120585830 Ch07 Test Bank Jeter Advanced Accounting 3rd Edition

8/9/2019 120585830 Ch07 Test Bank Jeter Advanced Accounting 3rd Edition

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Chapter 7

Elimination of Unrealized Gains or Losses on

Intercompany Sales of Property and Equipment

Multiple Choice

1. In the year a subsidiary sells land to its parent company at a gain, a workpaper entry is made debiting1. Retained Earnings - P Company.2. Retained Earnings - S Company.3. Gain on Sale of Land.

a. 1 b. 2c. 3d. both 1 and 2.

2. In years subsequent to the year a 90% owned subsidiary sells equipment to its parent company at a gain, thenoncontrolling interest in consolidated income is computed by multiplying the noncontrolling interest percentage

by the subsidiary‟s reported net incomea. minus the net amount of unrealized gain on the intercompany sale. b. plus the net amount of unrealized gain on the intercompany sale.c. minus intercompany gain considered realized in the current period.d. plus intercompany gain considered realized in the current period.

3. Company S sells equipment to its parent company (P) at a gain. In years subsequent to the year of theintercompany sale, a workpaper entry is made under the cost method debitinga. Retained Earnings - P. b. Noncontrolling interest.c. Equipment.d. all of these.

4. Pinick Corp. owns 90% of the outstanding common stock of Shell Company. On December 31, 2011, Shell soldequipment to Pinick for an amount greater than the equipment‟s book value but less than its original cost. Theequipment should be reported on the December 31, 2011 consolidated balance sheet ata. Pinick ‟s original cost less 90% of Shell‟s recorded gain. b. Pinick ‟s original cost less Shell‟s recorded gain.c. Shell‟s original cost.d. Pinick ‟s original cost.

5. Pratt Company owns 100% of Sage Corporation. On January 1, 2011 Pratt sold equipment to Sage at a gain.Pratt had owned the equipment for four years and used a ten-year straight-line rate with no residual value. Sage isusing an eight-year straight-line rate with no residual value. In the consolidated income statement, Sage‟s

recorded depreciation expense on the equipment for 2011 will be reduced bya. 10% of the gain on sale. b. 12 1/2% of the gain on sale.c. 80% of the gain on sale.d. 100% of the gain on sale.

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Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd

Edition7-2

6. Pratt Corporation owns 100% of Stone Company‟s common stock. On January 1, 2011, Pratt sold equipmentwith a book value of $210,000 to Stone for $300,000. Stone is depreciating the equipment over a ten-year life bythe straight-line method. The net adjustments to compute 2011 and 2012 consolidated income would be anincrease (decrease) of

2011 2012a. ($90,000) $0

b. ($90,000) $9,000c. ($81,000) $0d. ($81,000) $9,000

7. In the year an 80% owned subsidiary sells equipment to its parent company at a gain, the noncontrolling interestin consolidated income is calculated by multiplying the noncontrolling interest percentage by the subsidiary‟sreported net incomea. plus the intercompany gain considered realized in the current period. b. plus the net amount of unrealized gain on the intercompany sale.c. minus the net amount of unrealized gain on the intercompany sale.d. minus the intercompany gain considered realized in the current period.

8. The amount of the adjustment to the noncontrolling interest in consolidated net assets is equal to thenoncontrolling interest‟s percentage of thea. unrealized intercompany gain at the beginning of the period. b. unrealized intercompany gain at the end of the period.c. realized intercompany gain at the beginning of the period.d. realized intercompany gain at the end of the period.

9. In January 2008, S Company, an 80% owned subsidiary of P Company, sold equipment to P Company for$1,980,000. S Company‟s original cost for this equipment was $2,000,000 and had accumulated depreciation of$200,000. P Company continued to depreciate the equipment over its 9 year remaining life using the straight-linemethod. This equipment was sold to a third party on January 1, 2011 for $1,440,000. What amount of gain shouldP Company record on its books in 2011?

a. $60,000. b. $120,000.c. $240,000.d. $360,000.

