Chapter 5 Solutions

Chapter 05 - Consolidated Financial Statements - Intra-Entity Asset Transactions

CHAPTER 5CONSOLIDATED FINANCIAL STATEMENTS - INTRA-ENTITY ASSET TRANSACTIONS

Answers to Questions

1. One reason for the significant volume and frequency of intra-entity transfers is that many business combinations are specifically organized so that the companies can provide products for each other. This design is intended to benefit the business combination as a whole because of the economies provided by vertical integration. In effect, more profit can often be generated by the combination if one member is able to buy from another rather than from an outside party.

2. The sales between Barker and Walden totaled $100,000. Regardless of the ownership percentage or the gross profit rate, the $100,000 was simply an intra-entity asset transfer. Thus, within the consolidation process, the entire $100,000 should be eliminated from both the Sales and the Purchases (Inventory) accounts.

3. Sales price per unit ($900,000 ÷ 3,000 units) $ 300Number of units in Safeco’s ending inventory × 500Intra-entity inventory at transfer price $150,000Gross profit rate (0.6 ÷ 1.6) .375Intra-entity profit in ending inventory $56,250

4. In intra-entity transactions, a transfer price is often established that exceeds the cost of the inventory. Hence, the seller is recording a gross profit on its books that, from the perspective of the business combination as a whole, remains unrealized until the asset is consumed or sold to an outside party. Any unrealized gross profit on merchandise still held by the buyer must be deferred whenever consolidated financial statements are prepared. For the year of transfer, this consolidation procedure is carried out by removing the unrealized gross profit from the inventory account on the balance sheet and from the ending inventory balance within cost of goods sold. In the year following the transfer (if the goods are resold or consumed), the realized gross profit must be recognized within the consolidation process. Reductions are made on the worksheet to the beginning inventory component of cost of goods sold and to the beginning retained earnings balance of the original seller. The gross profit is thus taken out of last year’s earnings (retained earnings) and recognized in the current year through the reduction of cost of goods sold. If the transfer was downstream in direction and the parent company has applied the equity method, the adjustment in the subsequent year is made to the Investment in Subsidiary account rather than to retained earnings.

5. On the individual financial records of James, Inc., a gross profit is recorded in the year of transfer. From the viewpoint of the business combination, this gross profit is actually earned in the period in which the products are sold or consumed by Matthews Co. An initial consolidation entry must be made in the year of transfer to defer any gross profit that remains unrealized. A second entry must be made in the following time period to allow the gross profit to be recognized in the year of its ultimate realization.

6. GAAP allows discretion regarding the effect of unrealized intra-entity profits and noncontrolling interest values. This textbook reasons that unrealized profits relate to the seller and to the computation of the seller's income. Therefore, any unrealized profits created by upstream

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Chapter 05 - Consolidated Financial Statements – Intra-Entity Asset Transactions

transfers (from subsidiary to parent) are attributed to the subsidiary. The effects resulting from the deferral and eventual recognition of these intra-entity profits are considered in the calculation of noncontrolling interest balances. In contrast, unrealized profits from downstream transfers are viewed as relating solely to the parent (as the seller) and, thus, have no effect on the noncontrolling interest.

7. Consolidated financial statements are largely unchanged across downstream versus upstream transfers. Sales and purchases (Inventory) balances created by the transactions are eliminated in total. Any unrealized gross profits remaining at the end of a fiscal period get deferred until ultimately earned through sale or consumption of the assets.

The direction of intra-entity transfers (upstream versus downstream) does have one effect on consolidated financial statements. In computing noncontrolling interest balances (if present), the deferral of unrealized gross profits on upstream sales is taken into account. Downstream sales, however, are attributed to the parent and are viewed as having no impact on the outside interest.

8. The computation of this noncontrolling interest balance is dependent on the direction of the intra-entity transactions that is not indicated in this question. If the unrealized gross profits were created by downstream sales from King to Pawn, they relate only to King. The noncontrolling interest in the subsidiary's net income is not affected and would be $11,000 ($110,000 × 10%). In contrast, if the transfers were upstream from Pawn to King, the deferral and recognition of the profits are attributed to Pawn. Pawn's "realized" income would be $80,000 and the noncontrolling interest's share of the subsidiary's income is reported as $8,000:

Pawn's reported income ............................................... $110,000Recognition of prior year unrealized gross profit .......... 30,000Deferral of current year unrealized gross profit ............ (60,000)Pawn's realized income ................................................ $80,000Outside ownership percentage ..................................... 10%Noncontrolling interest in subsidiary's income.............. $ 8,000

9. The deferral and subsequent recognition of intra-entity profits are allocated to the noncontrolling interest in the same periods as the parent. When one affiliate sells to another affiliate, ownership does not change and therefore the underlying profit is deferred. When the purchasing affiliate subsequently sells the inventory to an entity outside the affiliated group, ownership changes, and the profit may be recognized. Intra-entity profits are not really eliminated, but simply deferred until a sale to an outsider takes place.

