Advanced Accounting 9th edition Solution by Hoyle – Test Bank

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CHAPTER 5

CONSOLIDATED FINANCIAL STATEMENTS –

INTERCOMPANY ASSET TRANSACTIONS

Chapter Outline

The transfer of assets between the companies forming a business combination is a common practice. The opportunity for such direct acquisition (especially of inventory) is often the underlying motive for the creation of the combination.

Intercompany inventory transfers

The individual accounting systems of the two companies will record the transfer as a sale by one party and as a purchase by the other

Because the transaction was not made with an outside, unrelated party, the sales and purchases balances created by the transfer must be eliminated in the consolidation process (Entry Tl)

Any transferred inventory retained at the end of the year is recorded at its transfer price which in (many cases) will include an unrealized gross profit

For consolidation purposes, this intercompany gross profit must be deferred by eliminating the amount from the inventory account on the balance sheet and from the ending inventory figure within cost of goods sold (Entry G).

Because the effects of the transfer carry over into the subsequent fiscal period, the unrealized gross profit must also be removed a second time: from the beginning inventory component of cost of goods sold and from the beginning retained earnings balance (Entry *G).

The retained earnings figure being adjusted is that of the original seller.

If the equity method has been applied and the transfer was made downstream (by the parent), the beginning retained earnings account will be correct; therefore, in this one case, the adjustment is to the Equity in Investment Earnings account.

The consolidation process is designed to shift the profit from the period of transfer into the time period in which the goods are actually sold to unrelated parties or consumed

Effect of deferral process on the valuation of a noncontrolling interest

Official accounting pronouncements do not currently specify whether deferral of unrealized profits has an effect on the valuation of noncontrolling interest balances

This textbook adjusts the noncontrolling interest balances but only if the sale was made upstream from subsidiary to parent. Downstream sales are made by the parent and, thus, are viewed as having no effect on the outside interest.

 

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Intercompany land transfers

Any gain created by intercompany land transfers is unrealized and will remain so until the land is sold to an outside party

For each subsequent consolidation, the recorded value of the land account must be reduced to original cost with the unrealized gain that was recorded by the seller also being eliminated

In the year of transfer, an actual gain account exists within the accounting records of the seller and must be removed.

In all later time periods, since the unrealized gain has become an element of the seller’s beginning retained earnings balance, the reduction is made to this equity account.

If the land is ever sold to an outside party, the intercompany gain is realized and has to be recognized within that time period.

IV. Intercompany transfer of depreciable assets

As with other intercompany transfers, any unrealized gross profit must be deferred for consolidation purposes to establish appropriate historical cost balances.

However, the difference between the transfer-based accounting value and the historical cost of the asset will change each year because of the effects of depreciation. The amount of unrealized gain within retained earnings will also be reduced annually since excess depreciation expense is recognized (and closed into retained earnings) based on the inflated transfer price.

Consequently, elimination of the unrealized gain (within retained earnings) and the reduction of the asset value to historical cost will differ from year to year.

Also within the consolidation process, the recorded depreciation expense must be decreased every period to an amount appropriately based on the asset’s original acquisition price.

Learning Objectives

Understand that intercompany asset transfers often create accounting effects within the financial records of the individual companies that must be eliminated or adjusted prior to production of consolidated financial statements.

Eliminate the sales and purchases balances that are created by the intercompany transfer of inventory (Entry Tl).

Compute the amount of unrealized gross profit included in the recorded value of any transferred inventory that is still being held by the buyer at the end of a fiscal period.

Prepare the consolidation entry (Entry G) to eliminate any intercompany inventory gross profit that remains unrealized at the end of the year of transfer.

 

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Understand that the consolidation process for inventory transfers is designed to defer the unrealized portion of an intercompany gross profit from the year of transfer into the year of disposal or consumption.

Make the consolidation entry (Entry *G) to eliminate unrealized intercompany gross profits from beginning retained earnings (or in one specific instance from the Equity in Subsidiary Earnings account) and from the cost of goods sold for the period following the year of transfer.

Understand the difference in upstream and downstream transfers and how each affects the computation of noncontrolling interest balances.

Eliminate any unrealized gain created by the intercompany transfer of land from the accounting records of the year of transfer and subsequent years.

Understand that the elimination process for unrealized gross profits created by intercompany land transfers must be repeated in each fiscal period for as long as the asset is held within the business combination.

Realize that the account balances created by an unrealized gain resulting from the intercompany transfer of a depreciable asset will change from period to period because of the effect of depreciation expense.

Compute and eliminate the unrealized gain created by intercompany transfers of depreciable assets for any date subsequent to the transaction.

Produce the worksheet entry to reduce depreciation expense from a figure based on transfer price to one calculated from the asset’s historical cost balance.

Answers to Discussion Questions

Earnings Management

By selling goods to special purpose entities that it controlled but did not consolidate, did Enron overstate its earnings?

According to the Power’s Report (Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp.—February 1, 2004)

These partnerships—Chewco, LJM1, and LJM2—were used by Enron Management to enter into transactions that it could not, or would not, do with unrelated commercial entities. Many of the most significant transactions apparently were designed to accomplish favorable financial statement results,

not to achieve bona fide economic objectives or to transfer risk. (page 4)

Assuming Enron controlled LJM2, the transactions that produced the $67 million gain and the $20.3 million agency fee were not arm’s length and thus did not provide a proper basis for recognizing income.

What effect does consolidation have on the financial reporting for transactions with controlled entities?

In consolidation, all intercompany profit would have been deferred until the goods were sold to an outside party. Also the intercompany note receivable and payable would have been eliminated in consolidation.

As noted by Bala Dahran in his February 6, Congressional Testimony

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Despite their potential for economic and business benefits, the use of SPEs has always raised the question of whether the sponsoring company has some other accounting motivations, such as hiding of debt, hiding of poor-performing assets, or earnings management. Additionally, explosive growth in the use of SPEs led to debates among managers, auditors and accounting standard setters as to whether and when SPEs should be consolidated. This is because the intended accounting effects of SPEs can only be achieved if the SPEs are reported as unconsolidated entities separate from the sponsoring entity.

FASB Activity on Special Purpose Entities

Fortunately the FASB’s Interpretation 46R Consolidation of Variable Interest Entities explains how to identify an SPE that is not subject to control through voting ownership interests, but is nonetheless controlled by another enterprise and therefore subject to consolidation. The FASB requires each enterprise involved with an SPE to determine whether the financial support provided by that enterprise makes it the primary beneficiary of the SPE’s activities. The primary beneficiary of the SPE would then be required to include the assets, liabilities, and results of the activities of the SPE in its consolidated financial statements.

What Price Should We Charge Ourselves?

Transfer pricing is actually a topic for a managerial accounting discussion. Students, though, need to be aware that managerial and financial accounting do overlap at times. In this illustration, the price set by company officials for this component will affect the specific consolidation procedures needed in the preparation of financial statements for external reporting purposes.

Since Slagle owns 100 percent of Harrison’s common stock, consolidated net income will not be altered by the transfer pricing decision. All intercompany transactions as well as unrealized profits will be eliminated entirely. However, because the sales are upstream, if a noncontrolling interest had been present, the portion of the subsidiary’s income attributed to these outside owners would be influenced by the markup. Both the noncontrolling interest figure on the balance sheet and on the income statement are impacted by the amount of profits that remain unrealized when transactions are from subsidiary to parent.

To the accountant, the easiest approach is to set the transfer price at the seller’s cost ($70.00 in this case). No intercompany profits are created and the consolidation process is less complicated. However, as indicated in the narrative, that price may penalize the seller since no profits are recognized by that profit center. In addition, the buyer will then show artificially inflated income. Thus, some amount of profit is usually built into transfer pricing decisions. Those students who have already completed cost/managerial accounting can be asked to describe the various factors that should influence the establishment of this price. Interaction between accounting courses is beneficial to the students.

 

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Answers to Questions

One reason for the significant volume and frequency of intercompany transfers is that many business combinations are specifically organized so that the companies can provide products for each other. This design is intended to benefit the business combination as a whole because of the economies provided by vertical integration. In effect, more profit can often be generated by the combination if one member is able to buy from another rather than from an outside party.

The sales between Barker and Walden totaled $100,000. Regardless of the ownership percentage or the markup, the $100,000 was simply an intercompany asset transfer. Thus, within the consolidation process, the entire $100,000 should be eliminated from both the Sales and the Purchases (Inventory) accounts.

3.	Sales price per unit ($900,000 ÷ 3,000 units)	$   300
	Number of units in Safeco’s ending inventory		× 500
	Intercompany inventory at transfer price	$150,000
	Gross profit rate (.6 ÷ 1.6)		.375
	Intercompany profit in ending inventory	$56,250

In intercompany transactions, a transfer price is often established that exceeds the cost of the inventory. Hence, the seller is recording a gross profit on its books that, from the perspective of the business combination as a whole, remains unrealized until the asset is consumed or sold to an outside party. Any unrealized gross profit on merchandise still held by the buyer must be eliminated whenever consolidated financial statements are produced. For the year of transfer, this consolidation procedure is carried out by removing the unrealized gross profit from the inventory account on the balance sheet and from the ending inventory balance within cost of goods sold. In the year following the transfer (if the goods are resold or consumed), the unrealized gross profit must again be eliminated within the consolidation process. This second reduction is made on the worksheet to the beginning inventory component of cost of goods sold as well as to the beginning retained earnings balance of the original seller. The gross profit is then moved into the year of realization. If the transfer was downstream in direction and the parent company has applied the equity method, the adjustment in the subsequent year must be made to the equity in subsidiary earnings account rather than to retained earnings.

On the individual financial records of James, Inc., a gross profit is recorded in the year of transfer. From the viewpoint of the business combination, this gross profit is actually earned in the period in which the products are sold or consumed by Matthews Co. An initial consolidation entry must be made in the year of transfer to defer any gross profit that remains unrealized. A second entry must be made in the following time period to allow the gross profit to be recognized in the year of its ultimate realization.

Currently, no official accounting pronouncement answers the question as to the relationship between unrealized intercompany profits and noncontrolling interest values, although the issue has been under study by the FASB. This textbook reasons that unrealized profits relate to the seller and to the computation of the seller’s income. Therefore, any unrealized profits created by upstream transfers (from subsidiary to parent) are attributed to the subsidiary. The effects resulting from the deferral and eventual recognition of these intercompany profits are considered to have an impact on the calculation of noncontrolling interest balances. In contrast, unrealized profits from downstream transfers are viewed as relating solely to the parent (as the seller) and, thus, have no effect on the noncontrolling interest.

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The basic consolidation process does not differ between downstream and upstream transfers. Sales and purchases (Inventory) balances created by the transactions must be eliminated in total. Any unrealized gross profits remaining at the end of a fiscal period are deferred until ultimately earned through sale or consumption of the assets.

The direction of intercompany transfers (upstream versus downstream) does have one effect on consolidated financial statements. In computing noncontrolling interest balances (if present), the deferral of unrealized gross profits on upstream sales is taken into account. Downstream sales, however, are attributed to the parent and are viewed as having no impact on the outside interest.

The computation of this noncontrolling interest balance is dependent on the direction of the intercompany transactions that is not indicated in this question. If the unrealized gross profits were created by downstream sales from King to Pawn, they relate only to King. The noncontrolling interest in the subsidiary’s net income is not affected and would be $11,000 ($110,000 × 10%). In contrast, if the transfers were upstream from Pawn to King, the deferral and recognition of the profits are attributed to Pawn. Pawn’s “realized” income would be

$80,000 and the noncontrolling interest’s share of the subsidiary’s income is reported as

$8,000:
Pawn’s reported income ………………………………………….	$110,000
Recognition of prior year unrealized gross profit ………..	30,000
Deferral of current year unrealized gross profit ………….	(60,000)
Pawn’s realized income …………………………………………..	$80,000
Outside ownership percentage ………………………………..	10%
Noncontrolling interest in subsidiary’s income …………….	$ 8,000

The deferral and subsequent recognition of intercompany profits are allocated to the noncontrolling interest in the same periods as the parent. When one affiliate sells to another affiliate, ownership does not change and therefore the underlying profit is deferred. When the purchasing affiliate subsequently sells the inventory to an entity outside the affiliated group, ownership changes, and the profit may be recognized. Intercompany profits are not really eliminated, but simply deferred until a sale to an outsider takes place.

