E6.6 Various Intercompany Transactions

CHAPTER 6 SOLUTIONS TO EXERCISES AND PROBLEMS EXERCISES E6.1

Intercompany Land Transactions

a. Consolidation Working Paper 2010 Gain on sale of land

50,000

Land 50,000 To eliminate the unconfirmed gain on the intercompany sale of land and reduce the land account to original acquisition cost. 2011 Investment in Sagamore

50,000 Land 50,000 To add the prior year unconfirmed gain to the investment account to maintain equivalence with the retained earnings of Sagamore and reduce the land account to original acquisition cost. b. 2012 Investment in Sagamore

50,000

Gain on sale of land 50,000 To 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. Current year intercompany sale of land at a loss of $14,000. In prior year, the parent sold land to its subsidiary at a gain of $30,000. The subsidiary still holds the land. 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.

2. 3. 4.

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©Cambridge Business Publishers, 2010 135

E6.3

Intercompany Merchandise Transactions

Consolidation Working Paper Retained earnings, Converse -1/1 10,000 Investment in Converse 18,000 Cost of goods sold 28,000 To eliminate the intercompany profit on upstream intercompany sales, assumed confirmed during 2011, from the beginning inventory. Prior year profits on upstream sales are removed from Converse’s beginning retained earnings; $10,000 = $50,000 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 2011 equity accrual; $18,000 = $78,000 - 78,000/1.3. Sales

840,000

Cost of goods sold To eliminate intercompany merchandise sales made during 2011. Cost of goods sold

840,000

29,000

Inventory 29,000 To eliminate unconfirmed intercompany profit from ending inventory; $29,000 = ($40,000 x 20% = $8,000) + [91,000 - (91,000/1.3) = $21,000].

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.

©Cambridge Business Publishers, 2010 136

Advanced Accounting, 1st Edition

E6.5

Intercompany Equipment Transactions

a. 2010 Consolidation Working Paper Gain on sale of equipment 50,000 Equipment 50,000 To eliminate the gain on intercompany sale of equipment; $50,000 = $500,000 – ($600,000 $150,000). Accumulated depreciation

10,000 Depreciation expense To eliminate the excess depreciation recorded by Spencer in 2010 ($50,000/5). Equipment

10,000

150,000

Accumulated depreciation 150,000 To restate the equipment and accumulated depreciation accounts to their original acquisition cost basis. b. 2011 Consolidation Working Paper Investment in Spencer 40,000 Accumulated depreciation 10,000 Equipment 50,000 To eliminate the amount of intercompany gain unconfirmed in prior years, remove the excess depreciation recorded in prior years and reduce the equipment to its net book value at date of intercompany sale. Accumulated depreciation

10,000

Depreciation expense To eliminate the excess depreciation recorded by Spencer in 2011. Equipment

10,000

150,000

Accumulated depreciation 150,000 To restate the equipment and accumulated depreciation accounts to their original acquisition cost basis.

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©Cambridge Business Publishers, 2010 137

E6.6

Various Intercompany Transactions

a.

Consolidation Working Paper (Upstream) Retained earnings – Sand Hill Land Retained Earnings – Sand Hill

2,500,000 2,500,000 1,400,000

Cost of goods sold Cost of goods sold

1,400,000 3,200,000

Inventory Retained earnings – Sand Hill Accumulated depreciation

3,200,000 800,000 400,000

Equipment Accumulated depreciation

1,200,000 200,000

Depreciation expense Equipment

200,000 2,000,000

Accumulated depreciation b.

2,000,000

Consolidation Working Paper (Downstream)

Investment in Sand Hill

2,500,000 Land

Investment in Sand Hill

2,500,000 1,400,000

Cost of goods sold Cost of goods sold

1,400,000 3,200,000

Inventory Investment in Sand Hill Accumulated depreciation

3,200,000 800,000 400,000

Equipment Accumulated depreciation

1,200,000 200,000

Depreciation expense Equipment

200,000 2,000,000

Accumulated depreciation

©Cambridge Business Publishers, 2010 138

2,000,000

Advanced Accounting, 1st Edition

E6.7

Intercompany Transactions, Equity Method Income and Noncontrolling Interest

a.

