Aa2e Ham Ch06 Solutions

CHAPTER 6

SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS

1. c

Only the expenses related to provision of services are transactions with outside parties. The $3,000,000 revenue reported by Suzlon and the $3,000,000 expense reported by Patni are eliminated.

2. d

Eliminating entries remove the intercompany asset (loan receivable) and liability (loan payable) and the interest revenue and interest expense. There is no effect on timing of income recognition, and therefore no adjustment is made to the investment account or beginning retained earnings.

3. a

Downstream sales only affect equity in net income. The effect is [($540,000 - $480,000) - ($540,000 - $480,000)/1.2] = increase of $10,000.

4. d

Only the adjustment to 2013 depreciation affects equity in net income and noncontrolling interest in net income. It is an upstream sale, so the increase of $2,000,000/10 = $200,000 is shared 80% - 20%.

5. b

From the consolidated company’s perspective, it paid $35,000 for the land and sold it for $85,000. Therefore the consolidated gain is $50,000.

6. a

The intercompany gain, recognized by the subsidiary in 2010, is $400,000. In 2013, the parent sells the land to an outside party for $550,000, reporting a loss of $850,000 (= $1,400,000 - $550,000). The consolidated loss is $450,000 (= $1,000,000 - $550,000). The 2013 eliminating entry adjusts the reported $850,000 loss to $450,000, and reclassifies it from the subsidiary’s beginning retained earnings.

©Cambridge Business Publishers, 2013Solutions Manual, Chapter 6 1

7. a

The consolidation working paper for 2013 is:Parent Subsidiary Dr Cr Consolidated

Inventory $100,000 -- 20,000 (I-2) $80,000Sales 450,000 500,000 (I-1) 500,000 450,000CGS 400,000 400,000 (I-2) 20,000 500,000 (I-1) 320,000

8. d

Eliminating entries are:Sales 30,000,000

CGS 30,000,000

Investment in subsidiary 200,000CGS 200,000

CGS 225,000Inventory 225,000

9. b

Eliminating entries are:Patent 600,000

Investment in subsidiary 600,000Unconfirmed downstream loss at the beginning of 2013 is [($1,000,000/5) x 3)] = $600,000.

Amortization expense 200,000Patent 200,000

To correct the amortization expense for 2013.

10. c

Eliminating entries are:

Retained earnings, subsidiary 1,700,000Equipment, net 1,700,000

Unconfirmed upstream gain at the beginning of 2012 is [($2,000,000/20) x 17)] = $1,700,000.

Equipment, net 100,000Depreciation expense 100,000

To correct the depreciation expense for 2013.

©Cambridge Business Publishers, 20132 Advanced Accounting, 2nd Edition

EXERCISES

E6.1 Intercompany Land Transactions

a. Consolidation Working Paper2012Gain on sale of land 150,000

Land 150,000To eliminate the unconfirmed gain on the intercompany sale of land and reduce the land account to original acquisition cost.

2013Investment in Sunnyvale 150,000

Land 150,000To add the prior year unconfirmed gain to the investment account to maintain equivalence with the retained earnings of Sunnyvale and reduce the land account to original acquisition cost.

b. 2014Investment in Sunnyvale 150,000

Gain on sale of land 150,000To include the prior year intercompany gain, now confirmed, in current year income and restate the investment account by offsetting the previous reduction while the gain was unconfirmed.

E6.2 Intercompany Land Transactions

1. In a prior year, the subsidiary sold land to the parent at a gain of $20,000. The parent still holds the land.

2. Current year intercompany sale of land at a loss of $14,000.3. In prior year, the parent sold land to its subsidiary at a gain of $30,000. The subsidiary

still holds the land.4. In a prior year, the subsidiary sold land to the parent at a gain of $18,000. The parent

sold the land to an outside party this year.


E6.3 Intercompany Merchandise Transactions

(in thousands) Consolidation Working Paper

Retained earnings, Converse -1/1 15,000Investment in Converse 27,000

Cost of goods sold 42,000To eliminate the intercompany profit on upstream intercompany sales, assumed confirmed during 2013, from the beginning inventory. Prior year profits on upstream sales are removed from Converse’s beginning retained earnings; $15,000 = $75,000 x 20%. Prior year profits on downstream sales are added to Nike’s Investment in Converse as they had been removed from the Investment account via the 2013 equity accrual; $27,000 = $117,000 - 117,000/1.3.

Sales 1,150,000Cost of goods sold 1,150,000

To eliminate intercompany merchandise sales made during 2013.

Cost of goods sold 41,500Inventory 41,500

To eliminate unconfirmed intercompany profit from ending inventory; $41,500 = ($80,000 x 20% = $16,000) + [110,500 - (110,500/1.3) = $25,500].

E6.4 Analysis of Land Sale Alternatives

Under a direct sale of the land by Sawyer to the developer, Sawyer reports a gain of $3,900,000. The noncontrolling interest in net income is $780,000 (= .2 x $3,900,000) and the distribution to the noncontrolling shareholder is $390,000 (= .5 x $780,000).

