Chapter 4 Odd Numbered Solutions

Chapter 4
Consolidation of Non-Wholly Owned

Subsidiaries
Copyright  2016 McGraw-Hill Education. All rights reserved.

Solutions Manual, Chapter 4 1
SOLUTIONS TO REVIEW QUESTIONS
1. No, it is not the same. A negative acquisition differential exists if the implied value for a
100% acquisition is less than the carrying amount of the subsidiary's net assets. Negative
goodwill exists if the implied acquisition cost is less than the fair value of the subsidiary's
identifiable net assets. It is possible to have a negative acquisition differential and end up
with positive goodwill.
2. Proprietary theory requires consolidation of the parent's share of the subsidiary's net assets,
therefore giving no recognition to the non-controlling interest at all. Entity theory views the
consolidated entity as being owned by two groups of shareholders, the parent and the non-
controlling interest, and views the purchase transaction to have revalued both parties'
ownership. Thus, the entity theory requires the non-controlling interest to be recorded at its
percentage share of the fair value of the subsidiary's net assets (including goodwill) at the
date that the parent acquired its controlling interest. Parent company extension theory also
gives attention to NCI as one of the shareholders groups; Under this theory, non-controlling
interest is to be recorded at its percentage share of the fair value of the subsidiary's
identifiable net assets (excluding goodwill).
3. Goodwill of this nature is treated as if it does not exist at the date of acquisition. A new
goodwill figure is calculated based on the acquisition cost at the date of acquisition. When
preparing the schedule to allocate the acquisition differential, we assume that the goodwill
had been written off by the subsidiary just before the parent acquired its controlling interest
in the subsidiary. When calculating goodwill and goodwill impairment in subsequent years,
we must make adjustments on consolidation based on the goodwill calculated at the date of
acquisition
4. If 80% of a subsidiary cost $80,000, it is inferred that 100% would have cost $100,000. The
fair value of 100% of the subsidiary's net assets is subtracted from this implied acquisition
cost and the difference is goodwill. The amount of the non-controlling interest is determined
based on the subsidiary's fair values and goodwill arising from the purchase. With a small

2 Modern Advanced Accounting in Canada, Eighth Edition
ownership percentage (e.g., 52%), or when majority ownership is reached through a series
of small step acquisitions, this inference as to what 100% would cost is significantly less
reliable than at higher ownership percentages.
5. Non-controlling interest represents the equity interest of the non-controlling shareholders in

the fair value of the subsidiary. IFRS 10 requires that it be shown in shareholders' equity in
the consolidated balance sheet under both the parent company extension and entity
theories.
6. Goodwill and non-controlling interest differ under the two consolidation theories. Under the
parent company extension theory, only the parent’s share of the subsidiary’s goodwill is
reported because it is too difficult or subjective to measure the total goodwill of the
subsidiary. Since the non-controlling interest’s share of the subsidiary’s goodwill is not
included on the consolidated balance sheet, the value for non-controlling does not include a
share of the subsidiary’s goodwill. Therefore, both goodwill and non-controlling interest are
smaller amounts under the parent company extension theory in comparison to the entity
theory.
7. Contingent consideration is the additional consideration that may be payable for the
acquisition of a business. The additional consideration is dependent upon whether certain
future events occur (or do not occur). For example, a further payment may be required if
future net income reaches (or fails to reach) a certain level. The contingent consideration
should be measured at fair value at the date of acquisition. To do so, the parent should
assess the amount expected to be paid in the future under different scenarios, assign
probabilities as to the likelihood of the scenarios occurring, derive an expected value of the
likely amount to be paid, and use a discount rate to derive the value of the expected
payment in today’s dollars.
8. Changes in the fair value of contingent consideration that will be payable in cash should be
recognized in net income at each reporting date with a corresponding adjustment to the
contingent liability.
9. A private company may choose not to consolidate its subsidiaries and instead can report its
investment in subsidiaries using the equity method or the cost method. All subsidiaries
should be reported using the same method. However, if the entity would otherwise choose
to use the cost method and the security is traded in an active market, it must report the
investment at fair value.
10. Negative goodwill exists if the implied acquisition cost for a 100% investment is less than the
fair value of the subsidiary's identifiable net assets. Negative goodwill is reported on the
consolidated income statement as a gain on purchase.
11. No, the historical cost principle is not applied when accounting for negative goodwill. In fact,
it is violated. The subsidiary’s identifiable net assets are reported at fair value on the
consolidated balance sheet at the date of acquisition regardless of the amount paid by the
parent. The negative goodwill is reported as a gain on purchase, which is not consistent with
the historical cost principle.
12. Any income earned by the subsidiary subsequent to the date of acquisition is incorporated in
the consolidated income statement on a line-by-line basis. Any income earned by the
subsidiary prior to the date of acquisition is not incorporated in the consolidated income
statement because the subsidiary was not part of the consolidated group prior to the date of
acquisition.
13. The consolidation elimination entries are not recorded in the accounting records of either the
parent or subsidiary unless the subsidiary applies push down accounting. The elimination
entries are recorded on a consolidated working paper or consolidated worksheet, which is
used to facilitate the consolidation process.
14. Deferred charges do not meet the definition of an asset. Therefore, the deferred charge
should not be reported on the consolidation balance sheet. In other words, the deferred
charge should be measured at zero and would appear as a fair value deficiency on the
schedule of acquisition differential.
15. A parent-founded subsidiary would not have any acquisition differential i.e., there would not
be any difference between the fair value and carrying amount of assets and liabilities on the
date of acquisition.

