electronic supplement to chapter 6 -...

ELECTRONIC SUPPLEMENT TO CHAPTER 6

Electronic Supplement to Chapter 6 1

C H A P T E R 6

Chapter 6 in your text discusses consolidation working papers when the parentcompany uses the equity method of accounting. This supplement repeats those

illustrations for the incomplete equity and cost methods of parent company accounting.As in the supplements to Chapters 4 and 5, this supplement departs from the normal

numerical sequencing to make it easier to compare the alternative working paper formats.Exhibit I6-4 presents incomplete equity method accounting. Exhibit T6-4 presents the tra-ditional approach to cost method accounting (i.e., no initial conversion to equity methodaccounting). These exhibits correspond to equity method Exhibit 6-4 in the textbook chapter.

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CONSOLIDATION EXAMPLE—UPSTREAM AND DOWNSTREAM SALESOF PLANT ASSETSPlank Corporation acquired a 90% interest in Sharp Corporation at its underlying bookvalue of $450,000 on January 3, 2005. Since Plank Corporation acquired its interest inSharp, the two corporations have participated in the following transactions involving plantassets:

1. On July 1, 2005, Plank sold land to Sharp at a gain of $5,000. Sharp resoldthe land to outside entities during 2007 at a loss to Sharp of $1,000.

2. On January 2, 2006, Sharp sold equipment with a five-year remaining use-ful life to Plank at a gain of $20,000. This equipment was still in use byPlank at December 31, 2007.

3. On January 5, 2007, Plank sold a building to Sharp at a gain of $32,000.The remaining useful life of the building on this date was eight years, andSharp still owned the building at December 31, 2007.

Incomplete Equity MethodIf Plank Corporation had used an incomplete equity method and failed to consider intercom-pany transactions in accounting for its investment in Sharp, its separate financial statementswould show overstated amounts for beginning and ending retained earnings, investmentincome, net income, and the investment in Sharp.

CONVERSION TO EQUITY METHOD APPROACH The following incomplete equity-to-equityconversion schedule shows computations to support the working paper entry to convertPlank’s separate accounts to the equity method.

2 ADVANCED ACCOUNTING

Plank’sBeginningRetained Investment Income fromEarnings in Sharp Sharp

Prior Year’s EffectSale of land to Sharp in 2005 $ �5,000 $ �5,000Purchase of equipment from Sharp on

January 1, 2006 ($20,000 gain � 90%) �18,000 �18,000Piecemeal recognition through 2006

depreciation of equipment[($20,000 gain ÷ 5 years) � 90%] +3,600 +3,600

Current Year’s EffectSharp’s sale of land to outside entity +5,000 $ +5,000Sale of building to Sharp on January 5, 2007 �32,000 �32,000Piecemeal recognition of gain on

equipment—2007 +3,600 +3,600Piecemeal recognition of gain on

building through depreciation($32,000 gain ÷ 8 years) +4,000 +4,000

Working paper adjustment to convert tothe equity method $�19,400 $�38,800 $�19,400

The working paper entry prepared from the schedule is as follows:

Retained earnings—Plank January 1 (�SE) 19,400

Income from Sharp (�R, �SE) 19,400

Investment in Sharp (�A) 38,800

The equality of these numbers is coincidental, because the retained earnings adjustment consistsof overstatements from prior sales of land and equipment, and the income adjustment consists ofrecognition of previously deferred gain on land, piecemeal recognition of the gain on equipment,and the gain on buildings less related piecemeal recognition.

After entering the conversion to equity entry in the consolidation working papers, all otherworking paper entries should be the same as those in Exhibit 6-4 under the equity method.

TRADITIONAL WORKING PAPER SOLUTION FOR INCOMPLETE EQUITY METHOD Exhibit I6-4 illus-trates working paper procedures to consolidate the financial statements of Plank and Sharp whenPlank uses an incomplete equity method of accounting and consolidates without converting to theequity method.

