Assume the same facts as in E8-6 except that the company uses straight-line amortization. Required: Select the correct answer for each of the following questions. What amount of interest expense should be included in the 20X4 consolidated income statement? $14,000 $18,000 $21,000 $27,000 What amount of gain or loss on bond retirement should be included in the 20X4 consolidated income statement? $4,000 gain $4,000 loss $12,000 gain $16,000 loss Income assigned to the noncontrolling interest in the 20X4 consolidated income statement should be $6,000 $8,100 $8,400 $16,000. Data from E8-6: On January 1, 20X4, Passive Heating Corporation paid $104,000 for $100,000 par value, 9 percent bonds of Solar Energy Corporation. Solar had issued $300,000 of the 10-year bonds on January 1, 20X2, for $360,000. The bonds pay interest semiannually. Passive previously had purchased 80 percent of the common stock of Solar on January 1, 20X1, at underlying book value. Passive reported operating income (excluding income from subsidiary) of $50,000, and Solar reported net income of $30,000 for 20X4. Required: Select the correct answer for each of the following questions. What amount of interest expense should be included in the 20X4 consolidated income statement? $14,626. $18,415. $21,678. $27,112. What amount of gain or loss on bond retirement should be included in the 20X4 consolidated income statement? $4,243 gain $4,243 loss $12,923 gain $16,115 loss Income assigned to the noncontrolling interest in the 20X4 consolidated income statement should be $6,534. $8,321. $8,388. $16,826.
> Browne Corporation purchased 11,000 shares of Schroeder Corporation on January 1, 20X3, at book value. At that date, the fair value of the noncontrolling interest was equal to 26.6 percent of Schroeder’s book value. On December 31, 20X8
> Mega Corporation purchased 90 percent of Tarp Company’s voting common shares on January 1, 20X2, at underlying book value. At that date, the fair value of the noncontrolling interest was equal to 10 percent of the book value of Tarp Com
> Assume the same facts as in E8-15 except for the changes in the trial balances, but prepare entries using straight-line amortization of bond discount or premium. Required: Record the journal entry or entries for 20X4 on Mega’s b
> Wood Corporation owns 70 percent of Carter Company’s voting shares. On January 1, 20X3, Carter sold bonds with a par value of $600,000 at 98. Wood purchased $400,000 par value of the bonds; the remainder was sold to nonaffiliates. The bonds mature in fiv
> Blatant Advertising Corporation acquired 60 percent of Quinn Manufacturing Company’s shares on December 31, 20X1, at underlying book value of $180,000. At that date, the fair value of the noncontrolling interest was equal to 40 percent
> Porter Company purchased 60 percent ownership of Temple Corporation on January 1, 20X1, at underlying book value. At that date, the fair value of the noncontrolling interest was equal to 40 percent of Temple’s book value. On January 1,
> Assume the same facts as in E8-14 except for the changes in the trial balances and assuming the bonds were sold for $82,000, but prepare entries using straight-line amortization of bond discount or premium. Data from E8-14: Porter Company purchased 60
> Weal Corporation purchased 60 percent of Modern Products Company’s shares on December 31, 20X7, for $210,000. At that date, the fair value of the noncontrolling interest was $140,000. On January 1, 20X9, Weal purchased an additional 20
> Explain how a reciprocal ownership arrangement between two subsidiaries could lead the parent company to overstate its income if no adjustment is made for the reciprocal relationship.