Under the intercompany sale, even though the gain is larger, it is eliminated in consolidation, and does not enter into the noncontrolling interest in net income. As long as the parent holds the land (which it plans to do under a long-term lease), the gain is not reflected in noncontrolling interest in net income. Moreover, the income from the lease is the parent’s income, so the noncontrolling interest is unaffected. Under this approach, the noncontrolling stockholder receives nothing.

Hence, the direct sale of the land by Sawyer to the developer generates the most dividends for the noncontrolling stockholder.


E6.5 Intercompany Equipment Transactions

a. 2013 Consolidation Working Paper Gain on sale of equipment 250,000

Equipment 250,000To eliminate the gain on intercompany sale of equipment; $250,000 = $800,000 – ($750,000 - $200,000).

Accumulated depreciation 50,000Depreciation expense 50,000

To eliminate the excess depreciation recorded by Sawyer in 2013 ($250,000/5).

Equipment 200,000Accumulated depreciation 200,000

To restate the equipment and accumulated depreciation accounts to their original acquisition cost basis.

b. 2014 Consolidation Working Paper Investment in Sawyer 200,000Accumulated depreciation 50,000

Equipment 250,000To 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.


To eliminate the excess depreciation recorded by Sawyer in 2014.

Equipment 200,000Accumulated depreciation 200,000

To restate the equipment and accumulated depreciation accounts to their original acquisition cost basis.


E6.6 Various Intercompany Transactions

a. Consolidation Working Paper(Upstream)

Retained earnings – Sand Hill 2,500,000Land 2,500,000

Retained Earnings – Sand Hill 1,400,000Cost of goods sold 1,400,000

Cost of goods sold 3,200,000Inventory 3,200,000

Retained earnings – Sand Hill 800,000Accumulated depreciation 400,000

Equipment 1,200,000


Equipment 2,000,000Accumulated depreciation 2,000,000

b. Consolidation Working Paper(Downstream)

Investment in Sand Hill 2,500,000Land 2,500,000

Investment in Sand Hill 1,400,000Cost of goods sold 1,400,000

Cost of goods sold 3,200,000Inventory 3,200,000

Investment in Sand Hill 800,000Accumulated depreciation 400,000

Equipment 1,200,000


Equipment 2,000,000Accumulated depreciation 2,000,000


E6.7 Intercompany Transactions, Equity Method Income and Noncontrolling Interest

a.

TotalEquity in NI

Noncontrolling Interest in NI

Swaraj reported net income $7,000,000 $5,600,000 $1,400,000Amortization of identifiable intangibles (1,750,000) (1,400,000) (350,000)Upstream loss on land 300,000 240,000 60,000Unconfirmed profit in end. inventory - upstream (600,000) (480,000) (120,000)Confirmed profit in beg. inventory - upstream 350,000 280,000 70,000Confirmed profit on downstream equipment sale(= $1,000,000/10)

100,000 100,000 _______

$5,400,000 $4,340,000 $1,060,000 b. Consolidation Working Paper

Land 300,000Loss on sale of land 300,000

To eliminate the unconfirmed loss on upstream land sale.

Cost of goods sold 600,000Inventory 600,000

To eliminate the unconfirmed profit in ending inventory due to upstream sales.

Retained earnings—Swaraj, beg. 350,000Cost of goods sold 350,000

To recognize the confirmed profit in beginning inventory due to upstream sales

Investment in Swaraj 700,000Accumulated depreciation 300,000

Equipment 1,000,000To eliminate the unconfirmed profit as of the beginning of the year on downstream equipment sales (=7/10 x $1,000,000).


To eliminate intercompany profit from depreciation expense (= $1,000,000/10).


E6.8 Income Effects of Unconfirmed Intercompany Profits

ItemDecrease in consolidated net

income to the controlling interestDecrease in noncontrolling

interest in net income1. $ 200,000 -- 2. 240,000 $ 60,000 3. 800,000 -- 4. 520,000 130,000

$1,760,000 $190,000

E6.9 Consolidated Income Statement—Intercompany Transactions

(in thousands)a.

Total Equity in NI


SCO’s reported net income $200,000 $ 150,000 $ 50,000Amortization of identifiable intangibles (36,000) (27,000) (9,000)Unconfirmed profit in end. inv. - downstream (50,000) (50,000)Unconfirmed profit in end. inv. - upstream (40,000 ) (30,000 ) (10,000 )

$ 74,000 $ 43,000 $ 31,000 b. PCO and SCO

Consolidated Income StatementSales ($2,000,000 + $1,200,000 - $400,000) $2,800,000 Cost of goods sold ($1,000,000+$700,000-$400,000+$50,000+$40,000) (1,390,000)Other expenses ($600,000 + $300,000 + $36,000) (936,000 ) Consolidated net income $ 474,000 Noncontrolling interest in net income (31,000 ) Consolidated net income to controlling interest $ 443,000


E6.10 Consolidated Income Statement, Intercompany Transactions

a.