Notice that the entries are similar to those in Exhibit 6-4, except that the debit amounts in entriesa and b are to the parent’s beginning retained earnings instead of the investment account. This isbecause the parent did not eliminate intercompany unrealized profits in prior years through a one-line consolidation of its investment in Sharp. The working paper entries from Exhibit I6-4 arereproduced for convenient reference as follows:

a Retained earnings—Plank January 1 (�SE) 5,000

Gain on land (R, +SE) 5,000

To recognize previously deferred gain on land.

b Retained earnings—Plank January 1 (�SE) 14,400

Accumulated depreciation—equipment (+A) 8,000

Minority interest January 1 (�L) 1,600

Equipment (�A) 20,000

Depreciation expense (�E, +SE) 4,000

To eliminate unrealized profit on upstream sale of equipment.

c Gain on building (�R, �SE) 32,000

Accumulated depreciation (+A) 4,000

Buildings (�A) 32,000


EXHIBIT I6-4Intercompany Salesof Plant Assets—Incomplete EquityMethod, Tradit ionalApproach

PLANK CORPORATION AND SUBSIDIARY CONSOLIDATION WORKING PAPERSFOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS)

90% Adjustments and ConsolidatedPlank Sharp Eliminations Statements

Income StatementSales $2,000 $700 $2,700

Gain on building 32 c 32

Loss (or gain) on land (1) a 5 4

Income from Sharp 72 d 72

Cost of goods sold (1,000) (320) (1,320)

Depreciation expense (108) (50) b 4 c 4 (150)

Other expenses (676.6) (249) (925.6)

Minority interest expense e 8.4 (8.4)

Net Income 319.4 $ 80 $ 300

Retained Earnings a 5Retained earnings—Plank $ 419.4 b 14.4 $ 400

Retained earnings—Sharp $200 f 200

Net income 319.4 80 300

Dividends (200) (30) d 27e 3 (200)

Retained earnings—December 31, 2007 $ 538.8 $250 $ 500

Balance SheetCash $ 131.8 $ 32 $ 163.8

Other current assets 200 150 350

Land 160 40 200

Buildings 500 232 c 32 700

Accumulated depreciation—buildings (200) (54) c 4 (250)

Equipment 620 400 b 20 1,000

Accumulated depreciation—equipment (258) (100) b 8 (350)

Investment in Sharp 585 d 45f 540

$1,738.8 $700 $1,813.8

Current liabilities $ 200 $ 50 $ 250

Capital stock 1,000 400 f 400 1,000

Retained earnings 538.8 250 500

$1,738.8 $700

Minority interest b 1.6 e 5.4f 60 63.8

$1,813.8


Depreciation expense (�E, +SE) 4,000

To eliminate unrealized gain on downstream sale of building.

d Income from Sharp (�R, �SE) 72,000

Dividends (+SE) 27,000


To eliminate investment income (as recorded by Plank) anddividends, and return investment account to its beginning-of-the-period balance under an incomplete equity method.

e Minority interest expense (E, �SE) 8,400

Dividends—Sharp (+SE) 3,000

Minority interest (+L) 5,400

To enter minority interest share of subsidiary income and dividends.

f Retained earnings—Sharp (�SE) 200,000

Capital stock—Sharp (�SE) 400,000



To eliminate reciprocal equity and investment balances andenter beginning minority interest.

Cost MethodNow assume that Plank has used the cost method in accounting for its investment in Sharp. Underthe cost method. Plank’s investment in Sharp account remains at the $450,000 original investment.Net income and retained earnings are understated by Plank’s share of Sharp’s undistributed incomeplus or minus any unrealized intercompany profits.

CONVERSION TO EQUITY METHOD APPROACH The working paper entry to convert Plank’s cost-based accounting records from the cost to the equity method in journal form is:

Investment in Sharp (+A) 96,200

Dividend income (�R, �SE) 27,000

Income from Sharp (R, +SE) 52,600

Retained earnings—Plank January 1 (+SE) 70,600

To adjust Plank’s account balances to an equity basis as a firststep in consolidating its subsidiary.