10. In years subsequent to the upstream intercompany sale of nondepreciable assets, the necessary consolidatedworkpaper entry under the cost method is to debit thea. Noncontrolling interest and Retained Earnings (Parent) accounts, and credit the nondepreciable asset. b. Retained Earnings (Parent) account and credit the nondepreciable asset.c. Nondepreciable asset, and credit the Noncontrolling interest and Investment in Subsidiary accounts.d. No entries are necessary.

11. When preparing consolidated financial statement workpapers, unrealized intercompany gains, as a result ofequipment or inventory sales by affiliates, are allocated proportionately by percent of ownership between parentand subsidiary only when the selling affiliate isa. the parent and the subsidiary is less than wholly owned. b. a wholly owned subsidiary.c. the subsidiary and the subsidiary is less than wholly owned.d. the parent of a wholly owned subsidiary.



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Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment 7-3

12. Gain or loss resulting from an intercompany sale of equipment between a parent and a subsidiary isa. recognized in the consolidated statements in the year of the sale. b. considered to be realized over the remaining useful life of the equipment as an adjustment to depreciation in

the consolidated statements.c. considered to be unrealized in the consolidated statements until the equipment is sold to a third party.d. amortized over a period not less than 2 years and not greater than 40 years.

13. In 2011, P Company sells land to its 80% owned subsidiary, S Company, at a gain of $50,000. What is the effectof this sale of land on consolidated net income assuming S Company still owns the land at the end of the year?a. consolidated net income will be the same as if the sale had not occurred. b. consolidated net income will be $50,000 less than it would had the sale not occurred.c. consolidated net income will be $40,000 less than it would had the sale not occurred.d. consolidated net income will be $50,000 greater than it would had the sale not occurred.

14. Several years ago, P Company bought land from S Company, its 80% owned subsidiary, at a gain of $50,000 to SCompany. The land is still owned by P Company. The consolidated working papers for this year will require:a. no entry because the gain happened prior to this year. b. a credit to land for $50,000.

c. a debit to P‟s retained earnings for $50,000.d. a debit to Noncontrolling interest for $50,000.

15. On January 1, 2010 S Corporation sold equipment that cost $120,000 and had a book value of $48,000 to PCorporation for $60,000. P Corporation owns 100% of S Corporation and the equipment has a 4-year remaininglife. What is the effect of the sale on P Corporation‟s Equity from Subsidiary Income account for 2011?a. no effect b. increase of $12,000.c. decrease of $12,000.d. increase of $3,000.

16. P Corporation acquired an 80% interest in S Corporation two years ago at an implied value equal to the book

value of S. On January 2, 2011, S sold equipment with a five-year remaining life to P for a gain of $120,000. Sreports net income of $600,000 for 2011 and pays dividends of $200,000. P‟s Equity from Subsidiary Income for2011 is:a. $480,000. b. $384,000.c. $403,200.d. $576,000

17. P Company purchased land from its 80% owned subsidiary at a cost of $100,000 greater than it subsidiary‟s bookvalue. Two years later P sold the land to an outside entity for $50,000 more than it‟s cost. In its current yearconsolidated income statement P and its subsidiary should report a gain on the sale of land of:a. $50,000.

b. $120,000.c. $130,000.d. $150,000.



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Edition7-4

18. On January 1, 2010, P Corporation sold equipment with a 3-year remaining life and a book value of $40,000 to its70% owned subsidiary for a price of $46,000. In the consolidated workpapers for the year ended December 31,2011, an elimination entry for this transaction will include a:a. debit to Equipment for $6,000. b. debit to Gain on Sale of Equipment for $6,000.c. credit to Depreciation Expense for $6,000.

d. debit to Accumulated Depreciation for $4,000.

