Chapter 8 Consolidated Finanical Statemetns

Chapter 8
Consolidated Financial statements: Intercompany Transactions

ACCT 501 (All examples are from the textbook by J. Larson)
Objectives of the Chapter
To discuss the accounting and working paper eliminations for related party transactions between a parent company and its subsidiaries for: I. intercompany transactions not involving profit or loss such as loans on promissory notes, leases of property under operating leases and rendering of services;
Consolidated FS-Intercompany Transactions 2
Objectives of the Chapter (Contd.)

II.intercompany transactions involving profit or loss such as intercompany sale of merchandise, plant assets, intangible assets and leases of property (under capital/sales-type leases).
Consolidated FS-Intercompany Transactions
Principle to follow to account for the intercompany transactions for the consolidated financial statements:
The consolidated financial statements should include only transactions resulting from the consolidated groups dealings with outsiders.
Principle to follow to account for the intercompany transactions for the consolidated financial statements: (Contd.)
Separate ledger accounts are established for all intercompany assets, liabilities, revenue and expenses. These separate accounts clearly identify the intercompany items that should be eliminated in the preparation of consolidated financial statements.
I. Accounting for Intercompany Transactions Not Involving Profit (Gain) or Loss
loans on Notes or Open Accounts The parent company may make loans to its subsidiaries. The interest rate charged by the parent company usually exceeds the parent companys borrowing rate.
I. Accounting for Intercompany Transactions Not Involving Profit (Gain) or Loss (Contd.)
Intercompany
ledger accounts are used by the parent and the subsidiary to account for these intercompany transactions in order to differentiate intercompany loans and loans with outsiders.
Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary)
Assume that Palm Corp. made the following cash loans to its wholly owned subsidiary, Starr Company, on promissory notes:
Term of Note, Interest Rates, Months % Date of Note Amount Feb.1, 2001 6 10 $10,00 0 Apr.1, 2001 6 10 15,000 Sept.1, 2001 Nov.1, 2001 6 6 10 10
21,000 24,000
8
Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.)
PALM CORPORATION STARR COMPANY Intercompany Notes Receivable Intercompany Notes Payable 2001 2001 2001 2001 02/01 10,000 10,000 08/01 08/01 10,000 10,000 02/01 04/01 15,000 15,000 10/01 10/01 15,000 15,000 04/01 09/01 21,000 21,000 09/01 11/01 24,000 24,000 11/01 Bal on Bal on 45,000 45,000 11/01 11/01
Palm Corp. and Starr Company will use the following ledger accounts to record the foregoing transactions (assuming all notes were paid by Starr when due):
Intercompany Interest Receivable
2001 12/31
1,100
Intercompany Interest Payable 2001 1,100 12/31 Intercompany Interest Expense 2001 08/01 500 10/01 750 12/31 1,100 Bal on 2,350 12/31
10
Intercompany Interest Revenue 2001 500 08/01 750 10/01 1,100 12/31 on 2,350 Bal 12/31
In the working paper for consolidated financial statements for Palm and subsidiary for the year ended 12/31/2001, the foregoing ledger accounts appear as shown below:
11
PALM CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001
Palm Starr Eliminations Consolidated Corporation Company Inc. (Dec.)
Income Statement Intercompany rev. (exp.) Balance Sheet Intercompany rec. (pay.)
2,350 46,100*
(2,350) (46,100)
12
*45,000 + $1,100 = $46,100

Discounting of Intercompany Notes
If an intercompany note receivable is discounted at a bank (by the payee, i.e., Palm in example 8.1), the note becomes payable to an outsider the bank. Therefore, discounted intercompany notes are not eliminated in the working paper.
Example 8.2: Discounting of Intercompany Notes
Continued with Example 8.1 and Assumed that on 12/1/2001, Palm had discounted at a 12% discount rate the $24,000 note receivable from Starr. Palm would record the following entry:
Cash 23,940 Interest Expense ($1,260 discount 1,000*) 260 Intercompany Notes Receivable Intercompany Interest Revenue ($24,000 x 0.10 x 1/12) 24,000 200
14
Example 8.2: Discounting of Intercompany Notes (Contd.)

To record discounting of 10%,six-month note receivable from Starr Company dated Nov. 1,2001, at a discount rate of 12%. Cash proceeds are computed as follows: Maturity value of note [$24,000 + ($24,000 x 0.10 x 6/12)] 25,200 Less: Discount ($25,200 x 0.12 x 5/12) 1,260 $23,940 Proceeds
*Interest on note that accrues to discounting bank during discounting period.

Palm should inform Starr of the discounting. Starr would prepare the following journal entry on 12/1/2001: Intercompany Notes Payable 24,000 Intercompany Interest Expense 200 Notes Payable 24,000 Interest Payable 200
To transfer 10%, six-month note payable to Palm Corporation dated Nov. 1, 2001, from intercompany notes to outsider notes.
Under the note discounting assumption, the ledger accounts related to the intercompany notes would appear in the 12/31/2001 working paper for consolidated financial statements as follows:
17

PALM CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001 Income Statement Intercompany rev. (exp.) Balance Sheet Intercompany rec. (pay.)
Palm Corporation Starr Eliminations Consolidated Company Inc. (Dec.)
2,150*
(2,150)*
21,700 (21,700)
*$200 less than in illustration on page 348 because $24,000 discounted note earned interest for one month rather than two months. $21,000 note dated Sept. 1, 2001, plus $700 accrued interest.
Leases of Property under Operating Leases
When both the parent and subsidiary account the lease as an operating lease, the lessee will record the lease payment as intercompany rent expense, while the lessor will record the lease payment received as intercompany rent revenue.
19
Leases of Property under Operating Leases (Contd.)
For an intercompany operating lease, there is no profit or loss involved. The inercompany rent revenue would be offset against intercompany rent expense in the manner similar to the offset of intercompany interest revenue and expense illustrated earlier.
20
Rendering of Services
One affiliate may render services to another and result in intercompany fee revenue and expense (i.e., management fee charged to subsidiaries by a parent company).
21
Rendering of Services (Contd.)
The intercompany fee revenue and expense are offset in the working paper. Both the parent company and the subsidiary should record the fee billing in the same accounting period.
22
Income Texas Applicable to Intercompany Transactions
No income tax effects associated with the elimination of the intercompany revenue or expenses since no profit or loss involved in these intercompany transactions. It does not matter whether the parent company and its subsidiaries file separate income tax returns or a consolidated tax return.
II. Accounting for Intercompany Transactions Involving Profit (Gain) or Loss
For intercompany transactions involving profit or loss, the unrealized profits or losses must be eliminated in the preparation of consolidated financial statements until they are realized.
24
The Importance of Eliminating or Including Intercompany Profits (Gains) and Losses
Failure to eliminate unrealized profits and losses would result in consolidated income statements that report not only results of transactions with outsiders but also the results of related party activities within the affiliated group.
25
The Importance of Eliminating or Including Intercompany Profits (Gains) and Losses (Contd.)
Similarly, no recognition of realized gains (losses) would misstate the consolidated net income. The management can manipulate consolidated net income if unrealized intercompany profits and losses were not eliminated.
26
Intercompany Sales of Merchandise
Types of Sales Downstream intercompany sales Upstream intercompany sales Lateral intercompany sales
27
Intercompany Sales of Merchandise (Contd.)

a. Intercompany Sales at Cost Example 8.3: Intercompany sale at cost Assume that Palm sold merchandise costing $150,000 to Starr during the year ended 12/31/2001 at a selling price equals to Palms cost. The ending inventories of Starr on 12/31/2001 included $25,000 of merchandise obtained form Palm.
Example 8.3 : (Contd.)
By 12/31/2001, Starr still owed Palm $15,000 for merchandise purchased during 12/31/2001. Assuming perpetual inventory system for both companies, the following aggregate entries would be prepared by both companies for the foregoing transactions:
Palm Corporation Journal Entries Intercompany Accounts Receivable 150,000 150,000 Intercompany Sales
To record sales to Starr Company
Intercompany Cost of Goods Sold 150,000 Inventories 150,000

To record cost of goods sold to Satrr Company.
Cash Intercompany Accounts Receivable

