acct 501 (all examples are from the textbook by j. larson) chapter 8 consolidated financial...

ACCT 501(All examples are from the textbook by J. Larson)

Chapter 8 Consolidated Financial

statements: Intercompany Transactions

Consolidated FS-Intercompany Transactions 2

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;


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).


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 group’s 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 company’s 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:

Date of NoteTerm of Note,

MonthsInterest Rates,

% AmountFeb.1, 2001 6 10 $10,00

0Apr.1, 2001 6 10 15,000

Sept.1, 2001 6 10 21,000

Nov.1, 2001 6 10 24,000


Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.) 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):PALM CORPORATION

Intercompany Notes Receivable2001 2001

02/01 10,000 10,000 08/0104/01 15,000 15,000 10/0109/01 21,00011/01 24,000Bal on 11/01

45,000

STARR COMPANY Intercompany Notes Payable

2001 2001

08/01 10,000 10,000 02/0110/01 15,000 15,000 04/01

21,000 09/0124,000 11/0145,000 Bal on

11/01


Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.)

Intercompany Interest Receivable

2001

12/31 1,100

Intercompany Interest Payable2001

1,100 12/31

Intercompany Interest Revenue2001

500 08/01750 10/01

1,100 12/312,350 Bal on

12/31

Intercompany Interest Expense2001

08/01 50010/01 75012/31 1,100Bal on 12/31

2,350


Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.) 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:


Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.)

PALM CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements

For Year Ended December 31, 2001Palm

CorporationStarr

CompanyEliminations

Inc. (Dec.)Consolidated

Income Statement

Intercompany rev. (exp.) 2,350 (2,350)Balance Sheet

Intercompany rec. (pay.) 46,100* (46,100)*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 23,940Interest Expense ($1,260 discount – 1,000*) 260

Intercompany Notes Receivable 24,000 Intercompany Interest Revenue 200

($24,000 x 0.10 x 1/12)


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 Proceeds $23,940

*Interest on note that accrues to discounting bank during discounting period.


Example 8.2: Discounting of Intercompany Notes (Contd.) Palm should inform Starr of the discounting.

Starr would prepare the following journal entry on 12/1/2001:

Intercompany Notes Payable 24,000Intercompany 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.


Example 8.2: Discounting of Intercompany Notes (Contd.) 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:


Example 8.2: Discounting of Intercompany Notes (Contd.)

PALM CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements

For Year Ended December 31, 2001Palm

CorporationStarr

CompanyEliminations

Inc. (Dec.)Consolidated

Income Statement

Intercompany rev. (exp.) 2,150* (2,150)*Balance Sheet

Intercompany rec. (pay.) 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.


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.


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).


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.


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.


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.


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.


Intercompany Sales of Merchandise

Types of Sales Downstream intercompany sales Upstream intercompany sales Lateral intercompany sales


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 Palm’s cost.

The ending inventories of Starr on 12/31/2001 included $25,000 of merchandise obtained form Palm.


Intercompany Sales of Merchandise (Contd.)

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:



Example 8.3 : (Contd.) Palm Corporation Journal EntriesIntercompany Accounts Receivable 150,000

Intercompany Sales 150,000To record sales to Starr Company

Intercompany Cost of Goods Sold 150,000

Inventories 150,000To record cost of goods sold to Satrr Company.

Cash 135,000

Intercompany Accounts Receivable 135,000

To record payments received from Starr Company



Example 8.3 : (Contd.) Starr Company Journal EntriesInventories 150,000

Intercompany Accounts Payable 150,000

To record purchases from Palm Corporation.


Cash 135,000To record payments made to Palm Corporation.

Trade Accounts Receivable 160,000

Sales 160,000To record sales.

Cost of Goods Sold 125,000

Inventories 125,000To record cost of goods sold.



Example 8.3 : (Contd.) 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):



Example 8.3 : (Contd.) PALM CORPORATION AND SUBSIDIARY

Partial Working Paper for Consolidated Financial StatementsFor Year Ended December 31, 2001

Palm Corporation

Starr Company

Eliminations Inc. (Dec.)

Consolidated

Income Statement

Intercompany rev. (exp.) *Balance Sheet

Intercompany rec. (pay.) 15,000 (15,000) *Palm Corporation’s $15,000 intercompany sales and intercompany cost of goods sold are offset in Palm’s separate income statement in the working paper.



Example 8.3 : (Contd.) Note:

Starr Company’s cost of goods sold and inventories are not affected by working paper eliminations. Both Starr’s cost of goods sold and inventories are stated at cost.


Intercompany Sales of Merchandise (Contd.)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.


Intercompany Sales of Merchandise (Contd.) 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).


