Friendship

CHAPTER 11

11-1 Marketable securities may be either short-term or long-term investments. Short-term refers to intention, not to salability.

11-2 Trading securities are debt or equity securities that a company buys only with the intent to resell them shortly. Held-to-maturity securities are debt securities that the company purchases with the intent to hold them until they mature. Available-for-sale securities include all short-term investments that are not trading or held-to-maturity securities.

11-3 The market method is now routinely applied to investments in short-term securities classified as "available for sale" or "trading securities". The cost method applies only to "held-to-maturity" debt securities.

11-4 No. This statement is true for trading securities, but not for available-for-sale securities (where the gain or loss is taken directly to an account in stockholders' equity) or for held-to-maturity securities (where changes in market price are not reported).

11-5 Amortization of bond discount increases an investor's interest income. The payment of $1,000 at maturity includes return of the $950 invested plus $50 of interest. Amortization spreads this extra interest income over the life of the bond.

11-6 Investments of 20 to 50 percent of the shares of unconsolidated subsidiaries over which significant influence, but not control, is exercised are carried in the balance sheet at original cost plus the consolidated group's share of accumulated income since acquisition reduced by dividends received. This is called the equity method.

11-7 The equity method is usually appropriate for long-term investments where the investor has an ownership interest of 20 to 50 percent, because the owner would usually have the ability to exert significant influence over the investee. This method is also often used by the parent to account for majority-owned subsidiaries between financial statement preparation dates.

11-8 Under the equity method the investor recognizes income as it is earned by the investee and accounts for dividends as a reduction of the investment. Under the market method the investor recognizes income when cash dividends are paid by the investee. In addition, the market method adjusts carrying values to market.

11-9 A parent-subsidiary relationship exists when one corporation owns more than 50% of the outstanding voting shares of another corporation.

11-10 The reasons for establishing subsidiaries include limiting the liabilities in a risky venture, saving income taxes, conforming with government regulations with respect to a part of the business, doing business in a foreign country, and expanding in an orderly way. It is also often easier to sell or spin-off a subsidiary than an integrated part of the firm.

11-11 The answer depends upon who sells Company A the shares. If Company A purchases the shares of B from the shareholders of B, not from the company itself, the company's books are unaffected. If Company A purchases the shares from Company B when Company B is created, Company B debits cash and credits common stock and additional-paid-in-capital.

11-12 Eliminating entries remove double-counting. Adding together the books of the parent and subsidiary includes both the net assets of the subsidiary and also the parent's ownership interest in those assets (the investment in subsidiary account). The consolidated statements should not show both amounts. The investment in subsidiary account is deleted by the eliminating entry along with the subsidiary's owners' equity. Consolidation also requires adjustment for intercompany transactions: purchases and sales, receivables and payables between parent and subsidiary.

11-13 No. The consolidated statement and the parent-only statement will show the same amount of net income. The difference is in the format of reporting, not in the amount of income that is reported. The parent reports subsidiaries' results using the equity method.

11-14 If the parent owns, say, 90% of the subsidiary stock, then outsiders to the consolidated group own the other 10%. The account Minority Interest in Subsidiaries is a measure of this outside interest. Note that this minority interest is in the subsidiary, not in the parent company. The financial statement of the consolidated company will show the minority interest.

11-15 According to the FASB, control cannot exist unless an ownership interest exceeds 50 percent. Significant influence is presumed if the ownership interest is between 20 and 50 percent.

11-16 Goodwill is measured by the excess of purchase price over the fair value, not the book value, of the net identifiable assets (identifiable assets less liabilities) acquired. Goodwill is an intangible asset related to the whole entity.

11-17 In the U.S. GAAP used to require that goodwill be amortized over no more than 40 years, assuming it does not have an infinite life. The rule was recently changed so that goodwill is written off only when its value is impaired. In some countries it is treated as having an infinite life and in other countries immediate write-off against equity is permitted.

11-18 Twenty percent is the common cut-off between the use of the market and equity method. Particularly when affiliates are incurring losses, parents might prefer the market method so they do not have to record their proportionate share of the losses on their income statement. Note that many start up companies may report losses while having steady or rising market values.

11-19 Historically, subsidiaries whose business is totally different from the parent and other subsidiaries were not consolidated. Examples were finance companies and insurance companies that are subsidiaries of parent companies with entirely different activities such as manufacturing, merchandising, mining, and transportation. Under current GAAP, all subsidiaries that are more than 50% owned are consolidated, unless the control is temporary.

11-20 Under the direct method the body of the statement of cash flows would show the $20,000 dividends as part of cash flows from operating activities. The reconciliation schedule would adjust net income as follows:

Deduct: Pro-rata share of affiliated

company net income $(32,000)

Add: Dividends received 20,000

Alternatively, the reconciliation schedule might have

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