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Q5.

4
Q5.5
Q5.6
Q5.7
Q5.8

5-1

SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)


Item

Topics Covered

Leve
l

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 unconfirmed Mod


intercompany profits in beginning and ending
inventories; upstream and downstream sales.

15-20

E5.4

Analysis of alternative sales of land from minority


stockholder perspective.

Mod

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

SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)

5-2

Item

Topics Covered

Leve
l

Time

E5.7

Projecting future consolidation entries for


intercompany transactions.

Mod

15-20

E5.8

Effect of intercompany transactions on equity


Mod
method income accrual and minority interest in net
income.

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


accrual with intercompany transactions and
purchase premium amortization.

Mod

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 Mod


preparation of financial statement working paper;
upstream and downstream intercompany
merchandise transfers.

50-60

P5.4

Calculation of bonus; subsidiary income with


consolidation adjustments.

15-20

5-3

Mod

SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)


Item

Topics Covered

Leve
l

Time

P5.5

Consolidated income statement and equity income


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.

High

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 and Mod


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 and Mod


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.)


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

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.
New
Problem
Number

Source

New
Problem
Number

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

E5.10

E5.10

P5.10

P5.10

E5.11

E5.11

P5.11

P5.11

P5.12

new

Q5.10

Source

New
Proble
m
Numbe
r

Source

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.

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.

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.

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.

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.

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

50,000

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.

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

840,00
0

To eliminate intercompany merchandise sales made during


20X4.

E5.3 (cont=d)
Inventory, 12/31
(Income Statement)

29,000
Inventory
(Balance Sheet)

29,00
0
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.

E5.5 INTERCOMPANY EQUIPMENT TRANSACTIONS


Requirement 1:
Consolidated Financial Statement Working Paper
Gain on Sale of
Equipment

5,000
Equipment

5,00
0

To eliminate the gain on intercompany sale of equipment.


Accumulated
Depreciation

1,000

Depreciation
1,000
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

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

5,00
0
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

1,000
Depreciation
Expense

1,000

To eliminate the excess depreciation recorded by Spencer


in 20X2.
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

Retained Earnings - S

25,000
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

20,000

Depreciation

E5.6 (cont=d)
Requirement 2:
Consolidated Financial Statement Working Paper
(Downstream)
Investment in S

25,000
Land

Investment in S

25,000
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

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

$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)

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

Total
Elimination
$ 20,000
30,000
80,000
65,000
$195,000

$140,000
(8,000)
5,000
$137,000

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
$150,000
PCO=s share of SCO=s net income (.75 X $200,000)
- 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

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

$2,800,000
(1,390,000)
(925,000)
$ 485,000
(40,000)
$ 445,000

SOLUTIONS TO PROBLEMS
P5.1INTERCOMPANY 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).

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

300,00
0
Accumulated
Depreciation

300,00
0

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).

P5.1 (cont=d.)
Transaction (3)
Plant Assets ($200,000 ($600,000 - $360,000))

40,00
0
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

360,00
0
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

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.
P5.2INTERPRETING 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.

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)
P5.3CONDENSED 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)
Less P's share of S's intercompany profits in P's ending
inventory (.9 X $80,000; upstream)
Equity method income accrual

$810,00
0
60,000
90,000
(75,000)
(72,000)
$813,00
0

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

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

S Company
6,000,000
-980,000
6,980,000
950,000
3,200,000
1,930,000
6,080,000

--

--

2,613,000

900,000

Retained Earnings Statement


Retained Earnings,
January 1, 20X6-P
Retained Earnings,
January 1, 20X6-S

6,700,000

--

Net Income-from Inc. Stmt.


Dividends-P
Dividends-S

2,613,000
(1,000,000)
--

Retained Earnings, Dec. 31,


20X6 to Bal. Sheet

8,313,000

--

2,300,000
900,000
-(400,000)
2,800,000

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)

92,000

Consolidated
15,100,000
-2,775,000
17,875,000
2,790,000
6,300,000
6,080,000
15,170,000
(92,000)

6,960,000

6,060,000

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

(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

5,900,00
0
Purchases

5,900,00
0

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.

155,000

P5.3 (cont=d.)
(5)
Retained Earnings - S,
January 1

2,200,00
0
1,200,00
0

Capital Stock - S
Investment in S

3,060,00
0
340,000

Minority Interest in S

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].

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

$150,00
0
$380,000
x
.8
$304,000
x .35
(106,400
)
60,000
$103,60
0
(41,440)
$ 62,160
x .15
$ 9,324

P5.5CONSOLIDATED 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)]
Plus Pow's gain on prior year intercompany sale of land
now confirmed through external sale
Net equity method income accrual

$760,000
380,000
(200,000)
95,000
(200,000)
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)).

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.

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

$160,000
5,000
(6,400)
(12,800)
(2,500)
$143,300

P5.7 (cont=d.)
Requirement 2:
Consolidated Financial Statement Working Paper
Income from S

143,30
0

Dividends - S
(.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

250,00
0
Purchases

250,00
0

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

20,000

To eliminate the gain on the intercompany sale of machinery.

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
1,580,00
0
Investment in S
(2)
Accumulated
Depreciation
Minority Interest
in S (3)

1,311,50
0
2,500
316,000

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.

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

16,000
19,200

To record the change in the minority interest during 20X4.


(1) $35,200 = .2 ($200,000) - $1,600 - $4,000 + $800.

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.

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

132,00
0
Purchases

132,00
0

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.

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

40,00
0
Accumulated Depreciation

40,000

To record current year purchase premium amortization.


Minority Interest in Net
Income (1)

30,00
0
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).

13,000
17,000

P5.9
COMPREHENSIVE INTERCOMPANY
TRANSACTIONS
Stockholders' equity S

7,000,000
Investment in S

Sales

7,000,000
60,000,00
0

Purchases (cost of
goods sold)
Investment in S

60,000,00
0
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
43,000,00
0

All other assets

43,000,00
0

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

8,000

P5.10 (cont=d.)
Requirement 2:
Increase EMIA by
($ amount)

Transactio
n
a.
b.
c.
d.

Decrease EMIA by
($ amount)

No effect
(check)

25,000
36,000
22,400
8,000

Requirement 3:
Transaction
a.
b.
c.
d.

P5.11

Increase MINI by
($ amount)

Decrease MINI by
($ amount)

No effect
(check)

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.
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
Decrease in group income under FIFO

$ 59,000
(74,000)
(17,000)
$(32,000)

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

$ 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.