Intercompany Sales of Merchandise (Contd.)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:



Example 8.4 : (Contd.) Post Company Journal EntriesInventories 120,000


To record purchases from Sage.


Cash 90,000To record payments made to Sage Company.

Trade Accounts Receivable 100,000

Sales 100,000To record sales.

Cost of Goods Sold 80,000

Inventories 80,000To record cost of goods sold.



Example 8.4 : (Contd.) Sage Corporation Journal EntriesIntercompany Accounts Receivable 120,000

Intercompany Sales 120,000To record sales to Post Corporation

Intercompany Cost of Goods Sold 96,000

Inventories 96,000To record cost of goods sold to Post Corporation.

Cash 90,000

Intercompany Accounts Receivable 90,000

To record payments received from Post Corporation.



Example 8.4 : (Contd.) The intercompany gross profit in Sage’s sale

to Post in year 2001 is analyzed as follows:

Selling Price Cost

Gross Profit (25% of Cost; 20%Of Selling

Price)

Beginning inventoriesAdd: Sales $120,000 $96,000 $24,000 Subtotals $120,000 $96,000 $24,000Less: Ending inventories 40,000 32,000 8,000Cost of goods sold $80,000 64,000 $16,000



Example 8.4 : (Contd.) The following working paper elimination is

required for Sage’s intercompany’s sales of merchandise to Post for the year ended 12/31/2001:

(b) Intercompany Sales--Sage 120,000

Intercompany Cost of Goods Sold—Sage 96,000Cost of Goods Sold—Post 16,000

Inventories--Post 8,000To eliminate intercompany sales, cost of goods sold, and unrealized intercompany profit in inventories. (Income tax effects are disregarded.)



Example 8.4 : (Contd.) 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):



Example 8.4 : (Contd.)

Income Statement

PostCorp.

Sage Company

Eliminations Inc.(Dec.)

Consolidated

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)

POST CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements

For Year Ended December 31, 2001



Example 8.4 : (Contd.) Contd.

PostCorp.

Sage Company

Eliminations Inc.(Dec.)

Consolidated

Balance SheetAssets

Intercompany rec.(pay.) (30,000) 30,000 Inventories 900,000 475,000 (b) (8,000) 1,367,000


Notes to the Intercompany Sales of Merchandise at a Mark Up by a Partially Own Subsidiary1.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 Sage’s 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

Sage’s 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 purchaser’s beginning inventories is realized through sales of the merchandise to outsiders during the following accounting period.


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 Sage’s intercompany sales of merchandise to Post Corporation during the year ended 12/31/2002, are analyzed as follows:



Analysis of Gross Profit

Selling Price Cost

Gross Profit (25% of Cost; 20%Of Selling

Price)

Beginning inventories $40,000 $32,000 $8,000Add: Sales 150,000 120,000 30,000 Subtotals $190,000 $152,000 $38,000Less: Ending inventories 60,000 48,000 12,000Cost of goods sold $130,000 $104,000 $26,000



Sage’s intercompany sales ($120,000) and intercompany cost of goods sold ($96,000) for the year ended 12/31/2001 had been closed to Sage’s retained earnings at the end of 2001.

Thus, from a consolidated point of view Sage’s 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:



(b) Retained Earnings—Sage($8,000 x 0.95)* 7,600 Minority Interest in Net Assets of Subsidiary($8,000 x 0.05)

400

Intercompany Sales--Sage 150,000 Intercompany Cost of Goods Sold-Sage 120,000 Cost of Goods Sold—Post 26,000 Inventories—Post 12,000To 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.


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.


Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.) 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 stockholder’s interest should be treated as realized.

It should not to be eliminated in the consolidated financial statements.


Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.) The following table illustrates the types

of intercompany sales and the related issues of the unrealized intercompany profit in the ending inventory:


Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.)Type Seller Buyer Issue Current

PracticeA Parent or

wholly own Subsidiary

Partially-own subsidiary

Should all unrealized intercompany profit in the ending inventory of the buyer be eliminated?

All unrealized intercompany profit in the ending inventory is eliminated

B (as in

Example 8.4)

Partially-owna subsidiary

Parent or subsidiary

Should all unrealized intercompany profit in the ending inventory of the buyer be eliminated?

Same as for type A due to FASB’s preference


Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.)Note to the above table:

a.The unrealized intercompany profit is attributable to the seller (the partially-own 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.


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.


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:


Intercompany Gain on Sale of Land (Contd.)


Post Corporation Journal Entry Sage Company Journal EntryCash 175,000 Land 175,000 Land 125,000 Cash 175,000Intercompany Gain on Sale of Land 50,000

To record acquisition of land from Post Corporation.