Salley reported net income Amortization of identifiable intangibles Downstream loss on land Unconfirmed profit in end. inventory - upstream Confirmed profit in beg. inventory - upstream Confirmed profit on downstream equipment sale (= $800,000/10)

b. Land

Total $7,000,000 (1,750,000) 300,000 (400,000) 250,000

Equity in NI $5,600,000 (1,400,000) 300,000 (320,000) 200,000

Noncontrolling Interest in NI $1,400,000 (350,000)

80,000 $5,480,000

80,000 $4,460,000

_______ $1,020,000

(80,000) 50,000

Consolidation Working Paper 300,000

Loss on sale of land To eliminate the unconfirmed loss on downstream land sale. Cost of goods sold

300,000

400,000

Inventory To eliminate the unconfirmed profit in ending inventory due to upstream sales. Retained earnings—Salley, beg.

250,000

Cost of goods sold To recognize the confirmed profit in beginning inventory due to upstream sales Investment in Salley Accumulated depreciation

400,000

250,000

560,000 240,000

Equipment 800,000 To eliminate the unconfirmed profit as of the beginning of the year on downstream equipment sales (=7/10 x $800,000). Accumulated depreciation

80,000

Depreciation expense To eliminate intercompany profit from depreciation expense (= $800,000/10).

Solutions Manual, Chapter 6

80,000

©Cambridge Business Publishers, 2010 139

E6.8

Item 1. 2. 3. 4.

E6.9

Income Effects of Unconfirmed Intercompany Profits Decrease in consolidated net Decrease in noncontrolling income to the controlling interest interest in net income $ 200,000 -240,000 $ 60,000 800,000 -520,000 130,000 $1,760,000 $190,000

Consolidated Income Statement—Intercompany Transactions

(all amounts in thousands) a. Total SCO’s reported net income Amortization of identifiable intangibles Unconfirmed profit in end. inv. - downstream Unconfirmed profit in end. inv. - upstream

$200,000 (36,000) (50,000) (40,000) $ 74,000

Equity in NI $ 150,000 (27,000) (50,000) (30,000) $ 43,000

Noncontrolling Interest in NI $ 50,000 (9,000) (10,000) $ 31,000

b. PCO and SCO Consolidated Income Statement Sales ($2,000,000 + $1,200,000 - $400,000) Cost of goods sold ($1,000,000+$700,000-$400,000+$50,000+$40,000) Other expenses ($600,000 + $300,000 + $36,000) Consolidated net income Noncontrolling interest in net income Consolidated net income to controlling interest

$2,800,000 (1,390,000) (936,000) $ 474,000 (31,000) $ 443,000

E6.10 Consolidated Income Statement, Intercompany Transactions a. Star’s reported net income Amortization of identifiable intangibles Goodwill impairment loss Confirmed profit in beg. inv. - upstream Unconfirmed profit in end. inv. - downstream

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Total $ 900,000 (100,000) (200,000) 110,000 (60,000) $ 650,000

Equity in NI $ 720,000 (80,000) (160,000) 88,000 (60,000) $ 508,000

Noncontrolling Interest in NI $ 180,000 (20,000) (40,000) 22,000 -$ 142,000

Advanced Accounting, 1st Edition

b. Pon and Star Consolidated Income Statement Sales ($9,000,000 + $4,000,000 – $1,000,000) Cost of goods sold ($6,000,000+$2,500,000–$1,000,000– $110,000+$60,000) Other expenses ($2,000,000 + $600,000 + $100,000 + $200,000) Consolidated net income Less consolidated net income attributed to noncontrolling interest Consolidated net income attributed to controlling interest

$ 12,000,000 ( 7,450,000) ( 2,900,000) 1,650,000 ( 142,000) $ 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.