SOLUTIONS TO CASES
Case 4-1
Under all theories of consolidation except for the entity theory, only the portion of Leafs’ goodwill
purchased by Maple is reported on the consolidated balance sheet. Given an acquisition cost of
$1,200,000, Maple paid $528,000 for its share of Leafs’ goodwill as shown in the first column of
Exhibit I. Putting a value on 100% of Leafs’ goodwill is not an easy matter as there are different
ways of determining this value.
First, one could assume a linear relationship between the amount paid for 60% and the value of
100% of the subsidiary. In this case, if 60% of the shares were worth $1,200,000, then 100% of
the shares should have been worth $2,000,000. In turn, 100% of goodwill would be measured at
$880,000 as indicated in the second column of Exhibit I. (See below.)
Secondly, one could listen to the argument made by the management of Maple and assume
that there was not a linear relationship between the amount paid for 60% and the value of 100%
of the subsidiary. Management stated that it was willing to pay a premium of $240,000 over and
above the market price of the shares in order to gain control over Maple and the premium would
be $240,000 regardless of the percentage of shares acquired. If this were the case, the total
value of Leafs would be $1,840,000 of which $720,000 would be allocated to goodwill as
indicated in the third column of Exhibit I.
The value assigned to goodwill will affect the value reported for non-controlling interest under
the entity theory. When goodwill is measured at $880,000, non-controlling interest is reported at
$800,000 as indicated in the fourth column in Exhibit II. When goodwill is measured at
$720,000, non-controlling interest is reported at $640,000 as indicated in the fifth column in
Exhibit II.
The subsidiary’s assets and liabilities are brought on to the consolidated balance sheet at fair
values only at the date of acquisition. These fair values become the historical values for
reporting purposes subsequent to the date of acquisition. That is, the subsidiary’s assets and
liabilities are not remeasured to fair value on each reporting date subsequent to the date of
acquisition.
The entity theory presents the fair value of the net assets of the subsidiary including goodwill at
the date of acquisition. The entity theory probably best reflects the economic reality of the
business combination since fair value is often a better reflection of economic reality. Since the
entity theory presents the highest values for assets, it will produce the lowest percentage return
on assets in subsequent periods because these assets need to be depreciated, expensed or
written off at some point. For this reason, the management of Maple may probably prefer to not
use the entity theory when preparing the consolidated financial statements.
EXHIBIT I
ALLOCATION OF ACQUISITION COST
(In 000s)
60% 100% 100%
Cost of 60% of Leafs $1,200
Implied value of 100% of Leafs (Note 1) $2,000
Implied value of 100% of Leafs (Note 2) $1,840
Carrying amount of Leafs’ net assets 400 400
(60% x [2,000 –1,600]) 240 . .
Acquisition differential 960 1,600
1,440
Allocated
Fair value excess for identifiable assets 480 800 800
Fair value excess for liabilities (48) (80) (80)
Goodwill $528 $880 $720
Notes:
1. The implied value is calculated assuming a linear relationship between the value for 60%
and the value of 100% i.e., if 60% is worth $1,200,000 then 100% is worth $1,200,000 /
0.6 = $2,000,000
2. The implied value is calculated assuming a non-linear relationship and assuming that
each share is worth $40 and that a control premium of $240,000 is paid regardless of the
number of shares purchased. Given that the total shares outstanding is 24,000 / 0.6 =
40,000, the total value of Leafs would be 40,000 shares x $40 + $240,000 = $1,840,000

EXHIBIT II
Maple Company
Consolidated Balance Sheet
At December 31, Year 7
(In 000s)
(See notes)
Proprietary Parent Co. Parent Ex Entity Entity

(a) (b) (c) (d1) (d2)
Identifiable assets $5,680 $6,480 $6,800 $6,800 $6,800
Goodwill 528 528 528 880 720
$6,208 $7,008 $7,328 $7,680 $7,520
Liabilities $ 4,008 $4,648 $4,680 $4,680 $4,680

Non-controlling interest 160
Shareholders’ equity
Controlling interest 2,200 2,200 2,200 2,200 2,200
Non-controlling interest . . 448 800 640
$6,208 $7,008 $7,328 $7,680 $7,520
Notes:
1. The assets and liabilities are calculated as follows:
(a) Carrying amounts for Maple and 60% of fair values for Leafs
(b) Carrying amounts for Maple and carrying amounts for Leafs plus 60% of fair value
excess for Leafs’ identifiable assets and liabilities plus 60% of the value of Leafs’
goodwill
(c) Carrying amounts for Maple and carrying amounts for Leafs plus 100% of fair value
goodwill
(d1) Carrying amounts for Maple and carrying amounts for Leafs plus 100% of fair value
goodwill assuming a linear relationship between the value of 60% and the value of 100%
(d2) Carrying amounts for Maple and carrying amounts for Leafs plus 100% of fair value
goodwill assuming a non-linear relationship and a control premium of $120,000
2. The non-controlling interest is calculated as follows:

(b) 40% x carrying amount of Leafs’ shareholders’ equity
(c) 40% x fair value of Leafs’ identifiable assets and liabilities
(d1) 40% x fair value of Leafs’ identifiable assets, liabilities, and goodwill
(d2) 40% x fair value of Leafs’ identifiable assets and liabilities and Leafs’ goodwill in total
less goodwill purchased by Maple i.e., 40% x ((2,800,000 –1,680,000) + (720,000 –
528,000))
Case 4-3
Factory Optical Distributors, Teaching Note*
Purpose of the case

The purpose of this case is to provide students with an opportunity to work with IFRS 10
Consolidated Financial Statements. The requirement is very directive, asking students to
examine the specific clauses of a franchise agreement to determine if control exists. The
answer is not immediately obvious, since ownership by the parent is much less than 50%, and
there are no convertible preferred shares outstanding or signed shareholder agreements in
place. Students must look further to decide whether the details of the franchise agreement give
FOD (Burnaby) control over the franchisee. Control has the following three elements:
(a) the investor has power over the investee to direct the relevant activities.
(b) the investor has exposure, or rights, to variable returns from its involvement with the
investee and
(c) the investor has the ability to use its power over the investee to affect the amount of the
investor’s returns.
All three elements must be met for the investor to have control.
* © 1995 J.C. (Jan) Thatcher, Lakehead University, Faculty of Business Administration and
Margaret Forbes. Used with permission. Adapted by Darrell Herauf.

