Solution manual advanced accounting 11th edition joe ben hoyle chap005

Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions CHAPTER CONSOLIDATED FINANCIAL STATEMENTS INTRA-ENTITY ASSET TRANSACTIONS Chapter Outline I The transfer of assets between the companies forming a business combination is a common practice The opportunity for such direct acquisition (especially of inventory) is often the underlying motive for the creation of the combination II Intra-entity inventory transfers A The individual accounting systems of the two companies will record the transfer as a sale by one party and as a purchase by the other B Because the transaction was not made with an outside, unrelated party, the sales and purchases balances created by the transfer must be eliminated in the consolidation process (Entry Tl) C Any transferred inventory retained at the end of the year is recorded at its transfer price which in (many cases) will include an unrealized gross profit For consolidation purposes, this intra-entity gross profit must be deferred by eliminating the amount from the inventory account on the balance sheet and from the ending inventory figure within cost of goods sold (Entry G) Because the effects of the transfer carry over into the subsequent fiscal period, the unrealized gross profit must also be removed a second time: from the beginning inventory component of cost of goods sold and from the beginning retained earnings balance (Entry *G) a The retained earnings figure being adjusted is that of the original seller b If the equity method has been applied and the transfer was made downstream (by the parent), the beginning retained earnings account will be correct; therefore, in this one case, the adjustment is to the Investment in Subsidiary account The consolidation process is designed to shift the profit from the period of transfer into the time period in which the goods are actually sold to unrelated parties or consumed D Effect of deferral process on the valuation of a noncontrolling interest Authoritative accounting literature (FASB ASC) permits but does not require deferral of unrealized profits on the valuation of noncontrolling interest balances This textbook adjusts the noncontrolling interest balances but only if the sale was made upstream from subsidiary to parent Downstream sales are made by the parent and, thus, are viewed as having no effect on the outside interest 5-1 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions III Intra-entity land transfers A Any gain created by intra-entity land transfers is unrealized and will remain so until the land is sold to an outside party B For each subsequent consolidation, the recorded value of the land account must be reduced to original cost The unrealized gain recorded by the seller must also be removed and deferred until the land is sold to an outsider In the year of transfer, an actual gain account exists within the accounting records of the seller and must be removed In all later time periods, since the unrealized gain has become an element of the seller's beginning retained earnings balance, the reduction is made to this equity account If the land is ever sold to an outside party, the intra-entity gain is realized and has to be recognized within that time period IV Intra-entity transfer of depreciable assets A As with other intra-entity transfers, any unrealized gross profit must be deferred for consolidation purposes to establish appropriate historical cost balances B However, the difference between the transfer-based accounting value and the historical cost of the asset will change each year because of the effects of depreciation The amount of unrealized gain within retained earnings will also be reduced annually since excess depreciation expense is recognized (and closed into retained earnings) based on the inflated transfer price C Consequently, elimination of the unrealized gain (within retained earnings) and the reduction of the asset value to historical cost will differ from year to year D Also within the consolidation process, the recorded depreciation expense must be decreased every period to an amount appropriately based on the asset's original acquisition price Answers to Discussion Questions Earnings Management By selling goods to special purpose entities that it controlled but did not consolidate, did Enron overstate its earnings? According to the Power’s Report (Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp.—February 1, 2004) These partnerships—Chewco, LJM1, and LJM2—were used by Enron Management to enter into transactions that it could not, or would not, with unrelated commercial entities Many of the most significant transactions apparently were designed to accomplish favorable financial statement results, not to achieve bona fide economic objectives or to transfer risk (page 4) Assuming Enron controlled LJM2, the transactions that produced the $67 million gain and the $20.3 million agency fee were not arm’s length and thus did not provide a proper basis for recognizing income 5-2 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions What effect does consolidation have on the financial reporting for transactions with controlled entities? In consolidation, all intra-entity profit would have been deferred until the goods were sold to an outside party Also the intra-entity note receivable and payable would have been eliminated in consolidation As noted by Bala Dahran in his February 6, Congressional Testimony Despite their potential for economic and business benefits, the use of SPEs has always raised the question of whether the sponsoring company has some other accounting motivations, such as hiding of debt, hiding of poor-performing assets, or earnings management