine. Therefore, this alternative does not fairly present the true
tax situation for the consolidated entity or the non-controlling interest. The manager’s
suggestion would produce similar results as the other option.
Case 7-4
Memo to: Partner
From: Stephanie Baker, CA
Subject: Canadian Developments Limited (CDL) Engagement
As requested, I have analyzed the accounting implications, financial statement disclosure, and other
matters of importance relating to several transactions that CDL entered into during the Year 8 fiscal
year.
Overall, the policies suggested by CDL management lead me to conclude that there is a bias towards
adopting policies that maximize earnings and provide a strong balance sheet in order to attract new
investors.

Changes in capital structure
If the convertible debentures are, in substance, permanent equity of CDL, then their classification as
shareholders' equity is appropriate and gives the proper presentation of the economic substance of the
transaction. Therefore, it is necessary to determine whether these debentures are, in substance, equity
or debt.
Likelihood of conversion
The classification of the debenture will depend on the likelihood of the debenture being converted
to common shares. In this instance, the holders of the debentures are a relatively small group
(major shareholder (53%) and large institutions), and CDL may be able to find out from them what
their intentions are. If the majority of the holders confirm their intention to convert, the question of
uncertainty will be largely resolved.
CDL has the option to trigger (force) conversion by repaying the debt at maturity by issuing common
shares. The existence of the option, however, is not sufficient to permit accounting for the debenture on
the unsupported assumption that the conversion will occur. CDL must intend to force conversion if it
wishes to account for the debentures as permanent equity.
Unusual features
The lower interest rate on the debenture indicates that a large portion of the security's value lies in
the conversion feature, thus increasing the likelihood of conversion.
Future financial solvency

Although it is impossible to assess the company's solvency 20 years from now with accuracy, it is
important to assess the financial stability and trends. This will provide insight into whether the company
will be able to meet the solvency tests required to force conversion. Financial solvency is unlikely to be
a concern in 20 years time in light of the following: the size of the company (lots of equity); publicly held
debt (major financial institutions will have debt covenants aimed at solvency); and diversification that
should insulate the company from shocks to one sector of the economy.
Other factors
There are other, less critical, factors that can be considered in determining whether the debenture
should be classified as debt or equity:
• In common with other forms of debt the debenture pays interest and therefore the return is not
dependent on earnings.
• The legal form of the instrument is debt; if CDL were liquidated, this debenture would take
precedence over equity.
• The debentures can be redeemed by the holder at the purchase price.
The most important consideration in this decision is the intention of CDL and the debt holders
regarding conversion. If we can establish that conversion is likely, then I would support the client's
classification of this debenture as equity.
There should be full disclosure in the notes to the financial statements regarding the classification of
this transaction. We must ensure that the income statement treatment of the interest payments is
consistent with the balance sheet presentation. That is, if this debenture is classified as equity, then
the interest payments should be disclosed as dividends. If Revenue Canada requires debt
treatment, then the dividends should be disclosed net of tax.
There will be no effect on CDL's basic earnings per share figure regardless of the balance sheet
treatment given to this transaction because the amount available to the common shareholders will
be the same under both presentations. However, if the conversion proved dilutive, then the effects
of the conversion would have to be incorporated in the calculation of the fully diluted earnings per
share. If CDL does not already disclose fully diluted earnings per share and the conversion is
dilutive, then fully diluted earnings per share will have to be disclosed.
Redeemable preferred shares

Two issues need to be considered with respect to the redeemable preferred shares: their
classification on the balance sheet (same issue as the convertible debentures), and their
measurement on the balance sheet.
Classification
Since the preferred shares are mandatorily redeemable in five years' time, they do not constitute a
part of CDL's permanent capital. CDL should classify share capital according to the substance i.e.
debt, which would result in the preferred shares being excluded from the permanent equity section
of the balance sheet.
Measurement of the conversion

There are three alternatives for recording the conversion:
1) Record at $20 million
This alternative is supported by the historic cost concept. The cost to CDL of the preferred shares

is $20 million. This approach would be reinforced if the $20 million were the legal, stated amount
(i.e., the paid-in amount). CDL could then appropriate retained earnings for the future payment of
$20 million.
2) Record at $40 million
The $40 million represents the effective "stake" of the shareholder in CDL. The excess $20 million
should first be charged against contributed surplus, and then the balance charged against retained
earnings.
3) Amortize $20 million over 5 years
This alternative would gradually reflect the increase in the effective stake of the shareholder over
the five-year term. Since the shares are classified as debt, the charge would be to income.
Investors contribute cash to enterprises so that they can earn a return on their investment. Whether
a payment is made each year or not, an investor expects ultimately to receive the return earned
annually. In the case of a preferred share issue that is mandatorily redeemable, the return will be
provided either annually or at maturity, usually in a fixed form.
In this instance, the return has been fixed at $40 million payable in five years' time. The $40 million
represents both a return of capital and income over the five-year period until maturity. In substance,
the earnings on the invested capital are accruing over the five years and will be paid out in one
lump sum. Accounting for the substance of the transaction suggests discounting the $40 million
payment and accruing the annual dividend each year as a form of interest expense.
The conversion will need to be disclosed in the notes to the financial statements.
Disposal of residential real estate segment

In substance, all that has happened to CDL is that it sold the residential real estate operations.
However, control over the assets of the commercial division did not change since CDL
controlled these assets both before and after this series of transactions. Therefore, under the
historic cost concept, the assets of the commercial division should remain at carrying amounts.
In RPI's case, the assets should be recorded at historical cost for the following reasons:
• There is not a new economic entity.
• The fair values were not determined at arm's length, as the buyer had nothing to lose if an
inflated price was chosen.
• Appraisal increments (which we could obtain) would be accepted if there had been a
reorganization of capital.

RPI for its separate entity financial statements and CDL for it consolidated financial statements
could use the revaluation model in IAS 16 to value the assets of the commercial division at fair
value. However, it would have to do so on an ongoing basis and not on a one-shot deal.
Case 7-5
Memo to: Engagement Partner
From: CA
Re: Accounting Issues for Bakersfield Ball Boys Limited (BBB)
Users' objectives and risk
Below I have outlined the major accounting concerns facing the BBB engagement for the June
30, Year 11 financial statements. Before proceeding to the specific issues, I want to bring
several broader issues to your attention.
BBB is a private company. Accordingly, it can use IFRS or ASPE. BBB’s majority shareholder,
Tall Bottle, is a public company. Since Tall Bottle must use IFRS, it will likely insist that BBB
also uses IFRS to facilitate the preparation of consolidated financial statements. My comments
below are made on the assumption that BBB is using IFRS.
In analyzing and recommending accounting policies for the new issues facing BBB in Year 11,
we must be sensitive to the fact that the objectives of the minority shareholders, Mr. Bill Griffin
and Excavating Inc., conflict with those of the management of BBB and, probably, the majority
shareholder of BBB, Tall Bottle Ltd. (Tall Bottle). Commencing with the current year,
management's remuneration contract includes a bonus based on annual pre-tax income.
Accordingly, management is likely to want to maximize income. It appears that Tall Bottle
supported the new bonus arrangement, possibly hoping to maximize income and net assets for
consolidation. However, Mr. Bill Griffin and Excavating Inc. were opposed to the bonus
arrangement. Therefore, these minority shareholders will want to ensure that income is not
unjustifiably overstated. A factor that could mitigate this conflict is that BBB may want to
decrease revenues, where possible, in order to minimize any payments (or maximize receipts)
under the new equalization program.
As a result of these conflicting objectives, our overall exposure on this engagement has
increased. This exposure risk will be further increased if we recommend accounting policies,
since they might ultimately cause financial harm to one of the users of the financial statements.

We should therefore consider whether it would be prudent for us to avoid recommending
accounting policies in light of the given conflicts.
On the assumption that we will recommend accounting policies in spite of the increased
exposure risk, I have given priority to the objectives of the management of BBB since they are
preparing the financial statements, and the majority shareholder, Tall Bottle, supports their
objectives. In light of the increased exposure, we must ensure that our recommendations are
not too aggressive.
(Candidates failed to identify the conflicting objectives of the users of the financial statements
and the corresponding risks.)
Sportsplus contract
Exclusive rights
Since the minority shareholders may have concerns that the management of BBB and the
majority shareholder are benefiting from BBB at their expense, we must be careful in dealing
with the Sportsplus contract arrangement. During the year, Sportsplus granted valuable
advertising rights to Tall Bottle at no cost, in exchange for BBB's local television rights. It
appears that Tall Bottle may have benefited from this deal at the expense of the other
shareholders. We will need to determine whether BBB gave up any revenues in its deal with
Sportsplus so that Tall Bottle could become BBB's official sponsor. Specifically, was the sale of
television rights to Sportsplus at fair market value? This will be difficult for us to determine. If we
establish that the sale was not at fair market value, we could suggest that a receivable from Tall
Bottle be established for the difference between the contract price and fair value. Tall Bottle may
suggest that the free advertising they received was compensation for management services
provided to BBB. If so, BBB should recognize a management fee expense and revenue from
sale of TV rights. If Tall Bottle opposes this accounting treatment, as a minimum this related
party transaction should be disclosed in the notes to the financial statements so that other
shareholders can assess its implications.
(Candidates failed to recognize the reporting implications of the exclusive-rights contract.)
Signing bonus
The $250,000 signing bonus received by BBB for renewing its contract with Sportsplus can be
accounted for in several ways. One approach is to take the full amount into income in the
current year. Management may argue, for example, that the critical event in earning the

payment is the signing of the contract in the current year.
An alternative approach is to consider the payment as part of the total revenue for the contract.
The amount of the signing bonus would then be taken into income over the contract term.
Management will obviously favour recognizing all the income in Year 11. However, given the
magnitude of the payment, the substance of the transaction is probably better portrayed by
treating the payment as part of the total revenue for the contract. In light of the stronger
theoretical support for amortizing this revenue over the contract term and the strong concerns
that the minority shareholders may raise, it is my recommendation that the signing bonus be
amortized over the three-year contract term.
(Although candidates identified the alternative methods of recognizing revenue for the signing
bonus, they did not analyze the merits of each alternative in adequate depth.)
Payment for high ratings

We must find out whether the $315,000 payment to BBB for its high ratings over the previous
contract term was conditional on the re-signing of the television contract. If it was, then this
amount relates to the new contract and should be recognized over the new contract term.
If the amount relates to past ratings (i.e., it was not conditional on the re-signing) and if during
any of the prior periods BBB could have made a reasonable estimate of the amount that would
be paid, then the amount should have been accrued in that prior period. Under these conditions,
a correction of an error will be necessary. However, if a reasonable estimate of the amount
could not have been made in the prior periods, then it is appropriate to take the amount into
income in the current year.
As a minor matter, we may want management to consider whether it would be appropriate to
allocate more of the revenues to certain games and less to others, based on their popularity,
etc.
(Candidates did not identify the accounting implications of the payments for high ratings. Most
candidates tried to analyze the signing bonus issue and the high ratings payment issue together,
even though they were based on different facts and therefore required separate analysis.)
Player contracts
Player contracts probably represent one of the most significant costs of BBB. Accordingly, these
commitments should be disclosed in the notes to the financial statements, as required by
generally accepted accounting principles (GAAP).

Bill Board
Bill Board's injury has compelled him to retire from playing baseball. In view of the impairment in
"future benefit," we should consider whether we should expense in the current year a portion, or
all, of the payments required under his guaranteed contract. The portion not written off should
be included in administrative expenses on the income statement over the period of benefit, and
not in player contracts.
Frank Ferter
It is uncertain at this time whether Frank Ferter will be selected to play for the All Star Team,
which would oblige BBB to pay him a $50,000 bonus. Since Ferter is favoured to capture this
honour, it is likely that the amount will be paid by BBB and, therefore, the amount should be
accrued in the financial statements. If investigation reveals that his inclusion in the team is
unpredictable, then this contingent liability should be disclosed in the notes to the financial
statements. In any event, this amount is probably immaterial to the financial statements.
Management's proposal to amortize the cost of Ferter's three-year contract over ten years
seems overly aggressive. Their position is probably based on an attempt to increase their
bonus. It is very difficult to estimate the future benefit of this player to the future of the team-the
uncertainty of the future benefit is analogous to that of advertising expenditures. Given the
uncertainty, it is recommended that the contract be expensed over the three-year period.
(Overall, candidates were able to identify and appropriately discuss the accounting implications
of the player contracts.)
Termination payment
As a result of the move to its new premises, BBB was required to make a final payment of $3.6
million to NoWay Park to terminate its lease. This payment can be accounted for in several ways.
One approach is to expense the payment in the current year since no future benefit will be obtained
by BBB from this site.
An alternative approach is to amortize the payment over the ten-year term of the new lease with Big
Top stadium. This approach is supported by the fact that the termination payment was a cost that
had to be incurred in order to rent the new premises. This cost should therefore be matched to the
period during which the benefit is to be derived from the new stadium.
A final option is to amortize the cost over the remaining three-year period of the previous lease with
NoWay. However, this approach has little theoretical support, except perhaps the argument that it is
the first three years of the new lease that carry the highest cost.

Although management would prefer to amortize the termination payment over the term of the
new lease, it is hard to justify this alternative. It is unlikely that the annual rent under the new
lease was affected by the termination cost on the old lease. BBB is no longer getting any benefit
from the old lease.. Therefore, I recommend that the termination payment be expensed in the
current year.
(Candidates were able to identify the alternative accounting methods for the lease termination
payment, and they discussed these alternatives in adequate depth.)
Equalization costs
As a result of the new equalization program, BBB may receive from, or be required to pay to,
the league a portion of its revenues. However, the final amount cannot be determined until the
season ends, since it depends on many variables, such as BBB's revenues and the revenues
of all other teams in the league. These amounts in turn depend on how each team is doing in
the league, which teams are in the playoffs, etc. Furthermore, it is difficult to estimate BBB's
revenues in the new stadium because there is no basis for comparison. An accounting problem
arises, however, because BBB's year-end is mid-way through the season.
One approach is to postpone recording any amount in the accounts until the net cost/revenue
is known in October. One can argue that it is simply too difficult to make any reasonable
estimate, given all the unknown variables discussed above. Under this approach, however,
BBB would disclose the possible contingent liability.
The alternative is to accrue for an amount that will likely be paid by BBB (contingent gains
cannot be accrued). However, this accrual will be very difficult to measure, for the reasons
discussed above.
In light of the fact that the statements will be used to determine management bonuses and the
difficulty associated with estimating the net revenue/cost, I recommend that no amount be
accrued in the financial statements and only the contingent liability be disclosed. Although this
treatment will cause an inconsistency between the period of management "effort" and the
period in which the net amount is included, an estimate of the amount is simply too difficult at
present. This approach will not require any adjustment to the prior year's financial statements.
(Candidates understood that the June 30 year-end caused an accounting problem with regard to
these equalization payments. However, they did not identify or analyze the accounting
implications.)
Roof collapse
We must determine the net cost to BBB of the roof collapse, after considering recoveries from
the insurance company. If there is a material net cost to BBB, then this cost should be disclosed
separately.
Ticket refunds
The ticket refunds should be reported as a reduction of net sales. The unused tickets should be
recorded as unearned revenue.
Gift certificates
The gift certificates can be recorded as a liability. However, it seems more appropriate to give no
accounting recognition to these certificates because the certificates are really only an executory
contract at present and a portion of them may never be reimbursed.
(Candidates failed to identify and discuss the accounting and audit implications of the roof
collapse.)
Insurance claim
Attached to this memo is my draft report to BBB, which includes the statement of loss.
REPORT TO BAKERS FIELD BALL BOYS LIMITED
Bakersfield Ball Boys Limited Management

Dear Sir/Madam:
Attached in Appendix I is the statement of loss you requested to support your claim for
damages in accordance with your business-interruption insurance policy. Our underlying
premise in preparing this statement is that BBB should be put into the same position as if the
roof collapse had not occurred. Our calculations show that your total claim amounts to
$1,980,696.
We must review the insurance policy to ensure that all items included in our statement of loss
are appropriate and that no items to which BBB is entitled are missing from the statement. After
reviewing the policy, we will make any changes needed.
At present, the statement does not include several items that should be considered and
perhaps added. For example, the insurance company should reimburse you for any legal,

accounting and audit fees. Furthermore, BBB should consider whether there are any other
indirect costs that it may incur. Have any lawsuits against BBB arisen? Will attendance at Big
Top decline? Are the television ratings likely to be adversely affected?
Please call us once you have had an opportunity to review the enclosed information so that we
can discuss any comments you may have.
Yours truly,
CA
(Generally, candidates understood the concepts to be applied in preparing the statement of loss
(i.e. a differential revenue/cost analysis) and prepared an appropriate statement.
APPENDIX I
Bakersfield Ball Boys Ltd.
Statement of Loss
Re: Roof Collapse at Big Top
Lost revenue
Ticket sales (Note 1) $1,400,000
Confection gross profit (Note 2) 79,896
1,479,896
Additional costs (costs saved)
Gift certificates (Note 3) 480,000
Stadium rental 132,500
Groundskeeper costs (Note 4) (7,500)
Cleaning crew (Note 5) (10,500)
Food vendors (Note 6) (13,700)
580,800
Net loss to BBB $2,060,696
Note 1:
Number of Big Top cancelled tickets 40,000
Ticket price x $35
Lost ticket sale revenues $1,400,000