Objectives and constraints
Since FOD is a public company, audited financial statements are required. Thus, IFRS must be
used in reporting the franchise investments.
Discussion
Factory Optical Distributors (FOD) (Burnaby) owns 35% of the franchise operation’s outstanding
common shares. No other equity instruments can be issued. Thus control does not exist based
on share ownership or ownership of convertible rights, options, or warrants. As well, there is no
evidence of an irrevocable shareholder agreement conferring control to either party.
IFRS 10 requires consolidation of all subsidiaries. A subsidiary is defined as an entity that is

controlled by another entity. The following specifics of the franchise agreement between FOD
(Burnaby) and its franchise operations suggest that the franchisee may be controlled by FOD
(Burnaby):
 FOD is the only supplier of the lenses to the franchisees and approves the suppliers of
frames. Thus, FOD has control over the supply of the primary products offered by the
franchise (while the franchisee controls the services offered).
 FOD maintains control over advertising, requires a minimum amount to be spent on
advertising and promotion, and dictates special sales and promotions. These points,
coupled with FOD's control over the supply of frames and lenses, indicate that FOD is
highly involved in many of the day-to-day decisions that must be made for the
franchises to succeed.
 The franchise agreement sets a maximum on the salary of the franchisee, limiting the
rights of the franchisee to withdraw funds from the corporation without involving the
other shareholders.
 The franchise fee is not a flat fee, but is variable based on revenue. Thus, FOD benefits
from the returns earned by the franchises.
 FOD guarantees the financing for new franchise locations or for renovations to existing
locations and, thus, is exposed to the same financial risk as the franchises.
The following specifics of the franchise agreement suggest that the franchisee may not control
the franchisees:

 The franchisee has clear voting control based on common share ownership. The
franchisee is in charge of day-to-day operations and thereby determines the following:
o quality of services provided to the customer
o other products and services to be offered to the public
o selling price of products and services
The decision as to whether or not the franchisees are controlled by FOD is one of professional
judgment. Some students may feel that given FOD's control of financing and operating policies,
and exposure to similar business risks, a subsidiary does exist. Others may feel that the factors
discussed in the case do not provide sufficient evidence, and a subsidiary does not exist. In the
opinion of the authors, a subsidiary does exist and consolidation would be appropriate.
There is no right or wrong answer to this case. A good classroom discussion will raise all of the
issues, and will allow students to formulate their own opinions based on professional judgment.
Case 4-5
REPORT TO PARTNER
Fabio & Fox, Chartered Professional Accountants

For The Year Ending September 30, Year 8
As requested, I have prepared a report that can be used for your next meeting with Leo Titan,
Chief Executive Officer of Lauder Adventuress Limited (“LAL”). The report deals with the
accounting implications of the matters discussed with Leo. Over the past year, the business of
LAL has changed: it now owns a sports franchise and is currently building a sports arena. A
number of transactions have taken place in connection with the construction of the arena. You
have asked me to comment on the various issues related to these transactions.
There are multiple users of LAL’s financial statements, and they may have differing objectives.
Before selecting the accounting policy for each transaction, we must consider the different users
and decide who the primary user of the financial statements is.
Users of LAL’s financial statements

There are many users of LAL’s financial statements and, as noted, the objectives of each user
may conflict. The users include LAL’s:
Creditors. LAL’s creditors look to the financial statements to predict future cash flows and
determine whether their loans will be repaid. Further, they look to the financial statements to
ensure that the loan covenants are not violated and assist in determining the value of their
security. The financial statements may not be appropriate for this use.
Non-controlling shareholders. The non-controlling shareholders are not active in the business
and need the financial statements to assess and monitor their investment and to assess Leo’s
performance. They are also interested in being able to predict cash flow and in minimizing cash
outflows in the form of taxes and unwarranted bonus payments.
Management. Management bases its bonus on the financial statements and uses them to report
the financial results of the company to shareholders. As a result, management may have a bias
towards selecting accounting policies that tend to increase income and delay recognition of
expenses, thus maximizing bonuses.
Other users of the financial statements include Revenue Canada for income tax purposes.
However, our engagement is with the directors of LAL and its management, and they must be
our primary concern. As a result, the recommendations presented below must be consistent with
their objectives, must fairly disclose the financial results of LAL, and must enable all users to
monitor their investment.
As noted, the company uses International Financial Reporting Standards (“IFRS”). Some
flexibility may exist in the choice of accounting policies. New policies can be selected to reflect
the changing business.
Overall, the accounting policies recommended must balance management’s objective of

