The balance sheets of Forest Company and Garden Company are presented below as at December 31, Year 8.

Additional Information
€¢ Forest acquired 90% of Garden for $207,900 on July 1, Year 1, and accounts for its investment under the cost method. At that time, the shareholders€™ equity of Garden amounted to $175,000, the accumulated amortization was $95,000, and the assets of Garden were undervalued by the following amounts:
Inventory......... $12,000
Buildings......... $10,000 remaining life, 10 years
Patents ......... $16,000 remaining life, 8 years
€¢ During Year 8, Forest reported net income of $41,000 and declared dividends of $25,000, whereas Garden reported net income of $63,000 and declared dividends of $50,000.
€¢ During Years 2 to 7, goodwill impairment losses totalled $1,950. An impairment test conducted in Year 8 indicated a further loss of $7,150.
€¢ Forest sells goods to Garden on a regular basis at a gross profit of 30%. During Year 8, these sales totalled $150,000. On January 1, Year 8, the inventory of Garden contained goods purchased from Forest amounting to $18,000, while the December 31, Year 8, inventory contained goods purchased from Forest amounting to $22,000.
€¢ On August 1, Year 6, Garden sold land to Forest at a profit of $18,000. During Year 8, Forest sold one-quarter of the land to an unrelated company.
€¢ Forest€™s bonds have a par value of $100,000, pay interest annually on
December 31 at a stated rate of 6%, and mature on December 31, Year 11. Forest incurs an effective interest cost of 8% on these bonds. They had a carrying amount of $93,376 on January 1, Year 8. On that date, Garden acquired $60,000 of these bonds on the open market at a cost of $57,968. Garden will earn an effective rate of return of 7% on them. Both companies use the effective-interest method to account for their bonds.
The Year 8 income statements of the two companies show the following with respect to bond interest.

€¢ Garden owes Forest $22,000 on open account on December 31, Year 8.
€¢ Assume a 40% corporate tax rate and allocate bond gains (losses) between the two companies.
Required:
(a) Prepare the following statements:
(i) Consolidated balance sheet
(ii) Consolidated retained earnings statement
(b) Prepare the Year 8 journal entries that would be made on the books of Forest if the equity method was used to account for the investment.
(c) Explain how a loss on the elimination of intercompany bondholdings is viewed as a temporary difference and gives rise to a deferred income tax asset.
(d) If Forest had used parent company extension theory rather than entity theory, how would this affect the debt-to-equity ratio at the end of Year 9?
 
 

Transcribed Image Text:

BALANCE SHEETS-at December 31, Year 8 Forest Garden Cash $ 13,000 $ 48,800 Receivables 25,000 80,000 86,674 62,000 Inventories Investment in shares of Garden Plant and equipment Accumulated depreciation 207,900 740,000 (625,900) 460,000 (348,400) 4,500 Patents Investment in bonds of Forest 58,426 $372,000 $440,000 Current liabilities $ 59,154 $ 53,000 Dividends payable Bonds payable 6% 6,000 94,846 30,000 Common shares 200,000 80,000 150,000 139,000 Retained earnings $440,000 $372,000 BALANCE SHEETS-at December 31, Year 8 Forest Garden Cash $ 13,000 $ 48,800 Receivables 25,000 80,000 86,674 62,000 Inventories Investment in shares of Garden Plant and equipment Accumulated depreciation 207,900 740,000 (625,900) 460,000 (348,400) 4,500 Patents Investment in bonds of Forest 58,426 $372,000 $440,000 Current liabilities $ 59,154 $ 53,000 Dividends payable Bonds payable 6% 6,000 94,846 30,000 Common shares 200,000 80,000 150,000 139,000 Retained earnings $440,000 $372,000

Answer rating: 100% (QA)

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