To record sale of land to Sage Company



Example 8.5: (Contd.) 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).



Example 8.5: (Contd.) 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 Land—Post

50,000

Land--Sage 50,000To eliminate unrealized intercompany gain on Sale of land. (Income Tax effects are disregarded.)



Example 8.5: (Contd.) The above working paper elimination is

entered in the working paper for consolidated financial statements for the year ended 12/31/2001 as follows:



Example 8.5: (Contd.) POST CORPORATION AND SUBSIDIARY

Partial Working Paper for Consolidated Financial StatementsFor Year Ended December 31, 2001

Post Corp.

Sage Company

Eliminations Inc. (Dec.)

Consolidated

Income Statement

Intercompany gain on sale of land 50,000 (c)(50,000)

Balance Sheet

Land (for building site) 175,000 (c)(50,000) 125,000



Example 8.5: (Contd.) 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.



Example 8.5: (Contd.) 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 Earnings—Post 50,000

Land—Sage 50,000To eliminate unrealized intercompany gain in land. (Income tax effects are disregarded.)



Example 8.5: (Contd.) 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.



Example 8.5: (Contd.) 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 200,000

Land 175,000

Gain on Sale of Land 25,000To record sale of land to an outsider.



Example 8.5: (Contd.) 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 Earnings—Post 50,000

Gain on Sale of Land— Post 50,000

To recognize $50,000 gain on Post Corporation’s sale of land to Sage Company resulting from sale of land by Sage to an outsiders. (Income tax effects are disregarded.)


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:


Intercompany Gain on Sale of Depreciable Plant Asset (Contd.)Selling price of machinery to Post Corp. $ 60,000Cost of machinery to Sage Company when acquired Jan. 2,1999 50,000Estimated residual value:

To Sage Company, Jan.2,1999 $ 4,000 To Post Corporation, Dec. 31,2001 4,000Economic life:

To Sage Company, Jan.2,1999 10 years To Post Corporation, Dec. 31,2001 5 yearsAnnual depreciation expense (straight-line method): To Sage Company ($46,000 x 0.10) $ 4,600 To Post Corporation($56,000 x 0.20) 11,200


Intercompany Gain on Sale of Depreciable Plant Asset (Contd.)

Post Corp. Journal Entry Sage Company Journal EntryMachinery 60,000 Cash 60,000 Cash 60,000 Accumulated

Depreciation ($4,600 x 3) 13,800 Machinery 50,000

To record acquisition of machinery from Sage Company.

Intercompany Gain on Sale of Machinery 23,800To record sale of machinery to Post Corp..

The two companies would account for the sale on 12/31/2001 as follows:


Intercompany Gain on Sale of Depreciable Plant Asset (Contd.) The following working paper elimination

is required for the consolidated financial statements on 12/31/2001:

(d) Intercompany Gain on Sale of Machinery—Sage

23,800

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


Intercompany Gain on Sale of Depreciable Plant Asset (Contd.) 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

$ 60,000

Less:Amount of elimination—intercompany gain 23,800Difference– equal to carrying amount

$ 36,200


Intercompany Gain on Sale of Depreciable Plant Asset (Contd.) 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 Sage’s retained earnings, for consolidation purposes, on 12/31/2001 I (see textbook 376-378).


Intercompany Gain subsequent to Date of Sale of Depreciable Plant Asset The following working paper elimination

is required for the consolidated financial statements of 12/31/2002:

(d) Retained Earnings—Sage ($23,800 x 0.95)

22,610

Minority Interest in Net Assets of Subsidiary ($23,800 x 0.05) 1,190 Accumulated Depreciation—Post 4,760

Machinery—Post 23,800

Depreciation Expense-Post 4,760To eliminate unrealized intercompany gain in machinery and in related depreciation.(Income tax effects are disregarded.) Gain element in straight-line depreciation computed as $23,800 x 0.2 = $4,760,based on five-year economic life.


Intercompany Gain subsequent to Date of Sale of Depreciable Plant Asset (Contd.) The elimination of the Post’s

depreciation expense can also be verified as follows:Post’s annual straight-line depreciation expense [($60,000-$4,000) x 0.2] $ 11,200Less:Straight-line depreciation expense for a five-year economic life, based on Sage’s carrying amount on date of sale [(36,200-$4,000) x 0.20] 6,440Difference– equal to intercompany gain element in Post’s annual depreciation expense $ 4,760


Intercompany Gain in Depreciation and Minority Interest From the consolidation view point, the

intercompany gain element of the acquiring affiliate’s annual depreciation expense represents a realization of a portion of the total intercompany gain by the selling affiliate .


