Chapter 1 Test Bank - CPA Diary



Chapter 10 Test Bank

SUBSIDIARY PREFERRED STOCK, COSOLIDATED EARNINGS PER SHARE,

AND CONSOLIDATED INCOME TAXATION

| |

|Multiple Choice Questions |

|Use the following information for Questions 1 and 2. |

| |

|Parminter Corporation owns an 80% interest in the common stock of Sanchez Corporation and 20% of Sanchez’s preferred stock on December 31, |

|2005. Sanchez had 2005 net income of $30,000. Sanchez’s equity was as follows: |

|10% preferred stock $ 50,000 |

|Common stock 350,000 |

LO1

|1. | |How much should the Parminter’s Investment in Sanchez change during 2005? |

| | | | |

| | |a. |$ 5,000. |

| | |b. |$20,000. |

| | |c. |$25,000. |

| | |d. |$30,000. |

LO1

|2. | |What should be the noncontrolling interest expense in the consolidated financial statements of Parminter? |

| | | | |

| | |a. |$ 5,000. |

| | |b. |$20,000. |

| | |c. |$25,000. |

| | |d. |$30,000. |

|Use the following information for Questions 3, 4, and 5. |

| |

|On January 1, 2005, Pardy Corporation acquired a 70% interest in the common stock of Salter Corporation for $7,000,000 when Salter’s |

|stockholders’ equity was as follows: |

|10% cumulative, nonparticipating preferred stock, | | | | |

|$100 par, with a $105 liquidation preference | | | | |

|callable at $110 | | |$ 1,000,000 | |

|Common stock, $10 par value | | |6,000,000 | |

|Additional paid-in capital | | |1,500,000 | |

|Retained earnings | | |2,500,000 | |

|Total stockholders’ equity | | |$11,000,000 | |

| | | | | |

LO1

|3. | |There were no dividends in arrears on the date of the business combination. The goodwill from Pardy’s investment in Salter on |

| | |January 1, 2005 is |

| | | | |

| | |a. |$ 0. |

| | |b. |$ 35,000. |

| | |c. |$ 70,000. |

| | |d. |$105,000. |

LO1

|4. | |Salter has a 2005 net loss of $200,000. Pardy’s share of Salter’s net loss is |

| | | | |

| | |a. |$ 50,000. |

| | |b. |$ 70,000. |

| | |c. |$140,000. |

| | |d. |$210,000. |

LO1

|5. | |If Salter’s net income is $220,000, what is Pardy’s share of Salter’s net income? |

| | | | |

| | |a. |$ 84,000. |

| | |b. |$119,000. |

| | |c. |$154,000. |

| | |d. |$189,000. |

LO1

|6. | |Pamplin Corporation stockholders’ equity consisted of $1,000,000 of $10 par value Common Stock, $750,000 of Additional Paid-in|

| | |Capital, and $3,000,000 of Retained Earnings on January 1, 2005. On this date, Pamplin purchased 90% of the outstanding common|

| | |stock of Sage Corporation for $1,500,000 with all excess purchase cost assigned to goodwill. The stockholders’ equity of Sage |

| | |on this date consisted of $800,000 of $100 par value, 8% non-cumulative, preferred stock callable at $105, $900,000 of $10 par|

| | |value common stock and $500,000 of Retained Earnings. Sage’s net income for 2005 was $100,000. |

| | | |

| | |In a separate transaction on January 1, 2005, Pamplin purchased 70% of Sage’s preferred stock for $600,000. At the end of |

| | |2005, the amount of Pamplin’s income from Sage (excluding dividends from preferred stock) and the balance in its Additional |

| | |Paid-in Capital account, respectively, are |

| | | | |

| | |a. |$62,400 and $710,000. |

| | |b. |$62,400 and $750,000. |

| | |c. |$32,400 and $710,000. |

| | |d. |$32,400 and $750,000. |

LO1

|7. | |Pan Corporation has total stockholders’ equity of $5,000,000 consisting of $1,000,000 of $10 par value Common Stock, |

| | |$1,000,000 of Additional Paid-in Capital, and $3,000,000 of Retained Earnings. Pan owns 80% of Sailor Corporation’s common |

| | |stock purchased at book value. Sailor has $900,000 of 10% cumulative preferred stock outstanding. Pan acquired 60% of the |

| | |preferred stock of Sailor for $500,000. After this transaction the balances in Pan’s Retained Earnings and Additional Paid-in |

| | |Capital accounts, respectively, are |

| | | | |

| | |a. |$2,960,000 and $1,000,000. |

| | |b. |$3,000,000 and $960,000. |

| | |c. |$3,000,000 and $1,040,000. |

| | |d. |$3,040,000 and $1,000,000. |

LO1

|8. | |If a company’s preferred stock is cumulative with a call provision and has dividends in arrears, the amount of total preferred|

| | |stockholders’ equity would be calculated as the number of shares outstanding times the |

| | | | |

| | |a. |sum of the par value per share plus any liquidation premium per share, plus the sum of any preferred dividends in |

| | | |arrears, plus the current year’s dividend requirement, but only if dividends have been declared. |

