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Chapter 4

ACTG 2010 Chapter 4: ACTG2010 - Chapter 11


Department
Accounting
Course Code
ACTG 2010
Professor
Douglas Kong
Chapter
4

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John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 11-1
Solutions Manual Copyright © 2013 McGraw-Hill Ryerson Ltd.
CHAPTER 11
Investments in Other Companies
QUESTIONS
Q11-1.
Goodwill is the excess of the price paid for all or part of a company over the fair market value of
the identifiable assets less liabilities. It’s difficult to be sure what goodwill represents because
it’s a residual but it’s often attributed to things such as management ability, location, synergies
created by the acquisition, customer loyalty, reputation, and benefits associated with the
elimination of a competitor. It’s only recorded on the financial statements when an entity
purchases control of another entity.
Q11-2.
The extent of influence of one corporation over another determines how the investment is
accounted for. If the influence is sufficient that the entity makes the important decisions for the
investee (control), that company is called a subsidiary and the financial statements of both
entities are aggregated to produce consolidated financial statements. When a company has
significant influence over another company equity accounting is used. When little or no
influence can be exerted, the investment is passive and is accounted for (according to IFRS) at
amortized cost, fair value through other comprehensive income, or fair value through profit or
loss. The classification affects how the investment is valued on the balance sheet and how gains
and loses are accounted for. If the investor can influence decisions but not control them
(significant influence), equity accounting is used.
Q11-3.
a. When the investing entity controls the other, the investor makes the important decisions
for the investee. When there is control, consolidation accounting is used.
b. Significant influence means that important decisions can be influenced, but not
determined by the investor. Equity accounting is used when there is significant influence.
c. When little or no influence can be exerted, the investment is passive and is accounted for
(according to IFRS) at amortized cost, fair value through other comprehensive income, or
fair value through profit or loss. The classification affects how the investment is valued
on the balance sheet and how gains and loses are accounted for.
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John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 11-2
Solutions Manual Copyright © 2013 McGraw-Hill Ryerson Ltd.
Q11-4.
Consolidated financial statements aggregate the financial statements the parent and all its
subsidiaries into a single set of financial statements that present the financial position and results
of operations for the entire economic entity. The consolidated statements represent the
aggregation of more than one legal entity into statements for a single economic entity. For
example, the assets on the consolidated balance sheets are the sum of the assets of the parent and
those of the subsidiaries, with some adjustments. Consolidated financial statements communicate
to investors in the parent the assets that are at its disposal and the revenues and expenses that the
consolidated entity has generated. This aggregation reduces the time and effort required to learn
about the entity. Without consolidated statements, users would have to examine financial
statements for each of the firms in the consolidated group. This could be very time consuming.
(This approach would, however, be desirable for some users, such as financial analysts.) The
consolidated statements also eliminate the effects of inter-company transactions, which can be
used to manipulate the statements. The disadvantage is that they aggregate information so that
details are lost and the opportunity to compare the performance of parts of the whole to other
companies in their industry is gone. Particularly when a company operates a variety of dissimilar
businesses, there are no comparable companies as a basis for assessing the aggregated results.
Q11-5.
There are a variety of reasons including the pursuit of a reasonable return on surplus cash, a
means of expanding operations more quickly than opening new stores or plants, to ensure
markets for their products or ensure supplies of their needed inputs, or to diversify.
Q11-6.
An inter-company transaction is a sale from one company in the consolidated group to another
company in the consolidated group. If the transactions aren’t eliminated, consolidated net income
would include the revenue and profit on transactions that aren’t outside the consolidated entity.
The balance sheet could include accounts receivable and payables that arose on the intercompany
transactions and inventory could be written up in value. The entity concept requires that
transactions be recorded only if an exchange takes place with an external entity. By not
eliminating intercompany transactions, gains would be recognized before they are realized.
Additionally, management would have an opportunity to manipulate income simply by arranging
sales within the economic entity.
Q11-7.
A subsidiary is a corporation that is controlled by another corporation. They are accounted for on
a consolidated basis, which means that the financial statements of the parent and the subsidiary
are aggregated into a single set of consolidated financial statements.
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John Friedlan, Financial Accounting: A Critical Approach, 4th edition Page 11-3
Solutions Manual Copyright © 2013 McGraw-Hill Ryerson Ltd.
Q11-8.
The non-controlling interest represents the claim on the subsidiary by owners of shares not
owned by the controlling shareholder. Non-controlling interest on the income statement
represents the share of net income that belongs to shareholders other than the controlling
shareholder. Non-controlling interest is necessary because balance sheets report 100% of the
assets and liabilities and income statements represent 100% of the revenues and expenses of the
subsidiaries even if the parent doesn’t own 100% of the shares. Non-controlling interest on the
balance sheet represents the equity of non-controlling shareholders.
Q11-9.
There is little information for a non-controlling shareholder in the non-controlling interest
amounts in consolidated balance sheets and income statements. The non-controlling shareholders
will receive the financial statements of the subsidiary itself. The information in the consolidated
statements is aggregated so they don’t provide clear information about the non-controlling
shareholders’ investment.
Q11-10.
Clearly, the available flexibility will provide managers with the opportunity to pursue their
reporting objectives. The preference of management as to the allocation of the purchase price
among the identifiable assets and liabilities would depend on the balance sheet/income strategy.
If management wanted to keep balance sheet values high and delay deprecition of the difference
between purchase price and book values, they would prefer to allocate more to goodwill, which
will not be amortized, and to capital assets with long remaining useful lives, and less to inventory
and other assets that will be sold or amortized over short periods of time. For tax purposes
allocating more of the cost to assets that will be expensed more quickly would be the appropriate
strategy.
Q11-11.
Segment disclosure disaggregates information by type of operations and geographic location.
Segment disclosures are required under IFRS to overcome the problems that arise because of the
aggregation that occurs in consolidated financial statements. It can be useful to users of financial
statements if it facilitates comparison of that business segment to other companies that operate in
the same segment. Without segmented information, it’s difficult or impossible to assess the
contribution of a business segment to the success of the whole entity. For example, a
manufacturer may have a finance subsidiary to provide financing to purchasers of its product.
Without segmented information, it may be difficult to compare the profitability of the
manufacturing operations to that of another company in the same industry.
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