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Intercompany Transaction:
Non-current Assets(Part 2)
ARTHIK DAVIANTI
Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary
following a downstream and upstream depreciable asset
transfer.
Transfers of Depreciable AssetsWhat is the major difference between depreciable and non-
depreciable assets?• Depreciation—DUH!• Adds complexity because you have a “moving target” instead
of a stationary target. However, the concepts are the same!
Adjust for:• Unrealized gain (same as with land)• Differences in depreciation expense
The goal is to get back to the asset’s old basis “as if ” it were still on the books of the original owner.• One difference—depreciated going forward based on the new
estimated new life.• Same as a change of depreciation estimates on any company’s
books
Developing Fixed Asset Elimination Entries
Compare “Actual” with “As if ”
• “Actual” = How the transferred asset and related accounts actually appear on the companies’ books
• “ As if ” = How the transferred asset and related accounts would have appeared if the asset had stayed on the original owner’s books
The difference between the two gives the elimination entry or entries.
Choosing the Right Depreciable Life
What’s not relevant?The original owner’s remaining useful life at the transfer date.
What’s relevant?The acquirer’s estimated remaining useful life (if different from the original remaining life).
Downstream saleof depreciable
assets
Illustration (p. 323)Peerless Products Corporation sells equipment to Special Foods on December 31, 20X1, for $7,000 as follows:
Peerless Product
SpecialFoods$9,000 $7,000
Dec 31, 20W8 Dec 31, 20X1
Purchase equipment
Inter-corporate transfer of equipment
Consolidated Entity
Illustration (p. 323)Assume the equipment has been depreciated – useful life of 10 years using straight line method with no residual value.
Original cost to Peerless 9,000Accumulated depreciation on December 31, 20X1 Annual depreciation ($9,000 : 10 years) 900 Number of years x 3
(2,700)Book value on December 31, 20X1 6,300
9,000
Buildings & Equipment
Accumulated Depreciation
7,000
Book Value = 6,300
Sale:
Sale price $7,000 Book Value 6,300Gain $ 700
Separate Company Entries – 20X1Special Foods records:
December 31, 20X1(11) Equipment 7,000
Cash 7,000Record purchase of equipment
Special Foods – no depreciation (purchase at end of year)Peerless records depreciation – prior to calculating the gain on sale:
December 31, 20X1(12) Depreciation expense 900
Accumulated depreciation 900Record depreciation on equipment sold
Peerless also records the sale and recognise the $700 ($7,000 - $6,300) gain on the sale:
December 31, 20X1(13) Cash 7,000
Accumulated depreciation 2,700 Equipment 9,000 Gain on sale of equipment 700Record sale of equipment
Separate Company Entries – 20X1
Peerless also records the normal fully adjusted equity method entries to recognise its share of Special Foods’ income and dividend for 20X1:
(14) Investment in Special Foods 40,000 Income from Special Foods 40,000Record Peerless’ 80% share of Special Foods’ 20X1 income $50,000 X 0.80
(15) Cash 24,000 Investment in Special Foods 24,000Record Peerless’ 80% share of Special Foods’ 20X1 dividend $30,000 X 0.80
Separate Company Entries – 20X1
Under the fully adjusted equity method, Peerless Inc. defers relative the gain on the intercompany sale of equipment as follows:(16) Income from special Foods 700
Investment in Special Foods 700Defer unrealised gain on asset sale to Special Foods
Investment in Special Foods
700
Income from Special Foods
700Defer Gain
80% NI 40,000 40,000 80% NI
39,300 Ending balance
Acquisition 240,000
24,000 80% Dividend
Acquisition 255,300
Separate Company Entries – 20X1
Book Value CalculationsInvestmentAccount Common RetainedNCI (20%) (80%) Stock Earnings
Original book value 60,000 240,000 200,000 100,000+ Net income 10,000 40,000 50,000- Dividend (6,000) (24,000) (30,000)
Ending book value 64,000 256,000 200,000 120,000
=
Analyze book value of Special Foods and allocate each component to Peerless and the NCI shareholders:
Consolidation Worksheet – 20X1
Basic investment account elimination entry:Common Stock 200,000Retained Earnings 100,000Income from Special Foods 39,300NCI in NI of Special Foods 10,000
Dividends Declared30,000
Investment in Special Foods255,300NCI in NA of Special Foods
64,000
Consolidation Worksheet – 20X1
What accounts and balances actually exist after the fixed asset transfer?