To record payments received from Starr Company
135,000 135,000
30
Starr Company Journal Entries Inventories 150,000 Intercompany Accounts 150,000 Payable
To record purchases from Palm Corporation.
Intercompany Accounts Payable Cash

To record payments made to Palm Corporation.
135,000
135,000 160,000
Trade Accounts Receivable Sales

To record sales.
160,000
125,000 125,000
Cost of Goods Sold Inventories

To record cost of goods sold.
31
The following is a partial working paper for consolidated financial statements of Palm and subsidiary (include only the data related to this intercompany sale of merchandise at cost):
32

Palm Corporation
PALM CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001 Income Statement Intercompany rev. (exp.) Balance Sheet Intercompany rec. (pay.)
Starr Eliminations Consolidated Company Inc. (Dec.)
15,000
(15,000)
*Palm Corporations $15,000 intercompany sales and intercompany cost of goods sold are offset in Palms separate income statement in the working paper.
Note: Starr Companys cost of goods sold and inventories are not affected by working paper eliminations. Both Starrs cost of goods sold and inventories are stated at cost.
34

b.Intercompany Sales with Unrealized Intercompany Profit in Ending Inventories Without the working paper elimination, the consolidated ending inventory and cost of goods sold are both overstated.
35
The ending inventory is overstated for the mark up of the unsold ending inventory (the unrealized gain). The cost of goods sold is overstated for the mark up of the cost of goods sold (the realized gain).
36
Example 8.4:Intercompany sales at a mark up
During 2001, Sage company (the 95%owned subsidiary) sold merchandize to Post at a gross profit margin of 20% on sales price. Sales by Sage to Post totaled $120,000 in year 2001, of which $40,000 remained unsold by Post on 12/31/2001.
Example 8.4: (Contd.)
On 12/31/2001, Post still owed $30,000 to Sage for merchandise. Both companies use the perpetual inventory system.
The foregoing transactions are recorded in summary form by the two companies as follows:
Post Company Journal Entries Inventories 120,000 Intercompany Accounts 120,000 Payable
To record purchases from Sage.
Intercompany Accounts Payable Cash

To record payments made to Sage Company.
90,000
90,000 100,000
Trade Accounts Receivable Sales

To record sales.
100,000
80,000 80,000
Cost of Goods Sold Inventories

To record cost of goods sold.
39
Sage Corporation Journal Entries Intercompany Accounts Receivable 120,000 120,000 Intercompany Sales
To record sales to Post Corporation
Intercompany Cost of Goods Sold Inventories

To record cost of goods sold to Post Corporation.
96,000
96,000
Cash
Intercompany Accounts Receivable
To record payments received from Post Corporation.
90,000
90,000
40
The intercompany gross profit in Sages sale to Post in year 2001 is analyzed as follows:
Selling Price
Cost $96,000 $96,000 32,000 64,000 Gross Profit (25% of Cost; 20%Of Selling Price) $24,000 $24,000 8,000 $16,000
41
Beginning inventories Add: Sales Subtotals Less: Ending inventories Cost of goods sold $120,000 $120,000 40,000 $80,000
The following working paper elimination is required for Sages intercompanys sales of merchandise to Post for the year ended 12/31/2001:
(b) Intercompany Sales--Sage Intercompany Cost of Goods SoldSage Cost of Goods SoldPost Inventories--Post
To eliminate intercompany sales, cost of goods sold, and unrealized intercompany profit in inventories. (Income tax effects are disregarded.)
120,000
96,000 16,000 8,000
42
Entering the preceding eliminations in the working paper for consolidated financial statements results in the consolidated amounts shown below (amounts for total sales to outsiders and cost of goods sold are assumed):
43
POST CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001 Post Sage Eliminations Consolidated Income Company Inc.(Dec.) Corp. Statement Revenue: Sales: 5,800,000 1,200,000 7,000,000 Intercompany sales 120,000 (b)(120,000) Costs and expenses: Cost of goods sold 4,100,000 760,000 (b) (16,000) 4,844,000 Intercompany cost of goods sold 96,000 (b) (96,000)
Contd.
Post Corp. Sage Company Eliminations Consolidated Inc.(Dec.)
Balance Sheet Assets Intercompany rec.(pay.) Inventories
(30,000) 900,000
30,000 475,000
(b) (8,000)
1,367,000
45
Notes to the Intercompany Sales of Merchandise at a Mark Up by a Partially Own Subsidiary

1.The $8,000 unrealized intercompany profit is attributable to Sage (the seller, a partially-owned subsidiary). This unrealized intercompany profit should be taken into account in the computation of the minority interest in Sages net income for year 2001 (would be illustrated in Example 8.9).
Notes to the Intercompany Sales of Merchandise at a Mark Up by a Partially Own Subsidiary (Contd.)
2.Also, this $8,000 would be entered into the Sages portion of consolidated retained earnings on 12/31/2001. 3.If the intercompany sales of merchandise are made by a parent company or by a wholly owned subsidiary, the unrealized intercompany profit will not have any effect on any minority interest in net income. This is because the selling agent does not have minority stockholders.
Intercompany (Unrealized) Profit in Beginning and Ending Inventories
It is assumed that, on a FIFO basis, the intercompany profit in the purchasers beginning inventories is realized through sales of the merchandise to outsiders during the following accounting period.
48
Intercompany (Unrealized) Profit in Beginning and Ending Inventories(contd.)
Only the intercompany profit in ending inventories remains unrealized at the end of the period. Continuing with Example 8.4, assume that Sages intercompany sales of merchandise to Post Corporation during the year ended 12/31/2002, are analyzed as follows:

Analysis of Gross Profit
Gross Profit Selling (25% of Cost; Price 20%Of Selling Cost Price) $40,000 $32,000 $8,000 150,000 120,000 30,000 $190,000 $152,000 $38,000 60,000 48,000 $130,000 $104,000
Beginning inventories Add: Sales Subtotals Less: Ending inventories Cost of goods sold
12,000 $26,000
50
Sages intercompany sales ($120,000) and intercompany cost of goods sold ($96,000) for the year ended 12/31/2001 had been closed to Sages retained earnings at the end of 2001. Thus, from a consolidated point of view Sages 12/31/2001 retained earnings was overstated by $7,600 (95% * $8,000).
The remaining $400 unrealized profit on 12/31/2001 is attributable to the minority interest in net assets of Sage. The following working paper elimination would be prepared on 12/31/2002 to reflect the above facts:
52

(b) Retained EarningsSage($8,000 x 0.95)* Minority Interest in Net Assets of Subsidiary($8,000 x 0.05) 7,600 400
Intercompany Sales--Sage 150,000 Intercompany Cost of Goods Sold-Sage 120,000 Cost of Goods SoldPost 26,000 InventoriesPost 12,000
To eliminate intercompany sales, cost of goods sold, and unrealized intercompany profit in inventories. (Income tax effects are disregarded.)
* As indicated in Chapter 7 (Page 29), this elimination is posted to the beginning-of-year retained earnings in the statement of retained earnings section of the working paper for consolidated financial statements. Consolidated FS-Intercompany Transactions 53
Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest
A general principle is that all the unrealized intercompany profit in the ending inventory of the buyer (i.e., a partially owned or wholly owner subsidiary or a parent), should be eliminated for the consolidated financial statement as long as the seller is either the parent or other wholly owned subsidiaries.
Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.)
On the other hand, when the seller is a partially owned subsidiary (either to its parent or to other subsidiaries), there is no general agreement regarding whether the unrealized intercompany profit in the ending inventory of the buyer (a parent or other subsidiaries) should be all eliminated.
The argument is : The intercompany sale to the minority stockholder is considered as a sale to outsiders. Therefore the unrealized intercompany profit in the ending inventory attributes to minority stockholders interest should be treated as realized. It should not to be eliminated in the consolidated financial statements.
The following table illustrates the types of intercompany sales and the related issues of the unrealized intercompany profit in the ending inventory:
57
Current Practice A Parent or Partially- Should all All unrealized wholly own unrealized intercompany own subsidiary intercompany profit in the Subsidiary profit in the ending ending inventory inventory is of the buyer be eliminated eliminated? B PartiallyParent or Should all Same as for a (as in own subsidiary unrealized type A due to Example subsidiary intercompany FASBs 8.4) profit in the preference ending inventory of the buyer be eliminated?
Type
Seller
Buyer
Issue
Note to the above table: a.The unrealized intercompany profit is attributable to the seller (the partiallyown sub.) and must be considered in the computation of the minority interest in net income of the partially own sub. of the year (see Example 8.4 and Example 8.9).
Intercompany Sales of Plant Assets
Intercompany sales of plant assets differ from intercompany sales of merchandise in two ways: 1. Intercompany sales of plant assets between affiliated companies are rare transactions.
60
Intercompany Sales of Plant Assets (Contd.)