maximizing its bonus and the shareholders’ and creditors’ need to predict future cash flows
using financial statements they can rely on.
The accounting implications for each issue identified are discussed below. The alternative
accounting treatments available are explained and an accounting policy is recommended where
possible. The policies recommended ensure that the financial statements are not materially
misleading and enable the users of the financial statements to predict the future cash flows of
the company.
Land revaluation ($100 million)
The land currently owned and recorded in the financial statements is worth considerably more
than $5.4 million if the sale of the excess land is used as a basis for calculating its value.
Management would like to recognize a fair value increment in order to increase the value of the
land to $100 million. The alternative is disclosing the potential increased value of the land in a
note to the financial statements. However, neither approach is reasonable nor justifiable based
on the information provided. All land is not identical or of equal value and, as a result, reporting
an increment in the Year 8 financial statements based on the selling price of the excess land
sold to developers would be misleading.
It would be possible, however, for the company to choose to move to a revaluation model to
account for its investment in land. IAS 16 provides an option with regards to accounting for
property, plant and equipment – either a cost or revaluation model may be used. This would
permit the company to revalue land to its fair value. However, it would be required to apply such
a revaluation policy to all land held by LAL as the revaluation model is applied to an entire class
of property, plant and equipment. Further this policy must be applied on an ongoing basis.
Revaluation increases are credited to equity (as opposed to the income statement) except to the
extent that they reverse a revaluation decrease of the same asset previously recognized in the
income statement. Therefore, if the company expects that the value of the land has increased,
such revaluation increase would impact equity and not the operating results for the current
period, so changing to a revaluation model would not achieve the company’s objective of
maximizing its earnings. It should also be noted that adopting a revaluation policy may be more
onerous than using the cost method and may involve more complex record keeping. For
example, values need to be tracked at the asset level as revaluation increases and decreases
are only offset at the asset level and not the asset class level. Revaluations would need to be
made with sufficient regularity that the carrying amount of the asset does not differ materially
from that which would be determined using fair value at the balance sheet date.
Given the objectives of the users of the financial statements as noted previously, and the fact
that moving to a revaluation model would not increase earnings or be reflective of current cash
flows, as well as the increased complexity associated with applying the revaluation model, I
would initially recommend that the company maintain its accounting policy for land at historical
cost.
As noted above, recognizing fair value increments in the income statement for this type of asset
is not in accordance with IFRS.
Sale of land ($24 million)
Management intends to report the sale of the excess land in fiscal Year 8. We must decide
whether it should be reported in the Year 8 or the Year 9 fiscal period. The sale has been
agreed to, the sales contract has been signed, and a 25% deposit has been received. These
facts support recognition in fiscal Year 8. However, the sale does not close until the Year 9 fiscal
period and, although the deposit has been paid, the collectibility of the balance may not be
assured.
The sale has not closed and therefore the gain on sale should be reported in Year 9. The gain
on sale could be presented as a separate line item on the income statement if such presentation
is relevant to an understanding of the company’s financial performance. Note disclosure of the
sale will help provide all users of the financial statements with the relevant information.
One possibility to be considered is whether this excess land could have been classified as
investment property up to and including the date of the sale. We do not have sufficient
information to make that assessment. Paragraph 5 of IAS 40 provides the definition of
investment property. “It is property (land or a building—or part of a building—or both) held (by
the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or
both, rather than for:
(a) use in the production or supply of goods or services or for administrative purposes; or
(b) sale in the ordinary course of business.”
If it were possible to consider the excess land as investment property, LAL would have the
option of using either the cost model or the fair value option. If the fair value option were chosen,
in effect the sale price would be recognized in Year 8 regardless of conditions surrounding the
sale, as fair value changes are recognized in income statement. Note that the use of the fair
value option may in effect recognize a portion of the contingent profit element of the sale if this
type of compensation would generally be offered on comparable transactions (i.e., – fair value
determined based on a market model not using entity specific values). More information is
needed.
NSL start-up costs ($20 million)
We must determine whether the start-up costs related to NSL should be capitalized or should be
expensed as an operating cost. Their treatment will become an important issue to management
if NSL is consolidated with LAL. Generally, start-up costs should be expensed as incurred under
IFRS unless such costs can be considered a tangible or intangible asset. If a future benefit
results from having incurred them, they qualify as an asset and can be capitalized. It is therefore
necessary to consider the nature of the particular start-up costs incurred.
According to IAS 38 (paragraph 69), “In some cases, expenditure is incurred to provide future
economic benefits to an entity, but no intangible asset or other asset is acquired or created that
can be recognized. In these cases, the expenditure is recognized as an expense when it is
incurred… Other examples of expenditure that are recognized as an expense when they are
incurred include: expenditure on start-up activities (i.e., start-up costs), unless this expenditure is
included in the cost of an item of property, plant and equipment in accordance with IAS 16.
Start-up costs may consist of establishment costs such as legal and secretarial costs incurred in
establishing a legal entity, expenditure to open a new facility or business (i.e., pre-opening
costs) or expenditures for starting new operations or launching new products or processes (i.e.,
pre-operating costs).” Therefore, the equipment costs ($3.2 million) would likely qualify for
capitalization as property, plant and equipment. However, advertising and promotion costs ($1.5
million), wages, benefits and bonuses ($6.8 million), and other operating costs ($3.3 million) are
period costs and should be expensed as incurred.
We would need further information to determine whether or not the costs related to the
acquisition of the player contracts ($12 million) can be capitalized as costs of acquiring an
intangible asset (IAS 38). If they do not qualify for recognition as intangible assets, the costs
should be expensed as incurred. The amount of control and whether there are future economic
benefits would have to be assessed to determine if the costs meet the criteria for capitalization
as an intangible asset (IAS 38.15). Note that if capitalizing, impairment should be reviewed upon
indicators of impairment. Due to the nature of this asset, impairment reviews are likely required
on a regular basis and may introduce more volatility to reported earnings.
Purchase of amusement park ($4.25 million)
Since the asset is acquired as part of a business combination, IFRS 3 applies. This means that
the assets acquired are recorded at their fair values at the date of acquisition. Any other costs
incurred to acquire those assets are expensed. While the specific costs in question here are not
addressed in IFRS 3, the Basis for Conclusions to IFRS 3 at BC365 and BC369 seems to
support that the assets should be recorded at their fair values and should not include other
costs. If the acquirer has to move the assets or prepare a site etc. those are not costs related to
the business combination itself but to separate activities of the acquirer. As such, given that the
assets are already recorded at their fair value on acquisition, it would seem that any other costs
to relocate, install, prepare site etc. should be expensed.
Therefore, under IFRS, the costs incurred to set up, or move, the amusement park assets to the
new location must be expensed for accounting purposes. This would include the $350,000
incurred to transport the amusement park assets to their new location, the $400,000 spent to get
the assets in operating order, and the $500,000 spent to install the assets in their new location
(i.e., the amount spent on site preparation and foundations).
In addition, there is a negative acquisition differential equal to $1.3 million. This differential is net
of the present value of a loss carry forward recorded as an asset in the acquisition cost. In order
to recognize a deferred tax asset, its realization must be probable. If a deferred tax asset
qualifies for recognition, it should be recognized at its undiscounted amount as IFRS prohibits
discounting of deferred tax assets (IAS 12, paragraph 53). This would increase the negative
acquisition cost differential, thereby increasing the credit to the income statement (refer below).
The negative acquisition cost differential (or “excess”) reflects a bargain purchase. In
accordance with IFRS 3, before recognizing a gain on a bargain purchase, the company would
first need to reassess whether it has correctly identified all of the assets acquired and all of the
liabilities assumed and recognize any additional assets or liabilities that are identified in that
review. To the extent that excess still remains after such review, the company would recognize a
gain in the income statement reflecting the bargain purchase.
Insurance on construction ($1.4 million)
Management wants to capitalize the cost of insurance related to the construction activity in the
current period. One argument is that this amount relates to the cost of constructing the building
and would not otherwise have been incurred. According to IAS 16, paragraph 16, the cost of the
building should include any costs directly attributable to bringing it to the location and condition
