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Chapter 6
Elimination of Unrealized Profit on Intercompany Sales of Inventory
Multiple Choice
1.
2.
3.
4.
Pratt Company owns 80% of Storey Companys common stock. During 2011, Storey sold $400,000
of merchandise to Pratt. At December 31, 2011, one-fourth of the merchandise remained in Pratts
inventory. In 2011, gross profit percentages were 25% for Pratt and 30% for Storey. The amount of
unrealized intercompany profit that should be eliminated in the consolidated statements is
a. $80,000.
b. $24,000.
c. $30,000.
d. $25,000.
5.
The noncontrolling interests share of the selling affiliates profit on intercompany sales is
considered to be realized under
a. partial elimination.
b. total elimination.
c. 100% elimination.
d. both total and 100% elimination.
6.
The workpaper entry in the year of sale to eliminate unrealized intercompany profit in ending
inventory includes a
a. credit to Ending Inventory (Cost of Sales).
b. credit to Sales.
c. debit to Ending Inventory (Cost of Sales).
d. debit to Inventory - Balance Sheet.
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6-2
Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
7.
Perez Company acquired an 80% interest in Seaman Company in 2010. In 2011 and 2012, Sutton
reported net income of $400,000 and $480,000, respectively. During 2011, Seaman sold $80,000 of
merchandise to Perez for a $20,000 profit. Perez sold the merchandise to outsiders during 2012 for
$140,000. For consolidation purposes, what is the noncontrolling interests share of Seaman's 2011
and 2012 net income?
a. $90,000 and $96,000.
b. $100,000 and $76,000.
c. $84,000 and $92,000.
d. $76,000 and $100,000.
8.
A 90% owned subsidiary sold merchandise at a profit to its parent company near the end of 2010.
Under the partial equity method, the workpaper entry in 2011 to recognize the intercompany profit
in beginning inventory realized during 2011 includes a debit to
a. Retained Earnings - P.
b. Noncontrolling interest.
c. Cost of Sales.
d. both Retained Earnings - P and Noncontrolling Interest.
9.
The noncontrolling interest in consolidated income when the selling affiliate is an 80% owned
subsidiary is calculated by multiplying the noncontrolling minority ownership percentage by the
subsidiarys reported net income
a. plus unrealized profit in ending inventory less unrealized profit in beginning inventory.
b. plus realized profit in ending inventory less realized profit in beginning inventory.
c. less unrealized profit in ending inventory plus realized profit in beginning inventory.
d. less realized profit in ending inventory plus realized profit in beginning inventory.
10.
11.
P Company sold merchandise costing $240,000 to S Company (90% owned) for $300,000. At the
end of the current year, one-third of the merchandise remains in S Companys inventory. Applying
the lower-of- cost-or-market rule, S Company wrote this inventory down to $92,000. What amount
of intercompany profit should be eliminated on the consolidated statements workpaper?
a. $20,000.
b. $18,000.
c. $12,000.
d. $10,800.
12.
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6-3
13.
A parent company regularly sells merchandise to its 80%-owned subsidiary. Which of the
following statements describes the computation of noncontrolling interest income?
a. the subsidiarys net income times 20%.
b. (the subsidiarys net income x 20%) + unrealized profits in the beginning inventory
unrealized profits in the ending inventory.
c. (the subsidiarys net income + unrealized profits in the beginning inventory unrealized profits
in the ending inventory) 20%.
d. (the subsidiarys net income + unrealized profits in the ending inventory unrealized profits in
the beginning inventory) 20%.
14.
P Corporation acquired a 60% interest in S Corporation on January 1, 2011, at book value equal to
fair value. During 2011, P sold merchandise that cost $135,000 to S for $189,000. One-third of this
merchandise remained in Ss inventory at December 31, 2011. S reported net income of $120,000
for 2011. Ps income from S for 2011 is:
a. $36,000.
b. $50,400.
c. $54,000.
d. $61,200.
