The only procedural difference in the workpaper entries relating to the elimination of unrealized intercompany profit in depreciable or nondepreciable assets when the selling affiliate i
Trang 1CHAPTER 7 Note: The letter A indicated for a question, exercise, or problem means that the question,
exercise, or problem relates to a chapter appendix
ANSWERS TO QUESTIONS
1 Intercompany profit in depreciable asset transfers is realized as a result of the utilization of the asset
in the generation of revenue Such utilization is measured by depreciation and, accordingly, the recognition of the realization of intercompany profit is accomplished through depreciation adjustments in the periods following the intercompany transfers
When intercompany sales involve nondepreciable assets, any profit recognized by the selling affiliate will remain unrealized from the consolidated entity‟s point of view for all subsequent periods or until the asset is disposed of
2 Intercompany profit may be included in the selling affiliate‟s carrying value of an asset that is sold
to third parties If the sales price in the sale to the third party is less that the inflated carrying value, the selling affiliate will recognize a loss on the sale From the point of view of the consolidated entity, however, the carrying value of the asset is its cost to the affiliated group (selling affiliate‟s cost less unrealized intercompany profit) and if this value is less than the selling price to the third party, the consolidated group will recognize a gain In effect, previously unrecognized intercompany profit is realized upon the sale of the asset to a third party
3 The only procedural difference in the workpaper entries relating to the elimination of unrealized intercompany profit in depreciable or nondepreciable assets when the selling affiliate is a less than wholly owned subsidiary is that the noncontrolling interest in the unrealized intercompany profit at the beginning of the year must be recognized by debiting or crediting the noncontrolling shareholders‟ percentage interest in such adjustments to the beginning retained earnings of the subsidiary
Trang 24 Consolidated income is equal to the parent company‟s income from its independent operations that has been realized in transactions with third parties plus subsidiary income that has been realized in transactions with third parties and adjusted for the amortization, depreciation, or impairment of the differences between implied and book values (this total is then allocated to the controlling and noncontrolling interests) The controlling interest in consolidated income is equal to the parent company‟s income from its independent operations that has been realized in transactions with third
parties plus its share of subsidiary income that has been realized in transactions with third parties
and adjusted for the amortization, depreciation, or impairment of the differences between implied and book values
Controlling Interest in Consolidated Income Unrealized gain on intercompany
sale (downstream sales) Net income internally generated by P Company
Gain realized through usage (depreciation adjustment) Unrealized profit on downstream Realized profit (downstream sales) from beginning inventory sales to S Company (ending
Inventory) P Company's percentage of S Company's adjusted income
realized from third parties
Controlling interest in Consolidated Income
5 It is important to distinguish between upstream and downstream sales of property and equipment because calculation of the noncontrolling interest in the consolidated financial statements differs depending on whether the sale giving rise to the intercompany profit is upstream or downstream
6 Profit relating to the intercompany sale of property and equipment is recognized in the consolidated financial statements over the useful life of the equipment It is recognized in the consolidated financial statements by reducing depreciation expense (thus increasing consolidated income)
7 Consolidated retained earnings may be defined as the parent company‟s cost basis retained earnings that has been realized in transactions with third parties plus (minus) the parent company‟s share of the increase (decrease) in subsidiary retained earnings that has been realized in transactions with third parties from the date of acquisition to the current date and adjusted for the cumulative effect
of amortization of the difference between implied and book values
Trang 3ANSWERS TO BUSINESS ETHICS CASE
1 The arguments against expensing options include the following:
Valuation is subjective, involves assumptions that may be unrealistic, and may yield numbers that time will prove to be of limited usefulness
Disclosure is a reasonable substitute
Companies may alter their reward systems with the result that lower level employees are most affected