SP 7,000 0
Buildings & Equipment
Accumulated Depreciation Gain on Sale
700“Actual”
Review:Assume Peerless purchased an equipment on 31/12/20W8 for $9,000 and estimated that the machine would have a useful life of 10 years with no salvage value. On 12/31/20X1, Peerless sold the equipment to its 80% owned subsidiary, Special Foods., for $7,000.
Peerless’ income is overstated by the $700 gain.Special Foods’ Building and equipment is also overstated by the same amount.Compare what actually happened (as recorded in the individual financial statement of the two companies) with what is ‘as if’ it had not been transferred (historical cost $9,000 with accumulated depreciation $2,700)
SP 7,000 0
Buildings & Equipment
Accumulated Depreciation Gain on Sale
700“Actual”
“As if”P 9,000 2,700 0
Consolidation Worksheet – 20X1
The worksheet entry on 12/31/X1 to eliminate the asset transfer is simply the “adjustment” to change from “actual” to “as if” the asset hadn’t been transferred.
SP 7,000 0
Accumulated Depreciation Gain on Sale
700“Actual”
“As if” P 9,000 2,700 0
2,000 2,700 700
Consolidation Worksheet – 20X1
Eliminate gain on sale of equipment to Special FoodGain on Sale 700Buildings and equipment 2,000
Accumulated depreciation 2,700
Buildings & Equipment
Consolidation Worksheet—20X1
Adjustments
Parent Sub DR CR ConsolidatedIncome Statement Gain on Sale 700 700 0 Income from Sub 39,300 39,300
Basic 0
Balance Sheet Investment in Sub 255,300 255,300
Basic 0
Buildings & equipment 791,000 607,000 2,000 1,400,000
Less: Acc. depreciation (447,300) (320,000) 2,700 770,000
(worksheet, Baker p. 326).
During 20X2, Special Foods – depreciate the $7,000 cost of the equipment from Peerless Products over 7 years of its remaining life using straight line.The depreciation – $7,000 : 7 years = $1,000
(17) Depreciation expense 1,000 Accumulated depreciation 1,000Record depreciation expense for 20X2
Separate Company Entries – 20X2
Peerless also records the normal fully adjusted equity method entries to recognise its share of Special Foods’ $74,000 income and $40,000 dividend for 20X2. Note: Special Foods’ net income is $74,000, it has been reduced by $1,000 of depreciation on the transferred asset.
(18) Investment in Special Foods 59,200 Income from Special Foods 59,200Record Peerless’ 80% share of Special Foods’ 20X2 income $74,000 X 0.80
(19) Cash 32,000 Investment in Special Foods 32,000Record Peerless’ 80% share of Special Foods’ 20X2 dividend $40,000 X 0.80
Separate Company Entries – 20X2
Separate Company Entries – 20X2
Gain = 700 7 = 100 Extra Depreciation
Book Value = 6,300 7 = 900 Parent Depreciation
1,000 Total Depreciation
Peerless must record an additional entry related to the transferred of asset – on Dec 31, 20X1 the equipment was recorded on Special Foods’ balance sheet at $7,000). Special Foods will record “extra” depreciation expense.Special Foods’ annual depreciation ($7,000 : 7 years = $1,000 per year) is $100 per year higher. If Peerless had kept the equipment, the depreciation would be $900 ($6,300 : 7).