Sales Revenue
Cost of Goods Sold
Gross profit
P _
$2,250,000
1,800,000
$450,000
S _
$1,125,000
937,500
$187,500
15.
16.
Consolidated cost of goods sold for P Company and Subsidiary for 2011 are:
a. $2,260,500.
b. $2,268,000.
c. $2,276,700.
d. $2,737,500.
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6-4
Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
Sales
Cost of Sales
Operating Expenses
Net Income (2011)
S __
$600,000
(400,000)
( 80,000)
$120,000
17.
18.
19.
The amount of intercompany profit eliminated is the same under total elimination and partial
elimination in the case of
1.
upstream sales where the selling affiliate is a less than wholly owned subsidiary.
2.
all downstream sales.
3.
horizontal sales where the selling affiliate is a wholly owned subsidiary.
a. 1.
b. 2.
c. 3.
d. both 2 and 3.
20.
Paige, Inc. owns 80% of Sigler, Inc. During 2011, Paige sold goods with a 40% gross profit to
Sigler. Sigler sold all of these goods in 2011. For 2011 consolidated financial statements, how
should the summation of Paige and Sigler income statement items be adjusted?
a. Sales and cost of goods sold should be reduced by the intercompany sales.
b. Sales and cost of goods sold should be reduced by 80% of the intercompany sales.
c. Net income should be reduced by 80% of the gross profit on intercompany sales.
d. No adjustment is necessary.
21.
P Corporation acquired a 60% interest in S Corporation on January 1, 2011, at book value equal to
fair value. During 2011, P sold merchandise that cost $225,000 to S for $315,000. One-third of this
merchandise remained in Ss inventory at December 31, 2011. S reported net income of $200,000
for 2011. Ps income from S for 2011 is:
a. $60,000.
b. $90,000.
c. $120,000.
d. $102,000.
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6-5
Sales Revenue
Cost of Goods Sold
Gross profit
S _
$900,000
750,000
$150,000
22.
23.
Consolidated cost of goods sold for P Company and Subsidiary for 2011 are:
a. $1,809,000.
b. $1,815,000.
c. $1,821,000.
d. $2,190,000.
Sales
Cost of Sales
Operating Expenses
Net Income (2011)
24.
25.
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S __
$450,000
(300,000)
( 60,000)
$ 90,000
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6-6
Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
Problems
6-1
On January 1, 2011, Palmer Company purchased a 90% interest in Sauder Company for $2,800,000.
At that time, Sauder had $1,840,000 of common stock and $360,000 of retained earnings. The
difference between implied and book value was allocated to the following assets of Sauder
Company:
Inventory
Plant and equipment (net)
Goodwill
$ 80,000
240,000
591,111
The plant and equipment had a 10-year remaining useful life on January 1, 2011.
During 2011, Palmer sold merchandise to Sauder at a 20% markup above cost. At December 31,
2011, Sauder still had $180,000 of merchandise in its inventory that it had purchased from Palmer.
In 2011, Palmer reported net income from independent operations of $1,600,000, while Sauder
reported net income of $600,000.
Required:
A. Prepare the workpaper entry to allocate, amortize, and depreciate the difference between
implied and book value for 2011.
B. Calculate controlling interest in consolidated net income for 2011.
6-2
Percy Company owns 80% of the common stock of Smyth Company. Percy sells merchandise to
Smyth at 20% above cost. During 2011 and 2012, intercompany sales amounted to $1,080,000 and
$1,200,000 respectively. At the end of 2011, Smyth had one-fifth of the goods purchased that year
from Percy in its ending inventory. Smyths 2012 ending inventory contained one-fourth of that
years purchases from Percy. There were no intercompany sales prior to 2011.
Percy reported net income from its own operations of $720,000 in 2011 and $760,000 in 2012.
Smyth reported net income of $400,000 in 2011 and $460,000 in 2012. Neither company declared
dividends in either year.
Required:
A. Prepare in general journal form all entries necessary on the consolidated statements workpapers
to eliminate the effects of the intercompany sales for both 2011 and 2012.