necessary for the building to be capable of operating in the manner intended.
The issue is whether the cost is “directly attributable” to the asset being constructed. Given that
it could be argued that this insurance cost is a necessary cost of the construction activity, this
amount could be capitalized, which would maximize income. On the other hand, one might
argue that insurance is an overhead cost and is generally incurred every year and should
therefore be expensed as incurred (IAS 16, paragraph 19 (d)).
I recommend that the amount be capitalized to the asset under construction and that the asset
value be monitored to ensure there is no impairment to the value.
Ride relocation ($540,000)
Again, we must decide whether the costs should be capitalized or expensed for accounting
purposes. Does the expenditure represent a “betterment” to the rides and increase their useful
life, or is the amount strictly a moving cost or repair-type expenditure?
In order to capitalize this amount, we must argue that the cost improves the useful life of the
rides or increases the amount of future income that can be earned from the rides. The support
for expensing these costs in the current period includes the fact that it is a moving cost and does
not improve or lengthen the useful life of the rides relocated.
Another possibility might potentially be to say that the dismantling is a preparation costs for the
new arena to be built- i.e., part of capital cost related to arena. However, although IAS 16, para.
16(c) refers to dismantling costs, these dismantling costs must relate to the item acquired, i.e., if
a machine was acquired, and the machine had to be dismantled in order to relocate to the
acquirer’s place of business, then such dismantling costs would be included in the cost of the
asset. It does not appear that costs to dismantle a different asset (i.e., rides) could be included
in the cost of the arena. IAS 16, para. 20 in fact suggests that costs to redeploy an item (i.e., in
this case, to move the rides from one location to another) should not be included in the carrying
amount of that item.
Based on the above discussion, the amount should be expensed in the current period. It is
difficult to argue that the useful life of the rides has been increased. Without strong support for
this position, capitalizing the cost is not reasonable. This treatment allows for better predictability
of cash flows given that the amount was incurred in the current period.
Arranging fees ($500,000)
A $500,000 fee was paid to a mortgage broker to arrange financing for LAL. This amount has
been recorded as “Other assets.” No financing has been arranged to date. The accounting for
the fee paid to the mortgage broker depends on the nature of the fee and the classification of
the resulting financial liability (IAS 39). We don’t have a lot of information as to the nature of the
fees. If the fee is similar to a commission it could be considered a transaction cost. However, if
the fee is payment for services of researching alternatives and then another fee would be levied
upon the actual transaction, then the first fee would not be a transaction cost and should be
expensed when incurred. If the arranging fee is not refundable if financing isn’t arranged, then
the fee should be expensed as incurred since it would not be considered to be a transaction cost
related to a financial liability (Transaction costs are defined in AG13 as “fees and commissions
paid to agents (including employees acting as selling agents), advisers, brokers and dealers,
levies by regulatory agencies and securities exchanges, and transfer taxes and duties.
Transaction costs do not include debt premiums or discounts, financing costs or internal
administrative or holding costs.”). In this sense, transaction costs are incremental costs that are
directly attributable to the acquisition of a financial liability.
If the arranging fee meets the definition of a transaction cost, then the classification of the
related financial liability must be considered as described below. Until such time as the related
financing was drawn down, transaction costs would be deferred on the balance sheet. Upon
drawdown of the related financing:
Transaction costs would be expensed if they relate to financial liabilities that are accounted
for at fair value through the profit and loss.
Transaction costs related to financial liabilities not at fair value through the profit and loss
would be netted against the financial liability.
Consolidation of NSL ($500,000)
NSL must be consolidated for accounting purposes because LAL controls the company.
Golf membership fees
We must determine whether the revenue from the non-refundable golf membership fees can be
recognized in income immediately or deferred and recognized in income over time—as
members use the course. The accounting depends on the nature of the services provided.
The justification for recognizing the amount in income is that the fee is non-refundable and there
is no future service that must be provided. In fact, members are required to pay a separate
monthly fee of $100 to maintain their membership. IAS 18, Paragraph 17 states: “Initiation,
entrance and membership fees. Revenue recognition depends on the nature of the services
provided. If the fee permits only membership, and all other services or products are paid for
separately, or if there is a separate annual subscription, the fee is recognized as revenue when
no significant uncertainty as to its collectibility exists. If the fee entitles the member to services or
publications to be provided during the membership period, or to purchase goods or services at
prices lower than those charged to non-members, it is recognized on a basis that reflects the
timing, nature and value of the benefits provided.”
Conversely, the support available for deferring the income is that the amount has not yet been
earned, that is, the member would not have paid the $2,000 entrance fee in absence of the right
it provides for membership over the subsequent membership period. If deferred, the income
should be recognized over a 5-year period —the length of the contract.
My preliminary recommendation is that the amount be taken into income immediately. The
amount is non-refundable, there is a separate, monthly membership fee over and above the
entrance fee, and immediate recognition better reflects the actual cash flows. All users of the
financial statements are served well by this policy.
The $350,000 in upgrade costs to the facilities should not be recorded in the financial
statements until incurred.
Contingent profit on the sale of excess land
Management wants to disclose the probability that a contingent gain will be earned on the sale
of the excess land in a note to the financial statements. Disclosure is possible. However, it is
important that disclosures for contingent assets avoid giving misleading indications of the
likelihood of income arising. According to IAS 37, if the likelihood that a future benefit will be
received is probable, then disclosure should be made in a note to the financial statements,
including a brief description of the nature of the contingent asset and, where practicable, an
estimate of its financial effect. (Note: consider the earlier discussion around investment property
and impact on financial statements if treated as investment property using the fair value option.)
If and when the payment is received, management should consider whether it should be
disclosed separately on the face of the income statement or in the notes when such
presentation is relevant to an understanding of LAL’s financial performance.
Golf course relocation costs ($168,000)
We must decide whether the golf-course relocation costs should be capitalized as part of the
golf course lands or whether they should be expensed for accounting purposes. Generally, the
decision depends on whether the expenditure represents a betterment or improvement to the
course or a repair to the current property.
The argument that the relocation cost improves the course and potentially increases the future
revenue that LAL could earn suggests that the amount should be capitalized.
On the other hand, one could argue that the cost does not increase the value of the course or
the potential for increased revenues in the future in that these costs serve only to relocate an
existing asset. Note that IAS 16, paragraph 19 c) specifically prohibits capitalization of costs
associated with relocating an asset.
Another argument might be that the golf course relocation costs are actually costs of getting the
road into its intended state and therefore that these costs should be capitalized as part of the
road costs. The relocation costs are arguably directly attributable to the cost of the road.
I recommend that the golf course relocation costs be capitalized as part of the road costs for
accounting purposes. Management maximizes its bonus, and the other users of the financial
statements will be able to predict future cash flows.
Private boxes ($36,000 vs. $180,000)
We must determine whether the revenue from leasing private boxes should be recognized for
accounting purposes or deferred. In order to recognize the deposits received as income, the
deposits received would have to be non-refundable with no requirement of providing service in
the future. However, each deposit is a prepayment on a five-year lease of a box. Therefore, the
support for deferring recognition of the income is that future revenue will be earned from use of
the boxes, i.e., that revenue has not yet been earned and therefore should not be recorded in
the financial statements. Therefore, since there is an element of future service involved by virtue
of the lease arrangement, the deposit should be recognized as income over the period of the
lease.
Bonus accrual
Overall, the bonus system appears to be determining the accounting policies selected, and poor
decisions may be made as a result. The bonuses must be accrued for in the year in which they
are earned, based on net income, and not when they are paid.
Conclusion
The recommendations made above are based on the analysis provided and the users and their
objectives. Overall, management’s selected policies are misleading, given the significant
expenses and short-term cash requirements of LAL. The accounting treatments selected must
be fairly disclosed so that the various users with their differing objectives can properly interpret
the financial statements.
SOLUTIONS TO PROBLEMS
Problem 4-1
(a)
Cost of 70% of Barrel $329,000
Implied value of 100% of Barrel 470,000 (a)
Carrying amount of Barrel’s net assets (480,000 - 180,000) 300,000
Acquisition differential 170,000
Allocated:
Plant and equipment (320,000 –270,000) 50,000 (b)
Goodwill $120,000 (c)
Pork Co.
Consolidated Statement of Financial Position
December 31, Year 2
Plant and equipment (400,000 + 270,000 + (b) 50,000) $720,000

