Chapter 5
Consolidated Financial Statements: Intercompany
Transactions 1
SUMMARY OF ASSIGNMENT MATERIAL
Item
Topics Covered
Level
Time
Q5.1
General objective when dealing with
intercompany transactions in consolidation.
Low
5-10
Q5.2
Comparison of gross profit and net profit on
intercompany transfers and indication of the
differential effects of applying them in
consolidation.
Low
5-10
Q5.3
Explanation of effect of transfer price change
(downstream).
Low
5-10
Q5.4
Explanation of effect of transfer price change
(upstream).
Low
5-10
Q5.5
Evaluation of three alternative approaches to
eliminating intercompany profits on upstream
sales.
Mod
15-10
Q5.6
Explanation of why equity method income accrual Low
is reduced by unconfirmed intercompany profits
on downstream sales.
5-10
Q5.7
Explanation of effect of prior intercompany
equipment sale on minority interest in net income.
Low
5-10
Q5.8
Intercompany equipment sale; consolidation
elimination entries after equipment is fully
depreciated.
Low
5-10
5-1
SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item
Topics Covered
Level
Time
Q5.9
Explanation of the effects of unconfirmed
inventory profits in beginning and ending
inventories on cost of goods sold. Discussion of
whether this approach will work for all inventory
methods.
Mod
10-15
Q5.10
Criticism of the text=s recommendation that
lower-of-cost-or-market write-downs following
intercompany merchandise sales be charged to the
selling affiliate in consolidation.
Mod
10-15
E5.1
Working paper eliminations relating to
intercompany sale of land; year of sale,
subsequent year, and when sold externally.
Mod
15-20
E5.2
Inferring intercompany land transactions by
analysis of elimination entries.
Mod
10-15
E5.3
Working paper eliminations involving
Mod
unconfirmed intercompany profits in beginning
and ending inventories; upstream and downstream
sales.
15-20
E5.4
Analysis of alternative sales of land from minority Mod
stockholder perspective.
15-20
E5.5
Working paper eliminations in year of sale and in
subsequent year for downstream sale of
equipment.
Mod
15-20
E5.6
Working paper eliminations relating to beginning
and ending unconfirmed intercompany profits on
land, merchandise and equipment; both upstream
and downstream transfers considered.
Mod
20-30
5-2
SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item
Topics Covered
Level
Time
E5.7
Projecting future consolidation entries for
intercompany transactions.
Mod
15-20
E5.8
Effect of intercompany transactions on equity
method income accrual and minority interest in
net income.
Mod
15-20
E5.9
Effect of downstream and upstream intercompany
land and inventory transactions on consolidated
net income and minority interest in net income.
Mod
15-20
E5.10
Effect on consolidated net income of alternative
treatments of lower-of-cost-or-market writedowns following an upstream intercompany
merchandise sale.
Mod
20-30
E5.11
Consolidated income statement and equity income Mod
accrual with intercompany transactions and
purchase premium amortization.
15-25
P5.1
Working paper elimination for current and prior
years= intercompany sales of depreciable assets;
two downstream and one upstream transaction.
Mod
40-50
P5.2
Interpreting consolidation elimination entries
regarding intercompany equipment sale.
Mod
20-25
P5.3
Computation of equity method income accrual
and preparation of financial statement working
paper; upstream and downstream intercompany
merchandise transfers.
Mod
50-60
P5.4
Calculation of bonus; subsidiary income with
consolidation adjustments.
Mod
15-20
5-3
SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item
Topics Covered
Level
Time
P5.5
Consolidated income statement and equity income High
accrual in a pooling of interests combination;
intercompany profits in beginning and ending
inventories; intercompany gain and loss on sales
of land, one parcel is sold externally;
intercompany gain on sale of equipment.
40-50
P5.6
Calculation of consolidated retained earnings and
of balance in the investment account; purchase
premium amortization and intercompany
transactions involving land, a patent, and
merchandise.
High
40-50
P5.7
Computation of equity method income accrual
Mod
and preparation of working paper eliminations;
purchase premium amortization and intercompany
transactions involving land, merchandise,
machinery and services.
40-50
P5.8
Computation of equity method income accrual
Mod
and preparation of working paper eliminations;
purchase premium amortization and intercompany
transactions involving merchandise and
equipment.
40-50
P5.9
Preparation of consolidation elimination entries;
several intercompany transactions.
Mod
20-25
P5.10
Comprehensive problem; several intercompany
transactions; effects on equity method income
accrual and minority interest in net income.
Mod
25-30
SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
5-4
Item
Topics Covered
Level
Time
P5.11
Compute effect on consolidated income of
unconfirmed intercompany profits in beginning
and ending inventories of P and S under LIFO
and FIFO.
Mod
20-30
P5.12
Prepare consolidated income statement
incorporating intercompany asset transfers of
inventory, depreciable assets, land, and patents.
High
40-50
5-5
CARRYBACK TABLE
The carryback table identifies the assignment items which are
new in this edition and those which are carried over from the seventh
edition. For the latter, the problem number in the seventh edition is
shown.
1
New
Problem
Number
Source
New
Problem
Number
Source
New
Problem
Number
Source
Q5.1
Q5.1
E5.1
E5.1
P5.1
P5.1
Q5.2
Q5.2
E5.2
E5.2
P5.2
P5.2
Q5.3
Q5.3
E5.3
E5.3
P5.3
P5.3
Q5.4
Q5.4
E5.4
E5.4
P5.4
P5.4
Q5.5
Q5.5
E5.5
E5.5
P5.5
P5.51
Q5.6
Q5.6
E5.6
E5.6
P5.6
P5.61
Q5.7
Q5.7
E5.7
E5.7
P5.7
P5.71
Q5.8
Q5.8
E5.8
E5.8
P5.8
P5.8
Q5.9
Q5.9
E5.9
E5.9
P5.9
P5.9
Q5.10
Q5.10
E5.10
E5.10
P5.10
P5.10
E5.11
E5.11
P5.11
P5.11
P5.12
new
Revised for new requirements of SFAS 141 and 142.