Several differences can be cited that exist between the consolidated process applicable to inventory transfers and that which is appropriate for land transfers. The total intercompany Sales balance is offset against Purchases (Inventory) when inventory is transferred but no corresponding entry is needed when land is involved. Furthermore, in the year of the sale, ending unrealized inventory gross profits are eliminated through an adjustment to cost of goods sold but a specific gross profit account exists (and must be removed) when land has been sold. Finally, unrealized inventory gross profits are usually expected to be realized in the year following the transfer. This effect is mirrored in that period by reduction of the beginning inventory figure (within cost of goods sold). For land transfers, however, the unrealized gain must be repeatedly deferred in each fiscal period for as long as the land continues to be held within the business combination.

As long as the land is held by the parent, its recorded value must be reduced to historical cost within each consolidated set of financial statements. In the year of the original transfer, the asset reduction is offset against the subsidiary’s recorded gain. For all subsequent years in which the property is held, the credit to the Land account is made against the beginning retained earnings balance of the subsidiary (since the unrealized gain will have been closed into that account).

 

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According to this question, the land is eventually sold to an outside party. The intercompany gain (which has been deferred in each of the previous years) is realized by the sale and should be recognized in the consolidated statements of this later period.

Because the transfer was upstream from subsidiary to parent, the above consolidated entries will also affect any noncontrolling interest balances being reported. Because of the deferral of the intercompany gross profit, the realized income balances applicable to the subsidiary will be less than the reported values. In the year of resale, however, the realized income for consolidation purposes is higher than reported. All noncontrolling interest totals are computed on the realized balances rather than the reported figures.

Depreciable assets are often transferred between the members of a business combination at amounts in excess of book value. The buyer will then compute depreciation expense based on this inflated transfer price rather than on an historical cost basis. From the perspective of the business combination, depreciation should be calculated solely on historical cost figures. Thus, within the consolidation process for each period, adjustment of the depreciation (that is recorded by the buyer) is necessary to reduce the expense to a cost-based figure.

From the viewpoint of the business combination, an unrealized gain has been created by the intercompany transfer and must be eliminated whenever consolidated financial statements are produced. This unrealized gain is closed by the seller into retained earnings necessitating subsequent reductions to that account. In the individual financial records, however, another income effect is created which gradually reduces the overstatement of retained earnings each period. The asset will be depreciated by the buyer based on the inflated transfer price. The resulting expense will be higher than the amount appropriate to the historical cost of the item. Because this excess depreciation is closed into retained earnings annually, the overstatement of the equity account is gradually reduced to a zero balance over the life of the asset.

 

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Answers to Problems

C

B Inventory remaining $100,000 × 50% = $50,000 Unrealized gross profit (based on Lee’s markup as the seller) $50,000 × 40% = $20,000. The ownership percentage has no impact on this computation.

A

C  UNREALIZED GROSS PROFIT, 12/31/09

Intercompany Gross profit ($100,000 – $75,000) ……………………..	$25,000
Inventory Remaining at Year’s End ……………………………………….		16%
Unrealized Intercompany Gross profit, 12/31/09 ……………………..	$4,000
UNREALIZED GROSS PROFIT, 12/31/10
Intercompany Gross profit ($120,000 – $96,000) ……………………..	$24,000
Inventory Remaining at Year’s End ……………………………………….		35%
Unrealized Intercompany Gross profit, 12/31/10 ……………………..	$8,400
CONSOLIDATED COST OF GOODS SOLD
Parent balance ………………………………………………………………..	$380,000
Subsidiary Balance ………………………………………………………….	210,000
Remove Intercompany Transfer ……………………………………….	(120,000)
Recognize 2009 Deferred Gross profit ………………………………	(4,000)
Defer 2010 Unrealized Gross profit …………………………………..		8,400
Cost of Goods Sold ……………………………………………………………..	$474,400

A Intercompany sales and purchases of $100,000 must be eliminated. Additionally, an unrealized gross profit of $10,000 must be removed from ending inventory based on a markup of 25 percent ($200,000 gross profit/$800,000 sales) which is multiplied by the $40,000 ending balance. This deferral increases cost of goods sold because ending inventory is a negative component of that computation. Thus, cost of goods sold for consolidation purposes is $690,000 ($600,000 + $180,000 – $100,000 + $10,000).

C The only change here from Problem 5 is the markup percentage which would now be 40 percent ($120,000 gross profit ÷ $300,000 sales). Thus, the unrealized gross profit to be deferred is $16,000 ($40,000 × 40%). Consequently, consolidated cost of goods sold is $696,000 ($600,000 + $180,000 – $100,000 + $16,000).

 

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7.  B  UNREALIZED GROSS PROFIT, 12/31/09
Ending inventory …………………………………………………………….	$40,000
Markup ($33,000/$110,000) ……………………………………………….		30%
Unrealized intercompany gross profit, 12/31/09 …………………	$12,000
UNREALIZED GROSS PROFIT, 12/31/10
Ending inventory …………………………………………………………….	$50,000
Markup ($48,000/$120,000) ……………………………………………….	40%
Unrealized intercompany gross profit, 12/31/10 …………………	$20,000
NONCONTROLLING INTEREST IN SUBSIDIARY’S INCOME
Reported income for 2010 ………………………………………………..	$90,000
Realized gross profit deferred in 2009 ………………………………	12,000
Deferral of 2010 unrealized gross profit …………………………….	(20,000)
Realized income of subsidiary …………………………………………	$82,000
Outside ownership ………………………………………………………….	10%
Noncontrolling interest ……………………………………………………	$8,200

8.  A Individual Records after Transfer

12/31/09

Machinery—$40,000

Gain—$10,000

Depreciation expense $8,000 ($40,000/5 years)

Income effect net—$2,000 ($10,000 – $8,000)

12/31/10

Depreciation expense—$8,000

Consolidated Figures—Historical Cost

12/31/09

Machinery—$30,000

Depreciation expense—$6,000 ($30,000/5 years)

12/31/10

Depreciation expense–$6,000

Adjustments for Consolidation Purposes:

2009: $2,000 income is reduced to a $6,000 expense (income is reduced by $8,000)

2010: $8,000 expense is reduced to a $6,000 expense (income is increased by $2,000)

 

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9.  B  UNREALIZED GAIN
Transfer Price …………………………………………………………………	$280,000
Book Value (cost after two years of depreciation) ……………..		240,000
Unrealized Gain ………………………………………………………………	$40,000
EXCESS DEPRECIATION
Annual Depreciation Based on Cost ($300,000/10 years) …….	$30,000
Annual Depreciation Based on Transfer Price
($280,000/8 years) ……………………………………………………….	35,000
Excess Depreciation ………………………………………………………..	$5,000
ADJUSTMENTS TO CONSOLIDATED NET INCOME
Defer Unrealized Gain ……………………………………………………..	$(40,000)
Remove Excess Depreciation …………………………………………..	5,000
Decrease to Consolidated Net Income ………………………………	$(35,000)

10. D Add the two book values and remove $100,000 intercompany transfers.

11. CIntercompany gross profit ($100,000 – $80,000)………………………$20,000Inventory remaining at year’s end …………………………………………60%Unrealized intercompany gross profit ……………………………………$12,000CONSOLIDATED COST OF GOODS SOLDParent balance ………………………………………………………………..$140,000Subsidiary balance ………………………………………………………….80,000

Remove intercompany transfer ………………………………………..

(100,000)

Defer unrealized gross profit (above) ……………………………….12,000Cost of goods sold ………………………………………………………………$132,00012. CConsideration transferred  ……………………….$260,000Noncontrolling interest fair value ………………65,000Suarez total fair value ……………………………….$325,000Book value of net assets …………………………..(250,000)Excess fair over book value$75,000

							Annual Excess
						Life	Amortizations

Excess fair value assigned to undervalued assets:

	Equipment …………………………………………..	25,000	5 years		$5,000
	Secret Formulas …………………………………	$50,000	20 years	2,500

Total  ………………………………………………………-0-$7,500

Consolidated Expenses = $37,500 (add the two book values and include current year amortization expense)

 

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13. A 20% of the beginning book value	$50,000
Excess fair value allocation (20%× $75,000)	15,000
20% share of Suarez net income
adjusted for amortization (20% × [110,000 – 7,500])		20,500
Ending noncontrolling interest balance	$85,500

C Add the two book values plus the original allocation ($25,000) less one year of excess amortization expense ($5,000).

B Add the two book values less the ending unrealized gross profit of $12,000.

Intercompany Gross profit ($100,000 – $80,000) ……………………..	$20,000
Inventory Remaining at Year’s End ……………………………………….		60%
Unrealized Intercompany Gross profit, 12/31 …………………………	$12,000

(15 Minutes) (Determine selected consolidated balances; includes inventory transfers and an outside ownership.)

Customer list amortization = $65,000/5 years = $13,000 per year

Intercompany Gross profit ($160,000 – $120,000) ……………………	$40,000
Inventory Remaining at Year’s End ………………………………………..		20%
Unrealized Intercompany Gross profit, 12/31 …………………………	$8,000

CONSOLIDATED TOTALS

Inventory = $592,000 (add the two book values and subtract the ending unrealized gross profit of $8,000)

Sales = $1,240,000 (add the two book values and subtract the $160,000 intercompany transfer)

Cost of Goods Sold = $548,000 (add the two book values and subtract the intercompany transfer and add [to defer] ending unrealized gross profit)

Operating Expenses = $443,000 (add the two book values and the amortization expense for the period)

Noncontrolling Interest in Subsidiary’s Net Income = $8,700 (30 percent of the reported income after subtracting 13,000 excess fair value amortization and deferring $8,000 ending unrealized gross profit) Gross profit is included in this computation because the transfer was upstream from Sanchez to Preston.

 

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(60 minutes) (Downstream intercompany profit adjustments when parent uses equity method and a noncontrolling interest is present)

Consideration transferred by Corgan	$980,000
Noncontrolling interest fair value	245,000
Smashing’s acquisition-date fair value	1,225,000
Book value of subsidiary	950,000
Excess fair over book value	275,000
Excess assigned to covenants	275,000
Useful life in years		÷ 20
Annual amortization	$13,750

2009 Ending Inventory Profit Deferral

Cost = $100,000 ÷ 1.6 = $62,500

Intercompany Gross profit = $100,000 – $62,500 = $37,500

Ending inventory gross profit = $37,500 × 40% = $15,000

2010 Ending Inventory Profit Deferral

Cost = $120,000 ÷ 1.6 = $75,000

Intercompany Gross profit = $120,000 – $75,000 = $45,000

Ending inventory gross profit = $45,000 × 40% = $18,000

a. Investment account:
Consideration transferred, January 1, 2009	$980,000
Smashing’s 2009 income × 80%	$120,000
Covenant amortization (13,750 × 80%)	(11,000)
Ending inventory profit deferral (100%)	(15,000)
Equity in Smashing’s earnings			94,000
2009 dividends		(28,000)
Investment balance 12/31/09	$1,046,000
Smashing’s 2010 income × 80%	$104,000
Covenants amortization (13,750 × 80%)	(11,000)
Beginning inventory profit recognition	15,000
Ending inventory profit deferral (100%)	(18,000)
Equity in Smashing’s earnings			90,000
2010 dividends		(36,000)
Investment balance 12/31/10	$1,100,000

 

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(continued)

b. 12/31/10 Worksheet Adjustments

*G Equity in earnings of Smashing	15,000
	COGS	15,000
S	Common stock—Smashing	700,000
	Retained earnings—Smashing	365,000
	Investment in Smashing	852,000
	Noncontrolling interest	213,000
A	Covenants	261,250
	Investment in Smashing	209,000
	Noncontrolling interest	52,250
I   Equity in earnings of Smashing	75,000
	Investment in Smashing	75,000
D	Investment in Smashing	36,000
	Dividends paid	36,000
E	Amortization expense	13,750
	Covenants	13,750
TI	Sales	120,000
	COGS	120,000
G	COGS	18,000
	Inventory	18,000