Additionally, explosive growth in the use of SPEs led to debates among managers, auditors and accounting standard setters as to whether and when SPEs should be consolidated This is because the intended accounting effects of SPEs can only be achieved if the SPEs are reported as unconsolidated entities separate from the sponsoring entity FASB Activity on Variable Interest Entities (VIEs) Fortunately the FASB’s ASC Topic 810 explains how to identify an SPE (a type of entity that is often a VIE) that is not subject to control through voting ownership interests, but is nonetheless controlled by another enterprise and therefore subject to consolidation The entity that controls the SPE is then required to include the assets, liabilities, and results of the activities of the SPE in its consolidated financial statements What Price Should We Charge Ourselves? Transfer pricing is actually a topic for a managerial accounting discussion Students, though, need to be aware that managerial and financial accounting overlap at times In this illustration, the price set by company officials for this component will affect the specific consolidation procedures needed in the preparation of financial statements for external reporting purposes Since Slagle owns 100 percent of Harrison's common stock, consolidated net income will not be altered by the transfer pricing decision All intra-entity transactions as well as unrealized profits will be removed entirely However, because the sales are upstream, if a noncontrolling interest had been present, the portion of the subsidiary's income attributed to these outside owners would be influenced by the markup Both the noncontrolling interest figure on the balance sheet and on the income statement are impacted by the amount of profits that remain unrealized when transactions are from subsidiary to parent To the accountant, the easiest approach is to set the transfer price at the seller's cost ($70.00 in this case) No intra-entity profits are created and the consolidation process is less complicated However, as indicated in the narrative, that price may penalize the seller since no profits are recognized by that profit center In addition, the buyer will then show artificially inflated income Thus, some amount of profit is usually built into transfer pricing decisions Those students who have already completed cost/managerial accounting can be asked to describe the various factors that should influence the establishment of this price Interaction between accounting courses is beneficial to the students 5-3 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions Answers to Questions One reason for the significant volume and frequency of intra-entity transfers is that many business combinations are specifically organized so that the companies can provide products for each other This design is intended to benefit the business combination as a whole because of the economies provided by vertical integration In effect, more profit can often be generated by the combination if one member is able to buy from another rather than from an outside party The sales between Barker and Walden totaled $100,000 Regardless of the ownership percentage or the gross profit rate, the $100,000 was simply an intra-entity asset transfer Thus, within the consolidation process, the entire $100,000 should be eliminated from both the Sales and the Purchases (Inventory) accounts Sales price per unit ($900,000 ÷ 3,000 units) $ 300 Number of units in Safeco’s ending inventory × 500 Intra-entity inventory at transfer price $150,000 Gross profit rate (0.6 ÷ 1.6) 375 Intra-entity profit in ending inventory $56,250 In intra-entity transactions, a transfer price is often established that exceeds the cost of the inventory Hence, the seller is recording a gross profit on its books that, from the perspective of the business combination as a whole, remains unrealized until the asset is consumed or sold to an outside party Any unrealized gross profit on merchandise still held by the buyer must be deferred whenever consolidated financial statements are prepared For the year of transfer, this consolidation procedure is carried out by removing the unrealized gross profit from the inventory account on the balance sheet and from the ending inventory balance within cost of goods sold In the year following the transfer (if the goods are resold or consumed), the realized gross profit must be recognized within the consolidation process Reductions are made on the worksheet to the beginning inventory component of cost of goods sold and to the beginning retained earnings balance of the original seller The gross profit is thus taken out of last year’s earnings (retained earnings) and recognized in the current year through the reduction of cost of goods sold If the transfer was downstream in direction and the parent company has applied the equity method, the adjustment in the subsequent year is made to the Investment in Subsidiary account rather than to retained earnings On the individual financial records of James, Inc., a gross profit is recorded in the year of transfer From the viewpoint of the business combination, this gross profit is actually earned in the period in which the products are sold or consumed by Matthews Co An initial consolidation entry must be made in the year of transfer to defer any gross profit that remains unrealized A second entry must be made in the following time period to allow the gross profit to be recognized in the year of its ultimate realization GAAP allows discretion regarding the effect of unrealized intra-entity profits and noncontrolling interest values This textbook reasons that unrealized profits relate to the seller and to the computation of the