77

Elimination of Unrealized
Gains or Losses on
Intercompany Sales of
Property and Equipment

Advanced Accounting, Fifth Edition

Slide
7-1
 Learning
Learning Objectives
Objectives
1. Understand the financial reporting objectives in accounting
for intercompany sales of nondepreciable assets on the
consolidated financial statements.
2. Explain the additional financial reporting objectives in
accounting for intercompany sales of depreciable assets on the
consolidated financial statements.
3. Explain when gains or losses on intercompany sales of
depreciable assets should be recognized on a consolidated
basis.
4. Explain the term “realized through usage.”
5. Describe the differences between upstream and downstream
sales in determining consolidated net income and the
controlling and noncontrolling interests in consolidated income.

Slide
7-2
 Learning
Learning Objectives
Objectives
6. Compare the eliminating entries when the selling affiliate is a
subsidiary (less than wholly owned) versus when the selling
affiliate is the parent company.
7. Compute the noncontrolling interest in consolidated net income
when the selling affiliate is a subsidiary.
8. Compute consolidated net income considering the effects of
intercompany sales of depreciable assets.
9. Describe the eliminating entry needed to adjust the
consolidated financial statements when the purchasing
affiliate sells a depreciable asset that was acquired from
another affiliate.
10. Explain the basic principles used to record or eliminate
intercompany interest, rent, and service fees.

Slide
7-3
 Intercompany
Intercompany Sales
Sales of
of Nondepreciable
Nondepreciable Property
Property

When there have been intercompany sales of nondepreciable

property, workpaper entries are necessary to:

 Include gains or losses on the sale in consolidated net income

only at the time such property is sold to parties outside the
affiliated group and in an amount equal to the difference
between the cost of the property to the affiliated group and
the proceeds received from outsiders.

 Present nondepreciable property in the consolidated balance

sheet at its cost to the affiliated group.

Slide
7-4
LO 1 Financial reporting objectives nondepreciable property.
 Intercompany
Intercompany Sales
Sales of
of Nondepreciable
Nondepreciable Property
Property
Upstream Sale

E7-4 (variation): Procter Company owns 90% of the

outstanding stock of Silex Company. On January 1, 2011,
Silex Company sold land to Procter Company for $350,000.
Silex had originally purchased the land on June 30, 2007, for
$200,000.

Procter Company plans to construct a building on the land

bought from Silex in which it will house new production
machinery. The estimated useful life of the building and the
new machinery is 15 years.

Slide
7-5
LO 1 Financial reporting objectives nondepreciable property.
 Intercompany
Intercompany Sales
Sales of
of Nondepreciable
Nondepreciable Property
Property

E7-4 (variation): Entries made on the books of each affiliate

to record this intercompany sale in 2011.

Entry on Books of Silex Entry on Books of Procter

Cash 350,000 Land 350,000

Land Cash 350,000
200,000
Additional Entry for Complete
Gain on sale Equity Method: Proctor Only
150,000
Note: No further entries are Equity in income 135,000
recorded on the books of Procter Investment in Silex 135,000
until the land is sold to outsiders. To reduce its income from subsidiary
by its share of the intercompany gain
($150,000 x 90%).

Slide
7-6
LO 1 Financial reporting objectives nondepreciable property.
 Intercompany
Intercompany Sales
Sales of
of Nondepreciable
Nondepreciable Property
Property
E7-4: B(1). Prepare the workpaper entries necessary
because of the intercompany sale of land for the year ended
December 31, 2011.

Gain on Sale of Land 150,000

Land ($350,000 - $200,000)

150,000
To eliminate the $150,000 gain reported by Silex Company and to
reduce the land balance from the $350,000 recorded on the books
of Procter to its $200,000 cost to the affiliated group.

Slide
7-7
LO 1 Financial reporting objectives nondepreciable property.
 Intercompany
Intercompany Sales
Sales of
of Nondepreciable
Nondepreciable Property
Property

E7-4: B(2). Prepare the workpaper entries for the year

ended December 31, 2012.
Upstream Sale
Cost Method and Partial Equity Method
Beg. Retained Earnings – Procter (90%) 135,000
Noncontrolling Interest (10%) 15,000
Land 150,000

Complete Equity Method

Investment in Silex Company (90%) 135,000
Noncontrolling Interest (10%) 15,000
Land 150,000

Slide
7-8
LO 1 Financial reporting objectives nondepreciable property.
 Intercompany
Intercompany Sales
Sales of
of Nondepreciable
Nondepreciable Property
Property

E7-4: Summary Points

1. Proctor (parent) continues to report the land on their

statements at the intercompany selling price of
$350,000. However, in the consolidated balance sheet,
the land is reported at its cost to the affiliated group of
$200,000.