B. Calculate controlling interest in consolidated net income for 2012.
6-3
Payton Company owns 90% of the common stock of Sanders Company. Sanders Company sells
merchandise to Payton Company at 25% above cost. During 2010 and 2011 such sales amounted to
$800,000 and $1,020,000, respectively. At the end of each year, Payton Company had in its
inventory one-fourth of the amount of goods purchased from Sanders Company during that year.
Payton Company reported income of $1,500,000 from its independent operations in 2010 and
$1,720,000 in 2011. Sanders Company reported net income of $600,000 in each year and did not
declare any dividends in either year. There were no intercompany sales prior to 2010.
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6-7
Required:
A. Prepare, in general journal form, all entries necessary on the 2011 consolidated statements
workpaper to eliminate the effects of intercompany sales.
B. Calculate the amount of noncontrolling interest to be deducted from consolidated income in the
consolidated income statement in 2011.
C. Calculate controlling interest in consolidated net income for 2011.
6-4
Powers Company owns an 80% interest in Smiley Company and a 90% interest in Toro Company.
During 2010 and 2011, intercompany sales of merchandise were made by all three companies.
Total sales amounted to $2,400,000 in 2010, and $2,700,000 in 2011. The companies sold their
merchandise at the following percentages above cost.
Powers
15%
Smiley
20%
Toro
25%
The amount of merchandise remaining in the 2011 beginning and ending inventories of the
companies from these intercompany sales is shown below.
Merchandise Remaining in Beginning Inventory
Powers
Smiley
Toro
Total
Sold by
Powers
Smiley
Toro
$225,000
$180,000
180,000
$189,000
216,000
135,000
$414,000
396,000
315,000
$207,000
$144,000
195,000
$138,000
198,000
150,000
$345,000
342,000
345,000
Reported net incomes (from independent operations including sales to affiliates) of Powers, Smiley,
and Toro for 2011 were $3,600,000, $1,500,000, and $2,400,000, respectively.
Required:
A. Calculate the amount noncontrolling interest to be deducted from consolidated income in the
consolidated income statement for 2011.
B. Calculate the controlling interest in consolidated net income for 2011.
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6-8
6-5
Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
The following balances were taken from the records of S Company:
Common stock
$2,500,000
Retained earnings, 1/1/11
$1,450,000
Net income for 2011
3,000,000
Dividends declared in 2011
(1,550,000)
Retained earnings, 12/31/11
2,900,000
Total stockholders equity, 12/31/11
$5,400,000
P Company owns 80% of the common stock of S Company. During 2011, P Company purchased
merchandise from S Company for $4,000,000. S Company sells merchandise to P Company at cost
plus 25% of cost. On December 31, 2011, merchandise purchased from S Company for $1,250,000
remains in the inventory of P Company. On January 1, 2011, P Companys inventory contained
merchandise purchased from S Company for $525,000. The affiliated companies file a consolidated
income tax return. There was no difference between the implied value and the book value of net
assets acquired.
Required:
A. Prepare all workpaper entries necessitated by the intercompany sales of merchandise.
B. Compute noncontrolling interest in consolidated income for 2011.
C. Compute noncontrolling interest in consolidated net assets on December 31, 2011.
6-6
P Corporation acquired 80% of S Corporation on January 1, 2011 for $240,000 cash when Ss
stockholders equity consisted of $100,000 of Common Stock and $30,000 of Retained Earnings.
The difference between the price paid by P and the underlying equity acquired in S was allocated
solely to a patent amortized over 10 years.
P sold merchandise to S during the year in the amount of $30,000. $10,000 worth of
inventory is still on hand at the end of the year with an unrealized profit of $4,000. The separate
company statements for P and S appear in the first two columns of the partially completed
consolidated workpaper.
Required:
Complete the consolidated workpaper for P and S for the year 2011.