(40 Minutes) (Series of independent questions concerning various aspects of the consolidation process when intercompany transfers have occurred)

a.  2009 Unrealized gross profit to be recognized in 2010

Total interco. gross profit on transfers ($90,000 – $54,000) ..	$36,000
Inventory retained at end of 2009 ……………………………………..		20%
Unrealized gross profit—12/31/09 ………………………………..	$7,200
2010 Unrealized Gross profit Deferred
Total interco. gross profit on transfers ($120,000 – $66,000)	$54,000
Inventory retained at end of 2010 ……………………………………..		30%
Unrealized gross profit—12/31/10 …………………………………	$16,200
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18. a. (continued)
Noncontrolling Interest’s Share of Kane’s Income
Kane’s reported income 2010 ……………………………………………	$110,000
Amortization of excess fair value to intangibles …………………	(5,000)
2009 gross profit realized in 2010 (upstream sales) ……………	7,200
2010 gross profit deferred (upstream sales) ………………………	(16,200)
Kane’s realized income ……………………………………………………	$96,000
Noncontrolling interest ownership …………………………………..	20%
Noncontrolling Interest’s Share of Kane’s Income ………………	$19,200
b.  Inventory—Smith book value …………………………………………..	$140,000
Inventory—Kane book value …………………………………………….	90,000
Unrealized gross profit, 12/31/10 (see part a) …………………….	(16,200)
Consolidated Inventory ……………………………………………………	$213,800
(Direction of transfer has no impact here)
c.  Downstream transfers do not affect the noncontrolling interest.
Kane’s reported income—2010  ………………………………………..	$110,000
Noncontrolling interest ownership  ………………………………….		20%
Noncontrolling Interest’s Share of Kane’s Income ………………	$22,000
d.  Smith’s reported income 2010 …………………………………………..	$300,000
Elimination of intercompany dividend income recorded
by parent ($40,000 × 80%) ……………………………………………	(32,000)
Kane’s reported income 2010 …………………………………………..	110,000
Amortization expense (given)  ………………………………………….	(5,000)
Realization of 2009 intercompany gross profit (see part a)  ..	7,200
Deferral of 2010 intercompany gross profit (see part a) ……..	(16,200)
Consolidated net income ………………………………………………….	$364,000

Because the parent applies the partial equity method, its retained earnings balance does not reflect the consolidated balance. Excess amortization and the effect of the unrealized gain at that date must be taken into account to arrive at a consolidated total.

Smith’s retained earnings, December 31, 2010 (given)  ………	$600,000
Excess amortizations 2009–2010 ($5,000× 2) …………………….	(10,000)
Deferral of parent’s 12/31/10 interco. gross profit (part a) ……	(16,200)
Consolidated Retained Earnings 12/31/10  ………………………..	$573,800

 

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(continued)

Because the parent applies the partial equity method, its retained earnings balance does not equal the consolidated balance. Excess amortizations must be taken into account to arrive at a consolidated total. In addition, because the intercompany transfer was upstream, the parent’s equity accrual did not reflect the intercompany profit deferral . Income recognition would have been based on the subsidiary’s reported figures rather than its realized income. The parent would have included the $16,200 ending unrealized gross profit in the subsidiary’s income in computing the annual equity accrual. Hence, that portion of the accrual (80% of $16,200 or $12,960) is overstated, causing the parent’s retained earnings to be too high by that amount; reduction is necessary to arrive at the consolidated balance.

The adjustment caused by the intercompany transfer can be computed in a second manner. The entire $16,200 unrealized gross profit will be deferred on the consolidated statements. However, because the transfer was upstream, the portion of the subsidiary’s income assigned to the outside owners will be reduced by 20 percent of that deferral or $3,240. The net effect on consolidated net income (and, hence, on the ending retained earnings balance) is $12,960.

Smith’s retained earnings, December 31, 2010 (given) ………..	$600,000
Excess Amortizations, 2009–2010 ($5,000 × 2) …………………..	(10,000)
Reduction of equity accrual because of subsidiary’s unrealized
gross profit (explained above) ……………………………………….	(12,960)
CONSOLIDATED RETAINED EARNINGS, 12/31/10 ……………..	$577,040
g.  Land—Smith’s book value ……………………………………………….	$600,000
Land—Kane’s book value ………………………………………………..	200,000
Elimination of unrealized gain on intercompany land ………..	(20,000)
CONSOLIDATED LAND ACCOUNT ……………………………………	$780,000

 

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(continued)

The intercompany transfer was upstream from Kane to Smith. Because the transfer occurred in 2009, beginning retained earnings of the seller for 2010 contains the remaining portion of the unrealized gain.

Transfer Pricing Figures
2009	Equipment	=	$80,000
	Gain	=	$20,000 ($80,000 – $60,000)
	Depreciation expense	=  $16,000 ($80,000/5)
	Income effect	=	$4,000 ($20,000 – $16,000)
	Accumulated depreciation	=	$16,000
2010	Depreciation expense	=	$16,000
	Accumulated depreciation	=	$32,000
Historical Cost Figures
2009	Equipment	=	$100,000
	Depreciation expense	=	$12,000 ($60,000/5 years)
	Accumulated depreciation	=	$52,000 ($40,000 + $12,000)
2010	Depreciation expense	=	$12,000
	Accumulated depreciation	=	$64,000

CONSOLIDATION ENTRIES FOR TRANSFERRED EQUIPMENT

ENTRY *TA
Retained Earnings, 1/1/10 (Kane) ……………………….	16,000
Equipment ($100,000 – $80,000) …………………………	20,000
Accumulated Depreciation ($52,000 – $16,000) .	36,000

To change beginning of year figures to historical cost by removing impact of 2009 transactions. Retained earnings reduction removes $4,000 income effect (above) and replaces it with $12,000 depreciation expense for 2009.

ENTRY ED
Accumulated Depreciation ………………………………..	4,000
Depreciation Expense ………………………………….	4,000

To reduce depreciation from transfer price figure ($16,000) to historical cost of $12,000.

This intercompany transfer was upstream from Kane to Smith. Thus, income effects are assumed to relate to the original seller (Kane). Because the sale occurred in 2009, the only effect in 2010 relates to depreciation expense. The expense based on the transfer price is $4,000 higher than the amount based on the historical cost. As an upstream transfer, this adjustment affects Kane and the noncontrolling interest computations.

Transfer price depreciation: $80,000/5 yrs. = $16,000

 

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Historical cost depreciation (based on book value): $60,000/5 yrs. = $12,000

18. (continued)
Noncontrolling Interest in Kane’s Income
Kane’s reported income less excess amortization ………………	$105,000
Reduction of depreciation expense to historical cost figure…		4,000
Kane’s realized income ……………………………………………………..	$109,000
Outside ownership percentage ………………………………………….		20%
Noncontrolling interest in Kane’s income ……………………..	$21,800

(20 Minutes) (Consolidation entries and noncontrolling interest balances affected by inventory transfers.)

Conversion from Markup on Cost to Gross Profit Rate

Markup (given as a percentage of cost) …………………………….	25%
Convert to gross profit rate [.25 ÷ (1.00 + 0.25)] ………………….
		20%
Noncontrolling Interest’s Share of Subsidiary’s Income
Reported income of subsidiary—2010 ……………………………….	$160,000
2009 intercompany gross profit realized in 2010
($250,000 × 30% × 20%) ………………………………………………..	15,000
2010 intercompany gross profit deferred
($300,000 × 30% × 20%) ………………………………………………..	(18,000)
Realized income of subsidiary—2010 …………………………..	$157,000
Outside ownership ………………………………………………………….	40%
Noncontrolling interest’s share of subsidiary’s income …	$62,800
b.  Entry *G
Retained Earnings, Jan. 1 (subsidiary) ……..	15,000
Cost of Goods Sold ……………………………		15,000
To remove intercompany gross profit from previous year so that it can be
recognized in current year.
Entry Tl
Sales ……………………………………………………….	300,000
Cost of Goods Sold (purchases) …………		300,000
To eliminate intercompany inventory sale and purchase.
Entry G
Cost of Goods Sold …………………………………	18,000
Inventory ……………………………………………		18,000

To remove effects of current year unrealized gross profit.

 

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(30 Minutes) (Compute selected balances based on three different intercompany asset transfer scenarios)

a.  Consolidated Cost of Goods Sold
Penguin’s cost of goods sold …………………………………………..	$290,000
Snow’s cost of goods sold ………………………………………………	197,000
Elimination of 2010 intercompany transfers ………………………	(110,000)
Reduction of beginning Inventory because of
2009 unrealized gross profit ($28,000/1.4 = $20,000
cost; $28,000 transfer price less $20,000
cost = $8,000 unrealized gross profit) ………………………….	(8,000)
Reduction of ending inventory because of
2010 unrealized gross profit ($42,000/1.4 = $30,000
cost; $42,000 transfer price less $30,000
cost = $12,000 unrealized gross profit) …………………………	12,000
Consolidated cost of goods sold …………………………….	$381,000
Consolidated Inventory
Penguin book value ……………………………………………………	$346,000
Snow book value ………………………………………………………..	110,000
Eliminate ending unrealized gross profit (see above) ……	(12,000)
Consolidated Inventory ……………………………………………….	$444,000

Noncontrolling Interest in Subsidiary’s Net Income

Because all intercompany sales were downstream, the deferrals do not affect Snow. Thus, the noncontrolling interest is 20% of the $58,000 (revenues minus cost of goods sold and expenses) reported income or $11,600.

b.  Consolidated Cost of Goods Sold
Penguin book value …………………………………………………………	$290,000
Snow book value …………………………………………………………….	197,000
Elimination of 2010 intercompany transfers ………………………	(80,000)
Reduction of beginning inventory because of
2009 unrealized gross profit ($21,000/1.4 = $15,000
cost; $21,000 transfer price less $15,000
cost = $6,000 unrealized gross profit) ………………………….	(6,000)
Reduction of ending inventory because of
2010 unrealized gross profit ($35,000/1.4 = $25,000
cost; $35,000 transfer price less $25,000
cost = $10,000 unrealized gross profit) …………………………	10,000
Consolidated cost of goods sold ……………………………………..	$411,000

 

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20. b. (continued)
Consolidated Inventory
Penguin book value …………………………………………………………	$346,000
Snow book value …………………………………………………………….	110,000
Eliminate ending unrealized gross profit (see above) ………..	(10,000)
Consolidated inventory ……………………………………………….	$446,000

Noncontrolling Interest in Subsidiary’s Net income

Since all intercompany sales are upstream, the effect on Snow’s income must be reflected in the noncontrolling interest computation:

Snow reported income …………………………………………………….			$58,000
2009 unrealized gross profit realized in 2010 (above) …………	6,000
2010 unrealized gross profit to be realized in 2011 (above) ..	(10,000)

Snow realized income ……………………………………………………..

			$54,000
Outside ownership percentage ………………………………………..				20%

Noncontrolling interest in Snow’s income ……………………

$10,800

c.  Consolidated Buildings (Net)Penguin’s buildings ……………………………………….

				$358,000
Snow’s buildings ……………………………………………				157,000

Remove write-up created by transfer($80,000 – $50,000) …………………………………….

$(30,000)

Remove excess depreciation created by transfer($30,000 unrealized gain over 5 year life)(2 years) ……………………………………………………

12,000

(18,000)

Consolidated buildings (net) ………………………

$497,000

Consolidated ExpensesPenguin’s book value ……………………………………..

				$150,000
Snow’s book value …………………………………………				105,000
Remove excess depreciation on transferred building
($30,000) unrealized gain/5 years) ……………….				(6,000)

Consolidated expenses …………………………………..

$249,000

 

Noncontrolling Interest in Subsidiary’s Net Income

Because the transfer was made downstream, it has no effect on the noncontrolling interest. Thus, Snow’s reported income ($58,000 computed as revenues minus cost of goods sold and expenses) is used for this computation. The 20 percent outside ownership will be allotted income of $11,600 (20% × $58,000).

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(15 Minutes) (Prepare consolidated income statement with a wholly-owned subsidiary, includes transfers)

In this business combination, the direction of the intercompany transfers (either upstream or downstream) is not important to the consolidated totals. Because Akron controls all of Toledo’s outstanding stock, no noncontrolling interest figures are computed. If present, noncontrolling interest balances are affected by upstream sales but not by downstream.

For purposes of a 2010 consolidation, the following worksheet entries would affect income statement balances:

Entry *G
Retained Earnings, 1/1/10 (seller) ……	17,500
Cost of Goods Sold …………………..	17,500

To remove 2009 unrealized gross profit from beginning account balances. Gross profit is the 25% markup ($80,000 ÷ $320,000) multiplied by remaining inventory ($70,000).