2. Due to the long economic lives of plant assets, it requires many accounting periods before the intercompany gains (losses) on sales of these assets are realized in transactions with outsiders.
61
Intercompany Gain on Sale of Land
Example 8.5: Assume that on 12/31/2001, Post (the parent company) sold to Sage (the partially owned subsidiary) a parcel of land costing $125,000 for $175,000. The two companies would record the following entries:
62

Post Corporation Journal Entry Cash 175,000 Land 125,000 Intercompany Gain on Sale of Land 50,000
To record sale of land to Sage Company
Intercompany Gain on Sale of Land (Contd.)
Sage Company Journal Entry Land 175,000 Cash 175,000

To record acquisition of land from Post Corporation.
63
In the consolidated financial statement, the land should be reported at the historical cost and the intercompany gain should be eliminated until it is realized (i.e., sold to an outsider by Sage).
64
The working paper elimination prepared on 12/31/2001 for the intercompany sale of land with gain transaction is as follows:
(c) Intercompany Gain on Sale of LandPost Land--Sage
To eliminate unrealized intercompany gain on Sale of land. (Income Tax effects are disregarded.)
50,000
50,000
The above working paper elimination is entered in the working paper for consolidated financial statements for the year ended 12/31/2001 as follows:
66
POST CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001
Income Statement Intercompany gain on sale of land Balance Sheet Land (for building site)
Post Corp.
Sage Eliminations Consolidated Company Inc. (Dec.)
50,000
(c)(50,000) 175,000 (c)(50,000) 125,000

67
No journal entries affecting land would be made by Sage in the subsequent years due to land is not depreciable. In the consolidated financial statements of subsequent years, the land should always be reported at the historical cost of $125,000 as long as it is not sold to an outsider.
Therefore, the following working paper elimination applies to all subsequent years as long as Sage does not sell the land to an outsider:
(c) Retained EarningsPost LandSage
To eliminate unrealized intercompany gain in land. (Income tax effects are disregarded.)
50,000 50,000
69
Note: The foregoing working paper elimination has no effect on the minority interest in net income or net assets of the subsidiary, because the unrealized gain is attributable to the seller that is not a partially own subsidiary.
70
Assume that, Sage sold the land to an outsider for $200,000 in the year ended 12/31/2003, the following entry would be recorded by Sage:
Cash Land Gain on Sale of Land
To record sale of land to an outsider.
200,000 175,000 25,000
A realized gain of $75,000 ($25,000 + $50,000) should be reported on the consolidated financial statement of 2002. Thus, the following working paper elimination is needed:
(c) Retained EarningsPost Gain on Sale of Land Post
To recognize $50,000 gain on Post Corporations sale of land to Sage Company resulting from sale of land by Sage to an outsiders. (Income tax effects are disregarded.)
50,000 50,000
Intercompany Gain on Sale of Depreciable Plant Asset
Assume that Sage (the partially owned subsidiary) sold machinery to Post (the parent) on 12/31/2001. Details of the sale and depreciation policy of the machinery are as follows:
73
Intercompany Gain on Sale of Depreciable Plant Asset (Contd.)

Selling price of machinery to Post Corp. Cost of machinery to Sage Company when acquired Jan. 2,1999 Estimated residual value: To Sage Company, Jan.2,1999 To Post Corporation, Dec. 31,2001 Economic life: To Sage Company, Jan.2,1999 To Post Corporation, Dec. 31,2001 Annual depreciation expense (straightline method): To Sage Company ($46,000 x 0.10) To Post Corporation($56,000 x 0.20) $ 60,000 50,000 $ 4,000 4,000 10 years 5 years $ 4,600 11,200
74
The two companies would account for the sale on 12/31/2001 as follows:
Post Corp. Journal Entry Sage Company Journal Entry Machinery 60,000 Cash 60,000 Cash 60,000 Accumulated Depreciation ($4,600 x 3) 13,800 Machinery 50,000 To record acquisition of Intercompany machinery from Sage Gain on Sale Company. of Machinery 23,800
To record sale of machinery to Post Corp..
The following working paper elimination is required for the consolidated financial statements on 12/31/2001:
23,800 23,800
(d) Intercompany Gain on Sale of MachinerySage Machinery-Post

To eliminate unrealized intercompany gain on sale of machinery.(Income tax effects are disregarded.)
76
The elimination results the machine to be reported on the consolidated financial statements at its carrying amount to Sage as follows:
Cost of machinery to Post Corporation
Less:Amount of elimination intercompany gain Difference equal to carrying amount
$ 60,000
23,800
$ 36,200
Note: the elimination of the $23,800 gain should be taken into account in the minority interest in the net income of Sage (the seller) for year 2001. The $23,800 is also included in the Sages retained earnings, for consolidation purposes, on 12/31/2001 I (see textbook 376-378).
78
Intercompany Gain subsequent to Date of Sale of Depreciable Plant Asset
(d) Retained EarningsSage

($23,800 x 0.95)
The following working paper elimination is required for the consolidated financial statements of 12/31/2002:
22,610 1,190 4,760 23,800 4,760 Minority Interest in Net Assets of Subsidiary ($23,800 x 0.05) Accumulated DepreciationPost MachineryPost Depreciation Expense-Post
To eliminate unrealized intercompany gain in machinery and in related depreciation.(Income tax effects are disregarded.) Gain element in straightline depreciation computed as $23,800 x 0.2 = $4,760,based on five-year economic life.
79
Intercompany Gain subsequent to Date of Sale of Depreciable Plant Asset (Contd.)
The elimination of the Posts depreciation expense can also be verified as follows:
Posts annual straight-line depreciation expense [($60,000-$4,000) x 0.2] Less:Straight-line depreciation expense for a five-year economic life, based on Sages carrying amount on date of sale
[(36,200-$4,000) x 0.20]
$ 11,200
6,440
$ 4,760
80
Difference equal to intercompany gain element in Posts annual depreciation expense

Intercompany Gain in Depreciation and Minority Interest
From the consolidation view point, the intercompany gain element of the acquiring affiliates annual depreciation expense represents a realization of a portion of the total intercompany gain by the selling affiliate .
81
Intercompany Gain in Depreciation and Minority Interest (Contd.)
Thus the $4,760 credit to Posts depreciation expense in the 12/31/2001 working paper elimination increases Sages net income for consolidated purposes. This increase must be considered in the computation of the minority interest in the subsidiarys net income for the year ended 12/31/2002.
Intercompany Gain in later Years
The following working paper elimination is required for the consolidated financial statements on 12/31/2003:
18,088 952 9,520 23,800 4,760
83
(d) Retained EarningsSage

[($23,800-$4,760) x 0.95]
Minority Interest in Net Assets of Subsidiary [($23,800-$4,760) x 0.05] Accumulated DepreciationPost

($4,760 x 2)
MachineryPost Depreciation Expense-Post

To eliminate unrealized intercompany gain in machinery and in related depreciation.(Income tax effects are disregarded.)
Intercompany Gain in later Years (Contd.)
Note to the working paper elimination: The sum of the debit amounts for retained earnings and minority interest in net assets of subsidiary is $4,760 less that that in 2002. This is because $4,760 intercompany gain has been realized in 2002 through the depreciation process in 2002.
The sum of the debit amounts for retained earnings and minority interest in net assets represents the unrealized portion of the intercompany gain at the beginning of the year. For each succeeding year, the unrealized position of the intercompany gain decreases (in the amount of $4,760), as indicated in the following summary of the working paper elimination debits for those years:

POST CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations-Debits Only December 31,2004 though 2006
Year Ended Dec. 31, 2004 2005 2006
Debits (d)Retained earningsSage Minority interest in net assets of subsidiary Accumulated depreciation-Post
$13,566 $ 9,044 $ 4,522 714 14,280 476 19,040 238 23,800

86
Similar working paper elimination will be prepared for year 2004,2005 and 2006. The changes are only in the debit accounts as indicated in the above table.
87
At the end of year 2006, the entire intercompany gain of $23,800 has been realized through Posts annual depreciation expense. The following working paper elimination is required for the machine until it is sold: Accumulated Depreciation- 23,800 Post Machinery-Psot 23,800
To eliminate intercompany gain in machinery and related accumulated depreciation.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions
88
Intercompany Lease of Property under Capital/Sale-Type Lease
Land, building, machinery, equipment and other property may be transferred between affiliate entities in the form of a sales-type lease to the lessor and a capital lease to the lessee.
89
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
Example 8.6 : Assume that Palm leased equipment to Starr (the wholly owned subsidiary) on 1/2/2001 under a sales-type lease requiring Starr to pay Palm $10,000 at beginning of each year starting 1/2/2001 through 2004, with a bargain purchase option of $1,000 payable on 1/2/2005.