TotalEquity in NI


Star’s reported net income $ 900,000 $ 720,000 $ 180,000Amortization of identifiable intangibles (100,000) (80,000) (20,000)Goodwill impairment loss (200,000) (160,000) (40,000)Confirmed profit in beg. inv. - upstream 110,000 88,000 22,000Unconfirmed profit in end. inv. - downstream (60,000 ) (60,000 ) --

$ 650,000 $ 508,000 $ 142,000

b. Pon and StarConsolidated Income Statement

Sales ($9,000,000 + $4,000,000 – $1,000,000) $ 12,000,000Cost of goods sold ($6,000,000+$2,500,000–$1,000,000–$110,000+$60,000)

( 7,450,000)

Other expenses ($2,000,000 + $600,000 + $100,000 + $200,000) ( 2,900,000)Consolidated net income 1,650,000Less consolidated net income attributed to noncontrolling interest ( 142,000 ) Consolidated net income attributed to controlling interest $ 1,508,000

E6.11 Ratio Analysis of Enron-Type Intercompany Transactions

(all dollar amounts in millions)

a. 1. ROA = ($9,000 - $8,000 + $500)/($10,000 + $500) = $1,500/$10,500 = .143 ROS = $1,500/($9,000 + $3,000) = $1,500/$12,000 = .125

2. ROA = ($9,000+$2,000-$8,000-$1,900)/($10,000+$4,000) = $1,100/$14,000 = .079

ROS = $1,100/($9,000 +$2,000) = .10

Consolidation (2) eliminates the intercompany revenue and the unconfirmed intercompany gain, voiding the internal transaction for financial reporting purposes. Ratios look better when the transaction with the SPE is considered to be arm’s length and consolidation is avoided (1).


b. 1. TL/TA = $6,000/($10,000 + $3,500) = $6,000/$13,500 = .444

2. TL/TA = ($6,000 + $3,600 + $3,500)/($10,000 + $4,000 + $3,500) = $13,100/$17,500 = .749

Without consolidation (1) Sponsor recognizes the $3,500 cash but not the liability, but in consolidation (2) the liability is also counted along with Sponsoree’s assets and liabilities. Sponsoree is more leveraged than Sponsor; Sponsoree’s separate TL/TA = $3,600/$4.000 = .9, while Sponsor’s separate TL/TA = $6,000/$10,000 = .6. Therefore consolidating Sponsoree causes consolidated TL/TA to be higher than Sponsor’s separate TL/TA.

c. 1. ROA = [$9,000 - $8,000 + .25 ($4,300 - $3,500)]/($10,000 + $3,500) = $1,200/$13,500 = .089

2. ROA = ($9,000 + $2,000 – $8,000 – $1,900)/($10,000 + $4,000 + $3,500) = $1,100/$17,500 = .063

Enron apparently used this technique to recognize gains on its own stock as income, something not permitted by GAAP. Without consolidation (1), Sponsor’s income includes 25% of the “gain” on its stock recognized in Sponsoree’s income and booked by Sponsor via the equity method. With consolidation (2) the “stock issuance” is voided and neither entity recognizes income on the appreciation of Sponsor’s stock.

E6.12 Comprehensive Consolidated Net Income

Schedule to determine consolidated net income (in thousands)Brown’s net income from its own operations $ 50,000Shoes.com’s net income from its own operations 20,000Decrease in cost of goods sold from sale of overvalued inventory 900Depreciation expense reduction from overvaluation adjustment 300Increase in fair value of contingent consideration liability (200)Amortization of discount on long-term debt (increase in interest expense) (100)Impairment loss on capitalized in-process R&D (600)Increase in cost of goods sold due to eliminated upstream ending inventory profit (400)Eliminated loss on downstream sale of patent 500Increase in patent amortization expense on the patent ($500/5) (100 ) Consolidated net income 70,300Less consolidated net income attributed to noncontrolling interest* (2,010 ) Consolidated net income attributed to controlling interest $ 68,290

* $2,010 = .1 x ($20,000 + $900 + $300 – $100 – $600 – $400)


PROBLEMS

P6.1 Consolidation Working Paper, Noncontrolling Interest, Intercompany Inventory Transactions

a. Calculation of goodwill:Acquisition cost $ 3,000,000Fair value of noncontrolling interest 275,000Total fair value 3,275,000Book value of Seaport $ 2,000,000Previously unrecorded intangibles __500,000 2,500,000Goodwill $ 775,000

Allocation of goodwill between controlling and noncontrolling interests:Total goodwill $ 775,000Peninsula’s goodwill: $3,000,000 – 90%($2,500,000) 750,000Goodwill to noncontrolling interest $ 25,000Proportions: $750/$775 to controlling interest and $25/$775 to the noncontrolling interest

b. Calculation of 2013 Equity in Net Income and Noncontrolling Interest in Net Income (in thousands):

TotalEquity in

NINoncontrolling interest in NI

Seaport Company reported net income ($6,000,000 – 3,170,000 – 1,930,000) $ 900,000 $ 810,000 $ 90,000Upstream markup, beginning inventory 100,000 90,000 10,000Downstream markup, beg. inventory 60,000 60,000Upstream markup, ending inventory (80,000) (72,000) (8,000)Downstream markup, ending inventory (75,000 ) (75,000 ) ______