Intercompany Gain in Depreciation and Minority Interest (Contd.) Thus the $4,760 credit to Post’s

depreciation expense in the 12/31/2001 working paper elimination increases Sage’s net income for consolidated purposes.

This increase must be considered in the computation of the minority interest in the subsidiary’s 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:

(d) Retained Earnings—Sage [($23,800-$4,760) x 0.95]

18,088

Minority Interest in Net Assets of Subsidiary [($23,800-$4,760) x 0.05] 952 Accumulated Depreciation—Post ($4,760 x 2)

9,520

Machinery—Post 23,800

Depreciation Expense-Post 4,760To 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.


Intercompany Gain in later Years (Contd.) 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:


Intercompany Gain in later Years (Contd.)

POST CORPORATION AND SUBSIDIARYPartial Working Paper Eliminations-Debits Only

December 31,2004 though 2006

Year Ended Dec. 31,

2004 2005 2006

Debits

(d)Retained earnings- Sage $13,566 $ 9,044 $ 4,522 Minority interest in net assets of subsidiary 714 476 238 Accumulated depreciation-Post 14,280 19,040 23,800


Intercompany Gain in later Years (Contd.) 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.


Intercompany Gain in later Years (Contd.) At the end of year 2006, the entire

intercompany gain of $23,800 has been realized through Post’s annual depreciation expense. The following working paper elimination is required for the machine until it is sold:Accumulated Depreciation- Post

23,800

Machinery-Psot 23,800To eliminate intercompany gain in machinery and related accumulated depreciation.(Income tax effects are disregarded.)


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.


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.


Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)

Example 8.6: (Contd.) Palm’s implicit interest rate, which was

known to Starr and was less than Starr’s 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.



Example 8.6: (Contd.) 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) $ 35,711Present value of $1,000 in four years at 8%(1,000 x 0.735030) 735Palm Corporation’s net investment in the lease $ 36,506



Example 8.6: (Contd.) Journal entries of Palm Corporation for Year

2001:

1/2 Intercompany Lease Receivables [($10,000 x 4)+$1,000] 41,000Intercompany Cost of Goods Sold 30,000

Intercompany Sales 36,506Unearned Intercompany Interest Revenue ($41,000-$36,506) 4,494Inventories 30,000

To record Sales-type lease with Starr Company at inception and cost of leased equipment.



Example 8.6: (Contd.) Contd.

1/2 Cash 10,000Intercompany Lease Receivable 10,000

To record receipt of first payment on intercompany lease.

12/31 Unearned Intercompany Interest Revenue [(31,000-$4,494) x 0.08]

2,120

Intercompany Interest Revenue 2,120To recognize interest earned for first year of intercompany sales-type lease.



Example 8.6: (Contd.) Journal entries of Starr Company for Year 2001:

1/2 Lease Equipment-Capital Lease 36,506Intercompany Liability under Capital Lease (net) 36,506

To record intercompany capital lease at inception.

1/2 Intercompany Liability under Capital Lease(net) 10,000

Cash 10,000To record lease payment for first year of intercompany lease.



Example 8.6: (Contd.) Contd.

12/31 Intercompany Interest Expense [($36,506-$10,000) x 0.08] 2,120

Intercompany Interest Payable 2,120To record accrued interest on intercompany lease obligation on 12/31/2001.

12/31Depreciation Expense ($36,560/6) 6,084

Lease Equipment-Capital Lease 6,084

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.)



Example 8.6: (Contd.) The selected ledger accounts for both

companies relative to the lease are as follows:PALM CORPORATION

Intercompany Lease Receivable01/02/01 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

0 Bal on 01/02/05



Example 8.6: (Contd.)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




Unearned Intercompany Interest Revenue4,494 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. 0Bal on 12/31/04 0



Example 8.6: (Contd.)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.



Example 8.6: (Contd.)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 2001b. Closing entry c. Interest for Year 2002d. Closing entry e. Interest for Year 2003f. Closing entryg. Interest for Year 2004;Adjusted $ 1 for

rounding.h. Closing entry




STARR COMPANYLeased Equipment—Capital 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

0 Bal on 01/02/06



Example 8.6: (Contd.)a. Capital lease at Inceptionb. 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. 0Bal on 01/02/05 0



Example 8.6: (Contd.)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)



Example 8.6: (Contd.)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

0 Bal on 12/31/04




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 entryg. ($925 x 0.08); Adjusted $ 1 for rounding.h. Closing entry