Palms
Intercompany Lease of Property under Capital/SaleType Lease (Contd.)
implicit interest rate, which was known to Starr and was less than Starrs incremental borrowing rate, was 8%. The economic life of the equipment to Starr was 6 years, with no residual value. The cost of the leased equipment was $30,000. There were no initial direct costs under the lease.
The present value of the minimum lease payment is computed as follows:

Present value of $10,000 each year for four years at 8% ($10,000 x 3.577097) $ 35,711 Present value of $1,000 in four years at 8%(1,000 x 0.735030) 735 Palm Corporations net investment in the lease $ 36,506
92
Journal entries of Palm Corporation for Year 2001:
1/2
Intercompany Lease Receivables
Intercompany Cost of Goods Sold Intercompany Sales Unearned Intercompany Interest Revenue ($41,000-$36,506) Inventories
To record Sales-type lease with Starr Company at inception and cost of leased equipment.
[($10,000 x 4)+$1,000]
41,000 30,000
36,506 4,494 30,000
93
Contd.
1/2
Cash
12/31 Unearned Intercompany Interest Revenue [(31,000-$4,494) x 0.08] Intercompany Interest Revenue
To recognize interest earned for first year of intercompany sales-type lease.
To record receipt of first payment on intercompany lease.
Intercompany Lease Receivable
10,000
10,000
2,120
2,120
94
Journal entries of Starr Company for Year 2001:
1/2
Lease Equipment-Capital Lease Intercompany Liability under Capital Lease (net)

To record intercompany capital lease at inception.
36,506 36,506 10,000
1/2
Intercompany Liability under Capital Lease(net) Cash

To record lease payment for first year of intercompany lease.
10,000
95
12/31 Intercompany Interest Expense

[($36,506-$10,000) x 0.08]
Contd.
2,120 2,120 6,084 6,084
Intercompany Interest Payable

To record accrued interest on intercompany lease obligation on 12/31/2001.
12/31
Depreciation Expense ($36,560/6) Lease Equipment-Capital Lease

To record depreciation expense (straight-line method) for first year of intercompany lease. (Six-year economic life of leased equipment is used because lease contains a bargain purchase option.)
96
The selected ledger accounts for both companies relative to the lease are as follows: PALM CORPORATION Intercompany Lease Receivable 01/02/01 41,000a 10,000b 01/02/01 10,000c 01/02/02 10,000d 01/02/03 10,000e 01/02/04 1,000f 01/02/05 Bal on 01/02/05 0 Consolidated FS-Intercompany Transactions 97
a. Inception of lease b. Receipt of first payment c. Receipt of second payment d. Receipt of third payment e. Receipt of fourth payment f. Receipt of purchase option
98
Unearned Intercompany Interest Revenue 4,494 a 01/02/01 12/31/01 2,120 b Bal. 2,374 12/31/02 1,490 c Bal. 884 12/31/03 809 d Bal. 75 12/31/04 75 e Bal. 0 Bal on 12/31/04 0
99
a. Inception of lease ($41,000 - $36,506) b. Interest for year [($31,000 - $4,494) x 0.08)] c. Interest for year [($21,000 - $2,374) x 0.08)] d. Interest for year [($11,000 - $884) x 0.08)] e. Interest for year [($1,000 - $75) x 0.08)]; Adjusted $1 for rounding.
100
Intercompany Interest Revenue 2,120a 12/31/01 12/31/01 2,120b 1,490c 12/31/02 12/31/02 1,490d 809e 12/31/03 12/31/03 809f 75g 12/31/04 12/31/04 75h Bal on 12/31/04 0
a. Interest for Year 2001 b. Closing entry c. Interest for Year 2002 d. Closing entry e. Interest for Year 2003 f. Closing entry g. Interest for Year 2004;Adjusted $ 1 for rounding. h. Closing entry
STARR COMPANY Leased EquipmentCapital Lease 01/02/01 36,506a 6,084b 12/31/01 6,084c 12/31/02 6,084d 12/31/03 6,084e 12/31/04 6,085 f 12/31/05 6,085g 12/31/06 Bal on 01/02/06 0
a. Capital lease at Inception b. Depreciation for Year 2001 c. Depreciation for Year 2002 d. Depreciation for Year 2003 e. Depreciation for Year 2004 f. Depreciation for Year 2001;Adjusted $1 for rounding. g. Depreciation for Year 2001;Adjusted $1 for rounding.
Intercompany Liability under Capital Lease 36,506 a 01/02/01 01/02/01 10,000b Bal. 26,506 01/02/02 7,880c Bal. 18,626 01/02/03 8,510d Bal. 10,116 01/02/04 9,191e Bal. 925 01/02/05 925f Bal. 0 Bal on 01/02/05 0
a. Capital lease at inception b. First lease payment c. ($10,000-$2,120 interest) d. ($10,000-$1,490 interest) e. ($10,000-$890 interest) f. ($10,000-$75 interest)
106
Intercompany Interest Expense 12/31/01 2,120a 2,120b 12/31/01 12/31/02 1,490c 1,490d 12/31/02 12/31/03 809e 809f 12/31/03 12/31/04 75g 75h 12/31/04 Bal on 12/31/04 0
a. ($26,506 x 0.08) b. Closing entry c. ($18,626 x 0.08) d. Closing entry e. ($10,116 x 0.08) f. Closing entry g. ($925 x 0.08); Adjusted $ 1 for rounding. h. Closing entry

12/31/01
12/31/02
Intercompany Lease of Property under Capital/SaleType Lease (Contd.) Depreciation Expense 6,084a 6,084b 12/31/01 6,084c 6,084d 12/31/02 6,084e 6,084 f 12/31/03 6,084g 6,084h 12/31/04 6,085i 6,085 j 12/31/05 6,085k 6,085 l 12/31/06 0 Bal on 12/31/06
12/31/03
12/31/04
12/31/05
12/31/06
109
a. ($36,506/6) b. Closing entry c. ($36,506/6) d. Closing entry e. ($36,506/6) f. Closing entry g. ($36,506/6) h. Closing entry i. ($36,506/6); Adjusted $1 for rounding. j. Closing entry k. ($36,506/6);Adjusted $1 for rounding. l. Closing entry
Partial working paper eliminations (in journal entry format) for the consolidated financial statements for year 2001 and year 2002 are as follows (note: intercompany interest revenue and intercompany interest expense are self-eliminated on the same line of the income statement section of the working paper for consolidated financial statements):
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) PALM CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations December 31, 2001
(b) Intercompany Liability under Capital Lease-Starr Intercompany Interest Payable-Starr Unearned Intercompany Interest Revenue- Palm Intercompany Sales-Palm Intercompany Cost of Goods Sold-Palm Intercompany Lease Receivables-Palm Leased Equipment-Capital Lease-Starr
26,506 2,120 2,374 36,506
30,000 31,000
5,422 1,084
[($36,506-$30,000)/6] To eliminate intercompany accounts assciated with intercompany lease and to defer unrealized portion of intercompany gross profit on sales-type lease.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions
Depreciation Expense-Starr
($36,506-$30,000-$1,084)
112
PALM CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations December 31, 2002 (b) Intercompany Liability under Capital LeaseStarr 18,626 Intercompany Interest Payable-Starr 1,490 Unearned Intercompany Interest RevenuePalm 884 Retained Earnings-Palm [($36,506-$30,000)-$1,084] 5,422 Intercompany Lease Receivables-Palm 21,000 Leased Equipment-Capital Lease-Starr ($5,422-$1,084) 4,388 Depreciation Expense-Starr 1,084
To eliminate intercompany accounts assciated with intercompany lease and to defer unrealized portion of intercompany gross profit on sales-type lease.(Income tax effects are disregarded.)
113
Note: The elimination of 12/31/2001 removes the parent companys intercompany sale and cost of goods sold. The subsidiarys depreciation expense of $1,084 for 2001 represents the realization of a portion of the parents gross profit margin on the intercompany sale.

