advacc jeter ch06

Chapter 6

Elimination of Unrealized Profit on Intercompany Sales of Inventory

Multiple Choice

1. Sales from one subsidiary to another are called

a. downstream sales.

b. upstream sales.

c. intersubsidiary sales.

d. horizontal sales.

2. Noncontrolling interest in consolidated income is never affected by

a. upstream sales.

b. downstream sales.

c. horizontal sales.

d. Noncontrolling interest is affected by all sales.

3. Failure to eliminate intercompany sales would result in an overstatement of consolidated

a. net income.

b. gross profit.

c. cost of sales.

d. all of these.

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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Edition

6-2

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. In determining controlling interest in consolidated income in the consolidated financial statements,

unrealized intercompany profit on inventory acquired by a parent from its subsidiary should:

a. not be eliminated.

b. be eliminated in full.

c. be eliminated to the extent of the parent companys controlling interest in the subsidiary. d. be eliminated to the extent of the noncontrolling interest in the subsidiary.

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. The material sale of inventory items by a parent company to an affiliated company:

a. enters the consolidated revenue computation only if the transfer was the result of arms length bargaining.

b. affects consolidated net income under a periodic inventory system but not under a perpetual inventory system.

c. does not result in consolidated income until the merchandise is sold to outside parties. d. does not require a working paper adjustment if the merchandise was transferred at cost.



Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

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.

Use the following information for Questions 15 & 16:

P Company regularly sells merchandise to its 80%-owned subsidiary, S Corporation. In 2010, P sold

merchandise that cost $240,000 to S for $300,000. Half of this merchandise remained in Ss December 31, 2010 inventory. During 2011, P sold merchandise that cost $375,000 to S for $468,000. Forty percent of

this merchandise inventory remained in Ss December 31, 2011 inventory. Selected income statement information for the two affiliates for the year 2011 is as follows:

P _ S _

Sales Revenue $2,250,000 $1,125,000

Cost of Goods Sold 1,800,000 937,500

Gross profit $450,000 $187,500

15. Consolidated sales revenue for P and Subsidiary for 2011 are:

a. $2,907,000. b. $3,000,000. c. $3,205,500. d. $3,375,000.

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.




Edition

6-4


P Company owns an 80% interest in S Company. During 2011, S sells merchandise to P for $200,000 at a

profit of $40,000. On December 31, 2011, 50% of this merchandise is included in Ps inventory. Income statements for P and S are summarized below:

P __ S __

Sales $1,200,000 $600,000

Cost of Sales (600,000) (400,000)

Operating Expenses (300,000) ( 80,000)

Net Income (2011) $300,000 $120,000

17. Controlling interest in consolidated net income for 2011 is:

a. $300,000. b. $380,000. c. $396,000. d. $420,000.

18. Noncontrolling interest in income for 2011 is:

a. $4,000. b. $19,200. c. $20,000. d. $24,000.

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.




6-5


P Company regularly sells merchandise to its 80%-owned subsidiary, S Corporation. In 2010, P sold

merchandise that cost $192,000 to S for $240,000. Half of this merchandise remained in Ss December 31, 2010 inventory. During 2011, P sold merchandise that cost $300,000 to S for $375,000. Forty percent of

this merchandise inventory remained in Ss December 31, 2011 inventory. Selected income statement information for the two affiliates for the year 2011 is as follows:

P _ S _

Sales Revenue $1,800,000 $900,000


Gross profit $ 360,000 $150,000

22. Consolidated sales revenue for P and Subsidiary for 2011 are:

a. $2,325,000.

b. $2,400,000.

c. $2,565,000.

d. $2,700,000.

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.


P Company owns an 80% interest in S Company. During 2011, S sells merchandise to P for $150,000 at a

profit of $30,000. On December 31, 2011, 50% of this merchandise is included in Ps inventory. Income statements for P and S are summarized below:

P __ S __

Sales $900,000 $450,000

Cost of Sales (450,000) (300,000)

Operating Expenses (225,000) ( 60,000)

Net Income (2011) $225,000 $ 90,000

24. Controlling interest in consolidated net income for 2011 is:

a. $225,000.

b. $285,000.

c. $297,000.

d. $315,000.