Note 2:
Assuming that confection sales at Big Top would have been the same, on a per-seat basis, lost
confection sales are ca1culated as follows:
[Projected net sales at Big Top, less stadium's share of sales] - [Actual net sales at NoWay, less
stadium's share of sales] =
[($191,750 x 70,000/30,000 x 50% food cost) - (191,750 x 70,000/30,000 x 15% to stadium)] –
[($191,750 X 50% food cost) - ($191,750 X 10% to stadium)] = $79,896
Note 3:
Gift certificates issued 40,000

Value x $12
$480,000
Note that this amount may be reduced by the portion that is not likely to be redeemed. The
insurance company may refuse to reimburse these costs, arguing that they were not a
necessary cost as a result of the roof collapse.
Note 4:
NoWay actual costs $9,000
Big Top projected costs 16,500
Costs saved $7,500
Note 5:
NoWay actual costs $15,250
Big Top projected costs 25,750*
Costs saved $10,500
* Assumes that BBB did not have to pay for clean-up crews at Big Top.
Note 6:
No Way actual costs $19,200
Big Top projected costs 32,900
Costs saved $13,700

Case 7-6
To: Partner
From: CA
Subject: Enviro Facilities Inc. Engagement
Overview
The Enviro Facilities Inc. (EFI) engagement has considerable risk associated with it. In
reviewing the file, I noted a number of events that raise concerns about the integrity of EFI’s
management. These events include:
(1) management’s refusal to notify the bank of its error in converting foreign funds and the
inclusion of the amount of the error in income;
(2) the change in the accounting estimate of the useful lives of assets, which has the effect of
increasing income;
(3) the ongoing dispute with the provincial tax auditors;
(4) the patent infringement suit; and
(5) the rumour that an affiliated company may not comply with environmental legislation.
No single one of these circumstances provides compelling evidence of questionable

management integrity. Changing accounting estimates is commonplace and often justifiable.
There has been no conviction on the patent infringement suit and nuisance lawsuits are not
unusual. An aggressive approach to tax can be in the interests of the shareholders, and the
rumour regarding the affiliated company is just that: a rumour. Collectively however, these
events give a hint that management may lack integrity, thus increasing the risk associated with
the engagement.
Moody’s has put EFI’s credit rating on alert for downgrading due to a toughening of
environmental legislation. EFI therefore has an incentive to improve the appearance of its
financial statements so as to influence Moody’s decision. A downgrade in the credit rating
would be costly to EFI as it would increase the cost of borrowing.
EFI’s managers and owners probably have an incentive to report higher income because of the
pending sale of the company. EFI’s accounting policies and the estimates used suggest that
this is the case. The prospective purchasers will likely use the financial statements to determine
the price of the shares, particularly because the company is private and no market price is

available for the shares. Furthermore, EFI operates in an industry where the valuation of assets
is very subjective and requires estimates.
Provincial sales tax audit

The amount under investigation by the provincial auditors is $7.22 million, which is greater than
the materiality threshold. The result of the sales tax audit must therefore be carefully
considered to determine whether and how it should be reported in the statements. The situation
is difficult to assess because the audit is continuing and there has not yet been an assessment
or even an indication by the provincial auditors of what they have determined. If they rule
against EFI, both the balance sheet and the income statement will be affected. A negative
ruling will increase the cost of the items purchased. Long-lived assets on the balance sheet will
increase by the amount of the tax reassessment. That amount will be amortized to the income
statement over the lives of the assets. Thus the income statement will reflect the portion of the
tax that relates to the amortized portion of the assets. Similarly, the income statement will be
affected by tax pertaining only to supplies that have been expensed. The effect on income is
important because prospective purchasers in deciding what price to pay for EFI’s shares may
rely on the statement. Once we receive the notice of assessment from the government, we will
be able to evaluate whether the interpretation by the auditor is correct.
If the issue is not resolved by the time we sign the financial statements, we must decide whether
this issue should be disclosed as a contingent liability or whether the amount should be accrued
in the financial statements. If we determine that the liability is likely and the $7.22 million is a
reasonable estimate, then it should be accrued. We should consult our tax department to help
us in this regard. The risk to us is that there could be inadequate disclosure of a material event,
which is especially crucial because of the possible sale of the shares. Conversely, disclosure
when the likelihood of the liability being realized is small may reduce the proceeds that the
current owners of the company could receive.
Bank error
The treatment of the bank error results in income being increased by $6,128,258, an amount
that is material. This misstatement of income could influence the decisions of potential buyers
and bond-rating agencies. Clearly, including the amount in income is not correct accounting.
The money does not belong to EFI, and the bank could ask for repayment once they discover
the error. The amount of the error should be set up as a liability, not included as revenue. Of
course, the liability may never be paid if the bank does not notice the error. If EFI refuses to
change its method of accounting for the error, we should point out that the amount is taxable.
The company may then agree to change its accounting approach since it imposes real
economic costs. Our firm should also question whether we should remain associated with EFI
given their unwillingness to return money that clearly does not belong to them.
Patent infringement award
The award against EFI made by the court in the patent infringement case is unusual. Aggrieved
parties normally receive a straightforward payment as compensation. The payment is usually
treated as an expense for accounting purposes. In this case, however, EFI is receiving
something that could have value, so the accounting is more complex. Various accounting
approaches could reasonably be used. First, since the purchase is a court-imposed penalty, the
$18 million share purchase could be considered to be an $18 million fine and shares to have
been acquired at zero cost. This approach would be unattractive to EFI since it would have a
significant effect on the income statement at a time when it is very concerned about the bottom
line (because of the potential sale of the shares and the alert placed on EFI’s credit rating). An
alternative approach would be to record the shares as an asset on the balance sheet at $18
million. This approach would be attractive to EFI’s management because the income statement
would be unaffected.
It is clear that EFI may be receiving an asset because of the court decision. The first step would
be to determine whether the shares would meet the definition of an asset. According to the
IFRS Framework, paragraph 49, “An asset is a resource controlled by the entity as a result of
past events and from which future economic benefits are expected to flow to the entity”. The
shares will be controlled by EFI and are the result of a past event (the court ruling), however
whether or not there will be any future benefits depends on the performance of Waste Systems.
If EFI is likely to derive a future benefit from the shares, then the definition of an asset has been
met.
The next question to be resolved is what the asset is worth. If the shares are to be recorded on
the balance sheet at $18 million, they must be worth $18 million. If the market value is less than
$18 million, then the amount in excess of the fair market value should be expensed since that
amount represents a penalty. Since Waste Systems Integrated Limited is a private company, it
could be difficult to arrive at a reasonable estimate of its fair market value. I strongly suggest
that we have a valuation done of the company so that we have authoritative support for the
value. Such support is especially important in view of EFI management’s concern about the
income-statement figures at the present time. That Waste Systems had been in financial
difficulty is an indication that its market value is low.
If we determine that Waste Systems has a value greater than zero and should be recorded as
an asset, a number of accounting issues will need to be resolved. We must determine whether
the shares should be considered a long- or short-term asset and whether we should
consolidate, or use the equity method. We cannot make these accounting decisions until we
have found out, for example, whether there are restrictions on EFI’s ability to sell the shares. (If
there are, accounting as a financial asset would be appropriate; otherwise, we must determine
what management’s intentions are.) Similarly, we need to find out what proportion of Waste
Systems EFI owns, to help determine the method of accounting for the investment.

Waste-disposal sites
EFI has significantly lengthened the estimated lives of its waste disposal sites and decreased
the estimated cost of sealing and cleaning up the sites. The change has a significant effect on
income, which is important because the owners are considering selling their shares. Waste-
disposal sites represent 64% of EFI’s assets and 41% of operating expenses. The disposal
sites will be an important consideration for prospective purchasers, and they may rely on the
financial statements. Thus we must exercise great care in this highly risky part of the audit.
Compounding the problem is the fact that EFI changed consulting engineers this year and the
new engineers, Cajanza Consulting Engineers (Cajanza), recommended the changes.
However, there may be an independence problem. EFI owes Cajanza $2.9 million, and the
amounts owing date back to Year 4. It is not clear why this amount has been outstanding for so
long, but EFI may be using the debt to influence Cajanza’s judgment or Cajanza may feel
pressure to provide results favorable to EFI to secure its money. It is difficult to understand how
the costs of sealing and cleaning up sites can decrease at a time when environmental regulation
is increasing, so the reduction in estimated costs requires some attention.
EFI uses three different methods for amortizing the cost of the sites. We must decide whether
using three methods is justifiable. The IFRS Framework requires that consistent accounting
policies be applied across the entity, so it is likely that using these different methods is not
acceptable. “The measurement and display of the financial effect of like transactions and other
events must be carried out in a consistent way throughout an entity and over time for that entity
and in a consistent way for different entities.”[IFRS Framework, par.39] Therefore, the company
should determine which accounting policy is the most appropriate and apply this accounting
policy consistently. The same methodology should be used to calculate amortization expense
across for an asset class.
Given the circumstances and the incentives for management to increase earnings, additional
audit steps should be taken to satisfy us that the estimated lives and clean-up costs are
reasonable. One approach would be for us to engage an engineering firm to assess the lives
and clean-up costs of the sites.
In any case, it will be necessary for the changes in estimates to be disclosed in the notes.

Locating and negotiating costs
EFI amortizes the costs of locating new waste-disposal sites and negotiating agreements with
municipalities. This approach is debatable and requires professional judgment to resolve.
IAS 16 states that the cost of an item of property, plant and equipment includes any costs
directly attributable to bringing the asset to the location and condition necessary for it to be
capable of operating in the manner intended by management. One could argue that locating
new waste-disposal sites and negotiating agreements with municipalities is a cost of bringing
the asset to the location and condition necessary for it to be capable of operating in the manner
intended by management.
On the other hand, one could argue that the cost associated with negotiating a contract would
be considered an administrative cost and would be expensed as incurred. According to IAS
16.19 “Examples of costs that are not costs of an item of property, plant and equipment
are…administration and other general overhead costs.”
We will have to discuss this matter with management to determine their rational for capitalizing
the cost. If we deem that it is not a cost of bringing the asset to the location and condition
necessary for use, the cost will need to be expensed.
Onkon-Lakerton contract
EFI has recognized the guaranteed portion of the contract with the Onkon-Lakerton municipality
as revenue. The revenue recognition criteria [IAS 18.20] states that “when the outcome of a
transaction involving the rendering of services can be estimated reliably, revenue associated
with the transaction shall be recognized by reference to the stage of completion of the
transaction at the balance sheet date. The outcome of a transaction can be estimated reliably
when all the following conditions are satisfied:
(a) the amount of revenue can be measured reliably;
(b) it is probable that the economic benefits associated with the transaction will flow to the
entity;
(c) the stage of completion of the transaction at the balance sheet date can be measured
reliably; and
(d) the costs incurred for the transaction and the costs to complete the transaction can be
measured reliably.
EFI may be able to support their position that the outcome of the contract with Onkon-Lakerton
can be estimated reliably, due to the guaranteed minimum revenue of $3.2 million per year.
However, IFRS still requires that revenue recognition be based on the stage of completion of
the transaction. EFI has not performed any of the work in relation to the contract. Indeed, the
contract period has not yet even begun. Therefore, EFI cannot recognize the $3.2 million of
revenue related to this contract.
US subsidiary lawsuits
Two US subsidiaries of the company are being sued for improper disposal of hazardous waste.
The alleged activities took place before EFI acquired the subsidiaries, and the sale-purchase
agreement provides for a price adjustment in the event of this type of liability. Provided that the
agreement covers the situation in question, including costs of litigation, and the previous owner
is able and willing to meet the obligation, then no additional audit work is necessary and it is not
necessary to make any disclosure in the financial statements.
However, before we can come to that conclusion, we must assure ourselves that EFI is fully
protected. We must be certain that the price-adjustment clauses cover legal claims of this type
and that the clauses are still in force—for example, there may be limits on how long the seller
remains responsible for actions of this type. We must determine whether the previous owner is
ready, willing, and able to meet the terms of the contract. The previous owner could have gone
out of business, could lack the resources to satisfy the claim, or could deny responsibility for
some or all of the damages.
If we conclude that there is some probability that EFI will be responsible for some or all of the
claims, we will have to consider a provision should be recorded in accordance with IAS 37.
Affiliated company dumping/purchases of disposal sites
In anticipation of the sale of shares by the owners, EFI plans to dispose of waste sites whose
clean-up costs exceed their carrying amount. This transaction would be a related party
transaction and must be disclosed in the notes of the financial statements [per IAS 24], which
would draw attention to the users that the company was transferring the assets.
We must determine whether EFI will be free of liabilities after selling the sites. EFI may be liable
contractually or legally for any future clean-up costs that result from past ownership. If potential
liabilities exist they must be reported in the financial statements.
With regard to the rumour that Enviro (Bermuda) does not plan to comply with environmental
legislation, it is not necessary for us to do anything at this point because the information is only
a rumour and nothing illegal has been done yet. We should, however, be alert for information
that substantiates the rumours.
New cost-accounting system
The new cost-accounting system will have an effect on the financial statements, so we need to
consider the effect of the changes carefully. Compost is a by-product of the waste-collection
process. Cost allocation to by-products is arbitrary. Costs can be allocated according to the
amount of revenue generated by the sale of compost or on the basis of direct costs, or by
allocating just the incremental costs. What management needs to know is the incremental cost
of producing compost so that management can determine whether it is profitable to make and
sell compost.
An effect of the new cost accounting system will be to increase income in the first year because
some of the costs of the waste-disposal business that would previously have been expensed
will now be included in inventory as part of the cost of the compost. Only actual costs can be
capitalized. We need to determine if the standard cost approximates actual cost. If not, an
adjustment must be made to reflect actual costs. Depending upon the magnitude of the
allocated costs and inventory, we should consider retroactive treatment.
Overall conclusion
The effects of the bank error, the sales-tax audit, and the treatment of the waste disposal sites,
etc., raise the possibility that the financial statements may be materially misstated.
Management seems to have taken steps that have had the effect of increasing the net income
and the assets on the balance sheet. We must consider whether we should resign from the
engagement altogether because of the questionable integrity of management. Among other
integrity concerns, the company’s handling of the bank error and changes in accounting
estimates, apparently to window-dress the statements, should make us question whether we
want to be associated with this client.
SOLUTIONS TO PROBLEMS
Problem 7-1
Before tax 40% tax After tax
Asset profit – Y Company selling
January 1, Year 2 – sale 45,000 18,000 27,000
Depreciation Year 2 9,000 3,600 5,400
Balance December 31, Year 2 36,000 14,400 21,600 (a)
Depreciation Year 3 9,000 3,600 5,400 (b)
Balance December 31, Year 3 27,000 10,800 16,200
Asset profit – X Company selling

April 30, Year 3 – sale 60,000 24,000 36,000
Depreciation Year 3 (12,000  8/12) 8,000 3,200 4,800
Balance December 31, Year 3 52,000 20,800 31,200 (c)
Investment in Y Company
Balance January 1, Year 2 $ 86,900)

Year 2 transactions:
Increase in Y Company retained earnings
([125,000 – 70,000]  80%) 44,000)
X’s share of acquisition differential amortization * (1,150)
Holdback of Year 2 asset profit (net) ((a) 21,600  80%) (17,280)
Year 3 transactions:
Increase in Y Company retained earnings
([104,000 – 70,000])  80%) 27,200)
Acquisition differential amortization (1,150)
Realization of Year 2 asset profit ((b) 5,400  80%) 4,320)
Holdback of Year 3 asset profit (net) (c) (31,200)
Balance December 31, Year 3 $111,640)
* (86,900 / 80% – 100,000) x 80% / 6 =1,150
Problem 7-2
Equipment gain
Before Tax 40% tax After tax
Year 2 sale – Sally selling 15,000
* Depreciation Years 2 and 3 (3,000  2) 6,000
Balance December 31, Year 3 9,000 3,600 5,400
Depreciation Year 4 3,000 1,200 1,800 (a)
Balance December 31, Year 4 6,000 2,400 (b) 3,600
* Assuming the sale took place at the beginning of Year 2
(a) Calculation of consolidated profit – Year 4
Profit of Peggy 185,000