10. Several differences can be cited that exist between the consolidated process applicable to inventory transfers and that which is appropriate for land transfers. The total intra-entity Sales balance is offset against Purchases (Inventory) when inventory is transferred but no corresponding entry is needed when land is involved. Furthermore, in the year of the sale, ending unrealized inventory gross profits are deferred through an adjustment to cost of goods sold, but a specific gain or loss account exists (and must be removed) when land has been sold. Finally, unrealized inventory gross profits are usually expected to be realized in the year following the transfer. This effect is mirrored in that period by reduction of the beginning inventory figure (within cost of goods sold). For land transfers, however, the unrealized gain or loss must be repeatedly deferred in each fiscal period, through retained earnings, for as long as the land continues to be held within the business combination.

11. As long as the land is held by the parent, its recorded value must be reduced to historical cost within each consolidated set of financial statements. In the year of the original transfer, the asset reduction is offset against the subsidiary's recorded gain. For all subsequent years in which the property is held, the credit to the Land account is made against the beginning

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retained earnings balance of the subsidiary (since the unrealized gain will have been closed into that account).

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According to this question, the land is eventually sold to an outside party. The intra-entity gain (which has been deferred in each of the previous years) is realized by the sale and should be recognized in the consolidated statements of this later period.

Because the transfer was upstream from subsidiary to parent, the above consolidated entries will also affect any noncontrolling interest balances being reported. Because of the deferral of the intra-entity gain, the realized income balances applicable to the subsidiary will be less than the reported values. In the year of resale, however, the realized income for consolidation purposes is higher than reported. All noncontrolling interest totals are computed on the realized balances rather than the reported figures.

12. Depreciable assets are often transferred between the members of a business combination at amounts in excess of book value. The buyer will then compute depreciation expense based on this inflated transfer price rather than on an historical cost basis. From the perspective of the business combination, depreciation should be calculated solely on historical cost figures. Thus, within the consolidation process for each period, adjustment of the depreciation (that is recorded by the buyer) is necessary to reduce the expense to a cost-based figure.

13. From the viewpoint of the business combination, an unrealized gain has been created by the intra-entity transfer and must be deferred in the preparation of consolidated financial statements. This unrealized gain is closed by the seller into retained earnings necessitating subsequent reductions to that account. In the individual financial records, however, another income effect is created which gradually reduces the overstatement of retained earnings each period. The asset will be depreciated by the buyer based on the inflated transfer price. The resulting expense will be higher than the amount appropriate to the historical cost of the item. Because this excess depreciation is closed into retained earnings annually, the initial overstatement due to the gain is offset by the acculmulating overstatement ofdepreciation expense. Therefore, the overstatement of the equity account is gradually reduced to a zero balance over the life of the asset.

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Answers to Problems

10.D Add the two book values and remove $100,000 intra-entity transfers.

11.C Intra-entity gross profit ($100,000 - $80,000) ............................... $20,000Inventory remaining at year's end ................................................. 60%Unrealized intra-entity gross profit ............................................... $12,000

CONSOLIDATED COST OF GOODS SOLDParent balance ........................................................................... $140,000Subsidiary balance .................................................................... 80,000Remove intra-entity transfer ..................................................... (100,000)Defer unrealized gross profit (above) ...................................... 12,000

Cost of goods sold ......................................................................... $132,000

12.C Consideration transferred ............................ $260,000Noncontrolling interest fair value.................. 65,000Suarez total fair value..................................... $325,000Book value of net assets................................ (250,000)Excess fair over book value $75,000

Annual ExcessExcess fair value to undervalued assets: Life Amortizations

Equipment .................................................. 25,000 5 years $5,000Secret Formulas ........................................ $50,000 20 years 2,500

Total ................................................................ -0- $7,500

Consolidated expenses = $37,500 (add the two book values and include current year amortization expense)

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13. A 20% of the beginning book value $50,000Excess fair value allocation (20%× $75,000) 15,00020% share of Suarez net income adjusted for amortization (20% × [110,000 – 7,500]) 20,500Ending noncontrolling interest balance $85,500

14. C Add the two book values plus the $25,000 original allocation less one year of excess amortization expense ($5,000).

15. B Add the two book values less the ending unrealized gross profit of $12,000.

Combined pre-consolidation inventory balances........................ $260,000Intra-entity gross profit ($100,000 – $80,000) ................... $20,000Inventory remaining at year's end .................................... 60%Unrealized intra-entity gross profit, 12/31 .................................... 12,000 Consolidated total for inventory.................................................... $248,000

16. (15 Minutes) (Determine selected consolidated balances; includes inventory transfers and an outside ownership.)

