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Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

CHAPTER 5
CONSOLIDATED FINANCIAL STATEMENTS - INTRA-ENTITY ASSET
TRANSACTIONS
Answers to Questions
1.

2.

3.

4.

5.

6.

One reason for the significant volume and frequency of intra-entity 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 gross profit rate, the $100,000 was simply an intra-entity asset transfer. Thus,
within the consolidation process, the entire $100,000 should be eliminated from both the Sales
and the Purchases (Inventory) accounts.
Sales price per unit ($900,000 3,000 units)
$ 300
Number of units in Safecos ending inventory
500
Intra-entity inventory at transfer price
$150,000
Gross profit rate (0.6 1.6)
.375
Intra-entity profit in ending inventory
$56,250
In intra-entity 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
deferred whenever consolidated financial statements are prepared. 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 realized
gross profit must be recognized within the consolidation process. Reductions are made on the
worksheet to the beginning inventory component of cost of goods sold and to the beginning
retained earnings balance of the original seller. The gross profit is thus taken out of last years
earnings (retained earnings) and recognized in the current year through the reduction of cost of
goods sold. If the transfer was downstream in direction and the parent company has applied the
equity method, the adjustment in the subsequent year is made to the Investment in Subsidiary
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.
GAAP allows discretion regarding the effect of unrealized intra-entity profits and noncontrolling
interest values. 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

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Chapter 05 - Consolidated Financial Statements Intra-Entity Asset Transactions

7.

8.

9.

10.

11.

transfers (from subsidiary to parent) are attributed to the subsidiary. The effects resulting from
the deferral and eventual recognition of these intra-entity profits are considered in 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.
Consolidated financial statements are largely unchanged across downstream versus upstream
transfers. Sales and purchases (Inventory) balances created by the transactions are eliminated
in total. Any unrealized gross profits remaining at the end of a fiscal period get deferred until
ultimately earned through sale or consumption of the assets.
The direction of intra-entity 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
intra-entity 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 intra-entity 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. Intra-entity 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 intra-entity 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 deferred through an adjustment to cost of goods
sold, but a specific gain or loss 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 or
loss must be repeatedly deferred in each fiscal period, through retained earnings, 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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Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

12.

13.

According to this question, the land is eventually sold to an outside party. The intra-entity 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 intra-entity gain, 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
intra-entity transfer and must be deferred in the preparation of consolidated financial
statements. 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 initial
overstatement due to the gain is offset by the acculmulating overstatement ofdepreciation
expense. Therefore, the overstatement of the equity account is gradually reduced to a zero
balance over the life of the asset.

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Chapter 05 - Consolidated Financial Statements Intra-Entity Asset Transactions

Answers to Problems
10. D Add the two book values and remove $100,000 intra-entity transfers.
11. C Intra-entity gross profit ($100,000 - $80,000) ................................
Inventory remaining at year's end ..................................................
Unrealized intra-entity gross profit ................................................
CONSOLIDATED COST OF GOODS SOLD
Parent balance ............................................................................
Subsidiary balance .....................................................................
Remove intra-entity transfer ......................................................
Defer unrealized gross profit (above) ......................................
Cost of goods sold ..........................................................................
12. C Consideration transferred .............................
Noncontrolling interest fair value...................
Suarez total fair value......................................
Book value of net assets.................................
Excess fair over book value

$20,000
60%
$12,000
$140,000
80,000
(100,000)
12,000
$132,000

$260,000
65,000
$325,000
(250,000)
$75,000
Annual Excess

Excess fair value to undervalued assets:


Equipment ...................................................
Secret Formulas .........................................
Total .................................................................

Life Amortizations
25,000 5 years
$5,000
$50,000 20 years
2,500
-0$7,500

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

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Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

13. A 20% of the beginning book value


Excess fair value allocation (20% $75,000)
20% share of Suarez net income
adjusted for amortization (20% [110,000 7,500])
Ending noncontrolling interest balance

$50,000
15,000
20,500
$85,500

14. C Add the two book values plus the $25,000 original allocation less one year of
excess amortization expense ($5,000).
15. B Add the two book values less the ending unrealized gross profit of $12,000.
Combined pre-consolidation inventory balances......................... $260,000
Intra-entity gross profit ($100,000 $80,000) ................... $20,000
Inventory remaining at year's end ......................................
60%
Unrealized intra-entity gross profit, 12/31 .....................................
12,000
Consolidated total for inventory.....................................................
$248,000
16.