19. Parks Corporation owns 100% of Starr Company‟s common stock. On January 1, 2011, Parks sold equipmentwith a book value of $350,000 to Starr for $500,000. Starr is depreciating the equipment over a ten-year life bythe straight-line method. The net adjustments to compute 2011 and 2012 consolidated income would be anincrease (decrease) of

2011 2012a. ($150,000) $0 b. ($150,000) $15,000c. ($135,000) $0d. ($135,000) $15,000

20. In January 2008, S Company, an 80% owned subsidiary of P Company, sold equipment to P Company for$990,000. S Company‟s original cost for this equipment was $1,000,000 and had accumulated depreciation of$100,000. P Company continued to depreciate the equipment over its 9 year remaining life using the straight-linemethod. This equipment was sold to a third party on January 1, 2011 for $720,000. What amount of gain should PCompany record on its books in 2011?a. $30,000. b. $60,000.c. $120,000.d. $180,000.

21. P Corporation acquired an 80% interest in S Corporation two years ago at an implied value equal to the bookvalue of S. On January 2, 2011, S sold equipment with a five-year remaining life to P for a gain of $180,000. S

reports net income of $900,000 for 2011 and pays dividends of $300,000. P‟s Equity from Subsidiary Income for2011 is:a. $720,000. b. $576,000.c. $604,800.d. $864,000

22. P Company purchased land from its 80% owned subsidiary at a cost of $30,000 greater than it subsidiary‟s bookvalue. Two years later P sold the land to an outside entity for $15,000 more than it‟s cost. In its current yearconsolidated income statement P and its subsidiary should report a gain on the sale of land of:a. $15,000. b. $36,000.

c. $39,000.d. $45,000.

23. On January 1, 2010, P Corporation sold equipment with a 3-year remaining life and a book value of $100,000 toits 70% owned subsidiary for a price of $115,000. In the consolidated workpapers for the year ended December31, 2011, an elimination entry for this transaction will include a:a. debit to Equipment for $15,000. b. debit to Gain on Sale of Equipment for $15,000.c. credit to Depreciation Expense for $15,000.



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d. debit to Accumulated Depreciation for $10,000. Problems

7-1 Parker Company, a computer manufacturer, owns 90% of the outstanding stock of Santo Company. On January1, 2011, Parker sold computers to Santo for $500,000. The computers, which are inventory to Parker, had a costto Parker of $350,000. Santo Company estimated that the computers had a useful life of six years from the date o

purchase.

Santo Company reported net income of $310,000, and Parker Company reported net income of $870,000 from itsindependent operations (including sales to affiliates) for the year ended December 31, 2011.

Required:A. Prepare in general journal form the workpaper entries necessary because of the intercompany sales in the

consolidated statements workpaper for both 2011 and 2012.

B. Calculate controlling interest in consolidated net income for 2011.

7-2 On January 1, 2008, Penny Company purchased a 90% interest in Stein Company for $800,000, the same as the book value on that date. On January 1, 2011, Stein sold new equipment to Penny for $16,000. The equipmentcost $11,000 and had a five year estimated life as of January 1, 2011.

During 2012, Penny sold merchandise to Stein at 20% above cost in the amount (selling price) of $126,000. Atthe end of the year, Stein had one-third of this merchandise in its ending inventory. At the beginning of 2012,Stein had $48,000 of inventory purchased in 2011 from Penny

Required:A. Prepare all workpaper entries necessary to eliminate the effects of the intercompany sales on the consolidated

financial statements for 2012.

B. Calculate the amount of noncontrolling interest to be deducted from consolidated net income in theconsolidated income statement for 2012. Stein Company reported $40,000 of net income in 2012.

7-3 Pringle Company owns 104,000 of the 130,000 shares outstanding of Seely Corporation. Seely Corporation soldequipment to Pringle Company on January 1, 2011 for $740,000. The equipment was originally purchased bySeely Corporation on January 1, 2010 for $1,280,000 and at that time its estimated depreciable life was 8 years.The equipment is estimated to have a remaining useful life of four years on January 1, 2011. Both companies usethe straight-line method to depreciate equipment. In 2012 Pringle Company reported net income from itsindependent operations of $3,270,000, and Seely Corporation reported net income of $820,000 and declareddividends of $60,000. Pringle Company uses the cost method to record the investment in Seely Company.