The following cost-to-equity conversion schedule provides data to support the working paper entry.

Plank’sBeginning Investment IncomeRetained in from DividendEarnings Sharp Sharp Income

Prior Year’s Effect90% of Sharp’s increase in

undistributed income for2005 and 2006 [($600,000� $500,000) � 90%] $+90,000 $+90,000

Gain on sale of land to Sharp �5,000 �5,000Gain on purchase of

equipment from Sharp �18,000 �18,000Piecemeal recognition of gain

on equipment throughdepreciation ($4,000 � 90%) +3,600 +3,600

Current Year’s EffectReclassify dividend income as

decrease in investment �27,000 $�27,000(Continued)


Plank’sBeginning Investment IncomeRetained in from DividendEarnings Sharp Sharp Income

Share of Sharp’s reportedincome ($80,000 � 90%) +72,000 $+72,000

Sharp’s sale of land to outsideentity +5,000 +5,000

Gain from sale of building toSharp �32,000 �32,000

2007 piecemeal recognitionof gain on equipment($4,000 � 90%) +3,600 +3,600

2007 piecemeal recognitionof gain on building($32,000 ÷ 8 years) +4,000 +4,000

Working paper entry toconvert cost to equitymethod $+70,600 $+96,200 $+52,600 $�27,000

As in the case of the conversion from incomplete equity to the equity method, after this first cor-recting entry is made in the working papers to convert Plank’s accounting for its investment in Sharpto the equity method, the rest of the working paper entries are the same as those in Exhibit 6-4.

TRADITIONAL WORKING PAPER SOLUTION FOR COST METHOD Exhibit T6-4 illustrates working paperprocedures to consolidate the financial statements of Plank and Sharp when Plank uses the cost methodto account for its investment in Sharp and consolidates without converting to the equity method.

Working paper entries a, b, and c under the cost method are identical to those under an incompleteequity method. Entry d eliminates dividend income against dividends. Entry f takes up Plank’s share ofthe increase in Sharp’s retained earnings from the date of acquisition to the beginning of 2007. In otherwords, entry f establishes reciprocity between the investment and equity balances to the beginning of theyear. Entry g then eliminates the reciprocal investment and equity balances and enters beginning-of-the-period minority interest. We journalized these last three working paper entries as follows:

d Dividend income—Sharp (�R, �SE) 27,000

Dividends (+SE) 27,000

To eliminate dividend income.

e Minority interest expense (E, �SE) 8,400

Dividends—Sharp (+SE) 3,000


To enter minority interest share of subsidiary income and dividends.

f Investment in Sharp (+A) 90,000

Retained earnings—Plank January 1 (+SE) 90,000

To increase parent’s beginning retained earnings for itsshare of Sharp’s retained earnings increase between dateof acquisition and beginning of the period.

g Retained earnings—Sharp (�SE) 200,000

Capital stock—Sharp (�SE) 400,000



To eliminate reciprocal investment and equity balancesand enter beginning minority interest.

Comparison of Results Under the Three MethodsRegardless of the method (equity, incomplete equity, or cost) used by the parent in accounting forits subsidiary, or the approach used in the working papers to consolidate the financial statements ofthe parent and subsidiary, the final consolidated financial statements will always be the same. Here


EXHIBIT T6-4Intercompany Salesof Plant Assets—CostMethod, Tradit ionalApproach

PLANK CORPORATION AND SUBSIDIARY CONSOLIDATION WORKING PAPERSFOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS)

90% Adjustments and ConsolidatedPlank Sharp Eliminations Statements

Income StatementSales $2,000 $700 $2,700

Gain on building 32 c 32

Loss (or gain) on land (1) a 5 4

Income from Sharp 27 d 27

Cost of goods sold (1,000) (320) (1,320)