In
Year 2002 elimination, the original $6,506 unrealized gross profit element in the subsidiarys leased equipment has been reduced by $1,084 (the reduction of the subsidiarys year 2001 depreciation expense).
115
Intercompany Sales of Intangible Assets
The working paper eliminations for intercompany gains on sales of intangible assets are similar to those for intercompany gains in depreciable plant assets, except that no accumulated amortization is involved.
116
Example 8.7:
Intercompany Sales of Intangible Assets(Contd.)
On 1/2/2002 Palm sold a patent to its wholly own subsidiary,Starr, for $40,000. The carrying amount of this patent for Palm is $32,000. The patent had a remaining economic life of 4 years on 1/2/2002 and was amortized by the straight-line method. The working paper elimination for year 2002 and year 2003 related to this intercompany transaction is as follows:
PALM CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations December 31, 2002
(c) Intercompany Gain on Sale of Patent--Palm ($40,000- $32,000) Amortization Expense Starr($8,000/4) Patent-Starr ($8,000-2,000)
To eliminate unrealized intercompany gain in patent and related amortization.(Income tax effects are disregarded.)
8,000 2,000 6,000
118
PALM CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations December 31, 2003 (c) Retained Earnings--Palm
($8,000-$2,000)
6,000
Amortization Expense Starr($8,000/4)

Patent-Starr ($6,000-$2,000)
To eliminate unrealized intercompany gain in patent and related amortization.(Income tax effects are disregarded.)
2,000 4,000
119
Acquisition of Affiliates Bonds in An Open Market
Intercompany gains and losses may be realized by the consolidated entity when one affiliate acquires outstanding bonds of another affiliate in the open market. No realized or unrealized gain or loss would result from the direct acquisition of one affiliates bonds by another affiliate.
Acquisition of Affiliates Bonds in An Open Market (Contd.)
Example 8.8: Assume that on 1/2/2001, Sage (the partially owned subsidiary) issued to the public $500,000 face account of 10% bonds due 1/1/2006. The effective interest rate (market yield rate) is 12%. Interest was payable annually on 1/1.
The net proceeds of the bond issue to Sage were $463,952, computed as follows (bond issue costs are disregarded):
Present value of $500,000 in five years at 12%, with interest paid annually
($500,000 x 0.567427)
$ 283,713 180,239 $ 463,952

122
Add: Present value of $50,000 each year for five years at 12%
($50,000 x 3.604776)
Proceeds of bond issue
The following entries were recorded by Sage for year 2001 regarding the issuance of the bond and the accrued interest:
123
2001 Sage Company Journal Entries 1/2 Cash 463,952 Discount on Bonds Payable 36,048 500,000 Bonds Payable
To record issuance of 10% bonds due Jan. 1, 2006, at a discount to yield 12%.
12/31 Interest Expense
($463,952 x 0.12)
55,674 50,000 5,674
Interest Payable
($500,000 x 0.10)
Discount on Bonds Payable

To record accrual of annual interest on 10% bonds.
124
Assume that on 12/31/2001, Post (the parent company) had cash available for investment. The effective interest rate at the time is 15%. Thus, Sages bonds can be purchased in the open market at a substantial discount. Post acquired 60% of Sages bonds on 12/31/2001 at $257,175 plus $30,000 accrued interest.
The acquisition cost of 60% of Sages bonds is computed as follows:

Present value of $300,000 in four years at 15%, with interest paid annually
($300,000 x 0.571753)
$ 171,526
Add: Present value of $30,000 each year for four years at 15%
($30,000 x 2.854978)
85,649
$ 257,175
126
Cost to Post Corporation of $300,000 face amount of bonds
Post prepared the following journal entry on 12/31/2001 to record the acquisition of Sages bonds:
Investment in Sage Company Bonds 257,175 Intercompany Interest Receivable 30,000 287,175 Cash
To record acquisition of $300,000 face amount of Sage Companys 10% bonds due Jan. 1, 2006, and accrued interest for one year.
The following entry is prepared by Sage (the bond issuer) on 12/31/2001 when notified by the parent company of this acquisition:
Bonds Payable Discount on Intercompany Bonds Payable ($30,374 x 0.6) Interest Payable ($50,000 x 0.6) Intercompany Bonds Payable Discount on Bonds Payable 300,000
18,224 30,000
Intercompany Interest Payable

Transactions
300,000 18,224 30,000

128
To transfer to intercompany accounts all amounts attributable to bonds acquired by parent company in open market. Consolidated FS-Intercompany
From the viewpoint of the consolidated entity, Posts acquisition of Sages bonds is equivalent to the extinguishment of the bonds at a realized gain of $24,601, computed as follows:
Carrying amount of Sage Companys bonds acquired by Post Corporation on Dec.31,2001 ($300,000 18,224) $ 281,776 Less: Cost of Post Corporations investment 257,175 Realized gain on extinguishment of bonds $ 24,601
The $24,601 realized gain is not recorded in the accounting records of either the parent company or the subsidiary.
However, it is recognized in the working paper elimination (in journal entry format) on 12/31/2001, shown as follows:
POST CORPORATION AND SUBSIDIARY Partial Working Paper Elimination December 31,2001 (e) Intercompany Bonds Payable 300,000 Sage Discount on Intercompany Bonds Payable-Sage 18,224 Investment in Sage Company Bonds-Post 257,175 Gain on Extinguishment of Bonds-Sage 24,601
To eliminate subsidiarys bonds acquired by parent and to recognize gain on the extinguishment of the bonds.(Income tax effects are disregarded.)
Notes to the partial working paper elimination:

1. The intercompany interest receivable -- Post ($30,000) and intercompany interest payable-Sage ($30,000) are offset in the working paper elimination.
132

2. The gain is attributes to Sage the bond issuer (the subsidiary). This treatment assumes that parents open market acquisition of the subsidiarys bonds was, in substance, the extinguishment of the bonds by the subsidiary.
133

3. The gain is included in the consolidated income statement of Post and subsidiary for the year ended 12/31/2001.
If the gain is material, it is displayed as an extraordinary item.
134
Minority interest in Gain on Extinguishemtn of Bonds
Since the gain is attributed to the partially owned subsidiary, the gain should be considered in the computation of the minority interest in the subsidiarys net income for the year ended 12/31/2001.
135
Minority interest in Gain on Extinguishemtn of Bonds(Contd.)
This gain is also included in the subsidiarys retained earnings to be included in the consolidated retained earnings on 12/31/2001.
See Example 8.9 for example.
136
Accounting for Gain (from Acquisition of Affiliates Bonds) in Subsequent Years
In the following four years, the realized gain which is unrecorded by either affiliate on the date of acquisition,is reported by the consolidated entity through the differences in the two affiliates interest expense and the interest revenue.
137
Accounting for Gain (from Acquisition of Affiliates Bonds) in Subsequent Years (Contd.)
The accounting for the bond interest by the two affiliates for the year ended 12/31/2002 and related ledger accounts for four remaining years for both companies are as follows:
138
2002 Post Corporation Journal Entries 1/2 Cash 30,000 30,000 Intercompany Interest Receivable
To record receipt of accrued interest on Sage Companys 10% bonds.
12/31 Intercompany Interest Receivable Investment in Sage Company Bonds Intercompany Interest Revenue
30,000 8,576 38,576