Goodwill (c) 120,000
Inventory (120,000 + 102,000) 222,000
Accounts receivable (45,000 + 48,000) 93,000
Cash (22,000+ 60,000) 82,000
$1,237,000
Ordinary shares $260,000

Retained earnings 200,000
Non-controlling interest (30%  (a) 470,000) 141,000
Long-term debt (240,000 + 108,000) 348,000
Current liabilities (216,000 + 72,000) 288,000
$1,237,000
(b) Goodwill under entity theory $120,000

Less: NCI’s share (30%) 36,000
Goodwill under parent company extension theory $84,000
NCI under entity theory $141,000

Less: NCI’s share of goodwill (30%) 36,000
NCI under parent company extension theory $105,000
Problem 4-3
(a)
Cost of 90% investment $52,200
Implied value of 100% investment 58,000
Carrying amount of Seeview Co.’s net assets
Assets $94,650
Liabilities 67,700
26,950
Allocated: FV – CA
Inventory $1,900
Plant assets 10,050
Intangible assets 3,800
Contract with Bardier 23,000
38,750
Long-term debt 6,300 45,050
Negative goodwill (14,000)
Recognized in Petron’s income 14,000
Goodwill $–0–
Non-controlling interest (10% x 58,000) $5,800
Petron Co.
June 30, Year 2
Cash and receivables (93,000 –52,200 – 2,300 + 20,150) $58,650

Inventory (60,500 + 8,150 + 1,900) 70,550
Plant assets (203,000 + 60,050 + 10,050) 273,100
Intangible assets (33,000 + 6,300 + 3,800) 43,100
Contract with Bardier 23,000
$468,400
Current liabilities (65,500 + 27,600) $93,100

Long-term debt (94,250 + 40,100 – 6,300) 128,050
Common shares 140,500
Retained earnings (89,250 + 14,000 – 2,300) 100,950
Non-controlling interest 5,800
$468,400
(b)
Petron Co.
Balance Sheet
June 30, Year 2
Cash and receivables (93,000 – 52,200 – 2,300) $38,500

Inventory 60,500
Investment in Seeview (52,200 + 14,000) 66,200
Plant assets (net) 203,000
$401,200
Current liabilities $65,500

Long-term debt 94,250
Retained earnings (deficit) (89,250 + 14,000 – 2,300) 100,950
$401,200
(c)
See below for summary of journal entries.
CONSOLIDATED FINANCIAL STATEMENT WORKING PAPER

PETRON CO.
CONSOLIDATED BALANCE SHEET
June 30, Year 2
Eliminations
PETRON SEEVIEW Dr. Cr. Consolidated
Cash and receivables $ 93,000 $ 20,150 1 $ 52,200 $ 58,650
2 2,300
Inventory 60,500 8,150 5 $ 1,900 70,550
Plant assets (net) 203,000 60,050 5 10,050 273,100
Intangible assets 33,000 6,300 5 3,800 43,100
Investment in Seeview 0 0 1 52,200 4 58,000 0
3 5,800
Acquisition differential 4 31,050 5 31,050 0
Customer contract 5 23,000 23,000
Goodwill 0
$ 389,500 $ 94,650 $ 468,400
Liabilities:
Current liabilities $ 65,500 $ 27,600 $ 93,100
Long-term debt 94,250 40,100 5 6,300 128,050
159,750 67,700 221,150
Shareholders’ equity: 0
Common shares 140,500 40,050 4 40,050 140,500
Retained earnings 89,250 (13,100) 1 2,300 100,950
4 13,100
5 14,000
Non-controlling interest 4 5,800 5,800
229,750 26,950 247,250
$ 389,500 $ 94,650 $ 468,400
Total $ 176,450 $ 176,450
JOURNAL ENTRIES
1 Investment in Seeview $ 52,200

Cash $ 52,200
To record investment in Seeview
2 Retained earnings - legal fees 2,300

Cash 2,300
To record legal fees related to acquisition
3 Investment in Seeview 5,800

To establish non-controlling interest
4 Common shares 40,050

Investment in Seeview 58,000
To eliminate investment account and set up acquisition differential
5 Inventory 1,900
Plant assets 10,050