Profit of Sally 53,000
Add: Equipment gain realized (a) 1,800
Adjusted profit 54,800 (c)
Consolidated profit 239,800
Attributable to:
Shareholders of Peggy 226,100
NCI (25% x 54,800) 13,700
239,800
(b) Peggy Company

Consolidated Income Statement
Year 4
Revenues (580,000 + 270,000) $850,000

Miscellaneous expense (110,000 + 85,000) 195,000
Depreciation expense (162,000 + 97,000 - (a) 3,000) 256,000
Income tax expense (123,000 + 35,000 + (a) 1,200) 159,200

Total expenses 610,200
Consolidated profit 239,800
Attributable to:
Shareholders of Peggy 226,100
NCI (25% x 54,800) 13,700
239,800
(c) Deferred income taxes - December 31, Year 4 (b) 2,400
Problem 7-3
Intercompany profits – subsidiary selling

Equipment
Sale, Sept. 30, Year 5 8,000 3,200 4,800
Depreciation Year 5
(8,000 / 5  3/12) 400 160 240 (a)
Balance, Dec. 31, Year 5 7,600 3,040 4,560 (b)
Depreciation Year 6 (8,000 / 5) 1,600 640 960 (c)
Balance, Dec. 31, Year 6 6,000 2,400 3,600
Building
Sale, Jan. 1, Year 6 42,000 16,800 25,200
Depreciation Year 6 (42,000 / 7) 6,000 2,400 3,600 (d)
Balance, Dec. 31, Year 6 36,000 14,400 21,600 (e)
Intercompany Rent
Year 5 (12,000  3/12) 3,000 (f)
Year 6 12,000 (g)
Calculation of consolidated net income

Year 5 Year 6
Incorrectly reported income 120,000 142,000
Add: incorrect amount for NCI 32,500 5,160
Incorrect amount for consolidated net income 152,500 147,160
Less: Net unrealized profits
Equipment (b) 4,560
Building (e) 21,600
Add: equipment profit realized (c) 960
(h) 4,560 (i) 20,640
Corrected consolidated net income 147,940 126,520
Attributable to:
Shareholders of Parent 116,580 126,520
NCI (32,500 - 25% x (h) 4,560) 31,360
NCI (5,160 - 25% x (i) 20,640) 00,000
147,940 126,520
Parent Company
Corrected Consolidated Income Statements
Years 5 and 6
Year 5 Year 6
Miscellaneous revenues $750,000 $825,000
Miscellaneous expense 399,800 492,340
Rent expense (52,700 – (f) 3,000) 49,700
(64,300 – (g) 12,000) 52,300
Depreciation expense (75,000 – (a) 400) 74,600
(80,700 – (c) 1,600 – (d) 6,000) 73,100
Income tax expense (81,000 – (b) 3,040) 77,960
(94,500 + (c) 640 – (e) 14,400) 80,740
Consolidated net income 147,940 126,520
Attributable to:
Shareholders of Parent 116,580 126,520
NCI (32,500 - 25% x (h) 4,560) 31,360
NCI (5,160 - 25% x (i) 20,640) 00,000
147,940 126,520

Problem 7-4
(a) (in 000s) i) ii) iii) iv)
NORD’s own income 200 200 200 200
HABS’s own income 500 500
Less: unrealized profit - 500 - 500
HABS’s adjusted income 0 0
Consolidated net income 200
NORD’s ownership 75%
NORD’s share of HABS’s income 0
Dividend income from HABS (75% x 100) 75
NORD’s total income 200 200 275
Consolidated net income attributable to:
NORD’s shareholders 200
NCI (25% x 0) 0
200
(b) (in 000s) i) ii) iii) iv)

HABS’s own income 500 500 500 500
Less: unrealized profit - 500 - 500
HABS’s adjusted income 0 0
Dividend income from NORD (75% x 100) 75
NORD’s own income 200 200
Consolidated net income 200
HABS’s ownership 75%
HABS’s share of NORD’s income . 150 .
HABS’s total income 500 150 575
Consolidated net income attributable to:
HAB’s shareholders 150
NCI (25% x 200) 50
200
(c)
We can make the following observations about the income reported under the different reporting
methods:

1. Net income under the equity method is equal to consolidated net income attributable to
parent’s shareholders because the unrealized profit is eliminated in both situations.
2. The full amount of unrealized profit is eliminated regardless of whether the transaction is
upstream as per part (a) or downstream as per part (b).
3. Unrealized profit is not eliminated under the cost method.
4. Income under cost method will be higher than income under the equity method and
consolidated net income attributable to parent’s shareholders when dividends received from
the investee exceed the investor’s share of the investee’s adjusted net income.
When the parent controls the subsidiary, the consolidated financial statements best reflect the
financial position and results of operations of the combined entities. At the date of acquisition,
the net assets of the subsidiary including goodwill are reported at fair values. The net assets of
the parent are reported at their carrying values. Therefore, the consolidated financial
statements do not reflect the fair value of all assets and liabilities. However, the assets and
liabilities are reported at the values required by generally accepted accounting principles.
Problem 7-5
Calculation, allocation, and amortization of the acquisition differential
Cost of investment, July 1, Year 1 207,900

Implied value of 100% (207,900 / .9) 231,000
Total shareholders' equity of Garden 175,000
Acquisition differential 56,000
Allocation: FV – CA
Inventory 12,000
Buildings 10,000
Patents 16,000 38,000
Balance – goodwill 18,000
Amortization
Balance Balance
July 1/1 Years 1 to 7 Year 8 Dec. 31/8
Inventory 12,000 12,000

Buildings (10 years) 10,000 6,500 1,000 2,500 (a)
Patents (8 years) 16,000 13,000 2,000 1,000 (b)
Goodwill 18,000 1,950 7,150 8,900
56,000 33,450 10,150 12,400 (c)
Intercompany receivables and payables

On open account 22,000 (d)
Dividends (30,000  90%) 27,000 (e)
Intercompany profits and losses

Opening inventory - Forest selling
(18,000  30%) 5,400 2,160 3,240 (f)
Ending inventory - Forest selling
(22,000  30%) 6,600 2,640 3,960 (g)
Land profit - Garden selling

August 1, Year 6 18,000 7,200 10,800 (h)
Sale of ¼ of land, Year 8 4,500 1,800 2,700 (i)
Balance, Dec. 31, Year 8 13,500 5,400 8,100 (j)
Intercompany bond transactions

Cost to retire bonds 57,968
Carrying amount on bonds retired (93,376  60/100) 56,026
Loss to the entity Jan. 1, Year 8 1,942 777 1,165
Interest elimination gain [(k) 882 – (m) 458] 424 170 254
Balance loss, Dec. 31, Year 8 1,518 607 911
Par value (100,000  60%) 60,000

Carrying amount (93,376  60%) 56,026
Loss to Forest 3,974 1,590 2,384)
Interest elimination gain (56,026 x 8% - 60,000 x 6%) 882 353 529) (k)(k)
Balance loss Dec. 31, Year 8 3,092 1,237 1,855) (l)

Par value 60,000
Cost to Garden 57,968
Gain to Garden 2,032 813 1,219)
Interest elimination loss (57,968 x 7% - 60,000 x 6%) 458 183 275) (m)(m)
Balance gain Dec. 31, Year 8 1,574 630 944) (n)
Deferred income taxes, Dec. 31, Year 8

Ending inventory (g) 2,640
Land (j) 5,400
Bond loss [(l) 1237 – (n) 630] 607 8,647) (o)
Garden’s accumulated depreciation, date of acquisition 95,000 (p)
Calculation of consolidated net income Year 8

Income of Forest 41,000)
Less: Dividends from Garden (50,000  90%) 45,000
Profit in ending inventory (g) 3,960
Loss on bonds (net) (l) 1,855 50,815)
(9,815)
Add: profit in opening inventory (f) 3,240)
Adjusted net income (loss) (6,575)
Income of Garden 63,000
Add: Bond gain (net) (n) 944
Realized gain on land (i) 2,700 3,644
66,644
Less: Amortization of the acquisition differential (c) 10,150
Adjusted income 56,494
Consolidated net income, Year 8 49,919
Attributable to:
Shareholders of Forest 44,270
NCI (10% x 56,494) 5,649
49,919
Calculation on consolidated retained earnings – Jan. 1, Year 8

Retained earnings of Forest, Jan. 1, Year 8 64,000
Less: Profit in opening inventory (f) 3,240
Adjusted retained earnings 60,760
Retained earnings of Garden, Jan. 1, Year 8 126,000
Retained earnings of Garden at acquisition (175,000 – 150,000) 25,000
Increase 101,000
Less: Amortization of acquisition differential (c) 33,450
Unrealized profit on land (h) 10,800
Adjusted increase 56,750
Forest's ownership % 90% 51,075
Consolidated retained earnings, Jan. 1, Year 8 111,835
Calculation of non-controlling interest – Dec. 31, Year 8
Common shares 150,000

Retained earnings 139,000
Total shareholders' equity 289,000
Add: Unamortized acquisition differential (c) 12,400
Bond gain (net) (n) 944
302,344
Less: unrealized profit on sale of land (j) 8,100
Adjusted shareholders' equity 294,244
Non-controlling interest’s share 10%
Non-controlling interest, Dec. 31, Year 8 29,424
(a) (i) Forest Company

Consolidated Balance Sheet
December 31, Year 8
Cash (13,000 + 48,800) 61,800

Receivables (25,000 + 86,674 – (d) 22,000 – (e) 27,000) 62,674
Inventories (80,000 + 62,000 – (g) 6,600) 135,400
Plant and equipment (740,000 + 460,000 + (a) 10,000 – (j) 13,500 – 95,000 1,101,500
Accumulated depreciation (625,900 + 348,400 + (a) 7,500 – 95,000)) (886,800)
Patents (0 +4,500 + (b) 1,000) 5,500
Goodwill 8,900
Deferred income taxes (o) 8,647
Total assets 497,621
Current liabilities (59,154 + 53,000 – (d) 22,000) 90,154

Dividends payable (6,000 + 30,000 – (e) 27,000) 9,000
6% bonds payable (94,846  40%) 37,938
Retained earnings (see part (a) (ii)) 131,105
Non-controlling interest 29,424
Total liabilities and shareholders' equity 497,621
(a) (ii) Forest Company

Consolidated Retained Earnings Statement
Year 8
Retained earnings, Jan. 1 111835)
Add: net income 44,270)
156,105)
Less: dividends 25,000)
Retained earnings, Dec. 31 131,105)
(b)
Dec. 31 Investment in Garden Company 50,845
Investment income 50,845
To record 90% of adjusted subsidiary income
(56,494*  90%)
Dec. 31 Cash 45,000

Investment in Garden Company 45,000
To record 90% of Garden's dividend of 50,000

Investment in Garden Company 2,575
To record the adjustments to parent’s net income

(3,960 + 1,855 – 3,240)
* see the calculation of consolidated net income.
(c) A loss is recognized on the consolidated books when the subsidiary purchased the
parent’s bonds in the open market because the bonds are deemed to be retired from a
consolidated point of view. However, the bonds have not been retired from a separate–
company perspective. On the separate–entity books, the discount on the bonds will
continue to be amortized and income tax will be determined based on the amortization of
the premium or discount. The total loss recognized over the remaining term of the bonds
through the amortization of the discount will equal the loss on the deemed retirement –
only the timing is different. Therefore, these differences are considered to be timing
differences and would give rise to a deferred income tax asset.
(d) The debt-to-equity ratio would increase. Debt would stay the same while equity would
decrease due to the reduction in NCI under the parent company extension theory.
Problem 7-6
(a)
Acquisition differential – buildings 1,250 (a)
Yearly amortization (25,000 / 20)
Intercompany revenues and expenses
Interest revenue and expense (12,000  ½) 6,000 (b)
Rental revenue and administrative expense 50,000 (c)
Sales and purchases 90,000 (d)
Intercompany profits
Land gain – M selling
realized in Year 6 10,000 4,000 6,000 (e)

Opening inventory – K selling 12,000 4,800 7,200 (f)
Ending inventory – K selling 5,000 2,000 3,000 (g)
Machinery gain – M selling

realized by depreciation in Year 6
(13,000  5) 2,600 1,040 1,560 (h)
Calculation of non-controlling interest in profit of K Company – Year 6
Income of K 25,500
Add: profit in opening inventory (f) 7,200
32,700
Less: Amortization of acquisition differential (a) 1,250
Profit in ending inventory (g) 3,000
Adjusted profit 28,450
Non-controlling interest, Year 6 5,690 (i)
M Co.
Year 6
Sales (600,000 + 350,000 – (d) 90,000) $860,000

Interest revenue (6,700 – (b) 6,000) 700
Gain on land sale (8,000 + (e) 10,000) 18,000
Total revenues 878,700
Cost of goods sold
(334,000 + 225,000 – (d) 90,000 – (f) 12,000 + (g) 5,000) 462,000
Distribution expense (80,000 + 70,000 – (h) 2,600 + (a) 1,250) 148,650
Administrative expense (147,000 + 74,000 – (c) 50,000) 171,000
Interest expense (1,700 + 6,000 – (b) 6,000) 1,700
Income tax expense
(20,700 + 7,500 + (e) 4,000 + (f) 4,800 – (g) 2,000 + (h) 1,040) 36,040

Profit 59,310
Attributable to:
Shareholders of M 53,620
Non-controlling interest (i) 5,690
$ 59,310
(b)
M Co.
Income Statement
December 31, Year 6
Sales $600,000
Interest revenue 6,700
Dividend income from subsidiary (20,000 x 80%) 16,000
622,700
Cost of goods sold 334,000
Distribution expense 80,000
Administrative expense 147,000
Interest expense 1,700
Income tax expense 20,700
583,400
Profit $ 39,300
Problem 7-7
Calculation, allocation, and amortization of acquisition differential
Total 70% 30%
Cost of investment, Jan. 1, Year 6 483,000 483,000
Fair value of NCI 195,000 195,000
678,000
Carrying amounts of Gold's net assets:
Ordinary shares 500,000
Total shareholders' equity 540,000 378,000 162,000
Acquisition differential 138,000 105,000 33,000
Allocation: FV - CA

Inventory -12,000
Land 50,000
Plant and equipment 70,000 108,000 75,600 32,400
Balance – goodwill 30,000 29,400 600
Balance Amortization Balance

Jan. 1/6 Years 6 to 11 Dec. 31/11
Inventory -12,000 -12,000 –
Land 50,000 – 50,000 (a)
Plant and equipment 70,000 21,000 49,000 (b)
108,000 9,000 99,000
Goodwill – parent’s portion 29,400 17,640 11,760
- NCI’s portion 600 360 240
30,000 18,000 12,000 (c)
Total 138,000 27,000 111,000

Intercompany bonds – Dec. 31, Year 11

Investment in Gold Co. bonds
(230,000 – [30,000/10]) 227,000
Bonds payable
(477,500  [200,000 / 500,000]) 191,000
Loss – entity 36,000 14,400 21,600 (d)
Investment 227,000
Par value 200,000
Loss to Pure 27,000 10,800 16,200
Par value 200,000

Carrying amount 191,000
Loss to Gold 9,000 3,600 5,400 (e)

Patent – Gold selling
Selling price, July 1, Year 8 63,000
Gain on sale 21,000 8,400 12,600
Amort. to Dec. 31, Year 11
([21,000/7]  3½) 10,500 4,200 6,300
Balance, Dec. 31, Year 11 10,500 4,200 6,300 (f)
Deferred income taxes, Dec. 31, Year 11

Gain on patent (f) 4,200
Loss on bonds (d) 14,400 18,600 (g)
Gold’s accumulated depreciation, date of acquisition 75,000 (h)

Total shareholders' equity – Gold 700,000
Less: Gain on sale of patent (f) 6,300
Loss on sale of bond (e) 5,400 11,700)
Adjusted shareholders' equity 688,300)
206,49006,490
Share of acquisition differential
- other than goodwill (30% x 99,000) 29,700
- goodwill 240 29,940
236,430
Pure Company
Consolidated Statement of Financial Position
December 31, Year 11
Land (100,000 + 150,000 + (a) 50,000) 300,000)