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6-9
Income Statement
Sales
Dividend Income
Cost of Sales
Other Expenses
Noncontrolling Interest in Income
Net Income
Retained Earnings Statement
Retained Earnings 1/1
Add: Net Income
Less: Dividends
Retained Earnings 12/31
Balance Sheet
Cash
Accounts Receivable-net
Inventories
Patent
Land
Equipment and Buildings-net
Investment in S Corporation
Total Assets
Equities
Accounts Payable
Common Stock
Retained Earnings
1/1 Noncontrolling Interest in Net
Assets
12/31 Noncontrolling Interest in
Net Assets
Total Equities
P
Corp.
S
Corp.
200,000
16,000
(92,000)
(23,000)
150,000
(47,000)
(40,000)
101,000
63,000
110,000
101,000
( 30,000)
181,000
30,000
63,000
(20,000)
73,000
20,000
120,000
140,000
19,000
55,000
80,000
270,000
600,000
240,000
695,000
420,000
430,000
1,004,000
909,000
300,000
181,000
831,000
100,000
73,000
1,390,000
1,004,000
Eliminations
Dr.
Cr.
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Noncontrolling
Interest
Consolidated
Balances
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6-10 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
6-7
On January 1, 2011, Porter Company purchased an 80% interest in the capital stock of Shilo
Company for $3,400,000. At that time, Shilo Company had common stock of $2,200,000 and
retained earnings of $620,000. Porter Company uses the cost method to record its investment in
Shilo Company. Differences between the fair value and the book value of the identifiable assets of
Shilo Company were as follows:
Fair Value in Excess of Book Value
Equipment
Land
Inventory
$400,000
200,000
80,000
The book values of all other assets and liabilities of Shilo Company were equal to their fair values
on January 1, 2011. The equipment had a remaining life of five years on January 1, 2011; the
inventory was sold in 2011.
Shilo Companys net income and dividends declared in 2011 were as follows:
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6-11
Porter
Shilo
Eliminations Noncontrolling Consolidated
Company Company Dr.
Cr.
Interest
Balances
Income Statement
Sales
Dividend Income
Total Revenue
Cost of Goods Sold
Depreciation Expense
Other Expenses
Total Cost & Expenses
Net/Consolidated Income
Noncontrolling Interest in Income
Net Income to Retained Earnings
Retained Earnings Statement
1/1 Retained Earnings
Porter Company
Shilo Company
Net Income from above
Dividends Declared
Porter Company
Shilo Company
12/31 Retained Earnings to
Balance Sheet
4,400,000 1,800,000
192,000
4,592,000 1,800,000
3,600,000
800,000
160,000
120,000
240,000
200,000
4,000,000 1,120,000
592,000
680,000
592,000
680,000
2,000,000
592,000
920,000
680,000
(360,000)
(240,000)
2,232,000 1,360,000
Porter
Shilo
Eliminations Noncontrolling Consolidated
Company Company Dr.
Cr.
Interest
Balances
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Shilo Company
Difference between Implied and Book Value
Land
Plant and Equipment
Total Assets
Accounts Payable
Notes Payable
Common Stock:
Porter Company
Shilo Company
Retained Earnings from above
1/1 Noncontrolling Interest in Net Assets
12/31 Noncontrolling Interest in Net Assets
Total Liabilities & Equity
280,000
1,040,000
960,000
3,400,000
1,440,000
7,120,000
528,000
360,000
260,000
760,000
700,000
1,280,000
1,120,000
4,120,000
440,000
120,000
4,000,000
2,200,000
2,232,000 1,360,000
7,120,000 4,120,000
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6-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
6-8
Pool Company owns a 90% interest in Slater Company. The consolidated income statement drafted
by the controller of Pool Company appeared as follows:
Pool Company and Subsidiary
Consolidated Income Statement
for Year Ended December 31, 2011
Sales
Cost of Sales
Operating Expenses
Consolidated Income
Less Noncontrolling Interest in Consolidated Income
Controlling Interest in Consolidated Net Income
$13,800,000
$9,000,000
1,800,000
10,800,000
3,000,000
190,000
$2,810,000
During your audit you discover that intercompany sales transactions were not reflected in the
controllers draft of the consolidated income statement. Information relating to intercompany sales
and unrealized intercompany profit is as follows:
Cost
Selling
Price
Unsold at
Year-End
$1,500,000
900,000
$1,800,000
1,350,000
1/4
2/5
Required:
Prepare a corrected consolidated income statement for Pool Company and Slocum Company for the
year ended December 31, 2011.