(15 Minutes) (Determine selected consolidated balances; includes inventory


transfers and an outside ownership.)
Customer list amortization = $65,000 5 years = $13,000 per year
Intra-entity gross profit ($160,000 $120,000) .............................
Inventory remaining at year's end...................................................
Unrealized intra-entity gross profit, 12/31 .....................................

$40,000
20%
$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 intraentity transfer)

Cost of goods sold = $548,000 (add the two book values and subtract the intraentity 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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Chapter 05 - Consolidated Financial Statements Intra-Entity Asset Transactions

18.

(40 Minutes) (Series of independent questions concerning various aspects of


the consolidation process when intra-entity transfers have occurred)
a. Placid Lake's 2013 net income before effect from Scenic......
Scenic's reported net income 2013 ..........................................
Amortization expense (given) ..................................................
Realization of 2012 intra-entity gross profit (see below) ......
Deferral of 2013 intra-entity gross profit (see below) .............
Consolidated net income............................................................

$300,000
110,000
(5,000)
7,200
(16,200)
$396,000

2012 Unrealized gross profit to be recognized in 2013:


Intra-entity gross profit on transfers ($90,000 $54,000) ......
Inventory retained at end of 2012 .............................................
Unrealized gross profit12/31/12 .......................................

$36,000
20%
$ 7,200

2013 Unrealized gross profit deferred:


Intra-entity gross profit on transfers ($120,000 $66,000) ....
Inventory retained at end of 2013 .............................................
Unrealized gross profit12/31/13........................................

$54,000
30%
$16,200

b. Noncontrolling interest's share of Scenic's income (upstream sales):


Scenic's reported net income 2013...........................................
$110,000
Amortization of excess fair value to intangibles.....................
(5,000)
2012 gross profit realized in 2013 (upstream sales) ...............
7,200
2013 gross profit deferred (upstream sales) ...........................
(16,200)
Scenic's realized income ...........................................................
$96,000
Noncontrolling interest ownership ...........................................
20%
Noncontrolling interest's share of Scenic's net income.........
$19,200
Placid Lakes net income from own operations.......................
Placid Lakes share of Scenics adjusted NI (80% $96,000). . .
Placid Lakes share of consolidated net income ....................

$300,000
76,800
$376,800

c. Noncontrolling interest's share of Scenic's net income (downstream sales):


Downstream transfers do not affect the noncontrolling interest.
Scenic's reported net income 2013 after amortization............
Noncontrolling interest ownership ...........................................
Noncontrolling interest share of Scenic net income ..............

$105,000
20%
$21,000

Placid Lakes net income from own operations.......................


Placid Lakes share of Scenics adjusted NI (80% $105,000).
Realization of 2012 intra-entity gross profit (see part a.) .....
Deferral of 2013 intra-entity gross profit (see part a.) ............
Placid Lakes share of consolidated net income ....................

$300,000
84,000
7,200
(16,200)
$375,000

18. (continued)

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Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

d. InventoryPlacid Lake book value ..........................................


InventoryScenic book value ...................................................
Unrealized gross profit, 12/31/13 (see part a) .........................
Consolidated inventory .............................................................
(Direction of transfer has no impact here)

$140,000
90,000
(16,200)
$213,800

e. LandPlacid Lakes book value ...............................................


LandScenic's book value .......................................................
Elimination of unrealized intra-entity gain on land .................
Consolidated land balance ........................................................