25. Noncontrolling interest in income for 2011 is:

a. $3,000.

b. $14,400.

c. $15,000.

d. $18,000.




Edition

6-6

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 $ 80,000

Plant and equipment (net) 240,000

Goodwill 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.




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 $225,000 $189,000 $414,000

Smiley $180,000 216,000 396,000

Toro 180,000 135,000 315,000

Merchandise Remaining in Ending Inventory

Powers Smiley Toro Total

Sold by

Powers $207,000 $138,000 $345,000

Smiley $144,000 198,000 342,000

Toro 195,000 150,000 345,000

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.




Edition

6-8

6-5 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.




6-9

P Corporation and Subsidiary

Consolidated Statements Workpaper

at December 31, 2011

P S Eliminations Noncontrolling Consolidated

Corp. Corp. Dr. Cr. Interest Balances

Income Statement

Sales 200,000 150,000

Dividend Income 16,000

Cost of Sales (92,000) (47,000)

Other Expenses (23,000) (40,000)

Noncontrolling Interest in Income

Net Income 101,000 63,000

Retained Earnings Statement

Retained Earnings 1/1 110,000 30,000

Add: Net Income 101,000 63,000

Less: Dividends ( 30,000) (20,000)

Retained Earnings 12/31 181,000 73,000

Balance Sheet

Cash 20,000 19,000

Accounts Receivable-net 120,000 55,000

Inventories 140,000 80,000 Patent Land 270,000 420,000 Equipment and Buildings-net 600,000 430,000

Investment in S Corporation 240,000

Total Assets 695,000 1,004,000

Equities

Accounts Payable 909,000 831,000

Common Stock 300,000 100,000

Retained Earnings 181,000 73,000

1/1 Noncontrolling Interest in Net

Assets

12/31 Noncontrolling Interest in

Net Assets

Total Equities 1,390,000 1,004,000




Edition

6-10

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 $400,000

Land 200,000

Inventory 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:

Year 2011 Net Income of $400,000; Dividends Declared of $100,000

Required:

Prepare a consolidated statements workpaper for the year ended December 31, 2012 using the

partially completed worksheet.




6-11

PORTER COMPANY AND SUBSIDIARY


For the Year Ended December 31, 2012

Porter Shilo Eliminations Noncontrolling Consolidated

Company Company Dr. Cr. Interest Balances

Income Statement

Sales 4,400,000 1,800,000

Dividend Income 192,000

Total Revenue 4,592,000 1,800,000


Depreciation Expense 160,000 120,000

Other Expenses 240,000 200,000

Total Cost & Expenses 4,000,000 1,120,000

Net/Consolidated Income 592,000 680,000

Noncontrolling Interest in Income

Net Income to Retained Earnings 592,000 680,000


1/1 Retained Earnings

Porter Company 2,000,000

Shilo Company 920,000

Net Income from above 592,000 680,000

Dividends Declared

Porter Company (360,000)

Shilo Company (240,000)

12/31 Retained Earnings to

Balance Sheet 2,232,000 1,360,000



Balance Sheet

Cash 280,000 260,000

Accounts Receivable 1,040,000 760,000

Inventory 960,000 700,000

Investment in Shilo Company 3,400,000

Difference between Implied and Book Value

Land 1,280,000

Plant and Equipment 1,440,000 1,120,000

Total Assets 7,120,000 4,120,000

Accounts Payable 528,000 440,000

Notes Payable 360,000 120,000

Common Stock:


Shilo Company 2,200,000

Retained Earnings from above 2,232,000 1,360,000

1/1 Noncontrolling Interest in Net Assets

12/31 Noncontrolling Interest in Net Assets

Total Liabilities & Equity 7,120,000 4,120,000




Edition

6-12

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 $13,800,000

Cost of Sales $9,000,000

Operating Expenses 1,800,000 10,800,000

Consolidated Income 3,000,000

Less Noncontrolling Interest in Consolidated Income 190,000

Controlling Interest in Consolidated Net Income $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:

Selling Unsold at

Cost Price Year-End

2010 SalesSlater to Pool $1,500,000 $1,800,000 1/4 2011 SalesPool to Slater 900,000 1,350,000 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. Determination of the noncontrolling interest in consolidated net income differs depending on

whether intercompany sales are downstream or upstream. Explain the difference in calculating

noncontrolling interest for downstream and upstream sales.