Entry E
Amortization Expense ……………………..	15,000
Patented technology ………………….	15,000
To recognize excess amortization expense for the current period.
Entry Tl
Sales ………………………………………………	320,000
Cost of Goods Sold …………………..	320,000
To eliminate intercompany transfers of inventory during 2010.
Entry G
Cost of Goods Sold ………………………..	12,500
Inventory …………………………………..	12,500

To remove 2010 unrealized gross profit from ending account balances. Gross profit is the 25% markup ($80,000 ÷ $320,000) multiplied by remaining inventory ($50,000).

By including the impact of each of these four consolidation entries, the following income statement can be created from the individual account balances:

AKRON, INC. AND CONSOLIDATED SUBSIDIARY
Income Statement
Year Ending December 31, 2010
Sales …………………………………………………………………………	$1,380,000
Cost of goods sold ……………………………………………………..		575,000
Gross profit …………………………………………………………..	805,000
Operating expenses ……………………………………………………		635,000
Consolidated net income ……………………………………….	$170,000

 

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(60 minutes) (Downstream intercompany asset transfer when parent uses equity method and when a noncontrolling interest is present)

a. Investment account:Consideration paid (fair value) 1/1/09

						$810,000
Netspeed’s reported income for 2009	$80,000
Database amortization	(12,000)

Netspeed’s adjusted net income

	$68,000
Quickport’s ownership percentage	90%

Quickport’s share of Netspeed’s income

	$61,200
Gain on equipment transfer deferral	(3,000)
Depreciation adjustment (6 months)	500
Equity in earnings of Netspeed Company,						$58,700
Quickport’s share of Netspeed’s dividends (90%)						(7,200)

Balance 12/31/09

						$861,500
Netspeed’s reported income for 2010	$115,000
Database amortization	(12,000)

Netspeed’s adjusted 2010 net income

	$103,000
Quickport’s ownership percentage	90%

Quickport’s share of Netspeed income

	$92,700
Depreciation adjustment	1,000
Equity in earnings of Netspeed Company, 2010						$93,700
Quickport’s share of Netspeed’s dividends, 2010 (90%)	(7,200)

Balance 12/31/10

$948,000

b. 12/31/10 Worksheet Adjustments*TA   Equipment6,000Investment in S2,500Accumulated depreciation

8,500

To transfer the unrealized interco. equipment reduction (as of Jan. 1, 2010) from the Investment account to the equipment and A.D. accounts.

S	Common stock—S	800,000
	RE—S	112,000
		Investment in S	820,800
		Noncontrolling interest	91,200
A	Database	48,000
		Investment in S	43,200
		Noncontrolling interest	4,800
I	Equity in earnings of S	93,700
		Investment in S	93,700
D	Investment in S	7,200
		Dividends paid	7,200
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(continued)

E	Amortization expense	12,000
	Database	12,000
ED	Accumulated depreciation	1,000
	Depreciation expense	1,000

Alternative set of equivalent adjustments for part b.

*TA	Equipment	6,000
	Investment in S	1,500
	Accumulated Depreciation	7,500
	To transfer the unrealized intercompany equipment reduction (as of
	Dec. 31, 2010) from the investment account to the equipment and A.D.
	accounts.
*ED	Equity in earnings of S	1,000
	Depreciation expense	1,000
	To transfer the current realized portion of the intercompany
	equipment gain from the Equity in Earnings of S account to increase
	current consolidated income through a reduction in depreciation
	expense.
S	Common stock—S	800,000
	RE—S	112,000
	Investment in S	820,800
	Noncontrolling interest	91,200
A	Database	48,000
	Investment in S	43,200
	Noncontrolling interest	4,800
I	Equity in earnings of S	92,700
	Investment in S	92,700
D	Investment in S	7,200
	Dividends paid	7,200
E	Amortization expense	12,000
	Database	12,000

 

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23. (20 Minutes) (Consolidation entries for intercompany equipment transfer.)

INDIVIDUAL RECORDS BASED ON TRANSFER PRICE 12/31/09

Equipment = $95,000

Gain on transfer = $45,000 ($95,000 – $50,000)

Depreciation expense = $19,000 ($95,000/5 years)

Accumulated depreciation = $19,000

12/31/10

Depreciation expense $19,000

Accumulated depreciation = $38,000 (2 years) 12/31/11

Effect on retained earnings, 1/1/11 = $7,000 credit balance (gain less two years depreciation)

Depreciation expense = $19,000

Accumulated depreciation = $57,000 (3 years)

CONSOLIDATED REPORTING BASED ON HISTORICAL COST 12/31/09

Equipment = $130,000

Depreciation expense = $10,000 ($50,000/5 years)

Accumulated depreciation = $90,000 ($80,000 + $10,000) 12/31/10

Depreciation expense = $10,000

Accumulated depreciation = $100,000 ($90,000 + $10,000) 12/31/11

Effect on retained earnings, 1/1/11 = ($20,000) (two years depreciation)

Depreciation expense = $10,000

Accumulated depreciation = $110,000 ($100,000 + $10,000)

Entry *TA
	Retained earnings, 1/1/11 (Padre) ………………….	27,000
	Equipment ($130,000 – $95,000) …………………….	35,000
		Accumulated depreciation ($100,000 – $38,000)	62,000
	To adjust beginning-of-year amounts to balances for consolidated
	entity. Retained earnings adjustment reduces $7,000 credit balance to
	$20,000 debit balance as computed above.
Entry ED
	Accumulated Depreciation …………………………….	9,000
		Depreciation Expense ……………………………..	9,000
	To remove excess depreciation for current year to reflect an
	allocation of the historical cost ($10,000) rather than the transfer price
	($19,000).
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(20 Minutes) (Determine consolidated net income when an intercompany transfer of equipment occurs. Includes an outside ownership)

a.  Income—Slaughter ………………………………………………………….			$220,000
Income—Bennett ……………………………………………………………..			90,000
Excess amortization for unpatented technology ………………..			(8,000)
Remove unrealized gain on equipment …………………………….			(50,000)

($120,000 – $70,000)Remove excess depreciation created byinflated transfer price ($50,000 ÷ 5) ………………………………

				10,000
Consolidated net income …………………………………………………			$262,000

b.  Income calculated in (part a.) …………………………………………..

$262,000

Noncontrolling interest in Bennett’s incomeIncome—Bennett ………………………………………….

	$90,000
Excess amortization ……………………………………..	(8,000)

Adjusted net income …………………………………….

	$82,000
Noncontrolling interest in Bennett’s income (10%) ………..	(8,200)

Consolidated net income to parent company …………………….

			$253,800
c.  Income calculated in (part a.) …………………………………………..			$262,000
Noncontrolling interest in Bennett’s income (see Schedule 1)		(4,200)
Consolidated net income to parent company …………………….			$257,800

 

Schedule 1: Noncontrolling Interest in Bennett’s Income (includes upstream transfer)

Reported net income of subsidiary …………………………………..	$90,000
Excess amortization …………………………………………………………	(8,000)
Eliminate unrealized gain on equipment transfer ………………	(50,000)
Eliminate excess depreciation ($50,000 ÷ 5) ………………………	10,000
Bennett’s realized net income ………………………………………….	$42,000
Outside ownership ………………………………………………………….		10%
Noncontrolling interest in subsidiary’s income …………….	$ 4,200
d.  Net income 2010—Slaughter ……………………………………………	$240,000
Net income 2010—Bennett ……………………………………………….	100,000
Excess amortization …………………………………………………………	(8,000)
Eliminate excess depreciation stemming from transfer
($50,000 ÷ 5) (year after transfer) ………………………………….		10,000
Consolidated net income …………………………………………	$342,000

 

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(35 minutes) (Compute consolidated totals with transfers of both inventory and a building.)

Excess Amortization Expenses
Equipment $60,000 ÷ 10 years =	$6,000	per year
Franchises $80,000 ÷ 20 years =	$4,000	per year
Annual excess amortizations	$10,000

Unrealized Gross profit—Inventory, 1/1/11
Markup ($70,000 – $49,000) ………………………………………………	$21,000
Markup percentage ($21,000 ÷ $70,000) …………………………….	30%
Remaining inventory ……………………………………………………….	$30,000
Markup percentage ………………………………………………………….		30%
Unrealized gross profit, 1/1/11 …………………………………………..	$9,000
Unrealized Gross profit—Inventory, 12/31/11
Markup ($100,000 – $50,000) …………………………………………….	$50,000
Markup percentage ($50,000 ÷ $100,000) …………………………..	50%
Remaining inventory ……………………………………………………….	$40,000
Markup percentage ………………………………………………………….		50%
Unrealized gross profit, 12/31/11 ………………………………………	$20,000
Impact of intercompany Building Transfer
12/31/10—Transfer price figures
Transfer price …………………………………………………………….	$50,000
Gain on transfer ($50,000 – $30,000) …………………………….	20,000
Depreciation expense ($50,000 ÷ 5) ……………………………..	10,000
Accumulated depreciation …………………………………………..	10,000
12/31/11—Transfer price figures
Depreciation expense …………………………………………………	10,000
Accumulated depreciation …………………………………………..	20,000
12/31/10—Historical cost figures
Historical cost ……………………………………………………………	$70,000
Depreciation expense ($30,000 book value ÷ 5 years) ……	6,000
Accumulated depreciation ($40,000 + $6,000) ……………….	46,000
12/31/11—Historical cost figures
Depreciation expense …………………………………………………	6,000
Accumulated depreciation …………………………………………..	52,000

 

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(continued)

CONSOLIDATED BALANCES

Sales = $1,000,000 (add the two book values and subtract $100,000 in intercom-pany transfers)

Cost of Goods Sold = $571,000 (add the two book values and subtract $100,000 in intercompany purchases. Subtract $9,000 because of the previous year unrealized gross profit and add $20,000 to defer the current year unrealized gross profit.)

Operating Expenses = $206,000 (add the two book values and include the $10,000 excess amortization expenses but remove the $4,000 in excess depreciation expense [$10,000 – $6,000] created by building transfer)

Investment Income = $0 (the intercompany balance is removed so that the individual revenue and expense accounts of the subsidiary can be shown)

Inventory = $280,000 (add the two book values and subtract the $20,000 ending unrealized gross profit)

Equipment (net) = $292,000 (add the two book values and include the $60,000 allocation from the acquisition-date fair value less three years of excess amortizations)

Buildings (net) = $528,000 (add the two book values and subtract the $20,000 unrealized gain on the transfer after two years of excess depreciation [$4,000 per year])

 

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(35 Minutes) (Prepare consolidation entries for a business combination with intercompany inventory and equipment transfers; includes an outside ownership.)

a.  Entry *G
Retained Earnings, 1/1/11 (Sledge) …………..	2,000
Cost of Goods Sold ……………………………	2,000

To remove unrealized gross profit from beginning account balances. This is the 40% markup ($6,000/$15,000) multiplied by remaining inventory ($5,000).

Entry *TA
Equipment ………………………………………………	4,000
Investment in Sledge ………………………………	2,400
Accumulated Depreciation ………………….	6,400

To adjust the equipment balance to original cost ($16,000) and to adjust accumulated depreciation to the correct consolidated January 1, 2011 balance ($7,000 less $600 extra depreciation in 2010). The net reduction to the reported equipment balance (cost less A.D. = $2,400) equals the amount of unrealized gain at January 1, 2011. The $2,400 debit to the Investment account appropriately transfers the reduction in the net book value of the transferred equipment to the subsidiary’s accounts. The Investment account was reduced by $3,000 in 2010 for the original intercompany gain and increased by $600 in 2010 for the extra depreciation ($3,000 gain/5 years) through application of the equity method. Entry ED (below) completes the adjustment of A.D. and depreciation expense to their correct December 31, 2011 balances.

Entry S
Common Stock (Sledge) ……………………………………	120,000
Retained Earnings, 1/1/11 (adjusted) (Sledge) ……..	258,000
	Investment in Sledge (80%) …………………………..	302,400
	Noncontrolling interest in Sledge, 1/1/11 (20%) .	75,600
To eliminate subsidiary’s stockholders’ equity accounts (after adjustment
for Entry *G) and recognize noncontrolling interest balance as of January
1, 2011.
Entry A
Contracts ($60,000 – $3,000 for 2 years)	……………..	54,000
Buildings ($20,000 – $2,000 for 2 years)	……………..	16,000
	Investment in Sledge (80%) ……………………………	56,000
	Noncontrolling interest in Sledge, 1/1/11 (20%) .	14,000
To recognize acquisition-date fair value allocations adjusted for 2 years
of amortization (2009 and 2010).
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26. (continued)
Entry I
Equity Income of Subsidiary ……………………………..	10,600
Investment in Sledge ……………………………………	10,600

To remove intercompany income accrual recorded by parent using full equity method (80% of $17,500 realized income [see Part b] less $5,000 in excess amortizations for the year [see Entry E] plus $600 removal of excess depreciation from 2010 intercompany equipment transfer).