| | |b. |sum of the par value per share, plus any liquidation premium per share, plus the sum of any preferred dividends in |

| | | |arrears, plus the current year’s dividend requirement, regardless of whether dividends have been declared. |

| | |c. |call price plus the sum of any preferred dividends in arrears, plus the current year’s dividend requirement, but only|

| | | |if dividends have been declared. |

| | |d. |call price plus the sum of any preferred dividends in arrears, plus the current year’s dividend requirement, |

| | | |regardless of whether dividends have been declared. |

| | | | |

| | | | |

LO1

|9. | |When a parent acquires the preferred stock of a subsidiary, there will be a constructive retirement that eliminates the equity|

| | |related to the preferred stock held by the parent and |

| | | | |

| | |a. |any difference paid above the par value first reduces additional paid-in capital and then retained earnings. |

| | |b. |any difference paid above the par value first reduces retained earnings and then additional paid-in capital. |

| | |c. |any difference paid above the par value increases additional paid-in capital. |

| | |d. |any difference paid above the par value increases retained earnings. |

LO1

|10. | |When a parent acquires subsidiary preferred stock, no subsequent working paper entry is necessary to adjust additional paid-in|

| | |capital under which of the following methods? |

| | | |

| | |I. The constructive retirement method. |

| | |II. The cost method. |

| | | | |

| | |a. |I only. |

| | |b. |II only. |

| | |c. |I and II. |

| | |d. |I or II if no redemption feature is present. |

LO2

|11. | |In a company with minority interest equity, how is the preferred stock call premium addressed? |

| | | | |

| | |a. |It is recorded as an increase in additional paid-in capital. |

| | |b. |It is recorded as a decrease in additional paid-in capital. |

| | |c. |It is recorded as an increase in retained earnings. |

| | |d. |It is recorded as a decrease in retained earnings. |

LO2

|12. | |If a parent company has controlling interest in a subsidiary which has no potentially dilutive securities, then in the |

| | |calculation of consolidated EPS, it will be necessary to |

| | | | |

| | |a. |only make an adjustment of subsidiary’s basic earnings. |

| | |b. |replace the parent’s equity in subsidiary earnings with the parent’s equity in subsidiary’s diluted EPS. |

| | |c. |make a replacement calculation in the parent's basic earnings for the EPS. |

| | |d. |only use the parent's common shares and common share equivalents. |

LO2

|13. | |A subsidiary has some outstanding options that permit holders to purchase the company’s common stock. How will the options |

| | |affect consolidated EPS? |

| | | | |

| | |a. |If the exercise price per share is greater than average market price then the basic consolidated EPS will be |

| | | |decreased. |

| | |b. |If the exercise price per share is greater than average market price then the basic consolidated EPS will be |

| | | |increased. |

| | |c. |If the exercise price per share is greater than average market price then the diluted consolidated EPS will be |

| | | |increased. |

| | |d. |If the exercise price per share is greater than average market price then the diluted consolidated EPS will be |

| | | |decreased. |

LO2

|14. | |Parnaby has 25,000 common stock shares outstanding and its 100%-owned subsidiary Sandal has 5,000 common stock shares |

| | |outstanding. The separate income for Parnaby and Sandal is $150,000 and $75,000 respectively. EPS for the consolidated |

| | |company is |

| | | | |

| | |a. |$5.00. |

| | |b. |$6.00. |

| | |c. |$7.50. |

| | |d. |$9.00. |

LO2

|15. | |In computing the diluted EPS of the parent, any replacement computation of subsidiary income may be affected by |

| | | | |

| | |a. |the constructive gain from purchase of parent bonds. |

| | |b. |the constructive loss from purchase of parent bonds. |

| | |c. |the current amortization from investment in the subsidiary. |

| | |d. |the parent’s equity in subsidiary realized income. |

LO2

|16. | |An 80%-owned subsidiary has outstanding bonds payable that are convertible into the subsidiary’s common stock. No bonds are |

| | |held by the parent corporation. In calculating the subsidiary’s diluted EPS, the amount of bond interest expense that will be |

| | |added back to the subsidiary’s income to the common stockholders will be |

| | | | |

| | |a. |the face amount of the convertible bonds times the bond coupon rate times the subsidiary’s marginal tax rate. |

| | |b. |the face amount of the convertible bonds times the effective rate of interest on the bonds times the subsidiary’s |

| | | |marginal tax rate. |

| | |c. |the face amount of the convertible bonds times the bond coupon rate times (100% minus the subsidiary’s marginal tax |

| | | |rate). |

| | |d. |the face amount of the convertible bonds times the effective rate of interest on the bonds times (100% minus the |

| | | |subsidiary’s marginal tax rate). |

LO2

|17. | |When a subsidiary has outstanding options to purchase common stock, the number of shares added to the denominator of the |

| | |subsidiary’s EPS calculation is equal to the number of |

| | | | |

| | |a. |shares that can be purchased with the current market value of the options. |

| | |b. |shares into which the options can be converted minus the number of shares purchased at the average market price that |

| | | |are assumed to be repurchased from the money received from the option shares. |

| | |c. |shares into which the options can be converted. |

| | |d. |shares into which the options can be converted minus the number of shares purchased at the exercise price that are |