$ 905,000 $ 813,000 $ 92,000


c. Consolidation Working Paper, December 31, 2013 (in millions)

Trial Balances Taken From Books

Dr (Cr)

Eliminations

Peninsula Seaport Dr CrConsolidated

BalancesCurrent assets $ 1,950 $ 980 155 (I-3) $ 2,775Investment in Seaport 4,183 -- (I-2) 60 453 (C)

3,060 (E)730 (R)

--

Property, plant and equipment, net 5,810 5,120 10,930Intangibles 4,270 -- (R) 300 4,570Goodwill (R) 475 475Liabilities (4,900) (2,100) (7,000)Capital stock (3,000) (1,200) (E) 1,200 (3,000)Retained earnings, Jan. 1 (6,700) (2,300) (I-2) 100

(E) 2,200(6,700)

Noncontrolling interest 340 (E)45 (R)52 (N)

(437)

Dividends 1,000 400 360 (C)40 (N)

1,000

Sales (15,000) (6,000) (I-1)5,900 (15,100)Equity in net income of Seaport (813) (C) 813 --Cost of goods sold 9,050 3,170 (I-3) 155 160 (I-2)

5,900 (I-1)6,315

Operating expenses 4,150 1,930 6,080Noncontrolling interest in net income ______ _____ (N) 92 ______ 92

$ 0 $ 0 $ 11,295 $ 11,295 $ 0


P6.2 Consolidation Working Paper, Noncontrolling Interest, Intercompany Merchandise Transactions

(in thousands)

a. Calculation of goodwill:Acquisition cost $ 120,000Fair value of noncontrolling interest 35,000 Total fair value $ 155,000Book value of Wholesome $ 74,000Revaluations: Plant and equipment, net (15,000) Intangibles 25,000 Long-term debt (4,000 ) 80,000 Goodwill $ 75,000

Allocation of goodwill between controlling and noncontrolling interest:Total goodwill $ 75,000Kellogg’s goodwill: $120,000 – 75%($80,000) 60,000Goodwill to noncontrolling interest $ 15,000Proportions: $60,000/$75,000 = 80% to controlling interest and 20% to the noncontrolling interest

b.

Total

Equity in net income

of Wholesome

Noncontrolling interest in net

income of Wholesome

Wholesome’s reported net income for 2013 $ 5,000 $ 3,750 $ 1,250Revaluation write-offs for 2013:

Plant & equipment ($15,000/10) 1,500 1,125 375Intangibles ($25,000/10) (2,500) (1,875) (625)Goodwill (80/20 split) (1,000) (800) (200)

Intercompany sales adjustments:Upstream beg. inventory profit confirmed 2,400 1,800 600Upstream end. inventory profit

unconfirmed (3,000 ) (2,250 ) (750 ) Total $ 2,400 $ 1,750 $ 650

Note: The long-term debt premium is completely amortized by 2013.


c. Consolidation Working Paper, December 31, 2013


Dr (Cr)

Eliminations

Kellogg’s Wholesome Dr CrConsolidated

BalancesCurrent assets $ 35,000 $ 20,000 3,000 (I-3) $ 52,000Plant and equipment, net 262,650 192,000 (O) 1,500 7,500 (R) 448,650Investment in Wholesome 131,100 -- 1,750 (C)

67,200 (E)62,150 (R) --

Identifiable intangibles 100,000 10,000 (R) 12,500 2,500 (O) 120,000Goodwill -- -- (R) 73,000 1,000 (O) 72,000Current liabilities (30,000) (25,000) (55,000)Long-term debt (350,000) (100,000) (450,000)Capital stock (80,000) (54,000) (E) 54,000 (80,000)Retained earnings, Jan. 1 (60,000) (38,000) (I-2) 2,400

(E) 35,600 (60,000)Noncontrolling interest -- -- 22,400 (E)

15,850 (R)650 (N) (38,900)

Sales revenue (400,000) (140,000) (I-1) 60,000 (480,000)Equity in NI of Wholesome (1,750) -- (C) 1,750 --Cost of goods sold 250,000 65,000 (I-3) 3,000 2,400 (I-2)

60,000 (I-1) 255,600Operating expenses 143,000 70,000 (O) 2,000 215,000Noncontrolling interest in NI _____-- _____-- (N) 650 _______ 650

$ 0 $ 0 $ 246,400 $246,400 $ 0


P6.3 Intercompany Transfers of Depreciable Assets

a. Consolidation Working PaperTransaction (1)Investment in Smart (2.5 x ($80,000/8)) 25,000Accumulated depreciation (5.5 x $80,000/8)) 55,000

Plant assets 80,000To 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.


To eliminate the excess annual depreciation expense recorded by Smart in 2012.

Plant assets 20,000Accumulated depreciation 20,000

To restate the asset and accumulated depreciation accounts to their original acquisition cost basis.

Transaction (2)Retained earnings-Smart (6 x ($50,000/10)) 30,000Accumulated depreciation (4 x ($50,000/10)) 20,000

Plant assets 50,000To 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.