Special Foods will record “extra” depreciation expense.Special Foods’ annual depreciation ($7,000 : 7 years = $1,000 per year) is $100 per year higher.If Peerless had kept the equipment, the depreciation would be $900 ($6,300 : 7).Thus, in 20X2 (and over the next six years) Peerless reverse 1/7 of the gain deferral, as follows:
(20) Investment in Special Foods 100 Income from Special Foods 100Reverse 1/7 of the deferred gain on fixed asset sold to Special Foods
Separate Company Entries – 20X2
Book Value CalculationsInvestmentAccount Common RetainedNCI (20%) (80%) Stock Earnings
Original book value 64,000 256,000 200,000 100,000+ Net income 10,000 59,200 74,000- Dividend (8,000) (32,000) (40,000)
Ending book value 64,000 256,000 200,000 154,000
=
Consolidation worksheet (p. 329)
Consolidation Worksheet – 20X2
Basic investment account elimination entry:Common Stock 200,000Retained Earnings 100,000Income from Special Foods 59,300NCI in NI of Special Foods 14,800
Dividends Declared40,000
Investment in Special Foods283,300NCI in NA of Special Foods
64,000
Consolidation Worksheet – 20X1
The 20X2 worksheet’s entries: revalues the assets and corrects depreciation expense.
1,000
Accumulated Depreciation Gain on Sale
700“Actual”
“As if” 3,600 0
2,000 2,700 700
Consolidation Worksheet – 20X1
Entries to adjust equipment and accumulated depreciation “as if” still on parent’s books:Investment in Special Foods 700Buildings and equipment 2,000
Accumulated depreciation 2,700
Buildings & Equipment
SP 7,000
P 9,000
100
Accumulated depreciation 100Depreciation expense 100
Consolidation Worksheet—20X2
Adjustments
Parent Sub DR CR ConsolidatedIncome Statement Less: Depreciation Expense (49,100) (160,000) 100 (70,000) Income from Sub 39,300 59,300
Basic 0
Balance Sheet Investment in Sub 282,600 700 283,300
Basic 0
Buildings & equipment 791,000 607,000 2,000 1,400,000
Less: Acc. depreciation (496,400) (341,000) 100 2,700 840,000
(worksheet, Baker p. 329).
The 20X1 consolidated net income is computed and allocated as follows:
Subsidiary Trial Balance
Elimination Consolidated Amounts
Buildings and equipment $7,000 $2,000 $9,000Accumulated depreciation (1,000) (2,600) (3,600)Depreciation expense 1,000 (100) 900
Consolidation Worksheet—20X2
Consolidated Net Income and Retained Earnings
The 20X2 consolidated net income must include an adjustment for realization of profit on the 20X1 sale of equipment to Special Foods.
Peerless’ separate income $160,900Partial realization of intercompany gain on downstream sale of equipment 100Peerless’ separate realized income $161,000Special Foods’ net income 74,000Consolidate net income, 20X2 $235,000Income to noncontrolling interest ($74,000 X 0.20) (14,800)Income to controlling interest $220,200
Noncontrolling InterestIncome allocated to the NCI in 20X2 – proportionate with share. NCI’s share is $14,800 ($74,000 x 0.20).Noncontrolling interest on December 31, 20X2, is equal to a proportionate share of Special Foods’ book value:Book value of Special Foods, December 31, 20X2: Common stock $200,000 Retained earnings 154,000 Total book value $354,000Noncontrolling stockholders’ proportionate share X 0.20Noncontrolling interest, December 31, 20X2 $70,800
Consolidation in Subsequent Years
Consolidation procedure – similar to those in 20X2.The procedure include two objectives:1. Restating the asset and accumulated depreciation
balances.2. Adjusting depreciation expense for the year.
