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Solution manual advanced accounting 4e jeter ch07

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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

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CHAPTER 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

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4 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

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ANSWERS 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

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transactions 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

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Cost Method and Partial Equity Method

Beginning Retained Earnings – Procter Company

Noncontrolling Interest

Complete Equity Method

Investment in Silex Company

Noncontrolling Interest

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Exercise 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

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Cost of Sales (beginning inventory – income statement) 5,000

000,75

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(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

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Controlling Interest in Consolidated Net Income – 2011 $820,000

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Gain 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

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Less unrealized intercompany profit on 1/1/11 sales of equipment to

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Cost Method or Partial Equity Method

Beginning Retained Earnings - P Company (.8 $125,000) 100,000

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Problem 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

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Retained 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

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Explanation 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

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Problem 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

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Problem 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

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Problem 7-6 (continued)

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Explanation 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

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Problem 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

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Problem 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

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Problem 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

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Explanations 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

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Problem 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

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Problem 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

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Problem 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

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Total 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

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Problem 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)

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Problem 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

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Problem 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

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Problem 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

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