Ch07_Test Bank Jeter Advanced Accounting 3rd Edition

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 debiting

1. Retained Earnings - P Company.

2. Retained Earnings - S Company.

3. Gain on Sale of Land.

a. 1

b. 2

c. 3

d. both 1 and 2.

2. In years subsequent to the year a 90% owned subsidiary sells equipment to its parent company at a gain, the

noncontrolling interest in consolidated income is computed by multiplying the noncontrolling interest percentage

by the subsidiary‟s reported net income

a. 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 the

intercompany sale, a workpaper entry is made under the cost method debiting

a. 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 sold

equipment to Pinick for an amount greater than the equipment‟s book value but less than its original cost. The

equipment should be reported on the December 31, 2011 consolidated balance sheet at

a. 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 is

using 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 by

a. 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

Edition

7-2

6. Pratt Corporation owns 100% of Stone Company‟s common stock. On January 1, 2011, Pratt sold equipment

with a book value of $210,000 to Stone for $300,000. Stone is depreciating the equipment over a ten-year life by

the straight-line method. The net adjustments to compute 2011 and 2012 consolidated income would be an

increase (decrease) of

2011 2012

a. ($90,000) $0

b. ($90,000) $9,000

c. ($81,000) $0

d. ($81,000) $9,000

7. In the year an 80% owned subsidiary sells equipment to its parent company at a gain, the noncontrolling interest

in consolidated income is calculated by multiplying the noncontrolling interest percentage by the subsidiary‟s

reported net income

a. 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 the

noncontrolling interest‟s percentage of the

a. 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-line

method. This equipment was sold to a third party on January 1, 2011 for $1,440,000. What amount of gain should

P 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 consolidated

workpaper entry under the cost method is to debit the

a. 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 of

equipment or inventory sales by affiliates, are allocated proportionately by percent of ownership between parent

and subsidiary only when the selling affiliate is

a. 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.




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 is

a. 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 effect

of 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 S

Company. 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 P

Corporation for $60,000. P Corporation owns 100% of S Corporation and the equipment has a 4-year remaining

life. 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. S

reports net income of $600,000 for 2011 and pays dividends of $200,000. P‟s Equity from Subsidiary Income for

2011 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 book

value. Two years later P sold the land to an outside entity for $50,000 more than it‟s cost. In its current year

consolidated 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.





Edition

7-4

18. On January 1, 2010, P Corporation sold equipment with a 3-year remaining life and a book value of $40,000 to its

70% 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 equipment

with a book value of $350,000 to Starr for $500,000. Starr is depreciating the equipment over a ten-year life by

the straight-line method. The net adjustments to compute 2011 and 2012 consolidated income would be an

increase (decrease) of

2011 2012

a. ($150,000) $0

b. ($150,000) $15,000

c. ($135,000) $0

d. ($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-line

method. This equipment was sold to a third party on January 1, 2011 for $720,000. What amount of gain should P

Company 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 book

value 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 for

2011 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 book

value. Two years later P sold the land to an outside entity for $15,000 more than it‟s cost. In its current year

consolidated 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 to

its 70% owned subsidiary for a price of $115,000. 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 $15,000.

b. debit to Gain on Sale of Equipment for $15,000.

c. credit to Depreciation Expense for $15,000.





7-5

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 January

1, 2011, Parker sold computers to Santo for $500,000. The computers, which are inventory to Parker, had a cost

to Parker of $350,000. Santo Company estimated that the computers had a useful life of six years from the date of

purchase.

Santo Company reported net income of $310,000, and Parker Company reported net income of $870,000 from its

independent 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 equipment

cost $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. At

the 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 the

consolidated 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 sold

equipment to Pringle Company on January 1, 2011 for $740,000. The equipment was originally purchased by

Seely 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 use

the straight-line method to depreciate equipment. In 2012 Pringle Company reported net income from its

independent operations of $3,270,000, and Seely Corporation reported net income of $820,000 and declared

dividends 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 the

consolidated income statement for 2012.

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





Edition

7-6

7-4 P Company bought 60% of the common stock of S Company on January 1, 2011. On January 1, 2011 there was

an intercompany sale of equipment at a gain of $63,000. The equipment had an estimated remaining life of six

years. Net incomes of the two companies from their own operations (including sales to affiliates) were as

follows:

2011 2012

P 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. On

the 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 Company

sold 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, the

entry necessary on the December 31, 2012 consolidated statements workpaper to properly reflect this gain or

loss.





7-7

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 land

on 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 for

this equipment and had accumulated depreciation of $40,000 thus far. The equipment has a five-year remaining

life.

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, Sanka

Company sold equipment to Pike Company for $300,000. Sanka Company had purchased the equipment for

$450,000 on January 1, 2006 and has been depreciating it over a 10 year life by the straight-line method. The

management of Pike Company estimated that the equipment had a remaining life of 5 years on January 1, 2011.