Options are not a “real” expense and may never be exercised
Option valuation opens the door for manipulation as managers can alter their
compensation and governance in general
The arguments in favor of expensing options include the following:
Difficulty or subjectivity in valuation is not a reason for avoidance of recording other relevant financial statement items, such as deferred taxes, pension liabilities, etc
Transparency is a major objective of financial reporting, and without proper expensing
of executive compensation, transparency is lacking
Not expensing options generates costs of misinformation
If employees are over-compensated, the users need to be aware of that fact
When options qualify as a “real” expense, as defined in the conceptual framework, based on the best available information at the balance sheet date, they should be reflected as such in the financial statements
2 Ideally the CEO or CFO should not be a past employee of the company‟s audit firm, as such a
relationship could jeopardize his or her independence However, it is not unusual for a
company to hire a former auditor, who might later be promoted to CEO or CFO, or might even
be hired to such a position If this happens, the company might want to consider switching auditors or taking other measures to make sure that the audit firm is viewed as sufficiently independent Under the Sarbanes-Oxley Act of 2002 mandates that the audit firm‟s
independence is impaired if a former member of the audit engagement team accepts a
supervisory accounting position, unless the individual observes a one-year „cooling off‟ period
3 The Sarbanes-Oxley Act of 2002 mandates that each member of the audit committee be a
outside member of the board of directors of the issuer and to be independent Independent means not receiving any consulting, advisory, or other compensatory fee from the issuer At least one member must be a financial expert The audit committee is responsible for
appointment, compensation, retention, and oversight of the independent auditors
Trang 4transactions with third parties 0.8 ($300,000 - $240,000 + $30,000) 72,000
transactions with third parties 0.8 ($300,000 + $30,000) 264,000
Exercise 7-2
2011
Income of Polar Company realized in transitions with third parties
Polar Company‟ share of income of Superior Company realized in
Polar Company‟s share of income of Superior Company realized in
Trang 5Cost Method and Partial Equity Method
Beginning Retained Earnings – Procter Company
Noncontrolling Interest
Complete Equity Method
Investment in Silex Company
Noncontrolling Interest
Trang 6Exercise 7-5
Cost Method and Partial Equity Method
Part A Upstream Sale
Beginning Retained Earnings – Patterson Co (.8 $300,000) 240,000
Part B Downstream Sale
Beginning Retained Earnings – Patterson Co 300,000
Complete Equity Method
Part A Upstream Sale
Part B Downstream Sale
Exercise 7-6
Part A $700,000 - $600,000 = $100,000
Part B $700,000 - $400,000 = $300,000
Part C Cost Method and Partial Equity Method
Beginning Retained Earnings – P Company (.9 $200,000) 180,000
Trang 7Cost of Sales (beginning inventory – income statement) 5,000
000,75
Trang 8(2) Cost Method or Partial Equity Method
Beginning Retained Earnings – Pinta Co 90,000
Complete Equity Method
Part B Calculation of Controlling interest in Consolidated Net Income For Year Ended Dec 31,
2011
Less unrealized profit on 2011 sales of equipment to Standard Company (90,000) Plus profit on sales of equipment to Standard Company realized through
Pinta Company‟s income from its independent operations that
Income of Standard Company that has been realized in transactions
Trang 9Controlling Interest in Consolidated Net Income – 2011 $820,000
Trang 10Gain on Sale of Equipment ($500,000 - $380,000) 120,000
2012
Beginning Retained Earnings - Powell Co ($120,000 8) 96,000
Beginning Retained Earnings - Powell Co ($15,000 8) 12,000
Noncontrolling Interest in Consolidated Income = 20 ($200,000 + $30,000) (46,000) Controlling Interest in Consolidated Net Income
Trang 11Less unrealized intercompany profit on 1/1/11 sales of equipment to
Trang 12Cost Method or Partial Equity Method
Beginning Retained Earnings - P Company (.8 $125,000) 100,000
Trang 13Problem 7-4 PROUT COMPANY AND SUBSIDIARY
For the Year Ended December 31, 2012 Prout Sexton Eliminations Noncontrolling Consolidated Company Company Debit Credit Interest Balances
Other Expenses 145,000 90,000 (3) 8,000 227,000 Total Cost & Expenses 1,274,200 975,000 2,241,200
Net Income to Retained Earnings 280,800 135,000 80,000 8,000 27,000 316,800
* Noncontrolling interest in consolidated income = 20 $135,000 = $27,000
Explanations of workpaper entries are on next page
Trang 14Retained Earnings from above 1,460,800 1,075,000 1,240,000 288,000 7,000 1,576,800
Total Liabilities & Equity 4,765,800 2,411,000 2,688,000 2,688,000 5,472,800