Example 8.6: (Contd.)Depreciation Expense

12/31/01 6,084a

6,084b 12/31/01

12/31/02 6,084c

6,084d 12/31/02

12/31/03 6,084e

6,084 f 12/31/03

12/31/04 6,084g

6,084h 12/31/04

12/31/05 6,085i

6,085 j 12/31/05

12/31/06 6,085k

6,085 l 12/31/06

0 Bal on 12/31/06



Example 8.6: (Contd.)a. ($36,506/6)b. Closing entry c. ($36,506/6)d. Closing entry e. ($36,506/6)f. Closing entryg. ($36,506/6)h. Closing entryi. ($36,506/6); Adjusted $1 for rounding.j. Closing entryk. ($36,506/6);Adjusted $1 for rounding.l. Closing entry



Example 8.6: (Contd.) 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):



Example 8.6: (Contd.)PALM CORPORATION AND SUBSIDIARY

Partial Working Paper EliminationsDecember 31, 2001

(b) Intercompany Liability under Capital Lease-Starr 26,506 Intercompany Interest Payable-Starr 2,120 Unearned Intercompany Interest Revenue- Palm 2,374 Intercompany Sales-Palm 36,506

Intercompany Cost of Goods Sold-Palm 30,000Intercompany Lease Receivables-Palm 31,000Leased Equipment-Capital Lease-Starr ($36,506-$30,000-$1,084) 5,422Depreciation Expense-Starr [($36,506-$30,000)/6] 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.)





(b) Intercompany Liability under Capital Lease- Starr 18,626 Intercompany Interest Payable-Starr 1,490 Unearned Intercompany Interest Revenue- Palm 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)

4,388Depreciation 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.)



Example 8.6: (Contd.) Note:

The elimination of 12/31/2001 removes the parent company’s intercompany sale and cost of goods sold.

The subsidiary’s depreciation expense of $1,084 for 2001 represents the realization of a portion of the parent’s gross profit margin on the intercompany sale.



Example 8.6: (Contd.) In Year 2002 elimination, the original

$6,506 unrealized gross profit element in the subsidiary’s leased equipment has been reduced by $1,084 (the reduction of the subsidiary’s year 2001 depreciation expense).


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.


Intercompany Sales of Intangible Assets(Contd.)

Example 8.7: 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:





(c) Intercompany Gain on Sale of Patent--Palm ($40,000- $32,000) 8,000

Amortization Expense— Starr($8,000/4) 2,000Patent-Starr ($8,000-2,000)

6,000

To eliminate unrealized intercompany gain in patent and related amortization.(Income tax effects are disregarded.)





(c) Retained Earnings--Palm ($8,000-$2,000) 6,000

Amortization Expense—Starr($8,000/4) 2,000Patent-Starr ($6,000-$2,000)

4,000

To eliminate unrealized intercompany gain in patent and related amortization.(Income tax effects are disregarded.)


Acquisition of Affiliate’s 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 affiliate’s bonds by another affiliate.


Acquisition of Affiliate’s 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.


Acquisition of Affiliate’s Bonds in An Open Market (Contd.)

Example 8.8: (Contd.) 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) $ 283,713Add: Present value of $50,000 each year for five years at 12%($50,000 x 3.604776) 180,239Proceeds of bond issue $ 463,952



Example 8.8: (Contd.) The following entries were recorded

by Sage for year 2001 regarding the issuance of the bond and the accrued interest:



Example 8.8: (Contd.) 2001 Sage Company Journal Entries

1/2 Cash 463,952

Discount on Bonds Payable 36,048

Bonds Payable 500,000To 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

Interest Payable ($500,000 x 0.10) 50,000Discount on Bonds Payable 5,674

To record accrual of annual interest on 10% bonds.



Example 8.8: (Contd.) 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, Sage’s bonds can be purchased in the open market at a substantial discount.

Post acquired 60% of Sage’s bonds on 12/31/2001 at $257,175 plus $30,000 accrued interest.



Example 8.8: (Contd.) The acquisition cost of 60% of Sage’s

bonds is computed as follows:

Present value of $300,000 in four years at 15%, with interest paid annually ($300,000 x 0.571753) $ 171,526Add: Present value of $30,000 each year for four years at 15%($30,000 x 2.854978) 85,649Cost to Post Corporation of $300,000 face amount of bonds $ 257,175



Example 8.8: (Contd.) Post prepared the following journal

entry on 12/31/2001 to record the acquisition of Sage’s bonds:

Investment in Sage Company Bonds 257,175Intercompany Interest Receivable 30,000

Cash 287,175To record acquisition of $300,000 face amount of Sage Company’s 10% bonds due Jan. 1, 2006, and accrued interest for one year.