Plant and equipment (625,000 + 940,000 + (b) 70,000 – (h) 75,000) 1,560,000)
Less: accumulated depreciation

(183,000 + 220,000 + (b) 21,000 – (h) 75,000) (349,000)
Patent (net) (31,500 – (f) 10,500) 21,000)
Goodwill (c) 12,000)
Deferred income taxes (g) 18,600)
Inventory (225,000 + 180,000) 405,000)
Accounts receivable (212,150 + 170,000) 382,150)
Cash (41,670 + 57,500) 99,170)
Total assets 2,448,920)
Ordinary shares 750,000)

Retained earnings 1,019,960)
Non-controlling interest 236,430)
Bonds payable (477,500  [300,000 / 500,000]) 286,500)
Accounts payable (56,030 + 100,000) 156,030)
Total liabilities and shareholders' equity 2,448,920)
Problem 7-8
Cost of 80% investment in Spruce Ltd., Jan. 2, Year 1 2,000,000

Implied value of 100% 2,500,000
Carrying amounts of Spruce's net assets:
Retained earnings 1,250,000
Total shareholders' equity 1,750,000
Mineral rights 750,000
Balance 0

Jan. 1/1 Years 1 to 3 Year 4 Dec. 31/4
Mineral rights 750,000 (a) 0 (b) 0 750,000 (c)

Intercompany sales and purchases 1,000,000 (d)
Unrealized intercompany profits

Equipment Jan. 2/2 – Spruce selling
(500,000 – 400,000) 100,000 (e)
Depreciation Years 2 and 3 40,000
Balance, Dec. 31, Year 3 60,000 24,000 36,000 (f)
Depreciation, Year 4 20,000 8,000 12,000 (g)
Balance, Dec. 31, Year 4 40,000 16,000 24,000 (h)
Inventory Jan. 1, Year 4 – Spruce selling 200,000 80,000 120,000 (i)

Inventory Dec. 31, Year 4 – Spruce selling 120,000 48,000 72,000 (j)
Intercompany bonds
Cost of bonds Jan. 2, Year 4 242,500
Carrying value of bonds purchased
Par 500,000
Issue premium
(14,000 – [14,000 / 7  2]) 10,000
510,000
Intercompany portion 50%
255,000
Gain to entity, Jan. 1, Year 4 12,500 5,000 7,500 (k)
Interest elimination loss, Year 4* 2,500 1,000 1,500
Net gain to entity, Dec. 31, Year 4 10,000 4,000 6,000 (l)
Allocation:
Cost 242,500
Par value (500,000  50%) 250,000
Gain to Spruce, Jan. 1, Year 4 7,500 3,000 4,500
Interest elimination loss, Year 4* 1,500 600 900
Net gain to Spruce, Dec. 31, Year 4 6,000 2,400 3,600 (m)
Par value 250,000
Carrying value 255,000

Gain to Poplar, Jan. 1, Year 4 5,000 2,000 3,000
Interest elimination loss, Year 4* 1,000 400 600
Net gain to Poplar, Dec. 31, Year 4 4,000 1,600 2,400 (n)
* 5 years remaining to maturity.
Spruce’s accumulated depreciation, date of acquisition 600,000 (o)
Deferred income tax – Dec. 31, Year 4
Equipment (h) 16,000

Inventory (j) 48,000
Deferred income tax asset 64,000
Less: deferred tax liability – bonds (l) 4,000
Net deferred income tax asset 60,000 (p)
Intercompany interest revenue and expense
Interest revenue – Spruce

8%  250,000 20,000
Discount amortization (7,500 / 5) 1,500 21,500
Interest expense – Poplar

8%  500,000 40,000
Premium amortization (14,000 / 7) 2,000
38,000
Intercompany portion 50% 19,000 (q)
Interest elimination loss – Year 4 (before tax) 2,500
Calculation of consolidated net income – Year 4
Income of Poplar 1,100,000

Less: Dividend from Spruce (250,000  80%) 200,000
900,000
Add: bond gain (net) (n) 2,400
Adjusted net income 902,400
Income of Spruce 521,500

Less: Amortization of acquisition differential (b) 0
Closing inventory profit (j) 72,000
449,500
Add: Opening inventory profit (i) 120,000

Equipment profit realized (g) 12,000
Bond gain (net) (m) 3,600 135,600
Adjusted net income 585,100 (r)
Consolidated net income 1,487,500
Attributable to:
Shareholders of Poplar 1,370,480
NCI (20% x 585,100) 117,020
1,487,500
(a) (i) Poplar Ltd.

Year 4
Sales (4,900,000 + 2,000,000 – 1,000,000 (d)) 5,900,000

Gain on bond retirement (k) 12,500
Total revenues 5,912,500
Cost of goods sold
(2,400,000 + 850,000 – (d) 1,000,000 – (i) 200,000 + (j) 120,000) 2,170,000
Other expenses (962,000 + 300,000 – (g) 20,000) 1,242,000
Interest expense (38,000 – (q) 19,000) 19,000

Income tax expense
(600,000 + 350,000 + (i) 80,000 – (j) 48,000 + (g) 8,000 + (l) 4,000) 994,000
Total expenses 4,425,000
Net income 1,487,500
Attributable to:
Shareholders of Poplar 1,370,480
NCI (20% x 585,100) 117,020
1,487,500

Calculation of consolidated retained earnings – Jan. 1, Year 4
Retained earnings of Poplar, Jan. 1, Year 4 10,000,000
Retained earnings of Spruce, Jan. 1, Year 4 2,000,000
At acquisition 1,250,000
Increase 750,000
Less:
Opening inventory profit (i) 120,000
Net equipment profit (f) 36,000
Adjusted increase 594,000 (s)
Poplar's ownership % 80% 475,200
Consolidated retained earnings, Jan. 1 Year 4 10,475,200
(ii) Poplar Ltd.

Consolidated Statement of Retained Earnings
Year 4
Retained earnings, Jan. 1, Year 4 $10,475,200

Add: net income 1,370,480
11,845,680
Less: dividends 600,000
Retained earnings, Dec. 31, Year 4 $11,245,680
Common shares of Spruce 500,000)

Retained earnings of Spruce, Jan. 1, Year 4 2,000,000)
Net income, Year 4 521,500)
Dividends, Year 4 (250,000)
Total shareholders' equity, Dec. 31, Year 4 2,771,500)
Less: Equipment profit (h) 24,000
Inventory profit (j) 72,000 96,000)
2,675,500)
Add: Unamortized acquisition differential (c) 750,000
Bond gain (net) (m) 3,600)
Adjusted shareholders' equity, Spruce 3,429,100)
Non-controlling interest, Dec. 31, Year 4 685,820)
(iii) Poplar Ltd.

Consolidated Balance Sheet
Dec. 31, Year 4
Cash (1,000,000 + 500,000) 1,500,000)
Accounts receivable (2,000,000 + 356,000) 2,356,000)
Inventory (3,000,000 + 2,250,000 – (j) 120,000) 5,130,000)
Plant and equipment (14,000,000 + 2,900,000 – (e) 100,000 – (o) 600,000) 16,200,000)
Accumulated depreciation (4,000,000 + 1,000,000 – (f) 60,000 – (o) 600,000) (4,340,000)
Mineral rights (c) 750,000)
Deferred income taxes (p) 60,000)
Total assets 21,656,000)
Accounts payable (2,492,000 + 2,478,500) 4,970,500

Bonds payable (500,000  50%) 250,000
Premium on bonds payable (8,000  50%) 4,000
Common shares 4,500,000
Retained earnings 11,245,680
Non-controlling interest 685,820
Total liabilities and shareholders' equity 21,656,000
(b) Investment Account, Dec. 31, Year 4 - Equity Method
Balance, Dec. 31, Year 4 – cost method 2,000,000

Add: Adjusted increase in Spruce's retained earnings to
Jan. 1, Year 4 (s) 594,000
2,475,200
Add: Adjusted income of Spruce, Year 4 (r) 585,100
Bond gain (net) – Poplar (n) 2,400

2,945,680
Less: Dividend from Spruce (250,000  80%) 200,000
Balance, Dec. 31, Year 4 2,745,680
Alternative calculation:
Consolidated retained earnings, Dec. 31, Year 4 11,245,680
Retained earnings – Poplar Dec. 31, Year 4 – cost
method (10,000,000 + 1,100,000 – 600,000) 10,500,000
Difference 745,680
Investment in Spruce – cost method 2,000,000
Investment in Spruce – equity method, Dec. 31, Year 4 2,745,680
(c)
Gains should be recognized when they are realized i.e., when there has been a transaction with
outsiders and consideration has been given/received. When the parent acquires the subsidiary’s
bonds for cash in the open market, it is transacting with an outsider and giving cash as
consideration. From the separate entity perspective, the parent is investing in bonds. However,
from a consolidated point of view, the parent is retiring the bonds of the subsidiary when it
purchases the bonds from the outside entity. Therefore, when the investment in bonds is offset
against the bonds payable on consolidation, any difference in the carrying amounts is recorded as a
gain or loss on the deemed retirement of the bonds.
Problem 7-9
Cost of 85% investment in Sloan Ltd. 3,026,000
Carrying amounts of Sloan's net assets:
Common shares 2,200,000 Dr
Retained earnings 1,100,000 Dr
Total shareholders' equity 3,300,000
Allocation:
FV – CA
Plant and equipment 200,000
Accounts receivable - 75,000

Long-term liabilities 52,680 177,680
Balance – goodwill 82,320
Amortization
Balance Balance
Plant and equipment 200,000 30,000 10,000 160,000

Accounts receivable - 75,000 - 75,000 - -
Long-term liabilities * 52,680 15,804 5,268 31,608 (a)
Goodwill 82,320 36,375 12,125 33,820 (b)
Total 260,000 7,179 27,393 225,428 (c)
*10 years remaining to maturity
Intercompany dividend revenue (98,000  85%) 83,300) (d)
Intercompany Profits (Losses)

Patent, Jan. 1, Year 2 – Sloan selling (25,000) (10,000) (15,000)
Amortization Years 2 and 3 (10,000) (4,000) (6,000) (e)
Balance, Dec. 31, Year 3 (15,000) (6,000) (9,000)
Amortization Year 4 (5,000) (2,000) (3,000) (f)
Balance, Dec. 31, Year 4 (10,000) (4,000) (6,000) (g)
Land Year 3 – Porter selling 21,000) 8,400) 12,600) (h)
Inventories
Beginning – Porter selling 14,000) 5,600) 8,400) (i)
– Sloan selling 1,500) 600) 900) (j)
Totals 15,500) 6,200) 9,300)
Ending – Porter selling 10,000) 4,000) 6,000) (k)

– Sloan selling 2,500) 1,000) 1,500) (l)
Totals 12,500) 5,000) 7,500)

(a) (i) Patent (263,000 + (g) 10,000) 273,000)
(ii) Goodwill (b) 33,820)
(iii Retained earnings

Retained earnings Porter, Dec. 31, Year 4 4,833,000)
Less: Land gain (h) 12,600
Ending inventory profit (k) 6,000 18,600)
Adjusted retained earnings 4,814,400)
Retained earnings Sloan, Dec. 31, Year 4 1,409,000
At acquisition 1,100,000
Increase 309,000
Add: patent loss (g) 6,000
315,000
Less: Acquisition differential amortization
((c) 7,179 + (c) 27,393) 34,572
ending inventory profit (l) 1,500
Adjusted increase 278,928 (m)
Porter's ownership % 85% 237,089)
5,051,489)
(iv) Non-controlling interest (Method 1)
Shareholders' equity Sloan (1,409,000 + 2,200,000) 3,609,000
Add: unamortized acquisition differential (c) 225,428
patent loss (g) 6,000
3,840,428
Less: ending inventory profit (l) 1,500
Adjusted shareholders' equity 3,838,928
575,839
Calculation of consolidated non-controlling interests – end of Year 4 (Method 2)

Non-controlling interests at date of acquisition (15% x [3,026,000 / .85) 534,000
Sloan’s adjusted increase in retained earnings (m) 278,928
NCI’s share @ 15% 41,839
(v) Long-term liabilities (1,876,000 + 750,000 – (a) 31,608) 2,594,392
(b) Porter's total revenues $2,576,000

Less: dividends from Sloan (d) 83,300
2,492,700
Sloan's net income 177,000
Less: Amortization of acquisition differential (c) 27,393
Patent loss amortized (f) 3,000
Ending inventory profit (l) 1,500 31,893
145,107
Add: beginning inventory profit (j) 900
Porter's ownership % 85%
124,106
Add: beginning inventory profit (Porter selling) (i) 8,400
132,506
Less: Ending inventory profit (k) 6,000 126,506
Total revenues Porter – equity $2,619,206
(c) Bond Amortization Table
Date Effective Interest (1) Interest Paid (2) Amortization (3) Balance
Jan 1, Yr 1 (750,000 – 52,680 = ) 697,320
Dec 31, Yr 1 48,812 45,000 3,812 701,132
Dec 31, Yr 2 49,079 45,000 4,079 705,211
Dec 31, Yr 3 49,365 45,000 4,365 709,576
Dec 31, Yr 4 49,670 45,000 4,670 714,246
Balance on consolidated balance sheet will be 1,876,000 + 714,246 = 2,590,246
Notes:
1) Balance x 7%
2) 750,000 x 6%
3) Effective interest – interest paid

Problem 7-10
Cost of bonds 150,064
Par value of bonds 800,000 (a)
Less: unamortized discount 73,065 (b)
Carrying amount of bonds 726,935
Intercompany portion (160,000 / 800,000) 20% 145,387
Loss to the entity 4,677 (c)
Tax at 40% 1,871 (d)
Loss after tax 2,806 (e)
Cost 150,064 Par 160,000

Par 160,000 Carrying amount 145,387
Gain to Alpha 9,936 (f) Loss to Beta 14,613 (i)
Tax at 40% 3,974 (g) Tax at 40% 5,845 (j)
Gain after tax 5,962 (h) Loss after tax 8,768 (k)
Bond Amortization Table for Alpha
Date Effective Interest (6%) Interest Paid (5%) Amortization Balance

Jan 1, Yr 4 150,064
June 30, Yr 4 9,004 8,000 1,004 151,068
Dec 31, Yr 4 9,064 8,000 1,064 152,132
Total 18,068 16,000 2,068 (l)
Bond Amortization Table for Beta
Date Effective Interest (6.5%) Interest Paid (5%) Amortization Balance

Jan 1, Yr 4 726,935
June 30, Yr 4 47,251 40,000 7,251 734,186
Dec 31, Yr 4 47,722 40,000 7,722 741,908
Total 94,973 80,000 14,973
Intercompany (20%) 18,995 16,000 2,995 (m)

Alpha
Gain on bonds (f) 9,936 (g) 3,974 (h) 5,962
Interest elimination loss* (l) 2,068 827 1,241
Balance December 31, Year 4 gain 7,868 3,147 4,721 (n)
Beta
Gain (loss) on bonds (i)(14,613) (j) (5,845) (k) (8,768)
Interest elimination loss (gain) (m) (2,995) (1,198) (1,797)
Balance December 31, Year 4 gain (loss) (11,618) (4,647) (6,971) (o)
* from bond amortization

(a) Loss on bonds, Year 4 (c) 4,677
(b) December 31, Year 4

Investment in Beta Corporation 102,600
90%  114,000 share of Beta's profit
Cash 27,000
90%  30,000 dividends from Beta

Net bond loss allocated to Beta (90%  (o) 6,971)
Investment in Beta Corporation (n) 4,721

Net bond gain allocated to Alpha
(c) Carrying amount of bonds 741,908

Intercompany portion (20%) 148,382
Consolidated bonds payable December 31, Year 4 593,526
Problem 7-11
Cost of bonds July 1, Year 7 152,500

Par value of bonds 400,000 (a)
Less: unamortized discount 20,000
Intercompany portion 40% 152,000
Loss to entity July 1, Year 7 (before tax) 500 (b)
Par value ((a) 400,000  40%) 160,000

Cost of bonds 152,500
Gain to Parent Co. (before tax) 7,500 (c)
Par value 160,000
Loss to Sub. Co. (before tax) 8,000 (d)

Entity
Loss (gain) July 1, Year 7 (b) 500 200 300
Interest elimination gain (loss)
Year 7* 50 20 30
Balance loss (gain) Dec. 31, Year 7 450 180 (h) 270
Parent Co.
Loss (gain) July 1, Year 7 (c) (7,500) (3,000) (4,500)
Year 7* (750) (300) (450)
Balance loss (gain) Dec. 31, Year 7 (6,750) (2,700) (4,050) (e)
Sub. Co.
Loss (gain) July 1, Year 7 (d) 8,000 3,200 4,800
Year 7* 800 320 480
Balance loss (gain) Dec. 31, Year 7 7,200 2,880 4,320 (f)
* 10 interest periods to maturity
Intercompany interest revenue

