Financial Final Exams

Update for the 2008 Edition

Errata and Explanation/Additional Clarification

Last Updated May 28, 2008

Section A: ERRATA

Item A.1
Final Exam 2, Testlet 1, Question 19

Question
During year X54, Strum's pension consultant advised that due to changing mortality tables an "actuarial
loss" of $50,000 would have to be taken into account when making its year- end pension journal entries.
As of 12/31/X54, the fair value of pension plan assets was $200,000, the projected benefit obligation was
$350,000, the accumulated benefit obligation was $250,000, and the average remaining service period of
plan participants was five years.

Because of this information, Strum's X5 pension expense would be increased by

Option 1 $0
Option 2 $3,000
Option 3 $15,000
Option 4 $10,000

Explanation
Choice 2 is correct, based on the following computation:
The greater of:
Market value of plan assets $200,000

Or projected benefit obligation $350,000 x .10 = $35,000

Actuarial loss $50,000 - $35,000 (from above) = $15,000 ÷ 5 = $3,000

The amount of the actuarial loss in excess of 10% of the market value of plan assets or the projected
benefit obligation (whichever is greater) is amortized over the average remaining service period.
Choice 3 is incorrect. Failure to amortize over 5 years would result in this incorrect answer.
Choices 1 and 4 are incorrect, per the above calculations.

Comments
As highlighted in blue above, the date of the actuarial loss and the 12/31 pension balances should be
changed to 20X4, rather than 20X5. An actuarial loss/gain is not amortized in the period in which it is
incurred. Amortization begins in the subsequent period. So the $50,000 actuarial loss incurred in 20X4
would be amortized starting in 20X5 using the calculation shown in the explanation.

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Item A. 2
Final Exam 2, Testlet 3. Question 5

Question
Winkin and Blinkin share profits 70:30 and have capital balances of $90,000 and $40,000 respectively.
Winkin and Blinkin have agreed to admit Nod as a 25 percent partner for $50,000. The partners have
agreed to recognize goodwill on the transaction. What is the amount of Winkin's capital account
immediately following the formation of Winkin, Blinkin & Nod?

Option 1 50,200
Option 2 90,000
Option 3 104,000
Option 4 140,000

Explanation
Choice 3 is correct. Using the goodwill method, determine the total amount of the partnership's capital
as a result of recapitalization by dividing the new partner's contribution by their negotiated percentage.
Determine goodwill as the difference between the total recapitalized amount and the amounts currently
recorded and the new partner's capital. Distribute the difference to existing partners based on their profit
and loss sharing percentages. Computations performed as follows.

Choice 1 is incorrect. The capital account for Blinkin is not correct.

Choice 2 is incorrect. The original amount of Winkin's capital account is incorrect.
Choice 4 is incorrect. Winkin's share of earnings (70%) times the new capitalization ($200,000) is
incorrect.

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Comments
The answer and explanation given above are incorrect. The question states that Nod pays $50,000 to
enter the partnership, but the explanation states that Nod contributes $36,000. The answer should be
calculated using the $50,000 contribution stated in the facts, as follows:
Nod contribution $ 50,000
Percentage purchases 25%
Total implied value $200,000
Total capital accounts (180,000) ($90,000 + $40,000 + $50,000)
Goodwill $ 20,000
Goodwill allocated to Winkin = $20,000 x 70% = $14,000
Goodwill allocated to Blinkin = $20,000 x 30% = $ 6,000
Revised capital:
Winkin: $90,000 + $14,000 = $104,000
Blinkin: $40,000 + $6,000 = $46,000
Nod: $50,000

Winkin's ending capital account is $104,000. Unfortunately, this is not one of the answer options
provided.

Item A.3
Final Exam 2, Testlet 3, Question 8

Question:
Kid Company, a toy manufacturer, owns 60 percent of the voting common stock of Cone Company. Kid
would not produce consolidated financial statements if:
Option 1
Cone is a real-estate company.
Option 2
Cone owns 40% of Kid
Option 3
Kid intends to sell all of its Cone stock in the next accounting period.
Option 4
Cone is located and does all of its business in a foreign country.

Explanation:
Choice 3 is correct. The investor company would not produce consolidated financial statements if it
intends to sell its stock in the investee company in the next accounting period. The investment securities
would be accounted for as "trading securities."
Choice 1 is incorrect. The industry the subsidiary operates in does not affect the decision to consolidate.
Choice 2 is incorrect. The subsidiary's partial ownership of the parent does not affect the decision to
consolidate.
Choice 4 is incorrect. A parent produces consolidated financial statements if it "controls" the subsidiary.
Where the subsidiary is located is not relevant.

Comment:
Kid must produce consolidated financial statements in all of the situations listed. Temporary control
(Option 3) does not allow a parent company to avoid consolidation. All majority owned subsidiaries must
be consolidated unless control does not rest with the majority owner; for instance, when the subsidiary is
in legal reorganization, bankruptcy, or operates under severe foreign restrictions.

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 Section B: ADDITIONAL INFORMATION/CLARIFICATION

Item B.1
Final Exam 2, Testlet 2, Question 11
This question has generated some confusion; although, it is correct. The question and answer are as
follows:

Question
On 12/31/X4, Planet Company acquired 80% of the voting common stock of Star Company by issuing
100,000 shares of its own common stock (fair value $8/share). In the acquisition, Planet paid legal fees
in the amount of $15,000 and paid SEC registration fees of $10,000. The book value of Star on 12/31/X4
was $700,000. Star's only balance sheet item with a fair value different from book value was a building.
The building had a book value of $100,000 and a fair value of $150,000. During the year X5 Star
Company declared and paid dividends in the amount of $10,000. Star's net income was $50,000. To
account for this activity, Planet Company:

Option 1
Must use the equity method.
Option 2
Can use either the equity method or the cost method.
Option 3
Must use the cost method.
Option 4
Must classify the Star Co. stock it holds as available-for-sale securities.

Explanation
Choice 2 is correct. A parent can use either the equity method or the cost method to account for its
investment in its subsidiary. Since all intercompany accounts are eliminated, the equity method and the
cost method will produce the exact same results on the consolidated financial statements.
Not choices 1 and 3 per the above discussion.
Not choice 4. If the equity method is used or consolidated financial statements are produced,
classification of "available-for-sale security" does not apply because the investment in the subsidiary is
eliminated.

Comments
This question places an emphasis on the words "account for." “Account for” in this question is not the
same as "report." From a reporting standpoint, consolidation would be used because Planet owns 80% of
Star. However, on its books, to "account for" its subsidiary, Planet can do anything it wants to do (i.e., it
can use either the cost method or the equity method).
Remember that both the cost method on Page F3-11 and the equity method on Page F3-13 are labeled
"External Reporting." Consolidated financial statements on Page F3-21 should be labeled that way also
and is so labeled by the National Instructor in his comments. All three of these methods are methods of
reporting based on the degree of control.
To repeat, on the books of the investor company (called the parent when more than 50% is owned),
either the cost method or the equity method can be used. The adjusting EJE are different to reflect which
method is used internally.