2. If the intercompany seller had been the parent

(downstream sale), the entire $150,000 would go to the
controlling interest, resulting in a $150,000 debit to the
beginning retained earnings of the parent company.

Slide
7-9
LO 1 Financial reporting objectives nondepreciable property.
 Intercompany
Intercompany Sales
Sales of
of Nondepreciable
Nondepreciable Property
Property

Sales to Outsiders
E7-6: P Company owns 90% of the outstanding common stock
of S Company. On January 1, 2011, S Company sold land to P
Company for $600,000. S Company originally purchased the
land for $400,000.

On January 1, 2012, P Company sold the land purchased

from S Company to a company outside the affiliated group
for $700,000.

Required:

A. Calculate the amount of gain on the sale of the land that is

recognized on the books of P Company in 2012.
Slide
7-10
LO 1 Financial reporting objectives nondepreciable property.
 Intercompany
Intercompany Sales
Sales of
of Nondepreciable
Nondepreciable Property
Property

E7-6: A. Calculate the gain on the sale of the land that is

recognized on the books of P Company in 2012.

Selling price to third party $ 700,000

Cost of land to P Company 600,000
Gain recognized by P Company $ 100,000

B. Calculate the gain that should be recognized

in the consolidated statements in 2012.

Selling price to third party $ 700,000

Cost of land to affiliate group 400,000
Gain recognized in consolidation $ 300,000

Slide
7-11
LO 1 Financial reporting objectives nondepreciable property.
 Intercompany
Intercompany Sales
Sales of
of Nondepreciable
Nondepreciable Property
Property

E7-6: C. Prepare the workpaper entries for the year ended

December 31, 2012.
Cost Method and Partial Equity Method
Beg. Retained Earnings – Procter (90%) 180,000
Noncontrolling Interest (10%) 20,000
Gain on Sale of Land 200,000 *

Complete Equity Method

Investment in Silex Company (90%) 180,000
Noncontrolling Interest (10%) 20,000
Gain on Sale of Land 200,000 *
* Gain recognized in consolidation less gain recognized by P Company
($300,000 - $100,000 = $200,000).
Slide
7-12
LO 1 Financial reporting objectives nondepreciable property.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
(Machinery,
(Machinery, Equipment,
Equipment, and
and Buildings)
Buildings)

Realization through Usage

A firm may sell property or equipment to an affiliate for a
price that differs from its book value.
From the view of the consolidated entity, the intercompany
gain (loss) is considered to be realized from the use of the
property or equipment in the generation of revenue. The use
is measured by depreciation adjustments.

Slide
7-13
LO 4 Intercompany gain realized through usage.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
(Machinery,
(Machinery, Equipment,
Equipment, and
and Buildings)
Buildings)

When there have been intercompany sales of depreciable

property, workpaper entries are necessary:
 To report only those gains or losses that result from the
sale of depreciable property to outside parties.
 To present property in the consolidated balance sheet at
its cost to the affiliated group.
 To present accumulated depreciation in the consolidated
balance sheet based on the cost to the affiliated group.
 To present depreciation expense in the consolidated
income statement based on the cost to the affiliated
group.
Slide
7-14
LO 2 Financial reporting objectives— depreciable property.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
(Machinery,
(Machinery, Equipment,
Equipment, and
and Buildings)
Buildings)

Workpaper Elimination Entries

Firms using the cost or partial equity method
An additional objective is to equate beginning consolidated retained
earnings with the amount of consolidated retained earnings reported
at the end of the prior reporting.
Firms using the complete equity method
This final objective is not necessary because the parent’s retained
earnings already reflects all adjustments accurately.
For upstream sales
The entries also serve to equate beginning NCI and prior ending NCI.

Slide
7-15
LO 2 Financial reporting objectives— depreciable property.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
Upstream Sale

P7-1 (Cost or Partial Equity): Powell Company owns 80% of the

outstanding common stock of Sullivan Company. On June 30, 2011,
Sullivan Company sold equipment to Powell Company for $500,000.
The equipment cost Sullivan Company $780,000 and had
accumulated depreciation of $400,000 on the date of the sale.
The management of Powell Company estimated that the equipment
had a remaining useful life of four years from June 30, 2011. In
2012, Powell Company reported $300,000 and Sullivan Company
reported $200,000 in net income from their independent
operations (including sales to affiliates but excluding dividend or
equity income from subsidiary).