Carryforward tables for all chapters, identifying the disposition of
seventh edition assignment items, appear at the beginning of the
solutions manual.
5-6
ANSWERS TO QUESTIONS
Q5.1
The answer is based on the general objective of consolidated
statements; namely, to report the financial affairs of a group of
affiliated companies as if they were a single unified economic entity.
Subsidiaries are treated as if they were branches or divisions. The
general objective of the consolidation process as it relates to
intercompany transactions is to treat intercompany transactions as if
they never occurred.
Q5.2
Gross profit or gross margin refers to the excess of revenue from sale
over the costs clearly attached to the item being sold. The costs clearly
attached are legitimately capitalized as assets prior to sale. Acquisition
costs of property and product costs of manufactured inventories
qualify. Period costs - selling, general and administrative (SGA)
expenses - are normally not embodied in assets' values. It is these costs
which are deducted from gross profit to compute net profit.
Elimination of unconfirmed intercompany profits in consolidation
reduces the carrying values of transferred assets to their original
acquisition cost or book value to the consolidated entity. If only net
profit is eliminated in consolidation, the difference between gross and
net profit - SGA expenses - would be capitalized in consolidation, a
result contrary to generally accepted accounting principles.
5-7
Q5.3
There will be no effect on the consolidated financial statements.
Intercompany sales and purchases are eliminated in consolidation, as
are any unconfirmed profits in ending inventory. What remains is A's
costs from its suppliers and B's revenues from its customers, neither of
which are affected by the internal transfer price.
Q5.4
In this case, because the subsidiary is the seller, the elimination of any
unconfirmed profits in ending inventory will affect the minority
interest in net income. Otherwise, the conclusions of answer (3) above
apply.
Q5.5
(1)
(2)
Elimination of only the controlling interest's share recognizes the
separate legal identity of the subsidiary and reflects the minority's
portion - which technically has been realized - in the Minority
Interest in S.
Elimination of the total amount proportionately against the
majority and minority interests reflects the view that in
consolidation, the effects of transactions between the affiliates are
eliminated because they are not arm's length transactions. There
is no implication that only the controlling interest's portion of the
transaction is not arm's length. Indeed, the controlling interest
controls the entire transaction, not just part of it.
5-8
Q5.5 (cont=d.)
(3)
Elimination of the total amount entirely against the controlling
interest is based on the view that it is because of the controlling
interest that the transaction is not arm's length. While the
statement is undeniably true, the accounting treatment that
follows arbitrarily charges the majority for the minority's share.
Yet when the intercompany profit is confirmed, the majority will
not be credited for the minority's share.
In our judgment, opinion (2) best reflects the controlling
interest's viewpoint in consolidation, namely, that none of the
intercompany profit is realized by the consolidated entity until an
external sale has occurred.
Q5.6
There seems to be no obvious intuitive reason for deducting
unconfirmed intercompany profits on downstream sales from the
equity method accrual as they have nothing at all to do with S's net
income. Rather, the requirement is imposed by APBO 18 through its
one-line consolidation concept. In short, the equity method accrual
must reflect all consolidation working paper adjustments which affect
consolidated net income. Such adjustments include purchase premium
amortization and elimination of unconfirmed intercompany gains on
both upstream and downstream sales.
Q5.7
There is no effect on the minority interest in net income. P was the
seller in the original transaction; the elimination of depreciation
expense represents a partial confirmation of P's previously
unconfirmed profit. There is no effect on S's income and hence no
effect on the minority interest in net income.
5-9
Q5.8
Because all the intercompany gain has previously been confirmed, the
only elimination entry that is required is the restoration of the original
(pre-sale) accumulated depreciation (debit Equipment and credit
Accumulated Depreciation).
Q5.9
The text's approach for dealing with unconfirmed intercompany profits
in beginning and ending inventories is valid for all cost flow
assumptions. The cost flow assumption determines which units (and
how much intercompany profit) remain in ending inventory. Under
FIFO the intercompany profit in beginning inventory will normally not
be present in the ending inventory because the related goods are
assumed sold. Similarly, if LIFO is being used, any intercompany profit
in beginning inventory will also be in the ending inventory unless
inventory has declined during the year. This is true because the units
in beginning inventory are assumed to remain in the ending inventory
under LIFO.
Q5.10
The objection is based on the fact that intercompany transfer prices are
generally considered valid once the external sale takes place. Thus a
gain could be recognized by the selling affiliate and a loss by the
purchasing affiliate if the external selling price is less than the internal
transfer price. Opportunities for manipulation are possible here also.
While we see the similarity with the LCM case, we believe that our
treatment at least succeeds in avoiding the confirmation of
intercompany profit prior to external sale. Lower-of-cost-or-market
write-downs should not be used to trigger confirmation of
intercompany profits.
5-10
SOLUTIONS TO EXERCISES
E5.1 INTERCOMPANY LAND TRANSACTIONS
Requirement 1:
Consolidated Financial Statement Working Paper
20X7
Gain on Sale of Land
50,000
Land
50,000
To eliminate the unconfirmed gain on the intercompany sale
of land and reduce Land to original acquisition cost.
20X8
Investment in S
50,000
Land
50,000
To add the unconfirmed gain to the investment account
(it was removed via the equity method in 20X7) to
maintain equivalence with the retained earnings of S and
reduce Land to original acquisition cost.
Requirement 2:
Investment in S
50,000
Gain on Sale of Land
To include the intercompany gain, now confirmed, in current
year income and restate the investment account by offsetting
the previous reduction while the gain was unconfirmed.
5-11
50,000
E5.2 INTERCOMPANY LAND TRANSACTIONS
1.
In a prior year, S sold land to P at a gain of $20,000. P still holds
the land.
2.
Current year intercompany sale of land at loss of $14,000.
3.
In prior year, P sold land to S at a gain of $30,000. S still holds
the land.
4.
In a prior year, S sold land to P at a gain of $18,000. P sold the
land to an outside party this year.