(160,000  10%  ½ + [(c) 7,500 / 5  ½]) = 8,750
Intercompany interest expense
Interest expense ((a) 400,000  10%) 40,000
Discount amortization ([20,000 / 10 periods]  2) 4,000
Total interest expense for the year 44,000

Interest expense July 1 to Dec. 31, Year 7 22,000
Intercompany portion 40% 8,800 (g)
Gain on elimination of intercompany revenues and expenses 50
Calculation of consolidated net income, Year 7

Income of Parent Co. 184,750
Add: Net bond gain (e) 4,050
Income of Sub. Co. 64,000
Less: Net bond loss (f) 4,320
Adjusted net income 59,680 (i)
Consolidated net income, Year 7 248,480
Attributable to:
Shareholders of Parent 233,560
NCI (25% x 59,680) 14,920
248,480
Parent Co.
Year 7
Miscellaneous revenue (900,000 + 500,000) 1,400,000

Loss on retirement of intercompany bonds (b) 500
Interest expense (44,000 – (g) 8,800) 35,200
Other expense (600,000 + 350,000) 950,000
Income tax expense (124,000 + 42,000 – (h) 180) 165,820
Net income 248,480
Attributable to:
Shareholders of Parent 233,560
NCI (25% x 59,680) 14,920
248,480

Problem 7-12
Intercompany bond purchase – Oct. 1, Year 5
Par value of 20% (80,000/400,000) of Palmer's bonds 80,000
Cost of 20% purchased 76,000
Gain to Scott Corporation (before tax) 4,000 (a)
Par value of 20% of Palmer's bonds 80,000

Carrying amount ([400,000 – 8,000]  20%) 78,400
Loss to Palmer Corporation (before tax) 1,600 (b)
Gain to entity ((a) 4,000 – (b) 1,600) (before tax) 2,400 (c)
Yearly interest elimination loss (2,400 / 4) 600 (d)
Interest elimination loss Year 5 ((d) 600  3/12 ) 150
60% 60%
Before tax After tax Before tax After tax
Entity Palmer
Gain (loss) Oct. 1,
Year 5 (c) 2,400 1,440 (b) (1,600) (960)
Interest elimination
loss (gain)* 150 90 (100) (60)
Balance gain (loss)
Dec. 31, Year 5 2,250 1,350 (1,500) (900) (e)
Scott
Gain (loss) Oct. 1,
Year 5 (a) 4,000 2,400
Interest elimination
loss (gain)* 250 150
Balance gain (loss)
Dec. 31, Year 5 3,750 2,250 (f)
* ¼ x 3/12
a) December 31, Year 5
Investment in Scott Corporation 49,000
70%  $70,000 Share of Scott's profit
Cash 10,500
Investment in Scott Corporation 10,500
70%  $15,000 Share of Scott's dividends
Investment income (e) 900

Investment in Scott Corporation 900
Net bond loss allocated to Palmer
Investment in Scott Corporation (f) 1,575

Net bond gain allocated to Scott ($2,250  70%)
b) Carrying amount of bonds Oct. 1, Year 5 (400,000 – 8,000) 392,000

Discount amortization Oct. to Dec. Year 5 (8,000 / 4 x 3/12) 500
Carrying amount of bonds, Dec. 31, Year 5 392,500
Intercompany portion (20%  392,500) 78,500
Consolidated bonds payable Dec. 31, Year 5 314,000
Problem 7-13 (in 000s)

Calculation and allocation of acquisition differential
Cost of 60% investment in ENS $ 780

Implied value of 100% investment in ENS 1,300
Carrying amount of ENS:
Common shares $500
Retained earnings 120
Total shareholders’ equity 620
Acquisition differential 680
Allocated: (FV – CA)
Equipment - 30

Internet domain names 100
Land 120 190
Balance — goodwill $ 490
Acquisition differential amortization and goodwill impairment schedule (in 000s)
Balance Amortization/Impairment Balance

Dec. 31, Yr1 Yr2- Yr4 Yr5 Dec. 31, Yr5
Equipment (6 years) $ (30) $ (15) $ (5) $ (10) (a)

Internet domain names 100 - - 100
Land 120 - - 120 (b)
Goodwill 490 390 25 75 (c)
Total $ 680 $ 375 $ 20 $ 285 (d)
Intercompany sales and cost of sales $600 (e)

Intercompany other revenues and other expenses ($5 x 12) $60 (f)
Intercompany inventory profits – ENS selling
ENS’s gross margin % = (3,010 – 2,107) / 3,010 = 30%

Closing inventory (30% x $200) $ 60 $ 24 $ 36 (g)
Beginning inventory (30% x $250) $ 75 $ 30 $ 45 (h)
Intercompany receivables and payables 150 (i)
Intercompany depreciable assets profits – RAV selling

Proceeds on sale $750
Carrying amount 600
Gain on sale of building, July 1, 2002 150 $60 $90
Realized gain per year (15 years remaining) 10 4 6 (j)
Realized gains to December 31, 2005 (3.5 years) 35 14 21 (k)
Unrealized gains, December 31, 2005 $ 115 $46 $69 (l)
ENS’s income ($3,010 – $2,107 – $120 – $432) = $351 (m)

(a)
Sales (4,220 + 3,010 – (e) 600) 6,630
Other revenues (80 + 0 – (f) 60) 20
Cost of goods purchased (2,340 + 2,137 – (e) 600) 3,877
Change in inventory (60 – 30 + (g) 60 – (h) 75) 15
Amortization expense (240 + 120 – (a) 5 – (j) 10) 345
Goodwill impairment (0 + 0 + (c) 25) 25
Income tax and other expenses (960 + 432 – (g) 24 + (h) 30 + (j) 4 – (f) 60) 1,342
Consolidated net income $1,046
Attributable to:
Shareholders of RAV 910
Non-controlling interest (40% x [(m) 351 – (g) 36 + (h) 45 – (d) 20]) 136
1,046
(b)
Current assets
Cash (150 + 75) 225
Accounts receivable (275 + 226 – (i) 150) 351
Inventory (594 + 257 – (g) 60) 791
Property, plant & equipment

Land (600 + 170 + (b) 120) 890
Building – net (710 + 585 – (l) 115) 1,180
Equipment – net (690 + 349 – (a) 10) 1,029
Intangible assets
Internet domain names 100
Goodwill 75
(c)
Subsidiary’s retained earnings, beginning of year $279
Unrealized after-tax profit in beginning inventory (h) (45)
234

Subsidiary’s common shares 500
734
Unamortized acquisition differential (d) (285 + 20) 305
1,039
NCI’s share (40%) $415.6
(d)
i) RAV’s separate entity income would decrease because it would report dividend income from
ENS of $182.4 (60% x $304) instead of investment income of $210.
ii) Consolidated net income would remain the same because intercompany dividends and
other intercompany transactions are eliminated and only income from outsiders is reported.
Income from outsiders remains the same.
(adapted from CGA Canada)
Problem 7-14
Year 9 income statements
P Company S Company
Sales 630,000 340,000
Interest income 1,850
Gain on sale of land 7,000
Total revenues 652,339 341,850
Cost of sales 485,000 300,000
Interest expense 17,000
Selling and admin. expense 50,000 20,000
Income tax expense 34,000 8,740
Total expenses 586,000 328,740
Net income 66,339 13,110
Bonds payable – P Company

Issued Jan. 1, Year 2 200,000 (a)
Discount Jan. 1, Year 2 10,000)
Amortized – Years 2 to 8 (10,000 / 10  7) (7,000)

– to July 1, Year 9 (1,000  ½) (500) 2,500
Balance, July 1, Year 9 197,500 (b)
Discount amortization July to Dec., Year 9 500
Balance, Dec. 31, Year 9 198,000
Investment in bonds – S Company

Par value July 1, Year 9 40,000
Purchase discount, July 1, Year 9 (40,000 – 38,750) 1,250)
Amortized, Year 9 (1,250 / 2½  ½) (250) (c) 1,000
Balance, Dec. 31, Year 9 39,000
Cost of intercompany bonds July 1, Year 9 38,750
Par value 40,000
Gain on bond – S Company (before tax) 1,250 (d)
Par value, July 1, Year 9 40,000

Carrying amount ((b) 197,500  20%) 39,500
Loss on bonds – P Company (before tax) 500 (e)
Gain to entity, July 1, Year 9 ((d) 1,250 – (e) 500) 750 (f)

Entity
Gain July 1, Year 9 (f) 750 300 450
Interest elimination gain Year 9* 150 60 90 (g)
Balance gain Dec. 31, Year 9 600 240 360 (h)
P Company
Gain (loss) July 1, Year 9 (e) (500) (200) (300)
Interest elimination gain (loss) Year 9* (100) (40) (60)
Balance gain (loss), Dec. 31, Year 9 (400) (160) (240) (i)
S Company
Gain July 1, Year 9 (d) 1,250 500 750
Interest elimination gain Year 9* 250 100 150
Balance gain Dec. 31, Year 9 1,000 400 600 (j)
* ½ year amortization, 2½ years to maturity

Sales 75,000 (k)
Interest expense – P Company
8%  200,000 (a) 16,000
Discount amortization, Year 9 (500 + 500) 1,000
Total Year 9 17,000
½ year 8,500
Intercompany portion (40,000 / 200,000) 20% 1,700
Interest revenue – S Company
8%  (c) 40,000  ½ 1,600
Purchase discount amortized (c) 250 1,850
Interest elimination loss – Year 9 (g) 150
Land – S selling – realized in Year 9
(21,000 – 15,000) 6,000 2,400 3,600 (l)
Calculation of investment income

S Company net income 13,110
Add: Bond gain net (j) 600
Land gain (l) 3,600
Adjusted net income 17,310 (m)
P Company's ownership % 90%
15,579
Less: bond loss (net) – P Company (i) 240
15,339
(a) P Co.
Year 9

Sales (630,000 + 340,000 – (k) 75,000) $895,000
Gain on bond retirement (f) 750
Gain on sale of land (7,000 + (l) 6,000) 13,000
Cost of sales (485,000 + 300,000 – (k) 75,000) 710,000
Interest expense (17,000 – 1,700) 15,300
Selling and admin. expense (50,000 + 20,000) 70,000
Income tax expense (34,000 + 8,740 + (h) 240 + (l) 2,400) 45,380
Net income 68,070
Attributable to:
Shareholders of P Co. 66,339
Non-controlling interest ((m) 17,310  10%) 1,731
Consolidated net income $ 68,070
(b) P Co.
Year 9
Retained earnings, Jan. 1, Year 9 $ 85,000

Add: net income 66,339
151,339
Retained earnings, Dec. 31, Year 9 $141,339
Problem 7-15
Champlain NCI
(80%) (20%)
Cost of 80% investment in Samuel 129,200
Fair value of NCI’s Interest in Samuel (14 x 2,000) 28,000

Carrying amounts of Samuel's net assets:
Total shareholders' equity 62,000 49,600 12,400
Acquisition differential, Jan. 1, Year 1 79,600 15,600
Inventories -18,000 - 14,400 - 3,600
Patent 14,000 11,200 2,800
Balance – Goodwill 82,800 16,400

Inventories -18,000 -18,000 - -

Patent 14,000 7,000 1,750 5,250 (a)
Subtotal -4,000 -11,000 1,750 5,250
Goodwill – Champlain’s purchase 82,800 34,800 19,200 28,800 (b)
- NCI’s share 16,400 6,600 3,600 6,200 (c)
95,200 30,400 24,550 40,250
Champlain’s share
(80% x subtotal + Goodwill) 79,600 26,000 20,600 33,000 (d)
NCI’s share
(20% x subtotal + Goodwill) 15,600 4,400 3,950 7,250 (e)
Opening inventory – Samuel selling 1,900 760 1,140 (f)
Closing inventory – Samuel selling 3,300 1,320 1,980 (g)
Equipment Jan. 1/3 – Samuel selling 21,000 (h)

Depreciation to Dec. 31, Year 4 ([21,000 / 6]  2) 7,000
Balance, Dec. 31, Year 4 14,000 5,600 8,400 (i)
Depreciation Year 5 (21,000  6) 3,500 1,400 2,100 (j)
Balance, Dec. 31, Year 5 10,500 4,200 6,300 (k)
Land – Champlain selling 7,000 2,800 4,200 (l)
Intercompany revenues and expenses, receivables and payables

Sales and purchases 92,000 (m)
Receivables and payables 21,000 (n)
Dividends receivable and payable (5,500  80%) 4,400 (o)
Samuel’s accumulated depreciation, date of acquisition 17,000 (p)
Deferred income taxes (Dec. 31, Year 5)

Inventory (g) 1,320
Equipment (k) 4,200
Land (l) 2,800 8,320 (q)
Calculation of consolidated profit – Year 5

Profit of Champlain 42,800
Less: Dividends from Samuel (11,000  80%) 8,800 (r)
Adjusted profit 34,000
Profit of Samuel 13,000
Add: Opening inventory profit (f) 1,140
Equipment gain realized (j) 2,100 3,240
16,240
Less: Closing inventory profit (g) 1,980
14,260 (s)
Less: Amortization of acquisition differential
- Champlain’s share (d) 20,600
- NCI’s share (e) 3,950 24,550
Adjusted profit (10,290)
Profit 23,710
Attributable to:

Shareholders of Champlain 24,808
NCI (20% x (r) 14,260 – (e) 3,950) - 1,098
23,710
(a) (i) Champlain Ltd.

Year 5
Sales (535,400 + 270,000 – (m) 92,000) 713,400

Miscellaneous revenue (9,900 – (r) 8,800) 1,100
Cost of sales
(364,000 + 206,000 – (m) 92,000 + (g) 3,300 – (f) 1,900) 479,400
Selling expense (78,400 + 24,100) 102,500
Admin. exp. (including depreciation & goodwill impairment loss)
(46,300 + 20,700 + (a) 1,750 + (b) 19,200 + (c) 3,600 – (j) 3,500) 88,050
Income taxes (13,800 + 6,200 + (f) 760 – (g) 1,320 + (j) 1,400) 20,840
Profit 23,710
Attributable to:
Shareholders of Champlain 24,808
NCI (20% x (s) 14,260 – (e) 3,950) - 1,098
23,710
Retained earnings of Champlain, Jan. 1/5 45,500

Less: Land profit (l) 4,200
Adjusted retained earnings 41,300
Retained earnings of Samuel, Jan. 1/5 68,000
At acquisition 12,000
Increase 56,000
Less: Inventory profit (f) 1,140
Equipment gain (net) (i) 8,400 9,540
Adjusted increase 46,460
Champlain's ownership % 80% 37,168
Less: Champlain’s share of amort. of acquisition differential. (d)
(26,000)
Consolidated retained earnings, Jan. 1, Year 5 52,468
(a) (ii) Champlain Ltd.

Year 5
Retained earnings, Jan. 1, Year 5 52,468
Add: profit 24,808
77,276
Retained earnings, Dec. 31, Year 5 57,276

Retained earnings (68,000 + 13,000 – 11,000) 70,000
Total shareholders' equity, Dec. 31, Year 5 120,000
Less: Inventory profit (g) 1,980
Equipment gain (k) 6,300 8,280
Adjusted shareholders' equity 117,720
22,344
Add: NCI’s share of unamortized acquisition differential (e) 7,250
(a) (iii) Champlain Ltd.