Short Answer
1.
Past and proposed GAAP agree that unrealized intercompany profit should not be included in
consolidated net income or assets. Briefly explain the preferred approach of eliminating
intercompany profit.
2.
Does the elimination of the effects of intercompany sales of merchandise always affect the amount
of reported consolidated net income? Explain.
2.
Why is the gross profit on intercompany sales, rather than profit after deducting selling and
administrative expenses, ordinarily eliminated from consolidated inventory balances?
3.
P Company sells inventory costing $100,000 to its subsidiary, S Company, for $150,000. At the end
of the current year, one-half of the goods re-mains in S Companys inventory. Applying the lower of
cost or market rule, S Company writes down this inventory to $60,000. What amount of
intercompany profit should be eliminated on the consolidated statements workpaper?
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6-13
4.
Are the adjustments to the noncontrolling interest for the effects of intercompany profit eliminations
illustrated in this text necessary for fair presentation in accordance with generally accepted
accounting principles? Explain.
5.
Why are adjustments made to the calculation of the noncontrolling interest for the effects of
intercompany profit in upstream but not in down-stream sales?
6.
What procedure is used in the consolidated statements workpaper to adjust the noncontrolling
interest in consolidated net assets at the be-ginning of the year for the effects of intercompany
profits?
7.
What is the essential procedural difference between workpaper eliminating entries for unrealized
intercompany profit made when the selling affiliate is a less than wholly owned subsidiary and those
made when the selling affiliate is the parent company or a wholly owned subsidiary?
8.
Define the controlling interest in consolidated net income using the t-account or analytical approach.
9.
Why is it important to distinguish between up-stream and downstream sales in the analysis of
intercompany profit eliminations?
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6-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
ANSWER KEY
Multiple Choice
1.
2.
3.
4.
d
b
c
c
5.
6.
7.
8.
a
c
d
d
9.
10.
11.
12.
c
b
c
c
13.
14.
15.
16.
a
c
a
c
17.
18.
19.
20.
b
c
d
a
21.
22.
23.
24.
c
a
c
b
25. c
Problems
6-1
24,000
216,000
80,000
591,111
911,111
$1,600,000
(30,000)
1,570,000
540,000
(104,000)*
$2,006,000
* 80,000 + (240,000/10)
6-2
A. 2011
Sales
1,080,000
Purchases (Cost of Goods Sold)
1,080,000
36,000
36,000
1,200,000
Purchases (Cost of Goods Sold)
1,200,000
50,000
36,000
50,000
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6-3
A. Sales
$760,000
(50,000)
36,000
746,000
$368,000
$1,114,000
1,020,000
1,020,000
51,000
$600,000
(51,000)
40,000
589,000
.1
$ 58,900
$1,720,000
$600,000
(51,000)
40,000
$589,000
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530,100
$2,250,100
6-15
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6-16 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
6-4
Smiley
Toro
$1,500,000
$2,400,000
66,000
63,000
(57,000)
(69,000)
1,509,000
2,394,000
.2
.1
$301,800
$239,400
$3,600,000
54,000
(45,000)
$3,609,000
$1,500,000
66,000
(57,000)
1,509,000
1,207,200
$2,400,000
63,000
(69,000)
$2,394,000
2,154,600
$6,970,800
6-5
A. Sales
4,000,000
Cost of Goods Sold
4,000,000
250,000
250,000
84,000
21,000
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105,000
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6-17
(1) .8($105,000)
(2) .2($105,000)
B. $3,000,000 .20 = $600,000 noncontrolling interest in consolidated income.
C. [(.20 $5,400,000) -.20($1,250,000 $1,250,000/1.25)] = $1,030,000 noncontrolling interest in
consolidated net assets on December 31, 2011.