139
To accrue annual interest on Sage Companys 10% bonds ($257,175 x 0.15 =$38,576). Consolidated FS-Intercompany Transactions
2002 Sage Company Journal Entries 1/2 Intercompany Interest Payable Interest Payable Cash
30,000 20,000 50,000
To record payment of accrued interest on 10% bonds.
12/31 Intercompany Interest Expense 33,813 Interest Expense 22,542 Intercompany Interest Payable 30,000 Interest Payable 20,000 Discount on Intercompany Bonds Payable 3,813 Discount on Bonds Payable 2,542
To accrue annual interest on 10% bonds. Interest is computed as follows: Intercompany ($300,000-$18,224) x 0.12= $33,813 Other ($200,000- $12,150) x 0.12= $22,542
POST CORPORATION Investment in Sage Company Bonds 12/31/01 257,175 a 12/31/02 8,576 b 12/31/03 9,863 c 12/31/04 11,342 d 12/31/05 13,044 e Bal on 12/31/05 300,000
a.Acquisition of $300,000 face amount of bonds b.Accumulation of discount ($38,576-$ 30,000)
c.Accumulation of discount ($39,863-$30,000)

d.Accumulation of discount ($41,342-$30,000) e.Accumulation of discount ($43,044-$30,000)
142
Intercompany Interest Revenue 38,576a 12/31/02 12/31/02 38,576b 39,863c 12/31/03 12/31/03 39,863d 41,342e 12/31/04 12/31/04 41,342f 43,044g 12/31/05 12/31/05 43,044h Bal on 12/31/05 0
a.($257,175 x 0.15) b.Closing entry
c.($265,751 x 0.15)
d.Closing entry e.($275,614 x 0.15)
f. Closing entry
g.($286,956 x 0.15),Adjusted $ 1 for rounding. h. Closing entry
Sage Company Intercompany Bonds Payable 300,000a 12/31/01 300,000 Bal on 12/31/01 a. Bonds acquired by parent company
145
Discount on Intercompany Bonds Payable 12/31/01 18,224a 3,813b 12/31/02 4,271c 12/31/03 4,783d 12/31/04 5,357e 12/31/05 Bal on 12/31/05 0
146
a.Bonds acquired by parent company
b.Amortization ($33,813-$30,000) c.Amortization ($34,271-$30,000) d.Amortization ($34,783-$30,000) e.Amortization ($35,357-$30,000)
147
Intercompany Interest Expense 12/31/02 33,813a 33,813b 12/31/02 12/31/03 34,271c 34,271d 12/31/03 12/31/04 34,783e 34,783f 12/31/04 12/31/05 35,357g 35,357h 12/31/05 Bal on 12/31/05 0
a.[($300,000-$18,224) x 0.12] b.Closing entry
c.[($300,000-$14,411) x 0.12]
d.Closing entry e.[($300,000-$10,140) x 0.12]
f. Closing entry
g.[($300,000-$5,357) x 0.12] h. Closing entry
A summary of the differences between the intercompany interest revenue Post and intercompany interest expense Sage is as follows:
150
Post Sage DifferenceCorporations Companys Representing Intercompany Intercompany Recording of Interest Interest Realized Gain Revenue Expense $ 38,576 $ 33,813 $ 4,763 39,863 34,271 5,592 41,342 34,783 6,559 43,044 35,357 7,687 $ 162,825 $138,224 $ 24,601
Year Ended Dec. 31, 2002 2003 2004 2005 Totals
151
Notes to the above summary table: 1. Although the acquisition gain is not recognized by either affiliate at acquisition, the gain is recognized by the consolidated entities in the following four years through the differences in the intercompany interest revenue Post and the intercompany interest expense Sage.
2. The total of differences between parents intercompany interest revenue and subsidiary intercompany interest expense is equal to the realized gain on parents acquisition of subsidiarys bonds.
153
Working Paper Elimination on 12/31/2002 (One Year Subsequently to Acquisition of Bonds)
The working paper elimination for the bonds and interest on 12/31/2002 is as follows:
(e)Intercompany Interest Revenue-Post 38,576 Intercompany Bonds Payable-Sage 300,000 Discount on Intercompany Bonds PayableSage 14,411 Investment in Sage Company Bonds- Post 265,751 Intercompany Interest Expense-Sage 33,813 Retained Earnings-Sage($24,601 x 0.95) 23,371 Minority Interest in Net Assets of Subsidiary ($24,601 x 0.05) 1,230
To eliminate subsidiarys bonds owned by parent company, and related interest revenue and expense; and to increase subsidiarys beginning retained earnings by amount of unamortized realized gain on the extinguishments of the bonds.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions
154
Working Paper Elimination on 12/31/2002 (One Year Subsequently to Acquisition of Bonds) (Contd.)
Note to the above working paper elimination: The foregoing working paper elimination reduces the consolidated income (before minority interest) by $4,796 (the difference between the intercompany interest revenue and intercompany interest expense for year 2002).
155
Working Paper Elimination on 12/31/2002 (One Year Subsequently to Acquisition of Bonds) (Contd.)
Note (contd.):
This is because the entire gain of $24,601 had been recognized in the consolidated income statement of year 2001. This is evident by the credit of retained earnings and the minority interest in net assets of subsidiary of $23,371 and $1,230, respectively. If the gain of $4,796 is not eliminated, the consolidated income of year 2002 will be overstated by $4,796.
Working paper elimination on 12/31/2002
Similar working paper elimination for years 2004 and 2005 would be prepared. Assume that Sage paid the bonds in full on maturity 1/2/2006. Therefore, no further working paper eliminations for the bonds would be required.
157
Working paper elimination on 12/31/2002 (Contd.)
The working paper elimination on 12/31/2003 is as follows:
(e)Intercompany Interest Revenue-Post 39,863 Intercompany Bonds Payable-Sage 300,000 Discount on Intercompany Bonds PayableSage 10,140 Investment in Sage Company Bonds- Post 275,614 Intercompany Interest Expense-Sage 34,271 Retained Earnings-Sage[($24,601-$4,763) x 0.95] 18,846 Minority Interest in Net Assets of Subsidiary [($24,601-$4,763) x 0.05] 992
To eliminate subsidiarys bonds owned by parent company, and related interest revenue and expense; and to increase subsidiarys beginning retained earnings by amount of unamortized realized gain on the extinguishments of the bonds.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions
158
Effect of Intercompany Profits on Minority Interest in Net Income
The following working paper eliminations for Post and its 95%-owned subsidiary (Sage) are taken from p138and p139 of chapter 7, and from pages 42,65,76, and 131of this chapter. These eliminations are followed by a revised elimination (which differs from the one on p150 of chapter 7) for minority interest in net income of subsidiary.
Intercompany Profits on Minority Interest in Net Income (contd.)

POST CORPORATION AND SUBSIDIARY Working Paper Eliminations December 31, 2001 (a)Common Stock Sage 400,000 Additional Paid-in Capital-Sage 235,000 Retained Earnings-Sage($384,000-$4,750) 379,250 Retained Earnings of Subsidiary-Post 4,750 Intercompany Investment Income-Post 81,700 Plant Assets(net)-Sage($176,000-$14,000) 162,000 Leasehold(net)-Sage ($25,000-$5,000) 20,000 Goodwill (net)-Post($37,050-$950) 36,100 Cost of Goods Sold-Sage 17,000 Operating Expenses-Sage 2,000
Contd.
Investment in Sage Company Common Stock-Post Dividends Declared-Sage Minority Interest in Net Assets of Subsidiary ($61,000 - $2,500)
1,229,300 50,000 58,500
161
The above working paper elimination (a) is to carry out the following: (1) Eliminate intercompany investment and equity accounts of subsidiary at the beginning of year,and subsidiary dividends. (2) Provide for Year 2001 depreciation and amortization on differences between current fair values and carrying amounts of Sage's identifiable net assets as follows:

Cost of Operating Goods Sold Expenses $ 2,000 $ 2,000
10,000 5,000 $ 17,000 $ 2,000 $ 2,000
Building depreciation Machinery depreciation Leasehold amortization Totals
163

(3) Allocate unamortized differences between combination date current fair values and carrying amounts to appropriate assets. (4) Establish minority interest in net assets of subsidiary at beginning of year ($61,000), less minority interest in dividends declared by subsidiary during year ($50,000 x 0.05=$2,500). (Income tax effects are disregarded.)