$600,000
200,000
(20,000)
$780,000

f. The intra-entity transfer was upstream from Scenic to Placid Lake. Because the
transfer occurred in 2012, beginning retained earnings of the seller for 2013
contains the remaining portion of the unrealized gain.
Transfer pricing figures:
2012

Equipment
Gain
Depreciation expense
Income effect
Accumulated depreciation

=
=
=
=
=

$80,000
$20,000 ($80,000 $60,000)
$16,000 ($80,000 5)
$4,000 ($20,000 $16,000)
$16,000

2013

Depreciation expense
Accumulated depreciation

=
=

$16,000
$32,000

Historical cost figures:


2012

Equipment
Depreciation expense
Accumulated depreciation

=
=
=

$100,000
$12,000 ($60,000 5 years)
$52,000 ($40,000 + $12,000)

2013

Depreciation expense
Accumulated depreciation

=
=

$12,000
$64,000

CONSOLIDATION ENTRIES FOR TRANSFERRED EQUIPMENT


ENTRY *TA
Retained Earnings, 1/1/13 (Scenic) ..........................
Equipment ($100,000 $80,000) ...............................
Accumulated Depreciation ($52,000 $16,000).

16,000
20,000
36,000

To change beginning of year figures to historical cost by removing impact of 2012


transactions. Retained earnings reduction removes $4,000 income effect (above)
and replaces it with $12,000 depreciation expense for 2012.

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Chapter 05 - Consolidated Financial Statements Intra-Entity Asset Transactions

18. (continued)
ENTRY ED
Accumulated Depreciation ........................................
4,000
Depreciation Expense ..........................................
4,000
To reduce depreciation from transfer price ($16,000) to historical cost of $12,000.
This intra-entity transfer was upstream from Scenic to Placid Lake. Thus, income
effects are assumed to relate to the original seller (Scenic). Because the sale
occurred in 2012, the only effect in 2013 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 Scenic and the
noncontrolling interest computations.
Transfer price depreciation: $80,000 5 yrs. = $16,000
Historical cost depreciation (based on book value): $60,000 5 yrs. = $12,000
Noncontrolling Interest in Scenic's Net Income
Scenic's reported net income less excess amortization .........
Reduction of depreciation expense to historical cost figure.
Scenic's realized income .............................................................
Outside ownership percentage ..................................................
Noncontrolling interest in Scenics net income ..................

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$105,000
4,000
$109,000
20%
$21,800

Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

20.

(30 Minutes) (Compute selected balances based on three different intra-entity


asset transfer scenarios)
a. Consolidated Cost of Goods Sold
Penguins cost of goods sold ...................................................
Snows cost of goods sold ........................................................
Elimination of 2013 intra-entity transfers .................................
Reduction of beginning Inventory because of
2012 unrealized gross profit ($28,000 1.4 = $20,000
cost; $28,000 transfer price less $20,000
cost = $8,000 unrealized gross profit) ................................
Reduction of ending inventory because of
2013 unrealized gross profit ($42,000 1.4 = $30,000
cost; $42,000 transfer price less $30,000
cost = $12,000 unrealized gross profit) ..............................
Consolidated cost of goods sold ..................................
Consolidated Inventory
Penguin book value ..............................................................
Snow book value ...................................................................
Defer ending unrealized gross profit (see above) ............
Consolidated Inventory ........................................................

$290,000
197,000
(110,000)

(8,000)

12,000
$381,000
$346,000
110,000
(12,000)
$444,000

Noncontrolling Interest in Subsidiarys Net Income


Because all intra-entity 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 net income or $11,600.
b. Consolidated Cost of Goods Sold
Penguin book value ....................................................................
Snow book value ........................................................................
Elimination of 2013 intra-entity transfers .................................
Reduction of beginning inventory because of
2012 unrealized gross profit ($21,000 1.4 = $15,000
cost; $21,000 transfer price less $15,000
cost = $6,000 unrealized gross profit) ................................
Reduction of ending inventory because of
2013 unrealized gross profit ($35,000 1.4 = $25,000
cost; $35,000 transfer price less $25,000
cost = $10,000 unrealized gross profit) ..............................
Consolidated cost of goods sold .............................................

5-9

$290,000
197,000
(80,000)

(6,000)

10,000
$411,000

Chapter 05 - Consolidated Financial Statements Intra-Entity Asset Transactions

20. b. (continued)
Consolidated inventory
Penguin book value ....................................................................
Snow book value ........................................................................
Defer ending unrealized gross profit (see above) ..................
Consolidated inventory ........................................................