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©Cambridge Business Publishers, 2010 141

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 (amounts in thousands) Brown’s net income from its own operations $ 40,000 Shoes.com’s net income from its own operations 25,000 Increase in cost of goods sold from sale of revalued inventory (700) Depreciation expense reduction from overvaluation adjustment 200 Increase in fair value of contingent consideration liability (220) Amortization of premium on long-term debt (reduction in interest expense) 90 Impairment loss on capitalized in-process R&D (800) Increase in cost of goods sold due to eliminated upstream ending inventory profit (330) Eliminated loss on downstream sale of patent 400 Increase in patent amortization expense on the patent ($400/5) (80) Consolidated net income 63,560 Less consolidated net income attributed to noncontrolling interest* (2,346) Consolidated net income attributed to controlling interest $ 61,214 * $2,346 = .1 x ($25,000 – $700 + $200 + $90 – $800 – $330)

©Cambridge Business Publishers, 2010 142

Advanced Accounting, 1st Edition

PROBLEMS P6.1

Consolidation Working Paper, Noncontrolling Interest, Intercompany Inventory Transactions

a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Seaport Previously unrecorded intangibles Goodwill

$ 3,000,000 275,000 3,275,000 $ 2,000,000 __500,000

2,500,000 $ 775,000

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

Calculation of 2010 Equity in Net Income and Noncontrolling Interest in Net Income (in thousands): Equity in Noncontrolling Total NI interest in NI Seaport Company reported net income ($6,000,000 – 3,170,000 – 1,930,000) $ 900,000 $ 810,000 $ 90,000 Upstream markup, beginning inventory 100,000 90,000 10,000 Downstream markup, beg. inventory 60,000 60,000 Upstream markup, ending inventory (80,000) (72,000) (8,000) Downstream markup, ending inventory (75,000) (75,000) ______ $ 905,000 $ 813,000 $ 92,000

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©Cambridge Business Publishers, 2010 143

c. Consolidation Working Paper, December 31, 2010 (in millions) Trial Balances Taken From Books Dr (Cr)

Eliminations Consolidated

Peninsula Current assets Investment in Seaport

Property, plant and equipment, net Intangibles Goodwill Liabilities Capital stock Retained earnings, Jan. 1

$ 1,950 4,183

Seaport $

980 --

5,810 4,270

5,120 --

(4,900) (3,000) (6,700)

(2,100) (1,200) (2,300)

Dr (I-2)

60

1,000

400

Sales Equity in net income of Seaport Cost of goods sold

(15,000) (813) 9,050

(6,000)

Operating expenses Noncontrolling interest in net income

4,150 ______ $ 0

1,930 _____ $ 0

©Cambridge Business Publishers, 2010 144

3,170

155 (I-3) 453 (C) 3,060 (E) 730 (R)

(E) 1,200 (I-2) 100 (E) 2,200 340 45 52 360 40 (I-1)5,900 (C) 813 (I-3) 155

$ 2,775 --

10,930 4,570 475 (7,000) (3,000) (6,700)

(R) 300 (R) 475

Noncontrolling interest

Dividends

Balances

Cr

(E) (R) (N) (C) (N)

160 (I-2) 5,900 (I-1)

(N) 92 ______ $ 11,295 $ 11,295

(437)

1,000 (15,100) -6,315 6,080 92 $ 0

Advanced Accounting, 1st Edition

P6.2

Consolidation Working Paper, Noncontrolling Interest, Intercompany Merchandise Transactions

(all amounts thousands) a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Wholesome Revaluations: Plant and equipment, net Intangibles Long-term debt Goodwill

$ 120,000 35,000 $ 155,000 $ 74,000 (15,000) 25,000 (4,000)

80,000 $ 75,000

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

Wholesome’s reported net income for 2010 Revaluation write-offs for 2010: Plant & equipment ($15,000/10) Intangibles ($25,000/10) Goodwill (80/20 split) Intercompany sales adjustments: Upstream beg. inventory profit confirmed Upstream end. inventory profit unconfirmed Total

Equity in net income of Total Wholesome $ 5,000 $ 3,750

Noncontrolling interest in net income of Wholesome $ 1,250

1,500 (2,500) (1,000)

1,125 (1,875) (800)

375 (625) (200)

2,400 (3,000) $ 2,400

1,800 (2,250) $ 1,750

600 (750) $ 650

Note: The long-term debt premium is completely amortized by 2010.