Depreciation expense (108) (50) b 4c 4 (150)

Other expenses (676.6) (249) (925.6)

Minority interest expense e 8.4 (8.4)

Net Income $ 274.4 $ 80 $ 300

Retained Earnings a 5Retained earnings—Plank $ 329.4 b 14.4 f 90 $ 400

Retained earnings—Sharp $200 g 200

Net income 274.4 80 300

Dividends (200) (30) d 27e 3 (200)

Retained earnings—December 31, 2007 $ 403.8 $250 $ 500

Balance SheetCash $ 131.8 $ 32 $ 163.8

Other current assets 200 150 350

Land 160 40 200

Buildings 500 232 c 32 700

Accumulated depreciation—buildings (200) (54) c 4 (250)

Equipment 620 400 b 20 1,000

Accumulated depreciation—equipment (258) (100) b 8 (350)

Investment in Sharp 450 f 90 g 540

$1,603.8 $700 $1,813.8

Current liabilities $ 200 $ 50 $ 250

Capital stock 1,000 400 g 400 1,000

Retained earnings 403.8 250 500

$1,603.8 $700

Minority interest b 1.6 e 5.4g 60 63.8

$1,813.8


is a summary of the differences in the financial statement items of Plank under the equity, incom-plete equity, and cost methods.

IncompleteEquity Equity CostMethod Method Method

Income StatementIncome from Sharp $ 52,600 $ 72,000 —Dividend income from Sharp — — $ 27,000Net income 300,000 319,400 274,400

Retained Earnings StatementRetained earnings January 1, 2007 400,000 419,400 329,400Net income 300,000 319,400 274,400Dividends (no difference) (200,000) (200,000) (200,000)Retained earnings December 31, 2007 500,000 538,800 403,800

Balance SheetInvestment in Sharp 546,200 585,000 450,000Retained earnings December 31, 2007 500,000 538,800 403,800

A S S I G N M E N T M A T E R I A L

W 6-1 Income information for 2003 taken from the separate company financial statements of ParkCorporation and its 75%-owned subsidiary, Skyline Corporation, is presented as follows:

Park Skyline

Sales $1,000,000 $460,000Gain on sale of building 20,000 —Income from Skyline 75,000 —Cost of goods sold (500,000) (260,000)Depreciation expense (100,000) (60,000)Other expenses (200,000) (40,000)

Net income $ 295,000 $100,000

Park’s gain on sale of building relates to a building with a book value of $40,000 and a 10-yearremaining useful life that was sold to Skyline for $60,000 on January 1, 2003.

R E Q U I R E D1. At what amount will the gain on sale of building appear on the consolidated income statement of Park and

Subsidiary for the year 2003.

2. Calculate consolidated depreciation expense for 2003.

3. Calculate consolidated net income for Park and Subsidiary for 2003.

4. What entry should be made on Park’s books on December 31, 2003 (after the books are closed) to correctthe accounts to an equity basis?

W 6-2 Comparative balance sheets for Pony Corporation and its 90%-owned subsidiary, Sox Corporation,on December 31, 2008, are as follows (in thousands):

Pony SoxCorporation Corporation

AssetsCash $ 3,200 $ 1,200Receivables—net 4,760 2,000Inventories 4,040 1,800Land 4,700 1,000Building—net 8,000 4,000Equipment—net 14,000 6,000Investment in Sox 11,300 —

Total assets $50,000 $16,000(Continued)


Pony SoxCorporation Corporation

Liabilities and Stockholders’ EquityAccounts payable $ 4,000 $ 2,000Other liabilities 8,000 2,000Common stock 30,000 10,000Retained earnings 8,000 2,000

Total equities $50,000 $16,000

Pony acquired its 90% interest in Sox for cash on December 31, 2005, at a price $500,000 inexcess of underlying book value. The excess was due to patents having a 10-year amortization period.