| | | |assumed to be purchased from the money received from the option shares. |

LO2

|18. | |When a subsidiary has preferred stock that is convertible into common stock, the parent’s equity in the subsidiary’s diluted |

| | |earnings is calculated by the number of |

| | | | |

| | |a. |subsidiary shares into which the subsidiary’s dilutive securities can be converted times the subsidiary’s basic EPS |

| | | |figure. |

| | |b. |parent shares into which the subsidiary’s dilutive securities can be converted times the parent’s basic EPS figure. |

| | |c. |subsidiary shares held by the parent times the subsidiary’s diluted EPS figure. |

| | |d. |parent shares into which the subsidiary’s dilutive securities can be converted times the subsidiary’s basic EPS |

| | | |figure. |

| | | | |

| | | | |

LO3

|19. | |Palm owns a 70% interest in Sable, a domestic subsidiary. Palm will pay taxes on |

| | | | |

| | |a. |none of the dividends it receives from Sable. |

| | |b. |20% of the dividends it receives from Sable. |

| | |c. |66% of the dividends it receives from Sable. |

| | |d. |80% of the dividends it receives from Sable. |

LO3

|20. | |Palmer Company owns a 25% interest in Sad, Incorporated, a domestic company. Sad had income of $60,000 and paid dividends of |

| | |$20,000. Palmer’s tax rate is 35%. For simplicity, assume that Sad’s undistributed earnings are Palmer’s only temporary timing|

| | |difference. Which of the following statements is correct? |

| | | | |

| | |a. |Under the Internal revenue Code, Palmer pays current taxes of $700. |

| | |b. |Under the Internal revenue Code, Palmer pays current taxes of $1,050. |

| | |c. |Under GAAP, Palmer provides for income taxes on Sad’s undistributed earnings with a credit to deferred income taxes |

| | | |of $700. |

| | |d. |Under GAAP, Palmer provides for income taxes on Sad’s undistributed earnings with a credit to deferred income taxes |

| | | |of $1,050. |

LO3

|21. | |Palmquist Corporation and its 80%-owned subsidiary, Sadler Corporation, are members of an affiliated group. Sadler had |

| | |$3,000,000 of income and paid $1,000,000 dividends in 19X6. Palmquist and Sadler had 35% income tax rates. Palmquist’s |

| | |provision for income taxes on Sadler’s undistributed earnings was |

| | | | |

| | |a. |$ 0. |

| | |b. |$ 56,000. |

| | |c. |$112,000. |

| | |d. |$168,000. |

LO3

|22. | |Palomba Corporation allocates income tax expense to its 90%-owned subsidiary using the percentage allocation method. Under |

| | |this method, consolidated income tax expense will be allocated |

| | | | |

| | |a. |on the basis of the tax provisions recorded by both companies. |

| | |b. |on the basis of the subsidiary’s pretax income included in consolidated pretax income. |

| | |c. |on the basis of the income taxes remitted to the IRS. |

| | |d. |90% to the subsidiary. |

LO3

|23. | |Which statement best describes the effect of an inter-company transaction on income tax expense when corporate affiliates file|

| | |separate tax returns, but prepare consolidated financial statements? |

| | | | |

| | |a. |The selling entity excludes the unrealized gain on its separate return and the unrealized gain is eliminated on the |

| | | |consolidated financial statements. |

| | |b. |The selling entity includes the unrealized gain on its separate return and the unrealized gain is included on the |

| | | |consolidated financial statements as part of consolidated net income. |

| | |c. |The selling entity includes the unrealized gain on its separate return and the unrealized gain is eliminated on the |

| | | |consolidated financial statements. |

| | |d. |The selling entity excludes the unrealized gain on its separate return and the unrealized gain is included on the |

| | | |consolidated financial statements. |

|Use the following information for questions 24 and 25. |

| |

|Paltridge Company owns 60% of Saga Corporation. At the beginning of the current year no timing differences exist. Saga has $50,000 of net |

|income on its separate return, all of which is subject to tax. Paltridge sells a machine to Saga for $30,000 that has a net book value of |

|$10,000 and a 4-year remaining useful life. Saga has a 40% dividend payout ratio, and the marginal tax rate for both companies is 35%. |

LO3

|24. | |Saga's provision for current income taxes will be calculated as |

| | | |

| | |a. |35% x ($50,000 net income). |

| | |b. |35% x ($50,000 net income + $5,000 piecemeal recognition of gain). |

| | |c. |35% x ($50,000 net income - $20,000 gain on sale + $5,000 |

| | | |piecemeal recognition of gain). |

| | |d. |35% x ($50,000 net income - $20,000 gain on sale). |

LO3

|25. | |The amount of income taxes that Paltridge will have to provide for the undistributed earnings of Saga will be calculated as |

| | | | |

| | |a. |35% x $50,000 x 60% x 20%. |

| | |b. |35% x $50,000 x 60% x 30%. |

| | |c. |35% x $30,000 x 60% x 20%. |

| | |d. |35% x $30,000 x 60% x 30%. |

LO1

Exercise 1

|Saito Corporation’s stockholders’ equity on December 31, 2004 was as follows: |

| |

|10% cumulative preferred stock, $100 par value, | | | | |

|callable at $105, with one year dividends in arrears |$ | |10,000 | |

|Common stock, $1 par value | | |50,000 | |

|Additional paid-in capital | | |150,000 | |

|Retained earnings | | |160,000 | |

|Total stockholders’ equity |$ | |370,000 | |

| | | | | |

| | | | | |

| | | | | |

|On January 1, 2005, Panata Corporation paid $300,000 for a 70% interest in Saito’s underlying equity. |

|Required: |

| | |

|1. |Determine the excess purchase cost in excess of book value that was paid by Panata for its investment in Saito. |

| | |

|2. |Determine the January 1, 2005 balance for the minority interest that appeared on a consolidated balance sheet. |