E5.3 INTERCOMPANY MERCHANDISE TRANSACTIONS
Consolidated Financial Statement Working Paper
Retained Earnings, Salem-1/1
Investment in Salem
10,000
18,000
Inventory, 1/1 (Income
Statement)
28,000
To eliminate the intercompany profit on upstream intercompany
sales, assumed confirmed during 20X4, from the beginning inventory.
Profits on upstream sales are removed from Salem=s beginning
retained earnings; $10,000 = $50,000 - $50,000/1.25. Profits
on downstream sales are added to Portland=s Investment in Salem
as they had been removed from the 20X3 equity accrual;
$18,000 = $78,000 - $78,000/1.3.
Sales
840,000
Purchases
840,000
To eliminate intercompany merchandise sales made during 20X4.
5-12
E5.3 (cont=d)
Inventory, 12/31
(Income Statement)
29,000
Inventory
(Balance Sheet)
29,000
To eliminate unconfirmed intercompany profit from ending inventory
on both the income statement and balance sheet; $29,000 = $40,000 ($40,000/1.25) + $91,000 - ($91,000/1.3).
E5.4 ANALYSIS OF LAND SALE ALTERNATIVES
Under a direct sale of the land by S to the developer, S would have a
gain of $3,900,000. The minority interest in net income would be
$780,000 (= .2 x $3,900,000) and the distribution to the minority
shareholder would be $390,000 (= .5 x $780,000).
Under the intercompany sale, even though the gain is larger, it would
be eliminated in consolidation, and would not enter into the minority
interest in net income. So long as P held the land (which it plans to do
under a long-term lease), the gain would not be reflected in minority
interest in net income. Moreover, the income from the lease is P's
income, so the minority interest would be unaffected. Under this
approach, the minority stockholder would receive nothing.
Hence, the minority stockholder should prefer the direct sale to the
developer.
5-13
E5.5 INTERCOMPANY EQUIPMENT TRANSACTIONS
Requirement 1:
Consolidated Financial Statement Working Paper
Gain on Sale of Equipment
5,000
Equipment
To eliminate the gain on intercompany sale of equipment.
Accumulated Depreciation
5,000
1,000
Depreciation
Expense
To eliminate the excess depreciation recorded by Spencer in
20X1. Spencer recorded $10,000 (=$50,000/5) whereas
depreciation based on original acquisition cost would have
been $9,000 (=$45,000/5).
Equipment
1,000
15,000
Accumulated Depreciation
15,000
To restate the equipment and accumulated depreciation
accounts to their original acquisition cost basis.
Requirement 2:
Investment in Spencer
Accumulated Depreciation
4,000
1,000
Equipment
To eliminate the amount of intercompany gain unconfirmed
in prior years, remove the excess depreciation recorded in
prior years and reduce the equipment to its net book value
at date of intercompany sale.
Accumulated Depreciation
5,000
1,000
Depreciation Expense
To eliminate the excess depreciation recorded by Spencer
in 20X2.
5-14
1,000
E5.5 (cont=d.)
Equipment
15,000
Accumulated Depreciation
15,000
To restate the equipment and accumulated depreciation
accounts to their original acquisition cost basis.
E5.6 VARIOUS INTERCOMPANY TRANSACTIONS
Requirement 1:
Consolidated Financial Statement Working Paper
(Upstream)
Retained Earnings - S
25,000
Land
25,000
Retained Earnings - S
14,000
Inventory, 1/1 (I/S)
Inventory, 12/31 (I/S)
14,000
32,000
Inventory, Balance Sheet
Retained Earnings - S
Accumulated Depreciation
32,000
8,000
4,000
Equipment
Accumulated Depreciation
12,000
2,000
Depreciation Expense
Equipment
2,000
20,000
Accumulated Depreciation
5-15
20,000
E5.6 (cont=d)
Requirement 2:
Consolidated Financial Statement Working Paper
(Downstream)
Investment in S
25,000
Land
25,000
Investment in S
14,000
Inventory, 1/1 (I/S)
Inventory, 12/31 (I/S)
14,000
32,000
Inventory, Balance Sheet
Investment in S
Accumulated Depreciation
32,000
8,000
4,000
Equipment
Accumulated Depreciation
12,000
2,000
Depreciation Expense
Equipment
2,000
20,000
Accumulated Depreciation
5-16
20,000
E5.7 INTERCOMPANY LAND AND EQUIPMENT SALES
Requirement 1:
Land
Equipment
80,000
18,000
Purchase Premium
Depreciation Expense
98,000
6,000
Equipment
6,000
Requirement 2:
Land
80,000
Purchase Premium
80,000
Requirement 3:
No entry
E5.8 INTERCOMPANY TRANSACTIONS; EQUITY METHOD
INCOME ACCRUAL AND MINORITY INTEREST
Requirement 1:
Equity method income accrual:
Income of S ($700,000 x .8)
Unconfirmed loss - land
Unconfirmed gain, ending inventory ($40,000 x .8)
Confirmed gain, beginning inventory ($25,000 x .8)
Confirmed gain, equipment
Amortization of purchase premium
5-17
$560,000
30,000
(32,000)
20,000
8,000
(14,000)
$572,000
E5.8 (cont=d.)
Requirement 2:
Minority interest in net income:
Income of S ($700,000 x .2)
Unconfirmed gain, ending inventory ($40,000 x .2)
Confirmed gain, beginning inventory ($25,000 x .2)
$140,000
(8,000)
5,000
$137,000
E5.9 INCOME EFFECTS OF UNCONFIRMED
INTERCOMPANY PROFITS
Item
1.
2.
3.
4.
Decrease in
Consolidated
Net Income
$ 20,000
24,000
80,000
52,000
$176,000
Decrease in Minority
Interest In Net Income
C
$ 6,000
C
13,000
$19,000
5-18
Total
Elimination
$ 20,000
30,000
80,000
65,000
$195,000
E5.10
LOWER OF COST OR MARKET
(1)
If the LCM loss of $20,000 is attributed to the purchasing
affiliate, P will recognize the loss on its books and the controlling
interest bears the entire charge. Consolidated net income is
decreased by $20,000.
