intercompany transactions of non-current assets - depreciable assets

Intercompany Transaction:

Non-current Assets(Part 2)

ARTHIK DAVIANTI

Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary

following a downstream and upstream depreciable asset

transfer.

Transfers of Depreciable AssetsWhat is the major difference between depreciable and non-

depreciable assets?• Depreciation—DUH!• Adds complexity because you have a “moving target” instead

of a stationary target. However, the concepts are the same!

Adjust for:• Unrealized gain (same as with land)• Differences in depreciation expense

The goal is to get back to the asset’s old basis “as if ” it were still on the books of the original owner.• One difference—depreciated going forward based on the new

estimated new life.• Same as a change of depreciation estimates on any company’s

books

Developing Fixed Asset Elimination Entries

Compare “Actual” with “As if ”

• “Actual” = How the transferred asset and related accounts actually appear on the companies’ books

• “ As if ” = How the transferred asset and related accounts would have appeared if the asset had stayed on the original owner’s books

The difference between the two gives the elimination entry or entries.

Choosing the Right Depreciable Life

What’s not relevant?The original owner’s remaining useful life at the transfer date.

What’s relevant?The acquirer’s estimated remaining useful life (if different from the original remaining life).

Downstream saleof depreciable

assets

Illustration (p. 323)Peerless Products Corporation sells equipment to Special Foods on December 31, 20X1, for $7,000 as follows:

Peerless Product

SpecialFoods$9,000 $7,000

Dec 31, 20W8 Dec 31, 20X1

Purchase equipment

Inter-corporate transfer of equipment

Consolidated Entity

Illustration (p. 323)Assume the equipment has been depreciated – useful life of 10 years using straight line method with no residual value.

Original cost to Peerless 9,000Accumulated depreciation on December 31, 20X1 Annual depreciation ($9,000 : 10 years) 900 Number of years x 3

(2,700)Book value on December 31, 20X1 6,300

9,000

Buildings & Equipment

Accumulated Depreciation

7,000

Book Value = 6,300

Sale:

Sale price $7,000 Book Value 6,300Gain $ 700

Separate Company Entries – 20X1Special Foods records:

December 31, 20X1(11) Equipment 7,000

Cash 7,000Record purchase of equipment

Special Foods – no depreciation (purchase at end of year)Peerless records depreciation – prior to calculating the gain on sale:

December 31, 20X1(12) Depreciation expense 900

Accumulated depreciation 900Record depreciation on equipment sold

Peerless also records the sale and recognise the $700 ($7,000 - $6,300) gain on the sale:

December 31, 20X1(13) Cash 7,000

Accumulated depreciation 2,700 Equipment 9,000 Gain on sale of equipment 700Record sale of equipment

Separate Company Entries – 20X1

Peerless also records the normal fully adjusted equity method entries to recognise its share of Special Foods’ income and dividend for 20X1:

(14) Investment in Special Foods 40,000 Income from Special Foods 40,000Record Peerless’ 80% share of Special Foods’ 20X1 income $50,000 X 0.80

(15) Cash 24,000 Investment in Special Foods 24,000Record Peerless’ 80% share of Special Foods’ 20X1 dividend $30,000 X 0.80


Under the fully adjusted equity method, Peerless Inc. defers relative the gain on the intercompany sale of equipment as follows:(16) Income from special Foods 700

Investment in Special Foods 700Defer unrealised gain on asset sale to Special Foods

Investment in Special Foods

700

Income from Special Foods

700Defer Gain

80% NI 40,000 40,000 80% NI

39,300 Ending balance

Acquisition 240,000

24,000 80% Dividend

Acquisition 255,300


Book Value CalculationsInvestmentAccount Common RetainedNCI (20%) (80%) Stock Earnings

Original book value 60,000 240,000 200,000 100,000+ Net income 10,000 40,000 50,000- Dividend (6,000) (24,000) (30,000)

Ending book value 64,000 256,000 200,000 120,000

=

Analyze book value of Special Foods and allocate each component to Peerless and the NCI shareholders:

Consolidation Worksheet – 20X1

Basic investment account elimination entry:Common Stock 200,000Retained Earnings 100,000Income from Special Foods 39,300NCI in NI of Special Foods 10,000

Dividends Declared30,000

Investment in Special Foods255,300NCI in NA of Special Foods

64,000


What accounts and balances actually exist after the fixed asset transfer?