Required:A. Prepare, in general journal form, the workpaper entries relating to the intercompany sale of equipment that are

necessary in the December 31, 2012 consolidated financial statements workpapers.

B. Calculate the amount of noncontrolling interest to be deducted from consolidated net income in theconsolidated income statement for 2012.

C. Calculate controlling interest in consolidated net income for 2012.



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Edition7-6

7-4 P Company bought 60% of the common stock of S Company on January 1, 2011. On January 1, 2011 there wasan intercompany sale of equipment at a gain of $63,000. The equipment had an estimated remaining life of sixyears. Net incomes of the two companies from their own operations (including sales to affiliates) were asfollows:

2011 2012P Company $280,000 $210,000

S Company 70,000 105,000

A. If S Company sold the equipment to P Company, fill in the following matrix:2011 2012

Noncontrolling interest in consolidated net income

Controlling Interest in Consolidated net income

B. If P Company sold the equipment to S Company, fill in the following matrix:2011 2012

Noncontrolling interest in consolidated net income

Controlling interest in consolidated net income

7-5 On January 1, 2011, Pinkel Company purchased equipment from its 80%-owned subsidiary for $2,400,000. Onthe date of the sale, the carrying value of the equipment on the books of the subsidiary company was $1,800,000.The equipment had a remaining useful life of six years on January 2011. On January 1, 2012, Pinkel Companysold the equipment to an outside party for $2,200,000.

Required:A. Prepare, in general journal form, the entries necessary in 2011 and 2012 on the books of Pinkel Company to

account for the purchase and sale of the equipment.

B. Determine the consolidated gain or loss on the sale of the equipment and prepare, in general journal form, theentry necessary on the December 31, 2012 consolidated statements workpaper to properly reflect this gain orloss.



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7-6 P Corporation acquired 80% of the outstanding voting stock of S Corporation when the fair values equaled the book values.

On July 1, 2010, P sold land to S for $300,000. The land originally cost P $200,000. S recently resold the landon October 30, 2011 for $350,000.

On October 1, 2011, S Corporation sold equipment to P Corporation for $80,000. S originally paid $100,000 forthis equipment and had accumulated depreciation of $40,000 thus far. The equipment has a five-year remaininglife.

Required:A. Complete the consolidated income statement for P Corporation and subsidiary for the year ended December

31, 2011.

7-7 Pike Company owns 90% of the outstanding common stock of Sanka Company. On January 1, 2011, SankaCompany sold equipment to Pike Company for $300,000. Sanka Company had purchased the equipment fo$450,000 on January 1, 2006 and has been depreciating it over a 10 year life by the straight-line method. Themanagement of Pike Company estimated that the equipment had a remaining life of 5 years on January 1, 2011In 2011, Pike Company reported $225,000 and Sanka Company reported $150,000 in net income from theirindependent operations.

Required:

A. Prepare in general journal form the workpaper entries relating to the intercompany sale of equipment that are

necessary in the December 31, 2011 and 2012 consolidated statements workpapers. Pike Company uses thecost method to record its investment in Sanka Company.

B. Calculate equity in subsidiary income for 2011 and noncontrolling interest in net income for 2011.

P S Elimination Entries

Dr. Cr.

Noncontrolling

Interest

Consolidated

Balances

Sales 1,200,000 600,000

Dividend Income from S 80,000

Gain on Sale ofEquipment 20,000

Gain on Sale of Land 50,000

Cost of Sales (800,000) (300,000)

Depreciation Expense (160,000) (80,000)

Other Expenses (200,000) (160,000)

Noncontrolling Interestin Income

Net Income 120,000 130,000



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Edition7-8

7-8 On January 1, 2010, Peine Company acquired an 80% interest in the common stock of Stine Company on theopen market for $3,000,000, the book value at that date.

On January 1, 2011, Peine Company purchased new equipment for $58,000 from Stine Company. The equipmencost $36,000 and had an estimated life of five years as of January 1, 2011.