Summary is in page 332
Upstream saleof depreciable
assets
Upstream SaleSpecial Foods sales equipment to Peerless Products for $7,000 on December 31, 20X1, and reports total income for 20X1 of $50,700 ($50,000 + $700), including $700 gain on the sale of equipment.Special Foods originally purchased the equipment for $9,000 three years before the intercompany sale.The book value of the equipment:
P
S
NCI
20%
80%
Original cost to Special Foods 9,000Accumulated depreciation on December 31, 20X1 Annual depreciation ($9,000 : 10 years) 900 Number of years x 3
(2,700)Book value on December 31, 20X1 6,300
Separate Company Entries – 20X1Special Foods records depreciation for the year and the
sale of the equipment to Peerless on Dec 31, 20X1:December 31, 20X1
(21) Depreciation expense 900 Accumulated depreciation 900Record 20X1 depreciation expense on equipment sold
December 31, 20X1(22) Cash 7,000
Accumulated depreciation 2,700 Equipment 9,000 Gain on sale of equipment 700Record sale of equipment
Peerless also records the purchase of the equipment from Special Foods:
December 31, 20X1(23) Equipment 7,000
Cash 7,000Record purchase of equipment
Separate Company Entries – 20X1
Peerless also records the normal fully adjusted equity method entries to recognise its share of Special Foods’ income and dividend for 20X1:
(24) Investment in Special Foods 40,560 Income from Special Foods 40,560Record Peerless’ 80% share of Special Foods’ 20X1 income $50,700 X 0.80
(25) Cash 24,000 Investment in Special Foods 24,000Record Peerless’ 80% share of Special Foods’ 20X1 dividend $30,000 X 0.80
Separate Company Entries – 20X1
Under the fully adjusted equity method, Peerless Inc. defers relative the gain on the intercompany sale of equipment as follows:(26) Income from special Foods 560
Investment in Special Foods 560Defer 80% of the unrealised gain on asset purchase from Special Foods: $700 X 0.80
Investment in Special Foods
560
Income from Special Foods
560Defer Gain
80% NI 40,560 40,560 80% NI
40,000 Ending balance
Acquisition 240,000
24,000 80% Dividend
Acquisition 256,000
Separate Company Entries – 20X1
Book Value CalculationsInvestmentAccount Common RetainedNCI (20%) (80%) Stock Earnings
Original book value 60,000 240,000 200,000 100,000+ Net income 10,140 40,560 50,700- Dividend (6,000) (24,000) (30,000)
Ending book value 64,140 256,560 200,000 120,700
=
Analyze book value of Special Foods and allocate each component to Peerless and the NCI shareholders:
Consolidation Worksheet – 20X1
Basic investment account elimination entry:Common Stock 200,000Retained Earnings 100,000Income from Special Foods 40,000NCI in NI of Special Foods 10,000
Dividends Declared30,000
Investment in Special Foods256,000NCI in NA of Special Foods
64,000
Consolidation Worksheet – 20X1
The equipment now on Peerless’ books ($7,000, no depreciation – adjust to “as if” it had been transferred.Historical cost of $9,000 with accumulated depreciation of $2,700.
Consolidation Worksheet – 20X1
P 7,000 0
Accumulated Depreciation Gain on Sale
700“Actual”
“As if” SP 9,000 2,700 0
2,000 2,700 700
Eliminate gain on sale of equipment to Special FoodGain on Sale 700Buildings and equipment 2,000
Accumulated depreciation 2,700
Buildings & Equipment
Consolidation Worksheet—20X1
Adjustments
Parent Sub DR CR ConsolidatedIncome Statement Gain on Sale 700 700 0 Income from Sub 40,000 40,000
Basic 0
Balance Sheet Investment in Sub 256,000 256,000
Basic 0
Buildings & equipment 807,000 591,000 2,000 1,400,000
Less: Acc. depreciation (450,000) (317,300) 2,700 770,000
(worksheet, Baker p. 335).
Noncontrolling InterestThe income assigned to the noncontrolling shareholders based on their share of Special Foods’ realized income, as follows:
Net income of Special Foods for 20X1 $50,700Unrealized intercompany sale (700)Realized net income of Special Foods for 20X1 50,000Noncontrolling shareholders’ proportionate share X 0.20Income to noncontrolling interest, 20X1 $10,000
Consolidated Net IncomeThe 20X1 consolidated net income is computed and allocated as follows:
Peerless’ separate income $140,000Special Foods’ net income $50,700Less: Unrealized intercompany gain on upstream land sale (700)Special Foods’ net income 50,000Consolidate net income, 20X1 $190,000Income to noncontrolling interest ($50,000 X 0.20) (10,000)Income to controlling interest $180,000
Separate Company Entries – 20X2
Gain = 700 7 = 100 Extra Depreciation
Book Value = 6,300 7 = 900 Parent Depreciation
1,000 Total Depreciation
Special Foods reports net income of $75,900 ($900 of depreciation expense on the transferred asset – in Peerless’ income statement.The extra $100 of depreciation now in Peerless’ income statement:
Peerless recognizes 80% of the deferred gain: (($700 : 7 years) X 0.80 = $80Peerless’ extra depreciation – cancels out 1/7 of the unrealized gain.