Short Answer Questions from the Textbook

1. 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?




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?




Edition

6-14

ANSWER KEY

Multiple Choice

1. d 5. a 9. c 13. a 17. b 21. c 25. c

2. b 6. c 10. b 14. c 18. c 22. a

3. c 7. d 11. c 15. a 19. d 23. c

4. c 8. d 12. c 16. c 20. a 24. b

Problems

6-1 A. Depreciation Expense (240,000/10) 24,000

Plant and Equipment (net) (240,000 24,000) 216,000 1/1 Inventory 80,000

Goodwill 591,111

Difference Between Implied and Book Value 911,111

B. Palmers net income from independent operations $1,600,000 Less: unrealized profit on sales to Sauder

[180,000 (180,000/1.20)] (30,000) Palmers income from independent operations that has been realized in transactions with third parties 1,570,000

Palmers share of Sauders income (600,000 .90) 540,000 Less: amortization of difference between implied

and book value (104,000)*

Controlling Interest in Consolidated Net Income for 2011 $2,006,000

* 80,000 + (240,000/10)

6-2 A. 2011

Sales 1,080,000

Purchases (Cost of Goods Sold) 1,080,000

12/31 Inventory (Income Statement)

[216,000 (216,000/1.20)] 36,000 12/31 Inventory(Balance Sheet) 36,000

2012

Sales 1,200,000

Purchases (Cost of Goods Sold) 1,200,000

12/31 Inventory (Income Statement)

[300,000 (300,000/1.20)] 50,000 12/31 Inventory (Balance Sheet) 50,000

Beginning R/E Percy 36,000 1/1 Inventory (Income Statement) 36,000




6-15

B. Percys Income from independent operations $760,000 Less: Unrealized profit in ending inventory (50,000)

Add: Unrealized profit in beginning inventory 36,000

Percys Income Realized in Transactions with third parties 746,000

Percys Share of Subsidiary Income $368,000 Controlling Interest in Consolidated Net Income $1,114,000

6-3 A. Sales 1,020,000

Purchases (Cost of Sales) 1,020,000

To eliminate intercompany sales.

12/31 Inventory (Income Statement) 51,000

Inventory (Balance Sheet) 51,000

To eliminate unrealized intercompany profit in ending inventory.

Beginning Retained Earnings Payton (.90 $40,000) 36,000

Noncontrolling interest 4,000

1/1 Inventory (Balance Sheet) 40,000

To recognize unrealized profit in beginning inventory realized during the year.

B. Noncontrolling Interest Calculation:

Sanders Company reported net income $600,000

Less: Unrealized profit in ending inventory (51,000)

Add: Realized profit in beginning inventory 40,000

Subsidiary income included in consolidated income

Noncontrolling interest ownership percentage 589,000

.1

Noncontrolling interest in consolidated income $ 58,900

C. Controlling Interest in Consolidated Net Income:

Payton Companys net income from independent operations $1,720,000

Reported net income of Sanders Company $600,000

Less: Unrealized profit on sales of 2011 (51,000)

Add: Profit on intercompany sales to Payton

realized in transactions with third parties 40,000

Subsidiary income realized in

transactions with third parties $589,000

Payton Companys share of subsidiary income (589,000 .9) 530,100

Controlling interest in consolidated net income $2,250,100




Edition

6-16

6-4 Smiley Toro

A. Reported subsidiary income $1,500,000 $2,400,000

Add: Unrealized profit in beginning inventory 66,000 63,000

Less: Unrealized profit in ending inventory (57,000) (69,000)

Subsidiary income included in consolidated income 1,509,000 2,394,000

Noncontrolling interest ownership percentage .2 .1

Noncontrolling interest in consolidated income $301,800 $239,400

Total noncontrolling interest:$301,800 + $239,400 = $541,200

B. Powers Companys income independent operations $3,600,000 Add: Unrealized profit considered realized in 2011

($414,000 $414,000/1.15) 54,000 Less: Unrealized profit in 2011 income

($345,000 $345,000/1.15) (45,000) Powers income realized in transactions with third parties $3,609,000