6-6
Income Statement
Sales
Dividend Income
Cost of Sales
Other Expenses
Noncontrolling Interest in Income
Net income
Retained Earnings Statement
Retained Earnings 1/1
Add: Net Income
Less: Dividends
Retained Earnings 12/31
Balance Sheet
Cash
Accounts Receivable-net
Inventories
Patent
Land
Equipment and Buildings-net
Investment in S Corporation
Total Assets
Equities
Accounts Payable
Common Stock
Retained Earnings from above
1/1 Noncontrolling Interest in Net
Assets
12/31 Noncontrolling Interest in Net
Assets
Total Equities
Corp.
Corp.
Eliminations
Dr
Cr
63,000
67,000
110,000
101,000
( 30,000)
181,000
30,000
63,000
(20,000)
73,000
(d) 30,000
67,000
20,000
120,000
140,000
19,000
55,000
80,000
(a) 30,000
30,000
30,000
(c) 16,000
46,000
831,000
100,000
73,000
9,200
9,200
9,200
(4,000)
5,200
110,000
117,800
(30,000)
197,800
39,000
175,000
216,000
153,000
690,000
1,030,000
(d)240,000
2,303,000
(d)100,000
97,000
46,000
5,200
(d)60,000
60,000
65,200
1,390,000 1,004,000
Balances
(113,000)
(80,000)
(9,200)
117,800
(b) 4,000
(e) 17,000
270,000
420,000
600,000
430,000
240,000
1,390,000 1,004,000
909,000
300,000
181,000
Consolidated
320,000
97,000
(d)170,000
Noncontrolli
ng
Interest
367,000
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367,000
1,740,000
300,000
197,800
65,200
2,303,000
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6-18 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
6-7
Porter
Shilo
Company Company
Income Statement
Sales
Dividend Income
Total Revenue
Cost of Goods Sold
Depreciation Expense
Other expense
Total Cost & Expenses
Net/Consolidated Income
Noncontrolling Interest in Income
Net Income to Retained Earnings
Statement of Retained Earnings
1/1 Retained Earnings
Eliminations
Dr.
Cr.
Noncontrolling
Interest
Consolidated
Balances
120,000
120,000
6,200,000
---6,200,000
4,400,000
360,000
440,000
5,200,000
1,000,000
120,000
880,000
4,400,000 1,800,000
192,000
(a) 192,000
4,592,000 1,800,000
3,600,000
800,000
160,000
120,000 (d) 80,000
240,000
20,000
4,000,000 1,120,000
592,000
680,000
592,000
Porter Company
Shilo Company
Net Income from above
Dividends Declared
2,000,000
Porter Company
Shilo Company
12/31 Retained Earnings to
Balance Sheet
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Shilo Company
Difference between Implied and
Book Value
Land
Plant and Equipment
Goodwill
Total Assets
Accounts Payable
Notes Payable
Common Stock:
Porter Company
Shilo Company
Retained Earnings from above
(360,000)
592,000
680,000
272,000
(c) 64,000
(d) 64,000 (e) 240,000
920,000 (b) 920,000
680,000
272,000
120,000
880,000
(360,000)
(240,000)
2,232,000 1,360,000
280,000
1,040,000
960,000
3,400,000
2,112,000
1,320,000
(a) 192,000
(48,000)
432,000
72,000
260,000
760,000
700,000
2,632,000
540,000
1,800,000
1,660,000
---
1,480,000
2,800,000
750,000
9,030,000
968,000
480,000
4,000,000
4,000,000
432,000
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72,000
2,632,000
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6-8
6,572,000
6,572,000
6-19
878,000
950,000
712,000
950,000
9,030,000
$12,450,000
$7,755,000
1,800,000
9,555,000
2,895,000
197,500
$2,697,500
$9,000,000
(1,350,000)
180,000
(75,000)
$7,755,000
$190,000
$1,900,000
0.1
Plus unrealized profit on subsidiary sales in 2010 that is considered realized in 2011
(1/4 x ($1,800,000 - $1,500,000))
75,000
Less unrealized profit on subsidiary sales in 2011 (there were no upstream sales in 2011)
0
Income realized in transactions with third parties
1,975,000
0.10
Noncontrolling interest in consolidated income
$197,500
Short Answer
1.