seller's income Therefore, any unrealized profits created by upstream transfers (from subsidiary to parent) are attributed to the subsidiary The effects resulting from the deferral and eventual recognition of these intra-entity profits are considered in the calculation of noncontrolling interest balances In contrast, unrealized profits from downstream transfers are viewed as relating solely to the parent (as the seller) and, thus, have no effect on the noncontrolling interest 5-4 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions 10 Consolidated financial statements are largely unchanged across downstream versus upstream transfers Sales and purchases (Inventory) balances created by the transactions are eliminated in total Any unrealized gross profits remaining at the end of a fiscal period get deferred until ultimately earned through sale or consumption of the assets The direction of intra-entity transfers (upstream versus downstream) does have one effect on consolidated financial statements In computing noncontrolling interest balances (if present), the deferral of unrealized gross profits on upstream sales is taken into account Downstream sales, however, are attributed to the parent and are viewed as having no impact on the outside interest The computation of this noncontrolling interest balance is dependent on the direction of the intra-entity transactions that is not indicated in this question If the unrealized gross profits were created by downstream sales from King to Pawn, they relate only to King The noncontrolling interest in the subsidiary's net income is not affected and would be $11,000 ($110,000 × 10%) In contrast, if the transfers were upstream from Pawn to King, the deferral and recognition of the profits are attributed to Pawn Pawn's "realized" income would be $80,000 and the noncontrolling interest's share of the subsidiary's income is reported as $8,000: Pawn's reported income $110,000 Recognition of prior year unrealized gross profit 30,000 Deferral of current year unrealized gross profit (60,000) Pawn's realized income $80,000 Outside ownership percentage 10% Noncontrolling interest in subsidiary's income $ 8,000 The deferral and subsequent recognition of intra-entity profits are allocated to the noncontrolling interest in the same periods as the parent When one affiliate sells to another affiliate, ownership does not change and therefore the underlying profit is deferred When the purchasing affiliate subsequently sells the inventory to an entity outside the affiliated group, ownership changes, and the profit may be recognized Intraentity profits are not really eliminated, but simply deferred until a sale to an outsider takes place Several differences can be cited that exist between the consolidated process applicable to inventory transfers and that which is appropriate for land transfers The total intraentity Sales balance is offset against Purchases (Inventory) when inventory is transferred but no corresponding entry is needed when land is involved Furthermore, in the year of the sale, ending unrealized inventory gross profits are deferred through an adjustment to cost of goods sold, but a specific gain or loss account exists (and must be removed) when land has been sold Finally, unrealized inventory gross profits are usually expected to be realized in the year following the transfer This effect is mirrored in that period by reduction of the beginning inventory figure (within cost of goods sold) For land transfers, however, the unrealized gain or loss must be repeatedly deferred in each fiscal period, through retained earnings, for as long as the land continues to be held within the business combination 5-5 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions 11 12 13 As long as the land is held by the parent, its recorded value must be reduced to historical cost within each consolidated set of financial statements In the year of the original transfer, the asset reduction is offset against the subsidiary's recorded gain For all subsequent years in which the property is held, the credit to the Land account is made against the beginning retained earnings balance of the subsidiary (since the unrealized gain will have been closed into that account) According to this question, the land is eventually sold to an outside party The intra-entity gain (which has been deferred in each of the previous years) is realized by the sale and should be recognized in the consolidated statements of this later period Because the transfer was upstream from subsidiary to parent, the above consolidated entries will also affect any noncontrolling interest balances being reported Because of the deferral of the intra-entity gain, the realized income balances applicable to the subsidiary will be less than the reported values In the year of resale, however, the realized income for consolidation purposes is higher than reported All noncontrolling interest totals are computed on the realized balances rather than the reported figures Depreciable assets are often transferred between the members of a business combination at amounts in excess of book value The buyer will then compute depreciation expense based on this inflated transfer price rather than on an historical cost basis From the perspective of the business combination, depreciation should be calculated solely on historical cost figures Thus, within the consolidation process for each period, adjustment of the depreciation (that is recorded by the buyer) is necessary to reduce the expense to a cost-based figure From the viewpoint of the business combination, an unrealized gain has been created by the intra-entity transfer and must be deferred in the preparation of consolidated financial statements