Smiley Companys Reported Net Income $1,500,000 Add: Unrealized profit considered realized

in 2011 ($396,000 $396,000/1.2) 66,000 Less: Unrealized profit in 2011 income

($342,000 $342,000/1.20) (57,000) Subsidiary income realized in transactions

with third parties 1,509,000

Powers share of subsidiary income (.8 1,509,000) 1,207,200 Toro Companys reported net income $2,400,000 Add: Unrealized profit considered realized

in 2011 ($315,000 $315,000/1.25) 63,000 Less: Unrealized profit in 2011 income

($345,000 $345,000/1.25) (69,000) Subsidiary income realized in transactions

with third parties $2,394,000

Powers share of subsidiary income (.9 2,394,000) 2,154,600 Controlling Interest in Consolidated Net Income $6,970,800

6-5

A. Sales 4,000,000

Cost of Goods Sold 4,000,000

Cost of Goods Sold 250,000

Ending Inventory (Balance Sheet) 250,000

[$1,250,000 - ($1,250,000/1.25)]

1/1 Retained Earnings P Company (1) 84,000 Noncontrolling intrest (2) 21,000

Cost of Goods Sold (Beginning Inventory) 105,000

[$525,000 ($525,000/1.25)] = $105,000




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 P Corporation and Subsidiary


at December 31, 2011

Eliminations

P S Dr Cr Noncontrolli

ng

Consolidated

Corp. Corp. Interest Balances

Income Statement

Sales $200,000 $ 150,000 (a) 30,000 320,000

Dividend Income 16,000 (c) 16,000

Cost of Sales (92,000) (47,000) (b) 4,000 (a) 30,000 (113,000)

Other Expenses (23,000) (40,000) (e) 17,000 (80,000) Noncontrolling Interest in Income 9,200 (9,200)

Net income 101,000 63,000 67,000 30,000 9,200 117,800


Retained Earnings 1/1 110,000 30,000 (d) 30,000 110,000

Add: Net Income 101,000 63,000 67,000 30,000 9,200 117,800

Less: Dividends ( 30,000) (20,000) (c) 16,000 (4,000) (30,000)

Retained Earnings 12/31 181,000 73,000 97,000 46,000 5,200 197,800

Balance Sheet

Cash 20,000 19,000 39,000

Accounts Receivable-net 120,000 55,000 175,000

Inventories 140,000 80,000 (b) 4,000 216,000 Patent (d)170,000 (e) 17,000 153,000 Land 270,000 420,000 690,000 Equipment and Buildings-net 600,000 430,000 1,030,000

Investment in S Corporation 240,000 (d)240,000 Total Assets 1,390,000 1,004,000 2,303,000

Equities

Accounts Payable 909,000 831,000 1,740,000

Common Stock 300,000 100,000 (d)100,000 300,000

Retained Earnings from above 181,000 73,000 97,000 46,000 5,200 197,800


Assets (d)60,000 60,000


Assets 65,200 65,200

Total Equities 1,390,000 1,004,000 367,000 367,000 2,303,000




Edition

6-18

6-7 PORTER COMPANY AND SUBSIDIARY





Income Statement

Sales 4,400,000 1,800,000 6,200,000

Dividend Income 192,000 (a) 192,000 ----

Total Revenue 4,592,000 1,800,000 6,200,000

Cost of Goods Sold 3,600,000 800,000 4,400,000

Depreciation Expense 160,000 120,000 (d) 80,000 360,000

Other expense 240,000 20,000 440,000

Total Cost & Expenses 4,000,000 1,120,000 5,200,000

Net/Consolidated Income 592,000 680,000 1,000,000

Noncontrolling Interest in Income 120,000 120,000

Net Income to Retained Earnings 592,000 680,000 272,000 120,000 880,000

Statement of Retained Earnings

1/1 Retained Earnings


(c) 64,000

(d) 64,000 (e) 240,000 2,112,000

Shilo Company 920,000 (b) 920,000

Net Income from above 592,000 680,000 272,000 120,000 880,000

Dividends Declared

Porter Company (360,000)

(360,000)

Shilo Company (240,000) (a) 192,000 (48,000)