Customer list amortization = $65,000 ÷ 5 years = $13,000 per year

Intra-entity gross profit ($160,000 – $120,000) ............................. $40,000Inventory remaining at year's end.................................................. 20%Unrealized intra-entity gross profit, 12/31 .................................... $8,000

CONSOLIDATED TOTALS

Inventory = $592,000 (add the two book values and subtract the ending unrealized gross profit of $8,000)

Sales = $1,240,000 (add the two book values and subtract the $160,000 intra-entity transfer)

Cost of goods sold = $548,000 (add the two book values and subtract the intra-entity transfer and add [to defer] ending unrealized gross profit)

Operating expenses = $443,000 (add the two book values and the amortization expense for the period)

Noncontrolling interest in subsidiary's net income = $8,700 (30 percent of the reported income after subtracting 13,000 excess fair value amortization and deferring $8,000 ending unrealized gross profit) Gross profit is included in this computation because the transfer was upstream from Sanchez to Preston.

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18. (40 Minutes) (Series of independent questions concerning various aspects of the consolidation process when intra-entity transfers have occurred)

a. Placid Lake's 2013 net income before effect from Scenic...... $300,000Scenic's reported net income 2013 ......................................... 110,000Amortization expense (given) ................................................. (5,000)Realization of 2012 intra-entity gross profit (see below) ...... 7,200Deferral of 2013 intra-entity gross profit (see below) ............ (16,200)Consolidated net income........................................................... $396,000

2012 Unrealized gross profit to be recognized in 2013:

Intra-entity gross profit on transfers ($90,000 – $54,000) ..... $36,000Inventory retained at end of 2012 ............................................ 20%

Unrealized gross profit—12/31/12 ...................................... $ 7,200

2013 Unrealized gross profit deferred:

Intra-entity gross profit on transfers ($120,000 – $66,000) . . . $54,000Inventory retained at end of 2013 ............................................ 30%

Unrealized gross profit—12/31/13....................................... $16,200

b. Noncontrolling interest's share of Scenic's income (upstream sales):Scenic's reported net income 2013.......................................... $110,000Amortization of excess fair value to intangibles..................... (5,000)2012 gross profit realized in 2013 (upstream sales) .............. 7,2002013 gross profit deferred (upstream sales) .......................... (16,200)Scenic's realized income .......................................................... $96,000Noncontrolling interest ownership .......................................... 20%Noncontrolling interest's share of Scenic's net income........ $19,200

Placid Lake’s net income from own operations...................... $300,000Placid Lake’s share of Scenic’s adjusted NI (80%× $96,000)... 76,800Placid Lake’s share of consolidated net income ................... $376,800

c. Noncontrolling interest's share of Scenic's net income (downstream sales):Downstream transfers do not affect the noncontrolling interest.

Scenic's reported net income 2013 after amortization........... $105,000Noncontrolling interest ownership .......................................... 20%Noncontrolling interest share of Scenic net income ............. $21,000

Placid Lake’s net income from own operations...................... $300,000Placid Lake’s share of Scenic’s adjusted NI (80% × $105,000) 84,000Realization of 2012 intra-entity gross profit (see part a.) ..... 7,200Deferral of 2013 intra-entity gross profit (see part a.) ............ (16,200)Placid Lake’s share of consolidated net income ................... $375,000

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18. (continued)

d. Inventory—Placid Lake book value ......................................... $140,000Inventory—Scenic book value ................................................. 90,000Unrealized gross profit, 12/31/13 (see part a) ......................... (16,200)Consolidated inventory ............................................................ $213,800(Direction of transfer has no impact here)

e. Land—Placid Lake’s book value .............................................. $600,000Land—Scenic's book value ...................................................... 200,000Elimination of unrealized intra-entity gain on land ................ (20,000)Consolidated land balance ....................................................... $780,000

f. The intra-entity transfer was upstream from Scenic to Placid Lake. Because the transfer occurred in 2012, beginning retained earnings of the seller for 2013 contains the remaining portion of the unrealized gain.

Transfer pricing figures:

2012 Equipment = $80,000Gain = $20,000 ($80,000 – $60,000)Depreciation expense = $16,000 ($80,000 ÷ 5)Income effect = $4,000 ($20,000 – $16,000)Accumulated depreciation = $16,000

2013 Depreciation expense = $16,000Accumulated depreciation = $32,000

Historical cost figures:

2012 Equipment = $100,000Depreciation expense = $12,000 ($60,000 ÷ 5 years)Accumulated depreciation = $52,000 ($40,000 + $12,000)

2013 Depreciation expense = $12,000Accumulated depreciation = $64,000

CONSOLIDATION ENTRIES FOR TRANSFERRED EQUIPMENT

ENTRY *TARetained Earnings, 1/1/13 (Scenic) .......................... 16,000Equipment ($100,000 – $80,000) .............................. 20,000

Accumulated Depreciation ($52,000 – $16,000). 36,000

To change beginning of year figures to historical cost by removing impact of 2012 transactions. Retained earnings reduction removes $4,000 income effect (above) and replaces it with $12,000 depreciation expense for 2012.