(27) Investment in Special Foods 80 Income from Special Foods 80Recognized 80% of 1/7 of the deferred gain on fixed asset purchased from Special Foods.
Separate Company Entries – 20X2
Book Value CalculationsInvestmentAccount Common RetainedNCI (20%) (80%) Stock Earnings
Original book value 64,140 256,560 200,000 100,000+ Net income 15,180 60,720 75,900- Dividend (8,000) (32,000) (40,000)
Ending book value 71,320 285,280 200,000 156,600
=
Consolidation worksheet (p. 338)
Consolidation Worksheet – 20X2
Basic investment account elimination entry:Common Stock 200,000Retained Earnings 120,700Income from Special Foods 60,800NCI in NI of Special Foods 15,200
Dividends Declared40,000
Investment in Special Foods285,360NCI in NA of Special Foods
71,340
Consolidation Worksheet – 20X2
The 20X2 worksheet’s entries: revalues the assets and corrects depreciation expense.
1,000
Accumulated Depreciation Gain on Sale
700“Actual”
“As if” 3,6000
2,000 2,700 560140
Consolidation Worksheet – 20X2
Entries to adjust equipment and accumulated depreciation “as if” still on parent’s books:Investment in Special Foods 560NCI in NA of Special Foods 140Buildings and equipment 2,000
Accumulated depreciation 2,700
Buildings & Equipment
P 7,000
SP 9,000
100
Accumulated depreciation 100Depreciation expense 100
Consolidation Worksheet—20X2
Adjustments
Parent Sub DR CR ConsolidatedIncome Statement Less: Depreciation Expense (49,100) (160,000) 100 (70,000) Income from Sub 60,800 60,800
Basic 0
Balance Sheet Investment in Sub 284,800 560 285,360
Basic 0
Buildings & equipment 807,000 591,000 2,000 1,400,000
Less: Acc. depreciation (501,000) (336,400) 100 2,700 840,000
(worksheet, Baker p. 338).
Consolidated Net IncomeThe 20X2 consolidated net income is computed and allocated as follows:
Peerless’ separate income $159,000Special Foods’ net income $75,900Less: Unrealized intercompany gain on upstream sale of equipment 100Special Foods’ realized net income 76,000Consolidate net income, 20X1 $235,000Income to noncontrolling interest ($76,000 X 0.20) (15,200)Income to controlling interest $219,800
Noncontrolling InterestIncome allocated to the NCI in 20X2 – proportionate with share. NCI’s share is $15,200 ($76,000 x 0.20).Noncontrolling interest on December 31, 20X2, is equal to a proportionate share of Special Foods’ book value:Book value of Special Foods, December 31, 20X2: Common stock $200,000 Retained earnings 156,600 Total book value $356,600Unrealized 20X1 intercompany gain on upstream sale (700)Intercompany gain realized in 20X2 100Realized book value of Special Foods $356,000Noncontrolling stockholders’ proportionate share X 0.20Noncontrolling interest, December 31, 20X2 $71,2000
Consolidation in Subsequent YearsConsolidation procedure – similar to those in 20X2
(until 20X8 – equipment’s end of useful life).Summary in page 340
Investment in Special Foods 560NCI in NA of Special Foods 140Buildings & Equipment 2,000
Accumulated Depreciation 2,700
Accumulated Depreciation 100 Depreciation Expense 100
20X2 Worksheet Entries:
20X3 Worksheet Entries:
SP: 9,000
Equipment
P: 7,000 2,000
Accumulated Depreciation
1,000 2,700
96,000“As if”
“Actual” 100
Equipment
P: 90,000 30,000
Accumulated Depreciation
1,000 2,600
4,500“As if”
“Actual” 100
Investment in Special Foods 480NCI in NA of Special Foods 120Buildings & Equipment 2,000
Accumulated Depreciation 2,600
Accumulated Depreciation 100 Depreciation Expense 100 SP: 9,000
Source:
BAKER CHRISTENSEN COTTLRELLAdvanced Financial Accounting
Ninth Edition
McGRAW HILL INTERNATIONAL EDITION