Consolidated Statement of Financial Position
December 31, Year 5
Property, plant, and equipment (198,000+104,000–(l) 7,000–(h) 21,000 – (p) 17,000)

257,000)
Accumulated depreciation (86,000 + 30,000 – 10,500* – (p) 17,000) (88,500)
Patent (a) 5,250)
Goodwill (b & c) 35,000)
Deferred income taxes (q) 8,320)
Inventories (35,000 + 46,000 – (g) 3,300) 77,700)
Accounts receivable (60,000 + 55,000 – (n) 21,000 – (o) 4,400) 89,600)
Cash (18,100 + 20,600) 38,700)
Total assets 423,070)
Ordinary shares 225,000)

Retained earnings 57,276)
Non-controlling interest 29,594)
Dividends payable (5,000 + 5,500 – (o) 4,400) 6,100)
Accounts payable (56,000 + 70,100 – (n) 21,000) 105,100)
Total liabilities and shareholders’ equity 423,070)
* 7,000 + (j) 3,500 = 10,500
(b) When the gain on the sale of the equipment is eliminated on consolidation, the equipment
is restated to its carrying value on Champlain’s books prior to the intercompany sale. The
carrying value represents Champlain’s original cost less accumulated amortization based
on the historical cost. After the consolidation adjustment, the equipment is reported at the
historical cost to the consolidated entity net of accumulated amortization.
(c) The return on equity attributable to the shareholders of Samuel would not change because
the parent company extension theory only affects values used for non-controlling interests.
(d) Goodwill under entity theory 35,000

Less: NCI’s share 6,200
Goodwill under parent company extension theory 28,800
NCI on statement of financial position under entity theory 29,594

Less: NCI’s share of goodwill (20%) 6,200
NCI on statement of financial position under parent company extension theory 23,394
Problem 7-16

Cost of 80% investment, Dec. 31, Year 1 964,000
Carrying amounts of Orange's net assets:
Assets 1,000,000
Liabilities 300,000
Allocation
FV – CA
Receivables -25,000
Plant and equipment 300,000
Long-term liabilities -16,850 258,150
Goodwill 246,850

Dec. 31/1 Years 2 to 4 Year 5 Dec. 31/5
Receivables - 25,000 - 25,000 - -

Plant and equipment 300,000 90,000 30,000 180,000 (a)
Long-term liabilities - 16,850 - 10,110 - 3,370 - 3,370 (b)
Goodwill 246,850 33,600 11,200 202,050 (c)
505,000 88,490 37,830 378,680 (d)
Sales and purchases – Orange selling 300,000)

– Peach selling 280,000) 580,000) (e)
Management fees 25,000) (f)

Warehouse - Orange selling
Selling price 54,000)
Cost (100,000)
Acc. Depr. (2  5,000) 10,000)
Loss on sale – Dec. 31, Year 4 (36,000) (14,400) (21,600) (g)
Depreciation, Year 5 (36,000 / 18) (2,000) (800) (1,200) (h)
Balance, Dec. 31, Year 5 (34,000) (13,600) (20,400)
Opening inventory – Orange selling

(250,000 – 120,000) 130,000) 52,000) 78,000) (i)
Ending inventory – Orange selling

(300,000 – 160,000) 140,000) 56,000) 84,000) (j)
– Peach selling
(1/2  160,000) 80,000) 32,000) 48,000) (k)
220,000) 88,000) 132,000) (l)
Machine – Peach selling

Selling price 28,000)
Cost (32,000)
Acc. Depr. (6  4,000) 24,000)
Gain sale, Jan. 1, Year 5 20,000 8,000 12,000 (m)
Depreciation, Year 5 (20,000 / 2 yrs remaining) 10,000 4,000 6,000 (n)
Balance, Dec. 31, Year 5 10,000 4,000 6,000 (o)
Dividends paid by Orange to Peach (50,000 x 80%) 40,000 (p)

Income of Peach 1,500,000

Less: Dividends from Orange (50,000  80%) (p) 40,000
Profit in ending inventory (k) 48,000
Profit on sale of machine (net) (o) 6,000 94,000

Adjusted net income 1,406,000
Income of Orange 330,000
Less: Amortization of the acquisition differential (d) 37,830
Profit in ending inventory (j) 84,000
Loss realized on sale of warehouse (h) 1,200 123,030
206,970
Add: profit in opening inventory (i) 78,000
Consolidated net income, Year 5 1,690,970
Attributable to:
Shareholders of Peach 1,633,976
NCI (20% x 284,970) 56,994
1,690,970
(a) Peach Company

Year 5
Sales (6,000,000 + 1,000,000 – (e) 580,000) 6,420,000

Other revenues
(200,000 + 20,000 – (f) 25,000 – (m) 20,000 – (p) 40,000) 135,000
Total revenues 6,555,000
Cost of goods purchased
(2,525,000 + 390,000 – (e) 580,000) 2,335,000
Change in inventory (-25,000 + 10,000 – (i) 130,000 + (l) 220,000) 75,000
Depreciation expense
(500,000 + 80,000 + (a) 30,000 + (h) 2,000 – (n) 10,000) 602,000
Interest expense (400,000 + 16,000 – (b) 3,370) 412,630
Goodwill impairment loss (c) 11,200
Other expenses
(1,300,000 + 194,000 - (h) 800 + (i) 52,000 – (l) 88,000 –
(o) 4,000 – (f) 25,000) 1,428,200
Consolidated net income, Year 5 1,690,970
Attributable to:
Shareholders of Peach 1,633,976
NCI (20% x 284,970) 56,994
1,690,970
Retained earnings of Peach, Jan. 1, Year 5 4,200,000

Retained earnings of Orange, Jan. 1, Year 5 300,000
Retained earnings of Orange at acquisition 200,000
Increase 100,000
Add: loss on sale of warehouse (g) 21,600
121,600
Less: Amortization of the acquisition differential (d) 88,490
Profit in opening inventory (i) 78,000
Adjusted increase - 44,890
Peach's ownership % 80% - 35,912
Consolidated retained earnings, Jan. 1, Year 5 4,164,088
(b) Peach Company

Year 5
Retained earnings, Jan. 1, Year 5 4,164,088

Add: net income 1,633,976
5,798,064
Retained earnings, Dec. 31, Year 5 5,598,064
(c) Assets should never be reported on the balance sheet at an amount higher than the
future economic benefits. If an asset is sold at a loss, this may indicate that the asset is
impaired and the loss should be recognized even if the sale did not occur. If the selling
price in the intercompany transaction is not a true reflection of the economic value, the
loss would also not be realistic; if so, the loss would be eliminated on consolidation so
that the asset is reflected at the amount it was reported at prior to the intercompany sale.

(d) Bond Amortization Table for Consolidated Financial Statements
Date Effective Interest Amortization Ending

Interest Paid Balance
Dec 31, Yr 1 216,850
Dec 31, Yr 2 13,011 16,000 2,989 213,861
Dec 31, Yr 4 12,832 16,000 3,168 210,693
Dec 31, Yr 4 12,642 16,000 3,358 207,335
Dec 31, Yr 5 12,440 16,000 3,560 203,774
Dec 31, Yr 6 12,227 16,000 3,773 200,002
Amortization of premium under straight-line method for Year 5 3,370

Amortization of premium under effective-interest method for Year 5 3,560
Reduction in interest expense under effective-interest method 190
Interest expense under straight-line method 412,630
Interest expense under effective-interest method 412,440
NCI on income statement as previously reported 56,994

NCI’s share of increased income due to change in interest method
190 x (1 – 40%) x 20% 23
NCI on income statement as restated for effective-interest method 57,017
Problem 7-17
Cost of 70% investment in Dandy 7,000

Implied value of 100% 10,000
Carrying amounts of Dandy’s net assets:
Common shares 250
Acquisition differential, Jan. 1, Year 1 5,250

Inventory 100
Equipment 500 600
Balance – Goodwill 4,650

Amortization
Balance Balance
Inventory 100 100 - -
Equipment (10 year life) 500 250 50 200 (a)
Goodwill 4,650 3,550 70 1,030 (b)
5,250 3,900 120 1,230 (c)
Opening inventory – Dandy selling (2,000 x 40%) 800 320 480 (d)
Closing inventory – Dandy selling (2,500 x 40%) 1,000 400 600(e)

Equipment Jan. 1/2 – Handy selling 200 (f)
Depreciation to Dec. 31, Year 5 ([200 / 8]  4) 100
Balance, Dec. 31, Year 5 100 40 60(g)
Depreciation Year 6 (200  8) 25 10 15(h)
Balance, Dec. 31, Year 6 75 30 45(i)
Intercompany revenues and expenses, receivables and payables

Sales and purchases 5,000(j)
Consulting revenues and expenses (50 x 12) 600(k)
Deferred income taxes (Dec. 31, Year 6)

Inventory (e) 400
Equipment (i) 30 430(l)

Income of Handy 1,760
Less: Dividends from Dandy (800  70%) (m) 560
1,200
Add: Realized gain on equipment (h) 15

Income of Dandy 1,020
Add: Opening inventory profit (d) 480
Less: Amortization of acquisition differential (c) (120)
Closing inventory profit (e) (600)
Adjusted net income 780
Consolidated net income 1,995
Attributable to:
Shareholders of Handy 1,761
NCI (30% x 780) 234
1,995
(a) Handy Company

Year 6
Sales (21,900 + 7,440 – (j) 5,000) 24,340

Cost of sales (14,800 + 3,280 – (j) 5,000 + (e) 1,000 – (d) 800) 13,280
Gross profit 11,060
Other revenue (1,620 + 0 – (m) 560 – (k) 600) 460
Selling & admin expense (840 + 420 + (a) 50 – (h) 25) (1,285)
Other expenses (5,320 + 2,040 + (b) 70 – (k) 600) (6,830)
Income before income taxes 3,405
Income tax expense (800 + 680 + (d) 320 – (e) 400 + (h) 10) 1,410
Net income 1,995
Attributable to:
Shareholders of Handy 1,761
NCI (30% x 780) 234
1,995
(b)
Handy’s retained earnings 10,420
Unrealized gain on sale of equipment – net of tax (g) (60)
Subtotal 10,360
Dandy’s retained earnings, beginning of Year 6 $5,180

Dandy’s retained earnings, at acquisition 4,500
Change in retained earnings since acquisition 680
Cumulative differential amortization and impairment (c)(3,900)
Profit in beginning inventory – net of tax (d) (480)
-3,700
Handy’s share @ 70% - 2,590
Consolidated retained earnings 7,770
Handy Company
Consolidated Statement of Retained Earnings
For the year ended December 31, Year 6
Retained earnings, beginning of year 7,770

Net income 1,761
9,531
Dividends paid (1,600)
Retained earnings, end of year 7,931
(c) When unrealized profit is eliminated from the carrying value of the equipment, the
equipment ends up being reported at the original cost of the equipment less
accumulated amortization based on the original cost, as if the intercompany
transaction had never taken place. So, in effect, the equipment is reported at its
historical cost.
(d) Goodwill impairment loss under entity theory 70

Less: NCI’s share (30%) 21
Goodwill impairment loss under parent company extension theory 49
NCI on income statement under entity theory 234

Add: NCI’s share of goodwill impairment (30%) 21
NCI on income statement under parent company extension theory 255
(CGA-Canada adapted)

Problem 7-18
Under historical cost accounting and ignoring the intercompany sale, depreciation
expense would be $500,000 / 10 years = $50,000 per year. The equipment would be
reported as follows on the balance sheet:
Year 1 Year 2 Year 3
Cost 500,000 500,000 500,000
Accumulated depreciation 50,000 100,000 150,000
Carrying amount 450,000 400,000 350,000
Under the revaluation model and ignoring the intercompany sale, the equipment would
be reported as follows on the balance sheet:
Grossed up cost 511,111 520,000 528,571
Grossed up accumulated depreciation 51,111 104,000 158,571
Carrying amount = fair value 460,000 416,000 370,000
The amounts are grossed up using the ratio of fair value / carrying amount under
historical cost model.
Under the revaluation model and ignoring the intercompany sale, the depreciation
expense would be reported as follows on the income statement:
Carrying amount beginning of year 500,000 460,000 416,000
Remaining useful life 10 9 8
Depreciation expense for the year 50,000 51,111 52,000
Under the revaluation model and ignoring the intercompany sale, accumulated other
comprehensive income (AOCI) would be reported as follows on the balance sheet:

Fair value under revaluation model 460,000 416,000 370,000
Carrying amount under historical cost model450,000 400,000 350,000
AOCI 10,000 16,000 20,000

Using the above figures, the financial statement presentation would be as follows for the
separate entity and consolidated financial statements:
Year 1 MEL SENS CONS

(a) Equipment 511,111 511,111
(b) Accumulated depreciation 51,111 51,111
Net carrying value of equipment 460,000 460,000
(c) AOCI 10,000 10,000
(d) Gain on sale
(e) Depreciation expense 50,000 50,000

(a) Equipment 520,000 520,000
(c) AOCI 16,000 16,000
(d) Gain on sale
(e) Depreciation expense 51,111 51,111

(a) Equipment 422,857 528,571
(c) AOCI (370,000 – (420,000 x 7/8) 2,500 20,000
(d) Gain on sale of equipment (420,000 – 416,000) 4,000
(e) Depreciation expense (420,000 / 8) 52,500 52,000
WEB-BASED PROBLEMS
Web Problem 7-1
The following answers were determined using the 2011 consolidated financial
statements for Barrick Gold Corporation.

(a) The expenses on the consolidated statements of income are classified by
function (e.g. corporate administration and exploration and evaluation.
(b) It appears that no amortization was taken in 2011 as per note 18(b) .
Amortization expense does not appear on the consolidated statements of income
because expenses are classified by function and not by nature.
(c) The annual depreciation rates for property, plant and equipment are listed in note
2(m). For all of these assets, the useful lives appear to be fairly short. For
example, the maximum useful life for buildings is 25 years. The content of the
disclosures in notes 2(o) and 18(b) to the consolidated financial statements do
not include explicit useful lives assigned to the company’s intangible assets. The
intangible asset “supply contracts” will be amortized to cost of sales over the
effective term of the contract. Readers are not informed of the term to which this
note refers.
(d) Property, plant and equipment is $28,979 as per the consolidated balance
sheets. This represents 59.3% of total assets, which is an increase from 51.6% in
the previous year.
(e) The company values its plant and equipment at cost, including all expenditures
incurred to prepare the asset for its intended use plus applicable capitalized
costs that meet the asset recognition criteria less accumulated depreciation and
any accumulated impairment losses as per note 2(m) to the consolidated
financial statements.
(f) The asset turnover would be understated. Although sales are correctly stated,
total assets are overstated because the gain on the intercompany sale (which
took place two years ago) was not eliminated. The return on assets would also
be understated; income is understated because the excess depreciation on the
overstated asset was not eliminated and, again, assets are overstated because
the gain was not eliminated.
(g) Total equity, the denominator in the calculation of ROE, will increase by the
difference between the fair value of plant and equipment and its carrying amount.
Amortization expense attributable to plant and equipment will increase because it
will now be based on fair value. In turn, net income will decrease. With the
decrease in net income and increase in equity, the return on equity will decrease.
If ROE were calculated using comprehensive income, the fair value increment,
which is included in OCI, would increase comprehensive income. Then, the ROE

would likely increase. The impact on share price is hard to assess because it
depends on how the actual fair values compare to investors’ estimates of fair
values. If the fair values reported in the financial statements were higher than
expectations, the stock price would increase and vice versa.
Web Problem 7-2

The following answers were determined using the 2011 consolidated financial
statements of RONA Inc.
(a) The expenses are classified by function (e.g. selling, general and administrative
expenses) as per note 5.1.
(b) Amortization expense on other intangible assets is $23,831 as per note 5.2.
Amortization expense does not appear on the consolidated income statements
and other comprehensive income because expenses on the income statement
are classified by function and not by nature.
(c) Notes 3(g) through (j) to the consolidated financial statements disclose the
company’s accounting policies regarding property, plant, and equipment, non-
current assets held for sale, intangible assets, and goodwill. The estimated
useful lives of the tangible and intangible assets are usually expressed in a range
of years (e.g. 15 to 40 years for buildings). The estimated useful life for furniture
and equipment is 3 to 20 years; a 20-year useful life for a piece of furniture
and/or equipment seems quite long and, as such, appears to be overstated.
(d) Property, plant and equipment is $874,246 as per the consolidated statements of
financial position. This represents 31.4% of total assets, which is an increase
from 30.3% in the previous year.
(e) The company values its plant and equipment at cost (including capitalized
interest, if applicable) less accumulated depreciation and impairment losses as
per notes 3(g) and (k).
(f) The asset turnover would be understated. Although sales are correctly stated,
total assets are overstated because the gain on the intercompany sale (which
took place two years ago) was not eliminated. The return on assets would also
be understated; income is understated because the excess depreciation on the
overstated asset was not eliminated and, again, assets are overstated because
the gain was not eliminated.

(g) Total equity, the denominator in the calculation of ROE, will increase by the
difference between the fair value of plant and equipment and its carrying amount.
Amortization expense attributable to plant and equipment will increase because it
will now be based on fair value. In turn, net income will decrease. With the
decrease in net income and increase in equity, the return on equity will decrease.
If ROE were calculated using comprehensive income, the fair value increment,
which is included in OCI, would increase comprehensive income. Then, the ROE
would likely increase. The impact on share price is hard to assess because it
depends on how the actual fair values compare to investors’ estimates of fair
values. If the fair values reported in the financial statements were higher than
expectations, the stock price would increase and vice versa.