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18. (continued)

ENTRY EDAccumulated Depreciation ....................................... 4,000

Depreciation Expense ......................................... 4,000To reduce depreciation from transfer price ($16,000) to historical cost of $12,000.

This intra-entity transfer was upstream from Scenic to Placid Lake. Thus, income effects are assumed to relate to the original seller (Scenic). Because the sale occurred in 2012, the only effect in 2013 relates to depreciation expense. The expense based on the transfer price is $4,000 higher than the amount based on the historical cost. As an upstream transfer, this adjustment affects Scenic and the noncontrolling interest computations.

Transfer price depreciation: $80,000 ÷ 5 yrs. = $16,000Historical cost depreciation (based on book value): $60,000 ÷ 5 yrs. = $12,000

Noncontrolling Interest in Scenic's Net IncomeScenic's reported net income less excess amortization ........ $105,000Reduction of depreciation expense to historical cost figure. 4,000Scenic's realized income ........................................................... $109,000Outside ownership percentage ................................................. 20%

Noncontrolling interest in Scenic’s net income ................. $21,800

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20. (30 Minutes) (Compute selected balances based on three different intra-entity asset transfer scenarios)

a. Consolidated Cost of Goods SoldPenguin’s cost of goods sold .................................................. $290,000Snow’s cost of goods sold ....................................................... 197,000Elimination of 2013 intra-entity transfers ................................ (110,000)Reduction of beginning Inventory because of

2012 unrealized gross profit ($28,000 ÷ 1.4 = $20,000cost; $28,000 transfer price less $20,000cost = $8,000 unrealized gross profit) ................................ (8,000)

Reduction of ending inventory because of2013 unrealized gross profit ($42,000 ÷ 1.4 = $30,000cost; $42,000 transfer price less $30,000cost = $12,000 unrealized gross profit) .............................. 12,000

Consolidated cost of goods sold .................................. $381,000

Consolidated InventoryPenguin book value ............................................................. $346,000Snow book value .................................................................. 110,000Defer ending unrealized gross profit (see above) ........... (12,000)Consolidated Inventory ....................................................... $444,000

Noncontrolling Interest in Subsidiary’s Net IncomeBecause all intra-entity sales were downstream, the deferrals do not affect Snow. Thus, the noncontrolling interest is 20% of the $58,000 (revenues minus cost of goods sold and expenses) reported net income or $11,600.

b. Consolidated Cost of Goods SoldPenguin book value .................................................................. $290,000Snow book value ....................................................................... 197,000Elimination of 2013 intra-entity transfers ................................ (80,000)Reduction of beginning inventory because of

2012 unrealized gross profit ($21,000 ÷ 1.4 = $15,000cost; $21,000 transfer price less $15,000cost = $6,000 unrealized gross profit) ................................ (6,000)

Reduction of ending inventory because of2013 unrealized gross profit ($35,000 ÷ 1.4 = $25,000cost; $35,000 transfer price less $25,000cost = $10,000 unrealized gross profit) .............................. 10,000

Consolidated cost of goods sold ............................................ $411,000

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20. b. (continued)

Consolidated inventory

Penguin book value .................................................................. $346,000Snow book value ....................................................................... 110,000Defer ending unrealized gross profit (see above) .................. (10,000)

Consolidated inventory ....................................................... $446,000

Noncontrolling interest in subsidiary’s net income

Since all intra-entity sales are upstream, the effect on Snow's net income must be reflected in the noncontrolling interest computation:

Snow reported net income ....................................................... $58,0002012 unrealized gross profit realized in 2013 (above) ........... 6,0002013 unrealized gross profit to be realized in 2014 (above) . (10,000)Snow realized income ............................................................... $54,000Outside ownership percentage ................................................ 20%

Noncontrolling interest in Snow's net income .................. $10,800

c. Consolidated buildings (net)

Penguin’s buildings ............................................... $358,000Snow's buildings .................................................... 157,000Remove write-up created by transfer

($80,000 – $50,000) ............................................ $(30,000)Remove excess depreciation created by transfer

($30,000 unrealized gain over 5 year life)(2 years) .............................................................. 12,000 (18,000)Consolidated buildings (net) ........................... $497,000

Consolidated expenses

Penguin’s book value ............................................. $150,000Snow's book value ................................................. 105,000Remove excess depreciation on transferred building

($30,000) unrealized gain ÷ 5 years) ................ (6,000)Consolidated expenses ......................................... $249,000

Noncontrolling interest in subsidiary’s net income

Because the transfer was made downstream, it has no effect on the noncontrolling interest. Thus, Snow's reported net income ($58,000 computed as revenues minus cost of goods sold and expenses) is used for this computation. The 20 percent outside ownership will be allotted net income of $11,600 (20% × $58,000).