This unrealized gain is closed by the seller into retained earnings necessitating subsequent reductions to that account In the individual financial records, however, another income effect is created which gradually reduces the overstatement of retained earnings each period The asset will be depreciated by the buyer based on the inflated transfer price The resulting expense will be higher than the amount appropriate to the historical cost of the item Because this excess depreciation is closed into retained earnings annually, the initial overstatement due to the gain is offset by the acculmulating overstatement ofdepreciation expense Therefore, the overstatement of the equity account is gradually reduced to a zero balance over the life of the asset Answers to Problems D B Inventory remaining $100,000 × 50% = $50,000 unrealized gross profit (based on Lee's gross profit rate as the seller) $50,000 × 40% = $20,000 The ownership percentage has no impact on this computation A 5-6 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions C UNREALIZED GROSS PROFIT, 12/31/12 Intra-entity gross profit ($100,000 – $75,000) Inventory remaining at year's end Unrealized intra-entity gross profit, 12/31/12 $25,000 16% $4,000 UNREALIZED GROSS PROFIT, 12/31/13 Intra-entity gross profit ($120,000 – $96,000) Inventory remaining at year's end Unrealized intra-entity gross profit, 12/31/13 $24,000 35% $8,400 CONSOLIDATED COST OF GOODS SOLD Parent balance Subsidiary balance Remove intra-entity transfer Recognize 2012 deferred gross profit Defer 2013 unrealized gross profit Cost of goods sold $380,000 210,000 (120,000) (4,000) 8,400 $474,400 A Intra-entity sales and purchases of $100,000 must be eliminated Additionally, an unrealized gross profit of $10,000 must be removed from ending inventory based on a gross profit rate of 25 percent ($200,000 gross profit ÷ $800,000 sales) which is multiplied by the $40,000 ending balance This deferral increases cost of goods sold because ending inventory is a negative component of that computation Thus, cost of goods sold for consolidation purposes is $690,000 ($600,000 + $180,000 – $100,000 + $10,000) C The only change here from Problem is the gross profit rate which would now be 40 percent ($120,000 gross profit ÷ $300,000 sales) Thus, the unrealized gross profit to be deferred is $16,000 ($40,000 × 40%) Consequently, consolidated cost of goods sold is $696,000 ($600,000 + $180,000 – $100,000 + $16,000) B UNREALIZED GROSS PROFIT, 12/31/12 Ending inventory Gross profit rate ($33,000 ÷ $110,000) Unrealized intra-entity gross profit, 12/31/12 $40,000 30% $12,000 UNREALIZED GROSS PROFIT, 12/31/13 Ending inventory Gross profit rate ($48,000 ÷ $120,000) Unrealized intra-entity gross profit, 12/31/13 $50,000 40% $20,000 5-7 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions NONCONTROLLING INTEREST IN SUBSIDIARY'S INCOME Reported net income for 2013 Realized gross profit deferred in 2012 Deferral of 2013 unrealized gross profit Realized income of subsidiary Outside ownership Noncontrolling interest $90,000 12,000 (20,000) $82,000 10% $8,200 A Individual records after transfer: 12/31/12 Machinery = $40,000 Gain = $10,000 Depreciation expense $8,000 ($40,000 ÷ years) Net effect on income = $2,000 ($10,000 – $8,000) 12/31/13 Depreciation expense = $8,000 Consolidated figures—historical cost: 12/31/12 Machinery = $30,000 Depreciation expense = $6,000 ($30,000 ÷ years) 12/31/13 Depreciation expense = $6,000 Adjustments for consolidation purposes: 2012: $2,000 income is reduced to a $6,000 expense (income is reduced by $8,000) 2013: $8,000 expense is reduced to a $6,000 expense (income is increased by $2,000) B UNREALIZED GAIN Transfer price Book value (cost after two years of depreciation) Unrealized gain EXCESS DEPRECIATION Annual depreciation based on cost ($300,000 ÷ 10 years) Annual depreciation based on transfer price ($280,000 ÷ years) 5-8 $280,000 240,000 $40,000 $30,000 35,000 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions Excess depreciation ADJUSTMENTS TO CONSOLIDATED NET INCOME Defer unrealized gain Remove excess depreciation Decrease to consolidated net income $5,000 $(40,000) 5,000 $(35,000) 10 D Add the two book values and remove $100,000 intra-entity transfers 11 C Intra-entity gross profit ($100,000 - $80,000) Inventory remaining at year's end Unrealized intra-entity gross profit CONSOLIDATED COST OF GOODS SOLD Parent balance Subsidiary balance Remove intra-entity transfer Defer unrealized gross profit (above) Cost of goods sold 12 C Consideration transferred Noncontrolling interest fair value Suarez total fair value Book value of net assets Excess fair over book value $20,000 60% $12,000 $140,000 80,000 (100,000) 12,000 $132,000 $260,000 65,000 $325,000 (250,000) $75,000 Annual Excess Excess fair value to undervalued assets: Equipment Secret Formulas Total Life Amortizations 25,000 years $5,000 $50,000 20 years 2,500 -0$7,500 Consolidated expenses = $37,500 (add the two book values and include current year amortization expense) 13 A 20% of the beginning book value Excess fair value allocation (20%× $75,000) 20% share of Suarez net income adjusted for amortization (20% × [110,000 – 7,500]) Ending noncontrolling interest balance $50,000 15,000 20,500 $85,500 14 C Add the two book values plus the $25,000 original allocation less one year of excess amortization expense ($5,000) 5-9 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions 15 B Add the two book values less the ending unrealized gross profit of $12,000 Combined pre-consolidation inventory balances $260,000 Intra-entity gross profit ($100,000 – $80,000) $20,000 Inventory remaining at year's end 60% Unrealized intra-entity gross profit, 12/31 12,000 