Slide
7-16
LO 6 Subsidiary vs. parent as the seller.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-1: Entries on the books of Powell and Sullivan to record

the intercompany sale are:

Powell Company
Equipment 500,000
Cash 500,000

Sullivan Company
Cash 500,000
Accumulated Depreciation 400,000
Equipment 780,000
Gain on Sale of Equipment 120,000

Slide
7-17
LO 6 Subsidiary vs. parent as the seller.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-1: A. Prepare the workpaper entries necessary because of

the sale of equipment for the year ended December 31, 2011.
2011 Accumulated Carrying Depreciation
Cost Depreciation Value Life Expense
Original Cost $ 780,000 $ 400,000 $ 380,000 4 yr $ 95,000
Selling Price 500,000 500,000 4 yr 125,000
Difference $ 280,000 $ 400,000 $ (120,000) $ (30,000)

Equipment 280,000
Gain on Sale of Equipment 120,000
Accumulated Depreciation 400,000
To eliminate the intercompany gain and restore equipment to its
original cost to the consolidated entity.

Slide
7-18
LO 6 Subsidiary vs. parent as the seller.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-1: A. Prepare the workpaper entries necessary because of

the sale of equipment for the year ended December 31, 2011.
2011 Accumulated Carrying Depreciation
Cost Depreciation Value Life Expense
Original Cost $ 780,000 $ 400,000 $ 380,000 4 yr $ 95,000
Selling Price 500,000 500,000 4 yr 125,000
Difference $ 280,000 $ 400,000 $ (120,000) $ (30,000)

Accumulated Depreciation - Equipment 15,000

Depreciation Expense ($30,000/2) 15,000
To adjust depreciation expense to the correct amount to the
consolidated entity, thus realizing a portion of the gain through
usage.

Slide
7-19
LO 6 Subsidiary vs. parent as the seller.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-1: A. Prepare the workpaper entries necessary because of

the sale of equipment for the year ended December 31, 2012.
2012 Accumulated Carrying Depreciation
Cost Depreciation Value Life Expense
Original Cost $ 780,000 $ 400,000 $ 380,000 4 yr $ 95,000
Selling Price 500,000 500,000 4 yr 125,000
Difference $ 280,000 $ 400,000 $ (120,000) $ (30,000)

Equipment (to original cost) 280,000

Beg. Retained Earnings - Powell ($120,000 x80%) 96,000
Noncontrolling Interest ($120,000 x 20%) 24,000
Accumulated Depreciation - Equipment 400,000
To eliminate prior period intercompany gain and restore equipment to its
original cost to the consolidated entity.
Slide
7-20
LO 7 Computing the noncontrolling interest.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-1: A. Prepare the workpaper entries necessary because of

the sale of equipment for the year ended December 31, 2012.
2012 Accumulated Carrying Depreciation
Cost Depreciation Value Life Expense
Original Cost $ 780,000 $ 400,000 $ 380,000 4 yr $ 95,000
Selling Price 500,000 500,000 4 yr 125,000
Difference $ 280,000 $ 400,000 $ (120,000) $ (30,000)

Accumulated Depreciation - Equipment 45,000

Depreciation Expense ($120,000/4) 30,000
Beg. Retained Earnings – Powell ($15,000 x 80%) 12,000
Noncontrolling Interest ($15,000 x 20%) 3,000
To adjust depreciation for the current and prior year on equipment sold to
affiliate.
Slide
7-21
LO 7 Computing the noncontrolling interest.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-1 (variation): For the Compete Equity Method, the 2012

workpaper entries would have changed as follows:

Equipment (to original cost) 280,000

Investment in Sullivan ($120,000 x80%) 96,000
Noncontrolling Interest ($120,000 x 20%) 24,000
Accumulated Depreciation - Equipment 400,000

Accumulated Depreciation - Equipment 45,000

Depreciation Expense ($120,000/4) 30,000
Investment in Sullivan ($15,000 x 80%) 12,000
Noncontrolling Interest ($15,000 x 20%) 3,000

Slide
7-22
LO 7 Computing the noncontrolling interest.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-1 (variation): If this had been a Downstream sale, the

2012 entries would have changed as follows:

Cost or Partial Equity

Noncontrolling interest of 20% would be included in
Beginning Retained Earnings of Powell Company.

Complete Equity Method

Noncontrolling interest of 20% would be included in
Investment in Sullivan.

There is no differentiation between Controlling interest and

Noncontrolling interest with Downstream Intercompany Sales.