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25. (35 minutes) (Compute consolidated totals with transfers of both inventory and a building.)

Excess Amortization ExpensesEquipment $60,000 ÷ 10 years = $6,000 per yearFranchises $80,000 ÷ 20 years = $4,000 per yearAnnual excess amortizations $10,000

Unrealized Gross Profit—Inventory, 1/1/13:Gross profit ($70,000 – $49,000) .............................................. $21,000Gross profit rate ($21,000 ÷ $70,000) ....................................... 30%

Remaining inventory ................................................................. $30,000Gross profit rate ........................................................................ 30%Unrealized gross profit, 1/1/13.................................................. $9,000

Unrealized Gross Profit—Inventory, 12/31/13:Gross profit ($100,000 – $50,000) ............................................ $50,000Gross profit rate ($50,000 ÷ $100,000) ..................................... 50%

Remaining inventory ................................................................. $40,000Gross profit rate......................................................................... 50%Unrealized gross profit, 12/31/13 ............................................. $20,000

Impact of intra-entity Building Transfer:

12/31/12—Transfer price figuresTransfer price ....................................................................... $50,000Gain on transfer ($50,000 – $30,000) .................................. 20,000Depreciation expense ($50,000 ÷ 5 years) ......................... 10,000Accumulated depreciation .................................................. 10,000

12/31/13—Transfer price figuresDepreciation expense .......................................................... 10,000Accumulated depreciation .................................................. 20,000

12/31/12—Historical cost figuresHistorical cost ...................................................................... $70,000Depreciation expense ($30,000 book value ÷ 5 years) ..... 6,000Accumulated depreciation ($40,000 + $6,000) .................. 46,000

12/31/13—Historical cost figuresDepreciation expense .......................................................... 6,000Accumulated depreciation .................................................. 52,000

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25. (continued)

CONSOLIDATED BALANCES

Sales = $1,000,000 (add the two book values and subtract $100,000 in intra-entity transfers)

Cost of Goods Sold = $571,000 (add the two book values and subtract $100,000 in intra-entity purchases. Subtract $9,000 because of the previous year unrealized gross profit and add $20,000 to defer the current year unrealized gross profit.)

Operating Expenses = $206,000 (add the two book values and include the $10,000 excess amortization expenses but remove the $4,000 in excess depreciation expense [$10,000 – $6,000] created by building transfer)

Investment Income = $0 (the intra-entity balance is removed so that the individual revenue and expense accounts of the subsidiary can be shown)

Inventory = $280,000 (add the two book values and subtract the $20,000 ending unrealized gross profit)

Equipment (net) = $292,000 (add the two book values and include the $60,000 allocation from the acquisition-date fair value less three years of excess amortizations)

Buildings (net) = $528,000 (add the two book values and subtract the $20,000 unrealized gain on the transfer after two years of excess depreciation [$4,000 per year])

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27. (65 Minutes) (Determine consolidation totals after answering a series of questions about combination and intra-entity inventory transfers)

a. Consideration transferred ....................... $342,000Noncontrolling interest fair value............. 38,000Subsidiary fair value at acquisition-date 380,000Book value.................................................. (326,000)Fair value in excess of book value .......... $54,000 Annual Excess

Excess fair value assignments Life AmortizationsTo building ........................................... 18,000 9 yrs. $2,000To patented technology ...................... 36,000 6 yrs. 6,000Totals..................................................... -0- $8,000

b. Because Brey sold inventory to Petino, the transfers are upstream.

c. Gross profit on 2012 transfers ($135,000 – $81,000) .............. $54,000Gross profit percentage ($54,000 ÷ $135,000) ........................ 40%

Inventory remaining, 12/31/12 ................................................. $37,500Gross profit percentage ............................................................ 40%Unrealized gross profit, January 1, 2013 ............................... $15,000

d. Gross profit on 2013 transfers ($160,000 – $92,800) ............. $67,200Gross profit percentage ($67,200 ÷ $160,000) ........................ 42%

Inventory remaining, 12/31/13 ................................................. $50,000Gross profit percentage ............................................................ 42%Unrealized gross profit, December 31, 2013 ........................... $21,000

27. (continued)

e. Petino is applying the equity method because the $68,400 equals neither 90% of Brey's reported Income nor 90% of the dividends paid by Brey.