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©Cambridge Business Publishers, 2010 145

c. Consolidation Working Paper, December 31, 2010 Trial Balances Taken From Books Dr (Cr)

Eliminations Consolidated

Kellogg’s

Wholesome

Dr

Current assets Plant and equipment, net Investment in Wholesome

$ 35,000 261,900 131,850

$ 20,000 192,000 --

(O)

Identifiable intangibles Goodwill Current liabilities Long-term debt Capital stock Retained earnings, Jan. 1

100,000 -(30,000) (350,000) (80,000) (60,000)

10,000 -(25,000) (100,000) (54,000) (38,000)

--

--

(400,000) (1,750) 250,000

(140,000) -65,000

Noncontrolling interest

Sales revenue Equity in NI of Wholesome Cost of goods sold Operating expenses Noncontrolling interest in NI

143,000 _____-$ 0

©Cambridge Business Publishers, 2010 146

70,000 _____-$ 0

Cr 3,000 (I-3) 9,000 (R) 1,750 (C) 67,200 (E) 62,900 (R) 2,500 (O) 1,000 (O)

1,500

(R) 15,000 (R) 73,000

(E) 54,000 (I-2) 2,400 (E) 35,600

$

52,000 446,400

-122,500 72,000 (55,000) (450,000) (80,000) (60,000)

22,400 (E) 16,100 (R) 650 (N) (I-1) 60,000 (C) 1,750 (I-3) 3,000 (O) 2,000 (N) 650 $ 248,900

Balances

2,400 (I-2) 60,000 (I-1)

$

_______ 248,900

(39,150) (480,000) -255,600 215,000 650 $ 0

Advanced Accounting, 1st Edition

P6.3

Intercompany Transfers of Depreciable Assets

a. Consolidation Working Paper Transaction (1) Investment in Smart (2.5 x ($80,000/8)) 25,000 Accumulated depreciation (5.5 x $80,000/8)) 55,000 Plant assets 80,000 To eliminate the intercompany gain unconfirmed in prior years, remove the excess depreciation recorded in prior years and reduce the asset account to its net book value at date of intercompany sale. Accumulated depreciation

10,000

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

10,000

Plant assets

20,000 Accumulated 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)) Accumulated depreciation (4 x ($50,000/10))

30,000

20,000 Plant assets 50,000 To eliminate the intercompany gain unconfirmed in prior years, remove the excess depreciation recorded in prior years and reduce the asset account to its net book value at date of intercompany sale. Accumulated depreciation

5,000

Depreciation expense To eliminate the excess depreciation recorded by Pert in 2012. Plant assets

5,000

300,000

Accumulated depreciation 300,000 To restate the asset and accumulated depreciation accounts to their original acquisition cost basis.

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Transaction (3) Plant assets

40,000

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

8,000 Accumulated depreciation 8,000 To add back the reduced depreciation recorded by the purchasing affiliate (Smart) in 2012. Plant assets

360,000

Accumulated depreciation 360,000 To restate the asset and accumulated depreciation accounts to their original acquisition cost basis. b. Consolidation Working Paper Retained earnings-Smart 30,000 Gain on sale of plant assets 30,000 To include in current year income the portion of the original intercompany gain of $50,000 which had not been confirmed through depreciation as of the beginning of the year. This remaining portion, which would have 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)].

©Cambridge Business Publishers, 2010 148

Advanced Accounting, 1st Edition

P6.4

Consolidated Income Statement—Intercompany Transactions

a.