Slide
7-23
LO 7 Computing the noncontrolling interest.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
Year Subsequent to Intercompany Sale Upstream Sale
P7-6 (Cost Method): Pitts Company owns 80% of the common
stock of Shannon Company. The stock was purchased for
$960,000 on January 1, 2009, when Shannon Company’s retained
earnings were $675,000. On January 1, 2011, Shannon Company
sold fixed assets to Pitts Company for $960,000; Shannon
Company had purchased these assets for $1,350,000 on January
1, 2001, at which time their estimated useful life was 25 years.
The estimated remaining useful life to Pitts Company on 1/1/11 is
10 years. Both companies employ the straight-line method of
depreciation.
Required: A. Prepare a consolidated statements workpaper for
the year ended December 31, 2012.
Slide
7-24
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
P7-6 (Cost Method): Eliminations Consolidated
Income Statement Pitts Shannon Debit Credit NCI Balances
Sales $ 1,950,000 $ 1,350,000 $ 3,300,000
Dividend income 60,000 60,000 (4) -
Total revenue 2,010,000 1,350,000 3,300,000
Cost of goods sold 1,350,000 900,000 2,250,000
Other expenses 225,000 150,000 15,000 (3) 360,000
Total cost and expense 1,575,000 1,050,000 2,610,000
Net income 435,000 300,000 690,000
Noncontrolling interest 63,000 (63,000)
Net income $ 435,000 $ 300,000 $ 60,000 $ 15,000 $ 63,000 $ 627,000

Retained Earnings Statement

Retained earnings, 1/1
Pitts 1,215,000 120,000 (2) 290,400 (1) 1,397,400
12,000 (3)
Shannon 1,038,000 1,038,000 (5) -
Net income 435,000 300,000 60,000 15,000 63,000 627,000
Dividends declared (150,000) (75,000) 60,000 (4) (15,000) (150,000)
Retained earnings, 12/31 $ 1,500,000 $ 1,263,000 $ 1,218,000 $ 377,400 $ 48,000 $ 1,874,400

NCI in Consolidated Income = 20% x ($300,000 + $15,000) = $63,000

Slide
7-25
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
P7-6 (Cost Method):
Eliminations Consolidated
Balance Sheet Pitts Shannon Debit Credit NCI Balances
Inventory $ 498,000 $ 225,000 $ 723,000
Investment in S 960,000 290,400 (1) 1,250,400 (5) -
Fixed assets 2,168,100 2,625,000 390,000 (2) 5,183,100
Accum. Depreciation (900,000) (612,000) 30,000 (3) 540,000 (2) (2,022,000)
Total assets $ 2,726,100 $ 2,238,000 $ 3,884,100
-
Liabilities $ 465,600 $ 450,000 $ 915,600
Common stock 760,500 525,000 525,000 (5) 760,500
Retained earnings 1,500,000 1,263,000 1,218,000 377,400 48,000 1,874,400
NCI in net assets 30,000(2) 312,600 (5) 285,600 -
3,000 (3)
333,600 333,600
Total liab. & equity $ 2,726,100 $ 2,238,000 $ 2,483,400 $ 2,483,400 $ 3,884,100

Slide
7-26
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-6: Prepare the worksheet entries for Dec. 31, 2012.

Acquisition date retained earnings - Shannon $ 675,000

Retained earnings 1/1/12 - Shannon 1,038,000
Increase 363,000
Ownership percentage 80%
$ 290,400

1. Investment in Shannon Company 290,400

Retained Earnings – Pitts
290,400
To establish reciprocity/convert to equity

Slide
7-27
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-6: Prepare the worksheet entries for Dec. 31, 2012.

Accumulated Carrying Depreciation
Cost Depreciation Value Life Expense
Original Cost $ 1,350,000 $ 540,000 $ 810,000 10 yr $ 81,000
Selling Price 960,000 960,000 10 yr 96,000
Difference $ 390,000 $ 540,000 $ (150,000) $ (15,000)

2. Plant and Equipment 390,000

Retained Earnings – Pitts ($150,000 x 80%) 120,000
Noncontrolling Interest ($150,000 x 20%) 30,000
Accumulated Depreciation 540,000
To reduce controlling and noncontrolling interests for their shares of
unrealized intercompany profit at beg. of year, to restore fixed assets to
its book value to the selling affiliate on the date of the intercompany sale
Slide
7-28
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-6: Prepare the worksheet entries for Dec. 31, 2012.

Accumulated Carrying Depreciation
Cost Depreciation Value Life Expense
Original Cost $ 1,350,000 $ 540,000 $ 810,000 10 yr $ 81,000
Selling Price 960,000 960,000 10 yr 96,000
Difference $ 390,000 $ 540,000 $ (150,000) $ (15,000)

3. Accumulated Depreciation 30,000

Other Expenses (Depreciation Expense) 15,000
Retained Earnings – Pitts ($15,000 x 80%) 12,000
Noncontrolling Interest ($15,000 x 20%) 3,000
To reverse amount of excess depreciation recorded during year and to
recognize an equivalent amount of intercompany profit as realized
Slide
7-29
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-6: Prepare the worksheet entries for Dec. 31, 2012.