Example 8.8: (Contd.) 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 300,000Discount on Intercompany Bonds Payable ($30,374 x 0.6) 18,224Interest Payable ($50,000 x 0.6) 30,000

Intercompany Bonds Payable 300,000Discount on Bonds Payable 18,224

Intercompany Interest Payable 30,000To transfer to intercompany accounts all amounts attributable to bonds acquired by parent company in open market.



Example 8.8: (Contd.) From the viewpoint of the consolidated

entity, Post’s acquisition of Sage’s bonds is equivalent to the extinguishment of the bonds at a realized gain of $24,601, computed as follows:

Carrying amount of Sage Company’s bonds acquired by Post Corporation on Dec.31,2001 ($300,000 –18,224) $ 281,776Less: Cost of Post Corporation’s investment 257,175Realized gain on extinguishment of bonds $ 24,601



Example 8.8: (Contd.) 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:



Example 8.8: (Contd.)POST CORPORATION AND SUBSIDIARY

Partial Working Paper EliminationDecember 31,2001

(e) Intercompany Bonds Payable— Sage 300,000

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 subsidiary’s bonds acquired by parent and to recognize gain on the extinguishment of the bonds.(Income tax effects are disregarded.)


Acquisition of Affiliate’s Bonds in An Open Market (Contd.) 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.



2. The gain is attributes to Sage – the bond issuer (the subsidiary).

This treatment assumes that parent’s

open market acquisition of the subsidiary’s bonds was, in substance, the extinguishment of the bonds by the subsidiary.



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.


Acquisition of Affiliate’s Bonds in An Open Market (Contd.)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 subsidiary’s net income for the year ended 12/31/2001.


Acquisition of Affiliate’s Bonds in An Open Market (Contd.)Minority interest in Gain on Extinguishemtn of Bonds(Contd.) This gain is also included in the

subsidiary’s retained earnings to be included in the consolidated retained earnings on 12/31/2001.

See Example 8.9 for example.


Accounting for Gain (from Acquisition of Affiliate’s 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.


Accounting for Gain (from Acquisition of Affiliate’s 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:


Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 2002 Post Corporation Journal Entries

1/2 Cash 30,000

Intercompany Interest

Receivable

30,000

To record receipt of accrued interest on Sage Company’s 10% bonds.

12/31 Intercompany Interest Receivable 30,000Investment in Sage Company Bonds 8,576

Intercompany Interest Revenue 38,576

To accrue annual interest on Sage Company’s 10% bonds ($257,175 x 0.15 =$38,576).


Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 2002 Sage Company Journal Entries

1/2 Intercompany Interest Payable 30,000

Interest Payable 20,000

Cash

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 3,813Discount 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


Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

POST CORPORATIONInvestment 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)



Intercompany Interest Revenue38,576a 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 CompanyIntercompany Bonds Payable

300,000a 12/31/01

300,000 Bal on 12/31/01

a. Bonds acquired by parent company



Discount on Intercompany Bonds Payable12/31/01 18,224a

3,813b 12/31/02

4,271c 12/31/03

4,783d 12/31/04

5,357e 12/31/05

0 Bal on 12/31/05



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)



Intercompany Interest Expense12/31/02 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

0 Bal on 12/31/05



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:



Year EndedDec. 31,

Post Corporation’s Intercompany

Interest Revenue

Sage Company’s

Intercompany Interest Expense

Difference-Representing Recording of

Realized Gain

2002 $ 38,576 $ 33,813 $ 4,7632003 39,863 34,271 5,5922004 41,342 34,783 6,5592005 43,044 35,357 7,687Totals $ 162,825 $138,224 $ 24,601



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 parent’s intercompany interest

revenue and subsidiary intercompany interest expense is equal to the realized gain on parent’s

acquisition of subsidiary’s bonds.



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 Payable- Sage 14,411Investment in Sage Company Bonds- Post 265,751Intercompany Interest Expense-Sage 33,813Retained Earnings-Sage($24,601 x 0.95) 23,371Minority Interest in Net Assets of Subsidiary ($24,601 x 0.05) 1,230

To eliminate subsidiary’s bonds owned by parent company, and related interest revenue and expense; and to increase subsidiary’s beginning retained earnings by amount of unamortized realized gain on the extinguishments of the bonds.(Income tax effects are disregarded.)


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).


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.


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 Payable- Sage 10,140Investment in Sage Company Bonds- Post 275,614Intercompany Interest Expense-Sage 34,271Retained Earnings-Sage[($24,601-$4,763) x 0.95] 18,846Minority Interest in Net Assets of Subsidiary [($24,601-$4,763) x 0.05] 992



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 SUBSIDIARYWorking 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


Intercompany Profits on Minority Interest in Net Income (contd.) Contd.