Entry E
Depreciation Expense ………………………………………..	2,000
Amortization Expense ………………………………………..	3,000
Contracts ($60,000 ÷ 20 years) ………………………	3,000
Buildings ($20,000 ÷ 10 years) ………………………	2,000

To record excess amortizations for 2011 based on allocations and useful lives.

Entry TI
Sales …………………………………………………………………	20,000
Cost of Goods Sold ……………………………………..	20,000
To eliminate intercompany inventory transfers during 2011.
Entry G
Cost of Goods Sold …………………………………………..	4,500
Inventory ……………………………………………………..	4,500

To remove unrealized gross profit from ending account balances. The gross profit is the 45% markup ($9,000 ÷ $20,000) multiplied by remaining inventory ($10,000).

Entry ED
Accumulated Depreciation ………………………………..	600
Depreciation Expense …………………………………..	600

To eliminate excess depreciation on equipment recorded at transfer price. Expense is being reduced from the recorded amount ($2,400 or $12,000 ÷ 5) to historical cost figure ($1,800 or $9,000 ÷ 5).

 

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(continued)

b.  Noncontrolling Interest in the Subsidiary’s Income 2011

Revenues ………………………………………………………………………..	$130,000
Cost of goods sold ………………………………………………………….	(70,000)
Other expenses ……………………………………………………………….	(40,000)
Excess acquisition-date fair value amortization …………………	(5,000)
Income adjusted for amortization ………………………………..	$15,000
Gross profit on 2010 upstream inventory transfer
realized in 2011 (Entry *G) ………………………………………….	2,000
Gross profit on 2011 upstream inventory transfer
deferred until 2012 (Entry G) ……………………………………….	(4,500)
Realized income of subsidiary—2011 ………………………………..	$12,500
Outside ownership ………………………………………………………….		20%
Noncontrolling interest in subsidiary’s net income ……….	$2,500

(65 Minutes) (Determine consolidation totals after answering a series of questions about combination and intercompany inventory transfers)

a.  Consideration transferred  …………………..

$342,000

Noncontrolling interest fair value ………….38,000Subsidiary fair value at acquisition-date

	380,000
Book value ………………………………………….	(326,000)

Fair value in excess of book value ……….

	$54,000		Annual Excess
Excess fair value assignments					Life	Amortizations
To building …………………………………….	18,000		9 yrs.	$2,000
To patented technology ………………….		36,000		6 yrs.		6,000

Totals …………………………………………….

-0-

$8,000

 

b.  Because Brey sold inventory to Petino, the transfers are upstream.

c.  Gross profit on 2010 transfers ($135,000 – $81,000) …………..	$54,000
Gross profit percentage ($54,000 ÷ $135,000) …………………….	40%
Inventory remaining, 12/31/10  ………………………………………….	$37,500
Gross profit percentage …………………………………………………..		40%
Unrealized gross profit, January 1, 2011  ………………………….	$15,000
d.  Gross profit on 2011	transfers ($160,000 – $92,800) ………….	$67,200
Gross profit percentage ($67,200 ÷ $160,000) …………………….	42%
Inventory remaining, 12/31/11  ………………………………………….	$50,000
Gross profit percentage …………………………………………………..		42%
Unrealized gross profit, December 31, 2011 ………………………	$21,000
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(continued)

Petino is applying the equity method because the $68,400 equals neither 90% of Brey’s reported Income nor 90% of the dividends paid by Brey.

Brey’s reported income ……………………………………………………					$90,000
Excess fair value amortization…………………………………………..					(8,000)
Realized gross profit  ………………………………………………………					15,000
Deferred gross profit ………………………………………………………..					(21,000)

Adjusted subsidiary income ……………………………………………..

					$76,000
Ownership ………………………………………………………………………						90%

Investment income—Brey ………………………………………………..

$68,400

f.  Brey’s adjusted income (see e.) ……………………………………….

					$76,000
Outside ownership ………………………………………………………….						10%

Noncontrolling interest in subsidiary’s net income

……………

$7,600

g.  Investment in Brey (initial value) ………………………………………

$342,000

Income of BreyReported 2009…………………………………$64,0002010 ………………………………………….80,0002011  …………………………………………90,000Total …………………………………………234,000Unrealized gross profit, 12/31/11(see d.)

(21,000)

Realized income 2009-2011  ……………213,000Petino’s ownership ………………………..

	90%	191,700
Excess amortizations ($8,000 × 3 years × 90%)						(21,600)

Dividends paid by Brey2009 ………………………………………….$19,0002010 ………………………………………….23,0002011  …………………………………………27,000Total …………………………………………69,000Pitino’s ownership …………………………

90%

(62,100)

Investment in Brey, 12/31/11  ……………….

$450,000

h.  Entry SCommon Stock (Brey) …………………………150,000Retained Earnings, 1/1/11 (Brey) (reduced by1/1/11 unrealized gross profit) ……………..263,000Investment in Brey (90%) ………………..

						371,700
Noncontrolling Interest in Brey (10%)						41,300

 

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(continued) part i.

Sales Revenues = $1,068,000 (total less $160,000 intercompany sales)

Cost of Goods Sold = $570,000 (add book values less $160,000 in intercompany purchases. Also, adjust for 2010 unrealized gross profit [subtract $15,000] and 2011 unrealized gross profit [add $21,000])

Expenses = $260,400 (add book values with $8,000 amortization for excess fair value allocations)

Investment Income—Brey = $0 (intercompany balance is eliminated to include individual revenue and expense accounts of the subsidiary)

Noncontrolling Interest in Subsidiary’s Net Income = $7,600 (see f.)

Consolidated net income to parent = $230,000 (consolidated revenues less consolidated cost of goods sold, expenses, and the noncontrolling interest’s share of the subsidiary’s income)

Retained Earnings, 1/1 = $488,000 (parent equity method balance)

Dividends Paid = $136,000 (parent balance only)

Retained Earnings, 12/31 = $582,000 (consolidated beginning balance plus net income less dividends paid)

Cash and Receivables = $228,000 (total less $16,000 intercompany balance)

Inventory = $370,000 (total less ending unrealized gross profit)

Investment in Brey = $0 (intercompany balance is eliminated so that the individual assets and liabilities of the subsidiary can be reported)

Land, Buildings, and Equipment = $1,304,000 (add book values and include a $12,000 net allocation after 3 years of amortization)

Patented Technology = $18,000 (original allocation after 3 years of amortization [$6,000 per year])

Total Assets = $1,920,000 (add consolidated figures)

Liabilities = $773,000 (add book values less $16,000 intercompany balance)

Noncontrolling Interest in Brey, 12/31 = $50,000 ([10% of subsidiary’s book value at beginning of period plus unamortized excess less beginning unrealized gross profit] plus 10% of the subsidiary’s realized net income less 10% of subsidiary dividends).

Common Stock = $515,000 (parent balance only)

Retained Earnings, 12/31 = $582,000 (see above)

Total Liabilities and Stockholders’ Equity = $1,920,000 (summation)

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(20 Minutes) (Computation of selected consolidation balances as affected by downstream inventory transfers)

UNREALIZED GROSS PROFIT, 12/31/09: (downstream transfer)
Intercompany gross profit ($120,000 – $72,000) …………………	$48,000
Inventory remaining at year’s end …………………………………….		30%
Unrealized Intercompany Gross profit, 12/31/09 ……………………..	$14,400
UNREALIZED GROSS PROFIT, 12/31/10: (downstream transfer)
Intercompany gross profit ($250,000 – $200,000) ……………….	$50,000
Inventory remaining at year’s end …………………………………….		20%
Unrealized intercompany gross profit, 12/31/10 ……………………..	$10,000

CONSOLIDATED TOTALS

Sales = $1,150,000 (add the two book values and eliminate intercompany sales of $250,000)

Cost of goods sold:

Benson’s book value ……………………………………………………….	$535,000
Broadway’s book value ……………………………………………………	400,000
Eliminate intercompany transfers …………………………………….	(250,000)
Realized gross profit deferred in 2009 ………………………………	(14,400)
Deferral of 2010 unrealized gross profit …………………………….		10,000
Cost of goods sold ……………………………………………………..	$680,600

Operating expenses = $210,000 (add the two book values and include intangible amortization for current year)

Dividend income = -0- (intercompany transfer eliminated in consolidation)

Noncontrolling interest in consolidated income: (impact of transfers is not included because they were downstream)

Broadway reported income for 2010 …………………………….	$100,000
Intangible amortization ………………………………………………..		(10,000)
Broadway adjusted income ………………………………………….	90,000
Outside ownership ……………………………………………………..		30%
Noncontrolling interest in Broadway’s earnings ……….	$27,000

Inventory = $988,000 (add the two book values less the $10,000 ending unrealized gross profit)

Noncontrolling interest in subsidiary, 12/31/10 = $385,500

30% beginning $950,000 book value ……………………………….	$285,000
Excess January 1 intangible allocation (30% × $295,000) …	88,500
Noncontrolling Interest in Broadway’s earnings ……………..	27,000
Dividends (30% × $50,000) ……………………………………………..		(15,000)
Total noncontrolling interest at 12/31/10 …………………………	$385,500

 

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(25 Minutes) (Computation of selected consolidation balances as affected by upstream inventory transfers)

UNREALIZED GROSS PROFIT, 12/31/09: (upstream transfer)
Intercompany gross profit ($120,000 – $72,000) …………………	$48,000
Inventory remaining at year’s end …………………………………….		30%
Unrealized intercompany gross profit, 12/31/09 ……………………..	$14,400
UNREALIZED GROSS PROFIT, 12/31/10: (upstream transfer)
Intercompany gross profit ($250,000 – $200,000) ……………….	$50,000
Inventory remaining at year’s end …………………………………….		20%
Unrealized intercompany gross profit, 12/31/10 ……………………..	$10,000

CONSOLIDATED TOTALS

Sales = $1,150,000 (add the two book values and eliminate the Intercompany transfer)

Cost of goods sold:

Benson’s COGS book value …………………………………………….	$535,000
Broadway’s COGS book value ………………………………………….	400,000
Eliminate intercompany transfers …………………………………….	(250,000)
Realized gross profit deferred in 2009 ………………………………	(14,400)
Deferral of 2010 unrealized gross profit …………………………….		10,000
Consolidated cost of goods sold …………………………………	$680,600

Operating expenses = $210,000 (add the two book values and include intangible amortization for current year)

Dividend income = -0- (interco. transfer eliminated in consolidation)

Noncontrolling interest in consolidated income: (impact of transfers is

included because they were upstream)
Broadway reported income for 2010 …………………………………	$100,000
Intangible amortization ………………………………………………..	(10,000)
2009 gross profit recognized in 2010 ……………………………	14,400
2010 gross profit deferred …………………………………………..	(10,000)
Broadway realized income for 2010 ………………………………	$94,400
Outside ownership ……………………………………………………..		30%
Noncontrolling interest ……………………………………………………	$28,320

Inventory = $988,000 (add the two book values and defer the $10,000 ending unrealized gross profit)

Noncontrolling interest in subsidiary, 12/31/10 = $382,500

30% beginning book value less $14,400
	unrealized gross profit (30% × $935,600) …………………….	$280,680
Excess intangible allocation (30% × $295,000)……………….	(88,500)
Noncontrolling Interest in Broadway’s earnings ……………	28,320
Dividends (30% × $50,000) ……………………………………………	(15,000)
Total noncontrolling interest at 12/31/10	……………………….	$382,500
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(75 Minutes) (Determine consolidated balances after impact of upstream Inventory transfers and downstream transfer of building. Parent uses initial value method.)

PRELIMINARY COMPUTATIONSa.  Consideration transferred  …………………..$657,000Noncontrolling interest fair value ………….73,000Subsidiary fair value at acquisition-date730,000Book value ………………………………………….(620,000)Fair value in excess of book value ……….