Sow's reported net income Plus intercompany profit in Pow's beginning inventory, now assumed confirmed Less unconfirmed intercompany profit in Sow's ending inventory Plus Sow's unconfirmed loss on an intercompany sale of land Less Pow's unconfirmed gain on intercompany sale of machinery at beginning of year [$250,000 - $250,000/5)] Plus Pow's gain on prior year intercompany sale of land, confirmed through external sale Net equity method income accrual

Total $ 800,000

Equity in net income $ 760,000

Noncontrolling interest in net income $ 40,000

400,000

380,000

20,000

(200,000)

(200,000)

100,000

95,000

(200,000)

(200,000)

60,000 $ 960,000

60,000 $ 895,000

5,000

______ $ 65,000

b. Pow Company and Sow Company Consolidated 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 3,260,000 Noncontrolling interest in net income 65,000 Consolidated 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)

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©Cambridge Business Publishers, 2010 149

P6.5

Equity Accrual and Eliminating Entries—Intercompany Asset Transfers and Services

(all numbers in thousands) a.

Singular's net income Plus intercompany profits in Singular's beginning inventory (downstream sales); ($25,000 - $25,000/1.25) Less intercompany profits in Peopleserve's end. inventory (upstream sales); ($40,000 $40,000/1.25) Less unconfirmed gain on upstream intercompany sale of machinery; [$20,000 ($20,000/5)]

b. (C) Income from Singular

Noncontrolling interest in net income $ 40,000

Total $ 200,000

Equity in net income $ 160,000

5,000

5,000

(8,000)

(6,400)

(1,600)

(16,000) $ 181,000

(12,800) $ 145,800

(3,200) $ 35,200

Consolidation Working Paper

145,800 Dividends - Singular (.8 x .4 x $200,000) Investment in Singular To eliminate the current year equity method entries made by Peopleserve. (I-1) Stockholders’ equity (RE), 1/1 Singular

64,000 81,800

10,000

Land 10,000 To eliminate the unconfirmed gain from the prior year upstream transfer of land and reduce the land account to original acquisition cost. (I-2) Sales Cost of goods sold To eliminate intercompany merchandise sales.

©Cambridge Business Publishers, 2010 150

250,000 250,000

Advanced Accounting, 1st Edition

(I-3) Investment in Singular

5,000

Cost of goods sold 5,000 To eliminate unconfirmed intercompany profit on downstream sales from beginning inventory. (I-4) Cost of goods sold

8,000 Inventory 8,000 To eliminate unconfirmed intercompany profit on upstream sales from ending inventory. (I-5) Gain on sale of machinery

20,000

Machinery To eliminate the gain on the intercompany sale of machinery.

20,000

(I-6) Accumulated depreciation

4,000 Depreciation expense 4,000 To eliminate excess depreciation on the machinery acquired from Singular; this is the portion of the $20,000 gain confirmed to Singular in 2012. (I-7) Machinery

30,000

Accumulated depreciation 30,000 To restate the machinery and accumulated depreciation accounts to their original acquisition cost basis. (I-8) Computer service revenue

15,000

Computer service expense To eliminate intercompany revenue and expense. (I-9) Accounts payable Accounts receivable To eliminate intercompany receivables and payables.

Solutions Manual, Chapter 6

15,000

2,000 2,000

©Cambridge Business Publishers, 2010 151

(E) Stockholders’ equity – Singular (1)

1,580,000

Investment in Singular 1,264,000 Noncontrolling interest in Singular 316,000 To eliminate the remaining beginning stockholders= equity of Singular against the investment and establish the book value of noncontrolling interest as of 1/1/12. (1) $1,580,000 = $1,500,000 + $150,000 - .4 x $150,000 - $10,000, where $1,500,000 = $1,250,000 + $300,000 – $50,000 Goodwill = Stockholders’ equity—Singular at 1/2/11. (R) Goodwill

50,000

Investment in Singular To establish goodwill as of the beginning of the year.