Consolidated total for inventory $248,000 16 (15 Minutes) (Determine selected consolidated balances; includes inventory transfers and an outside ownership.) Customer list amortization = $65,000 ÷ years = $13,000 per year Intra-entity gross profit ($160,000 – $120,000) Inventory remaining at year's end Unrealized intra-entity gross profit, 12/31 $40,000 20% $8,000 CONSOLIDATED TOTALS 17  Inventory = $592,000 (add the two book values and subtract the ending unrealized gross profit of $8,000)  Sales = $1,240,000 (add the two book values and subtract the $160,000 intra-entity transfer)  Cost of goods sold = $548,000 (add the two book values and subtract the intra-entity transfer and add [to defer] ending unrealized gross profit)  Operating expenses = $443,000 (add the two book values and the amortization expense for the period)  Noncontrolling interest in subsidiary's net income = $8,700 (30 percent of the reported income after subtracting 13,000 excess fair value amortization and deferring $8,000 ending unrealized gross profit) Gross profit is included in this computation because the transfer was upstream from Sanchez to Preston (60 minutes) (Downstream intra-entity profit adjustments when parent uses equity method and a noncontrolling interest is present) Consideration transferred by Corgan Noncontrolling interest fair value Smashing’s acquisition-date fair value Book value of subsidiary Excess fair over book value Excess assigned to covenants Useful life in years Annual amortization 5-10 $980,000 245,000 1,225,000 950,000 275,000 275,000 ÷ 20 $13,750 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions (A) 87,000 NCI in Sander 12/31 Common stock APIC Retained earnings 12/31 Total liab and SE (900,000) (300,000) (3,300,000) (5,495,000) (800,000) (100,000) (550,000) (2,100,000) (329,000 ) 355,000 (S) 800,000 (S) 100,000 2,234,000 2,234,000 (355,000) (900,000) (300,000) (3,300,000) (6,500,000) 33 (50 Minutes) (Prepare consolidation entries for a combination where upstream inventory transfers have occurred as well as downstream equipment transfers Parent has applied initial value method) Consideration transferred Noncontrolling interest fair value Subsidiary fair value at acquisition-date Book value Fair value in excess of book value Excess fair value assignments to building to franchise agreements $665,000 285,000 $950,000 (800,000) $150,000 Annual Excess Life Amortizations 50,000 yrs $10,000 100,000 10 yrs 10,000 -0$20,000 Inventory Transfers (Upstream) 2012 gross profit deferred until 2013 ($12,000 × 30%) $3,600 2013 gross profit deferred until 2014 ($18,000 × 30%) $5,400 Equipment Transfer (Downstream) Unrealized gain as of January 1, 2013: Unrealized gain on transfer (1/1/12) 2012 excess depreciation ($36,000 ÷ yrs.) Unrealized gain January 1, 2013 $36,000 (6,000) $30,000 Excess depreciation—2013 ($36,000 ÷ yrs.) $6,000 Entry *G Retained Earnings, 1/1/13 (Young) Cost of Goods Sold 3,600 3,600 To recognize upstream intra-entity inventory gross profit deferred from previous year Entry *TA Retained Earnings, 1/1/13 (Monica) Equipment ($50,000 – $36,000) Accumulated Depreciation ($50,000 – $6,000) 5-42 30,000 14,000 44,000 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions To return equipment accounts to beginning book value based on historical cost and to remove unrealized gain from beginning retained earnings 33 (continued) Entry *C Investment in Young Retained Earnings, 1/1/13 (Monica) 123,480 123,480 Because the parent uses the initial value method, its retained earnings must be adjusted for the subsidiary's increase in book value less excess amortizations and upstream profits during 2011– 2012 as follows Retained earnings of Young, December 31, 2013 (given) Eliminate net income and dividends of Young ($160,000 – $50,000) Retained earnings of Young, December 31, 2012 Removal of unrealized gross profit (Entry *G) Realized retained earnings of Young, December 31, 2012 Retained earnings at date of acquisition Increase in retained earnings during 2011–2012 Ownership percentage Income accrual to be recognized Excess amortization for 2011–2012 ($20,000 × 70%× yrs.) ENTRY *C ADJUSTMENT (above) $740,000 (110,000) 630,000 (3,600) 626,400 (410,000) 216,400 70% 151,480 (28,000) $123,480 Entry S Common Stock (Young) 300,000 Additional Paid-In Capital (Young) 90,000 Retained Earnings, 1/1/13 (Young) (adjusted for *G) 626,400 Investment in Young (70%) 711,480 Noncontrolling Interest in Young (30%) 304,920 To eliminate stockholders' equity accounts of subsidiary and recognize noncontrolling interest; amount of retained earnings was previously reduced to realized balance by Entry *G The $626,400 figure is computed above Entry A Franchise Agreement Buildings Investment in Young Noncontrolling Interest in Young (30%) 5-43 80,000 30,000 77,000 33,000 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions To recognize amount paid within acquisition price for buildings and the franchise agreement Balances have been reduced by two years of excess amortizations 33 (continued) Entry I Dividend Income 35,000 Dividends Paid 35,000 To eliminate Intra-entity dividend payments recorded by parent as income since initial value method is used Entry E Depreciation Expense 10,000 Amortization Expense 10,000 Franchise Agreement Buildings To recognize current year excess amortization expense 10,000 10,000 Entry Tl Sales 90,000 Cost of Goods Sold 90,000 To remove intra-entity inventory transfers made during the current year Entry G Cost of Goods Sold 5,400 Inventory 5,400 To defer unrealized gross profit on 2013 intra-entity inventory transfers (computed above) Entry ED Accumulated Depreciation 6,000 Depreciation Expense 6,000 To remove current year depreciation on transferred