Brey’s reported net income ...................................................... $90,000Excess fair value amortization.................................................. (8,000)Realized gross profit ................................................................ 15,000Deferred gross profit.................................................................. (21,000 ) Adjusted subsidiary income..................................................... $76,000Ownership .................................................................................. 90%Investment income—Brey ........................................................ $68,400

f. Brey’s adjusted income (see e.) ............................................... $76,000Outside ownership .................................................................... 10%Noncontrolling interest in subsidiary's net income ............... $7,600

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g. Investment in Brey (consideration transferred) ..................... $342,000Net Income of Brey

Reported 2011....................................... $64,0002012 .................................................. 80,0002013 ................................................. 90,000Total ................................................. 234,000

Unrealized gross profit, 12/31/13(see d.) (21,000)Realized income 2011-2013 ............... 213,000Petino’s ownership .............................. 90% 191,700

Excess amortizations ($8,000 × 3 years × 90%) (21,600)

Dividends paid by Brey2011 .................................................. $19,0002012 .................................................. 23,0002013 ................................................. 27,000Total ................................................. 69,000

Pitino's ownership ............................... 90% (62,100)Investment in Brey, 12/31/13 ................... $450,000

h. Entry SCommon Stock (Brey) ............................... 150,000Retained Earnings, 1/1/13 (Brey) (reduced by 1/1/13 unrealized gross profit) ................. 263,000

Investment in Brey (90%) .................... 371,700Noncontrolling interest in Brey (10%) 41,300

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27. (continued) part i.

Sales Revenues = $1,068,000 (total less $160,000 intra-entity sales)

Cost of Goods Sold = $570,000 (add book values less $160,000 in intra-entity purchases. Also, adjust for 2012 unrealized gross profit [subtract $15,000] and 2013 unrealized gross profit [add $21,000])

Expenses = $260,400 (add book values with $8,000 amortization for excess fair value allocations)

Investment Income—Brey = $0 (intra-entity balance is eliminated to include individual revenue and expense accounts of the subsidiary)

Noncontrolling Interest in Subsidiary's Net Income = $7,600 (see f.)

Consolidated net income to parent = $230,000 (consolidated revenues less consolidated cost of goods sold, expenses, and the noncontrolling interest's share of the subsidiary's income)

Retained Earnings, 1/1 = $488,000 (parent equity method balance)

Dividends Paid = $136,000 (parent balance only)

Retained Earnings, 12/31 = $582,000 (consolidated beginning balance plus net income less dividends paid)

Cash and Receivables = $228,000 (total less $16,000 intra-entity balance)

Inventory = $370,000 (total less ending unrealized gross profit)

Investment in Brey = $0 (intra-entity balance is eliminated so that the individual assets and liabilities of the subsidiary can be reported)

Land, Buildings, and Equipment = $1,304,000 (add book values and include a $12,000 net allocation after 3 years of amortization)

Patented Technology = $18,000 (original allocation after 3 years of amortization [$6,000 per year])

Total Assets = $1,920,000 (add consolidated figures)

Liabilities = $773,000 (add book values less $16,000 intra-entity balance)

Noncontrolling Interest in Brey, 12/31 = $50,000 ([10% of subsidiary's book value at beginning of period plus unamortized excess less beginning unrealized gross profit] plus 10% of the subsidiary's realized net income less 10% of subsidiary dividends).

Common Stock = $515,000 (parent balance only)

Retained Earnings, 12/31 = $582,000 (see above)

Total Liabilities and Stockholders' Equity = $1,920,000 (summation)

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30. (75 Minutes) (Determine consolidated balances after impact of upstream Inventory transfers and downstream transfer of building. Parent uses initial value method.)

PRELIMINARY COMPUTATIONSa. Consideration transferred ....................... $657,000

Noncontrolling interest fair value............. 73,000Subsidiary fair value at acquisition-date 730,000Book value.................................................. (620,000)Fair value in excess of book value .......... $110,000 Annual Excess

Excess fair value assignments Life Amortizationsto equipment......................................... 20,000 4 yrs. $5,000to liabilities ........................................... 40,000 5 yrs. 8,000to brand names .................................... 50,000 10 yrs. 5,000Totals..................................................... -0- $18,000

Determination of subsidiary book value on 1/1/12Book value, 1/1/13 (based on stockholders' equity accounts) $700,000Eliminate net income – 2012 ..................................................... (80,000)Eliminate dividends – 2012 ....................................................... -0 -

Book value, 1/1/12 ................................................................ $620,000

Beginning inventory unrealized gross profit, 12/31/12 (Upstream)Ending Inventory ($145,000 × 30%) ......................................... $43,500Gross profit rate (given) ........................................................... 20%Unrealized intra-entity gross profit, 12/31/12 .......................... $ 8,700