	$110,000			Annual Excess
Excess fair value assignments					Life	Amortizations
to equipment…………………………………..	20,000		4 yrs.	$5,000
to liabilities ……………………………………	40,000		5 yrs.	8,000
to brand names ……………………………..		50,000		10 yrs.		5,000
Totals …………………………………………….	-0-			$18,000

Determination of Subsidiary Book Value on 1/1/09Book Value, 1/1/10 (based on stockholders’ equity accounts)

	$700,000
Eliminate Net Income – 2009 …………………………………………….					(80,000)
Eliminate Dividends – 2009 ………………………………………………						-0-
Book Value, 1/1/09 ………………………………………………………					$620,000
Beginning inventory unrealized gross profit, 12/31/09 (Upstream)
Ending Inventory ($200,000 × 25%) …………………………………..					$50,000
Markup (given) ………………………………………………………………..						20%
Unrealized Intercompany Gross profit, 12/31/09 ………………..	$10,000
Ending inventory unrealized gross profit, 12/31/10 (Upstream)
Ending Inventory ($150,000 × 40%) …………………………………..					$60,000
Markup (given) ………………………………………………………………..						20%
Unrealized Intercompany Gross profit, 12/31/10 ………………..	$12,000

 

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30. (continued)
Building unrealized gross profit, 1/2/09 (Downstream)
Transfer Price …………………………………………………………………	$25,000
Book Value ……………………………………………………………………..	10,000
Unrealized Gross profit ……………………………………………………	$15,000

Annual Excess Depreciation

Annual Depreciation Based on Book Value ($10,000/5 years)$2,000

Annual Depreciation Based on Transfer Price
($25,000/ 5 years) ………………………………………………………..			5,000
Excess Depreciation-Each Year ……………………………………….	$3,000
Adjust to Building to return to historical cost at 1/1/10
			Consolidation
Transfer Price	Historical Cost	Adjustment
Buildings	$25,000	$100,000	$75,000
Accumulated Depreciation
(1/1/09 balance after 1
more year of depreciation)	5,000	92,000	87,000

Consolidated Totals

Sales and Other Income = $1,250,000 (add the two book values and eliminate the intercompany transfers)

Cost of Goods Sold:

Moore’s book value …………………………………………………………	$500,000
Kirby’s book value …………………………………………………………..	400,000
Eliminate intercompany transfers …………………………………….	(150,000)
Realized gross profit deferred in 2009 ……………………………….	(10,000)
Deferral of 2010 unrealized gross profit …………………………….	12,000
Cost of goods sold ………………………………………………………….	$752,000

Operating and Interest Expense = $275,000 (add the two book values and include $18,000 amortization for current year but eliminate $3,000 excess depreciation from asset transfer)

Noncontrolling Interest in Subsidiary’s Income = $2,000 (impact of inventory transfers is included because they were upstream but building transfer is omitted because it was downstream)

 

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30. (continued) initial
Reported income for 2010 …………………………………………………………	$40,000
Realized gross profit deferred in 2009 ………………………………	10,000
Deferral of 2010 unrealized gross profit …………………………….	(12,000)
Realized income of subsidiary …………………………………………	$38,000
Excess fair value amortization…………………………………………..	(18,000)
Adjusted subsidiary net income ………………………………………..		20,000
Outside Ownership ………………………………………………………………		10%
Noncontrolling Interest ……………………………………………………	$2,000

Consolidated Net Income = $223,000 (consolidated sales less consolidated cost of goods sold, expenses, and noncontrolling interest)

To noncontrolling interest = $2,000 (above)

To controlling interest = $221,000

Retained Earnings, 1/1/10 = $1,024,800 (because the parent uses the initial value method, its retained earnings must be adjusted for changes in subsidiary’s book value, excess amortizations, and the impact of unrealized gross profits in previous years)

Moore’s Reported Balance, 1/1/10 ………………………….	$990,000
Impact of Building Transfer (parent’s income was over-
stated by the $15,000 gain but has been reduced by
one prior year of excess depreciation) ……………….	(12,000)
Adjustments to Convert Initial Value to Equity Method:
Increase in subsidiary’s book value during prior
years  ………………………………………………………….	$80,000
Excess fair value amortization …………………………..	(18,000)
Deferral of 12/31/09 Unrealized Gross profit
(subsidiary’s prior income was overstated) …..	(10,000)
Realized increase in book value ……………………		52,000
Ownership ………………………………………………………..		90%
Equity Accrual ………………………………………………….				46,800
Retained Earnings, 1/1/10 …………………………….	$1,024,800

Dividends Paid = $130,000 (parent balance only)

Retained Earnings, 12/31/10 = $1,115,800 (the beginning balance plus net income less dividends paid)

Cash and Receivables = $397,000 (add the two book values)

Inventory = $372,000 (add the two book values and defer the $12,000 ending unrealized gross profit)

Investment in Kirby = -0- (eliminated for consolidation purposes)

 

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(continued)

Equipment (Net) = $1,030,000 (add the two book values adjusted for excess allocation and amortization)

Buildings = $1,725,000 (add the two book values and add the $75,000 impact to return to historical cost as computed above for transfer)

Accumulated Depreciation = $384,000 (add the two book values plus adjustment to historical cost ($87,000 at beginning of year less $3,000 excess depreciation for current year)

Other Assets = $300,000 (add the two book values)

Brand Names = $40,000 (the original $50,000 allocation less two years of amortization at $5,000 per year)

Total Assets = $3,480,000 (summation of the consolidated totals)

Liabilities = $1,684,000 (add the two book values and subtract the original allocation [$40,000] after two years of amortization [$8,000 per year])

Noncontrolling Interest, 12/31/10 = $80,200 (10 percent of beginning book value [$690,000 after deferral of unrealized gross profit] plus $9,200 share of beginning unamortized excess fair value allocations plus $2,000 income share)

Common Stock = $600,000 (parent balance only)

Retained Earnings, 12/31/10 = $1,115,800 (computed above)

Total Liabilities and Equities = $3,480,000 (summation of consolidated balances).

The same consolidation balances can be derived by setting up a worksheet and utilizing the following entries:

CONSOLIDATION ENTRIES
Entry *G
Retained Earnings, 1/1/10 (Kirby) ………………….	10,000
Cost of Goods Sold …………………………………	10,000
(To recognize 2009 deferred gross profit as income in 2010)
Entry *TA
Building ……………………………………………………….	75,000
Retained earnings, 1/1/10 (Moore) …………………	12,000
Accumulated Depreciation ………………………	87,000
(To adjust 1/1/10 balance to historical cost figures)
Entry *C
Investment in Kirby ……………………………………..	46,800
Retained Earnings, 1/1/10 (Moore) ……………	46,800

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(To convert from initial value to equity method based on the following computation)

 

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(continued)

	Increase in subsidiary’s book value during prior years
	(income of $80,000) ………………………………….	$80,000
	Excess amortization for 2009…………………………	(18,000)
	Deferral of 12/31/09 unrealized gross profit …….	(10,000)
	Realized increase in subsidiary’s book value….	$52,000
	Ownership …………………………………………………..		90%
	Conversion to equity method adjustment ………	$46,800
S	Common Stock (Kirby) …………………………………	150,000
	Retained Earnings, 1/1/10 as adjusted (Kirby) …	540,000
	Investment in Kirby (90%) ………………………..	621,000
	Noncontrolling Interest in Kirby (10%) ……..	69,000
	(To eliminate subsidiary’s beginning stockholders’ equity accounts and
	recognize beginning noncontrolling interest balance)
A	Liabilities …………………………………………………….	32,000
	Equipment …………………………………………………..	15,000
	Brand Names ………………………………………………	45,000
	Investment in Kirby …………………………………	82,800
	Noncontrolling Interest in Kirby (10%) ……..	9,200
	(To recognize unamortized balance of excess allocations as of 1/1/10.
	Figures have been reduced by one year of amortization)

Entry I (the subsidiary paid no dividends so no adjustment needed)

E	Interest expense …………………………………………..	8,000
	Depreciation expense ……………………………………	5,000
	Brand names amortization expense ………………	5,000
	Liabilities ……………………………………………….	8,000
	Equipment ………………………………………………	5,000
	Brand names ………………………………………….	5,000
	(To recognize excess amortization expenses for current year)
Tl	Sales …………………………………………………………..	150,000
	Cost of Goods Sold …………………………………	150,000
	(To eliminate intercompany transfers for 2010)
G	Cost of Goods Sold ……………………………………..	12,000
	Inventory ………………………………………………..	12,000
	(To defer ending unrealized inventory gross profit)
ED Accumulated Depreciation ……………………………	3,000
	Depreciation Expense ……………………………..	3,000
	(To adjust depreciation for current year created by transfer of building)
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(55 Minutes) (Investment account balance and consolidated worksheet with downstream inventory transfers when parent uses equity method)

Acquisition-date fair value allocation and excess amortizationsa.  Consideration transferred  …………………….$372,000Noncontrolling interest fair value ……………248,000Subsidiary fair value at acquisition-date ..$620,000Book value ……………………………………………(320,000)Fair value in excess of book value …………$300,000Annual ExcessExcess fair value assignments …………..LifeAmortizationsto patents …………………………………………

	70,000	10 yrs.	$7,000
to customer list ……………………………….		45,000	15 yrs.	3,000
to goodwill ………………………………………	$185,000	indefinite	-0-

$10,000Determination of Investment in Scott account balanceConsideration transferred ………………………………$372,000Scott’s 2009 reported income ……………………..$70,000Excess fair value amortization ……………………(10,000)Scott income adjusted ……………………………….$60,000Woods’ ownership percentage …………………..60%$36,000Ending inventory profit deferral (100%) ……….(10,000)Equity accrual ………………………………………………..$26,0002009 dividends to Woods ………………………………..(6,000)Investment balance 12-31-09 …………………………..$392,000Scott’s 2010 reported income ……………………..60,000Excess fair value amortization ……………………(10,000)Scott income adjusted ……………………………….$50,000Woods’ ownership percentage …………………..60%$30,000Ending inventory profit deferral (100%) ……….(12,000)Beginning inventory profit recognized (100%)   10,000Equity accrual ………………………………………………..28,0002010 dividends to Woods ………………………………..(9,000)Investment balance 12-31-10 …………………………..$411,000Intercompany profits (downstream)

2009

2010

Intercompany transfers remaining in inventory

50,000

40,000

Gross profit rate*20%30%

$10,000

$12,000

* (150,000 – 120,000) ÷ 150,000 = 20%(160,000 – 112,000) ÷ 160,000 = 30%

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31. (continued)

WoodsScottAdj. & Elim.NCI  ConsolidatedSales(700,000)(335,000)(TI)150,000(885,000)Cost of goods sold460,000205,000(G) 12,000(*G) 10,000517,000(TI) 150,000Operating expenses188,00070,000(E)10,000268,000Income of Scott(28,000)(I)18,000-0-(*G) 10,000Separate company income(80,000)(60,000)Consolidated net income(100,000)to noncontrolling interest(20,000)20,000to parent(80,000)Retained earnings, 1/1(695,000)(280,000)(S) 280,000(695,000)Net income (above)(80,000)(60,000)(80,000)Dividends paid45,00015,000(D)9,0006,00045,000Retained earnings, 12/31(730,000)(325,000)(730,000)Cash and receivables248,000148,000396,000Inventory233,000129,000(G)12,000350,000Investment in Scott411,000-0-(D)9,000(S) 228,000-0-(A)174,000(I)18,000Buildings (net)308,000202,000510,000Equipment (net)220,00086,000306,000Patents (net)-0-20,000(A) 63,000(E)7,00076,000Customer list(A) 42,000(E)3,00039,000Goodwill(A)185,000185,000Total assets1,420,000585,0001,862,000Liabilities(390,000)(160,000)(550,000)Common stock(300,000)(100,000)(S) 100,000(300,000)Noncontrolling interest 1/1(S) 152,000(A)116,000(268,000)Noncontrolling interest 12/31282,000(282,000)Retained earnings, 12/31(730,000)(325,000)(730,000)Total liabilities and equities(1,420,000)(585,000)884,000884,000(1,862,000)

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32. Investment balance and worksheet preparation—upstream sales, equity method

a.  2011 income reported by Sander						$230,000
Excess patent fair value amortization ($350,000 ÷ 5 years)					(70,000)
Deferred gross profit for 12/31/11 intercompany inventory (160,000 × 25%)		(40,000)
Recognized gross profit for 1/1/11 intercompany inventory (125,000 × 28%)	35,000