$346,000
110,000
(10,000)
$446,000

Noncontrolling interest in subsidiarys net income


Since all intra-entity sales are upstream, the effect on Snow's net income must
be reflected in the noncontrolling interest computation:
Snow reported net income ........................................................
2012 unrealized gross profit realized in 2013 (above) ............
2013 unrealized gross profit to be realized in 2014 (above) ..
Snow realized income ................................................................
Outside ownership percentage .................................................
Noncontrolling interest in Snow's net income ...................

$58,000
6,000
(10,000)
$54,000
20%
$10,800

c. Consolidated buildings (net)


Penguins buildings .................................................
Snow's buildings .....................................................
Remove write-up created by transfer
($80,000 $50,000) .............................................
Remove excess depreciation created by transfer
($30,000 unrealized gain over 5 year life)
(2 years) ...............................................................
Consolidated buildings (net) ............................

$358,000
157,000
$(30,000)
12,000

(18,000)
$497,000

Consolidated expenses
Penguins book value ..............................................
Snow's book value ..................................................
Remove excess depreciation on transferred building
($30,000) unrealized gain 5 years) .................
Consolidated expenses ..........................................

$150,000
105,000
(6,000)
$249,000

Noncontrolling interest in subsidiarys net income


Because the transfer was made downstream, it has no effect on the
noncontrolling interest. Thus, Snow's reported net 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 net income of
$11,600 (20% $58,000).

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Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

25.

(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 ProfitInventory, 1/1/13:
Gross profit ($70,000 $49,000) ...............................................
Gross profit rate ($21,000 $70,000) ........................................

$21,000
30%

Remaining inventory ..................................................................


Gross profit rate .........................................................................
Unrealized gross profit, 1/1/13...................................................

$30,000
30%
$9,000

Unrealized Gross ProfitInventory, 12/31/13:


Gross profit ($100,000 $50,000) .............................................
Gross profit rate ($50,000 $100,000) .....................................

$50,000
50%

Remaining inventory ..................................................................


Gross profit rate..........................................................................
Unrealized gross profit, 12/31/13 ..............................................

$40,000
50%
$20,000

Impact of intra-entity Building Transfer:


12/31/12Transfer price figures
Transfer price .........................................................................
Gain on transfer ($50,000 $30,000) ...................................
Depreciation expense ($50,000 5 years) ..........................
Accumulated depreciation ...................................................
12/31/13Transfer price figures
Depreciation expense ...........................................................
Accumulated depreciation ...................................................
12/31/12Historical cost figures
Historical cost .......................................................................
Depreciation expense ($30,000 book value 5 years) ......
Accumulated depreciation ($40,000 + $6,000) ...................
12/31/13Historical cost figures
Depreciation expense ...........................................................
Accumulated depreciation ...................................................

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$50,000
20,000
10,000
10,000
10,000
20,000
$70,000
6,000
46,000
6,000
52,000

Chapter 05 - Consolidated Financial Statements Intra-Entity Asset Transactions

25. (continued)
CONSOLIDATED BALANCES

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

Cost of Goods Sold = $571,000 (add the two book values and subtract $100,000 in
intra-entity 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 intra-entity 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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Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

27.

(65 Minutes) (Determine consolidation totals after answering a series of questions


about combination and intra-entity inventory transfers)
a. Consideration transferred ........................
Noncontrolling interest fair value.............
Subsidiary fair value at acquisition-date .
Book value...................................................
Fair value in excess of book value ..........
Excess fair value assignments
To building ............................................
To patented technology .......................
Totals......................................................

$342,000
38,000
380,000
(326,000)
$54,000
18,000
36,000
-0-

Life
9 yrs.
6 yrs.

Annual Excess
Amortizations
$2,000
6,000
$8,000

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


c. Gross profit on 2012 transfers ($135,000 $81,000) ..............
Gross profit percentage ($54,000 $135,000) .........................

$54,000
40%

Inventory remaining, 12/31/12 ..................................................


Gross profit percentage .............................................................
Unrealized gross profit, January 1, 2013 ................................

$37,500
40%
$15,000

d. Gross profit on 2013 transfers ($160,000 $92,800) .............