(2)
Alternatively, charging the loss to the selling affiliate means that
the controlling interest's share is but $14,000, 70 percent of the
loss attributed to S Company and consolidated net income is
decreased by $14,000.
In effect, in case (1) the controlling interest is being charged for 100
percent of the $20,000 reversal in intercompany inventory profit
signalled by the LCM adjustment rather than for the 70 percent actually
owned. The $6,000 difference is the minority's share of the reduction
in intercompany profit which, in case (1), is charged against
consolidated net income instead of against the minority interest in net
income.
E5.11
CONSOLIDATED INCOME STATEMENT C
INTERCOMPANY TRANSACTIONS
Requirement 1:
Schedule to Compute Equity Method Income Accrual
PCO=s share of SCO=s net income (.75 X $200,000)
$150,000
- Purchase premium amortization
(25,000)
- Downstream intercompany profit
(50,000)
- 75% of upstream intercompany profit (.75 X $40,000)
(30,000)
Equity method income accrual
$ 45,000
5-19
E5.11 (cont=d.)
Requirement 2:
PCO and SCO
Consolidated Income Statement
Sales ($2,000,000 + $1,200,000 - $400,000)
Cost of Goods Sold ($1,000,000 + $700,000
- $400,000 + $50,000 + $40,000)
Other Expenses ($600,000 + $300,000 + $25,000)
Minority Interest in Net Income [.25 ($200,000 - $40,000)]
Consolidated Net Income
5-20
$2,800,000
(1,390,000)
(925,000)
$ 485,000
(40,000)
$ 445,000
SOLUTIONS TO PROBLEMS
P5.1 INTERCOMPANY TRANSFERS OF DEPRECIABLE
ASSETS
Requirement 1:
Consolidated Financial Statement Working Paper
Transaction (1)
Investment in S (2.5 x
($80,000/8))
Accumulated Depreciation
(5.5 x $80,000/8))
25,000
55,000
Plant Assets ($160,000 ($100,000 -$20,000))
80,000
To eliminate the intercompany gain unconfirmed in prior years,
remove the excess depreciation recorded in prior years and
reduce the asset account to its net book value at date of
intercompany sale.
Accumulated Depreciation
10,000
Depreciation Expense
10,000
To eliminate the excess annual depreciation expense recorded
by the purchasing affiliate (Smart) in 20X8.
Plant Assets
20,000
Accumulated Depreciation
20,000
To restate the asset and accumulated depreciation accounts
to their original acquisition cost basis. Asset account now
equals $100,000 (=$160,000 - $80,000 + $20,000).
Accumulated Depreciation now equals $85,000
(=$130,000 - $55,000 - $10,000 + $20,000).
5-21
P5.1 (cont=d.)
Transaction (2)
Retained earnings-S
(6 x ($50,000/10))
Accumulated Depreciation (4
x ($50,000/10))
30,000
20,000
Plant Assets ($200,000 ($450,000 - $300,000))
50,000
To eliminate the intercompany gain unconfirmed in prior years,
remove the excess depreciation recorded in prior years and
reduce the asset account to its net book value at date of
intercompany sale.
Accumulated Depreciation
5,000
Depreciation Expense
5,000
To eliminate the excess depreciation recorded by the
purchasing affiliate (Pert) in 20X8.
Plant Assets
300,000
Accumulated Depreciation
300,000
To restate the asset and accumulated depreciation accounts
to their original acquisition cost basis. The asset account now
equals $450,000 (=$200,000 - $50,000 + $300,000).
Accumulated Depreciation now equals $375,000
(= $100,000 - $20,000 - $5,000 + $300,000).
5-22
P5.1 (cont=d.)
Transaction (3)
Plant Assets ($200,000 ($600,000 - $360,000))
40,000
Investment in S
(4 x $40,000/5))
Accumulated Depreciation
($40,000/5)
32,000
8,000
To eliminate the intercompany loss unconfirmed in prior years,
add back the reduced depreciation recorded in prior years
and increase the asset account to its book value at date of
intercompany sale.
Depreciation Expense
8,000
Accumulated Depreciation
8,000
To add back the reduced depreciation recorded by the
purchasing affiliate (Smart) in 20X8.
Plant Assets
360,000
Accumulated Depreciation
360,000
To restate the asset and accumulated depreciation accounts
to their original acquisition cost basis. The asset account
now equals $600,000 (=$200,000 + $40,000 + $360,000).
Accumulated Depreciation now equals $376,000
(=$8,000 + $8,000 + $360,000).
P5.1 (cont=d.)
Requirement 2:
Consolidated Financial Statement Working Paper
Retained Earnings-S
30,000
Gain on Sale of Plant Assets
30,000
5-23
To include in current year income the portion of the original
intercompany gain of $50,000 which had not been confirmed
through depreciation as of the beginning of the year. This
remaining portion, which would have been reflected in
depreciation over the next six years (including 20X8), has now
been fully confirmed by an external sale in 20X8.
NOTE: If there is a minority interest in Smart, it would share in this
$30,000 gain but not in the gain of $280,000 recorded by Pert on the
external sale.
P5.2 INTERPRETING CONSOLIDATION ELIMINATION
ENTRIES: INTERCOMPANY EQUIPMENT SALE
Requirement 1:
Early in 20X5. Four years of depreciation have been recorded as of
December 31, 20X8.
Requirement 2:
S. The debit to Investment in S indicates that a downstream (P to S)
sale occurred.
Requirement 3:
$85,000, the current recorded cost on S's books.
5-24
P5.2 (cont=d.)
Requirement 4:
Equipment: $120,000
Accumulated depreciation: $75,000
Book value was $45,000 (= $85,000 sale price minus $40,000 gain).
Add the seller's accumulated depreciation of $75,000 to get seller's
cost.