item since its historical cost has been fully depreciated Noncontrolling Interest's Share of Subsidiary's Net Income Reported net income of Young (given) $160,000 Excess fair value amortization (20,000) Recognition of 2012 unrealized gross profit (Entry *G) 3,600 Deferral of 2013 unrealized gross profit (Entry G) (upstream) (5,400) Realized income of Young $138,200 Outside ownership percentage 30% Noncontrolling interest in subsidiary’s income $41,460 5-44 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions 34 (35 Minutes) (Consolidation entries with upstream Inventory transfers and downstream equipment transfers Parent uses equity method) Entry *G (Same as Entry *G in Problem 33.) Entry *TA Investment in Young 30,000 Equipment 14,000 Accumulated Depreciation 44,000 To return equipment account to its book value based on historical cost Because the parent uses the equity method and the transfer is downstream, the unrealized gain has already been removed from the parent's retained earnings Thus, the remaining gain is eliminated here from the Investment account rather than from retained earnings Entry *C (No Entry *C is needed because equity method has been applied.) Entry S (Same as Entry S in Problem 33.) Entry A (Same as Entry A in Problem 33.) Entry I Investment Income Investment in Young To eliminate intra-entity income accrual 102,740 102,740 Reported net income of Young (given) $160,000 Excess fair value amortization (20,000) Recognition of 2012 unrealized gross profit (Entry *G) 3,600 Deferral of 2013 unrealized gross profit (Entry G) (upstream) (5,400) Realized income of Young $138,200 Outside ownership percentage 70% Monica’s share of Young’s realized income $96,740 Depreciation adjustment for asset transfer gain 6,000 Equity accrual for 2013 $102,740 Entry D Investment in Young Dividends Paid To eliminate intra-entity dividend transfers 35,000 35,000 Entry E (Same as Entry E in Problem 33.) Entry TI (Same as Entry Tl in Problem 33.) Entry G (Same as Entry G in Problem 33.) Entry ED (Same as Entry ED in Problem 33.) Noncontrolling interest in subsidiary’s income (Same as in Problem 33.) 5-45 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions 35 (60 Minutes) (Consolidation worksheet for combination with upstream inventory transfers and downstream transfer of land Also asks about transfer of a building Parent uses partial equity method.) Consideration transferred Noncontrolling interest fair value Subsidiary fair value at acquisition-date Book value Fair value in excess of book value Excess fair value assignment to customer list $570,000 380,000 $950,000 (850,000) $100,000 Annual Excess Life Amortizations 100,000 20 yrs $5,000 -0- a CONSOLIDATION ENTRIES Entry *TL Retained Earnings, 1/1/13 (Gibson) 40,000 Land 40,000 To remove unrealized gain on Intra-entity downstream transfer of land made in 2012 Entry *G Retained Earnings, 1/1/13 (Keller) 10,000 Cost of Goods Sold 10,000 To defer unrealized upstream Inventory gross profit from 2012 until 2013 computed as the 2012 ending inventory balance of $30,000 (20% × $150,000) multiplied by 33-1/3% gross profit rate ($50,000 ÷ $150,000) Entry *C Retained Earnings, 1/1/13 (Gibson) Investment in Keller 9,000 9,000 Parent is applying the partial equity method as can be seen by the amount in the Income of Keller Company account (60 percent of the reported balance) Thus, the parent’s share of amortization of $3,000 ($100,000 divided by 20 years × 60%) must be recognized for the previous year 2012 In addition, the equity accrual recorded by the parent has been based on Keller's reported net income As shown in Entry *G, $10,000 of that reported net income has not actually been realized as of January 1, 2013 Thus, the previous accrual must be reduced by $6,000 to mirror the parent's 60% ownership The total of the two adjustments being made here is $9,000 5-46 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions 35 (continued) Entry S Common Stock(Keller) 320,000 Additional Paid-In Capital 90,000 Retained Earnings, 1/1/13 (Keller) (adjusted for Entry *G) 610,000 Investment in Keller (60%) 612,000 Noncontrolling Interest in Keller, 1/1/13 (40%) 408,000 To remove stockholders' equity accounts of Keller and recognize beginning noncontrolling interest Retained earnings balance has been adjusted in Entry *G Entry A Customer List 95,000 Investment in Keller Noncontrolling Interest in Keller, 1/1/13 (40%) 57,000 38,000 To recognize amount paid within acquisition price for the customer list Original balance is adjusted for previous year’s amortization Entry I Income of Keller Investment in Keller To eliminate intra-entity income accrual 84,000 84,000 Entry D Investment in Keller 36,000 Dividends Paid 36,000 To eliminate intra-entity dividend transfers—60% of subsidiary's payment Entry E Amortization Expense 5,000 Customer List To recognize current period excess amortization expense 5-47 5,000 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions Entry P Liabilities Accounts Receivable To eliminate intra-entity debt 40,000 Entry Tl Sales 200,000 Cost of Goods Sold To eliminate current year intra-entity inventory transfer 40,000 200,000 35 (continued) Entry G Cost of Goods Sold 12,000 Inventory 12,000 To defer 2013 unrealized inventory gross profit Unrealized gain is the ending inventory of $40,000 (20% of $200,000) multiplied by 30% gross profit rate ($60,000 ÷ $200,000) Noncontrolling Interest in Keller's Net Income Keller reported net income Excess fair value amortization 2012 Intra-entity gross profit realized in 2013 (inventory) 2013 Intra-entity gross profit deferred (inventory) Keller realized income 2013 Outside ownership percentage Noncontrolling interest in Keller's net income 5-48 $140,000 (5,000) 10,000 (12,000) $133,000 40% $ 53,200 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions 35 a (continued) Accounts Sales Cost of goods sold Operating expenses Income of Keller Separate company net income Consolidated net income To noncontrolling interest To parent RE, 1/1/13—Gibson GIBSON AND KELLER Consolidation Worksheet Year Ending December 31, 2013 Gibson (800,000) 500,000 100,000 (84,000 ) (284,000 ) (53,200) (1,116,000) RE, 1/1/13—Keller Net income (above) Dividends Retained earnings, 12/31/13 Cash Accounts receivable Inventory Investment in Keller Land Buildings and equipment (net) Customer list Total assets Liabilities Common stock Additional paid-in capital Retained earnings, 12/31/13 NCI in Keller, 1/1/13 NCI In Keller, 12/31/13 Total liabilities and equity Consolidation Entries Noncontrolling Keller Debit Credit Interest (500,000) (TI) 200,000 300,000 (G) 12,000 (*G) 10,000 (TI) 200,000 60,000 (E) 5,000 -0- (I) 84,000 (140,000 ) (284,000) 115,000 (1,285,000 ) 177,000 356,000 440,000 726,000 180,000 2,375,000 (480,000) (610,000) (1,285,000) (2,375,000 ) (*TL) 40,000 (*C) 9,000 (620,000) (*G) 10,000 (S) 610,000 (140,000) 60,000 (700,000 ) 90,000 410,000 320,000 (D) 36,000 390,000 496,000 300,000 (A) 95,000 1,510,000 (400,000) (P) 40,000 (320,000) (S) 320,000 (90,000) (S) 90,000 (700,000) (1,510,000 ) 1,551,000 5-49 (D) 36,000 (P) (G) (*C) (S) (I) (A) (*TL) 40,000 12,000 9,000 612,000 84,000 57,000 40,000 (E) 24,000 1,551,000 165,000 -0(333,000) 53,200 (279,800 ) (1,067,000) (279,800) 115,000 (1,231,800 ) 267,000 726,000 748,000 -0- 530,000 5,000 (S) 408,000 (A) 38,000 Consolidated Totals (1,100,000) 602,000 90,000 3,157,000 (840,000) (610,000) (408,000) (38,000) 475,200 (1,231,800) (475,200 ) (3,157,000 ) 796,000 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions 35 (continued) b If the intra-entity transfer had been a building rather than land, two adjustments to the consolidation entries would be needed Entry *TL would be changed and relabeled as Entry *TA and an Entry ED would be added to eliminate the overstatement of depreciation expense for 2013 All other consolidation entries would be the same as shown in Part a As a downstream transfer, entries *C and S are not affected Entry *TA Retained Earnings, 1/1/13 (Gibson) 36,000 Buildings 40,000 Accumulated Depreciation 76,000 To defer unrealized gain ($40,000 original amount less one year of excess depreciation at $4,000 per year) as of beginning of year Entry also returns Buildings account to historical cost (from $100,000 to $140,000) and Accumulated Depreciation account to historical cost (original $80,000 less one year of excess depreciation at $4,000) Because the Buildings account is shown at net value in the information given in this problem, the above entry would probably be made as follows: Entry *TA (Alternative) Retained Earnings, 1/1/13 (Gibson) Buildings (net) 36,000 36,000 Entry ED Accumulated Depreciation 4,000 Operating (or Depreciation) Expense 4,000 To remove excess depreciation for current year created by transfer price Excess depreciation for each year would be $4,000 based on allocating the $60,000 historical cost book value over 10 years ($6,000 per year) rather than the $100,000 transfer price ($10,000 per year) 36 (40 Minutes) (Prepare consolidation worksheet with intra-entity transfer of inventory and land No outside ownership exists) a Skyline reported net income Patented technology amortization Beginning inventory gross profit recognized Ending inventory gross profit deferred Deferral of land gain on sale Equity in Skyline’s earnings 5-50 $(88,000) 15,000 (14,400) 14,000 18,000 $(55,400) Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions b Acquisition-Date Fair Value Allocation Consideration transferred (fair value of shares issued) Book value of subsidiary Fair value in excess of book value Excess fair over book value assigned to: Trademarks (indefinite life) Patented technology Life of patented technology Annual amortization $450,000 300,000 $150,000 30,000 $120,000 years $15,000 Unrealized Upstream Inventory Gross Profit, 1/1 Inventory being held ($50,000 × 72%) Gross profit rate ($20,000 ÷ $50,000) Unrealized gross profit, 1/1 $36,000 40% $14,400 Unrealized Upstream Inventory Gross Profit, 12/31 Inventory being held (given) Gross profit rate ($40,000 ÷ $80,000) Unrealized gross profit, 12/31 $28,000 50% $14,000 CONSOLIDATION ENTRIES Entry *G Retained Earnings 1/1 (Skyline) 14,400 Cost of Goods Sold 14,400 To remove impact of beginning unrealized gross profit Amount computed above Entry S Common Stock (Skyline) 120,000 Additional Paid-In Capital (Skyline) 30,000 Retained Earnings 1/1 (Skyline, adjusted) 277,600 Investment in Skyline 427,600 To remove stockholders' equity accounts of subsidiary Retained earnings is adjusted for elimination of beginning unrealized gross profit in Entry *G 36 (continued) Entry A Trademarks 30,000 Patented Technology 105,000 Investment in Skyline 135,000 To recognize excess fair value allocations as of 1/1 Patented technology is adjusted for one prior year of amortization at $15,000 per year 5-51 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions Entry I Investment Income 55,400 Investment in Skyline 55,400 To remove intra-entity income accrued by parent using the equity method Entry D Investment in Skyline Dividends Distributed To eliminate Intra-entity dividend payments 20,000 20,000 Entry E Other Operating Expenses 15,000 Patented technology 15,000 To recognize current year amortization expense on patented technology Entry Tl Revenues 80,000 Cost of Goods Sold To eliminate intra-entity inventory transfer for current year 80,000 Entry G Cost of Goods Sold 14,000 Inventory 14,000 To defer