Both current and proposed GAAP require 100% elimination of intercompany profit in the
preparation of consolidated financial statements. Under 100% elimination, the entire amount of
unconfirmed intercompany profit is eliminated from consolidated net income and the related asset
balance. This approach is logical under the proposed view of consolidated financial statements,
based on the entity concept.
2.
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6-20 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
Short Answer Questions in Textbook Solutions
1. No. If all of the merchandise sold by one affiliate to another has subsequently been sold to outsiders, the
only effect that the elimination of intercompany sales of merchandise will have on the consolidated
financial statements is to reduce consolidated sales and consolidated cost of sales by an equal amount.
Consolidated net income will be unaffected.
2. The effect of eliminating profit on intercompany sales after deducting selling and administrative
expenses rather than gross profit is to include selling and administrative expenses associated with the
intercompany sale in consolidated inventories. Support for the gross profit approach is based on the
proposition that consolidated inventory balances should include manufacturing costs only and that
generally accepted accounting standards normally preclude the capitalization of selling and
administrative costs.
3. $10,000 in intercompany profit should be eliminated on the consolidated statements workpaper ($60,000
$100,000
= $10,000). After this elimination the merchandise will be included in the consolidated
2
$100,000
statements at its cost to the affiliated group of $50,000 (
).
2
4. Yes. Although 100 percent elimination of intercompany profit has long been required in the preparation
of consolidated financial statements, the adjustments to the noncontrolling interest described in this text
were discretionary prior to the current standard. The FASB requires that these adjustments be allocated
between the noncontrolling and controlling interests.
5. When the subsidiary is the intercompany seller, the unrealized profit is shown in the accounts of the sub
(S Company). These accounts provide the starting point for the calculation of the noncontrolling share
of current year earnings. Failure to eliminate unrealized profit would result in the overstatement of the
noncontrolling share in profits. However, when the parent is the intercompany seller, the unrealized
profit is shown in the accounts of the parent (P Company). Since the noncontrolling interest does not
share in the earnings of P Company, the noncontrolling interest is not affected by the unrealized profit
therein.
6. Noncontrolling interest in consolidated net assets at the beginning of the year is adjusted by debiting or
crediting the subsidiarys beginning retained earnings in the consolidated statements workpaper.
7. The only procedural difference in the workpaper entries relating to the elimination of intercompany
profits when the selling affiliate is a less than wholly owned subsidiary is that the noncontrolling interest
in the amount of intercompany profit in beginning inventory must be recognized by debiting or crediting
the noncontrolling shareholders percentage interest in such adjustments to the beginning retained
earnings of the subsidiary.
8. Controlling interest in consolidated net income is equal to the parent companys income from its
independent operations that has been realized in transactions with third parties plus its share of reported
subsidiary income that has been realized in transactions with third parties and adjusted for its share of
the amortization of the difference between implied and book value for the period.
9. It is important to distinguish between upstream and downstream sales because the calculation of
noncontrolling interest in the consolidated financial statements differs depending on whether the
intercompany sale giving rise to unrealized intercompany profit is upstream or downstream.
10. Profit relating to the intercompany sale of merchandise is recognized in the consolidated financial
statements in the period in which the merchandise is sold to outsiders. It is recognized in the
consolidated financial statements by reducing cost of goods sold (thus increasing gross profit and net
income).
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6-21
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