Trang 15Explanation to workpaper entries (not required)
To establish reciprocity/convert to equity (.80 ($1,040,000 - $800,000))
To reverse amount of excess depreciation recorded during current year and recognize an equivalent amount
of intercompany profit as realized
To eliminate intercompany dividends
Investment in Sexton Company ($1,600,000 + $192,000) 1,792,000
Noncontrolling Interest [$400,000 + ($1,040,000 - $800,000) x 20] 448,000
To eliminate investment account and create noncontrolling interest account
Accumulated Depreciation - Fixed Assets ($360,000/15)(2 ) 48,000
Accumulated Depreciation Based on Original Cost ((12/25) $400,000) 192,000
Book Value to the Affiliated Companies on 1/1/13 208,000
(3) No workpaper entries are necessary for 2014 and later years As of Dec 31, 2013, the amount of profit recorded by the affiliates on their books ($120,000 - $12,000 = $108,000) is equal to the amount
of profit considered realized in the consolidated financial statements ($8,000 + $8,000 + $92,000) =
$108,000
Trang 16Problem 7-5 PROUT COMPANY AND SUBSIDIARY
Consolidated Statements Workpaper – For the Year Ended 12/31/12 Prout Sexton Eliminations Consolidated Consolidated Noncontrol Consolidated
Debits Company Company Debit Credit Income Stat Ret Earnings Interest balances
Noncontrolling Interest in Income (.20 x $135,000 = $27,000) (27,000) 27,000
455,000 455,000 2,688,000 2,688,000
Trang 17Problem 7-6 PITTS COMPANY AND SUBSIDIARY
For the Year Ended December 31, 2012
Pitts Shannon Eliminations Noncontrolling Consolidated
Net Income to Retained Earnings 435,000 300,000 60,000 15,000 63,000 627,000
Statement of Retained Earnings
12/31 Retained Earnings to Balance Sheet 1,500,000 1,263,000 1,218,000 377,400 48,000 1,874,400
* Noncontrolling interest in income = 20 ($300,000 + $15,000) = $63,000
Explanations of workpaper entries are on separate page
Trang 18Problem 7-6 (continued)
Trang 19Explanation of workpaper entries (not required)
To establish reciprocity/convert to equity (.80 ($1,038,000 - $675,000))
To reverse amount of excess depreciation recorded during year and to
recognize an equivalent amount of intercompany profit as realized
(5) Beginning Retained Earnings - Shannon 1,038,000
Investment in Shannon Company ($960,000 + $290,400) 1,250,400 Noncontrolling Interest [$240,000 + ($1,038,000 – $675,000) x.20] 312,600
To eliminate investment account and create noncontrolling interest account
Part B Calculation of Consolidated Retained Earnings
Amount of Pitts Company‟s retained earnings that have not been realized
Pitts Company's retained earnings that have been realized in
Increase in retained earnings of Shannon Company from date
of acquisition to 12/31/12 ($1,263,000 - $675,000) $588,000
Less unrealized profit on sales of equipment to Pitts on 1/1/11
included therein ($150,000 - $15,000 - $15,000) (120,000)
Increase in reported retained earnings of Shannon Company
that has been realized in transactions with third parties 468,000
Trang 20Problem 7-6 (continued)
Consolidated Retained Earnings
Pitts Company's Retained Earnings on
Pitts' Company‟s share of unrealized
gain on upstream sales Pitts Company's share of the increase in
of equipment from S Company Shannon Company's Retained Earnings
($150,000 - $15,000 - $15,000).8 96,000 since acquisition ($1,263,000 - $675,000).8 470,400
Consolidated Retained Earnings $1,874,400
Trang 21Problem 7-7 PARSONS COMPANY AND SUBSIDIARY
For the Year Ended December 31, 2013
Statement of Retained Earnings
1/1 Retained Earnings
(4) 13,500 (3) 9,500 (5) 6,750
(11) 17,100
Dividend Declared
12/31 Retained Earnings to Balance Sheet 720,000 258,000 676,517 527,050 10,283 818,250
Parsons Shea Eliminations Noncontrolling Consolidated Company Company Debit Credit Interest Balances
Net Income to Retained Earnings 225,000 178,500 452,167 392,000 16,283 327,050
Trang 22Problem 7-7 (continued) Parsons Shea Eliminations Noncontrolling Consolidated
Company Company Debit Credit Interest Balances
Balance Sheet
Difference between Implied and Book
(5) 750 (11) 1,900
Total Liabilities & Equity 2,058,000 659,000 1,310,383 1,310,383 2,208,666
* Noncontrolling interest income = 10 ($178,500 + $7,500 - $10,500 - $12,667) = $16,283
Explanations of the workpaper entries are on a separate page
Trang 23Explanations of workpaper entries
To establish reciprocity/convert to equity (.9 ($139,500 - $60,000))
Beginning Retained Earnings – Parsons ($50,000 - $2,500) 47,500
To eliminate unrealized profit on intercompany sale of equipment and to restore
plant and equipment to its book value on the date of intercompany sale
To reverse excess depreciation recorded during 2013 (.20 $47,500)
(4) Beginning Retained Earnings - Parsons Co (.90 $15,000) 13,500
To eliminate unrealized profit on intercompany sale of land (upstream sale)