50,000

Note: Goodwill is attributed only to the controlling interest: Acquisition cost $ 1,250,000 Fair value of noncontrolling interest 300,000 Total fair value 1,550,000 Book value of Singular, 1/2/11 1,500,000 Goodwill $ 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 Singular balance of $1,390,800, calculated as follows: January 2, 2011 balance Equity in income of Singular, 2011 (2) Dividends, 2011 December 31, 2011 balance Equity in income of Singular, 2012 Dividends, 2012 December 31, 2012 balance (2)

$1,250,000 107,000 (48,000) 1,309,000 145,800 (64,000) $1,390,800

Equity in net income for 2011 calculation:

80% x Singular’s book income of $150,000 unconfirmed upstream land profit (80%) unconfirmed downstream profit in ending inventory (100%) Equity in net income of Singular, 2011 ©Cambridge Business Publishers, 2010 152

$ 120,000 (8,000) (5,000) $ 107,000

Advanced Accounting, 1st Edition

(N) Noncontrolling interest in net income

35,200

Dividends—Singular (.2 x .4 x $200,000) Noncontrolling interest in Singular To record the change in the noncontrolling interest during 2012.

P6.6

16,000 19,200

Comprehensive Problem: Consolidation Working Paper and Financial Statements

(all amounts in thousands) a. Calculation of goodwill: Acquisition cost Fair value of noncontrolling interest Total fair value Book value of Selene Previously unrecorded intangibles Goodwill Consideration paid 75% x $14,000 Goodwill to parent Goodwill to noncontrolling interest

$ 20,100 5,900 26,000 $ 10,000 4,000

$ 20,100 10,500 $ 9,600 $ 2,400

14,000 $ 12,000

80% 20%

b.

Calculation of 2012 Equity in Net Income and Noncontrolling Interest in Net Income (in thousands): Equity Noncontrolling Total in NI interest in NI Selene’s reported net income ($50,000 – 35,000 – 8,000) $ 7,000 $ 5,250 $ 1,750 Amortization, developed tech ($4,000/5) (800) (600) (200) Confirmed downstream gain on equipment (excess depreciation) ($2,000/10) 200 200 Upstream markup, beg. inv. ($1,800 – $1,800/1.2) 300 225 75 Upstream markup, end. inv. ($2,400 – $2,400/1.2) (400) (300) (100) Downstream markup, beg. inv. ($3,000 x 20%) 600 600 Downstream markup, end. inv. ($2,800 x 20%) (560) (560) _____ $ 6,340 $ 4,815 $ 1,525

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c. Consolidation Working Paper, December 31, 2012 (in thousands) Trial Balances Eliminations Taken From Books Dr (Cr) Consolidated

Pierre Cash Receivables Inventories Plant and equipment, net Investment in Selene

Intangibles Goodwill Current liabilities Long-term debt Capital stock Retained earnings, January 1

$ 1,000 5,600 70,000 460,000 25,040

Selene $ 2,500 10,000 30,000 150,000

Dr

$

(I-2) 200 (I-1) 1,600 (I-4) 600 (R) 1,600 (R) 9,000

(4,000) (2,800) (489,825) (163,700) (5,000) (2,000) (90,000) (20,000)

Sales revenue Equity in income of Selene Cost of sales

40,000 (150,000) (4,815) 100,000

Operating expenses Noncontrolling interest in net income

42,000 _____ $ -0-

35,000 8,000 _____ $ -0-

3,500 15,600 99,040 608,600

-800 9,000 (6,800) (653,525) (5,000) (90,000)

5,425 2,200 775 2,250 750

3,000 (50,000)

960 (I-5) 1,600 (I-1) 2,565 (C) 16,275 (E) 8,400 (R) 800 (O)

(E) 2,000 (I-4) 300 (E) 19,700

Noncontrolling interest

Dividends

Balances

Cr

(E) (R) (N) (C) (N)