SP 7,000 0


Accumulated Depreciation Gain on Sale

700“Actual”

Review:Assume Peerless purchased an equipment on 31/12/20W8 for $9,000 and estimated that the machine would have a useful life of 10 years with no salvage value. On 12/31/20X1, Peerless sold the equipment to its 80% owned subsidiary, Special Foods., for $7,000.

Peerless’ income is overstated by the $700 gain.Special Foods’ Building and equipment is also overstated by the same amount.Compare what actually happened (as recorded in the individual financial statement of the two companies) with what is ‘as if’ it had not been transferred (historical cost $9,000 with accumulated depreciation $2,700)

SP 7,000 0



700“Actual”

“As if”P 9,000 2,700 0


The worksheet entry on 12/31/X1 to eliminate the asset transfer is simply the “adjustment” to change from “actual” to “as if” the asset hadn’t been transferred.

SP 7,000 0


700“Actual”

“As if” P 9,000 2,700 0

2,000 2,700 700


Eliminate gain on sale of equipment to Special FoodGain on Sale 700Buildings and equipment 2,000

Accumulated depreciation 2,700


Consolidation Worksheet—20X1

Adjustments

Parent Sub DR CR ConsolidatedIncome Statement Gain on Sale 700 700 0 Income from Sub 39,300 39,300

Basic 0

Balance Sheet Investment in Sub 255,300 255,300

Basic 0

Buildings & equipment 791,000 607,000 2,000 1,400,000

Less: Acc. depreciation (447,300) (320,000) 2,700 770,000

(worksheet, Baker p. 326).

During 20X2, Special Foods – depreciate the $7,000 cost of the equipment from Peerless Products over 7 years of its remaining life using straight line.The depreciation – $7,000 : 7 years = $1,000

(17) Depreciation expense 1,000 Accumulated depreciation 1,000Record depreciation expense for 20X2


Peerless also records the normal fully adjusted equity method entries to recognise its share of Special Foods’ $74,000 income and $40,000 dividend for 20X2. Note: Special Foods’ net income is $74,000, it has been reduced by $1,000 of depreciation on the transferred asset.





Gain = 700 7 = 100 Extra Depreciation

Book Value = 6,300 7 = 900 Parent Depreciation

1,000 Total Depreciation

Peerless must record an additional entry related to the transferred of asset – on Dec 31, 20X1 the equipment was recorded on Special Foods’ balance sheet at $7,000). Special Foods will record “extra” depreciation expense.Special Foods’ annual depreciation ($7,000 : 7 years = $1,000 per year) is $100 per year higher. If Peerless had kept the equipment, the depreciation would be $900 ($6,300 : 7).

Special Foods will record “extra” depreciation expense.Special Foods’ annual depreciation ($7,000 : 7 years = $1,000 per year) is $100 per year higher.If Peerless had kept the equipment, the depreciation would be $900 ($6,300 : 7).Thus, in 20X2 (and over the next six years) Peerless reverse 1/7 of the gain deferral, as follows:

(20) Investment in Special Foods 100 Income from Special Foods 100Reverse 1/7 of the deferred gain on fixed asset sold to Special Foods





=

Consolidation worksheet (p. 329)





64,000


The 20X2 worksheet’s entries: revalues the assets and corrects depreciation expense.

1,000


700“Actual”

“As if” 3,600 0

2,000 2,700 700


Entries to adjust equipment and accumulated depreciation “as if” still on parent’s books:Investment in Special Foods 700Buildings and equipment 2,000



SP 7,000

P 9,000

100

Accumulated depreciation 100Depreciation expense 100


Adjustments

Parent Sub DR CR ConsolidatedIncome Statement Less: Depreciation Expense (49,100) (160,000) 100 (70,000) Income from Sub 39,300 59,300

Basic 0

Balance Sheet Investment in Sub 282,600 700 283,300

Basic 0


Less: Acc. depreciation (496,400) (341,000) 100 2,700 840,000


The 20X1 consolidated net income is computed and allocated as follows:

Subsidiary Trial Balance

Elimination Consolidated Amounts

Buildings and equipment $7,000 $2,000 $9,000Accumulated depreciation (1,000) (2,600) (3,600)Depreciation expense 1,000 (100) 900


Consolidated Net Income and Retained Earnings

The 20X2 consolidated net income must include an adjustment for realization of profit on the 20X1 sale of equipment to Special Foods.