Requirement 5:
Equipment: $120,000 (= $85,000 - $40,000 + $75,000)
Accumulated depreciation: 93,000 (=(4 x $8,500) - $16,000 +
$75,000)
P5.3 CONDENSED CONSOLIDATED FINANCIAL
STATEMENT WORKING PAPER--INTERCOMPANY
INVENTORY TRANSACTIONS
Requirement 1:
Schedule to Calculate the Equity Method Income Accrual
P's share of S's reported net income (.9 x $900,000)
Plus P's intercompany profits in S's beginning inventory
(downstream)
Plus P's share of S's intercompany profits in P's beginning inventory
(.9 x $100,000; upstream)
Less P's intercompany profits in S's ending inventory(downstream)
$810,000
60,000
90,000
(75,000)
Less P's share of S's intercompany profits in P's ending inventory (.9
X $80,000; upstream)
Equity method income accrual
5-25
(72,000)
$813,000
P5.3 (cont=d.)
P Company and S Company
Consolidated Financial Statement Working Paper
December 31, 20X6
Income Statement
Sales
Income from S
Inventory, December 31
Total Credits
Inventory, January 1
Purchases
Operating Expenses
Total Debits
Minority Interest in
Net Income
Net Income-to Retained
Earnings Statement
Retained Earnings Statement
Retained Earnings,
January 1, 20X6-P
Retained Earnings,
January 1, 20X6-S
Net Income-from Inc. Stmt.
Dividends-P
Dividends-S
Retained Earnings, Dec. 31,
20X6 to Bal. Sheet
P Company
15,000,000
813,000
1,950,000
17,763,000
2,000,000
9,000,000
4,150,000
15,150,000
-2,613,000
6,700,000
-2,613,000
(1,000,000)
-8,313,000
5-26
S Company
6,000,000
-980,000
6,980,000
950,000
3,200,000
1,930,000
6,080,000
--
Adjustments & Eliminations
Dr.
Cr.
(2) 5,900,000
(1)
813,000
(4)
155,000
6,868,000
(3)
160,000
(2) 5,900,000
6,060,000
(6)
900,000
92,000
(92,000)
6,960,000
6,060,000
-2,300,000
900,000
-(400,000)
2,800,000
Consolidated
15,100,000
-2,775,000
17,875,000
2,790,000
6,300,000
6,080,000
15,170,000
2,613,000
6,700,000
(3)
(5)
100,000
2,200,000
6,960,000
-6,060,000
(1)
(6)
9,260,000
360,000
40,000
6,460,000
2,613,000
(1,000,000)
-8,313,000
P5.3 (cont'd.)
Adjustments & Eliminations
Dr.
Cr.
P Company
S Company
1,950,000
3,453,000
980,000
--
10,810,000
16,213,000
5,120,000
6,100,000
4,900,000
3,000,000
--
2,100,000
-1,200,000
8,313,000
--
2,800,000
--
9,260,000
16,213,000
6,100,000
10,460,000
6,460,000
340,000
52,000
6,852,000
10,520,000
10,520,000
Consolidated
Balance Sheet
Inventory
Investment in S
Other Assets
Total
Liabilities
Capital Stock-P
Capital Stock-S
Retained Earnings-from Ret.
Earn. Stmt.
Minority Interest in S
Total
5-27
(3)
60,000
(4)
155,000
(1)
453,000
(5) 3,060,000
60,000
3,668,000
2,775,000
-15,930,000
18,705,000
7,000,000
3,000,000
--
(5) 1,200,000
(5)
(6)
8,313,000
392,000
18,705,000
P5.3 (cont'd.)
Formal Eliminating Entries
(Not Required)
(1)
Income from S
813,000
Dividends - S
Investment in S
360,000
453,000
To reverse the current period equity method entries.
(2)
Sales
5,900,000
Purchases
5,900,000
To eliminate intercompany merchandise sales;
$5,900,000 = $2,200,000 + $3,700,000.
(3)
Investment in S
Retained Earnings - S,
January 1
60,000
100,000
Inventory, January 1,
Income Statement
160,000
To eliminate the intercompany profit from the beginning
inventory, assumed confirmed during 20X6. The $60,000
in S=s beginning inventory resulted from downstream sales
and the $100,000 in P=s beginning inventory resulted from
upstream sales.
(4)
Inventory, December 31,
Income Statement
155,000
Inventory, Balance
Sheet
To eliminate the unconfirmed intercompany profit from
the ending inventories of P and S.
5-28
155,000
P5.3 (cont=d.)
(5)
Retained Earnings - S,
January 1
Capital Stock - S
2,200,000
1,200,000
Investment in S
Minority Interest in S
3,060,000
340,000
To eliminate the investment account against the stockholders=
equity of S and establish the minority interest, all as of
January 1, 20X6. Note that the amount of S=s beginning
retained earnings eliminated here reflects the removal of
$100,000 of upstream intercompany profit in P=s beginning
inventory in elimination (3) above.
(6)
Minority Interest in Net
Income
92,000
Dividends - S
Minority Interest in S
40,000
52,000
To record the change in the minority interest during 20X6.
The minority interest in net income consists of:
Minority=s share of S=s reported net income (.1 x $900,000)
Plus minority share of upstream intercompany profits in P=s
beginning inventory (.1 x $100,000)
Less minority=s share of upstream intercompany profits in P=s
ending inventory (.1 x $80,000)
Minority interest in net income
$90,000
10,000
(8,000)
$92,000
NOTE: Minority Interest in S at December 31, 20X6 is $392,000.
[.1($1,200,000 + $2,800,000 - $80,000) = $340,000 + $52,000].
