CHAPTER 13
Intercorporate Investments

Solutions

1. B is correct. If Cinnamon is deemed to have control over Cambridge, it would use the acquisition method to account for Cambridge and prepare consolidated financial statements. Proportionate consolidation is used for joint ventures; the equity method is used for some joint ventures and when there is significant influence but not control.
2. A is correct. If Cinnamon is deemed to have control over Cambridge, consolidated financial statements would be prepared, and Cinnamon’s total shareholders’ equity would increase and include the amount of the noncontrolling interest. If Cinnamon is deemed to have significant influence, the equity method would be used, and there would be no change in the total shareholders’ equity of Cinnamon.
3. C is correct. If Cinnamon is deemed to have significant influence, it would report half of Cambridge’s net income as a line item on its income statement, but no additional revenue is shown. Its profit margin is thus higher than if it consolidated Cambridge’s results, which would impact revenue and income, or if it only reported 19 percent of Cambridge’s dividends (no change in ownership).
4. C is correct. The full and partial goodwill method will have the same amount of debt; however, shareholders’ equity will be higher under full goodwill (and the debt to equity ratio will be lower). Therefore, the debt to equity will be higher under partial goodwill. If control is assumed, Cinnamon cannot use the equity method.
5. A is correct. Cambridge has a lower operating margin (88/1,100 = 8.0%) than Cinnamon (142/1,575 = 9.0%). If Cambridge’s results are consolidated with Cinnamon’s, the consolidated operating margin will reflect that of the combined company, or 230/2,675 = 8.6%.
6. A is correct. When a company is deemed to have control of another entity, it records all of the other entity’s assets on its own consolidated balance sheet.
7. B is correct. If Zimt is deemed to have significant influence, it would use the equity method to record its ownership. Under the equity method, Zimt’s share of Oxbow’s net income would be recorded as a single line item. Net income of Zimt = 75 + 0.5(68) = 109.
8. B is correct. Under the proportionate consolidation method, Zimt’s balance sheet would show its own total liabilities of €1,421 − 735 = €686 plus half of Oxbow’s liabilities of €1,283 − 706 = €577. €686 + (0.5 × 577) = €974.5.
9. C is correct. Under the assumption of control, Zimt would record its own sales plus 100 percent of Oxbow’s. €1,700 + 1,350 = €3,050.
10. C is correct. Net income is not affected by the accounting method used to account for active investments in other companies. “One-line consolidation” and consolidation result in the same impact on net income; it is the disclosure that differs.
11. B is correct. Under IFRS 9, FVPL and FVOCI securities are carried at market value, whereas amortized cost securities are carried at historical cost. €28,000 + 37,000 + 50,000 = €115,000.
12. C is correct. If Dumas had been classified as a FVPL security, its carrying value would have been the €55,000 fair value rather than the €50,000 historical cost.
13. B is correct. The coupon payment is recorded as interest income whether securities are amortized cost or FVPL. No adjustment is required for amortization since the bonds were bought at par.
14. C is correct. Unrealized gains and losses are included in income when securities are classified as FVPL. During 2018 there was an unrealized gain of €1,000.
15. B is correct. The difference between historical cost and par value must be amortized under the effective interest method. If the par value is less than the initial cost (stated interest rate is greater than the effective rate), the interest income would be lower than the interest received because of amortization of the premium.
16. B is correct. Under IFRS, SPEs must be consolidated if they are conducted for the benefit of the sponsoring entity. Further, under IFRS, SPEs cannot be classified as qualifying. Under US GAAP, qualifying SPEs (a classification that has been eliminated) do not have to be consolidated.
17. B is correct. Statewide Medical was accounted for under the pooling of interest method, which causes all of Statewide’s assets and liabilities to be reported at historical book value. The excess of assets over liabilities generally is lower using the historical book value method than using the fair value method (this latter method must be used under currently required acquisition accounting). It would have no effect on revenue.
18. A is correct. Under the equity method, BetterCare would record its interest in the joint venture’s net profit as a single line item, but would show no line-by-line contribution to revenues or expenses.
19. C is correct. Net income will be the same under the equity method and proportional consolidation. However, sales, cost of sales, and expenses are different because under the equity method the net effect of sales, cost of sales, and expenses is reflected in a single line.
20. B is correct. Under the proportionate consolidation method, Supreme Healthcare’s consolidated financial statements will include its 50 percent share of the joint venture’s total assets.
21. C is correct. The choice of equity method or proportionate consolidation does not affect reported shareholders’ equity.
22. C is correct. Although Supreme Healthcare has no voting interest in the SPE, it is expected to absorb any losses that the SPE incurs. Therefore, Supreme Healthcare “in substance” controls the SPE and would consolidate it. On the consolidated balance sheet, the accounts receivable balance will be the same since the sale to the SPE will be reversed upon consolidation.
23. A is correct. The current ratio using the equity method of accounting is Current assets/Current liabilities = £250/£110 = 2.27. Using consolidation (either full or partial goodwill), the current ratio = £390/£200 = 1.95. Therefore, the current ratio is highest using the equity method.
24. A is correct. Using the equity method, long-term debt to equity = £600/£1,430 = 0.42. Using the consolidation method, long-term debt to equity = long-term debt/equity = £1,000/£1,750 = 0.57. Equity includes the £320 noncontrolling interest under either consolidation. It does not matter if the full or partial goodwill method is used since there is no goodwill.
25. C is correct. The projected depreciation and amortization expense will include NinMount’s reported depreciation and amortization (£102), Boswell’s reported depreciation and amortization (£92), and amortization of Boswell’s licenses (£10 million). The licenses have a fair value of £60 million. £320 purchase price indicates a fair value of £640 for the net assets of Boswell. The net book (fair) value of the recorded assets is £580. The previously unrecorded licenses have a fair value of £60 million. The licenses have a remaining life of six years; the amortization adjustment for 2018 will be £10 million. Therefore, Projected depreciation and amortization = £102 + £92 + £10 = £204 million.
26. A is correct. Net income is the same using any of the methods but under the equity method, net sales are only £950; Boswell’s sales are not included in the net sales figure. Therefore, net profit margin is highest using the equity method.
27. A is correct. Net income is the same using any of the choices. Beginning equity under the equity method is £1,430. Under either of the consolidations, beginning equity is £1,750 since it includes the £320 noncontrolling interest. Return on beginning equity is highest under the equity method.
28. A is correct. Using the equity method, Total asset turnover = Net sales/Beginning total assets = £950/£2,140 = 0.444. Total asset turnover on beginning assets using consolidation = £1,460/£2,950 = 0.495. Under consolidation, Assets = £2,140 − 320 + 1,070 + 60 = £2,950. Therefore, total asset turnover is lowest using the equity method.
29. A is correct. Because the investment is designated as amortized cost, it is reported at the end of Year 1 using the effective interest method, whereby the amortization is calculated as the difference between the amount received and the interest income.