4. Dividend Income 60,000

Dividends Declared
To eliminate intercompany dividends 60,000

5. Beg. Retained Earnings - Shannon 1,038,000

Common Stock - Shannon 525,000
Investment in Shannon
Noncontrolling Interest 1,250,400
312,600
To eliminate investment account and create NCI account

Slide
7-30
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
Year Subsequent to Intercompany Sale Upstream Sale
P7-12 (Partial Equity Method): Prather Company owns 80% of
the common stock of Stone Company. The stock was purchased
for $960,000 on January 1, 2009, when Stone Company’s retained
earnings were $675,000. On January 1, 2011, Stone Company sold
fixed assets to Prather Company for $960,000; Stone Company
had purchased these assets for $1,350,000 on January 1, 2001, at
which time their estimated useful life was 25 years. The
estimated remaining useful life to Prather Company on 1/1/11 is 10
years. Both companies employ the straight-line method of
depreciation.
Required: A. Prepare a consolidated statements workpaper for
the year ended December 31, 2012.
Slide
7-31
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
P7-12 (Partial Equity Method):
Eliminations Consolidated
Income Statement Prather Stone Debit Credit NCI Balances
Sales $ 1,950,000 $ 1,350,000 $ 3,300,000
Equity in Sub. income 240,000 240,000 (1) -
Total revenue 2,190,000 1,350,000 3,300,000
Cost of goods sold 1,350,000 900,000 2,250,000
Other expenses 225,000 150,000 15,000 (3) 360,000
Total cost and expense 1,575,000 1,050,000 2,610,000
Net income 615,000 300,000 690,000
Noncontrolling interest 63,000 (63,000)
Net income $ 615,000 $ 300,000 $ 240,000 $ 15,000 $ 63,000 $ 627,000

Retained Earnings Statement

Retained earnings, 1/1
Pitts 1,505,400 120,000 (2) 12,000 (3) 1,397,400
Shannon 1,038,000 1,038,000 (4) -
Net income 615,000 300,000 240,000 15,000 63,000 627,000
Dividends declared (150,000) (75,000) 60,000 (1) (15,000) (150,000)
Retained earnings, 12/31 $ 1,970,400 $ 1,263,000 $ 1,398,000 $ 87,000 $ 48,000 $ 1,874,400

NCI in Consolidated Income = 20% x ($300,000 + $15,000) = $63,000

Slide
7-32
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
P7-12 (Partial Equity Method):
Eliminations Consolidated
Balance Sheet Prather Stone Debit Credit NCI Balances
Inventory $ 498,000 $ 225,000 $ 723,000
Investment in Stone 1,430,400 1,250,400 (4) -
180,000 (1)
Fixed assets 2,168,100 2,625,000 390,000 (2) 5,183,100
Accum. Depreciation (900,000) (612,000) 30,000 (3) 540,000 (2) (2,022,000)
Total assets $ 3,196,500 $ 2,238,000 $ 3,884,100
-
Liabilities $ 465,600 $ 450,000 $ 915,600
Common stock 760,500 525,000 525,000 (4) 760,500
Retained earnings 1,970,400 1,263,000 1,398,000 87,000 48,000 1,874,400
NCI in net assets 30,000(2) 312,600 (4) 285,600 -
3,000 (3)
333,600 333,600
Total liab. & equity $ 3,196,500 $ 2,238,000 $ 2,373,000 $ 2,373,000 $ 3,884,100

Slide
7-33
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-12: Prepare the worksheet entries for Dec. 31, 2012.

1. Equity In Subsidiary Income 240,000

Dividends Declared ($75,000 x 80%)
60,000
Investment in Stone Company
180,000
To reverse the effect of parent company entries during
the year for subsidiary dividends and income

Slide
7-34
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-12: Prepare the worksheet entries for Dec. 31, 2012.

Accumulated Carrying Depreciation
Cost Depreciation Value Life Expense
Original Cost $ 1,350,000 $ 540,000 $ 810,000 10 yr $ 81,000
Selling Price 960,000 960,000 10 yr 96,000
Difference $ 390,000 $ 540,000 $ (150,000) $ (15,000)

2. Plant and Equipment 390,000

Retained Earnings – Prather ($150,000 x 80%) 120,000
Noncontrolling Interest ($150,000 x 20%) 30,000
Accumulated Depreciation 540,000
To reduce controlling and noncontrolling interests for their shares of
unrealized intercompany profit at beg. of year, to restore fixed assets to
its book value to the selling affiliate on the date of the intercompany sale
Slide
7-35
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-12: Prepare the worksheet entries for Dec. 31, 2012.