Sander’s income adjusted$155,000To controlling interest (80%)$124,000To noncontrolling interest (20%)

$31,000

AdjustmentsConsolidate

	Plymouth	Sander		& Eliminations	NCI	d
Revenues	(1,740,000)	(950,000)	(TI) 300,000				(2,390,000)

(TI)300,00Cost of goods sold820,000500,000(G)40,00001,025,000(*G)35,000Depreciation expense104,00085,000189,000Amortization expense220,000120,000(E)70,000410,000Interest expense20,00015,00035,000Equity earnings—Sander(124,000)(I)124,0000Separate companyincome(700,000)(230,000)Consolidated net income(731,000)to noncontrollinginterest(31,000)31,000to controlling interest(700,000)Retained Earnings 1/1(2,800,000)(345,000)(S) 310,000(2,800,000)(*G) 35,000Net Income(700,000)(230,000)(700,000)Dividends paid200,00025,000(D) 20,0005,000200,000Retained Earnings 12/31(3,300,000)(550,000)(3,300,000)Cash535,000115,000650,000Accounts receivable575,000215,000790,000Inventory990,000800,000(G) 40,0001,750,000Investment in Sander1,420,000(D)20,000(S)968,000(A)348,0000(I) 124,000Buildings and Equipment1,025,000863,0001,888,000Patents950,000107,000(A) 210,000(E) 70,0001,197,000Goodwill(A) 225,000225,000Total Assets5,495,0002,100,0006,500,000Accounts Payable(450,000)(200,000)(650,000)Notes Payable(545,000)(450,000)(995,000)NCI in Sander 1/1(S)242,000(329,000(A) 87,000)NCI in Sander 12/31355,000(355,000)

 

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Common Stock	(900,000)	(800,000)		(S) 800,000			(900,000)
APIC	(300,000)	(100,000)		(S) 100,000			(300,000)
Retained Earnings 12/31	(3,300,000)	(550,000)					(3,300,000)

Total Liab. and SE(5,495,000)(2,100,000)2,234,0002,234,000(6,500,000)

 

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(50 Minutes) (Prepare consolidation entries for a combination where upstream inventory transfers have occurred as well as downstream equipment transfers. Parent has applied initial value method)

Consideration transferred  …………………………$665,000Noncontrolling interest fair value ………………..

285,000

Subsidiary fair value at acquisition-date ……..$950,000Book value…………………………………………………

(800,000)

Fair value in excess of book value ……………..

	$150,000			Annual Excess
Excess fair value assignments ……………….				Life	Amortizations
to building …………………………………………….	50,000	5 yrs.	$10,000
to franchise agreements ……………………….	100,000	10 yrs.	10,000

 

-0-

$20,000

Inventory Transfers (Upstream)2010 gross profit deferred until 2011 ($12,000 × 30%) ………………

	$3,600
2011 gross profit deferred until 2012 ($18,000 × 30%) ………………	$5,400

Equipment Transfer (Downstream)Unrealized gain as of January 1, 2011:Unrealized gain on transfer (1/1/10) ………………………………….

				$36,000
2010 excess depreciation ($36,000 ÷ 6 yrs.) ……………………….				(6,000)

Unrealized gain January 1, 2011 …………………………………………….

$30,000

Excess depreciation—2011 ($36,000 ÷ 6 yrs.) …………………………

$6,000

Entry *GRetained Earnings, 1/1/11 (Young) ………………..3,600Cost of Goods Sold …………………………………

3,600

To recognize upstream intercompany inventory gross profit deferred from previous year.

Entry *TA
Retained Earnings, 1/1/11 (Monica)  ………………	30,000
Equipment ($50,000 – $36,000) ……………………..	14,000
Accumulated Depreciation ($50,000 – $6,000)	44,000

To return equipment accounts to beginning book value based on historical cost and to remove unrealized gain from beginning retained earnings.

 

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33. (continued)
Entry *C
Investment in Young ……………………………….	123,480
Retained Earnings, 1/1/11 (Monica) ……..	123,480

Because the parent uses the initial value method, its retained earnings must be adjusted for the subsidiary’s increase in book value less excess amortizations and upstream profits during 2009–2010 as follows.

Retained earnings of Young, December 31, 2011 (given)	$740,000
Eliminate income and dividends of Young
($160,000 – $50,000) ……………………………………..	(110,000)
Retained earnings of Young, December 31, 2010 ..	630,000
Removal of unrealized gross profit (Entry *G) …….	(3,600)
Realized retained earnings of Young,
December 31, 2010 ………………………………………..	626,400
Retained earnings at date of acquisition …………….	(410,000)
Increase in retained earnings during 2009–2010 ….	216,400
Ownership percentage ………………………………………		70%
Income accrual to be recognized ……………………….	151,480
Excess amortization for 2009–2010 ($20,000 × 70%× 2 yrs.)		(28,000)
ENTRY *C ADJUSTMENT (above) ………………………	$123,480
Entry S
Common Stock (Young) ……………………………….	300,000
Additional Paid-in Capital (Young) ………………..	90,000
Retained Earnings, 1/1/11
(Young) (adjusted for *G) …………………………	626,400
Investment in Young (70%) …………………		711,480
Noncontrolling Interest in Young (30%) .		304,920

To eliminate stockholders’ equity accounts of subsidiary and recognize noncontrolling interest; amount of retained earnings was previously reduced to realized balance by Entry *G. The $626,400 figure is computed above.

Entry A
Franchise Agreement ……………………………………	80,000
Buildings …………………………………………………….	30,000
Investment in Young ……………………………….	77,000
Noncontrolling Interest in Young (30%) ……	33,000

To recognize amount paid within acquisition price for buildings and the franchise agreement. Balances have been reduced by two years of excess amortizations.

 

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33. (continued)
Entry I
Dividend Income ………………………………………….	35,000
Dividends Paid ……………………………………….	35,000
To eliminate Intercompany dividend payments recorded by parent as
income since initial value method is used.
Entry E
Depreciation Expense …………………………………..	10,000
Amortization Expense ………………………………….	10,000
Franchise Agreement ………………………………	10,000
Buildings …………………………………………………	10,000
To recognize current year excess amortization expense.
Entry Tl
Sales  ………………………………………………………….	90,000
Cost of Goods Sold (or Purchases) ………….	90,000

To remove intercompany inventory transfers made during the current year.

Entry G
Cost of Goods Sold (or Ending Inventory) …….	5,400
Inventory …………………………………………………	5,400

To defer unrealized gross profit on 2011 intercompany inventory transfers (computed above).

Entry ED
Accumulated Depreciation ……………………………	6,000
Depreciation Expense ……………………………..	6,000

To remove current year depreciation on transferred item since its historical cost has been fully depreciated.

Noncontrolling Interest’s Share of Subsidiary’s Net Income
Reported income of Young (given) ………………………………	$160,000
Excess fair value amortization …………………………………….	(20,000)
Recognition of 2010 unrealized gross profit (Entry *G) …	3,600

Deferral of 2011 unrealized gross profit (Entry G) (upstream) (5,400)

Realized income of Young ………………………………………….	$138,200
Outside ownership percentage ……………………………………		30%
Noncontrolling interest in subsidiary’s income ……………	$41,460

 

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(35 Minutes) (Consolidation entries with upstream Inventory transfers and downstream equipment transfers. Parent uses equity method)

Entry *G (Same as Entry *G in Problem 33.)

Entry *TA
Investment in Young ……………………………………	30,000
Equipment …………………………………………………..	14,000
Accumulated Depreciation ………………………	44,000

To return equipment account to its book value based on historical cost. Because the parent uses the equity method and the transfer is downstream, the unrealized gain has already been removed from the parent’s retained earnings. Thus, the remaining gain is eliminated here from the Investment account rather than from retained earnings.

Entry *C (No Entry *C is needed because equity method has been applied.)

Entry S (Same as Entry S in Problem 33.)
Entry A (Same as Entry A in Problem 33.)
Entry I
Investment Income ………………………………………	102,740
Investment in Young ……………………………….		102,740
To eliminate intercompany income accrual.
Reported income of Young (given) …………………………………….	$160,000
Excess fair value amortization ……………………………………………	(20,000)
Recognition of 2010 unrealized gross profit (Entry *G) ………..	3,600
Deferral of 2011 unrealized gross profit (Entry G) (upstream)	(5,400)
Realized income of Young …………………………………………………	$138,200
Outside ownership percentage ………………………………………….		70%
Monica’s share of Young’s realized income …………………………	$96,740
Depreciation adjustment for asset transfer gain …………………..	6,000
Equity accrual for 2011 ………………………………………………….	$102,740
Entry D
Investment in Young ……………………………………	35,000
Dividends Paid ……………………………………….		35,000

To eliminate intercompany dividend transfers.

Entry E (Same as Entry E in Problem 33.)

Entry TI (Same as Entry Tl in Problem 33.)

Entry G (Same as Entry G in Problem 33.)

Entry ED (Same as Entry ED in Problem 33.)

Noncontrolling interest in subsidiary’s income (Same as in Problem 33.)

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(60 Minutes) (Consolidation worksheet for combination with upstream inventory transfers and downstream transfer of land. Also asks about transfer of a building. Parent uses partial equity method.)

Consideration transferred  …………………………	$570,000
Noncontrolling interest fair value ………………..	380,000
Subsidiary fair value at acquisition-date ……..	$950,000
Book value…………………………………………………	(850,000)
Fair value in excess of book value ……………..	$100,000			Annual Excess
Excess fair value assignment ………………..				Life	Amortizations
to customer list ……………………………………..	100,000		20 yrs.	$5,000
		-0-
a.  CONSOLIDATION ENTRIES
Entry *TL
Retained Earnings, 1/1/10 (Gibson) ………….			40,000
Land ………………………………………………….				40,000

To remove unrealized gain on Intercompany downstream transfer of land made in 2009.

Entry *G
Retained Earnings, 1/1/10 (Keller) …………….	10,000
Cost of Goods Sold ……………………………	10,000

To defer unrealized upstream Inventory gross profit from 2009 until 2010 computed as the 2009 ending inventory balance of $30,000 (20% × $150,000) multiplied by 33-1/3% markup ($50,000/$150,000).

Entry *C
Retained earnings, 1/1/10 (Gibson) …………..	9,000
Investment in Keller ……………………………	9,000

Parent is applying the partial equity method as can be seen by the amount in the Income of Keller Company account (60 percent of the reported balance). Thus, the parent’s share of amortization of $3,000 ($100,000 divided by 20 years × 60%) must be recognized for the previous year 2009. In addition, the equity accrual recorded by the parent has been based on Keller’s reported income. As shown in Entry *G, $10,000 of that reported income has not actually been realized as of January 1, 2010. Thus, the previous accrual must be reduced by $6,000 to mirror the parent’s 60% ownership. The total of the two adjustments being made here is $9,000.

 

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35. (continued)
Entry S
Common Stock (Keller) ……………………………	320,000
Additional Paid-in Capital ………………………..	90,000
Retained earnings, 1/1/10 (Keller) (adjusted
for Entry *G) ……………………………………….	610,000
Investment in Keller (60%) ……………..		612,000
Noncontrolling Interest in Keller, 1/1/10 (40%)	408,000

To remove stockholders’ equity accounts of Keller and recognize beginning noncontrolling interest. Retained earnings balance has been adjusted in Entry *G.

Entry A
Customer List ………………………………………….	95,000
Investment in Keller ……………………………	57,000
Noncontrolling Interest in Keller, 1/1/10 (40%)	38,000

To recognize amount paid within acquisition price for the customer list.

Original balance is adjusted for previous year’s amortization.

Entry I
Income of Keller ……………………………………..	84,000
Investment in Keller ……………………………	84,000
To eliminate intercompany income accrual.
Entry D
Investment in Keller ………………………………..	36,000
Dividends Paid …………………………………..	36,000
To eliminate intercompany dividend transfers—60% of subsidiary’s
payment.
Entry E
Amortization Expense ………………………………	5,000
Customer List …………………………………….	5,000
To recognize current period excess amortization expense.
Entry P
Liabilities ………………………………………………..	40,000
Accounts Receivable ………………………….	40,000
To eliminate intercompany debt.
Entry Tl
Sales ……………………………………………………….	200,000
Cost of Goods Sold ……………………………	200,000

To eliminate current year intercompany inventory transfer.