To eliminate the excess depreciation recorded by Pert in 2012.




Transaction (3)Plant assets 40,000

Investment in Smart (4 x $40,000/5)) 32,000Accumulated depreciation ($40,000/5) 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 8,000Accumulated depreciation 8,000

To add back the reduced depreciation recorded by the purchasing affiliate (Smart) in 2012.



b. Consolidation Working PaperRetained earnings-Smart 30,000

Gain on sale of plant assets 30,000To 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 reduced depreciation over the next six years (including 2012), has now been fully confirmed by an external sale in 2012.

NOTE: If there is a noncontrolling interest in Smart, it shares in this $30,000 gain but not in the gain of $280,000 recorded by Pert on the external sale; $280,000 = $400,000 – [$200,000 – 4 x ($200,000/10)].


P6.4 Consolidated Income Statement—Intercompany Transactions

a.

Total

Equity in net

income


incomeSow's reported net income $ 800,000 $ 760,000 $ 40,000Plus intercompany profit in Pow's beginning inventory, now assumed confirmed 400,000 380,000 20,000Less unconfirmed intercompany profit in Sow's ending inventory (200,000) (200,000)Plus Sow's unconfirmed loss on an intercompany sale of land 100,000 95,000 5,000Less Pow's unconfirmed gain on intercompany sale of machinery at beginning of year [$250,000 - $250,000/5)] (200,000) (200,000)Plus Pow's gain on prior year intercompany sale of land, confirmed through external sale 60,000 60,000 ______Net equity method income accrual $ 960,000 $ 895,000 $ 65,000

b. Pow Company and Sow CompanyConsolidated Statement of Income and Retained Earnings

Sales $ 32,000,000 (1)Other income 1,510,000 (2)Total revenue 33,510,000 Cost of goods sold 23,400,000 (3)Operating expenses 5,850,000 (4)Other expenses 1,000,000 (5)Total expenses 30,250,000 Consolidated net income 3,260,000Noncontrolling interest in net income 65,000Consolidated net income to parent 3,195,000 Consolidated retained earnings, January 1 15,700,000 Dividends (1,000,000) Consolidated retained earnings, December 31 $ 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)


P6.5 Equity Accrual and Eliminating Entries—Intercompany Asset Transfers and Services

(in thousands)a.

TotalEquity in

net income


incomeSuro’s net income $ 200,000 $ 160,000 $ 40,000Plus intercompany profits in Suro’s beginning inventory (downstream sales); ($50,000 - $50,000/1.25) 10,000 10,000 Less intercompany profits in Pohang’s ending inventory (upstream sales); ($80,000 - $80,000/1.25)

(16,000) (12,800) (3,200)

Less unconfirmed gain on upstream intercompany sale of machinery; [$25,000 - ($25,000/5)] (20,000 ) (16,000 ) (4,000 )

$ 174,000 $ 141,200 $ 32,800 b. Consolidation Working Paper

(C)Income from Suro 141,200

Dividends - Suro(.8 x .4 x $200,000) 64,000Investment in Suro 77,200

To eliminate the current year equity method entries made by Pohang.

(I-1)Stockholders’ equity (RE), 1/1 - Suro 15,000

Land 15,000To eliminate the unconfirmed gain from the prior year upstream transfer of land and reduce the land account to original acquisition cost.

(I-2)Sales 350,000

Cost of goods sold 350,000To eliminate intercompany merchandise sales.

(I-3)Investment in Suro 10,000

Cost of goods sold 10,000To eliminate unconfirmed intercompany profit on downstream sales from beginning inventory.


(I-4)Cost of goods sold 16,000

Inventory 16,000To eliminate unconfirmed intercompany profit on upstream sales from ending inventory.

(I-5)Gain on sale of machinery 25,000

Machinery 25,000To eliminate the gain on the intercompany sale of machinery.

(I-6)Accumulated depreciation 5,000

Depreciation expense 5,000To eliminate excess depreciation on the machinery acquired from Suro; this is the portion of the $25,000 gain confirmed to Singular in 2012.

(I-7)Machinery 40,000

Accumulated depreciation 40,000To restate the machinery and accumulated depreciation accounts to their original acquisition cost basis. (I-8)Computer service revenue 20,000

Computer service expense 20,000To eliminate intercompany revenue and expense.

(I-9)Accounts payable 3,000

Accounts receivable 3,000To eliminate intercompany receivables and payables.

(E)Stockholders’ equity – Suro (1) 1,575,000

Investment in Singular 1,260,000Noncontrolling interest in Suro 315,000

To eliminate the remaining beginning stockholders= equity of Suro against the investment and establish the book value of noncontrolling interest as of 1/1/12.

(1) $1,575,000 = $1,500,000 + $150,000 - .4 x $150,000 - $15,000, where $1,500,000 = $1,250,000 + $300,000 – $50,000 Goodwill = Stockholders’ equity—Suro at 1/2/11.


(R) Goodwill 50,000

Investment in Suro 50,000To establish goodwill as of the beginning of the year.