(b)Intercompany Sales-Sage 120,000 Intercompany Cost of Goods Sold-Sage 96,000 Cost of Goods SoldPost 16,000 Inventories-Post 8,000
To eliminate intercompany sales, cost of goods sold, and unrealized profit in inventories.(Income tax effects are disregarded.)

(c)Intercompany Gain on Sale of Land- Post Land-Sage
To eliminate unrealized intercompany gain on sale of land.(Income tax effects are disregarded.)
50,000 50,000
(d)Intercompany Gain on Sale of Machinery- Sage Machinery-Post

To eliminate unrealized intercompany gain on sale of machinery.(Income tax effects are disregarded.)
23,800
23,800
166

(e)Intercompany Bonds Payable -Sage Discount on Intercompany Bonds Payable-Sage Investment in Sage Company BondsPost Gain on Extinguishment of Bonds-Sage
300,000
18,224 257,175 24,601
To eliminate subsidiarys bonds acquired by parent, and to recognize gain on the extinguishments of the bonds.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions
167

(f)Minority Interest in Net Income of subsidiary Minority Interest in Net Assets of Subsidiary
To establish minority interest in subsidiarys adjusted net incomes for Year 2001 as follows: Net income of subsidiary Adjustments for working paper eliminations: (a) ($17,000+$2,000) (b) (d) (e) Adjusted net income of subsidiary Minority interest share ($78,801 x 0.05)
3,940
3,940
$ 105,000 (19,000) (8,000) (23,800) 24,601 $ 78,801 $ 3,940
168
Working Paper for Consolidated Financial Statements (for Year 2001)
The following is a partial working paper for Post Corporation and subsidiary for the year ended 12/31/2001. The amounts for Post and Sage are the same as those on p145,146 of Chapter 7.
Working Paper for Consolidated Financial Statements (contd.)

Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001
Statement of Retained Earnings Retained earnings, beginning of year Net income Subtotals Dividends declared Retained earnings, end of year
Post Corp. Sage Company Elimination Inc. (Dec.) Consolidated
1,348,500 352,600 1,701,000 158,550

1,542,550
384,000 (a)(379,250) 105,000 (161,839)* 489,000 (541,089) 50,000 (a)(50,000)

439,000 (491,089)
1,353,250 295,761 1,649,011 158,550

1,490,461
170
Working Paper for Consolidated Financial Statements (contd.)
Contd.
Post Corp. Sage Company Elimination Consolidated Inc. (Dec.) (a) 58,500 62,440 (f) 3,940 xxx,xxx 62,440 x,xxx,xxx 1,057,000 400,000 (a) (400,000) 235,000 (a) (235,000) 1,560,250 439,000 (491,089) 1,490,461 (a) (4,750) 1,074,000 (1,130,839) x,xxx,xxx (1,068,399) x,xxx,xxx
$250,899 89,060 $161,839
171
Balance Sheet / Liabilities & Stockholders Equity Minority interest in net assets of subsidiary Total liabilities Common stock, $ 1 par Common stock, $ 10 par Additional paid-in capital Retained earnings Retained earnings of subsidiary Total stockholders equity Total liabilities & stockholders equity
x,xxx,xxx 1,057,000 1,560,250 1,542,550 4,750 4,164,550 x,xxx,xxx
Net decrease in revenue ( and gains): $81,700 + $120,000 + $50,000 + $23,800 - $24,601 Less: Net decrease in costs and expenses: $96,000 + $16,000 -$19,000 - $3,940 Decrease in combined net incomes to compute consolidated net income # A decrease in dividends and an increase in retained earnings
Working Paper for Consolidated Financial Statements(contd.)
The foregoing working paper indicates that when intercompany profits exist, consolidated net income is not the same as the parent company's net income The consolidated retained earnings are not the same as the total of the parent company's two retained earnings amounts.
Working Paper for Consolidated Financial Statements( for Year 2002)
Continued with the example of Post and its subsidiary (Sage), the followings are selected Post's t-accounts(investment in Sage, retained earnings) and Sage's t-account of retained earnings. Review of these accounts will help in understanding the working paper for consolidated financial statements of Year 2002.
Working Paper for Consolidated Financial Statements( for Year 2002)(cont.)

POST CORPORATION Investment in Sage Company Common Stock 12/31/99 1,192,250a 38,000b 11/24/00 12/31/00 85,500c 42,750d 12/31/00 950e 12/31/00 47,500f 11/22/01 12/31/01 99,750g 18,050h 12/31/01 950i 12/31/01 57,000j 11/25/02 12/31/02 109,250k 18.050l 12/31/02 950m 12/31/02 Bal on 2/31/02 1,262,550
Working Paper for Consolidated Financial Statements( for Year 2002) (cont.)
a.Total cost of business combination b.Dividend declared by Sage c.Net income of Sage d.Amortization of differences e.Amortization of goodwill f. Dividend declared by Sage g.Net income of Sage h.Amortization of differences i.Amortization of goodwill j. Dividend declared by Sage k.Net income of Sage l.Amortization of differences m. Amortization of goodwill
Retained Earnings 1,050,000a 457,050b 158,550 c 318,400d 158,550 e 1,508,350 12/31/99 12/31/00
12/31/00 12/31/01
12/31/01
Bal on 12/31/01
176
a.Balance
b.Close net income available for dividends c.Close Dividends Declared account d. Close net income available for dividends e.Close Dividends Declared account
177
Retained Earnings of Subsidiary 4,750a 12/31/00 34,200b 12/31/01 38,950 Bal on 12/31/01
a.Close net income not available for dividends b.Close net income not available for dividends
SAGE COMPANY Retained Earnings 334,000a 90,000b 40,000 c 105,000d 50,000 e 439,000
12/31/99 12/31/00 12/31/01

Bal on 12/31/01
12/31/00
12/31/01
179
a.Balance
b.Close net income c.Close Dividends Declared account d. Close net income e.Close Dividends Declared account
180
The following is the working paper for consolidated financial statements for year 2002 of Post and its 95%-partially owned subsidiary:
181
POST CORPORATION AND SUBSIDIARY Working paper for Consolidated Financial Statements For Year Ended December 31, 2002 Revenue: Net Sales Intercompany sales Intercompany interest revenue Intercompany investment income Intercompany revenue(expenses) Total revenue
Income Statement
Post Sage Corporation Company Eliminations Consolidated Inc.(Dec.)
5,900,000 1,400,000 150,000 (b)(150,000)
7,300,000
38,576
91,200 14,000 (14,000) 6,043,776 1,536,000
(e) (38,576)
(a) (91,200)
(279,776)
7,300,000
182
Income Statement (contd.) Costs and expenses:

Cost of goods sold Intercompany cost of goods sold Operating expenses Intercompany interest expense Interest expense Income taxes expense Minority interest in net income of subsidiary Total costs and expenses Net income
Contd.
Post Sage Eliminations Consolidated Corporation Company Inc.(Dec.) (a) 17,000 (b) (26,000) 4,300,000 950,000 (d) (4,760) 5,236,240
986,058 120,000 217,978 33,813 22,542 76,667 (b)(120,000) (a) 2,000 (e) (33,813) 1,206,036
51,518 246,000
74,060 322,667
4,600 6,843,603 456,397
183
(f) 5,583,576 460,200 1,421,000 115,000
4,600
*(160,973) (118,803)
Contd. Statement of Post Sage Eliminations Consolidated Retained Earnings Corporation Company Inc.(Dec.) (a) (400,050) Retained earnings, (b) (7,600) beginning of year 1,508,350 439,000 (c) (50,000) 1,490,461 (d) (22,610) (e) 23,371 460,200 115,000 (118,803) 456,397 Net income 1,968,550 554,000 (575,692) 1,946,858 Subtotal Dividends 158,550 60,000 (a) (60,000)* 158,550 declared Retained earnings, 1,810,000 494,000 (515,692) 1,788,308 end of year
* A decrease in dividends and an increase in retained earnings.
Balance Sheet/Assets Intercomapny receivables (payables) Inventories Other current assets Investment in Sage Company stock Investment in Sage Company bonds Plant assets (net) Land(for building site) Leasehold (net) Goodwill (net) Total assets
Contd.
Post Sage Corporation Company (3,500) 950,000 760,000 1,262,550 265,751 3,700,000
Eliminations Consolidated Inc.(Dec.) (12,000) 1,438,000 1,188,992
3,500 500,000 (b) 428,992
85,000 7,019,801
(a)(1,262,550) (e) (265,751) (a) 148,000 1,300,000 (d) (19,040) 175,000 (c) (50,000) (a) 15,000 (a) 35,150 2,407,492 (1,411,191)
5,128,960 125,000 15,000 120,150 8,016,102