> Assume the same facts as in E8-13 but prepare entries using straight-line amortization of bond discount or premium. Data from E8-13: Stang Corporation issued to Bradley Company $400,000 par value, 10-year bonds with a coupon rate of 12 percent on Janua
> Stang Corporation issued to Bradley Company $400,000 par value, 10-year bonds with a coupon rate of 12 percent on January 1, 20X5, at 105. The bonds pay interest semiannually on July 1 and January 1. On January 1, 20X8, Purple Corporation purchased $100,
> Parent Company holds 80 percent ownership of Subsidiary Company, and Subsidiary Company owns 90 percent of the stock of Tiny Corporation. What effect will $100,000 of unrealized intercompany profits on Tiny’s books on December 31, 20X5, have on the amoun
> Assume the same facts as in E8-12 but prepare entries using straight-line amortization of bond discount or premium. Data from E8-12: Bundle Company issued $500,000 par value, 10-year bonds at 104 on January 1, 20X3, which Mega Corporation purchased. Th
> Bundle Company issued $500,000 par value, 10-year bonds at 104 on January 1, 20X3, which Mega Corporation purchased. The coupon rate on the bonds is 11 percent. Interest payments are made semiannually on July 1 and January 1. On July 1, 20X6, Parent Comp
> Hydro Corporation needed to build a new production facility. Because it already had a relatively high debt ratio, the company decided to establish a joint venture with Rich Corner Bank. This arrangement permitted the joint venture to borrow $30 million f
> Strong Manufacturing Company holds 94 percent ownership of Thorson Farm Products and 68 percent ownership of Kenwood Distributors. Thorson has excess cash at the end of 20X4 and is considering buying shares of its own stock, shares of Strong, or shares o
> Online Enterprises owns 95 percent of Downlink Corporation. On January 1, 20X1, Downlink issued $200,000 of five-year bonds at 115. Annual interest of 12 percent is paid semiannually on January 1 and July 1. Online purchased $100,000 of the bonds on Augu
> Online Enterprises owns 95 percent of Downlink Corporation. On January 1, 20X1, Downlink issued $200,000 of five-year bonds at 115. Annual interest of 12 percent is paid semiannually on January 1 and July 1. Online purchased $100,000 of the bonds on July
> Hardcore Mining Company acquired 88 percent of the common stock of Mountain Trucking Company on January 1, 20X2, at a cost of $30 per share. On December 31, 20X7, when the book value of Mountain Trucking stock was $70 per share, Hardcore sold one-quarter
> Apple Corporation holds 60 percent of Shortway Publishing Company’s voting shares. Apple issued $500,000 of 10 percent bonds with a 10-year maturity on January 1, 20X2, at 90. On January 1, 20X8, Shortway purchased $100,000 of the Apple
> Apple Corporation holds 60 percent of Shortway Publishing Company’s voting shares. Apple issued $500,000 of 10 percent (paid semiannually) bonds with a 10-year maturity on January 1, 20X2, at 90. On January 1, 20X8, Shortway purchased $
> Book Corporation purchased 90,000 shares of Lance Company at underlying book value of $3 per share on June 30, 20X1. On January 1, 20X5, Lance reported its net book value as $400,000 and continued to have 100,000 shares of common stock outstanding. On th
> Assume the same facts as in E8-9 but prepare entries using straight-line amortization of bond discount or premium. Data from E8-9: Farley Corporation owns 70 percent of Snowball Enterprises’ stock. On January 1, 20X1, Farley sold $1 million par value,
> Farley Corporation owns 70 percent of Snowball Enterprises’ stock. On January 1, 20X1, Farley sold $1 million par value, 7 percent (paid semiannually), 20-year, first mortgage bonds to Kling Corporation at 97. On January 1, 20X8, Snowball purchased $300,
> Companies sometimes employ accounting practices that are not necessarily in accordance with accounting theory or even current standards. In some cases, companies may be following industry practices rather than generally accepted practices. In other cases
> Nettle Corporation sold $100,000 par value, 10-year first mortgage bonds to Timberline Corporation on January 1, 20X5. The bonds, which bear a nominal interest rate of 12 percent, pay interest semiannually on January 1 and July 1. The entry to record int
> Assume the same facts as in E8-8 but prepare entries using straight-line amortization of bond discount or premium. Data from E8-8: Able Company issued $600,000 of 9 percent first mortgage bonds on January 1, 20X1, at 103. The bonds mature in 20 years a
> Able Company issued $600,000 of 9 percent first mortgage bonds on January 1, 20X1, at 103. The bonds mature in 20 years and pay interest semiannually on January 1 and July 1. Prime Corporation purchased $400,000 of Able’s bonds from the original purchase
> Snow Corporation issued common stock with a par value of $100,000 and preferred stock with a par value of $80,000 on January 1, 20X5, when the company was created. Klammer Corporation acquired a controlling interest in Snow on January 1, 20X6.