Note: Goodwill is attributed only to the controlling interest:Acquisition cost $ 1,250,000Fair value of noncontrolling interest 300,000Total fair value 1,550,000Book value of Suro, 1/2/11 1,500,000Goodwill $ 50,000

Goodwill attributed to the controlling interest = $1,250,000 – 80% x $1,500,000 = $50,000; no goodwill is attributed to the noncontrolling interest.

Note that the above entries eliminate the Investment in Suro balance of $1,377,200, calculated as follows:

January 2, 2011 balance $1,250,000Equity in income of Suro, 2011 (2) 98,000Dividends, 2011 (48,000 ) December 31, 2011 balance 1,300,000Equity in income of Suro, 2012 141,200Dividends, 2012 (64,000 ) December 31, 2012 balance $1,377,200

(2) Equity in net income for 2011 calculation:

80% x Suro’s book income of $150,000 $ 120,000 unconfirmed upstream land profit (80%) (12,000)unconfirmed downstream profit in ending inventory (100%) (10,000 ) Equity in net income of Suro, 2011 $ 98,000

(N)Noncontrolling interest in net income 32,800

Dividends—Suro (.2 x .4 x $200,000) 16,000Noncontrolling interest in Suro 16,800

To record the change in the noncontrolling interest during 2012.


P6.6 Comprehensive Problem: Consolidation Working Paper and Financial Statements

(in thousands)

a. Calculation of goodwill:Acquisition cost $ 20,100Fair value of noncontrolling interest 5,900Total fair value 26,000Book value of Selene $ 10,000Previously unrecorded intangibles 4,000 14,000Goodwill $ 12,000

Consideration paid $ 20,10075% x $14,000 10,500Goodwill to parent $ 9,600 80%Goodwill to noncontrolling interest $ 2,400 20%

b. Calculation of 2014 Equity in Net Income and Noncontrolling Interest in Net Income (in thousands):

TotalEquity in NI

Noncontrolling interest in NI

Selene’s reported net income ($50,000 – 35,000 – 8,000) $ 7,000 $ 5,250 $ 1,750Amortization, developed tech ($4,000/5) (800) (600) (200)Confirmed downstream gain on equipment (excess depreciation) ($2,000/10) 200 200Upstream markup, beg. inv. ($1,800 – $1,800/1.2) 300 225 75Upstream markup, end. inv. ($2,400 – $2,400/1.2) (400) (300) (100)Downstream markup, beg. inv. ($3,000 x 20%) 600 600Downstream markup, end. inv. ($2,800 x 20%) (560 ) (560 ) _____

$ 6,340 $ 4,815 $ 1,525


c. Consolidation Working Paper, December 31, 2014 (in thousands)


Dr (Cr)

Eliminations

Pierre Selene Dr CrConsolidated

BalancesCash $ 1,000 $ 2,500 $ 3,500Receivables 5,600 10,000 15,600Inventories 70,000 30,000 960 (I-5) 99,040Plant and equipment, net 460,000 150,000 (I-2) 200 1,600 (I-1) 608,600Investment in Selene 25,040 (I-1) 1,600

(I-4) 6002,565 (C)

16,275 (E)8,400 (R) --

Intangibles (R) 1,600 800 (O) 800Goodwill (R) 9,000 9,000Current liabilities (4,000) (2,800) (6,800)Long-term debt (489,82

5)(163,700) (653,525)

Capital stock (5,000) (2,000) (E) 2,000 (5,000)Retained earnings, January 1 (90,000) (20,000) (I-4) 300

(E) 19,700 (90,000)Noncontrolling interest 5,425 (E)

2,200 (R)775 (N) (8,400)

Dividends 40,000 3,000 2,250 (C)750 (N) 40,000

Sales revenue (150,000)

(50,000) (I-3) 35,000 (165,000)

Equity in income of Selene (4,815) (C) 4,815 --Cost of sales 100,000 35,000 (I-5) 960 35,000 (I-3)

900 (I-4) 100,060Operating expenses 42,000 8,000 (O) 800 200 (I-2) 50,600Noncontrolling interest in net income _____ _____ (N) 1,525 _______ 1,525

$ -0 - $ -0 - $ 78,100 $ 78,100 $ -0 -

d. Consolidated Statement of Income and Retained Earnings For the Year 2014Sales $ 165,000Costs of goods sold (100,060 ) Gross margin 64,940Operating expenses (50,600 ) Consolidated net income 14,340Noncontrolling interest in income (1,525 ) Consolidated income to controlling interest 12,815Retained earnings, January 1 90,000Dividends (40,000 ) Retained earnings, December 31 $ 62,815


Consolidated Balance Sheet, December 31, 2014AssetsCurrent assets:Cash $ 3,500Receivables 15,600Inventories 99,040 Total current assets 118,140Plant and equipment, net 608,600Intangibles 800Goodwill 9,000 Total assets $ 736,540 Liabilities and Stockholders’ EquityCurrent liabilities $ 6,800Long-term debt 653,525 Total liabilities 660,325Stockholders’ equity Capital stock 5,000 Retained earnings 62,815 Equity to Pierre 67,815 Noncontrolling interest 8,400 Total stockholders’ equity 76,215 Total liabilities and stockholders’ equity $ 736,540