In 2011, Pike Company reported $225,000 and Sanka Company reported $150,000 in net income from their

independent 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 the

cost 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 of

Equipment 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 Interest

in Income

Net Income 120,000 130,000





Edition

7-8

7-8 On January 1, 2010, Peine Company acquired an 80% interest in the common stock of Stine Company on the

open 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 equipment

cost $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 priced

at 25% above Peine Company‟s cost. Stine Company still owes Peine Company $70,000 on open account and

has 20% of this merchandise in inventory at December 31, 2012. At the beginning of 2012, Stine Company had

in 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 consolidated

financial 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, 2012.

Calculate the amount of noncontrolling interest to be deducted from consolidated income in the consolidated

income 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 accomplish

several 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 a

depreciable 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 the

selling 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 is

the 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 profit

eliminations?

6. In what period and in what manner should profits relating to the intercompany sale of depreciable property and

equipment be recognized in the consolidated financial statements?

7. Define consolidated retained earnings using the analytical approach.





7-9

Business Ethics Question from the Textbook

Some people believe that the use of executive stock options is directly related to the increased number of earnings

restatements. For each of the following items, discuss the potential ethical issues that might be related to earnings

management 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 be

solely responsible for hiring the firm‟s auditors?





Edition

7-10

ANSWER KEY

Multiple Choice

1. c 7. c 13. a 19. d

2. d 8. a 14. b 20. b

3. d 9. b 15. d 21. c

4. b 10. a 16. c 22. d

5. b 11. c 17. d 23. d

6. d 12. b 18. d

Problems

7-1 A. 2011

Sales 500,000

Cost of Sales 350,000

Equipment 150,000

Accumulated Depreciation 25,000

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

2012

Beginning R/E – Parker 150,000

Equipment 150,000


Depreciation Expense 25,000

Beginning 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 that

has been realized from third party transactions 745,000

Income of Santo that has been realized in

transactions with third parties $310,000

Parker‟s share thereof (.9 × $310,000) 279,000

Controlling Interest in Consolidated Net Income – 2011 $1,024,000





7-11

7-2 A. Sales 126,000


Cost of Sales 7,000

Inventory [42,000 – (42,000/1.20) 7,000

Beginning R/E – Penny 8,000

Cost 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


Depreciation Expense (5,000/5) 1,000

Beginning 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 540,000

Beginning R/E – Pringle ($100,000 × .80) 80,000

Noncontrolling Interest ($100,000 × .20) 20,000


Accumulated Depreciation ($100,000/4) × 2 50,000


Beginning R/E – Pringle ($25,000 × .80) 20,000


B. Noncontrolling Interest Calculation:

Reported income of Seely Company $820,000

Plus: 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 $3,270,000

Reported net income of Seely Company $820,000

Plus profit on intercompany sale of

equipment considered to be realized

through depreciation in 2011 25,000

Reported subsidiary income that has been

realized in transactions with third

parties 845,000

× .8

Pringle Company‟s share thereof 676,000

Controlling Interest in Consolidated net income $3,946,000




Test Bank to accompany Jeter and Chaney Advanced Accounting

7-12

7-4 2011 2012

A.

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

Consolidated net income

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


(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 2012

B.

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

Consolidated income

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


(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


Equipment 2,400,000

Gain on Sale of Equipment 200,000

B. Pinkel Company Consolidated

Cost $2,400,000

Accumulated Depreciation (400,000)

1/1/12 Book Value 2,000,000 $1,500,000*

Proceeds from Sale 2,200,000 2,200,000

Gain 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)] 100,000






7-13

$2,400,000 – $1,800,000 = $600,000

$600,000/6 = $100,000

Unrealized intercompany gain on date of sale to outsiders = $600,000 – $100,000 = $500,000

7-6

P S Elimination Entries

Dr. Cr.

Noncontrolling

Interest

Consolidating

Balances

Sales $1,200,000 $600,000 $1,800,000

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)100,000 150,000

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

Depreciation Expense (160,000) (80,000) (c) 1,000 (239,000)

Other Expenses (200,000) (160,000) (360,000)

Noncontrolling Interest in Income

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

Net Income $120,000 $130,000 22,200 $228,800

a. Dividend Income from S 80,000

Dividends Declared 80,000

b. Gain on Sale of Equipment 20,000

Equipment 20,000


c. Accumulated Depreciation 1,000*


d. Retained Earnings – P 100,000

Gain on Sale of Land 100,000

* ($20,000/5) × 3/12





7-14

7-7

A. 2011


Equipment 150,000




2012

Retained Earnings – Pike 67,500

Noncontrolling Interest 7,500

Equipment 150,000




Beginning Retained Earnings – Pike 13,500

Noncontrolling Interest 1,500

B. Equity in Noncontrolling

Sub. Income Interest

Sanka Company net income $135,000 $15,000

Unrealized 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


(2) Accounts Payable 70,000

Accounts Receivable 70,000

(3) Cost of Sales (beginning inventory – income statement) 16,000

Inventory ($80,000 – ($80,000/1.25)) 16,000

(4) Beginning Retained Earnings – Peine ($100,000 – ($100,000/1.25)) 20,000

Cost of Sales (beginning inventory – income statement) 20,000

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


Property, Plant and Equipment 22,000

(6) Accumulated Depreciation 8,800

Depreciation Expense ($22,000/5) 4,400

Beginning 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





7-15

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 the

consolidated 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 to

the correct amount from the perspective of the consolidated entity, and adjusts the controlling and noncontrolling

interests for the unrealized intercompany profit associated with the equipment on the date of its premature

disposal.