> Assume the same facts as in E8-7 but prepare entries using straight-line amortization of bond discount or premium. Data from E8-7: Able Company issued $600,000 of 9 percent first mortgage bonds on January 1, 20X1, at 103. The bonds mature in 20 years a
> Able Company issued $600,000 of 9 percent first mortgage bonds on January 1, 20X1, at 103. The bonds mature in 20 years and pay interest semiannually on January 1 and July 1. Prime Corporation purchased $400,000 of Able’s bonds from the original purchase
> Bradley Corporation sold bonds to Flood Company in 20X2 at 90. At the end of 20X4, Century Corporation purchased the bonds from Flood at 105. Bradley then retired the full bond issue on December 31, 20X7, at 101. Century holds 80 percent of Bradley’s vot
> Assume the same facts as in E8-1 and prepare entries using straight-line amortization of bond discount or premium. Data from E8-1: Lamar Corporation owns 60 percent of Humbolt Corporation’s voting shares. On January 1, 20X2, Lamar Corporation sold $150
> Lamar Corporation owns 60 percent of Humbolt Corporation’s voting shares. On January 1, 20X2, Lamar Corporation sold $150,000 par value, 6 percent first mortgage bonds to Humbolt for $156,000. The bonds mature in 10 years and pay interest semiannually on
> How does the use of interperiod tax allocation procedures affect the amount of income assigned to noncontrolling shareholders in the period in which the subsidiary records unrealized intercompany profits?
> Are there any book-tax differences that arise in an acquisition that do not require the inclusion of a deferred tax asset or liability in the net identifiable assets acquired?
> Snapper Corporation holds 70 percent ownership of Bit Company, and Bit holds 60 percent ownership of Slide Company. Should Slide be consolidated with Snapper Corporation? Why?
> How will parent company shares held by a subsidiary be reflected in the consolidated balance sheet when the treasury stock method is used?
> Major companies often have very complex organizational structures, sometimes consisting of different types of entities. Some organizational structures include combinations of corporations, partnerships, and perhaps other types of entities. Complex organi
> What effect will a subsidiary’s 15 percent stock dividend have on the consolidated financial statements?
> How is the amount of income assigned to the noncontrolling interest affected when the parent purchases the bonds of its subsidiary from an unaffiliated company for less than book value?
> How is the amount of income assigned to the noncontrolling interest affected by the direct placement of a subsidiary’s bonds with the parent company?
> When a subsidiary purchases the bonds of its parent from a nonaffiliate for less than book value, what will be the effect on consolidated net income and income to the controlling interest?
> What portion of the sales of an acquired company is included in the consolidated income statement following a midyear acquisition?
> Are sales included in the consolidated cash flows worksheet in computing cash flows from operating activities under (a) the indirect method or (b) the direct method?
> A parent company sells common shares of one of its subsidiaries to a nonaffiliate for more than their carrying value on the parent’s books. How should the parent company report the sale? How should the sale be reported in the consolidated financial state
> Why are changes in inventory balances not shown in the statement of cash flows when the direct method is used in presenting the cash flows from operating activities?
> What portion of subsidiary preferred stock outstanding is reported as part of the noncontrolling interest in the consolidated balance sheet?
> How do the consolidation entries at the end of the year change when an acquisition occurs at midyear rather than at the beginning of the year?
> How are dividends declared by an acquired company prior to the date of a midyear acquisition treated in the consolidated financial statements?
> How is an increase in inventory included in the amounts reported as cash flows from operating activities under (a) the indirect method and (b) the direct method?
> Why are payments to suppliers not shown in the statement of cash flows when the indirect method is used in presenting cash flows from operating activities?
> Why are dividend payments to noncontrolling shareholders treated as an outflow of cash in the consolidated cash flow statement but not included as dividends paid in the consolidated retained earnings statement?