Ending inventory unrealized gross profit, 12/31/13 (Upstream)Ending Inventory ($160,000 × 40%) ......................................... $64,000Gross profit rate (given) ........................................................... 20%Unrealized intra-entity gross profit, 12/31/13 .......................... $12,800

Building unrealized gross profit, 1/2/12 (Downstream)Transfer price ............................................................................. $25,000Book value ................................................................................. 10,000Unrealized gross profit ............................................................. $15,000

Annual excess depreciationAnnual depreciation based on book value ($10,000 ÷ 5 years) $2,000Annual depreciation based on transfer price

($25,000 ÷ 5 years) ............................................................... 5,000Excess annual depreciation ..................................................... $3,000

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30. (continued)

Adjustment to buildings to return to historical cost at 1/1/13Consolidation

Transfer Price Historical Cost AdjustmentBuildings $25,000 $100,000 $75,000Accumulated depreciation

(1/1/12 balance after 1more year of depreciation) 5,000 92,000 87,000

Consolidated Totals

Sales and other Income = $1,240,000 (add the two book values and eliminate the intra-entity transfers)

Cost of goods sold:Moore's book value ................................................................... $500,000Kirby's book value ..................................................................... 400,000Eliminate intra-entity transfers ................................................. (160,000)Realized gross profit deferred in 2012..................................... (8,700)Deferral of 2013 unrealized gross profit .................................. 12,800Cost of goods sold .................................................................... $744,100

Operating and interest expenses = $275,000 (add the two book values and include $18,000 amortization for current year but eliminate $3,000 excess depreciation from asset transfer)

Noncontrolling interest in subsidiary’s income = $1,790 (impact of inventory transfers is included because they were upstream but building transfer is omitted because it was downstream)

Reported net income for 2013 ....................................................... $40,000Realized gross profit deferred in 2012 .................................... 8,700Deferral of 2013 unrealized gross profit .................................. (12,800)Realized income of subsidiary ................................................. $35,900Excess fair value amortization.................................................. (18,000 ) Adjusted subsidiary net income............................................... 17,900

Outside ownership ......................................................................... 10%Noncontrolling interest ............................................................. $ 1,790

Consolidated net income = $220,900 (consolidated sales less consolidated cost of goods sold, expenses, and noncontrolling interest)

To noncontrolling interest = $1,790 (above) To controlling interest = $219,110

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30. (continued)

Retained earnings, 1/1/13 = $1,025,970 (because the parent uses the initial value method, its retained earnings must be adjusted for changes in subsidiary's book value, excess amortizations, and the impact of unrealized gross profits in previous years)

Moore's reported balance, 1/1/13 ................................. $990,000Impact of building transfer (parent's income was over-

stated by the $15,000 gain but has been reduced byone prior year of excess depreciation) ................... (12,000)

Adjustments to convert initial value to equity method:Increase in subsidiary's book value during prior

years ..................................................................... $80,000Excess fair value amortization ................................. (18,000)Deferral of 12/31/12 unrealized gross profit

(subsidiary's prior income was overstated) ...... (8,700)Realized increase in book value ......................... 53,300

Ownership................................................................... 90%Equity accrual ............................................................ 47,970

Retained Earnings, 1/1/13 ................................... $1,025,970

Dividends Paid = $130,000 (parent balance only)Retained Earnings, 12/31/13 = $1,115,080 (the beginning balance plus controlling

interest share of consolidated net income less dividends paid)Cash and Receivables = $397,000 (add the two book values)Inventory = $371,200 (add the two book values and defer the $12,800 ending

unrealized gross profit)Investment in Kirby = -0- (eliminated for consolidation purposes)

Equipment (Net) = $1,030,000 (add the two book values adjusted for excess allocation and amortization)

Buildings = $1,725,000 (add the two book values and add the $75,000 impact to return to historical cost as computed above for transfer)

Accumulated Depreciation = $384,000 (add the two book values plus adjustment to historical cost ($87,000 at beginning of year less $3,000 excess depreciation for current year)

Other Assets = $300,000 (add the two book values)

Brand Names = $40,000 (the original $50,000 allocation less two years of amortization at $5,000 per year)

Total Assets = $3,479,200 (summation of the consolidated totals)

Liabilities = $1,684,000 (add the two book values and subtract the original allocation [$40,000] after two years of amortization [$8,000 per year])

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30. (continued)

NCI 12/31/13 = $80,120 (10 percent of $691,300 adjusted beginning book value [$700,000 less $8,700 deferral of unrealized gross profit] plus $9,200 share of beginning unamortized excess fair value allocations plus $1,790 net income share)

Common Stock = $600,000 (parent balance only)

Retained Earnings, 12/31/13 = $1,115,080 (computed above)

Total Liabilities and Equities = $3,479,200 (summation of consolidated balances).