LO1

Exercise 2

|Samford Corporation’s stockholders’ equity on December 31, 2004 was as follows: |

| |

|8% cumulative preferred stock, $100 par value, | | | | |

|callable at $109, with two years of dividends | | | | |

|in arrears |$ | |100,000 | |

|Common stock, $25 par value | | |700,000 | |

|Additional paid-in capital | | |250,000 | |

|Retained earnings | | |400,000 | |

|Total stockholders’ equity |$ | |1,450,000 | |

|On January 1, 2005, Park Corporation purchased a 70% interest in Samford’s common stock for $850,000. On this date the book values of |

|Park’s assets and liabilities are equal to their fair values. |

|Required: |

| | |

|1. |Determine the book value of the common stockholders’ interest in Samford Corporation. |

| | |

|2. |How much did Park pay for goodwill when it acquired its interest in Samford? |

LO2

Exercise 3

|Pancino Corporation owns a 90% interest in Sakal Corporation. Throughout 2005, Sakal had 20,000 shares of common stock outstanding and |

|Pancino has 50,000 shares of common stock outstanding. Sakal’s only dilutive security also consists of 10,000 stock options. It takes 4 |

|options plus $20 to acquire one share of Sakal common stock. The average price of Sakal’s stock is $50 per share. Pancino’s and Sakal’s |

|separate incomes for the year are $100,000 and $80,000, respectively. |

|Required: |

|Compute the amount of basic and diluted earnings per share for Pancino and Sakal Corporations. |

LO2

Exercise 4

|Parker Corporation owns an 80% interest in Sample Corporation. Throughout 2005, Sample had 10,000 shares of common stock outstanding and |

|Parker had 100,000 shares of common stock outstanding. Sample’s only dilutive security consists of $50,000 face amount of 8% bonds payable.|

|Each bond is convertible into 20 shares of Sample stock. Parker and Sample’s separate incomes for the year are $100,000 and $75,000, |

|respectively. |

|Required: |

| |

|Compute the amount of basic and diluted earnings per share for Parker and Sample Corporations. |

LO3

Exercise 5

|Pane Corporation owns 100% of Alder Corporation, 85% of Ball Corporation, 70% of Cake Corporation, 40% of Dash Corporation, and 10% of |

|Eager Corporation. All of these corporations are domestic corporations. Pane's marginal income tax rate is 35%. During 2008, Pane |

|Corporation received the following cash dividends: |

| |

|From Alder: |$180,000 |

|From Ball: |$170,000 |

|From Cake: |$160,000 |

|From Dash: |$100,000 |

|From Eager: |$ 60,000 |

|Required: |

| | |

|1. |Compute the amount of the dividend income that would be excluded from taxation under the current Internal Revenue Code. |

| | |

|2. |Compute Pane's current income tax liability for the dividend income received in 2008. |

LO3

Exercise 6

|Pretax operating incomes of Pang Corporation and its 70%-owned subsidiary, Sala Corporation, for the year 2005, are shown below. Sala pays |

|total dividends of $60,000 for the year. There are no unamortized cost-book differentials relating to Pang’s investment in Sala. During the|

|year, Pang sold land to Sala for a gain of $35,000 and Sala holds this land at the end of the year. The marginal corporate tax rate for |

|both corporations is 34%. |

| |

| | | |Pang | | |Sala | |

|Sales revenue | | |$ 900,000 | | |$ 600,000 | |

|Gain on sale of land | | |35,000 | | | | |

|Cost of sales | |( |480,000 |) |( |325,000 |) |

|Other expenses | |( |192,000 |) |( |78,000 |) |

|Pretax operating income (does not include investment income) | | | | | | | |

| | | |$ 263,000 | | |$ 197,000 | |

| | | | | | | | |

|Required: |

| | |

|1. |Determine the separate amounts of income tax expense for Pang and Sala as if they had filed separate tax returns. |

| | |

|2. |Determine Pang’s net income from Sala. |

LO3

Exercise 7

|Pretax operating incomes of Panitz Corporation and its 80%-owned subsidiary, Salazar Corporation, for the year 2005, are shown below. |

|Salazar pays total dividends of $65,000 for the year. There are no unamortized cost-book differentials relating to Panitz’s investment in |

|Salazar. During the year, Panitz sold land to Hamilton at a total loss of $15,000 which is included in its pretax operating income. Salazar|