Gross profit percentage ($67,200 $160,000) .........................

$67,200
42%

Inventory remaining, 12/31/13 ..................................................


Gross profit percentage .............................................................
Unrealized gross profit, December 31, 2013 ...........................

$50,000
42%
$21,000

27. (continued)
e. 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.
Breys reported net income .......................................................
Excess fair value amortization...................................................
Realized gross profit .................................................................
Deferred gross profit...................................................................
Adjusted subsidiary income.......................................................
Ownership ...................................................................................
Investment incomeBrey ..........................................................

$90,000
(8,000)
15,000
(21,000)
$76,000
90%
$68,400

f. Breys adjusted income (see e.) ................................................


Outside ownership .....................................................................
Noncontrolling interest in subsidiary's net income ................

$76,000
10%
$7,600

g. Investment in Brey (consideration transferred) ......................

$342,000

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Chapter 05 - Consolidated Financial Statements Intra-Entity Asset Transactions

Net Income of Brey


Reported 2011........................................
2012 ..................................................
2013 .................................................
Total ..................................................
Unrealized gross profit, 12/31/13(see d.)
Realized income 2011-2013 ................
Petinos ownership ...............................
Excess amortizations ($8,000 3 years 90%)

$64,000
80,000
90,000
234,000
(21,000)
213,000
90%

Dividends paid by Brey


2011 ...................................................
2012 ..................................................
2013 .................................................
Total ..................................................
Pitino's ownership ................................
Investment in Brey, 12/31/13 ....................

$19,000
23,000
27,000
69,000
90%

h. Entry S
Common Stock (Brey) ...............................
Retained Earnings, 1/1/13 (Brey) (reduced by
1/1/13 unrealized gross profit) ..................
Investment in Brey (90%) .....................
Noncontrolling interest in Brey (10%)

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191,700
(21,600)

(62,100)
$450,000

150,000
263,000
371,700
41,300

Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

27. (continued) part i.

Sales Revenues = $1,068,000 (total less $160,000 intra-entity sales)

Cost of Goods Sold = $570,000 (add book values less $160,000 in intra-entity
purchases. Also, adjust for 2012 unrealized gross profit [subtract $15,000] and
2013 unrealized gross profit [add $21,000])

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

Investment IncomeBrey = $0 (intra-entity 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 intra-entity balance)

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

Investment in Brey = $0 (intra-entity 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 intra-entity 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)

5-15

Chapter 05 - Consolidated Financial Statements Intra-Entity Asset Transactions

30.

(75 Minutes) (Determine consolidated balances after impact of upstream Inventory


transfers and downstream transfer of building. Parent uses initial value method.)
PRELIMINARY COMPUTATIONS
a. Consideration transferred ........................
Noncontrolling interest fair value.............
Subsidiary fair value at acquisition-date .
Book value...................................................
Fair value in excess of book value ..........
Excess fair value assignments
to equipment..........................................
to liabilities ............................................
to brand names .....................................
Totals......................................................

$657,000
73,000
730,000
(620,000)
$110,000
20,000
40,000
50,000
-0-

Annual Excess
Life
Amortizations
4 yrs.
$5,000
5 yrs.
8,000
10 yrs.
5,000
$18,000

Determination of subsidiary book value on 1/1/12


Book value, 1/1/13 (based on stockholders' equity accounts)
Eliminate net income 2012 ......................................................
Eliminate dividends 2012 ........................................................
Book value, 1/1/12 .................................................................

$700,000
(80,000)
-0$620,000

Beginning inventory unrealized gross profit, 12/31/12 (Upstream)


Ending Inventory ($145,000 30%) ...........................................
Gross profit rate (given) .............................................................
Unrealized intra-entity gross profit, 12/31/12 ..........................

$43,500
20%
$ 8,700

Ending inventory unrealized gross profit, 12/31/13 (Upstream)


Ending Inventory ($160,000 40%) ...........................................
Gross profit rate (given) .............................................................
Unrealized intra-entity gross profit, 12/31/13 ..........................