Sox Corporation’s inventories at December 31, 2008, included merchandise acquired fromPony at a price $50,000 in excess of its cost to Pony. Unrealized profit in Sox’s December 31,2007, inventories acquired from Pony were $40,000.

During 2008 Sox sold land to Pony at a gain of $200,000. Pony’s land account at December 31,2008, includes the full $700,000 paid for the land. Pony uses the equity method of accounting forits investment in Sox but has applied the equity method without amortizing patents or adjusting forunrealized profits (an incomplete equity method).

R E Q U I R E D : Prepare a consolidated balance sheet for Pony Corporation and Subsidiary at December 31,2008.

W 6-3 Prime Corporation owns 80% of the outstanding voting stock of Select Corporation, havingacquired its interest at book value when Select Corporation was incorporated on January 2,2005. Comparative income statements for Prime and Select for 2005 and 2006 are as follows(in thousands):

2005 2006

Prime Select Prime Select

Sales $500 $200 $600 $250Gain on machinery 10 — — —Gain on land — — — 5Dividend income 40 — 40 —

Total revenue 550 200 640 255Inventory January 1 80 40 70 50Purchases 300 100 400 120

Goods available for sale 380 140 470 170Inventory December 31 70 50 90 60Cost of goods sold 310 90 380 110

Gross profit 240 110 260 145Operating expenses 80 60 100 80

Net income $160 $ 50 $160 $ 65

A D D I T I O N A L I N F O R M AT I O N1. Prime Corporation uses the cost method of accounting for its investment in Select.

2. The $10,000 gain relates to machinery sold to Select at the beginning of 2005. Select still held themachinery on December 31, 2006, and is depreciating it at the rate of 20% per year. The $5,000 relates toland sold to Prime at the beginning of 2006.

3. Intercompany sales and inventory data for 2005 and 2006 are as follows:

2005 2006

Sales by Prime to Select $40,000 —Sales by Select to Prime — $50,000Unrealized profit in Select’s December 31 inventory 8,000 —Unrealized profit in Prime’s December 31 inventory — 10,000

R E Q U I R E D : Prepare comparative 2005 and 2006 consolidated income statements for Prime Corporationand Subsidiary. You may use a single line for cost of sales in your comparative income statements.


W 6-4 Pike Corporation issued 10,000 of its own $10 par shares for 90% of Shad Corporation’s outstand-ing common shares on January 1, 1999, in a pooling of interests business combination. Shad’sstockholders’ equity consisted of $100,000 capital stock, $50,000 other paid-in capital, and$50,000 retained earnings at the time of the pooling. Pike recorded the pooling as follows:

Investment in Shad (90%) (+A) 180,000

Capital stock, $10 par (+SE) 100,000

Other paid-in capital (+SE) 35,000

Retained earnings (+SE) 45,000

Separate company financial statements for Pike and Shad on December 31, 2000, are summa-rized as follows (in thousands):

Pike Shad

Income Statement for 2000Sales $ 600 $200Income from Shad 63.5 —Gain on equipment 18 —Cost of sales (270) (100)Operating expenses (121.5) (20)

Net income $ 290 $ 80

Retained Earnings for 2000Retained earnings December 31, 1999 $ 70 $ 90Add: Net income 290 80Deduct: Dividends (150) (40)

Retained earnings December 31, 2000 $ 210 $130

Balance Sheet on December 31, 2000Cash $ 166.5 $ 23Accounts receivable 180 100Dividends receivable 18 —Inventories 60 27Land 100 30Buildings—net 280 100Equipment—net 330 120Investment in Shad 215.5 —

Total assets $1,350 $400Accounts payable $ 225 $ 60Dividends payable 30 20Other liabilities 150 40Capital stock, $10 par 600 100Other paid-in capital 135 50Retained earnings 210 130

Total equities $1,350 $400

During 1999 and 2000, the intercompany transactions between these affiliated companies wereas follows:

I N V E N T O R Y I T E M S : During 1999, Pike sold inventory items that cost $30,000 to Shad for $50,000.Half of these items were inventoried by Shad at December 31, 1999. During 2000, Pike sold inventory itemsthat cost $20,000 to Shad for $40,000, and 40% of these items were inventoried by Shad at December 31,2000. Also, Shad owed Pike $5,000 at December 31, 2000.