> How do interperiod income tax allocation procedures affect consolidation entries in the period in which intercompany profits unrealized as of the beginning of the period are realized?
> How do interperiod income tax allocation procedures affect consolidation entries in the period in which unrealized intercompany profits arise?
> How do unrealized profits on intercompany transfers affect the amount reported as income tax expense in the consolidated financial statements?
> Why do companies that file consolidated tax returns often choose to allocate tax expense to the individual affiliates?
> What factors would cause an acquirer to include deferred tax assets and liabilities in the net identifiable assets acquired?
> Why not simply add a fourth part to the three-part consolidation worksheet to permit preparation of a consolidated cash flow statement?
> On January 1, 20X4, Passive Heating Corporation paid $104,000 for $100,000 par value, 9 percent bonds of Solar Energy Corporation. Solar had issued $300,000 of the 10-year bonds on January 1, 20X2, for $360,000. The bonds pay interest semiannually. Passi
> What is indirect ownership? How does one company gain control of another through indirect ownership?
> How are treasury shares held by a subsidiary reported in the consolidated financial statements?
> A parent company purchases additional common shares of one of its subsidiaries from the subsidiary at $10 per share above underlying book value. Explain how this purchase is reflected in the consolidated financial statements for the year.
> A subsidiary sells additional shares of its common stock to a nonaffiliate at a price that is higher than the previous book value per share. How does the sale benefit the existing shareholders?
> How does a call feature on subsidiary preferred stock affect the claim of the noncontrolling interest reported in the consolidated balance sheet?
> Why are subsidiary preferred dividends that are paid to nonaffiliates normally deducted from earnings in arriving at consolidated net income? When is it not appropriate to deduct subsidiary preferred dividends in computing consolidated net income?
> When multilevel affiliations exist, explain why it is generally best to prepare consolidated financial statements by completing the consolidation entries for companies furthest from parent company ownership first and completing the consolidation entries
> What effect will a subsidiary’s 15 percent stock dividend have on the consolidation entries used in preparing a consolidated balance sheet at the end of the year in which the dividend is distributed?
> Shortly after a parent company purchased its subsidiary’s bonds from a nonaffiliate, the subsidiary retired the entire issue. How is the gain or loss on bond retirement reported by the subsidiary treated for consolidation purposes?
> A parent purchases a subsidiary’s bonds directly from it. The parent later sells the bonds to a nonaffiliate. From a consolidated viewpoint, what occurs when the parent sells the bonds? Is a gain or loss reported in the consolidated income statement when
> Intercompany debt, both long term and short term, arises frequently. In some cases, intercorporate borrowings may arise because one affiliate can borrow at a cheaper rate than others, and lending to other affiliates may reduce the overall cost of borrowi
> A parent company purchased its subsidiary’s bonds from a nonaffiliate in the preceding year, and a loss on bond retirement was reported in the consolidated income statement. How will income assigned to the noncontrolling interest be affected in the year
> A subsidiary purchased bonds of its parent company from a nonaffiliate in the preceding period, and a gain on bond retirement was reported in the consolidated income statement as a result of the purchase. What effect will that event have on the amount of
> How would the relationship between interest income recorded by a subsidiary and interest expense recorded by the parent be expected to change when comparing a direct placement of the parent’s bonds with the subsidiary to a constructive retirement in whic
> How does the consolidation process deal with a subsidiary’s preferred stock?
> When the parent company purchases a subsidiary’s bonds from a nonaffiliate for more than book value, what income statement accounts will be affected in preparing consolidated financial statements? What will be the effect on income assigned to the control
> If an affiliate’s bonds are purchased from a nonaffiliate at the beginning of the current year, how can the amount of the gain or loss on constructive retirement be computed by looking at the two companies’ year-end trial balances?
> What is the effect of eliminating intercompany interest income and interest expense on consolidated net income when a loss on bond retirement has been reported in a prior year’s consolidated financial statements as a result of a constructive retirement o
> What is the effect of eliminating intercompany interest income and interest expense on consolidated net income when bonds have been sold directly to an affiliate? Why?