P6.7 Calculation of Investment and Consolidated Accounts Several Years After Acquisition

(in millions)

a.Pentland’s retained earnings from its own operations $ 55 Equity in net income, 2011 – 2014:75 % of Sketchers’ total net income since acquisition (75% x $140) 105 Less 75% of amortization on asset revaluation [75% x (($60/5) x 4)] (36)Less 80% of goodwill impairment loss (80% x $5) (Note 1) (4)Less 75% of unconfirmed gain on upstream land sale (75% x $30) (22.5)Less unconfirmed gain on downstream patent sale [$10 – (($10/10) x 3)] (7)Less 75% of unconfirmed profit on upstream ending inventory (75% x 20) (15)Less unconfirmed profit on downstream ending inventory (17 ) Equity in net income, 2011 – 2014 3 .5 Consolidated retained earnings, December 31, 2014 $ 58 .5


Note 1: Goodwill is shared in a 80:20 ratio, calculated as follows:Acquisition cost $ 180Fair value of noncontrolling interest 50 Total fair value 230Book value $ 20Revaluation of intangibles 60

80 Goodwill $ 150

Goodwill to controlling interest [180 – (75% x 80)] $ 120Goodwill share to controlling interest (120/150) 80%

b.Investment in Sketchers, January 2, 2011 $ 180Plus equity in net income, 2011 - 2014 3.5Less 75% of Sketchers’ dividends, 2011 – 2014 (12 x 75%) (9 ) Investment in Sketchers, December 31, 2014 $174 .5

c.Fair value of noncontrolling interest, January 2, 2011 $ 50 Plus noncontrolling interest in net income, 2011 – 2014:25 % of Sketchers’ total net income since acquisition (25% x $140) 35 Less 25% of amortization on asset revaluation [25% x (($60/5) x 4)] (12)Less 20% of goodwill impairment loss (20% x $5) (Note 1) (1)Less 25% of unconfirmed gain on upstream land sale (25% x $30) (7.5)Less 25% of unconfirmed profit on upstream ending inventory (25% x 20) (5 ) Noncontrolling interest in net income, 2011 – 2014 9 .5 Less 25% of Sketchers’ dividends, 2011 – 2014 (12 x 25%) (3 ) Consolidated noncontrolling interest, December 31, 2014 $ 56 .5


P6.8 Bonus Based on Adjusted Subsidiary Income

Net income before taxes $150,000 Adjustment for unconfirmed intercompany inventory profits:Increase in inventory $380,000Percent acquired from parent x .8Increase in intercompany inventory 304,000Gross margin percentage x .35Increase in unconfirmed intercompany inventory profit (106,400)Plus interest paid to parent (= $600,000 x .10) 60,000 Revised income base 103,600 Less 40% for corporate costs and income taxes (41,440 )Base for bonus 62,160

x .15 Bonus $ 9,324

P6.9 Consolidated Income Statement—Intercompany Transactions

a.

TotalEquity in

NINoncontrolling Interest in NI

Salem reported net income $6,200,000 $4,960,000 $1,240,000Confirmed profit in BI-downstream 650,000 650,000Unconfirmed profit in EI-upstream (500,000) (400,000) (100,000)Unconfirmed loss on asset sale-downstream 360,000 360,000Confirmed loss on asset sale-downstream= $360,000/6 (60,000) (60,000)Unconfirmed gain on land sale-upstream (190,000) (152,000) (38,000)Confirmed gain (excess amortization) on patent sale-upstream = $250,000/5 50,000 40,000 10,000Unconfirmed gain on prior year patent sale, as of beg.of year-upstream = $250,000/5 x 2 100,000 80,000 20,000

$6,610,000 $5,478,000 $1,132,000


b. Portland Company and Salem CompanyConsolidated Income Statement

Sales ($40,000,000 + 25,000,000 - 4,000,000) $61,000,000Other income ($6,000,000 + 2,000,000 - 190,000 + 100,000) 7,910,000Total revenue 68,910,000Cost of goods sold ($28,000,000 + 15,000,000 - 4,000,000 - 650,000 + 500,000) 38,850,000Operating expenses ($7,000,000 + 5,000,000 + 60,000 - 50,000) 12,010,000Other expenses ($1,000,000 + 800,000 - 360,000) 1,440,000Total expenses 52,300,000Consolidated net income 16,610,000Noncontrolling interest in net income 1,132,000Net income to the controlling interest $15,478,000

Check: Consolidated net income to the controlling interest must equal Portland’s reported net income, including the equity income accrual. $15,478,000 = $10,000,000 + $5,478,000.

NOTE ON THE PATENT: The patent acquired internally from Salem had a net book value of $200,000 [= $500,000 - (3/5) X 500,000] when sold by Portland 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 eliminated—increasing income—because 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.