|still holds this land at the end of the year. Also included in its pretax operating income are $40,000 of dividends received from Shaw |

|Corporation of which Panitz owns 8% and $50,000 of dividends from Sunny Corporation of which Salazar owns 6%. The marginal corporate tax |

|rate for both corporations is 34%. |

| |

| | | |Panitz | | |Salazar | |

|Sales revenue | | |$ 890,000 | | |$ 700,000 | |

|Loss on sale of land | |( |15,000 |) | | | |

|Dividend income from Shaw and Sunny | | | | | | | |

| | | |90,000 | | | | |

|Cost of sales | |( |400,000 |) |( |250,000 |) |

|Other expenses | |( |350,000 |) |( |350,000 |) |

|Depreciation expense | |( |50,000 |) |( |35,000 |) |

|Pretax operating income (does not include Salazar investment income) | | | | | | | |

| | | |$ 165,000 | | |$ 65,000 | |

| | | | | | | | |

|Required: |

| | |

|1. |Determine the separate amounts of income tax expense for Panitz and Salazar as if they had filed separate tax returns. |

| | |

|2. |Determine Panitz’s net income from Salazar. |

LO3

Exercise 8

|On January 1, 2005, Panos Corporation acquired all of the outstanding voting common stock of Saley Corporation in an acquisition. The |

|total purchase price for the stock was $1,300,000. Saley’s net assets on this date were as follows: |

| | | |Saley’s | | |Saley’s Fair | |

| | | |Book Values | | |Values | |

|Cash |$ | |20,000 | |$ |20,000 | |

|Inventories | | |210,000 | | |240,000 | |

|Land | | |200,000 | | |250,000 | |

|Building-net | | |600,000 | | |900,000 | |

|Total assets |$ | |1,030,000 | |$ |1,410,000 | |

| | | | | | | | |

|Liabilities |$ | |230,000 | |$ |230,000 | |

|Common stock | | |400,000 | | | | |

|Retained earnings | | |400,000 | | | | |

|Total equities |$ | |1,030,000 | | | | |

| | | | | | | | |

|Assume that for federal income tax purposes, the book values of Saley’s assets and liabilities will be carried over for tax purposes but |

|that the fair values will be recorded for GAAP purposes. The remaining useful life for the building is 20 years and goodwill will be |

|amortized over the 15-year time period allowed for tax purposes. All depreciation and amortization is done on the straight-line basis and |

|the federal tax rate is 34%. Half of the inventory to which the excess of cost over book value applies is sold in 2005. Ignore any tax |

|effect on Saley’s undistributed earnings. |

|Required: |

| | |

|1. |Calculate the amount of deferred income taxes that result from the acquisition transaction that are attributable to the net |

| |assets being recorded at book values for tax purposes, but at fair values for financial accounting purposes. |

| | |

|2. |Identify and calculate the dollar amount of any timing differences that accrue or reverse by the end of the first year after the|

| |acquisition. |

LO3

Exercise 9

|Paradise Corporation owns 100% of Aldred Corporation, 90% of Balme Corporation, 80% of Calder Corporation, 75% of Dale Corporation, 20% of |

|East Corporation, and 8% of Faber Corporation. All of these corporations are domestic corporations. During 2005, Paradise Corporation |

|reports net income of $1,500,000. This net income includes the full amount of dividends received from Aldred and Faber, but does not |

|include the dividends received from Balme, Calder, Dale, and East Corporations. All investees have paid out all of their net income in the |

|form of dividends. Paradise’s share of the various dividend distributions is as follows: |

| |

|From Aldred: |$90,000 |

|From Balme: |$92,000 |

|From Calder: |$88,000 |

|From Dale: |$66,000 |

|From East: |$50,000 |

|From Faber: |$40,000 |

| | |

|Required: |

| | |

|Calculate the correct amount of taxable income for Pal Corporation if a consolidated tax return is filed. |

LO3

Exercise 10

|On January 1, 2005, Parcel Corporation acquired all of the outstanding voting common stock of Salmon Corporation in an acquisition. The |

|total purchase price for the stock was $1,020,000. Salmons’s net assets on this date were as follows: |

| | | |Salmon’s | | |Salmon’s Fair | |

| | | |Book Values | | |Values | |

|Cash |$ | |20,000 | |$ |20,000 | |

|Inventories | | |210,000 | | |240,000 | |

|Land | | |200,000 | | |320,000 | |

|Building-net | | |600,000 | | |500,000 | |

|Total assets |$ | |1,030,000 | |$ |1,080,000 | |

| | | | | | | | |

|Liabilities |$ | |230,000 | |$ |210,000 | |

|Common stock | | |400,000 | | | | |

|Retained earnings | | |400,000 | | | | |

|Total equities |$ | |1,030,000 | | | | |

| | | | | | | | |

|Assume that for federal income tax purposes, the book values of Salmon’s assets and liabilities will be carried over for tax purposes but |

|that the fair values will be recorded for GAAP purposes. The remaining useful life for the building is 20 years and goodwill will be |

|amortized over the 15-year time period allowed for tax purposes. The liabilities are amortized over a 5-year period. All depreciation and |

|amortization is done on the straight-line basis and the federal tax rate is 34%. All inventories to which the excess of cost over book |

|value applies were sold in 2005. Ignore any tax effect on Salmon’s undistributed earnings. |

|Required: |

| | |

|1. |Calculate the amount of deferred income taxes that resulted from the acquisition transaction that were attributable to the net |

| |assets being recorded at book values for tax purposes but at fair values for financial accounting purposes. |

| | |

|2. |Identify and calculate the dollar amount of any timing differences that accrued or reversed by the end of the first year after |

| |the acquisition. |

SOLUTIONS

Multiple Choice Questions

|1. |b |Of the $30,000, 5,000 is preferred dividends and in the remainder 25,000 has 80% go to Parminter for $20,000. |