(I-3) 35,000 (C) 4,815 (I-5) 960

35,000 (I-3) 900 (I-4) (O) 800 200 (I-2) (N) 1,525 _______ $ 78,100 $ 78,100

(8,400) 40,000 (165,000) -100,060 50,600 1,525 $ -0-

d. Consolidated Statement of Income and Retained Earnings For the Year 2012 Sales $ 165,000 Costs of goods sold (100,060) Gross margin 64,940 Operating expenses (50,600) Consolidated net income 14,340 Noncontrolling interest in income (1,525) Consolidated income to controlling interest 12,815 Retained earnings, January 1 90,000 Dividends (40,000) Retained earnings, December 31 $ 62,815

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Consolidated Balance Sheet, December 31, 2012 Assets Current assets: Cash Receivables Inventories Total current assets Plant and equipment, net Intangibles Goodwill Total assets Liabilities and Stockholders’ Equity Current liabilities Long-term debt Total liabilities Stockholders’ equity Capital stock Retained earnings Equity to Pierre Noncontrolling interest Total stockholders’ equity Total liabilities and stockholders’ equity

P6.7

$

3,500 15,600 99,040 118,140 608,600 800 9,000 $ 736,540 $

6,800 653,525 660,325

5,000 62,815 67,815 8,400 76,215 $ 736,540

Calculation of Investment balance and Consolidated Retained Earnings Several Years Later

(all amounts in thousands) a. Calculation of Consolidated Retained Earnings Pacific Foods' retained earnings from its own operations Equity in net income, 2007 – 2010: 75 % of Sahara’s total net income since acquisition (.75 x $80,000) Less 75% of depreciation on asset revaluation [.75 x (($20,000/5) x 4)] Less 75% of goodwill impairment loss (.75 x $3,000) Less 75% of unconfirmed gain on upstream land sale (.75 x $15,000) Less unconfirmed gain on downstream patent sale [$8,000 – (($8,000/10) x 3)] Less 75% of unconfirmed profit on upstream ending inventory ($6,000 x .75) Less unconfirmed profit on downstream ending inventory Equity in net income, 2007 – 2010 Consolidated retained earnings, December 31, 2010

Solutions Manual, Chapter 6

$ 47,500 60,000 (12,000) (2,250) (11,250) (5,600) (4,500) (8,500) 15,900 $ 63,400

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b. Investment in Sahara, January 2, 2007 Plus equity in net income, 2007 - 2010 Less 75% of Sahara’s dividends, 2007 - 2010 Investment in Sahara, December 31, 2010

P6.8

$ 150,000 15,900 (7,500) $ 158,400

Bonus Based on Adjusted Subsidiary Income

Net income before taxes Adjustment for unconfirmed intercompany inventory profits: Increase in inventory Percent acquired from parent Increase in intercompany inventory Gross margin percentage Increase in unconfirmed intercompany inventory profit Plus interest paid to parent (= $600,000 x .10) Revised income base Less 40% for corporate costs and income taxes Base for bonus

$150,000 $380,000 x .8 304,000 x .35 (106,400) 60,000 103,600 (41,440) 62,160 x .15 $ 9,324

Bonus

P6.9

Consolidated Income Statement—Intercompany Transactions

a.

Salem reported net income Confirmed profit in BI-downstream Unconfirmed profit in EI-upstream Unconfirmed loss on asset sale-downstream Confirmed loss on asset sale-downstream = $360,000/6 Unconfirmed gain on land sale-upstream Confirmed gain (excess amortization) on patent sale-upstream = $250,000/5 Unconfirmed gain on prior year patent sale, as of beg.of year-upstream = $250,000/5 x 2

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Total $6,200,000 650,000 (500,000) 360,000

Equity in NI $4,960,000 650,000 (400,000) 360,000

Noncontrolling Interest in NI $1,240,000

(60,000) (190,000)

(60,000) (152,000)

(38,000)