Investment in Sage Company Common Stock-Post 1,229,300Dividends Declared-Sage 50,000

Minority Interest in Net Assets of Subsidiary ($61,000 - $2,500) 58,500


Intercompany Profits on Minority Interest in Net Income (contd.) 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 Goods Sold

Operating Expenses

Building depreciation $ 2,000 $ 2,000

Machinery depreciation 10,000

Leasehold amortization 5,000 $ 2,000

Totals $ 17,000 $ 2,000



(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 96,000Cost of Goods Sold- Post 16,000Inventories-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 50,000

Land-Sage 50,000To eliminate unrealized intercompany gain on sale of land.(Income tax effects are disregarded.)

(d)Intercompany Gain on Sale of Machinery- Sage 23,800

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



(e)Intercompany Bonds Payable -Sage 300,000

Discount on Intercompany Bonds Payable-Sage 18,224Investment in Sage Company Bonds- Post 257,175Gain on Extinguishment of Bonds-Sage 24,601

To eliminate subsidiary’s bonds acquired by parent, and to recognize gain on the extinguishments of the bonds.(Income tax effects are disregarded.)



(f)Minority Interest in Net Income of subsidiary 3,940

Minority Interest in Net Assets of Subsidiary 3,940To establish minority interest in subsidiary’s

adjusted net incomes for Year 2001 as follows:Net income of subsidiary $ 105,000Adjustments for working paper eliminations:(a) ($17,000+$2,000) (19,000)(b) (8,000)(d) (23,800)(e) 24,601Adjusted net income of subsidiary $ 78,801Minority interest share ($78,801 x 0.05) $ 3,940


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


Statement of Retained Earnings

Post Corp. Sage Company

EliminationInc. (Dec.)

Consolidated

Retained earnings, beginning of year 1,348,500 384,000 (a)(379,250) 1,353,250Net income 352,600 105,000 (161,839)* 295,761 Subtotals 1,701,000 489,000 (541,089) 1,649,011Dividends declared 158,550 50,000 (a)(50,000)† 158,550Retained earnings, end of year 1,542,550 439,000 (491,089) 1,490,461


Working Paper for Consolidated Financial Statements (contd.) Contd.Balance Sheet / Liabilities &

Stockholders’ EquityPost Corp. Sage

CompanyEliminationInc. (Dec.)

Consolidated

Minority interest in net assets of subsidiary

(a) 58,500(f) 3,940

62,440

Total liabilities x,xxx,xxx xxx,xxx 62,440 x,xxx,xxxCommon stock, $ 1 par 1,057,000 1,057,000

Common stock, $ 10 par 400,000 (a) (400,000)

Additional paid-in capital 1,560,250 235,000 (a) (235,000) 1,560,250Retained earnings 1,542,550 439,000 (491,089) 1,490,461Retained earnings of subsidiary 4,750 (a) (4,750)

Total stockholder’s equity 4,164,550 1,074,000 (1,130,839)

Total liabilities & stockholders equity x,xxx,xxx x,xxx,xxx (1,068,399) x,xxx,xxx

•Net decrease in revenue ( and gains): $81,700 + $120,000 + $50,000 + $23,800 - $24,601 $250,899•Less: Net decrease in costs and expenses: $96,000 + $16,000 -$19,000 - $3,940 89,060•Decrease in combined net incomes to compute consolidated net income $161,839•# 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 12/31/00950e 12/31/00

47,500f 11/22/01

12/31/01 99,750g 18,050h 12/31/01950i 12/31/01

57,000j 11/25/02

12/31/02 109,250k 18.050l 12/31/02950m 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 combinationb.Dividend declared by Sage c.Net income of Saged.Amortization of differencese.Amortization of goodwillf. Dividend declared by Sageg.Net income of Sageh.Amortization of differencesi.Amortization of goodwillj. Dividend declared by Sagek.Net income of Sagel.Amortization of differencesm. Amortization of goodwill


Retained Earnings1,050,000a 12/31/99

457,050b 12/31/00

12/31/00 158,550 c

318,400d 12/31/01

12/31/01 158,550 e

1,508,350 Bal on 12/31/01



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



Retained Earnings of Subsidiary4,750a 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 COMPANYRetained Earnings

334,000a 12/31/99

90,000b 12/31/00

12/31/00 40,000 c

105,000d 12/31/01

12/31/01 50,000 e

439,000 Bal on 12/31/01



a.Balance

b.Close net income

c.Close Dividends Declared account

d. Close net income

e.Close Dividends Declared account



The following is the working paper for consolidated financial statements for year 2002 of Post and its 95%-partially owned subsidiary:



POST CORPORATION AND SUBSIDIARYWorking paper for Consolidated Financial Statements


Income StatementPost

CorporationSage

CompanyEliminations

Inc.(Dec.)Consolidated

Revenue:

Net Sales 5,900,000 1,400,000 7,300,000 Intercompany sales 150,000 (b)(150,000) Intercompany interest revenue 38,576 (e) (38,576) Intercompany investment income 91,200 (a) (91,200) Intercompany revenue(expenses) 14,000 (14,000)

Total revenue 6,043,776 1,536,000 (279,776) 7,300,000



Contd.Income Statement

(contd.)Post

CorporationSage

CompanyEliminations


Costs and expenses: (a) 17,000(b) (26,000)

Cost of goods sold 4,300,000 950,000 (d) (4,760) 5,236,240Intercompany cost of goods sold 120,000 (b)(120,000)Operating expenses 986,058 217,978 (a) 2,000 1,206,036Intercompany interest expense 33,813 (e) (33,813)Interest expense 51,518 22,542 74,060

Income taxes expense 246,000 76,667 322,667

Minority interest in net income of subsidiary (f) 4,600 4,600Total costs and expenses 5,583,576 1,421,000 *(160,973) 6,843,603Net income 460,200 115,000 (118,803) 456,397



Contd.Statement of

Retained EarningsPost

CorporationSage

CompanyEliminations


Retained earnings, beginning of year

1,508,350 439,000

(a) (400,050)(b) (7,600)(c) (50,000)

(d) (22,610) (e) 23,371

1,490,461

Net income 460,200 115,000 (118,803) 456,397Subtotal 1,968,550 554,000 (575,692) 1,946,858

Dividends declared 158,550 60,000 (a) (60,000)* 158,550Retained earnings, end of year 1,810,000 494,000 (515,692) 1,788,308* A decrease in dividends and an increase in retained earnings.



Contd.Balance Sheet/Assets Post

CorporationSage

CompanyEliminations


Intercomapny receivables (payables) (3,500) 3,500Inventories 950,000 500,000 (b) (12,000) 1,438,000Other current assets 760,000 428,992 1,188,992

Investment in Sage Company stock 1,262,550 (a)(1,262,550)Investment in Sage Company bonds 265,751

(e) (265,751) (a) 148,000

Plant assets (net) 3,700,000 1,300,000 (d) (19,040) 5,128,960Land(for building site) 175,000 (c) (50,000) 125,000

Leasehold (net) (a) 15,000 15,000

Goodwill (net) 85,000 (a) 35,150 120,150

Total assets 7,019,801 2,407,492 (1,411,191) 8,016,102



Working Paper Elimination (for year 2002)

POST CORPORATION AND SUBSIDIARYWorking 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 1,262,550Dividends Declared-Sage 60,000

Minority Interest in Net Assets of Subsidiary 59,800


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:

Working Paper Elimination (for year 2002) (contd.)


Cost of Goods Sold

Operating Expenses

Building depreciation $ 2,000 $ 2,000

Machinery depreciation 10,000

Leasehold amortization 5,000 $ 2,000

Totals $ 17,000 $ 2,000



(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 120,000Cost of Goods Sold- Post 26,000Inventories-Post 12,000

To eliminate intercompany sales, cost of goods sold, and unrealized profit in inventories.(Income tax effects are disregarded.)



(c)Retained Earnings- Post 50,000

Land-Sage 50,000To eliminate unrealized intercompany gain in land.(Income tax effects are disregarded.)(d)Retained Earnings-Sage 22,610

Minority Interest in Net Assets of Subsidiary 1,190 Accumulated Depreciation-Post 4,760

Machinery- Post 23,800

Depreciation Expense- Post 4,760

To eliminate unrealized intercompany gain in machinery and in related depreciation (Income tax effects are disregarded.)



(e)Intercompany Interest Revenue- Post 38,576 Intercompany Bonds Payable- Sage 300,000

Discount on Intercompany Bonds Payable-Sage 14,411Investment in Sage Company Bonds-Post 265,715Intercompany Interest Expense-Sage 33,813Retained Earnings- Sage 23,371Minority Interest in Net Assets of Subsidiary 1,230




(f)Minority Interest in Net Income of Subsidiary 4,600

Minority Interest in Net Assets of Subsidiary 4,600To establish minority interest in subsidiary’s

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


acct 501 (all examples are from the textbook by j. larson) chapter 8 consolidated financial...

Documents

intercompany loans

intercompany assets

intercompany items

u intercompany ledger

loss n loans

n palm

foregoing transactions

consolidated groups