P L A N T A S S E T S : On January 12, 1999, Shad sold land with a book value of $10,000 to Pike for $15,000and a building with a book value of $50,000 to Pike for $70,000. The building is being depreciated over afour-year period. On January 1, 2000, Shad purchased equipment with a six-year remaining useful life fromPike at a gain to Pike of $18,000.

R E Q U I R E D : Prepare consolidation working papers for Pike Corporation and Subsidiary at and for the yearended December 31, 2000.


W 6-5 [AICPA adapted]Pain Corporation acquired all the outstanding $10 par value voting common stock of SeyCorporation on January 1, 2009, in exchange for 25,000 shares of its $10 par value voting commonstock. On December 31, 2008, Pain’s common stock had a closing market price of $30 per share ona national stock exchange. The acquisition was appropriately accounted for as a purchase. Bothcompanies continued to operate as separate business entities, maintaining separate accountingrecords with years ending December 31.

On December 31, 2009, the companies had condensed financial statements as follows (inthousands):

Pain Sey

Income Statement for the Year EndedDecember 31, 2009Net sales $3,800 $1,500Dividends from Sey 40 —Gain on sale of warehouse 30 —Cost of goods sold (2,360) (870)Operating expenses (including depreciation) (1,100) (440)

Net income $ 410 $ 190

Retained Earnings Statement for the YearEnded December 31, 2009Retained earnings—beginning $ 440 $ 156Add: Net income 410 190Less: Dividends paid — (40)

Retained earnings December 31, 2009 $ 850 $ 306

Balance Sheet at December 31, 2009AssetsCash $ 570 $ 150Accounts receivable—net 860 350Inventories 1,060 410Land, plant, and equipment 1,320 680Accumulated depreciation (370) (210)Investment in Sey (at cost) 750 —

Total assets $4,190 $1,380

Liabilities and Stockholders’ EquityAccounts payable and accrued expenses $1,340 $ 594Common stock, $10 par 1,700 400Additional paid-in capital 300 80Retained earnings 850 306

Total equities $4,190 $1,380

A D D I T I O N A L I N F O R M AT I O N1. There were no changes in the common stock and additional paid-in capital accounts during 2009 except

the one necessitated by Pain’s acquisition of Sey.

2. At the acquisition date, the fair value of Sey’s machinery exceeded its book value by $54,000. The excesscost will be amortized over the estimated average remaining life of six years. The fair values of all ofSey’s other assets and liabilities were equal to their book values. Any goodwill resulting from the acquisi-tion is not amortized.

3. On July 1, 2009, Pain sold a warehouse facility to Sey for $129,000 cash. At the time of the sale, Pain’s bookvalues were $33,000 for the land and $66,000 for the undepreciated cost of the building. Based on a real estateappraisal, Sey allocated $43,000 of the purchase price to land and $86,000 to building. Sey is depreciating thebuilding over its estimated five-year remaining useful life by the straight-line method with no salvage value.

4. During 2009, Pain purchased merchandise from Sey at an aggregate invoice price of $180,000, whichincluded a 100% markup on Sey’s cost. At December 31, 2009, Pain owed Sey $86,000 on these pur-chases, and $36,000 on this merchandise remained in Pain’s inventory.

R E Q U I R E D : Prepare working papers to consolidate the financial statements of Pain and Sey for the year2009. (Note: Conversion to equity is an inefficient approach to the solution for this problem because the con-solidation is in the year of acquisition.)

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