$64,000
20%
$12,800

Building unrealized gross profit, 1/2/12 (Downstream)


Transfer price ..............................................................................
Book value ...................................................................................
Unrealized gross profit ..............................................................

$25,000
10,000
$15,000

Annual excess depreciation


Annual depreciation based on book value ($10,000 5 years)
Annual depreciation based on transfer price
($25,000 5 years) ................................................................
Excess annual depreciation ......................................................

5-16

$2,000
5,000
$3,000

Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

30. (continued)
Adjustment to buildings to return to historical cost at 1/1/13
Transfer Price Historical Cost
Buildings
$25,000
$100,000
Accumulated depreciation
(1/1/12 balance after 1
more year of depreciation) 5,000
92,000

Consolidation
Adjustment
$75,000
87,000

Consolidated Totals

Sales and other Income = $1,240,000 (add the two book values and eliminate
the intra-entity transfers)

Cost of goods sold:


Moore's book value ....................................................................
Kirby's book value ......................................................................
Eliminate intra-entity transfers ..................................................
Realized gross profit deferred in 2012......................................
Deferral of 2013 unrealized gross profit ..................................
Cost of goods sold .....................................................................

$500,000
400,000
(160,000)
(8,700)
12,800
$744,100

Operating and interest expenses = $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 subsidiarys income = $1,790 (impact of inventory


transfers is included because they were upstream but building transfer is
omitted because it was downstream)

Reported net income for 2013 ........................................................


Realized gross profit deferred in 2012 .....................................
Deferral of 2013 unrealized gross profit ..................................
Realized income of subsidiary ..................................................
Excess fair value amortization...................................................
Adjusted subsidiary net income................................................
Outside ownership ...........................................................................
Noncontrolling interest ..............................................................

$40,000
8,700
(12,800)
$35,900
(18,000)
17,900
10%
$ 1,790

Consolidated net income = $220,900 (consolidated sales less consolidated


cost of goods sold, expenses, and noncontrolling interest)
To noncontrolling interest = $1,790 (above)
To controlling interest = $219,110

5-17

Chapter 05 - Consolidated Financial Statements Intra-Entity Asset Transactions

30. (continued)

Retained earnings, 1/1/13 = $1,025,970 (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, 1/1/13 ..................................


Impact of building transfer (parent's income was overstated by the $15,000 gain but has been reduced by
one prior year of excess depreciation) ....................
Adjustments to convert initial value to equity method:
Increase in subsidiary's book value during prior
years ......................................................................
Excess fair value amortization ..................................
Deferral of 12/31/12 unrealized gross profit
(subsidiary's prior income was overstated) ......
Realized increase in book value .........................
Ownership....................................................................
Equity accrual .............................................................
Retained Earnings, 1/1/13 ....................................

$990,000
(12,000)
$80,000
(18,000)
(8,700)
53,300
90%
47,970
$1,025,970

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


Retained Earnings, 12/31/13 = $1,115,080 (the beginning balance plus controlling
interest share of consolidated net income less dividends paid)
Cash and Receivables = $397,000 (add the two book values)
Inventory = $371,200 (add the two book values and defer the $12,800 ending
unrealized gross profit)
Investment in Kirby = -0- (eliminated for consolidation purposes)
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 = $3,479,200 (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])

5-18

Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

30. (continued)
NCI 12/31/13 = $80,120 (10 percent of $691,300 adjusted beginning book value
[$700,000 less $8,700 deferral of unrealized gross profit] plus $9,200 share of
beginning unamortized excess fair value allocations plus $1,790 net income share)
Common Stock = $600,000 (parent balance only)
Retained Earnings, 12/31/13 = $1,115,080 (computed above)
Total Liabilities and Equities = $3,479,200 (summation of consolidated balances).
The same consolidation balances can be derived using a worksheet and the
following adjusting and eliminating entries:
CONSOLIDATION ENTRIES
Entry *G
Retained Earnings, 1/1/13 (Kirby) .......................
8,700
Cost of Goods Sold .........................................
(To recognize 2012 deferred gross profit as income in 2013)
Entry *TA
Building...................................................................
Retained Earnings, 1/1/13 (Moore) ......................
Accumulated Depreciation .............................
(To adjust 1/1/13 balance to historical cost figures)

8,700

75,000
12,000
87,000

Entry *C
Investment in Kirby ...............................................
47,970
Retained Earnings, 1/1/13 (Moore) ................
47,970
(To convert from initial value to equity method based on the following
computation)
Increase in subsidiary's book value during prior year
(net income of $80,000)..................................
Excess amortization for 2012...............................
Deferral of 12/31/12 unrealized gross profit.......
Realized increase in subsidiary's book value....
Ownership ..............................................................
Conversion to equity method adjustment...........