Peerless’ separate income $160,900Partial realization of intercompany gain on downstream sale of equipment 100Peerless’ separate realized income $161,000Special Foods’ net income 74,000Consolidate net income, 20X2 $235,000Income to noncontrolling interest ($74,000 X 0.20) (14,800)Income to controlling interest $220,200

Noncontrolling InterestIncome allocated to the NCI in 20X2 – proportionate with share. NCI’s share is $14,800 ($74,000 x 0.20).Noncontrolling interest on December 31, 20X2, is equal to a proportionate share of Special Foods’ book value:Book value of Special Foods, December 31, 20X2: Common stock $200,000 Retained earnings 154,000 Total book value $354,000Noncontrolling stockholders’ proportionate share X 0.20Noncontrolling interest, December 31, 20X2 $70,800

Consolidation in Subsequent Years

Consolidation procedure – similar to those in 20X2.The procedure include two objectives:1. Restating the asset and accumulated depreciation

balances.2. Adjusting depreciation expense for the year.

Summary is in page 332

Upstream saleof depreciable

assets

Upstream SaleSpecial Foods sales equipment to Peerless Products for $7,000 on December 31, 20X1, and reports total income for 20X1 of $50,700 ($50,000 + $700), including $700 gain on the sale of equipment.Special Foods originally purchased the equipment for $9,000 three years before the intercompany sale.The book value of the equipment:

P

S

NCI

20%

80%

Original cost to Special Foods 9,000Accumulated depreciation on December 31, 20X1 Annual depreciation ($9,000 : 10 years) 900 Number of years x 3

(2,700)Book value on December 31, 20X1 6,300

Separate Company Entries – 20X1Special Foods records depreciation for the year and the

sale of the equipment to Peerless on Dec 31, 20X1:December 31, 20X1

(21) Depreciation expense 900 Accumulated depreciation 900Record 20X1 depreciation expense on equipment sold

December 31, 20X1(22) Cash 7,000

Accumulated depreciation 2,700 Equipment 9,000 Gain on sale of equipment 700Record sale of equipment

Peerless also records the purchase of the equipment from Special Foods:

December 31, 20X1(23) Equipment 7,000

Cash 7,000Record purchase of equipment


Peerless also records the normal fully adjusted equity method entries to recognise its share of Special Foods’ income and dividend for 20X1:




Under the fully adjusted equity method, Peerless Inc. defers relative the gain on the intercompany sale of equipment as follows:(26) Income from special Foods 560

Investment in Special Foods 560Defer 80% of the unrealised gain on asset purchase from Special Foods: $700 X 0.80

Investment in Special Foods

560

Income from Special Foods

560Defer Gain

80% NI 40,560 40,560 80% NI

40,000 Ending balance

Acquisition 240,000

24,000 80% Dividend

Acquisition 256,000





=

Analyze book value of Special Foods and allocate each component to Peerless and the NCI shareholders:





64,000


The equipment now on Peerless’ books ($7,000, no depreciation – adjust to “as if” it had been transferred.Historical cost of $9,000 with accumulated depreciation of $2,700.


P 7,000 0


700“Actual”

“As if” SP 9,000 2,700 0

2,000 2,700 700

Eliminate gain on sale of equipment to Special FoodGain on Sale 700Buildings and equipment 2,000




Adjustments

Parent Sub DR CR ConsolidatedIncome Statement Gain on Sale 700 700 0 Income from Sub 40,000 40,000

Basic 0

Balance Sheet Investment in Sub 256,000 256,000

Basic 0


Less: Acc. depreciation (450,000) (317,300) 2,700 770,000


Noncontrolling InterestThe income assigned to the noncontrolling shareholders based on their share of Special Foods’ realized income, as follows:

Net income of Special Foods for 20X1 $50,700Unrealized intercompany sale (700)Realized net income of Special Foods for 20X1 50,000Noncontrolling shareholders’ proportionate share X 0.20Income to noncontrolling interest, 20X1 $10,000

Consolidated Net IncomeThe 20X1 consolidated net income is computed and allocated as follows:

Peerless’ separate income $140,000Special Foods’ net income $50,700Less: Unrealized intercompany gain on upstream land sale (700)Special Foods’ net income 50,000Consolidate net income, 20X1 $190,000Income to noncontrolling interest ($50,000 X 0.20) (10,000)Income to controlling interest $180,000


Gain = 700 7 = 100 Extra Depreciation

Book Value = 6,300 7 = 900 Parent Depreciation

1,000 Total Depreciation

Special Foods reports net income of $75,900 ($900 of depreciation expense on the transferred asset – in Peerless’ income statement.The extra $100 of depreciation now in Peerless’ income statement:

Peerless recognizes 80% of the deferred gain: (($700 : 7 years) X 0.80 = $80Peerless’ extra depreciation – cancels out 1/7 of the unrealized gain.

(27) Investment in Special Foods 80 Income from Special Foods 80Recognized 80% of 1/7 of the deferred gain on fixed asset purchased from Special Foods.





=

Consolidation worksheet (p. 338)





71,340


The 20X2 worksheet’s entries: revalues the assets and corrects depreciation expense.

1,000


700“Actual”

“As if” 3,6000

2,000 2,700 560140


Entries to adjust equipment and accumulated depreciation “as if” still on parent’s books:Investment in Special Foods 560NCI in NA of Special Foods 140Buildings and equipment 2,000



P 7,000

SP 9,000

100

Accumulated depreciation 100Depreciation expense 100


Adjustments

Parent Sub DR CR ConsolidatedIncome Statement Less: Depreciation Expense (49,100) (160,000) 100 (70,000) Income from Sub 60,800 60,800

Basic 0

Balance Sheet Investment in Sub 284,800 560 285,360

Basic 0


Less: Acc. depreciation (501,000) (336,400) 100 2,700 840,000


Consolidated Net IncomeThe 20X2 consolidated net income is computed and allocated as follows:

Peerless’ separate income $159,000Special Foods’ net income $75,900Less: Unrealized intercompany gain on upstream sale of equipment 100Special Foods’ realized net income 76,000Consolidate net income, 20X1 $235,000Income to noncontrolling interest ($76,000 X 0.20) (15,200)Income to controlling interest $219,800

Noncontrolling InterestIncome allocated to the NCI in 20X2 – proportionate with share. NCI’s share is $15,200 ($76,000 x 0.20).Noncontrolling interest on December 31, 20X2, is equal to a proportionate share of Special Foods’ book value:Book value of Special Foods, December 31, 20X2: Common stock $200,000 Retained earnings 156,600 Total book value $356,600Unrealized 20X1 intercompany gain on upstream sale (700)Intercompany gain realized in 20X2 100Realized book value of Special Foods $356,000Noncontrolling stockholders’ proportionate share X 0.20Noncontrolling interest, December 31, 20X2 $71,2000

Consolidation in Subsequent YearsConsolidation procedure – similar to those in 20X2

(until 20X8 – equipment’s end of useful life).Summary in page 340

Investment in Special Foods 560NCI in NA of Special Foods 140Buildings & Equipment 2,000

Accumulated Depreciation 2,700

Accumulated Depreciation 100 Depreciation Expense 100

20X2 Worksheet Entries:

20X3 Worksheet Entries:

SP: 9,000

Equipment

P: 7,000 2,000


1,000 2,700

96,000“As if”

“Actual” 100

Equipment

P: 90,000 30,000


1,000 2,600

4,500“As if”

“Actual” 100

Investment in Special Foods 480NCI in NA of Special Foods 120Buildings & Equipment 2,000

Accumulated Depreciation 2,600

Accumulated Depreciation 100 Depreciation Expense 100 SP: 9,000

Source:

BAKER CHRISTENSEN COTTLRELLAdvanced Financial Accounting

Ninth Edition

McGRAW HILL INTERNATIONAL EDITION

intercompany transactions of non-current assets - depreciable assets

Business