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influence it is at present a failure, though the enterprise has been
carried out regardless of cost, even in the most liberal manner.
The American mission at Teheran has really succeeded in making
some headway.
However, the at present (in regard to converts) abortive mission to
Julfa has in the educational department certainly done wonders, and
has given an impetus to the native schools, which previously, heavily
subsidised by successful Armenian emigrants, had done no work at
all, and were battened on by a set of hungry priests and mirzas, who
on some pretext or other sent away their pupils for five days out of
seven, and declared a holiday. Where the income went nobody
knew; this much was apparent, there was no result.
The long fasts of the Armenian Church are loyally kept by the
poorer of the Armenian community and by the villagers. They occupy
altogether a sixth of the whole year, and in them no eggs or meat
may be eaten, only vegetables, fruits, grain, and vegetable oil, but
wine and spirits are freely indulged in.
CHAPTER XIII.
ISPAHAN.
Prince’s physician—Visit the Prince-Governor—Justice—The bastinado—Its

effects—The doctor’s difficulties—Carpets—Aniline dyes—How to choose—
Varieties—Nammad—Felt coats—Bad water—Baabis—A tragedy—The
prince’s view.
Almost as soon as I arrived in Julfa I received a visit from the

prince’s hakim-bashi, Mirza Abdul Wahab. This gentleman, a native
of Kashan, had received his medical education in Paris, and was an
M.D. of its University. He described his life in Ispahan as dull in the
extreme, that he was never off duty save when the Prince-Governor
was asleep, and that his anxieties on account of the vagaries of his
charge were great. The Mirza had spent seven years in France, and
had married there; he had also two native wives (his French wife
afterwards came to Teheran, but soon returned to France). He
complained of the many hours he had to stand, etiquette forbidding
any other attitude in the prince’s presence. He told me that he had to
read poetry to his Royal Highness for many hours each day.
“Not that I mind reading poetry,” said he, “but no one listens, which
is provoking in the extreme.”
I was very glad to have an acquaintance with whom I could
converse, for of course the hakim-bashi spoke French fluently. The
appointment as physician to the eldest son of the king and Governor
of Ispahan is a high employ, and the doctor hoped it would lead to
better things; but he did not like the being away from the capital. He
became shortly a Khan.
He invited me to call on the prince, and told me that his Royal
Highness would receive me at half-past eight a.m. the next day, or,
as he phrased it, two hours after sunrise. I promised to be punctual,
and duly presented myself at the appointed hour.
I passed through a garden crowded with soldiers, servants,
persons having petitions to make, and the usual hangers-on of a
great man and his train. In a crowded outer room sat the Minister (or
real Governor), Mahommed Ali Khan, under whose tutelage the Zil-
es-Sultan is. The prince himself, being a mere youth, has no real
power, and everything is done by Mahommed Ali Khan. The hakim-
bashi now met me, and conducted me past a sentry into the private
apartment of the prince.
I took off my goloshes at the door, keeping my hat on, and making
a salute. The doctor introduced me in a few words, and the prince, a
good-looking youth of about eighteen years, motioned me smilingly
to a chair which had been placed for me opposite him. I asked after
his health in French, but he insisted on my talking in Persian, and
was much amused at the hash I made of it. He was a fine, good-
humoured youth, full of spirits.
After the first few minutes he threw off all his air of dignity and
talked and laughed merrily, asking many questions as to the
manners of Europeans, the Queen, climate of England, etc. He then
gave me his likeness, and told me that he photographed himself,
which was the case. I was regaled with tea, and took my leave,
breakfasting in the town with the hakim-bashi at his residence.
Here I saw for the first time the administration of justice in Persia.
The doctor was given the charge of the Jews of Ispahan: the Jews
had attended in a large crowd to complain of extortions practised
upon them by the soldiers who stood sentry at his gate. These men,
not content with exacting small presents from the poor people, had
insulted the wife and daughter of one of their number and severely
beaten them.
As we sat smoking the kalian at the open window, the crowd of
some hundred Jewish men and women shrieked and gesticulated;
while the two accused soldiers, who stood with the doctor’s servants,
vehemently protested their innocence. The hakim-bashi shouted, so
did the accused, so did the accusers, who wept, beat on their heads,
and prepared apparently to rend their already ragged garments.
THE BASTINADO.
“Somebody must be beaten,” said the doctor, “and these Jews are
undoubtedly horribly persecuted.”
When the shouting was at its highest, the doctor called to the
sergeant of infantry and whispered in his ear. The two soldiers
turned pale, and the Jews proceeded to implore blessings on the
head of the doctor.
Presently a pole some eight feet long, with a transverse handle at
either end and a loop of rope in the middle, was produced, and,
kicking off their boots, the two soldiers lay down on the ground, and
each raised a foot; but the doctor was not to be appeased so easily,
and insisted on both feet of each man going into the loop. On this
being done, the noose was tightened by turning the pole by means
of the handles, and the soles of the soldiers’ feet were now upwards,
and a fair mark; two other soldiers held the ends of the pole, which is
termed a “fellek.”
The doctor now adjured the men to confess, as, if they did not, as
he put it to them, he should have to thrash them till they did, and
then have to punish them for the offence itself; whereas, if they
confessed, there would be only one beating and accounts would be
clear.
Both men confessed, though the value of a confession under such
circumstances may be doubted. Then the doctor’s servants drew
from his hauz a huge bundle of sticks some five feet long; they were
ordinary willow wands, switchy, and about twice the thickness of the
thumb at the butt; the bark was left on, and it appeared that they
were kept in water to prevent their breaking too easily.
Four of the soldiers now seized each half-a-dozen wands, and,
taking one in their right hands, awaited the signal. “Bezan!” (“Lay
on!”) exclaimed the hakim-bashi, and they proceeded to thrash the
bare soles of their comrades with the sticks; at first they struck fair
on the feet, but whenever the doctor’s eye was not on them, they
broke the stick over the “fellek” and substituted a fresh one.
The men now roared for mercy; some hundred sticks had been
broken over their feet, and, taking an average of four blows for each
stick, they had received four hundred, or two hundred each.
“Amān Agha!” “Mercy, Lord!” “Oh, hakim-bashi!” “Oh, merciless
Jews!” “Oh, Mussulmans!” “Oh, doctor, sahib!” “Oh, Lord, without
mercy!” “Oh, rascal Jews!” “Sons of dog fathers!” “Mer—cy!”
The hakim-bashi now addressed them—“Rascals, do you know
now that you are not to oppress the king’s subjects?”
“Ah,” replied one man, “but Jews—” He had better have been
silent, for the hakim-bashi raised his hand, and the beating
recommenced. I now interceded, and the men were led off, limping.
I asked the doctor if such beatings would not lame the men.
He replied, “Not in the least; they will be all right in two days, if a
little tender to-morrow. I have myself had quite as bad a beating from
my achōn (schoolmaster) when a boy. There is no degradation in the
punishment; all are liable to it, from the Prime Minister downwards.
What you have seen is merely a warning; one and two thousand
sticks are often given—I mean to say fairly broken over the soles of
the feet—and thicker sticks than mine; say, six thousand blows.”
I asked what was the result of such beating.
“Well,” said the doctor, “I have known them fatal; but it is very rare,
and only in the case of the victim being old or diseased.”
I was told that it is really very much a matter of bribing the
farrashes (carpet-spreaders) who administer the punishment. As a
rule, a severe beating, such as is given by the king’s farrashes,
keeps a man in bed for weeks or months. Culprits much prefer it to a
fine. Here the doctor called one of his servants.
“Which would you prefer,” said he, “to lose a month’s pay or take
such a beating as those soldiers had?”
“The beating, of course,” replied the man.
“His pay is ten kerans a month,” said the doctor (seven-and-
sixpence).
Custom, I suppose, is everything; to our tender feet such a beating
would be very terrible, but Persians of the lower class walk much
barefoot; in fact, like our own tramps, unless the road be very stony,
one sees them on the march take off their boots and go bare, to
save shoe-leather or sore feet.
The doctor told me of the trials and troubles of his position, his
long hours of duty, and his many anxieties when his young charge
was ill. “Your arrival is a great thing,” he said; “you can speak as I
cannot dare to, and you can insist on proper directions being carried
out. At present, when the prince is indisposed, all the visitors and all
the old women prescribe, and as he tries all the remedies, he
becomes really ill.
“Then I have to telegraph his state to the king; then the king’s
French physician and his other hakims are ordered to suggest
remedies. You can fancy the result. Why, when I came here, the then
hakim-bashi was a young and rowdy prince, who, though a very
good fellow, kept the Prince-Governor permanently on the sick-list,
gave him two china-bowls of physic to take a day, and tabooed
everything that was nice. Of course I broke through all that, and, by
keeping him free from physic and on good plain food, he is a strong
and healthy youth.” I sympathised with the doctor, and took my
leave.
From the doctor’s house I went to the principal bazaar of the town
to buy carpets, for I had disposed of most of my own on leaving
Kermanshah, to lessen the weight of my luggage. I was shown
several hundred carpets, some four by seven yards, down to little
rugs a yard square. Some of the finer carpets, astonished me by
their beauty, and also their price—forty pounds was a usual figure for
a large and handsome carpet.
The finer and more valuable carpets were not new—in fact, few
really good carpets are made nowadays. At the time I am speaking
of (sixteen years ago) the magenta aniline dyes were unknown to the
carpet-makers of Persia, and all the colours except the greens were
fast. Nowadays the exact reverse is the case. A very brilliant carpet
is produced, and if a wet handkerchief is rubbed on it, the colours
come off; these are not fast, and the carpet is worthless.
The aniline dyes are particularly used in the Meshed carpets, and
as these are the showiest and most attractive, they are largely
exported. Of course a native will not look at them, for when he buys
a carpet he expects it to last at least a century: he is generally not
disappointed. One sees many carpets which are quite fifty years old
with hardly a sign of wear.
At the time of which I am speaking, carpets had very seldom been
exported from Persia, and consequently there was no rubbish
manufactured; now (1883) it is quite different; if a very good carpet is
wanted, an old one must be bought.
The carpets made for the European market are coarse, and the
weaving loose. Many, indeed, are made of fast colours, but gaudy
patterns only are used, and the fine and original patterns formerly in
vogue are disappearing. Of a couple of hundred carpets brought for
sale, perhaps there may be only six distinct patterns, though, of
course, the borders and arrangement of the colours may vary. The
favourite patterns are the “Gul Anar” and “Herati:” the latter is
certainly very effective, and is the pattern of nine-tenths of the
carpets exported.
To choose a carpet, the first thing is to see if the colours are fast.
This is done by rubbing with a wet cloth. If the slightest tinge is
communicated to this, the carpet should be rejected. Then, if the
carpet is limp, and can be doubled on itself like a cloth, it is “shul-
berf” (loosely woven) and scamped. A carpet which is well woven (I
am speaking of new ones) is always stiff. Greens in the pattern
should be avoided, as they will fade to a drab, but this drab is not
unpleasing; white, on the contrary, in time becomes a pale yellow,
and is a good wearing colour, and should be chosen rather than
avoided.
The thinner and finer the carpet is, the greater is its value. The
size of the thread of the wool should be noticed, and the smaller it is
the better. It should be remembered that, in the question of price, a
thinner thread means a great difference in the amount of labour in
making.
The size, too, of the pattern should be noted, as a large pattern is
proportionately much cheaper. Again, the finer patterns being only
undertaken by the best weavers, one is more likely to get a good
carpet with a fine pattern than with a coarse. The general effect, too,
should be noted. This is never bad, but at times an eccentric pattern
is come across.
The softer the carpet is to the hand, the more valuable it is as a
rule, if it be not a Meshed carpet with aniline dye. These latter should
be avoided, as they always fade, and are of very small value.
One of the reasons why Oriental carpets last so long, is that chairs
are not used, and they are not walked on by boots, and so dirtied
and worn, but by bare feet. The carpet should now be doubled, and
the ends applied to each other. If one is broader than the other, it
shows careless work, and the carpet should be rejected as “kaj”
(uneven, or rather, crooked).
It must be then spread on a level floor and smoothed, to see if it
lies flat. Many carpets have “shatūr,” or creases; these never come
out. The carpet never lies flat, and wears in a patch over the “shatūr.”
If all is yet satisfactory the carpet must be turned bottom upwards,
and the edges carefully examined; if any darns are seen in the
edges of the carpet it must be rejected, for the Persians have a plan
of taking out any creases by either stretching the edges, which often
break under the process, or, if there is a redundancy, cutting it out
and fine drawing it so skilfully that it is only detected on carefully
examining the back. Such carpets are worthless.
The top of the carpet should now be inspected; if the edging of
cotton at the top or bottom be blue with no white in it, the carpet is
rubbish, and merely a thing got up for sale, absolutely a sham. The
edge or finish should be either white cotton or black wool; the latter
is by far the best, but is seldom seen nowadays. The all-woollen
carpets are mostly made near Mūrghab, and by the wandering tribes
of Fars; they are very seldom exported, and are always of sad
patterns, often very irregular.
In making a carpet, the women who weave it will often run out of
the exact shade of wool used in some part of the pattern or even
ground-work; they will continue with another shade of the same
colour. This has a curious effect to the European eye, but the native
does not look on it as a defect.
The value in Persia of a carpet in the present day may, if perfect
(either new or old), be reckoned at from fifteen shillings to two
pounds a square yard. In the larger carpets nothing can be obtained
under a pound a square yard.
Of course there are a few carpets which have been made to order
for great personages which are worth more than the price I have
given, but these are not easily obtained and only at prix fou. By the
term carpet, I mean what Persians call kali, that is, in
contradistinction to farsch. Kali is our idea of carpet, that is, a floor-
covering, having a pile.
Farsch means floor-covering generally, and may be “nammad,” or
felt, or “gelim,” a thin, pileless floor-covering of coarse pattern, and
much used in Europe as a portière; in these “gelim” white greatly
predominates, and they soon get soiled and dirty; they are only used
in Persia by the villagers and poor.
The farsch hamam-i, or bath carpet, is a finer species of gelim
made near Kermanshah; both sides are alike, the patterns are
elaborate and beautiful, and the colours very lovely, but they fade,
being mostly of aniline dye, and are harsh to the feel. Their only
recommendation is their extreme portability.
The nammad, or felts (carpets), are generally used by Persians to
go round the room and act as a frame to the carpet (kali), which
occupies the top and centre.
They are three in number for each room; two kanareh, or side
pieces, a yard to a yard and a half wide, and a sir-andaz, literally that
which is thrown over the head (of the apartment). The kanareh are
from half to two and a half inches in thickness, and are usually of a
light-brown or yellow-ochre colour, being ornamented with a slight
pattern of blue and white, or red and green, which is formed by
pinches of coloured wool inserted when the felt is made.
The best nammad are made at Yezd, and are often expensive;
they cost about thirty shillings a square yard, and will last a century;
they are two inches thick.
Nammad, however, are now getting out of fashion, for they will not
stand the wear produced by chairs, which are coming into common
use among the rich. Carpets are taking their place.
These nammad, or felts, are universally used as great-coats by
the peasantry, and are very good indeed as an outer covering, being
seamless. They are often made with bag-like sleeves with a slit at
the wrists, thus forming a glove, and when the peasant wants to use
his hands, they are thrust through the slit and the glove portion
turned back over the wrist. They are all in one piece.
The gelim, or tent carpets, are very suitable for travelling or rough
work, and being thin are easily dried. They wash well, and have no
pile.
There is yet another variety of carpet called jejim: this is very thin
and more like a plaid in consistency; it is used by horsemen, who
wrap their spare clothing in it and use it as a bed and carpet too.
For about fifty pounds I was able to get enough carpets for all my
living rooms, and, owing to the steady rise in the price of carpets, on
my departure in nine years’ time on leave, I got as much as I gave
for them. Exactly the same as with horses after the famine, the
demand being greater than the supply on account of exportation,
prices rose considerably.
A good deal of illness occurring just at this time among the staff, I
had my attention directed to the water, which, being mostly from
surface wells, was much contaminated. I therefore engaged a water-
carrier from the town, purchased a skin and bucket for him, and the
staff were supplied with a skinful twice a day, for cooking and
drinking purposes, from the monastery well—a deep and good one.
The Persians are particular what water they drink, and invariably
employ a sakka, or water-carrier; but the Armenians generally have
a cesspool just outside their house door, and in its immediate
proximity the well is dug, often only ten feet deep. The result is
obvious.
Our superintendent being a married man, collars which I had cast
off for the last year, principally because I could not get them washed,
had to be worn; and I had to send them to Teheran by post to get
them washed, for in Ispahan the art of ironing was unknown; and the
American term for a shirt, “boiled rag,” was literally appropriate.
I made the acquaintance of three brothers who were Syuds, or
holy men, but who had the reputation of being freethinkers; these
men called on me and insisted on my breakfasting with them in the
town: they were wealthy landed proprietors and merchants. I found
their house beautifully furnished and their hospitality was great; they
discoursed much on the subject of religion, and were very eloquent
on the injustices perpetrated in Persia. They were nearly related to
the Imām-i-Juma, or high priest, a very great personage indeed, who
ruled the town of Ispahan by his personal influence. It was said that
any one who incurred his displeasure always, somehow or other, lost
his life.
Under the shadow of such a relation, the Syuds Hassan and
Houssein and their brother openly held their very liberal opinions.
They were, in fact, sectaries of the Baab.
This impostor has succeeded in establishing a new religion, the
tenets of which are very difficult to get at—a community of property
being one. Mahommedans state that a community of women is also
observed; this is, however, very doubtful.
The execution of their prophet, far from decreasing their numbers,
has had an opposite effect; many among the Ispahanis and Zinjanis
still secretly profess Baabiism.
A few years before my arrival in Ispahan (1867), a determined
attempt was made on the life of the present Shah by a few of the
fanatics of this sect, and the unsuccessful conspirators were put to
death with horrible tortures. (For details see Lady Shiel’s work.) In
these latter days (1880), when I was in Ispahan, a priest was
denounced by his wife as a Baabi. I saw him led to prison; he
avowed his Baabiism and declined to retract, though offered his life;
he, however, denied the statements of his wife and daughter, who
accused him of wishing to prostitute them to others of his co-
religionists.
On being taken to the public square for execution, after having
been severely bastinadoed, and when in chains, knowing his last
hour was come, he was offered his life if he would curse Baab.
He replied, “Curses on you, your prince, your king, and all
oppressors. I welcome death and long for it, for I shall instantly
reappear on this earth and enjoy the delights of Paradise.” The
executioner stepped forward and cut his throat.
A few days after his execution, my friends the three brothers were
arrested, their valuables looted by the king’s son the Zil-es-Sultan,
the then Governor of Ispahan, and by the Imām-i-Juma, the
successor of their former protector in the office of high priest of
Ispahan. Their women, beaten and insulted, fled to the anderūns
(harems) of friends and relations, but were repulsed by them for fear
of being compromised. They then came to the telegraph-office in
Julfa and sat in an outer room without money or food. After a few
days the relatives, rather than let the (to them) scandal continue of
the women being in the quarters of Europeans, gave them shelter.
The real cause of the arrest of these men was not their religion;
the Imām-i-Juma owed them eighteen thousand tomans (seven
thousand two hundred pounds); they were sent for and told that if
they did not forgive the debt they would be denounced and inevitably
slain. But habit had made them bold; they declined to even remit a
portion of the sum owing; they were politely dismissed from the high
priest’s presence, and a proposition made to the prince that the
whole of their property should be confiscated by him, and that they
should be accused of Baabiism and executed. This was agreed to.
They were sent for and taken from the prince’s presence protesting
their innocence, the youngest brother cursing Baab as proof of his
orthodoxy.
The next day all were savagely beaten in prison, and it was
generally given out that they would be executed; but being men of
wealth and influence, no one believed in this.
The English missionary in Julfa, the assistant superintendent of
the telegraph, and a few Armenians, addressed a letter to the prince
which, while apparently pleading their cause, really, I fear,
accelerated their fate (if it had any effect). The prince was furious,
and vouchsafed no reply.
I happened to see him professionally, and he asked me why I had
not signed this letter. I replied that I had not been asked to in the first
place; and that I should hesitate to mix myself up in the politics of the
country, being a foreign official. He appreciated my motives, and
asked if I knew the three men.
I replied that all three were my intimate friends, and I trusted that
their lives were not really in danger.
I never have been able to ascertain if his reply was merely given to
quiet me or not; it was this:—
“The matter is really out of my hands—it has been referred to the
king; he is very bitter against Baabis, as you know; nothing that
sahibs in Julfa may do will have any effect. Why, sahib, what would
your Prince of Wales say if he were interviewed, and letters written to
him about confessed criminals by obscure Persians? The
missionary, the missionary, he only troubles me to make himself
notorious.”
I explained that these Syuds were really personal friends of the
missionary as well as my own.
“All disaffected people are friends of missionaries, as you very well
know.”
I again asked him if they would be spared or not?
“I can tell you nothing more,” he said; “one has cursed Baab, he
will not die. As for the others the king will decide; for me, I wish
personally to kill no one; you have known me long enough to know I
dislike blood. I am not the Hissam-u-Sultaneh” (the king’s uncle, a
very severe Governor). He changed the subject and declined to
return to it. I cannot tell if the two elder brothers had been offered
their lives or not. I went back to Julfa hoping that they would all be
spared. The town was in great excitement. Next morning at dawn
their throats were cut in the prison, and their bodies flung into the
square. The prince had not dared to execute them publicly for fear of
a tumult.
Their houses were looted, and part of their estates; the Imām-i-
Juma’s share of the plunder was large, and he never repaid the
eighteen thousand tomans. Such was Persia in 1880. The youngest
brother, who had cursed Baab, was spared, and afterwards
reinstated in part of his family property.
CHAPTER XIV.
JULFA AND ISPAHAN.
Julfa cathedral—The campanile—The monk—Gez—Kishmish wine—The bishop