P6.10 Comprehensive Intercompany Eliminations

Consolidation Working Paper(E)Stockholders' equity – MC Shops 7,000,000

Investment in MC Shops 7,000,000

(I)Sales 60,000,000

Cost of goods sold 60,000,000

Investment in MC Shops 2,000,000Cost of goods sold 2,000,000

$2,000,000 = 20% x $10,000,000 beginning inventory.Cost of goods sold 2,600,000

All other assets 2,600,000 $2,600,000 = 20% x $13,000,000 ending inventory.

Franchise fee revenue 8,000,000Franchise fee expense 8,000,000

Interest revenue 4,000,000Interest expense 4,000,000

Liabilities 43,000,000All other assets 43,000,000


P6.11 Consolidation of Equity Method Investments

a.Consolidation Working Paper, October 3, 2010


Dr. (Cr.)

Eliminations

StarbucksSeven

Companies Dr CrConsolidated

BalancesCurrent assets $ 2,756,400 $ 390,100 31,400 (I-2) $ 3,115,100Equity investments 308,100 (C) 43,200 307,742 (E)

43,558 (R) --Other noncurrent assets 3,321,400 570,300 3,891,700Goodwill (R) 85,408 85,408Current liabilities (1,779,100) (260,600) (I-2) 31,400 (2,008,300)Noncurrent liabilities (924,500) (70,500) (995,000)Shareholders’ equity, beg (2,734,000) (603,416) (E) 603,416 (2,734,000)Noncontrolling interest 295,674 (E)

41,850 (R) 12,683 (N) (350,207)

Dividends 179,216 91,400 (C) 87,816 (N) --

Revenues (10,707,400) (2,128,000) (I-1) 125,700 125,700 (a) (12,835,400)Equity method income (108,600) (a) 60,400

(C) 48,200--

Cost of sales and other operating expenses 9,396,600 1,882,700 (a) 65,300 125,700 (I-1) 11,218,900Other expenses, net 471,100 40,200 511,300Noncontrolling int. in NI ________ ________ (N) 100,499 ________ 100,499

$ -0 - $ -0 - $ 1,163,523 $1,163,523 $ -0 -

Eliminating entries:(a) Removes equity investees’intercompany revenues and cost of sales from the equity

method income account and assigns them to revenues and cost of sales.(C) Removes the remaining equity method income balance, 51% of investee dividends, and

adjusts the investment by the difference.(I-1) Removes intercompany revenues generated from investees.(I-2) Removes intercompany receivables and payables.(E) Eliminates investee beginning equity against the investment (51%) and noncontrolling

interest (49%).(R) Recognizes the beginning-of-year goodwill balance. The remaining balance in the

investment ($43,558) represents 51% of the total goodwill balance of $85,408 (= $43,558/.51). The remainder is credited to noncontrolling interest.

(N) Recognizes $100,499 noncontrolling interest in investee income (= 49% x $205,100), eliminates the noncontrolling interest’s dividends and updates the noncontrolling interest for the current year.


b.Total Assets Revenues

Consolidated amount $ 7,092,208 $ 12,835,400Starbucks’ reported 6,385,900 10,707,400Increase $ 706,308 $ 2,128,000

Percentage increase 11.06% 19.87%

P6.12 Evaluation of Eliminations Disclosures

a. Machinery & Engines is the parent company. Its records show an “Investment in Financial Products” account. We also observe that the income and stockholders’ equity of Machinery & Engines equal the consolidated amounts, a characteristic that is true of parent companies of wholly-owned subsidiaries that use the complete equity method on their own books.

b. The fact that no goodwill arises in the consolidation of Machinery & Engines with Financial Products suggests that Financial Products was formed as a subsidiary company by Machinery & Engines, rather than acquired in a business combination. Goodwill arises when the acquisition cost exceeds the fair value of the subsidiary’s identifiable net assets. When a parent company forms a subsidiary, there is no goodwill.

Another possible explanation is that the excess of acquisition cost over the acquisition-date fair value of identifiable net assets acquired is fully explained by revaluations of identifiable net assets.

A third explanation is that the acquired goodwill has been completely written off as impairment loss (or amortization prior to 2002) in previous years.

c. The goodwill on the books of Machinery & Engines suggests that Machinery & Engines acquired other companies in the past, and merged them into the parent. Because the other companies are no longer separate legal entities, Machinery & Engines reports their assets and liabilities directly on its own books, as discussed in Chapter 2 of this text.

d. Financial Products earned $400 million in revenue from Machinery & Engines; there was no intercompany revenue in the other direction.


e. Eliminating entry (in millions):

Common stock, FP 860Profit employed in the business, FP 2,566Accumulated other comprehensive income, FP 522

Investment in Financial Products 3,948

f. The main intercompany activity involves financing of customer receivables. Over $3 billion was added to current trade receivables and subtracted from current finance receivables, and over $550 million is added to long-term trade receivables and subtracted from long-term finance receivables, suggesting that Financial Products finances a significant amount of the sales made to Machinery & Engines customers.


Aa2e Ham Ch06 Solutions

Documents

land account

intercompany sale of

intercompany land transactions

investment account

consolidated gain

prior year intercompany

unconfirmed upstream

prior year unconfirmed