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|2. |d | |

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|3. |c | |

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|Stockholders’ equity |$ | |11,000,000 | |

|Less: Preferred stockholders’ equity | | |1,100,000 | |

|Common stockholders’ equity | | |9,900,000 | |

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|Cost of 70% interest acquired |$ | |7,000,000 | |

|Book value of 70% interest ($9,900,000) x (70%) | | |6,930,000 | |

|Goodwill |$ | |70,000 | |

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|4. |b | |

|Salter’s net loss |$ |( |200,000 |) |

|Income to the preferred stockholders | | |100,000 | |

|Loss to common stockholders | | |100,000 | |

|Pardy’s ownership percentage | | |70% | |

|Pardy’s share of the loss on investment |$ | |70,000 | |

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|5. |a | |

|Salter’s net income |$ | |220,000 | |

|Income to the preferred stockholders | | |100,000 | |

|Income to the common stockholders | | |120,000 | |

|Pardy’s ownership percentage | | |70% | |

|Pardy’s share of the income to the common shareholders | | | | |

| |$ | |84,000 | |

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|6. |c | |

|Preliminary computations: | | | | |

|Total stockholders’ equity |$ | |2,200,000 | |

|Less: Preferred stockholders’ equity | | |840,000 | |

|Equals: Common stockholders’ equity |$ | |1,360,000 | |

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|Price paid by Pamplin |$ | |1,500,000 | |

|Book value acquired ($1,360,000 x 90%) | | |1,224,000 | |

|Goodwill |$ | |276,000 | |

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|Net income as given |$ | |100,000 | |

|Less: Preferred dividends ($800,000 x 8%) | | |64,000 | |

|Income available to the common stockholders |$ | |36,000 | |

|Majority percentage | | |90% | |

|Income from Sage |$ | |32,400 | |

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|Reduction in paid-in capital due to Pamplin’s purchase of preferred stock | | | | |

|Par value of acquired preferred stock |$ | |560,000 | |

|Purchase price | | |600,000 | |

|Reduction in Pamplin’s additional paid-in capital |$ | |40,000 | |

|Ending balance in the paid-in capital account |$ | |710,000 | |

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|7. |c | |

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|When preferred stock of the subsidiary is acquired at an amount above or below the par value of the preferred stock, the excess cost over |

|par value is subtracted from the parent’s additional paid-in capital and any excess par value over cost is added to the parent’s additional|

|paid-in capital. The $40,000 by which the cost of the preferred stock is less than the par value is added to the parent’s additional |

|paid-in capital. |

|8. |b | |

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|9. |a | |

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|10. |a | |

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|11. |d | |

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|12. |d | |

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|13. |d | |

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|14. |d |(150,000+75,000)/25,000 |

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|15. |d | |

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|16. |d | |

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|17. |b | |

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|17. |a | |

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|18. |c | |

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|19. |b | |

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|20. |c | |

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|21. |a | |

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|22. |b | |

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|23. |c | |

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|24. |a | |

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|25. |c | |

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Exercise 1

|Requirement 1: | | | | |

|Total stockholders’ equity at December 31, 2004 |$ | |370,000 | |

|Less: Preferred stockholders’ equity 100 shares x | | | | |

|($105 call price + $10 dividend per share in arrears) | |( |11,500 |) |

|Common stockholders’ equity |$ | |358,500 | |

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|Price paid for common stock investment |$ | |300,000 | |

|Book value of 70% interest ($358,500 x 70%) | | |250,950 | |

|Excess of cost over book value |$ | |49,050 | |

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|Requirement 2 | | | | |

|Minority interest at January 1, 2005: | | | | |

|Minority interest: Preferred (100 shares x $115) |$ | |11,500 | |

|Minority interest: Common ($358,500 x 30%) | | |107,550 | |

|Total minority interest |$ | |119,050 | |

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Exercise 2

|Requirement 1: | | | | |

|Book value available to common stockholders: | | | | |

|Total stockholders’ equity at December 31, 2004 |$ | |1,450,000 | |

|Less: Preferred stockholders’ equity 1000 shares x | | | | |

|($109 call price + $8 dividend per share in arrears x 2 years) | | | | |

| | |( |125,000 |) |

|Common stockholders’ equity |$ | |1,325,000 | |

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|Book value of the common stockholders’ equity |$ | |1,325,000 | |

|Percentage acquired | | |70% | |

|80% of book value |$ | |927,500 | |

|Purchase cost | | |850,000 | |

|Equals: Goodwill |$ | |77,500 | |

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Exercise 3

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| | | |Basic | | |Diluted | |

|Sakal’s Basic and Diluted EPS: | | | | | | | |

|Sakal’s income to common shareholders |$ | |80,000 | |$ |80,000 | |

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|Common shares outstanding | | |20,000 | | |20,000 | |

|Incremental shares: | | | | | | | |

|Diluted EPS: | | | | | | | |

|2,500 shares – ($50,000 proceeds/$40 average price per share) | | | | | | | |

| | | | | | |1,250 | |

|Common shares and common equivalents | | |20,000 | | |21,250 | |

|Earnings per share |$ | |4.00 | |$ |3.76 | |

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| | | |Basic | | |Diluted | |