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Entry G
Cost of Goods Sold …………………………………	12,000
Inventory …………………………………………….	12,000

To defer 2010 unrealized inventory gross profit. Unrealized gain is the ending inventory of $40,000 (20% of $200,000) multiplied by 30% markup ($60,000/$200,000).

Noncontrolling Interest in Keller’s Net Income
Keller reported net income …………………………..	$140,000
Excess fair value amortization ………………………	(5,000)
2009	Intercompany gross profit realized in 2010 (inventory)	10,000
2010	Intercompany gross profit deferred (inventory)	(12,000)
Keller realized income 2010 …………………………..	$133,000
Outside ownership percentage …………………….		40%
Noncontrolling interest in Keller’s net income	$53,200

 

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35. a. (continued)GIBSON AND KELLERConsolidation WorksheetYear Ending December 31, 2010Consolidation Entries NoncontrollingConsolidatedAccountsGibsonKellerInterestTotalsDebitCreditSales(800,000)(500,000)(TI)200,000(1,100,000)Cost of goods sold500,000300,000(G)12,000(*G)10,000602,000Operating expenses100,00060,000(E)5,000(TI)200,000165,000Income of Keller(84,000)-0-(I)84,000-0-Separate company net income(284,000)(140,000)Consolidated net income(333,000)To noncontrolling interest(53,200)53,200To parent(279,800)RE, 1/1/10—Gibson(1,116,000)(*TL)40,000(1,067,000)(*C)9,000RE, 1/1/10—Keller(620,000)(*G)10,000Net income (above)(284,000)(140,000)(S)610,000(279,800)Dividends115,00060,000(D)36,00024,000115,000Retained earnings, 12/31/10(1,285,000)(700,000)(1,231,800)Cash177,00090,000267,000Accounts receivable356,000410,000(P)40,000726,000Inventory440,000320,000(G)12,000748,000Investment in Keller726,000(D)36,000(*C)9,000-0-(S)612,000(I)84,000(A)57,000Land180,000390,000(*TL)40,000530,000Buildings and equipment (net)496,000300,000796,000Customer List(A)95,000(E)5,00090,000Total assets2,375,0001,510,0003,157,000Liabilities(480,000)(400,000)(P)40,000(840,000)Common stock(610,000)(320,000)(S)320,000(610,000)Additional paid-in capital(90,000)(S)90,000Retained earnings, 12/31/10(1,285,000)(700,000)(1,231,800)NCI in Keller, 1/1/10(S)408,000(408,000)NCI In Keller, 12/31/10(A)38,000(38,000)(475,200)475,200Total liabilities and equity(2,375,000)(1,510,000)© The McGraw-Hill Companies, Inc., 2009(3,157,000)McGraw-Hill/IrwinHoyle, Schaefer, Doupnik, Advanced Accounting, 9/e5-51

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35. (continued)

If the intercompany transfer had been a building rather than land, two adjustments to the consolidation entries would be needed. Entry *TL would be changed and relabeled as Entry *TA and an Entry ED would be added to eliminate the overstatement of depreciation expense for 2010. All other consolidation entries would be the same as shown in Part a. As a downstream transfer, entries *C and S are not affected.

Entry *TA
Retained Earnings, 1/1/10 (Gibson) …………..	36,000
Buildings ………………………………………………..	40,000
Accumulated Depreciation …………………..	76,000

To eliminate unrealized gain ($40,000 original amount less one year

of excess depreciation at $4,000 per year) as of beginning of year.

Entry also returns Buildings account to historical cost (from

$100,000 to $140,000) and Accumulated Depreciation account to

historical cost (original $80,000 less one year of excess depreciation

at $4,000). Because the Buildings account is shown at net value in

the information given in this problem, the above entry would

probably be made as follows:

Entry *TA (Alternative)
Retained Earnings, 1/1/10 (Gibson) …………..	36,000
Buildings (net) ……………………………………	36,000
Entry ED
Accumulated Depreciation ……………………….	4,000
Operating (or Depreciation) Expense …..	4,000

To remove excess depreciation for current year created by transfer

price. Excess depreciation for each year would be $4,000 based on

allocating the $60,000 historical cost book value over 10 years

($6,000 per year) rather than the $100,000 transfer price ($10,000 per

year).

 

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(40 Minutes) (Prepare consolidation worksheet with intercompany transfer of inventory and land. No outside ownership exists)

a.  Skyline reported income…………………………………………………..	$(88,000)
Patented technology amortization …………………………………….	15,000
Beginning inventory gross profit recognized …………………….	(14,400)
Ending inventory gross profit deferred ……………………………..	14,000
Deferral of land gain on sale …………………………………………….		18,000
Equity in Skyline’s earnings ……………………………………………..	$(55,400)
b.  Acquisition-Date Fair Value Allocation
Consideration transferred (fair value of shares issued) ……..	$450,000
Book value of subsidiary …………………………………………………	300,000
Fair value in excess of book value …………………………………..	$150,000
Excess fair over book value assigned to:
Trademarks (indefinite life) …………………………………………..		30,000
Patented technology …………………………………………………….	$120,000
Life of patented technology ………………………………………….		8 years
Annual amortization ………………………………………………………..	$15,000
Unrealized Upstream Inventory Gross profit, 1/1
Inventory being held ($50,000 × 72%) ……………………………….	$36,000
Markup ($20,000/$50,000) ………………………………………………..		40%
Unrealized gross profit, 1/1 ……………………………………………..	$14,400
Unrealized Upstream Inventory Gross profit, 12/31
Inventory being held (given) ……………………………………………	$28,000
Markup ($40,000/$80,000) ………………………………………………..		50%
Unrealized gross profit, 12/31 …………………………………………..	$14,000
CONSOLIDATION ENTRIES
Entry *G
Retained earnings 1/1 (Skyline) …………………….	14,400
Cost of goods sold ………………………………….		14,400
To remove impact of beginning unrealized gross profit. Amount
computed above.
Entry S
Common stock (Skyline) ………………………………	120,000
Additional paid-in capital (Skyline) ………………..	30,000
Retained earnings 1/1 (Skyline, adjusted) ………	277,600
Investment in Skyline ……………………………….		427,600

To remove stockholders’ equity accounts of subsidiary. Retained earnings is adjusted for elimination of beginning unrealized gross profit in Entry *G.

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36. (continued)
Entry A
Trademarks ………………………………………………….	30,000
Patented technology …………………………………….	105,000
Investment in Skyline ………………………………	135,000

To recognize excess fair value allocations as of 1/1. Patented technology is adjusted for 4 prior years of amortization at $15,000 per year.

Entry I
Investment income ……………………………………….	55,400
Investment in Skyline ………………………………	55,400
To remove intercompany income accrued by parent using the equity
method.
Entry D
Investment in Skyline …………………………………..	20,000
Dividends distributed ………………………………	20,000
To eliminate Intercompany dividend payments.
Entry E
Other operating expenses ……………………………..	15,000
Patented technology ……………………………….	15,000

To recognize current year amortization expense on patented technology

Entry Tl
Revenues …………………………………………………….	80,000
Cost of goods sold ………………………………….	80,000
To eliminate intercompany inventory transfer for current year.
Entry G
Cost of goods sold ………………………………………	14,000
Inventory …………………………………………………	14,000
To defer unrealized inventory gross profit. Amount is computed above.
Entry TL
Gain on sale of land ……………………………………..	18,000
Land ……………………………………………………….	18,000

To remove gain from intercompany transfer of land during current year.

Entry P
Accounts payable ………………………………………..	65,000
Accounts receivable …………………………………	65,000
To remove intercompany payable and receivable.

 

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36. (continued)PARKWAY AND SKYLINEConsolidation WorksheetYear Ending December 31, 2010Consolidation EntriesConsolidatedAccountsParkwaySkylineDebitCreditTotalsRevenues(627,000)(358,000)(TI)80,000(905,000)Cost of goods sold289,000195,000(G)14,000(TI) 80,000(*G) 14,400403,600Other operation expenses170,00075,000(E)15,000260,000Gain on sale of land(18,000)(TL) 18,000-0-Investment income(55,400)(I)55,400-0-Net income(241,400)(88,000)(241,400)Retained earnings 1/1(314,600)(292,000)(*G)14,400(314,600)(S)277,600-0-Net income (above)(241,400)(88,000)(241,400)Dividends distributed70,00020,000(D)20,00070,000Retained earnings 12/31(486,000)(360,000)(486,000)Cash and receivables134,000150,000(P)65,000219,000Inventory281,000112,000(G)14,000379,000Investment in Skyline598,000(D)20,000(S) 427,600(A) 135,000-0-(I)55,400Trademarks50,000(A)30,00080,000Patented technology130,000(A) 105,000(E)15,000220,000Land, buildings, and equipment (net)637,000283,000(TL) 18,000902,000Total assets1,650,000725,0001,800,000Liabilities(463,000)(215,000)(P)65,000(613,000)Common stock

(410,000)

(120,000)

(S) 120,000

(410,000)

Additional paid-in capital(291,000)(30,000)(S)30,000(291,000)Retained earnings (above)(486,000)(360,000)(486,000)Total liabilities & stockholders’ equity(1,650,000)(725,000)(1,800,000)McGraw-Hill/Irwin© The McGraw-Hill Companies, Inc., 20095-56Solutions Manual HYPERLINK “http://www.downloadslide.com” 

Chapter 5 Excel Case Solution

Excel CaseEquity in Shawn Co. Earnings200978,000Fair Value Allocation Schedule 1/1/2009

			El profit	-34,200
Consideration transferred  1,000,000			Amortization	-12,600

C.S.500,000Equity earnings31,200R.E.185,000685,000LifeAmort.201085,000Tradename315,0002512,600BI profit34,200

			Inventory			El profit	-37,800
Shawn sells	GPR	remaining			Amortization	-12,600
to Patrick	60%	30%				Equity earnings	68,800

 

Intercompany Inventory Transfers (upstream)				Shawn Co. dividends
			Sales	Inventory   Interco. profit2009	25,000

2009190,00057,00034,200201027,0002010210,00063,00037,800Consolidation Adjustments

Investment account

*G RE-Shawn

34,200

Cost1,000,000COGS34,2002009Equity earnings31,200dividends-25,000SCommon stock-Shawn500,00012/31/091,006,200RE-Shawn203,800Investment in Shawn703,8002010Equity earnings68,800dividends-27,000ATradename302,40012/31/101,048,000Investment in Shawn302,400I   Equity in earnings of Shawn 68,800Investment in Shawn68,800DInvestment in Shawn27,000Dividends paid27,000EAmortization expense12,600Tradename12,600ITSales210,000COGS210,000GCOGS37,800Inventory37,800

Investment account goes to zero? 0

 

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Analysis and Research—Accounting Information and Salary Negotiations

With common control over related enterprises, a consolidated income statement better portrays economic reality. For example, it is likely that the Stadium’s concession and parking revenues would have been less if the team did not play there. Additionally, the $1,400,000 rent expense does not represent an arm’s length transaction—given that the $1,400,000 is the only rent revenue, it appears that the stadium is used exclusively for baseball with its fortunes intertwined with the team.

Searching SFAS 160 ―separate statements‖ and then ―intercompany‖ yields the following relevant support:

There is a presumption that consolidated financial statements are more meaningful than separate financial statements and that they are usually necessary for a fair presentation when one of the entities in the consolidated group directly or indirectly has a controlling financial interest in the other entities. [SFAS 160, ¶1]

In the preparation of consolidated financial statements, intercompany balances and transactions shall be eliminated. This includes intercompany open account balances, security holdings, sales and purchases, interest, dividends, etc. As consolidated financial statements are based on the assumption that they represent the financial position and operating results of a single economic entity, such statements shall not include gain or loss on transactions among the entities in the consolidated group. [SFAS 160, ¶6]

Granger Eagles Team and Stadium

Consolidated Income Statement

Ticket revenues	$2,000,000
Concession revenue	800,000
Parking revenue	100,000	$2,900,000
Ticket expense		25,000
Promotion	35,000
COGS	250,000
Depreciation	80,000
Player salaries	400,000
Staff salaries	350,000	1,140,000
Consolidated net income			$1,760,000

Other pertinent factors include

Any available comparisons for the market values for the players

The market value of any alternative uses for the stadium

The amount the owners have invested in the team

The amount the owners have invested in the stadium

Fair rates of return for the owners’ investments in the team and the stadium

 

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