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 of

intercompany profit is accomplished through depreciation adjustments in the periods following the intercompany

transfers.

When intercompany sales involve nondepreciable assets, any profit recognized by the selling affiliate will

remain unrealized from the consolidated entity‟s point of view for all subsequent periods or until the asset is

disposed of.

2. Intercompany profit may be included in the selling affiliate‟s carrying value of an asset that is sold to third parties. If

the sales price in the sale to the third party is less that the inflated carrying value, the selling affiliate will recognize a

loss on the sale. From the point of view of the consolidated entity, however, the carrying value of the asset is its cost

to the affiliated group (selling affiliate‟s cost less unrealized intercompany profit) and if this value is less than the

selling price to the third party, the consolidated group will recognize a gain. In effect, previously unrecognized

intercompany profit is realized upon the sale of the asset to a third party.

3. The only procedural difference in the workpaper entries relating to the elimination of unrealized intercompany profit

in depreciable or nondepreciable assets when the selling affiliate is a less than wholly owned subsidiary is that the

noncontrolling interest in the unrealized intercompany profit at the beginning of the year must be recognized by

debiting or crediting the noncontrolling shareholders‟ percentage interest in such adjustments to the beginning

retained earnings of the subsidiary.





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4. Consolidated income is equal to the parent company‟s income from its independent operations that has been realized

in transactions with third parties plus subsidiary income that has been realized in transactions with third parties and

adjusted for the amortization, depreciation, or impairment of the differences between implied and book values (this

total is then allocated to the controlling and noncontrolling interests). The controlling interest in consolidated income

is equal to the parent company‟s income from its independent operations that has been realized in transactions with

third parties plus its share of subsidiary income that has been realized in transactions with third parties and adjusted

for the amortization, depreciation, or impairment of the differences between implied and book values.

Controlling Interest in Consolidated Income

Unrealized gain on intercompany

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

Gain realized through usage (depreciation adjustment)

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

sales to S Company (ending

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

realized from third parties

Controlling interest in Consolidated Income

5. It is important to distinguish between upstream and downstream sales of property and equipment because calculation

of the noncontrolling interest in the consolidated financial statements differs depending on whether the sale giving rise

to the intercompany profit is upstream or downstream.

6. Profit relating to the intercompany sale of property and equipment is recognized in the consolidated financial

statements over the useful life of the equipment. It is recognized in the consolidated financial statements by reducing

depreciation expense (thus increasing consolidated income).

7. Consolidated retained earnings may be defined as the parent company‟s cost basis retained earnings that has been

realized in transactions with third parties plus (minus) the parent company‟s share of the increase (decrease) in

subsidiary retained earnings that has been realized in transactions with third parties from the date of acquisition to the

current date and adjusted for the cumulative effect of amortization of the difference between implied and book values.





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ANSWERS TO BUSINESS ETHICS CASE

1. The arguments against expensing options include the following:

Valuation is subjective, involves assumptions that may be unrealistic, and may yield numbers that time

will prove to be of limited usefulness.

Disclosure is a reasonable substitute.

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

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

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

corporate America from more important issues related to executive compensation and governance in

general.

The arguments in favor of expensing options include the following:

Difficulty or subjectivity in valuation is not a reason for avoidance of recording other relevant financial

statement items, such as deferred taxes, pension liabilities, etc.

Transparency is a major objective of financial reporting, and without proper expensing of executive

compensation, transparency is lacking.

Not expensing options generates costs of misinformation.

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

When options qualify as a “real” expense, as defined in the conceptual framework, based on the best

available information at the balance sheet date, they should be reflected as such in the financial

statements.

2. Ideally the CEO or CFO should not be a past employee of the company‟s audit firm, as such a relationship could

jeopardize his or her independence. However, it is not unusual for a company to hire a former auditor, who might

later be promoted to CEO or CFO, or might even be hired to such a position. If this happens, the company might

want to consider switching auditors or taking other measures to make sure that the audit firm is viewed as

sufficiently independent. Under the Sarbanes-Oxley Act of 2002 mandates that the audit firm‟s independence is

impaired if a former member of the audit engagement team accepts a supervisory accounting position, unless the

individual observes a one-year „cooling off‟ period.

3. The Sarbanes-Oxley Act of 2002 mandates that each member of the audit committee be a outside member of the

board of directors of the issuer and to be independent. Independent means not receiving any consulting, advisory,

or other compensatory fee from the issuer. At least one member must be a financial expert. The audit committee is

responsible for appointment, compensation, retention, and oversight of the independent auditors.




Documents

Ch07_Test Bank Jeter Advanced Accounting 3rd Edition