(5) Beginning Retained Earnings - Parsons Co (.90 $7,500) 6,750
To eliminate intercompany profit in beginning inventory (upstream sale)
To eliminate intercompany sale
To eliminate intercompany payables and receivables
(8) Cost of Goods Sold (Ending Inventory – Income Statement) 10,500
To eliminate unrealized profit in ending inventories
Trang 24Problem 7-7 (continued)
Noncontrolling Interest [$47,333 + ($139,500 – $60,000) x 10] 55,283
To eliminate the investment account and create noncontrolling interest account
To allocate the difference between implied and book value
(11) Beginning Retained Earnings - Parsons Co ($63,333/5 x 1.5) x 90 17,100
Noncontrolling Interest ($63,333/5 x 1.5) x 10 1,900
To amortize the difference between implied and book value
Alternative to entries (10) and (11)
(10a) Beginning Retained Earnings - Parsons Co ($63,333/5 x 1.5) x 90 17,100
Noncontrolling Interest ($63,333/5 x 1.5) x 10 1,900
To allocate and amortize the difference between implied and book value
Trang 25Problem 7-7 (continued)
Part B
Less intercompany unrealized profit on sales of equipment to Shea
on 12/31/2011 included therein ($47,500 - $9,500 - $9,500) (28,500)
Parsons Company's retained earnings that have been realized in
Increase in retained earnings of Shea Company from date of acquisition
Less cumulative effect of adjustment to date relating to amortization
of manufacturing formula ($19,000 + $12,667) (31,667)
Less unrealized profit on sales to Parsons in 2012 and 2013 that has not been
realized by sales to third parties ($15,000 + $10,500) (25,500)
Increase in reported retained earnings of Shea since acquisition that
has been realized in transactions with third parties 140,833
Alternatively
Consolidated Retained Earnings
Unrealized profit on upstream sales Parsons Company's Retained Earnings on 12/31/13 $720,000
in Parson‟s ending inventory
($15,000 + $10,500)(.90) 22,950 Increase in Shea Company's Retained
Earnings since acquisition Unrealized gain on downstream sales of
Trang 26Problem 7-8 PHELPS COMPANY AND SUBSIDIARY
Consolidated Statements Workpaper For the Year Ended December 31, 2011
Phelps Sloane Eliminations Noncontrolling Consolidated Company Company Debit Credit Interest Balances
Net Income to Retained Earnings 354,000 230,000 487,500 288,667 13,300 371,867
Statement of Retained Earnings
1/1 Retained Earnings
(8) 20,400 (9) 5,100
Trang 27Total Liabilities & Equity 2,352,000 1,345,000 2,096,892 2,096,892 2,693,196
* Noncontrolling interest income = 15 ($230,000 + $10,000 - $140,000 + $18,667 – $24,000 – $6,000) = $13,300
Explanations of the workpaper entries are on a separate page
Trang 28Problem 7-8 (continued)
Cost Depreciation Carrying Value Life Depreciation Original Cost $666,667 $166,667 $500,000 7.5 yr $66,667 Intercompany Selling Price 640,000 _ 640,000 7.5 yr 85,333
Explanations of workpaper entries (not required)
To establish reciprocity/convert to equity [($250,000 - $150,000) .85]
To eliminate intercompany sales
To recognize intercompany profit realized during the year
(4) Cost of Goods Sold (Ending Inventory – Income Statement) 15,000
To eliminate unrealized intercompnay profit
in ending inventory [$65,000 - ($65,000/1.30)]
To eliminate unrealized profit recorded on intercompany
sale of equipment and restate equipment to its book value on date
of intercompany sale
To reverse amount of excess depreciation recorded
during current year and to recognize an equivalent
amount of intercompany profit as realized ($140,000/7.5 years)
Trang 29Problem 7-8 (continued)
Investment in Sloane Company
Noncontrolling interest [$168,529 + ($250,000 – $150,000) x 15] 183,529
To eliminate investment account and create noncontrolling interest account
(8) Beginning Retained Earnings – Phelps (1/2 of inventory sold in 2010) 20,400
Noncontrolling Interest (1/2 of inventory sold in 2010) 3,600
Cost of Goods Sold (1/2 of inventory sold in 2011) 24,000
Alternative to entries (8) and (9)
(8a) Beginning Retained Earnings - Phelps
To allocate, amortize and depreciate the difference
between implied and book value
Trang 30Problem 7-9
Computation and Allocation of Difference Schedule
Parent Non- Entire Share Controlling Value
Share Purchase price and implied value $1,480,000 164,444 1,644,444 * Less: Book value of equity acquired 1,350,000 150,000 1,500,000
Difference between implied and book value 130,000 14,444 144,444
Increase noncontrolling interest to fair value of assets 15,556
Trang 31Problem 7-9 PIERCE COMPANY AND SUBSIDIARY
Consolidated Statements Workpaper For the Year Ended December 31, 2012
Pierce Sanders Eliminations Noncontrolling Consolidated Company Company Debit Credit Interest Balances
Net income to retained earnings 703,000 250,000 579,000 450,000 18,000 806,000
Statement of Retained Earnings
1/1 Retained earnings
(7) 36,000 (7) 140,000 (8) 13,500