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|Pancino’s Basic and Diluted EPS: | | | | | | | |

|Pancino’s separate income |$ | |100,000 | |$ |100,000 | |

|Pancino’s income from Sakal | | |72,000 | | |72,000 | |

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|Replacement computation: | | | | | | | |

|Reverse: Pancino’s income from Sakal | |( |72,000 |) |( |72,000 |) |

|18,000 shares x $4.00 | | |72,000 | | | | |

|18,000 shares x $3.76 | | | | | |67,680 | |

|Income to common |$ | |172,000 | |$ |167,680 | |

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|Common shares outstanding | | |50,000 | | |50,000 | |

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|Earnings per share |$ | |3.44 | |$ |3.35 | |

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Exercise 4

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| | | |Basic | | |Diluted | |

|Sample’s Basic and Diluted EPS: | | | | | | | |

|Sample’s income to common shareholders |$ | |75,000 | |$ |75,000 | |

|Add: Net of tax interest expense | | | | | | | |

|$50,000 x 8% x 66% | | |0 | | |2,640 | |

|Adjusted subsidiary earnings |$ | |75,000 | |$ |77,640 | |

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|Common shares outstanding | | |10,000 | | |10,000 | |

|Incremental shares: | | | | | | | |

|Diluted EPS: | | | | | | | |

|100 bonds x 20 shares | | | | | |2,000 | |

|Common shares and common equivalents | | |10,000 | | |12,000 | |

|Earnings per share |$ | |7.50 | |$ |6.47 | |

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| | | |Basic | | |Diluted | |

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|Parker’s Basic and Diluted EPS: | | | | | | | |

|Parker’s separate income |$ | |100,000 | |$ |100,000 | |

|Parker’s income from Sample | | |60,000 | | |60,000 | |

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|Replacement computation: | | | | | | | |

|Reverse: Parker’s income from Sample | |( |60,000 |) |( |60,000 |) |

| 8,000 shares x $7.50 | | |60,000 | | | | |

| 8,000 shares x $6.47 | | | | | |51,760 | |

|Income to common |$ | |160,000 | |$ |211,760 | |

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|Common shares outstanding | | |100,000 | | |100,000 | |

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|Earnings per share |$ | |1.60 | |$ |1.52 | |

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Exercise 5

|Requirement 1: | | | | | | | | | | |

|Excluded dividend income: | | | | | | | |

|From Alder: $180,000 x 100% | | | | |$ |180,000 | |

|From Ball: $170,000 x 100% | | | | | |170,000 | |

|From Cake: $160,000 x 80% | | | | | |128,000 | |

|From Dash: $100,000 x 80% | | | | | |80,000 | |

|From Eager: $60,000 x 70% | | | | | |42,000 | |

|Total excluded dividend income | | | | |$ |600,000 | |

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|Requirement 2: | | | | | | | |

|Total dividend income received | | | | |$ |670,000 | |

|Total excluded dividend income | | | | | |600,000 | |

|Included dividend income | | | | |$ |70,000 | |

|Current Income Tax Liability: | | | | | | | |

|$70,000 x 35% = $24,500 | | | | | | | |

Exercise 6

|Requirement 1 | | |Pang | | |Sala | |

|Income taxes currently payable: | | | | | | | |

|Taxes on operating income | | | | | | | |

| $263,000 x 34% |$ | |89,420 | | | | |

| $197,000 x 34% | | | | |$ |66,980 | |

|Taxes on dividends received: | | | | | | | |

| $60,000 x 70% x 20% x 34% | | |2,856 | | | | |

|Income taxes currently payable | | |92,276 | | |66,980 | |

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|Tax on undistributed income: | | | | | | | |

| $137,000 x 70% x 20% x 34% | | |6,521 | | | | |

|Deferred tax on gain on land | | | | | | | |

| $35,000 x 34% | |( |11,900 |) | | | |

|Income tax expense |$ | |86,897 | |$ |66,980 | |

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|Requirement 2 | | | | | | | |

|Pre-tax income from Sala | | | | |$ |197,000 | |

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|Less: income tax expense | | | | |( |66,980 |) |