50,000

40,000

10,000

100,000 $6,610,000

80,000 $5,478,000

20,000 $1,132,000

(100,000)

Advanced Accounting, 1st Edition

b. Portland Company and Salem Company Consolidated Income Statement Sales ($40,000,000 + 25,000,000 - 4,000,000) Other income ($6,000,000 + 2,000,000 - 190,000 + 100,000) Total revenue Cost of goods sold ($28,000,000 + 15,000,000 - 4,000,000 650,000 + 500,000) Operating expenses ($7,000,000 + 5,000,000 + 60,000 - 50,000) Other expenses ($1,000,000 + 800,000 - 360,000) Total expenses Consolidated net income Noncontrolling interest in net income Net income to the controlling interest

$61,000,000 7,910,000 68,910,000 38,850,000 12,010,000 1,440,000 52,300,000 16,610,000 1,132,000 $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.

Solutions Manual, Chapter 6

©Cambridge Business Publishers, 2010 157

P6.10 Comprehensive Intercompany Eliminations Consolidation Working Paper Elimination (E) Stockholders' equity – MC Shops

7,000,000 Investment in MC Shops

Eliminations (I) Sales

7,000,000

60,000,000 Cost of goods sold

Investment in S

60,000,000 2,000,000

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

2,000,000

2,600,000

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

2,600,000

8,000,000 Franchise fee expense

Interest revenue

8,000,000 4,000,000

Interest expense Liabilities

4,000,000 43,000,000

All other assets

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43,000,000

Advanced Accounting, 1st Edition

P6.11 Consolidation of Equity Method Investments a. Consolidation Working Paper, September 30, 2007

Current assets Equity investments Other noncurrent assets Goodwill Current liabilities Noncurrent liabilities Shareholders’ equity, beg Noncontrolling interest

Trial Balances Taken From Books Dr. (Cr.) 13 Starbucks Companies $ 1,696,487 $ 183,123 234,468 3,412,923

408,591

(2,155,566) (904,195) (1,611,479)

(166,386) (56,807) (338,243)

Dividends

Eliminations Consolidated

Dr (C)

8,721

Cost of sales and other operating expenses Other expenses, net Noncontrolling int. in NI

32,200 (I-2) 172,504 (E) 70,685 (R)

(R) 138,598 (I-2) 32,200 (E) 338,243

129,269

Revenues Equity method income

Balances

Cr

(9,411,497) (108,006)

(1,452,949)

(I-1) 107,900 (a) 50,800 (C) 57,206

8,465,558 381,307 ________ $ -0-

1,266,790 26,612 ________ $ -0-

(a) 57,100

165,739 67,913 14,836 65,927 63,342 107,900

(E) (R) (N) (C) (N) (a)

107,900 (I-1)

(N) 78,178 ________ $ 868,946 $ 868,946

$ 1,847,410 -3,821,514 138,598 (2,289,752) (961,002) (1,611,479)

(248,488) -(10,864,446) --

9,681,548 407,919 78,178 $ -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 ($32,200 = $30,600 + $1,600). (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 ($70,685) represents 51% of the total goodwill balance of $138,598 (= $70,685/.51). The remainder is credited to noncontrolling interest. (N) Recognizes $78,178 noncontrolling interest in investee income (= 49% x $159,547), eliminates the noncontrolling interest’s dividends and updates the noncontrolling interest for the current year. b.

Solutions Manual, Chapter 6

©Cambridge Business Publishers, 2010 159

Consolidated amount Starbucks’ reported Increase

Total Assets $ 5,807,522 5,343,878 $ 463,644

Revenues $ 10,864,446 9,411,497 $ 1,452,949

8.68%

15.44%

Percentage increase

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.

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e. Eliminating entry (in millions): Common stock, FP Profit employed in the business, FP Accumulated other comprehensive income, FP

860 2,566 522 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.

Solutions Manual, Chapter 6

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©Cambridge Business Publishers, 2010 162

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