185
Balance Sheet/Assets Intercomapny receivables (payables) Inventories Other current assets Investment in Sage Company stock Investment in Sage Company bonds Plant assets (net) Land(for building site) Leasehold (net) Goodwill (net) Total assets
Contd.
Post Sage Corporation Company (3,500) 950,000 760,000 1,262,550 265,751 3,700,000
Eliminations Consolidated Inc.(Dec.) (12,000) 1,438,000 1,188,992
3,500 500,000 (b) 428,992
85,000 7,019,801
(a)(1,262,550) (e) (265,751) (a) 148,000 1,300,000 (d) (19,040) 175,000 (c) (50,000) (a) 15,000 (a) 35,150 2,407,492 (1,411,191)
5,128,960 125,000 15,000 120,150 8,016,102

186
Working Paper Elimination (for year 2002)

POST CORPORATION AND SUBSIDIARY Working Paper Eliminations December 31, 2002 (a)Common Stock-Sage 400,000 Additional Paid-in Capital-Sage 235,000 Retained Earnings-Sage($439,000-$38,950) 400,050 Retained Earnings of Subsidiary-Post 38,950 Intercompany Investment Income-Post 91,200 Plant Assets(net)-Sage($162,000-$14,000) 148,000 Leasehold(net)-Sage ($20,000-$5,000) 15,000 Goodwill (net)-Post($36,100-$950) 35,150 Cost of Goods Sold-Sage 17,000 Operating Expenses-Sage 2,000
Working Paper Elimination (for year 2002) (contd.)
Contd.
Investment in Sage Company Common Stock-Post Dividends Declared-Sage Minority Interest in Net Assets of Subsidiary
1,262,550 60,000 59,800
188
The above elimination is to carry out the following: (1) Eliminate intercompany investment and equity accounts of subsidiary at beginning of year,and subsidiary dividends. (2) Provide for Year 2002 depreciation and amortization on differences between current fair values and carrying amounts of Sage's identifiable net assets as follows:

Cost of Operating Goods Sold Expenses $ 2,000 $ 2,000
10,000 5,000 $ 17,000 $ 2,000 $ 2,000
Building depreciation Machinery depreciation Leasehold amortization Totals
190

(3) Allocate unamortized differences between combination date current fair values and carrying amounts to appropriate assets. (4) Establish minority interest in net assets of subsidiary at beginning of year,excluding intercompany profits effects ($62,800), less minority interest in dividends declared by subsidiary during year ($60,000 x 0.05 = $3,000). (Income tax effects are disregarded.)

(b) Retained earnings-Sage 76,000 Minority Interest in Net Assets of Subsidiary 400 Intercompany Sales-Sage 150,000 Intercompany Cost of Goods Sold-Sage 120,000 Cost of Goods SoldPost 26,000 Inventories-Post 12,000
To eliminate intercompany sales, cost of goods sold, and unrealized profit in inventories.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions
192

(c)Retained Earnings- Post Land-Sage
To eliminate unrealized intercompany gain in land.(Income tax effects are disregarded.)
50,000
50,000
(d)Retained Earnings-Sage Minority Interest in Net Assets of Subsidiary Accumulated Depreciation-Post Machinery- Post Depreciation ExpensePost
22,610 1,190 4,760
23,800
4,760
193
To eliminate unrealized intercompany gain in machinery and in related depreciation (Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

(e)Intercompany Interest Revenue- Post Intercompany Bonds Payable- Sage Discount on Intercompany Bonds Payable-Sage Investment in Sage Company Bonds-Post Intercompany Interest Expense-Sage Retained Earnings- Sage Minority Interest in Net Assets of Subsidiary 38,576 300,000
14,411
265,715
33,813 23,371
1,230
To eliminate subsidiarys bonds owned by parent company, and related interest revenue and expense; and to increase subsidiarys beginning retained earnings by amount of unamortized realized gain on the extinguishments of the bonds.(Income tax effects are disregarded.)
194

(f)Minority Interest in Net Income of Subsidiary Minority Interest in Net Assets of Subsidiary
4,600
4,600
$ 115,000
To establish minority interest in subsidiarys adjusted net income for Year 2002 as follows: Net income of subsidiary Adjustments for working paper eliminations: (a) ($17,000+$2,000) (b) ($150,000-$120,000-$26,000) (d) Depreciation expense reduced (e) ($38,576-$33,813) Adjusted net income of subsidiary Minority interest share ($91,997 x 0.05)
(19,000) (4,000) 4,760 (4,763) $ 91,997 $ 4,600

195

Chapter 8 Consolidated Finanical Statemetns

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Chapter 8 Consolidated Finanical Statemetns

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Chapter 8

Consolidated Financial statements: Intercompany Transactions

Objectives of the Chapter

Objectives of the Chapter (Contd.)

Consolidated FS-Intercompany Transactions

Consolidated FS-Intercompany Transactions

Consolidated FS-Intercompany Transactions

I. Accounting for Intercompany Transactions Not Involving Profit (Gain) or Loss

Consolidated FS-Intercompany Transactions

Consolidated FS-Intercompany Transactions

Consolidated FS-Intercompany Transactions

Consolidated FS-Intercompany Transactions

*45,000 + $1,100 = $46,100

Discounting of Intercompany Notes

Example 8.2: Discounting of Intercompany Notes

Consolidated FS-Intercompany Transactions

Example 8.2: Discounting of Intercompany Notes (Contd.)

Example 8.2: Discounting of Intercompany Notes (Contd.)

Example 8.2: Discounting of Intercompany Notes (Contd.)

Consolidated FS-Intercompany Transactions

Example 8.2: Discounting of Intercompany Notes (Contd.)

Leases of Property under Operating Leases

Consolidated FS-Intercompany Transactions

Leases of Property under Operating Leases (Contd.)

Consolidated FS-Intercompany Transactions

Consolidated FS-Intercompany Transactions

Rendering of Services (Contd.)

Consolidated FS-Intercompany Transactions

Income Texas Applicable to Intercompany Transactions

II. Accounting for Intercompany Transactions Involving Profit (Gain) or Loss

Consolidated FS-Intercompany Transactions

The Importance of Eliminating or Including Intercompany Profits (Gains) and Losses

Consolidated FS-Intercompany Transactions

Consolidated FS-Intercompany Transactions

Intercompany Sales of Merchandise

Consolidated FS-Intercompany Transactions

Intercompany Sales of Merchandise (Contd.)

Example 8.3 : (Contd.)

Intercompany Sales of Merchandise (Contd.)

Example 8.3 : (Contd.)

Intercompany Sales of Merchandise (Contd.)

Intercompany Cost of Goods Sold 150,000 Inventories 150,000

Cash Intercompany Accounts Receivable

Consolidated FS-Intercompany Transactions

Example 8.3 : (Contd.)

Intercompany Sales of Merchandise (Contd.)

Intercompany Accounts Payable Cash

Trade Accounts Receivable Sales

Cost of Goods Sold Inventories

Consolidated FS-Intercompany Transactions

Example 8.3 : (Contd.)

Intercompany Sales of Merchandise (Contd.)

Consolidated FS-Intercompany Transactions

Example 8.3 : (Contd.)

Intercompany Sales of Merchandise (Contd.)

Starr Eliminations Consolidated Company Inc. (Dec.)

Example 8.3 : (Contd.)

Intercompany Sales of Merchandise (Contd.)

Consolidated FS-Intercompany Transactions

Intercompany Sales of Merchandise (Contd.)

Consolidated FS-Intercompany Transactions

Intercompany Sales of Merchandise (Contd.)

Consolidated FS-Intercompany Transactions

Example 8.4:Intercompany sales at a mark up