|Net Income from Sala | | | | |$ |130,014 | |

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Exercise 7

|Requirement 1 | | |Panitz | | |Salazar | |

|Taxable Income Calculation: | | | | | | | |

|Sales Revenue |$ | |890,000 | |$ |700,000 | |

|Loss on sale of land | |( |15,000 |) | | | |

|Cost of sales | |( |400,000 |) |( |250,000 |) |

|Other expenses | |( |350,000 |) |( |350,000 |) |

|Depreciation expense | |( |50,000 |) |( |35,000 |) |

|Dividend income: | | | | | | | |

| From Shaw $40,000 x 30% | | |12,000 | | | | |

| From Sunny $50,000 x 30% | | |15,000 | | | | |

|Taxable income |$ | |102,000 | |$ |65,000 | |

|Tax rate | | |34% | | |34% | |

|Income taxes currently payable |$ | |34,680 | |$ |22,100 | |

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|Requirement 2 | | | | | | | |

|Panitz’s income from Salazar: | | | | | | | |

|Assuming taxable income is the same as GAAP income | | | | | | | |

| | | | | | |$ 65,000 | |

|Less: Current income taxes | | | | | |22,100 | |

|Net income | | | | | |$ 42,900 | |

|Panitz’s ownership percentage | | | | | |80% | |

|Net Income from Salazar | | | | | |$ 34,320 | |

Exercise 8

|Preliminary calculations: | | | | | | | |

|Goodwill purchased: | | | | | | | |

|Total acquisition cost | | | | | |$1,300,000 | |

|Less: Fair value of net assets: | | | | | | | |

| $1,410,000 - $230,000 = | | | | | |1,180,000 | |

|Goodwill acquired | | | | | |$ 120,000 | |

|Requirement 1: | | | | | | | |

|Deferred incomes taxes: | | | | | | | |

|Excess fair value over book value: | | | | | | | |

| Inventories $240,000 - $210,000 | | | |$ | |30,000 | |

| Land $250,000 - $200,000 | | | | | |50,000 | |

| Building-net $900,000 - $600,000 | | | | | |300,000 | |

| Goodwill (accrue annually - tax) | | | | | |0 | |

|Total deferred items | | | |$ | |380,000 | |

|Tax rate | | | | | |34% | |

|Deferred income taxes | | | |$ | |129,200 | |

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|Requirement 2 | | | | | | | |

|Timing differences expiring or accruing during the first year after | | | | | | | |

|acquisition: | | | | | | | |

| Inventory sold | | | |$ | |15,000 | |

| Goodwill amortized - tax | | | | | |( 8,000) | |

| Excess building depreciation | | | | | |15,000 | |

|Total timing differences | | | |$ | |22,000 | |

|Tax rate | | | | | | 34% | |

|Tax effect | | | |$ | | 7,480 | |

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|The net deferred income tax liability will be reduced by $7,480 as a result of these timing differences. |

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Exercise 9

|Net income as reported: | | | |$ | |1,500,000 | |

|Excludable amount of dividends included in net income: | | | | | | | |

| Exclude 100% of Aldred dividends | | | | |( |90,000 |) |

| Exclude 70% of Faber dividends | | | | |( |28,000 |) |

|Includable amount of dividends not yet added to net income: | | | | | | | |

| Include 20% of Dale dividends | | | | | |13,200 | |

| Include 20% of East dividends | | | | | |10,000 | |

|Taxable income | | | |$ | |1,405,200 | |

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|The dividends from Balme and Calder are excluded in full. This problem also emphasizes the dividend exclusion ratio applicable when the |

|percentage of stock held is right on the dividing line between the different exclusion percentages. The 70% exclusion ratio applies for |

|stock holdings less than 20% and the 80% exclusion ratio applies for holdings less than 80% but at least 20%. |

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Exercise 10

|Preliminary calculations: | | | | | | | |

|Goodwill purchased: | | | | | | | |

|Total acquisition cost | | | | |$ |1,020,000 | |

|Less: Fair value of net assets: | | | | | | | |

| $1,080,000 - $210,000 = | | | | | |870,000 | |

|Goodwill acquired | | | | |$ |150,000 | |

|Requirement 1: | | | | | | | |

|Deferred incomes taxes: | | | | | | | |

|Excess fair value over book value: | | | | | | | |

| Inventories $240,000 - $210,000 | | | |$ | | 30,000 | |

| Land $320,000 - $200,000 | | | | | | 120,000 | |

| Building-net $500,000 - $600,000 | | | | | |(100,000) | |

|Liabilities $210,000 - $230,000 | | | | | |20,000 | |

| Goodwill (accrue annually - tax) | | | | | | 0 | |

|Total deferred items | | | |$ | | 70,000 | |

|Tax rate | | | | | |34% | |

|Deferred income taxes | | | |$ | | 23,800 | |

|Requirement 2 | | | | | | | |

|Timing differences expiring/ accruing during the first year after | | | | | | | |

|acquisition: | | | | | | | |

| Inventory sold | | | |$ | |30,000 | |

|Liabilities amortized | | | | | |4,000 | |

| Goodwill amortized (tax only) | | | | | |(10,000) | |

| Excess building depreciation | | | | | |( 5,000) | |

|Total timing differences | | | |$ | |19,000 | |

|Tax rate | | | | | | 34% | |

|Tax effect | | | |$ | | 6,460 | |

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|The net deferred income tax liability will be reduced by $6,460 as a result of these timing differences. |

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