5-29
P5.4
BONUS BASED ON ADJUSTED SUBSIDIARY INCOME
Net income before taxes
Adjustment for unconfirmed intercompany inventory
profits:
Increase in inventory
Percent acquired from parent
Increase in intercompany inventory
Gross margin percentage
Unconfirmed intercompany inventory profit
Plus interest paid to parent (= $600,000 x .10)
Revised income base
Less 40% for corporate costs and income taxes
Base for bonus
Bonus
5-30
$150,000
$380,000
x .8
$304,000
x .35
(106,400)
60,000
$103,600
(41,440)
$ 62,160
x .15
$ 9,324
P5.5 CONSOLIDATED INCOME
STATEMENTCINTERCOMPANY TRANSACTIONS
Requirement 1:
Pow Company and Sow Company
Schedule to Compute the Equity Method Income Accrual
Pow's share of Sow's reported net income (.95 x $800,000)
Plus Pow's share of Sow's intercompany profit in Pow's beginning
inventory, now assumed confirmed (.95 x $400,000)
Less Pow's unconfirmed intercompany profit in Sow's ending
inventory
Plus Pow's share of Sow's unconfirmed loss on an intercompany
sale of land (.95 x $100,000)
Less Pow's unconfirmed gain on intercompany sale of machinery at
the beginning of the year [$250,000 - $250,000/5)]
$760,000
380,000
(200,000)
95,000
(200,000)
Plus Pow's gain on prior year intercompany sale of land now
confirmed through external sale
Net equity method income accrual
5-31
60,000
$895,000
P5.5 (cont=d.)
Requirement 2:
Pow Company and Sow Company
Consolidated Statement of Income and Retained Earnings
Sales
Other Income
Total Revenue
Cost of Goods sold
Operating Expenses
Other Expenses
Total Expenses
Minority Interest in Net Income
Consolidated Net Income
Consolidated Retained Earnings, January 1
Dividends
Consolidated Retained Earnings, December 31
$32,000,000 (1)
1,510,000 (2)
$33,510,000
$23,400,000(3)
5,850,000(4)
1,000,000(5)
$30,250,000
$ 65,000(6)
$ 3,195,000
15,700,000
(1,000,000)
$17,895,000
(1) $32,000,000 = $25,000,000 + $10,000,000 - $3,000,000
(intercompany sales).
(2) $1,510,000 = $1,200,000 + $500,000 - $250,000 (unconfirmed gain on
machinery) + $60,000 (prior period gain on land now confirmed).
(3) $23,400,000 = $19,000,000 + $7,600,000 - $3,000,000 (intercompany
purchases) - $400,000 (intercompany profit in beginning inventory
assumed confirmed) + $200,000 (unconfirmed intercompany profit in
ending inventory)
(4) $5,850,000 = $4,100,000 + $1,800,000 - $50,000 (excess depreciation)
(5) $1,000,000 = $800,000 + $300,000 - $100,000 (unconfirmed loss on
land)
(6) $65,000 = .05 ($800,000 + $400,000 (intercompany profit in beginning
inventory assumed confirmed) + $100,000 (unconfirmed loss on land)).
5-32
P5.6
CALCULATION OF CONSOLIDATED RETAINED
EARNINGS
Requirement 1
Calculation of Consolidated Retained Earnings
Philip's retained earnings from its own operations
Plus 75 percent of Samson's total net income since acquisition
(.75 x $4,000,000)
Less 75 percent of unconfirmed gain on upstream intercompany
sale of land [.75 (%56,000 - $40,000)]
Less original gain on downstream intercompany sale of patent
($80,000 - $10,000)
Plus portion of intercompany gain on patent assumed confirmed
through amortization [3($80,000 - $10,000)/10]
Less unconfirmed intercompany profit in Samson's ending
inventory (downstream)
Less 75 percent of unconfirmed intercompany profit in Philip's
ending inventory (upstream; .75 x $60,000)
Less four years of purchase premium amortization:
Depreciable assets [4(.75 x $120,000/5)]
Goodwill impairment
Consolidated retained earnings, December 31, 20X4
$4,750,000
3,000,000
(12,000)
(70,000)
21,000
(85,000)
(45,000)
(72,000)
(11,000)
$7,476,000
NOTE: Samson's dividends do not enter into the calculation of
consolidated retained earnings. The 75 percent of Samson's dividends
paid to Philip are implicitly included in Philip's 75 percent share of
Samson's total net income since acquisition. Dividends paid by Philip
to its shareholders are relevant and have been reflected in the
$4,750,000 given as Philip's retained earnings from its own operations
at December 31, 20X4.
5-33
P5.6 (cont=d.)
Requirement 2:
The difference between consolidated retained earnings and
Philip's retained earnings from its own operations equals the sum of
Philip's equity method accruals during 20X1-20X4. It is the increment
to consolidated net income represented by Philip's share of Samson's
earnings, adjusted for purchase premium amortization and
unconfirmed intercompany profits. Under the equity method, the
investment account is reduced by the parent's share of the subsidiary's
dividends. Therefore, the balance in the investment account at
December 31, 20X4, under the equity method, is $2,826,000
[=$1,900,000 + ($7,476,000 - $4,750,000) - (.75 x $2,400,000)].
P5.7
EQUITY ACCRUAL AND ELIMINATING ENTRIES-INTERCOMPANY ASSET TRANSFERS, SERVICES,
AND
RECEIVABLES/PAYABLES
Requirement 1:
Schedule to Compute P's 20X4 Equity Method Income Accrual
P's share of S's net income (.8 X $200,000)
Plus intercompany profits in S's beginning inventory (downstream
sales) (.2 x $25,000)
Less 80% of intercompany profits in P's ending inventory
(upstream sales) (.8 x .2 x $40,000)
Less 80% of unconfirmed gain on upstream intercompany sale of
machinery; .8 [$20,000 - ($20,000/5)]
Purchase premium amortization ($50,000/20)
Equity method income accrual
P5.7 (cont=d.)
Requirement 2:
Consolidated Financial Statement Working Paper
Income from S
143,300
Dividends - S
5-34
$160,000
5,000
(6,400)
(12,800)
(2,500)
$143,300
(.8 x .4 x $200,000)
Investment in S
64,000
79,300
To eliminate the current year equity method entries made by P.
Retained Earnings - S
10,000
Land
10,000
To eliminate the unconfirmed gain from the prior year upstream
transfer of land and reduce the Land account to original
acquisition cost.
Sales
250,000
Purchases
250,000
To eliminate intercompany merchandise sales.
Investment in S
5,000
Inventory, 1/1/X4, I/S
5,000
To eliminate unconfirmed intercompany profit on downstream
sales from beginning inventory.