Customer contract 23,000
Long-term debt 6,300
Gain on bargain purchase 14,000
To allocate the acquisition differential
Total $ 176,450 $ 176,450
Problem 4-5
(a)
Investment in Joy Corp. $456,000
Total value of Joy Corp. $570,000
Therefore, Blue’s ownership % (456,000 / 570,000) 80%
(b) The three consolidated accounts that are not equal to the sum of the carrying amounts of
the parent and the subsidiary are plant and equipment, goodwill and inventory.
Plant and equipment - net

Consolidated amount (1,072,000 – 204,000) $868,000
Blue’s carrying amount (648,000 – 204,000) 444,000
Fair value of Joy’s plant and equipment $424,000
Goodwill
Consolidated amount $183,000
Blue’s carrying amount 0
Fair value of Joy’s goodwill $183,000
Inventory
Consolidated amount $353,000
Blue’s carrying amount 109,000
Fair value of Joy’s inventory $244,000
Problem 4-7

(a) Proprietary theory
Cost of investment $7,900
Carrying amount of S Company’s net assets
Assets $19,450
Liabilities 9,000
10,450
80% 8,360
Acquisition differential (460)
Inventory 200  80% $160
Plant and equipment (1,300)  80% (1,040) (880)

Goodwill $420
(b) (i) Parent company extension theory

Implied value of 100% investment ($7,900/ 0.8) $9,875
Assets $19,450
Liabilities 9,000
10,450
Inventory $200
Plant and equipment (1,300) (1,100)
Goodwill in total $525
Parent’s share of S Company’s goodwill (80%) $420
Non-controlling interest
Total value of S Company $9,875
Less: goodwill (525)
Fair value of net assets of S Company 9,350
NCI’s % 20%

NCI $1,870
P Company
Consolidated Statement of financial position
December 31, Year 1
Cash (4,500 + 2,550) $7,050

Inventory (6,660 + 5,300 + 200) 12,160
Plant and equipment (9,600 + 8,300 – 1,300) 16,600
Goodwill 420
$45,680
Accounts payable (1,400 + 2,200) $3,600

Other current liabilities (1,500 + 3,300) 4,800
Long-term liabilities (4,500 + 3,500) 8,000
Total liabilities 16,400
Shareholders' equity
Non-controlling interest 1,870 29,280
$45,680
(b) (ii) Entity theory

Implied cost of 100% investment (7,900/ 0.8) $9,875
Carrying amount of S Company

Assets $19,450
Liabilities 9,000
10,450
Inventory $200
Plant and equipment (1,300) (1,100)
Goodwill in total $ 525
Non-controlling interest
Total value of S Company 9,875
NCI @ 20% 1,975
P Company
Consolidated Statement of financial position
December 31, Year 1
Cash (4,500 + 2,550) $7,050

Inventory (6,660 + 5,300 + 200) 12,160
Plant and equipment (9,600 + 8,300 – 1,300) 16,600
Goodwill 525
$45,785
Accounts payable (1,400 + 2,200) $3,600

Other current liabilities (1,500 + 3,300) 4,800
Long-term liabilities (4,500 + 3,500) 8,000
Total liabilities 16,400
Shareholders' equity
$45,785
(c)
Parent Ex Entity
Current assets $28,660 $28,660
Current liabilities 8,400 8,400

Current ratio 3.41 3.41
Total debt $16,400 $16,400

Total equity 29,280 29,385
Debt to equity ratio 0.5601 0.5581
The current ratio is the same for both theories and therefore the liquidity position is the same
under both theories. The entity theory has a slightly lower debt to equity ratio and thereby shows
the strongest solvency position. The entity theory best reflects the true financial position of the
company because it incorporates the fair value of all of the subsidiary’s assets and liabilities.
Problem 4-9
Percy NCI
Cost of 70% interest in Saltz $175,000
Fair value of NCI’s interest in Saltz (20 x 3,000 shares) $60,000
Carrying amount of Saltz’s net assets
Assets $176,000
Liabilities 60,000
$116,000
Shareholders’ interest 81,200 34,800
Acquisition differential 93,800 25,200
Inventory $10,000
Plant 18,000
Trademarks 14,000
Taxi license 40,000
Long term debt 2,000
$84,000 58,800 25,200
Goodwill $35,000 $0
Percy Corp.
January 1, Year 1
Cash (200,000 – 175,000 + 4,000) $29,000

Inventory (60,000 + 42,000 + 10,000) 112,000
Plant (350,000 + 102,000 + 18,000) 470,000
Trademarks (0 + 14,000 + 14,000) 28,000
Taxi license 40,000
Goodwill 35,000
$778,000
Current liabilities (100,000 + 20,000) $120,000

Long-term debt (160,000 + 40,000 –2,000) 198,000
Common shares $220,000
$778,000
Problem 4-11
(a) (i) Parent company extension theory
Cost of 90% investment (6,300 shares × 5) $31,500
Implied value of 100% $35,000
Carrying amount of MES’s net assets
Assets $30,000
Liabilities 7,500
22,500
Plant assets $5,000
Current assets 1,200
Long-term debt (700) 5,500
Total goodwill 7,000
Less: non-controlling interest’s share of goodwill (10%) (700)
Goodwill (parent’s share) $6,300
Non-controlling interest (10% x [35,000 – 7,000]) $2,800
FLA Company
January 1, Year 5
Plant assets (60,000 + 20,000 + 5,000) $85,000

Goodwill 6,300
Current assets (40,000 + 10,000 + 1,200) 51,200
$142,500
Ordinary shares (30,000 + 31,500) $61,500

Long-term debt (15,000 + 2,500 + 700) 18,200
$142,500
(ii) Entity theory
Total FLA (90%) NCI (10%)
Cost of 90% interest in MES ($5 x 6,300 shares) $31,500 $31,500

Fair value of NCI’s interest in MES ($3 x 1,000 shares) 3,000 $3,000
Total value of MES 34,500
Carrying amount of MES’s net assets
Assets 30,000
Liabilities 7,500
22,500 20,250 2,250
Acquisition differential 12,000 11,250 750
Current assets $1,200
Plant assets 5,000
Long-term debt (700)