The same consolidation balances can be derived using a worksheet and the following adjusting and eliminating entries:

CONSOLIDATION ENTRIESEntry *G

Retained Earnings, 1/1/13 (Kirby) ....................... 8,700Cost of Goods Sold ........................................ 8,700

(To recognize 2012 deferred gross profit as income in 2013)

Entry *TABuilding.................................................................. 75,000Retained Earnings, 1/1/13 (Moore) ..................... 12,000

Accumulated Depreciation ............................ 87,000(To adjust 1/1/13 balance to historical cost figures)

Entry *CInvestment in Kirby .............................................. 47,970

Retained Earnings, 1/1/13 (Moore) ................ 47,970(To convert from initial value to equity method based on the following computation)

Increase in subsidiary's book value during prior year(net income of $80,000).................................. $80,000

Excess amortization for 2012.............................. (18,000)Deferral of 12/31/12 unrealized gross profit....... (8,700)Realized increase in subsidiary's book value.... $53,300Ownership ............................................................ 90%Conversion to equity method adjustment.......... $47,970

S Common Stock (Kirby) ........................................ 150,000Retained Earnings, 1/1/13 as adjusted (Kirby)... 541,300

Investment in Kirby (90%) .............................. 622,170Noncontrolling interest in Kirby (10%) ......... 69,130

(To eliminate subsidiary's beginning stockholders' equity accounts and recognize beginning noncontrolling interest balance)

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30. (continued)

A Liabilities .............................................................. 32,000Equipment ............................................................ 15,000Brand Names ........................................................ 45,000

Investment in Kirby ........................................ 82,800Noncontrolling Interest in Kirby (10%) ......... 9,200

(To recognize unamortized balance of excess allocations as of 1/1/13. Figures have been reduced by one year of amortization)

Entry I (the subsidiary paid no dividends so no adjustment needed)

E Operating and Interest Expense.......................... 18,000Liabilities ......................................................... 8,000Equipment........................................................ 5,000Brand Names ................................................... 5,000

(To recognize excess amortization expenses for current year)

Tl Sales ...................................................................... 160,000Cost of Goods Sold ........................................ 160,000

(To eliminate intra-entity transfers for 2013)

G Cost of Goods Sold ............................................. 12,800Inventory ......................................................... 12,800

(To defer ending unrealized inventory gross profit)

ED Accumulated Depreciation .................................. 3,000Depreciation Expense .................................... 3,000

(To adjust depreciation for current year created by transfer of building)

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30. continued: Worksheet (not part of requirements)

Moore and Subsidiary KirbyConsolidated Worksheet

December 31, 2013

Moore Kirby NCI Consolidated

Sales and other income (800,000) (600,000) (TI) 160,000 (1,240,000)

Cost of goods sold 500,000 400,000 (G) 12,800 (G*) 8,700 744,100

(TI)160,000

Op. and interest expenses 100,000 160,000 (E) 18,000 (ED) 3,000 275,000

Separate company income (200,000) (40,000)

Consolidated net income (220,900)

to noncontrolling interest (1,790) 1,790

to controlling interest (219,110)

Retained earnings, 1/1 (990,000) (TA*) 12,000 (*C) 47,970 (1,025,970)

(550,000) (S) 541,300

(G*) 8,700

Net income (200,000) (40,000) (219,110)

Dividends paid 130,000 0 130,000

Retained earnings, 12/31 (1,060,000) (590,000) (1,115,080)

Cash and receivables 217,000 180,000 397,000

Inventory 224,000 160,000 (G) 12,800 371,200

Investment in Kirby 657,000 0 (*C) 47,970 (S) 622,170 0

(A) 82,800

Equipment (net) 600,000 420,000 (A) 15,000 (E) 5,000 1,030,000

Buildings 1,000,000 650,000 (TA*) 75,000 1,725,000

Acc. depreciation—buildings (100,000) (200,000) (ED) 3,000 (TA*) 87,000 (384,000)

Brand names 0 0 (A) 45,000 (E) 5,000 40,000

Other assets 200,000 100,000 300,000

Total assets 2,798,000 1,310,000 3,479,200

Liabilities (1,138,000) (570,000) (A) 32,000 (E) 8,000 (1,684,000)

Common stock (600,000) (150,000) (S)150,000 (600,000)

Noncontrolling interest , 1/1 (S) 69,130

(A) 9,200 (78,330)

Noncontrolling interest,12/31 80,120 (80,120)

Retained earnings, 12/31 (1,060,000) (590,000) (1,115,080)

Total liabilities and equity (2,798,000) (1,310,000) 1,120,770 1,120,770 (3,479,200)

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Chapter 5 Solutions

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