Accumulated Carrying Depreciation
Cost Depreciation Value Life Expense
Original Cost $ 1,350,000 $ 540,000 $ 810,000 10 yr $ 81,000
Selling Price 960,000 960,000 10 yr 96,000
Difference $ 390,000 $ 540,000 $ (150,000) $ (15,000)

3. Accumulated Depreciation 30,000

Other Expenses (Depreciation Expense) 15,000
Retained Earnings – Prather ($15,000 x 80%) 12,000
Noncontrolling Interest ($15,000 x 20%) 3,000
To reverse amount of excess depreciation recorded during year and to
recognize an equivalent amount of intercompany profit as realized

Slide
7-36
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-12: Prepare the worksheet entries for Dec. 31, 2012.

4. Beg. Retained Earnings - Stone 1,038,000

Common Stock - Stone 525,000
Investment in Stone *

Noncontrolling Interest 1,250,400 **

312,600
To eliminate investment account and create NCI account

* (($1,263,000 - $675,000) x 80%) - $180,000 = $290,400 + $960,000 =

$1,250,400

** [$240,000 + ($1,038,000 - $675,000) x 20%] = $312,600

Slide
7-37
LO 6 Workpaper entries-upstream sales.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
Year Subsequent to Intercompany Sale Upstream Sale
P7-16 (Complete Equity Method): Prather Company owns 80% of
the common stock of Stone Company. The stock was purchased
for $960,000 on January 1, 2009, when Stone Company’s retained
earnings were $675,000. On January 1, 2011, Stone Company sold
fixed assets to Prather Company for $960,000; Stone Company
had purchased these assets for $1,350,000 on January 1, 2001, at
which time their estimated useful life was 25 years. The
estimated remaining useful life to Prather Company on 1/1/11 is 10
years. Both companies employ the straight-line method of
depreciation.
Required: Prepare a consolidated statements workpaper for the
year ended December 31, 2012.
Slide
7-38
LO 6 Upstream sales- complete equity method.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
P7-16 (Complete Equity Method):
Eliminations Consolidated
Income Statement Panther Stone Debit Credit NCI Balances
Sales $ 1,950,000 $ 1,350,000 $ 3,300,000
Equity in Stone income 252,000 252,000 (1) -
Total revenue 2,202,000 1,350,000 3,300,000
Cost of goods sold 1,350,000 900,000 2,250,000
Other expenses 225,000 150,000 15,000 (3) 360,000
Total cost and expense 1,575,000 1,050,000 2,610,000
Net income 627,000 300,000 690,000
Noncontrolling interest 63,000 (63,000)
Net income $ 627,000 $ 300,000 $ 252,000 $ 15,000 $ 63,000 $ 627,000

Retained Earnings Statement

Retained earnings, 1/1
Panther 1,397,400 1,397,400
Stone 1,038,000 1,038,000 (5) -
Net income 627,000 300,000 252,000 15,000 63,000 627,000
Dividends declared (150,000) (75,000) 60,000 (1) (15,000) (150,000)
Retained earnings, 12/31 $ 1,874,400 $ 1,263,000 $ 1,290,000 $ 75,000 $ 48,000 $ 1,874,400

NCI in Consolidated Income = 20% x ($300,000 + $15,000) = $63,000

Slide
7-39
LO 6 Upstream sales- complete equity method.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property
P7-16 (Complete Equity Method):
Eliminations Consolidated
Balance Sheet Panther Stone Debit Credit NCI Balances
Inventory $ 498,000 $ 225,000 $ 723,000
Investment in S 1,334,400 120,000 (2) 192,000 (1) -
12,000 (3)
1,250,400 (4)
Fixed assets 2,168,100 2,625,000 390,000 (2) 5,183,100
Accum. Depreciation (900,000) (612,000) 30,000 (3) 540,000 (2) (2,022,000)
Total assets $ 3,100,500 $ 2,238,000 $ 3,884,100
-
Liabilities $ 465,600 $ 450,000 $ 915,600
Common stock 760,500 525,000 525,000 (4) 760,500
Retained earnings 1,874,400 1,263,000 1,290,000 75,000 48,000 1,874,400
NCI in net assets 30,000(2) 312,600 (5) 285,600 -
3,000 (3)
333,600 333,600
Total liab. & equity $ 3,100,500 $ 2,238,000 $ 2,385,000 $ 2,385,000 $ 3,884,100

Slide
7-40
LO 6 Upstream sales- complete equity method.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-16: Prepare the worksheet entries for Dec. 31, 2012.

1. Equity in Subsidiary Income 252,000

Dividends Declared ($75,000 x 80%)
60,000
Investment in Stone Company
192,000
To reverse the effect of parent company entries during
the year for subsidiary dividends and income

Slide
7-41
LO 6 Upstream sales- complete equity method.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-16: Prepare the worksheet entries for Dec. 31, 2012.