5,500 4,950 550
Total goodwill $6,500 $6,300 $200
FLA Company
January 1, Year 5
Plant assets (60,000 + 20,000 + 5,000) $85,000
Goodwill 6,500
Current assets (40,000 + 10,000 + 1,200) 51,200
$142,700
Ordinary shares (30,000 + 31,500) $61,500

Long-term debt (15,000 + 2,500 + 700) 18,200
$142,700
(b) IFRS 3 allows the entity theory or the parent company extension theory.
Problem 4-13
(a)
Investment in Robin 1,040,000
Cash 1,040,000
Legal fees expense 25,000
Cash 25,000
(b)
Cost of 80% of Robin $1,040,000
Implied value of 100% of Robin $1,300,000
Carrying amount of Robin’s net assets
Assets $1,260,000
Liabilities 612,000
648,000

Current assets $48,000
Plant and equipment 132,000
Research project 100,000
Patents 72,000
Long-term debt (24,000) 328,000
Goodwill $324,000
The research project meets the requirement to be recognized as an identifiable asset. Robin
feels that it is within a year of developing a prototype for a state-of-the-art medical device.
Ravinder attributes a value of $100,000 to this technology and knowledge. This in-process
research is capable of being separated or divided from Robin’s other assets and could be sold,
transferred, licensed, rented, or exchanged (regardless of whether there is intent to do so).
(c)
RAVINDER CORP.
August 1, Year 3
Current assets (1,600,000 – 1,040,000 – 25,000 + 420,000 + 48,000) $1,003,000

Plant and equipment (1,330,000 + 1,340,000 – 500,000 + 132,000) 2,302,000
Accumulated depreciation (250,000 + 500,000 – 500,000) (250,000)
Patents – net (0 + 0 + 72,000) 72,000
Research project (0 + 0 + 100,000) 100,000
Goodwill (0 + 0 + 324,000) 324,000
$3,551,000
Current liabilities (1,360,000 + 252,000) $1,612,000
Long-term debt (480,000 + 360,000 + 24,000) 864,000
Retained earnings (120,000 –25,000) 95,000
$3,551,000
Problem 4-15

(a) To determine the fair values of the contingent consideration, Calof computes the present
value of the expected payments as follows:
 Cash contingency = $40,000 x 30% ÷ (1/[1 + .04]) = $11,539
 Share contingency = $5,000 x 20% ÷ (1/[1 + .04]) = $962
Calof then records in its accounting records the acquisition of Xiyu as follows:
Investment in Xiyu Company 287,501

Liability for contingent consideration for earnout 11,539
Liability for contingent consideration for stock price guarantee 962
(b)
Interest expense (11,538 x 4%) 462
Loss on contingent consideration for earnout 28,000
Liability for contingent consideration for earnout 28,462
Interest expense (962 x 4%) 38

Loss on contingent consideration for stock price guarantee 1,700
Liability for contingent consideration for stock price guarantee 1,738
(c)
The liability for contingent consideration for earnout will have a balance of $40,000 at December
31, Year 4 and will be presented as a current liability. The liability for contingent consideration
for stock price guarantee will have a balance of $2,700 at December 31, Year 4 and will also be
presented as a current liability.


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Chapter 4

Consolidation of Non-Wholly Owned

Copyright  2016 McGraw-Hill Education. All rights reserved.

Copyright  2016 McGraw-Hill Education. All rights reserved.

5. Non-controlling interest represents the equity interest of the non-controlling shareholders in

Copyright  2016 McGraw-Hill Education. All rights reserved.

Copyright  2016 McGraw-Hill Education. All rights reserved.

Proprietary Parent Co. Parent Ex Entity Entity

Liabilities $ 4,008 $4,648 $4,680 $4,680 $4,680

2. The non-controlling interest is calculated as follows:

Factory Optical Distributors, Teaching Note*

Purpose of the case

Copyright  2016 McGraw-Hill Education. All rights reserved.

IFRS 10 requires consolidation of all subsidiaries. A subsidiary is defined as an entity that is

Copyright  2016 McGraw-Hill Education. All rights reserved.

Fabio & Fox, Chartered Professional Accountants

Users of LAL’s financial statements

Overall, the accounting policies recommended must balance management’s objective of

Land revaluation ($100 million)

Sale of land ($24 million)

NSL start-up costs ($20 million)

Purchase of amusement park ($4.25 million)

Insurance on construction ($1.4 million)

Ride relocation ($540,000)

Arranging fees ($500,000)

Consolidation of NSL ($500,000)

Golf membership fees

Contingent profit on the sale of excess land

Golf course relocation costs ($168,000)

Private boxes ($36,000 vs. $180,000)

Plant and equipment (400,000 + 270,000 + (b) 50,000) $720,000

Ordinary shares $260,000

(b) Goodwill under entity theory $120,000

NCI under entity theory $141,000

Non-controlling interest (10% x 58,000) $5,800

Cash and receivables (93,000 –52,200 – 2,300 + 20,150) $58,650

Current liabilities (65,500 + 27,600) $93,100

Cash and receivables (93,000 – 52,200 – 2,300) $38,500

Current liabilities $65,500

CONSOLIDATED FINANCIAL STATEMENT WORKING PAPER

1 Investment in Seeview $ 52,200

2 Retained earnings - legal fees 2,300

3 Investment in Seeview 5,800

4 Common shares 40,050

Copyright  2016 McGraw-Hill Education. All rights reserved.

Total $ 176,450 $ 176,450

Therefore, Blue’s ownership % (456,000 / 570,000) 80%

Plant and equipment - net

Copyright  2016 McGraw-Hill Education. All rights reserved.

Plant and equipment (1,300)  80% (1,040) (880)

(b) (i) Parent company extension theory

Cost of 80% investment $7,900

Parent’s share of S Company’s goodwill (80%) $420

Copyright  2016 McGraw-Hill Education. All rights reserved.

Cash (4,500 + 2,550) $7,050

Accounts payable (1,400 + 2,200) $3,600

(b) (ii) Entity theory

Cost of 80% investment $7,900

Carrying amount of S Company

Cash (4,500 + 2,550) $7,050

Accounts payable (1,400 + 2,200) $3,600

Copyright  2016 McGraw-Hill Education. All rights reserved.

Total debt $16,400 $16,400