Inventory, 12/31/X4, I/S
8,000
Inventory, B/S
8,000
To eliminate unconfirmed intercompany profit on upstream sales
from ending inventory; $8,000 = $40,000 - ($40,000/1.25).
Gain on Sale of Machinery
20,000
Machinery
To eliminate the gain on the intercompany sale of machinery.
5-35
20,000
P5.7 (cont=d.)
Accumulated Depreciation
4,000
Depreciation Expense
4,000
To eliminate excess depreciation on the machinery acquired
from S; this is the portion of the $20,000 gain confirmed to
S in 20X4.
Machinery
30,000
Accumulated Depreciation
30,000
To restate the machinery and accumulated depreciation accounts
to their original acquisition cost basis.
Computer Service Revenue
15,000
Computer Service
Expense
15,000
To eliminate intercompany revenue and expense.
Accounts Payable
2,000
Accounts Receivable
2,000
To eliminate intercompany receivables and payables.
Plant Assets
Stockholders= Equity - S (1)
50,000
1,580,000
Investment in S (2)
Accumulated
Depreciation
Minority Interest in
S (3)
To eliminate the investment account against the stockholders=
equity of S and establish the minority interest and revalue
plant assets, all as of 1/1/X4.
5-36
1,311,500
2,500
316,000
P5.7 (cont=d)
(1)
(2)
$1,580,000 = ($1,250,000 - $50,000)/.8 + $150,000 - .4 x
$150,000 - $10,000.
The beginning of the year balance in the Investment is
$1,306,500, calculated as $1,250,000 + $104,500 (equity in net
income for 20X3) - $48,000 (dividends). Equity in net income
for 20X3 is calculated as follows:
$150,000 x 80% =
unconfirmed upstream land profit
unconfirmed downstream profit in ending inventory
purchase premium amortization (depreciation)
Equity in net income of S, 20X3
(3)
$120,000
( 8,000)
( 5,000)
( 2,500)
$104,500
$316,000 = .2 x $1,580,000.
Depreciation Expense
2,500
Accumulated Depreciation
2,500
To record current year purchase premium amortization.
Minority Interest in Net Income
(1)
35,200
Dividends - S (.2 x .4 x
$200,000)
Minority Interest in S
To record the change in the minority interest during 20X4.
(1) $35,200 = .2 ($200,000) - $1,600 - $4,000 + $800.
5-37
16,000
19,200
P5.8
EQUITY ACCRUAL AND ELIMINATING ENTRIES-INTERCOMPANY ASSET TRANSFERS
Requirement 1:
Schedule to Compute P's 20X8 Equity Method Income Accrual
P's share of S's reported net income (.8 x $130,000)
Plus P's share of upstream intercompany profit in beginning
inventory, confirmed during 20X8 (.8 x $20,000)
Less purchase premium amortization (depreciation) in 20X8
($200,000/5)
Less unconfirmed downstream intercompany profit in ending
inventory
Less gain on downstream intercompany sale of machinery
Plus portion of intercompany equipment gain assumed
confirmed via depreciation in 20X8 ($6,000/6)
Equity method income accrual
$104,000
16,000
(40,000)
(12,000)
(6,000)
1,000
$ 63,000
Requirement 2:
Consolidated Financial Statement Working Paper
Income from S (see above)
63,000
Dividends - S (.8 x
$65,000)
Investment in S
52,000
11,000
To eliminate the current year equity method entries made by P.
Retained earnings - S
20,000
Inventory 1/1/X8, I/S
20,000
To eliminate unconfirmed intercompany profit on upstream sales
from beginning inventory.
5-38
P5.8 (cont=d.)
Inventory, 12/31/X8, I/S
12,000
Inventory, B/S
12,000
To eliminate unconfirmed intercompany profit on downstream
sales from ending inventory.
Gain on Sale of Equipment
6,000
Equipment
6,000
To eliminate the gain on the intercompany sale of equipment.
Accumulated Depreciation
1,000
Depreciation Expense
1,000
To eliminate the excess depreciation on the equipment acquired
from P; this is the portion of the $6,000 gain confirmed to P
in 20X8.
Sales
132,000
Purchases
132,000
To eliminate intercompany sales for 20X8.
Stockholders= Equity S, 1/1 (1)
Depreciable Assets (2)
1,030,000
160,000
Investment in S (3)
Minority Interest in S (4)
984,000
206,000
To eliminate the remaining Investment in S balance against
S=s equity accounts, revalue S=s depreciable assets as of the
beginning of the year, and set up the minority interest in S
as of the beginning of the year.
(1)
S=s 1/1 Stockholders= Equity = ($800,000/.8) + $100,000 $50,000
= $1,050,000
$20,000 of S=s Stockholders= Equity was eliminated previously.
5-39
P5.8 (cont=d.)
(2)
Depreciable Assets on 1/1 = $200,000 original premium less
$40,000 for one year=s depreciation.
(3)
Investment in S on 1/1/X8 = $1,000,000 + $24,000 (equity in
net income of S for 20X7) - $40,000 (dividends for 20X7).
Equity in net income of S for 20X7 is calculated as follows:
80% of S=s book income for 20X7
Depreciation of premium
Unrealized profit in ending inventory (upstream)
Equity in net income of S, 20X7
(4)
$80,000
( 40,000)
( 16,000)
$24,000
Minority interest in S on 1/1/X8 is 20% x $1,030,000.
Depreciation Expense
40,000
Accumulated Depreciation
40,000
To record current year purchase premium amortization.
Minority Interest in Net
Income (1)
30,000
Dividends - S (.2 x .5 x
$130,000)
Minority Interest in S
To record the change in minority interest during 20X8.
(1) $30,000 = .2 ($130,000 + $20,000).