12/31 Retained Earnings to

Balance Sheet 2,232,000 1,360,000 1,320,000 432,000 72,000 2,632,000

Balance Sheet

Cash 280,000 260,000 540,000

Accounts Receivable 1,040,000 760,000 1,800,000

Inventory 960,000 700,000 1,660,000

Investment in Shilo Company 3,400,000 (e) 240,000 (b)3,640,000 ---

Difference between Implied and

Book Value (b) 1,430,000 (c)1,430,000

Land 1,280,000 (c) 200,000 1,480,000

Plant and Equipment 1,440,000 1,120,000 (c) 400,000 (d) 160,000 2,800,000

Goodwill (c) 750,000 750,000

Total Assets 7,120,000 4,120,000 9,030,000

Accounts Payable 528,000 440,000 968,000

Notes Payable 360,000 120,000 480,000

Common Stock:

Porter Company 4,000,000 4,000,000

Shilo Company 2,200,000 (b) 2,200,000

Retained Earnings from above 2,232,000 1,360,000 1,320,000 432,000 72,000 2,632,000




6-19


Assets (c) 16,000 (b) 910,000 878,000

(d) 16,000


Assets 950,000 950,000

Total Liabilities & Equity 7,120,000 4,120,000 6,572,000 6,572,000 712,000 9,030,000

6-8 POOL COMPANY AND SUBSIDIARY

Consolidated Income Statement


Sales ($13,800,000 $1,350,000) $12,450,000 Cost of Goods Sold (a) $7,755,000

Operating Expenses 1,800,000 9,555,000

Consolidated Income 2,895,000

Less Noncontrolling Interest in Consolidated Income (b) 197,500

Controlling Interest in Consolidated Net Income $2,697,500

(a) Reported Cost of Goods Sold $9,000,000

Less intercompany sales in 2011 (1,350,000)

Plus unrealized profit in ending inventory (2/5 x ($1,350,000 - $900,000)) 180,000

Less realized profit in beginning inventory (1/4 x ($1,800,000 - $1,500,000)) (75,000)

Corrected cost of goods sold $7,755,000

(b) Reported net income of subsidiary $1,900,000

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. For downstream sales, no modification to the noncontrolling interest in consolidated income is

needed. For upstream sales, the noncontrolling interest must be adjusted. The reported income of

the subsidiary is reduced by the amount of gross profit remaining in ending inventory of the

purchasing affiliate before multiplying by the noncontrolling percentage interest; it is increased for

gross profit realized from beginning inventory.

$190,000

0.1




Edition

6-20

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

2

000100 ,$ = $10,000). After this elimination the merchandise will be included in the consolidated

statements at its cost to the affiliated group of $50,000 (2

000100 ,$).

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).




6-21

Answers to Business Ethics Case

1. Independence of the auditor is essential in maintaining effective audits. When auditors are involved

in non-audit services, their independence may be impaired (in essence they may be viewed as

auditing their own work).

Many times auditors have to rely on management representation when no supporting evidence is

available. Auditors involvement in non-audit services can help them gain sufficient familiarity with their clients business and operational activities to reduce such dependencies and perhaps to lower audit risk.

2.

The growing importance of non-audit service fees to the audit firms over time may have increased

the potential for the auditors to lose independence, even to the extent of financial fraud involvement.

The increasing effort to reduce costs (in a competitive marketplace for audit services) imposes

limitations on the scope of the audit work involved-- to avoid operating at a loss. Subsidizing any

shortfall between audit revenues and audit costs with non-audit fees can help in overcoming such

limitations.

3.

Audit fees would have to increase if auditors are held liable to a greater degree. The increased fees

would cover both increased auditor effort to detect errors and to cover the increased litigation

settlements/insurance premiums. The additional benefits would be weighed against the costs.

Timeliness and accuracy present constant tradeoffs in any audit. Time and budget constraints may

potentially result in an audit staff not performing sufficient work to meet deadlines. Further,

excessive cost-cutting may cause audit work to be inappropriately reduced, which leads to increased

reliance by auditors on client presentations to document areas where the data are not easily

available. Such reliance can cause audit judgments to be inappropriately influenced. When factors

outside their control cause auditors to rely on the representations of others, they should not be solely

responsible for resulting errors. Legislation aimed at protecting auditors to some extent also serves

to keep audits from becoming prohibitively expensive.



advacc jeter ch06

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