Accumulated Carrying Depreciation
Cost Depreciation Value Life Expense
Original Cost $ 1,350,000 $ 540,000 $ 810,000 10 yr $ 81,000
Selling Price 960,000 960,000 10 yr 96,000
Difference $ 390,000 $ 540,000 $ (150,000) $ (15,000)

2. Plant and Equipment 390,000

Investment in Stone ($150,000 x 80%) 120,000
Noncontrolling Interest ($150,000 x 20%) 30,000
Accumulated Depreciation 540,000
To reduce controlling and noncontrolling interests for their shares of
unrealized intercompany profit at beg. of year, to restore the carrying value
of equipment to its book value on the date of the intercompany sale
Slide
7-42
LO 6 Upstream sales- complete equity method.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-16: Prepare the worksheet entries for Dec. 31, 2012.

Accumulated Carrying Depreciation
Cost Depreciation Value Life Expense
Original Cost $ 1,350,000 $ 540,000 $ 810,000 10 yr $ 81,000
Selling Price 960,000 960,000 10 yr 96,000
Difference $ 390,000 $ 540,000 $ (150,000) $ (15,000)

3. Accumulated Depreciation 30,000

Other Expenses (Depreciation Expense) 15,000
Investment in Stone Company ($15,000 x 80%) 12,000
Noncontrolling Interest ($15,000 x 20%) 3,000
To reverse amount of excess depreciation recorded during year and to
recognize an equivalent amount of intercompany profit as realized
Slide
7-43
LO 6 Upstream sales- complete equity method.
 Intercompany
Intercompany Sales
Sales of
of Depreciable
Depreciable Property
Property

P7-16: Prepare the worksheet entries for Dec. 31, 2012.

4. Beg. Retained Earnings - Stone 1,038,000

Common Stock - Stone 525,000
Investment in Stone *

Noncontrolling Interest 1,250,400 **

312,600
To eliminate investment account and create NCI account

* (($1,263,000 - $675,000) x 8)%) - $180,000 = $290,400 + $960,000 =

$1,250,400

** [$240,000 + ($1,038,000 - $675,000) x 20%] = $312,600

Slide
7-44
LO 6 Upstream sales- complete equity method.
 Calculation
Calculation And
And Allocation
Allocation Of
Of Consolidated
Consolidated
Net
Net Income;
Income; Consolidated
Consolidated Retained
Retained Earnings:
Earnings:
Complete
Complete Equity
Equity Method
Method

Under the Complete Equity Method:

 Controlling interest in consolidated net income will
always equal the net income reported by the parent.
 Consolidated retained earnings will equal the
retained earnings reported by the parent at any
point, assuming the parent has correctly adjusted
for any and all unrealized (and subsequently realized)
intercompany profit.

Slide
7-45
LO 8 Consolidated net income – complete equity method.
 Intercompany
Intercompany Interest,
Interest, Rents,
Rents, and
and Service
Service Fees
Fees

Income and expenses relating to interest, fees, and rents

should be reported in consolidation only when they arise from
transactions with parties outside the affiliated group.

Workpaper entry to eliminate intercompany interest:

Interest Income XXX
Interest Expense XXX

Workpaper entry to eliminate intercompany payables and receivables:

Notes Payable XXX
Notes Receivable XXX
Interest Payable XXX
Interest Receivable XXX
Slide
7-46
LO 10 Intercompany interest, rents, service fees.
 Intercompany
Intercompany Interest,
Interest, Rents,
Rents, and
and Service
Service Fees
Fees

Workpaper entry to eliminate intercompany rent:

Rent Income XXX
Rent Expense XXX

Intercompany Service Fees

When one affiliate charges fees to another, the form of the
eliminating entry is determined by how the transaction is
recorded by the affiliates.

Slide
7-47
LO 10 Intercompany interest, rents, service fees.
 Intercompany
Intercompany Interest,
Interest, Rents,
Rents, and
and Service
Service Fees
Fees

Eliminating entries relating to intercompany transactions depend

on how these transactions are recorded on the books of the
affiliates. In all cases the financial reporting objectives are:
 To include in revenue only the amounts that result from
transactions with parties outside the affiliated group.
 To present property in the consolidated balance sheet at its
cost to the affiliated group.
 To present accumulated depreciation in the consolidated
balance sheet based on the cost to the affiliated group.
 To present depreciation expense in the consolidated income
statement based on the cost to the affiliated group.
Slide
7-48
LO 10 Intercompany interest, rents, service fees.
 APPENDIX
APPENDIX -- Deferred
Deferred Tax
Tax Consequences
Consequences
Related
Related to
to Intercompany
Intercompany Sales
Sales of
of Equipment
Equipment