During 2012, Peine Company had merchandise sales to Stine Company of $400,000; the merchandise was pricedat 25% above Peine Company‟s cost. Stine Company still owes Peine Company $70,000 on open account andhas 20% of this merchandise in inventory at December 31, 2012. At the beginning of 2012, Stine Company hadin inventory $100,000 of merchandise purchased in the previous period from Peine Company.

Required:

A. Prepare all workpaper entries necessary to eliminate the effects of the intercompany sales on the consolidatedfinancial statements for the year ended December 31, 2012.

B. Assume that Stine Company reports net income of $160,000 for the year ended December 31, 2012Calculate the amount of noncontrolling interest to be deducted from consolidated income in the consolidatedincome statement for the year ended December 31, 2012.

Short Answer

1. When there have been intercompany sales of depreciable property, workpaper entries are necessary to accomplishseveral financial reporting objectives. Identify three of these financial reporting objectives for depreciable property.

2. An eliminating entry is needed to adjust the consolidated financial statements when the purchasing affiliate sells adepreciable asset that was acquired from another affiliate. Describe the necessary eliminating entry.

Short Answer Questions from the Textbook

1. From a consolidated point of view, when should profit be recognized on intercompany sales of depreciable assets? Nondepreciable assets?

2. In what circumstances might a consolidated gain be recognized on the sale of assets to a nonaffiliate when theselling affiliate recognizes a loss?

3. What is the essential procedural difference between workpaper eliminating entries for un-realized intercompany profit when the selling affiliate is a less than wholly owned subsidiary and such entries when the selling affiliate isthe parent company or a wholly owned subsidiary?

4. Define the controlling interest in consolidated net income using the t-account approach.

5. Why is it important to distinguish between up-stream and downstream sales in the analysis of intercompany profiteliminations?

6. In what period and in what manner should profits relating to the intercompany sale of depreciable property andequipment be recognized in the consolidated financial statements?

7. Define consolidated retained earnings using the analytical approach.



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Business Ethics Question from the TextbookSome people believe that the use of executive stock options is directly related to the increased number of earningsrestatements. For each of the following items, discuss the potential ethical issues that might be related to earningsmanagement within the firm.1. Should stock options be expensed on the Income Statement?2. Should the CEO or CFO be a past employee of the firm‟s audit firm?

3. Should the firm‟s audit committee be com-posed entirely of outside members and besolely responsible for hiring the firm‟s auditors?



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Edition7-10

ANSWER KEY

Multiple Choice

1. c 7. c 13. a 19. d2. d 8. a 14. b 20. b

3. d 9. b 15. d 21. c4. b 10. a 16. c 22. d5. b 11. c 17. d 23. d6. d 12. b 18. d

Problems

7-1 A. 2011Sales 500,000

Cost of Sales 350,000

Equipment 150,000

Accumulated Depreciation 25,000Depreciation Expense (150,000/6) 25,000

2012Beginning R/E – Parker 150,000

Equipment 150,000

Accumulated Depreciation 50,000Depreciation Expense 25,000Beginning R/E – Parker 25,000

B. Parker ‟s net income from independent operations $870,000- Unrealized profit on 2011 sales to Santo (150,000)+ Profit on sales to Santo realized through

2011 depreciation 25,000

Parker ‟s income from independent operations thathas been realized from third party transactions 745,000

Income of Santo that has been realized intransactions with third parties $310,000

Parker ‟s share thereof (.9 × $310,000) 279,000Controlling Interest in Consolidated Net Income – 2011 $1,024,000



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7-2 A. Sales 126,000Cost of Sales 126,000

Cost of Sales 7,000Inventory [42,000 – (42,000/1.20) 7,000

Beginning R/E – Penny 8,000Cost of Sales [48,000 – (48,000/1.20)] 8,000

Beginning R/E – Penny ($5,000 × .9) 4,500 Noncontrolling interest ($5,000 × .1) 500

Equipment (16,000 – 11,000) 5,000

Accumulated Depreciation 2,000Depreciation Expense (5,000/5) 1,000Beginning R/E – Penny ($1,000 × .9) 900 Noncontrolling interest ($1,000 × .1) 100