    The amount received each period ($500,000) is based on the par value of $10,000,000 and the stated 5% coupon rate. The interest income of $440,000 is calculated by multiplying the 4.0% market rate by the initial fair value or amortized cost at the beginning of the period of $11,000,000. The difference between the $500,000 received and the interest income of $440,000 is the amortization amount, which is equal to $60,000.

    The initial fair value of $11,000,000 is reduced by amortization, resulting in an amortized cost at the end of Year 1 of $10,940,000. This amount represents the carrying value reported on the balance sheet if the security is classified as amortized cost.

30. B is correct. The SPE balance sheet will show accounts receivable of $50,000,000, long-term debt of $40,000,000, and equity of $10,000,000. When the balance sheets are consolidated, Blanca’s cash will increase by $40,000,000 resulting from the sale of the receivables to the SPE (net of its $10,000,000 cash investment in the SPE). Long-term debt will also increase by $40,000,000. The consolidated balance sheet will show total assets of $140,000,000 and look exactly the same as if Blanca borrowed directly against the receivables.

    SPE Balance Sheet

    		Long-term debt	$40,000,000
    Accounts receivable	$50,000,000	Equity	$10,000,000
    Total assets	$50,000,000	Total liabilities and equity	$50,000,000

    Blanca Co. Consolidated Balance Sheet

    Cash	$60,000,000	Current liabilities	$25,000,000
    Accounts receivable	$50,000,000	Noncurrent liabilities	$70,000,000
    Other assets	$30,000,000	Shareholder’s equity	$45,000,000
    Total assets	$140,000,000	Total liabilities and equity	$140,000,000

31. A is correct. Topmaker’s representation on the Rainer board of directors and participation in Rainer’s policymaking process indicate significant influence. Significant influence is generally assumed when the percentage of ownership interest is between 20% and 50%. Topmaker’s representation on the board of directors and participation in the policymaking process, however, demonstrate significant influence despite its 15% equity interest.
32. B is correct. The goodwill in Topmaker’s $300 million purchase of Rainer’s common shares using the equity method is $60 million and is calculated as follows:

    $ Millions
    Purchase price	$300
    Less: acquired equity in book value of Rainer’s net assets (15% of $1,340 million)	201
    Excess purchase price	99
    Less: attributable to difference between fair and book value of net identifiable assets (plant and equipment) (15% of $260 million)	39
    Goodwill	$60

33. B is correct. The carrying value of Topmaker’s investment in Rainer using the equity method is $317 million and is calculated as follows:

    $ Millions
    Purchase price	$300
    Plus: Topmaker’s share of Rainer’s net income (15% of $360 million)	54
    Less: Dividends received (15% of $220 million)	33
    Less: Amortization of excess purchase price attributable to plant and equipment (15% of $260 million) divided by 10 years	3.9
    Investment in associate (Rainer) at the end of 2018	$317.1

34. B is correct. The inventory sale between Rainer (associate) and Topmaker (parent) is an upstream transaction. Under the equity method, the deferral process for unrealized profits is identical under upstream and downstream inventory transfers. The investor company’s (Topmaker’s) share of unrealized profits is deferred by reducing the recorded amount of equity income on the investor’s income statement. In later periods, when the inventory is sold to third parties, the deferred profits are added to equity income.
35. B is correct. The goodwill impairment loss under IFRS is $300 million and is calculated as the difference between the recoverable amount of a cash-generating unit and the carrying value of the cash-generating unit. Topmaker’s recoverable amount of the cash-generating unit is $14,900 million, which is less than the carrying value of the cash-generating unit ($15,200 million). The result is an impairment loss of $300 million ($14,900 − $15,200).

    A is incorrect because $120 million results from incorrectly calculating the impairment loss under US GAAP rather than under IFRS. Under US GAAP, the impairment loss is calculated using the following two-step approach:

    Step 1:	Determination of Impairment Loss Because the fair value of $14,800 million is below the carrying value of $15,200 million, a potential impairment loss has been identified.
    Step 2:	Measurement of the Impairment Loss

    $ Millions
    Fair value of reporting unit	$14,800
    Less: identifiable net assets	$14,400
    Implied goodwill	$400
    Current carrying value of goodwill	$520
    Less: implied goodwill	$400
    Impairment loss	$120

36. A is correct. According to IFRS, under the partial goodwill method, the value of the minority interest is equal to the non-controlling interest’s proportionate share of the subsidiary’s identifiable net assets. Rainer’s proportionate share is 20%, and the value of its identifiable assets on the acquisition date is $1.5 billion. The value of the minority interest is $300 million (20% × $1.5 billion).