Illustration: P Company owns a 70% interest in S Company and that

on January 1, 2011, S Company sells P Company equipment with a book
value of $500,000 (original cost of $800,000 and accumulated
depreciation of $300,000) for $600,000. On January 1, 2011, the
equipment has a remaining useful life of five years and is depreciated
using the straight-line method. The marginal income tax rates for
both companies are 40% and separate income tax returns are filed.
S Company will record a gain of $100,000 on the sale of the
equipment and each year P Company will record depreciation that is
$20,000 greater than depreciation based on the cost of the
equipment to the selling affiliate. Workpaper eliminating entries in
the December 31, 2011, and December 31, 2012, consolidated
Slide
7-49
 APPENDIX
APPENDIX -- Deferred
Deferred Tax
Tax Consequences
Consequences
Related
Related to
to Intercompany
Intercompany Sales
Sales of
of Equipment
Equipment
Illustration: Workpaper eliminating entries in the December 31,
2011 consolidated statements workpapers relating to the unrealized
profit on the intercompany sale of the equipment are illustrated
below:

Slide
7-50
 APPENDIX
APPENDIX -- Deferred
Deferred Tax
Tax Consequences
Consequences
Related
Related to
to Intercompany
Intercompany Sales
Sales of
of Equipment
Equipment

Since the selling affiliate is a partially owned subsidiary (upstream

sale), the calculation of the noncontrolling interest in consolidated
income requires that the after-tax amount of gain recorded by the
subsidiary (.60 x $100,000 = $60,000) be subtracted from the
reported net income of the subsidiary and that the after-tax amount
of the gain realized through depreciation (.6 x $20,000 = $12,000)
be added to the reported net income of the subsidiary before
multiplying by the noncontrolling interest percentage. Assuming that
S Company reported net income of $144,000 in 2011, the
noncontrolling interest in consolidated income is $28,800 [.30 x
($144,000 - $60,000 + $12,000)].

Slide
7-51
 APPENDIX
APPENDIX -- Deferred
Deferred Tax
Tax Consequences
Consequences
Related
Related to
to Intercompany
Intercompany Sales
Sales of
of Equipment
Equipment
Illustration: Workpaper eliminating entries in the December 31,
2012, consolidated statements workpapers relating to the unrealized
profit on the intercompany sale of the equipment are illustrated
below:

Slide
7-52
 APPENDIX
APPENDIX -- Deferred
Deferred Tax
Tax Consequences
Consequences
Related
Related to
to Intercompany
Intercompany Sales
Sales of
of Equipment
Equipment

If the sale of equipment is downstream, no adjustments to the

reported net income of the subsidiary are necessary in the
calculation of the noncontrolling interest in consolidated income.

Slide
7-53
 APPENDIX
APPENDIX -- Deferred
Deferred Tax
Tax Consequences
Consequences
Related
Related to
to Intercompany
Intercompany Sales
Sales of
of Equipment
Equipment

Slide
7-54
 APPENDIX
APPENDIX -- Impact
Impact ofof Unrealized
Unrealized
Intercompany
Intercompany Profit
Profit on
on the
the Calculation
Calculation of
of
Deferred
Deferred Tax
Tax Consequences
Consequences Related
Related To
To
Undistributed
Undistributed Subsidiary
Subsidiary Income
Income

Before calculating the deferred tax consequences relating to

undistributed subsidiary income, the amount of undistributed
income must be adjusted for the after-tax amount of unrealized
intercompany profit recorded by the subsidiary that has been
recognized in the determination of consolidated income.

Slide
7-55
 APPENDIX
APPENDIX –– Calculations
Calculations (and
(and Allocations)
Allocations) of
of
Consolidated
Consolidated net
net Income
Income and
and Consolidated
Consolidated
Retained
Retained Earnings.
Earnings.
When the affiliated companies file separate income tax returns, the
calculations of consolidated net income and consolidated retained
earnings must be modified to incorporate income tax consequences.

 Adjustments must now be made for the after-tax amounts of

unrealized intercompany profit.

 Consolidated net income is reduced by the income tax consequence

of undistributed income for the current year.

 Consolidated retained earnings is reduced by the income tax

consequence of undistributed income from the date of acquisition to
the date of the calculation.
Slide
7-56
 Copyright
Copyright

Copyright © 2012 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act
without the express written permission of the copyright owner
is unlawful. Request for further information should be
addressed to the Permissions Department, John Wiley & Sons,
Inc. The purchaser may make back-up copies for his/her own
use only and not for distribution or resale. The Publisher
assumes no responsibility for errors, omissions, or damages,
caused by the use of these programs or from the use of the
information contained herein.

Slide
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