$80,000
(18,000)
(8,700)
$53,300
90%
$47,970

S Common Stock (Kirby) .........................................


150,000
Retained Earnings, 1/1/13 as adjusted (Kirby). . .
541,300
Investment in Kirby (90%) ...............................
622,170
Noncontrolling interest in Kirby (10%) ..........
69,130
(To eliminate subsidiary's beginning stockholders' equity accounts and
recognize beginning noncontrolling interest balance)

5-19

Chapter 05 - Consolidated Financial Statements Intra-Entity Asset Transactions

30. (continued)
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 1/1/13. Figures
have been reduced by one year of amortization)
Entry I (the subsidiary paid no dividends so no adjustment needed)
E Operating and Interest Expense..........................
18,000
Liabilities ..........................................................
Equipment.........................................................
Brand Names ...................................................
(To recognize excess amortization expenses for current year)
Tl Sales .......................................................................
Cost of Goods Sold .........................................
(To eliminate intra-entity transfers for 2013)
G Cost of Goods Sold ..............................................
Inventory ...........................................................
(To defer ending unrealized inventory gross profit)

8,000
5,000
5,000

160,000
160,000
12,800
12,800

ED Accumulated Depreciation ..................................


3,000
Depreciation Expense .....................................
3,000
(To adjust depreciation for current year created by transfer of building)

5-20

Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

30. continued: Worksheet (not part of requirements)


Moore and Subsidiary Kirby
Consolidated Worksheet
December 31, 2013
Sales and other income
Cost of goods sold

Moore

Kirby

NCI

(800,000)

(600,000)

(TI) 160,000

500,000

400,000

(G) 12,800

Consolidated
(1,240,000)

(G*)

8,700

744,100

(TI)160,000
Op. and interest expenses

100,000

160,000

Separate company income

(200,000)

(40,000)

(E) 18,000

(ED)

3,000

275,000

Consolidated net income

(220,900)

to noncontrolling interest

(1,790)

to controlling interest
Retained earnings, 1/1

(219,110)
(990,000)

(TA*) 12,000
(550,000)

(*C) 47,970

(1,025,970)

(S) 541,300
(G*)

Net income

1,790

8,700

(200,000)

(40,000)

(219,110)

130,000

130,000

(1,060,000)

(590,000)

(1,115,080)

Cash and receivables

217,000

180,000

397,000

Inventory

224,000

160,000

Investment in Kirby

657,000

Dividends paid
Retained earnings, 12/31

(*C) 47,970

(G) 12,800

371,200

(S) 622,170

(A) 82,800
Equipment (net)

600,000

420,000

(A) 15,000

1,000,000

650,000

(TA*) 75,000

(100,000)

(200,000)

(ED) 3,000

(TA*) 87,000

(384,000)

Brand names

(A) 45,000

(E) 5,000

40,000

Other assets

200,000

100,000

300,000

2,798,000

1,310,000

3,479,200

(1,138,000)

(570,000)

(A) 32,000

(600,000)

(150,000)

(S)150,000

Buildings
Acc. depreciationbuildings

Total assets
Liabilities
Common stock
Noncontrolling interest , 1/1

(E) 5,000

1,030,000
1,725,000

(E) 8,000

(1,684,000)
(600,000)

(S) 69,130
(A) 9,200

Noncontrolling
interest,12/31

(78,330)
80,120

Retained earnings, 12/31

(1,060,000)

(590,000)

Total liabilities and equity

(2,798,000)

(1,310,000)

(80,120)
(1,115,080)

1,120,770

5-21

1,120,770

(3,479,200)