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

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Total stockholders’ equity $11,000,000

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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.

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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.

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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.

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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.
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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.

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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).

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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.

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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.

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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%.

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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.

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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.

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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.

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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.

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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.

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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
Book Fair
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.

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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.

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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
Book Fair
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.

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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.

2. d

3. c

Stockholders’ equity $ 11,000,000

Less: Preferred stockholders’ equity 1,100,000
Common stockholders’ equity 9,900,000

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

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

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

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

Price paid by Pamplin $ 1,500,000

Book value acquired ($1,360,000 x 90%) 1,224,000
Goodwill $ 276,000

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

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

7. c

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

9. a

10. a

11. d

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12. d

13. d

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

15. d

16. d

17. b

17. a

18. c

19. b

20. c

21. a

22. b

23. c

24. a

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

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

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

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

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

Basic Diluted
Sakal’s Basic and Diluted EPS:
Sakal’s income to common shareholders $ 80,000 $ 80,000

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

Basic Diluted

Pancino’s Basic and Diluted EPS:

Pancino’s separate income $ 100,000 $ 100,000
Pancino’s income from Sakal 72,000 72,000

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

Common shares outstanding 50,000 50,000

Earnings per share $ 3.44 $ 3.35

Exercise 4

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

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

Parker’s Basic and Diluted EPS:

Parker’s separate income $ 100,000 $ 100,000
Parker’s income from Sample 60,000 60,000

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

Common shares outstanding 100,000 100,000

Earnings per share $ 1.60 $ 1.52

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

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

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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

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

Requirement 2
Pre-tax income from Sala $ 197,000

Less: income tax expense ( 66,980 )

Net Income from Sala $ 130,014

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

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

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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

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

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

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

The net deferred income tax liability will be reduced by $6,460 as a

result of these timing differences.

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