unrealized inventory gross profit Amount is computed above Entry TL Gain on Sale of Land 18,000 Land 18,000 To remove gain from intra-entity transfer of land during current year Entry P Accounts Payable Accounts Receivable To remove intra-entity payable and receivable 5-52 65,000 65,000 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions 36 (continued) Accounts PARKWAY AND SKYLINE Consolidation Worksheet Year Ending December 31, 2013 Revenues Cost of goods sold Parkway (627,000) 289,000 Skyline (358,000) 195,000 Other operating expenses Gain on sale of land Investment income Net income 170,000 (18,000) (55,400) (241,400) 75,000 (88,000) Retained earnings 1/1 (314,600) (292,000) Net income (above) Dividends distributed Retained earnings 12/31 (241,400) 70,000 (486,000) (88,000) 20,000 (360,000) 134,000 281,000 598,000 150,000 112,000 Cash and receivables Inventory Investment in Skyline Trademarks Patented technology Land, buildings, and equipment (net) Total assets Liabilities Common stock Additional paid-in capital Retained earnings (above) Total liabilities & stockholders’ equity Consolidation Entries Debit Credit (TI) 80,000 (G) 14,000 (TI) 80,000 (*G) 14,400 (E) 15,000 (TL) 18,000 (I) 55,400 (*G) 14,400 (S) 277,600 (D) 20,000 (D) 20,000 (A) 30,000 (A) 105,000 637,000 1,650,000 50,000 130,000 283,000 725,000 (463,000) (410,000) (291,000) (486,000) (1,650,000) (215,000) (120,000) (30,000) (360,000) (725,000) (P) 65,000 (S) 120,000 (S) 30,000 5-53 844,400 (P) 65,000 (G) 14,000 (S) 427,600 (A) 135,000 (I) 55,400 (E) 15,000 (TL) 18,000 844,400 Consolidated Totals (905,000) 403,600 260,000 -0-0(241,400) (314,600) -0(241,400) 70,000 (486,000) 219,000 379,000 -080,000 220,000 902,000 1,800,000 (613,000) (410,000) (291,000) (486,000 ) (1,800,000) Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions Chapter Excel Case Solution Excel Case Equity in Shawn Co Earnings 2012 78,000 El profit (34,200) Amortization (12,600) Equity earnings 31,200 Fair Value Allocation Schedule 1/1/2012 Consideration transferred 1,000,000 C.S 500,000 R.E 185,000 685,000 Life Amort 2013 Tradename 315,000 25 12,600 BI profit Inventory El profit Shawn sells GPR remaining Amortization to Patrick 60% 30% Equity earnings Intra-entity Inventory Transfers (upstream) Sales Inventory Intra profit 2012 190,000 57,000 34,200 2013 210,000 63,000 37,800 Investment account Cost 34,200 2012 Equity earnings Dividends 12/31/12 703,800 2013 12/31/13 302,400 Equity earnings Dividends 1,000,000 31,200 (25,000) 1,006,200 68,800 (27,000) 1,048,000 85,000 34,200 (37,800) (12,600) 68,800 Shawn Co dividends 2012 25,000 2013 27,000 Consolidation Adjustments *G RE-Shawn 34,200 Cost of Goods Sold S Common Stock-Shawn 500,000 RE-Shawn 203,800 Investment in Shawn A Tradename Investment in Shawn I 302,400 Equity in Earnings of Shawn68,800 Investment in Shawn 68,800 D Investment in Shawn Dividends Paid 27,000 E Amortization Expense Tradename 12,600 27,000 12,600 IT Sales Cost of Goods Sold 210,000 210,000 G Cost of Goods Sold 5-54 37,800 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions Inventory 37,800 Investment account goes to zero? 5-55 Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions Analysis and Research—Accounting Information and Salary Negotiations a With common control over related enterprises, a consolidated income statement portrays economic reality better For example, it is likely that the Stadium’s concession and parking revenues would have been less if the team did not play there Additionally, the $1,400,000 rent expense does not represent an arm’s length transaction—given that the $1,400,000 is the only rent revenue, it appears that the stadium is used exclusively for baseball with its fortunes intertwined with the team Searching the FASB ASC for “separate statements” and then “intra-entity” yields the following relevant support: There is a presumption that consolidated financial statements are more meaningful than separate financial statements and that they are usually necessary for a fair presentation when one of the entities in the consolidated group directly or indirectly has a controlling financial interest in the other entities FASB ASC (para 810-10-10-1) As consolidated financial statements are based on the assumption that they represent the financial position and operating results of a single economic entity, such statements should not include gain or loss on transactions among the entities in the consolidated group FASB ASC (para 810-10-45-1) Granger Eagles Team and Stadium Consolidated Income Statement Ticket revenues Concession revenue Parking revenue $2,000,000 800,000 100,000 Ticket expense Promotion COGS Depreciation Player salaries Staff salaries Consolidated net income 25,000 35,000 250,000 80,000 400,000 350,000 $2,900,000 1,140,000 $1,760,000 b Other pertinent factors include  Any available comparisons for the market values for the players  The market value of any alternative uses for the stadium  The amount the owners have invested in the team  The amount the owners have invested in the stadium  Fair rates of return for the owners’ investments in the team and the stadium 5-56 ... completed cost/managerial accounting can be asked to describe the various factors that should influence the establishment of this price Interaction between accounting courses is beneficial to the students... Noncontrolling interest in Bennett's net income Income—Bennett $90,000 Excess amortization (8,000) Adjusted net income $82,000 Noncontrolling interest in Bennett’s net income (10%)... Transfer pricing is actually a topic for a managerial accounting discussion Students, though, need to be aware that managerial and financial accounting overlap at times In this illustration, the