B. Noncontrolling Interest in Consolidated net Income:

.1 × (40,000 + 1,000) = $4,100

7-3 A. Equipment 540,000Beginning R/E – Pringle ($100,000 × .80) 80,000 Noncontrolling Interest ($100,000 × .20) 20,000

Accumulated Depreciation 640,000

Accumulated Depreciation ($100,000/4) × 2 50,000Depreciation Expense 25,000Beginning R/E – Pringle ($25,000 × .80) 20,000 Noncontrolling Interest ($25,000 × .20) 5,000

B. Noncontrolling Interest Calculation:Reported income of Seely Company $820,000Plus: Intercompany profit considered realized

in the current period 25,000$845,000

Noncontrolling interest in Seely Company(.20 × 845,000) $169,000

C. Controlling Interest in Consolidated Net Income:Pringle Company‟s income from its

independent operations $3,270,000Reported net income of Seely Company $820,000

Plus profit on intercompany sale ofequipment considered to be realizedthrough depreciation in 2011 25,000

Reported subsidiary income that has beenrealized in transactions with third parties 845,000

× .8Pringle Company‟s share thereof 676,000Controlling Interest in Consolidated net income $3,946,000



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Test Bank to accompany Jeter and Chaney Advanced Accounting7-12

7-4 2011 2012A.

Noncontrolling interest in $ 7,000 (1) $ 46,200 (2)Consolidated net income

Controlling interest in 290,500 (3) 279,300 (4)

Consolidated net income

(1) .4($70,000 – $63,000 + $10,500) = $7,000(2) .4($105,000 + $10,500) = $46,200(3) $280,000 + .6($70,000 – $63,000 + $10,500) = $290,500(4) $210,000 + .6($105,000 + $10,500) = $279,300

2011 2012B.

Noncontrolling interest in $ 28,000 (5) $ 42,000 (6)Consolidated income

Controlling interest in 269,500 (7) 283,500 (8)

Consolidated net income(5) .4($70,000) = $28,000(6) .4($105,000) = $42,000(7) ($280,000 – $63,000 + $10,500) + .6($70,000) = $269,500(8) ($210,000 + $10,500) + .6($105,000) = $283,500

7-5 A. 2011(1) Equipment 2,400,000

Cash 2,400,000

(2) Depreciation Expense (1/6 × $2,400,000) 400,000


2012(3) Cash 2,200,000

Accumulated Depreciation 400,000Equipment 2,400,000Gain on Sale of Equipment 200,000

B. Pinkel Company ConsolidatedCost $2,400,000Accumulated Depreciation (400,000)1/1/12 Book Value 2,000,000 $1,500,000*

Proceeds from Sale 2,200,000 2,200,000Gain on Sale $ 200,000 $700,000

*$1,800,000 – 1/6($1,800,000) = $1,500,000

1/1 Retained Earnings - Pinkel[.8 × ($600,000 – $100,000)] 400,000

1/1 Noncontrolling interest [.2 × ($600,000 – $100,000)] 100,000Gain on Sale of Equipment 500,000



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$2,400,000 – $1,800,000 = $600,000$600,000/6 = $100,000Unrealized intercompany gain on date of sale to outsiders = $600,000 – $100,000 = $500,000

7-6

P S Elimination Entries

Dr. Cr.

Noncontrolling

Interest

Consolida

Balanc

Sales $1,200,000 $600,000$1,80

Dividend Income from S 80,000(a)80,000

Gain on Sale of Equipment 20,000(b)20,000

Gain on Sale of Land 50,000(d)100,000 15

Cost of Sales (800,000) (300,000)(1,100

Depreciation Expense (160,000) (80,000) (c) 1,000 (239Other Expenses (200,000) (160,000)