5-40
13,000
17,000
P5.9
COMPREHENSIVE INTERCOMPANY TRANSACTIONS
Stockholders' equity - S
7,000,000
Investment in S
Sales
7,000,000
60,000,000
Purchases (cost of
goods sold)
Investment in S
60,000,000
2,000,000
Beginning inventory
(cost of goods sold)
Ending inventory (cost
of goods sold)
2,000,000
2,600,000
All other assets
Franchise fee revenue
2,600,000
8,000,000
Franchise fee expense
Interest revenue
8,000,000
4,000,000
Interest expense
Liabilities
4,000,000
43,000,000
All other assets
5-41
43,000,000
P5.10 COMPREHENSIVE INTERCOMPANY
TRANSACTIONS
Requirement 1:
(a)
Land
25,000
Loss on sale
25,000
(b)
Ending inventory, I/S
(cost of goods sold)
45,000
Inventory
45,000
(c)
Retained Earnings - S
28,000
Beginning inventory, I/S
(cost of goods sold)
28,000
(d)
Investment in S
Accumulated
depreciation
56,000
24,000
Equipment
Equipment
80,000
270,000
Accumulated depreciation
Accumulated
depreciation
270,000
8,000
Depreciation expense
5-42
8,000
P5.10 (cont=d.)
Requirement 2:
Increase EMIA by
($ amount)
25,000
Transaction
a.
b.
c.
d.
Decrease EMIA by
($ amount)
No effect
(check)
36,000
22,400
8,000
Requirement 3:
Transaction
Decrease MINI by
($ amount)
No effect
(check)

a.
b.
c.
d.
P5.11
Increase MINI by
($ amount)
9,000
5,600

INVENTORY COST FLOW ASSUMPTIONS
Requirement 1:
The key to this problem lies in calculating the unconfirmed intercompany
profit in ending inventory. Selling companies= per-unit markups in current
year sales are shown below. These amounts are in the buyers= ending
inventories; i.e., Pin=s $40 markup is in Stick=s ending inventory and Stick=s
$8 markup is in Pin=s ending inventory.
Pin: .2 X $200,000/1,000 =
Stick: [(.2/1.2) X $600,000]/12,500 =
$40
$ 8
Under FIFO, with an inventory turnover of at least one, all units in beginning
inventories are sold and profits confirmed, thereby increasing group income.
Unconfirmed ending inventory profits result entirely from current year sales
and reduce group income.
5-43
P5.11 (cont=d.)
In sum:
Increase (Decrease) in
Group Income
Total beginning intercompany profit confirmed ($42,000 +
$17,000)
Intercompany profit in Pin=s ending inventory unconfirmed
($8 X 8,000)
Intercompany profit in Stick=s ending inventory unconfirmed (
$40 X 1,000)
Decrease in group income under FIFO
$ 59,000
(64,000)
(40,000)
$(45,000)
Requirement 2:
Under LIFO, with both inventories remaining constant or increasing, ending
intercompany profits consist of the beginning layer(s) plus, in the case of Pin,
$32,000 in profits on 4,000 units of current year purchases from Stick. Thus
the only effect on group income is a decrease of $32,000:
Increase (Decrease) in
Group Income
Total beginning intercompany profit confirmed ($42,000 +
$17,000)
Intercompany profit in Pin=s ending inventory unconfirmed
($42,000 + $32,000)
Intercompany profit in Stick=s ending inventory unconfirmed
$ 59,000
(74,000)
(17,000)
$(32,000)
Decrease in group income under FIFO
5-44
P5.11 (cont=d.)
Requirement 3:
The fact that group income is higher under LIFO by $13,000 (= $45,000 $32,000) is explained by observing that Stick=s per-unit markup decreased to
$8 from $10.50 (= $42,000/4,000) and Pin=s per-unit markup increased to $40
from $17 (= $17,000/1,000). Net of intercompany profit, Stick=s ending
inventory is $23,000 higher under LIFO ($17,000 is eliminated, $23,000 less
than the $40,000 eliminated under FIFO) whereas Pin=s ending inventory is
$10,000 lower under LIFO ($74,000 is eliminated, $10,000 more than the
$64,000 eliminated under FIFO).
LIFO income higher for Pin (based on sales to Stick)
[= ($40 - $17) X 1,000]
LIFO income lower for Stick (based on sales to Pin)
[= ($8 - $10.50) X 4,000]
Group income higher under LIFO than under FIFO
5-45
$ 23,000
(10,000)
$ 13,000
P5.12
CONSOLIDATED INCOME STATEMENT
CINTERCOMPANY TRANSACTIONS
P Co. and S Co.
Consolidated Income Statement
Sales (40,000,000 + 25,000,000 - 4,000,000)
Other Income
(6,000,000 + 2,000,000 - 190,000 + 100,000)
Total Revenue
Cost of Goods Sold (28,000,000 + 15,000,000 - 4,000,000 - 650,000
+ 500,000)
Operating Expenses
(7,000,000 + 5,000,000 + 60,000 - 50,000)
Other Expenses (1,000,000 + 800,000 - 360,000)
Total Expenses
Minority Interest in Net Income [.2 X (6,200,000 - 500,000 190,000 + 100,000 + 50,000)]
Net Income
$61,000,000
7,910,000
$68,910,000
$38,850,000
12,010,000
1,440,000
$52,300,000
$ 1,132,000
$15,478,000
Check: 15,478,000 = 10,000,000 + (.8 X 6,200,000) + 650,000 - (.8 X
500,000) + 360,000 - 60,000 - (.8 X 190,000) + (.8 X 100,000) + (.8 X
50,000); equity method accrual is 5,478,000 [= .8 X (6,200,000 - 500,000 190,000 + 100,000 + 50,000) + 650,000 + 360,000 - 60,000].
NOTE ON THE PATENT: The patent acquired internally from S had a net
book value of 200,000 [= 500,000 - (3/5) X 500,000] when sold by P for
420,000. The 220,000 (= 420,000 - 200,000) external gain reported in Other
Income is fully confirmed and does not affect the consolidation. This year=s
50,000 (= 250,000/5) excess amortization is eliminatedBincreasing
incomeBbecause the patent was held internally for the entire year. Moreover,
the remaining 100,000 upstream intercompany gain is now fully confirmed by
the external sale and is added to this year=s income. The 100,000 is the
original 250,000 intercompany gain reduced by three years of excess
amortization at 50,000 a year.
5-46