> When a parent company sells land to a subsidiary at more than book value, the consolidation entries at the end of the period include a debit to the gain on the sale of land. When a parent purchases the bonds of a subsidiary from a nonaffiliate at less th
> For a multicorporate entity, how is the recognition of gains or losses on bond retirement changed when emphasis is placed on the economic entity rather than the legal entity?
> Kruse Corporation holds 60 percent of the voting common shares of Gary’s Ice Cream Parlors. On January 1, 20X6, Gary’s purchased $50,000 par value, 10 percent first mortgage bonds of Kruse from Cane for $58,000. Kruse originally issued the bonds to Cane
> Musical Corporation acquires 80 percent of Dustin Corporation’s common shares on January 1, 20X2. On January 2, 20X2, Dustin acquires 60 percent of Rustic Corporation’s common stock. Information on company book values
> Find the value of an American put option using the binomial option pricing model. The parameters are S 62, X 70, r 0.08, u 1.10, and d 0.95. There are no dividends. Use n 2 periods.
> Consider a currency swap for $10 million and SF 15 million. One party pays dollars at a fixed rate of 9 percent, and the other pays Swiss francs at a fixed rate of 8 percent. The payments are made semiannually based on the exact day count and 360 days in
> Show how to combine a currency swap paying Swiss francs at a floating rate and receiving Japanese yen at a floating rate with another currency swap to obtain a plain vanilla swap paying Swiss francs at a floating rate and receiving Swiss francs at a fixe
> The value Max[0, X(1 r)−T − S0] was shown to be the lowest possible value of a European put. Why is this value irrelevant for an American put?
> Compare and contrast the characteristics of contango, backwardation, normal contango, and normal backwardation markets.
> One way to create a bear spread positions is by purchasing a high strike put option and selling a low strike put option. Identify a strategy with call options that creates a similar bear spread-shaped profit profile. The following option prices were obs
> One way to create a bull spread positions is by purchasing a low strike call option and selling a high strike call option. Identify a strategy with put options that creates a similar bull spread shaped profit profile.
> Using the information in the previous problem, calculate the price of the put described in problem 17, using the Black model for pricing puts.
> Use the Black model to determine a fair price for an interest rate put that expires in 74 days. The forward rate is 9.79 percent, and the exercise rate is 10 percent. The appropriate risk-free rate is 8.38 percent. All rates are continuously compounded.
> Assume the 30-day LIBOR is 5 percent and the 120-day LIBOR is 6 percent. This implies a continuously compounded 90-day forward rate of 6.3448 percent. Verify this result and explain what happens to the continuously compounded forward rate as the number o
> Assume the 30-day LIBOR is 5 percent and the 120-day LIBOR is also 5 percent. This implies a continuously compounded 90-day forward rate of 5.0172 percent. Verify this result and explain what happens to the continuously compounded 90-day forward rate as
> A bank is offering an interest rate call with an expiration of 45 days. The call pays off based on 180-day LIBOR. The volatility of forward rates is 17 percent. The 45-day forward rate for 180-day LIBOR is 0.1322, and the exercise rate is 12 percent. The
> Identify and define three versions of put-call parity.
> In each case examined in this chapter and in the preceding problems, we did not account for the interest on funds invested. One useful way to observe the effect of interest is to look at a conversion or a reverse conversion. Evaluate the August 165 puts
> You are the manager of a bond portfolio of $10 million face value of bonds worth $9,448,456. The portfolio has a yield of 12.25 percent and a duration of 8.33. You plan to liquidate the portfolio in six months and are concerned about an increase in inter
> Assume a standard deviation of 8 percent and use the Black model to determine whether the call option in problem 17 is correctly priced. If not, suggest a riskless hedge strategy.
> Consider a $30 million notional amount interest rate swap with a fixed rate of 7 percent, paid quarterly on the basis of 90 days in the quarter and 360 days in the year. The first floating payment is set at 7.2 percent. Calculate the first net payment an