(360

Noncontrolling Interest in Income

($130,000 – $20,000 + 1,000) × .2022,200 (22

Net Income $120,000 $130,000 22,200 $22

a. Dividend Income from S 80,000Dividends Declared 80,000

b. Gain on Sale of Equipment 20,000Equipment 20,000


c. Accumulated Depreciation 1,000*Depreciation Expense 1,000

d. Retained Earnings – P 100,000Gain on Sale of Land 100,000

* ($20,000/5) × 3/12



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7-7A. 2011

Gain on Sale of Equipment 75,000Equipment 150,000


Accumulated Depreciation 15,000Depreciation Expense 15,000

2012Retained Earnings – Pike 67,500 Noncontrolling Interest 7,500Equipment 150,000


Accumulated Depreciation 30,000Depreciation Expense 15,000Beginning Retained Earnings – Pike 13,500

Noncontrolling Interest 1,500

B. Equity in NoncontrollingSub. Income Interest

Sanka Company net income $135,000 $15,000Unrealized gain-equipment

($75,000) upstream (67,500) (7,500)Confirmed gain 13,500 1,500

$81,000 $ 9,000

7-8 A. (1) Sales 400,000

Cost of Sales 400,000

(2) Accounts Payable 70,000Accounts Receivable 70,000

(3) Cost of Sales (beginning inventory – income statement) 16,000Inventory ($80,000 – ($80,000/1.25)) 16,000

(4) Beginning Retained Earnings – Peine ($100,000 – ($100,000/1.25)) 20,000Cost of Sales (beginning inventory – income statement) 20,000

(5) Beginning Retained Earnings – Peine ($22,000 × .8) 17,600

Noncontrolling Interest ($22,000 × .2) 4,400Property, Plant and Equipment 22,000

(6) Accumulated Depreciation 8,800Depreciation Expense ($22,000/5) 4,400Beginning Retained Earnings – Peine ($4,400 × .8) 3,520 Noncontrolling Interest ($4,400 × .2) 880

B. Noncontrolling Interest in Consolidated Income .2 × ($160,000 + $4,400) = $32,880



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Short Answer

1. Workpaper entries are necessary to accomplish the following financial reporting objectives:a. To report as gains or losses in the consolidated income statement only those that result from the sale of

depreciable property to parties outside the affiliated group. b. To present property in the consolidated balance sheet at its cost to the affiliated group.

c. To present accumulated depreciation in the consolidated balance sheet and depreciation expense in theconsolidated income statement based on the cost to the affiliated group of the related assets.

2. The eliminating entry adjusts the gain or loss reported by the purchasing affiliate from the amount it recorded tothe correct amount from the perspective of the consolidated entity, and adjusts the controlling and noncontrollinginterests for the unrealized intercompany profit associated with the equipment on the date of its prematuredisposal.

Solutions to Short Answer Questions from the Textbook

1. Intercompany profit in depreciable asset transfers is realized as a result of the utilization of the asset in the generation

of revenue. Such utilization is measured by depreciation and, accordingly, the recognition of the realization ofintercompany profit is accomplished through depreciation adjustments in the periods following the intercompanytransfers.

When intercompany sales involve nondepreciable assets, any profit recognized by the selling affiliate willremain unrealized from the consolidated entity‟s point of view for all subsequent periods or until the asset is

disposed of.

2. Intercompany profit may be included in the selling affiliate‟s carr ying value of an asset that is sold to third parties. Ifthe sales price in the sale to the third party is less that the inflated carrying value, the selling affiliate will recognize aloss on the sale. From the point of view of the consolidated entity, however, the carrying value of the asset is its costto the affiliated group (selling affiliate‟s cost less unrealized intercompany profit) and if this value is less than the

selling price to the third party, the consolidated group will recognize a gain. In effect, previously unrecognizedintercompany profit is realized upon the sale of the asset to a third party.

3. The only procedural difference in the workpaper entries relating to the elimination of unrealized intercompany profitin depreciable or nondepreciable assets when the selling affiliate is a less than wholly owned subsidiary is that thenoncontrolling interest in the unrealized intercompany profit at the beginning of the year must be recognized bydebiting or crediting the noncontrolling shareholders‟ percentage interest in such adjustments to the beginningretained earnings of the subsidiary.