—The church—Its decorations—The day of judgment—The cemetery—
Establishment of the Armenian captives in Julfa—Lost arts—Armenian
artificers—Graves—Story of Rodolphe—Coffee-house—Tombstone bridges—
Nunnery—Schools—Medical missionary—Church Missionary establishment—
The Lazarist Fathers.
The sights of Julfa are very few—the cathedral, or Egglesiah

Wang, and the schools of the Church Missionary Society, the
cemetery, and the nunnery, being the only objects of interest.
The Egglesiah Wang, or “big church,” is a part of the monastery of
Julfa. At the entrance, which is by a stuccoed doorway surmounted
by a Latin cross in a mud wall, is a sort of stone drinking trough,
something like our old English fonts; it is embedded in the wall. The
door is of great thickness, so that in disturbed times the monks
would be safe against attacks of Mussulmans; and for the same
reason the entrance is narrow and winding. On emerging from this
short passage, one comes to the outer court, in one corner of which
are the graves of a few Europeans who have either died in Julfa or
been brought here for burial. These are noted in Sir F. Goldsmid’s
‘Telegraph and Travel,’ and some of the Latin inscriptions are
translated into English verse by him. A large campanile of imposing
appearance and peculiar (qy. Russian) style, stands in the centre; it
is new and well made, and consists of a brick tower standing on
stone columns, and containing three bells. The rest of the courtyard
is occupied by logs of wood from the monastery garden brought here
to season previous to being sold to the Julfa carpenters. Armenians
are very unromantic. The monastery church has a door opening into
this courtyard, but entrance is usually effected through a passage, in
which are the tombs of former bishops; these are mostly mere blocks
of stone let into the ground, but the two last bishops have more
ambitious mural monuments; the last, Thaddeus, having a black
marble tablet, probably cut in India, with an inscription (in English),
setting forth his virtues; over all is his photograph. There is an inner
entrance in this passage of railings, and the walls have some small
trap-doors through which the monks in stricter days used to confess
the laity—at least the females.
A few miserable daubs on plaster in this passage represent Saint
Michael weighing good and evil spirits, etc. To the right is a low door,
which leads to the church; at the extremity of the passage is a large
courtyard, which contains the apartments occupied by the
Arachnoort and the little bishop Christopher.
There is no pretension to magnificence in these. The rooms of
Christopher are small, and comfortable in a humble manner; a few
religious engravings and paintings of saints that Wardour Street
would not look at, hang on the walls; it is carpeted with cheap rugs,
and a mattress and a couple of cushions form the furniture; in the
corner is the tall, silver-headed ebon staff of the little bishop; in a
recess stand his conical hat and hood. A room quite without
ornament forms his bedroom, and his property, a few years ago
considerable, he has made over to the Church.
The little bishop is a gouty man, and does not indulge, though
there are legends that in his youth his potations were pottle deep; he
does not even smoke, but he snuffs—a thing that most of the old
people in Julfa do. A jovial old man in a skull-cap and flowing black
robes, he insists on regaling one with gez; a sort of sweetmeat,
prepared from the gezanjebine, a mawkish exudation from a plant
found in the desert near here, and akin to manna; it is mixed with
sugar and made up into round cakes with almonds or pistachios. It is
impossible to break these cakes with the finger; they will bend freely,
but on striking them with a hammer or another cake, they fracture at
once. Ispahan is celebrated through Persia for this sweetmeat, and
large quantities are sent away in every direction. In Julfa and
Ispahan the gez is always offered on the arrival of a guest, and
urgently pressed on one; it is considered impolite to refuse. The
flavour is merely sickly sweet, and it sticks to the jaws like butter-
scotch; it is white in colour, and very cloying. The monk, too, always
has a glass of good old Kishmish wine for his friends. The Kishmish
grape is the smallest in Persia; it is a bright yellow colour, and very
sweet; it is, when dried, what we call the Sultana raisin. The wine is
a golden yellow, delicious when quite new, but terribly heady. It is a
great favourite with the Armenians, as it is quickly intoxicating. As a
rule it will not keep well, but when it does is not to be despised. A
glass of arrack is offered as an alternative, and this is more suited to
the native taste; it is, as a rule, what is called in India “fixed
bayonets.”
The monk is a laughing philosopher, and generally has some store
of local yarns; in fact, he is a sort of “vieulx Parchemins,” and his
tales would have astonished and delighted the author of the ‘Contes
drolatiques.’
Passing under the guidance of the monk we ascend on the further
side of the courtyard a long staircase and enter a huge empty room
newly carpeted, which brings us to the curtained doorway of the
bishop’s private apartment. On the walls, decorated with many
figures in cut plaster of the Russian eagle (for the bishop is a
Russian subject, and wisely takes care that the Persian authorities
shall know it),[15] hang some twenty daubs in oil of saints and sacred
scenes; these are more pretentiously framed than those in the
monk’s room, but of equal value. A high chair, considerably
ornamented with native carvings, is the bishop’s habitual seat, and at
its side is a table covered with well-bound books, which at my first
visit considerably impressed me; but I found out afterwards that they
were always the same books, so my respect for the literary
attainments of the Arachnoort somewhat diminished.
After a decorous interval the bishop enters, a handsome man—a
man who would create a furore in England—a man with large,
dreamy, black eyes, which he uses as much as the late Mr. Fechter,
a pale and interesting face, and a long, silky beard, well combed,
and black as the raven’s wing. From his neck hang an amethyst
cross and a large portrait of the Virgin, in an oval enamel surrounded
by paste. Clad in black lined with violet, his tall conical cap and
flowing black hood give a fine stage picture, which is completed by a
gentle raising of the hand (a white and delicate hand) as if to bless; a
soft, whispering, almost purring voice, completed the charm of a man
who in some other sphere would have doubtless achieved the
success usually attained by great personal attractiveness. A sort of
smile, as of a superior nature compassionating itself, spreads over
his handsome face, and in a whisper he asks after one’s health. The
glossy beard is stroked, the black eyes are rolled; coffee is brought,
a kalian, and the visitor retires, after much bowing on both sides.
The church alone remains to be seen, for the monastery itself is
not in use, the cells being filled with firewood and corn. The church is
not large, and is divided by a row of coarsely-painted wooden rails
into two compartments, the outer and larger one, which is
surmounted by a dome, being decorated with large paintings in oil of
the events in Bible history from the creation. There is nothing
particularly remarkable in these; most are copied from well-known
pictures, while others are amusing in their naïveness. The general
effect is good, a sort of gorgeousness being produced by so many
yards of brightly-painted canvas. All round the walls are modern tile-
work, presenting a florid pattern of green leaves on a white ground.
The general effect of this is not bad. The episcopal throne is placed
just beyond the railings, and consists of an elaborately-carved and
ornamented chair, covered by a wooden domed canopy, gilt and
painted in gaudy colours. A few feet in front of this is a raised
platform, some four feet from the ground, running back into a recess.
This can be curtained off at pleasure; a gaudy curtain hangs at either
side of it. At the extremity of the recess is the altar; there is only one
in the church. It has a sort of cabinet for the host, and has numerous
smaller platforms above it, each a few inches high; on these are
coarsely painted a few figures of saints.
All round the church run various pictures of martyrdoms, some of
them horrible in their grim realness, others as intensely ridiculous.
Here are shown the various sufferings of Ripsimeh virgin and martyr,
also Gregor; these are the chief saints in the Armenian calendar.
Illustrations are also seen of the parables and miracles. One of
these is the man who had the beam in his eye seeing the mote in his
brother’s. The mote is depicted as a moat, and the beam as a huge
beam of wood.
A painful daub, framed, and meant for the Entombment, is gravely
exhibited as a Raphael, and once it was intimated to me that a good
offer would not be refused. It is even copied on the outer wall near
the bishops’ tombs.
But the bouquet of the whole collection is the great picture of the
Day of Judgment. All the persons of the Trinity are depicted, and the
heavenly hosts are shown with the delights of heaven. These are,
however, in the upper part of the picture, and of small size; but in the
lower part, that representing the pangs of hell, the artist has given
free vent to his taste for horrors.
New ideas for bogey might be derived from his very vivid
treatment of the devils. George Cruikshank, the devil-drawer par
excellence, is nowhere with the Eastern artist. These devils are life-
size, and so are the nude male and female figures suffering
torments. The mouth of hell is represented as a yawning beast,
vomiting fire and smoke, into the jaws of which the nude wicked are
tumbling. As a popular preacher is reported to have said, “The devil
feeds you on fire, and if you don’t take it properly you get touched up
with the spoon.” This is actually represented.
The position of the picture is well chosen, being over the door. All
the congregation must see it on going out; and if they feel certain of
getting their deserts, it must make them uncomfortable indeed.
Julfa was once a very large place, having twenty-four well-
populated parishes, and the Armenians were extremely prosperous.
A large village, with valuable lands, and an energetic trading
population, the agricultural portion of the community being market
gardeners, within a couple of miles of the then capital Ispahan; it was
a very different place from the Julfa of to-day, which contains merely
a population of old men, women, and girls, the better description of
male having all emigrated. Ispahan, too, is now merely a vast ruin,
with small local trade and few wants. Shah Abbas the Great brought
away the entire population of Julfa on the Araxes, which now marks
the Russo-Persian frontier on the road between Tabriz and Tiflis, and
is now merely a village of a few hovels; and, giving them lands in the
immediate and best part of the environs of Ispahan, in fact its
present site, called it Julfa. The far-seeing monarch sought to
introduce the thrifty trading habits of the Armenian among his own
subjects, and to give an impulse to the commerce of his country, and
the Julfa artisans in those days were not to be despised; travelling
east and west, they brought many arts from Europe, India, and
China. The weaving of shawls at Kerman and Yezd is still an
important trade, and only the connoisseur can detect the difference
between the Cashmere shawl and its imitation, that of Kerman:
probably the European would prefer the Kermani one. Silk weaving
was doubtless brought from China to Yezd. Coarse imitations of the
Chinese porcelain are to this day common in Persia, but the art is
dead. Enamelling, which the Armenians practised, and even
patronised—for in the Persian collection in the South Kensington
Museum may be seen a large enamelled tray, quite a unique
specimen, which bears an inscription saying it was made for ⸺,
prince of the Armenians—is a dying art.
As jewellers these people attain great proficiency. Any really
difficult work was always brought by the native gold or silver smiths
of Ispahan to be finished by an Armenian of Julfa, one Setrak. The
trade of watchmaker, or rather watchmender, is almost monopolised
in Persia by Armenians; and my former dispenser was a very good
drug-compounder, having received his instruction when a convict in
India, serving his time after committing a burglary with violence.
The cemetery lies on a bare and stony plain, under a lofty hill
called the Kūh Sufi. When Ispahan was the capital this plain was all
under cultivation by irrigation, the remains of the canals being yet
visible: here lie the inhabitants of Julfa, and also a few Europeans.
Each ancient grave is marked by a huge block of stone of a cube
form, the upper face being, however, generally larger than the under
one. Some are nine feet long, a yard high, and two feet wide. Many
of the stones have Dutch, Latin, and French inscriptions. One of
these latter is the well-known one of the watchmaker to Shah Abbas
the Great. “Cy gît Rodolfe” is the inscription it bears; and here lies
Rodolphe, who was a great favourite of the king, Abbas the Great.

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