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4. Consolidated income is equal to the parent company‟s income from its independent operations that has been realizedin transactions with third parties plus subsidiary income that has been realized in transactions with third parties andadjusted for the amortization, depreciation, or impairment of the differences between implied and book values (thistotal is then allocated to the controlling and noncontrolling interests). The controlling interest in consolidated incomeis equal to the parent company‟s income from its independent operations that has been realized in transactions with

third parties plus its share of subsidiary income that has been realized in transactions with third parties and adjustedfor the amortization, depreciation, or impairment of the differences between implied and book values.

Controlling Interest in Consolidated Income

Unrealized gain on intercompany

sale (downstream sales) Net income internally generated by P Company

Gain realized through usage (depreciation adjustment)

Unrealized profit on downstream Realized profit (downstream sales) from beginning inventory

sales to S Company (ending

Inventory) P Company's percentage of S Company's adjusted income

realized from third parties

Controlling interest in Consolidated Income

5. It is important to distinguish between upstream and downstream sales of property and equipment because calculationof the noncontrolling interest in the consolidated financial statements differs depending on whether the sale giving riseto the intercompany profit is upstream or downstream.

6. Profit relating to the intercompany sale of property and equipment is recognized in the consolidated financiastatements over the useful life of the equipment. It is recognized in the consolidated financial statements by reducing

depreciation expense (thus increasing consolidated income).

7. Consolidated retained earnings may be defined as the parent company‟s cost basis retained earnings that has beenrealized in transactions with third parties plus (minus) the parent company‟s share of the increase (decrease) insubsidiary retained earnings that has been realized in transactions with third parties from the date of acquisition to thecurrent date and adjusted for the cumulative effect of amortization of the difference between implied and book values.



17/17


ANSWERS TO BUSINESS ETHICS CASE

1. The arguments against expensing options include the following:

Valuation is subjective, involves assumptions that may be unrealistic, and may yield numbers that timewill prove to be of limited usefulness.

Disclosure is a reasonable substitute.

Companies may alter their reward systems with the result that lower level employees are most affected.

Options are not a “real” expense and may never be exercised.

Option valuation opens the door for manipulation as managers can alter their assumptions.

Diluted earnings per share are already disclosed, and expensing options amounts to double counting.

Expensing may destroy any advantage held by the U.S. as a world leader in technology, and distractcorporate America from more important issues related to executive compensation and governance ingeneral.

The arguments in favor of expensing options include the following:

Difficulty or subjectivity in valuation is not a reason for avoidance of recording other relevant financialstatement items, such as deferred taxes, pension liabilities, etc.

Transparency is a major objective of financial reporting, and without proper expensing of executivecompensation, transparency is lacking.

Not expensing options generates costs of misinformation.

If employees are over-compensated, the users need to be aware of that fact.

When options qualify as a “real” expense, as defined in the conceptual framework, based on the bestavailable information at the balance sheet date, they should be reflected as such in the financialstatements.

2. Ideally the CEO or CFO should not be a past employee of the company‟s audit firm, as such a relationship could jeopardize his or her independence. However, it is not unusual for a company to hire a former auditor, who might

later be promoted to CEO or CFO, or might even be hired to such a position. If this happens, the company mightwant to consider switching auditors or taking other measures to make sure that the audit firm is viewed assufficiently independent. Under the Sarbanes-Oxley Act of 2002 mandates that the audit firm‟s independence isimpaired if a former member of the audit engagement team accepts a supervisory accounting position, unless theindividual observes a one-year „cooling off‟ period.

3. The Sarbanes-Oxley Act of 2002 mandates that each member of the audit committee be a outside member of the board of directors of the issuer and to be independent. Independent means not receiving any consulting, advisory,or other compensatory fee from the issuer. At least one member must be a financial expert. The audit committee isresponsible for appointment, compensation, retention, and oversight of the independent auditors.

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120585830 Ch07 Test Bank Jeter Advanced Accounting 3rd Edition