Advanced Acccounting Exam 2

No E6-4, E6-5

A parent company reported sales of $400,000, and its subsidiary reported sales of $350,000 for the year. During the year, the parent sold inventory to the subsidiary for $250,000. What is the amount of consolidated sales that should be reported in the consolidated income statement?

• a. $750,000

• b. $650,000

• c. $500,000

• d. $400,000

c – $500,000 = ($400,000 +$350,000 - $250,000)

Which of the following statements is correct regarding the elimination of intercompany inventory sales in the preparation of consolidated financial statements?

• a. Sales and Cost of Goods Sold must be reduced by the full intercompany sales amount.

• b. Only the parent company's ownership percentage of the intercompany sales should be eliminated.

• c. Consolidated net income must be directly reduced by the full amount of the intercompany sales.

• d. No adjustments to sales and cost of goods sold are required if the goods were sold to third parties during the same year.

a

• Choice (b) is incorrect because 100% of the internal transfer price must be completely wiped out to remove the internal transaction. You never scale down the sales elimination based on the ownership percentage.

• Choice (c) is incorrect because the consolidation entry debits Sales and credits COGS by the exact same amount. Because both revenue and expenses are reduced equally, consolidated net income remains unchanged by this specific transaction line-cleanup.

• Choice (d) is incorrect because even if all inventory was successfully sold to outside third parties by year-end, failing to eliminate the internal leg would still artificially inflate ("double count") total Sales and total COGS on the worksheet.

Nolan Company (referred to as Sailing Company in some editions) owns 100 percent of the capital stock of both Twill Corporation and Webb Corporation.

Twill purchases merchandise inventory from Webb at 140 percent of Webb's cost. During the year, Webb sold merchandise to Twill that had originally cost Webb $40,000. Twill then sold all of this merchandise to unrelated outside customers for $81,200.

In preparing the combined financial statements, Nolan's bookkeeper completely disregarded the common ownership of Twill and Webb and did not make any adjustments. In preparing the combined financial statements, what amount should be eliminated from Cost of Goods Sold (COGS)?

• a. $56,000

• b. $40,000

• c. $41,200

• d. $81,200

a

• Why this is what it asks: It wants you to calculate the intercompany transfer price (the internal invoice amount) that needs to be wiped out of the consolidated expenses ($40,000 cost × 1.40 markup = $56,000).

Nolan Company (referred to as Sailing Company in some editions) owns 100 percent of the capital stock of both Twill Corporation and Webb Corporation.

Twill purchases merchandise inventory from Webb at 140 percent of Webb's cost. During the year, Webb sold merchandise to Twill that had originally cost Webb $40,000. Twill then sold all of this merchandise to unrelated outside customers for $81,200.

By what amount was unadjusted revenue overstated in the combined income statement because the bookkeeper disregarded the common ownership?

• a. $16,000

• b. $40,000

• c. $56,000

• d. $81,200

c

The revenue would be overstated by the amount of cost of goods sold that should have been eliminated ($40,000 cost × 1.40 markup = $56,000).

Clark Company engaged in transactions with affiliates during the year, including sales to Dean Inc. (where Clark holds a non-influential 15% interest) and raw material purchases of $240,000 from Kent Corporation (a wholly owned subsidiary) with a $48,000 gross profit, leaving $60,000 in inventory at year-end. Before adjustments, Clark reported unadjusted consolidated current assets of $320,000.

The Problem Prompt

What amount should Clark report in its December 31 consolidated balance sheet for current assets?

• a. $320,000

• b. $317,000

• c. $308,000 (Correct Answer)

• d. $303,000

c

Note on the trick: The Dean Inc. data is a distractor because the 15% holding requires no intercompany profit elimination.

Net assets reported $320,000

Profit on intercompany sale $48,000

Proportion of inventory

unsold at year end ($60,000 / $240,000) x 0.25

Unrealized profit at year

end (12,000)

Amount reported in

consolidated statements $308,000

Data for subsidiaries of Dunn Corporation include shipments from Lamm to Banks of $200,000 and intercompany profit of $50,000. Year-end inventory figures include $175,000 from outside parties for Banks, $250,000 for Lamm, and $60,000 acquired by Banks from Lamm.

At December 31, what is the correct amount of inventory that should be reported on the combined balance sheet of the two subsidiaries?

• a. $425,000

• b. $435,000

• c. $470,000

• d. $485,000

c

Note on the math: The markup percentage is 25% ($50,000 / $200,000), leaving $15,000 of unrealized profit in Banks' remaining $60,000 inventory from Lamm that must be eliminated from the total.

Inventory reported by

Banks ($175,000 + $60,000) $235,000

Inventory reported by

Lamm 250,000

Total inventory reported $485,000

Unrealized profit at year

end [$50,000 x ($60,000 /$200,000)] (15,000)

Amount reported in

consolidated statements $470,000

Selected information from the separate and consolidated balance sheets and income statements of Power Inc. (referred to as Pard Corp. in some editions) and its subsidiary, Spin Company, as of December 31, 20X8, is as follows:

• Sales Revenue: Power: $200,000 | Spin: $140,000 | Consolidated: $308,000

• Accounts Receivable: Power: $26,000 | Spin: $19,000 | Consolidated: $39,000

• Inventory: Power: $30,000 | Spin: $25,000 | Consolidated: $52,000

• Spin Stockholders' Equity: $50,000

• Consolidated Patents: $20,000

• Noncontrolling Interest (NCI) in Net Assets: $14,000

What was the total amount of intercompany sales from Power to Spin during 20X8?

• a. $3,000

• b. $6,000

• c. $12,000

• d. $32,000

d

• Why: Consolidated sales should only include sales to outsiders. Adding both separate revenues yields $340,000, so the difference between that and the consolidated total ($308,000) represents the eliminated intercompany transactions ($32,000).

Selected information from the separate and consolidated balance sheets and income statements of Power Inc. (referred to as Pard Corp. in some editions) and its subsidiary, Spin Company, as of December 31, 20X8, is as follows:

• Sales Revenue: Power: $200,000 | Spin: $140,000 | Consolidated: $308,000

• Accounts Receivable: Power: $26,000 | Spin: $19,000 | Consolidated: $39,000

• Inventory: Power: $30,000 | Spin: $25,000 | Consolidated: $52,000

• Spin Stockholders' Equity: $50,000

• Consolidated Patents: $20,000

• Noncontrolling Interest (NCI) in Net Assets: $14,000

At December 31, 20X8, what was the amount of Spin's intercompany payable to Power?

• a. $3,000

• b. $6,000

• c. $9,000

• d. $12,000

b

• Why: Combining separate receivables totals $45,000 ($26,000 + $19,000). Because the final consolidated sheet only reports $39,000, the remaining $6,000 was an internal group debt that had to be eliminated [5.21].

Selected information from the separate and consolidated balance sheets and income statements of Power Inc. (referred to as Pard Corp. in some editions) and its subsidiary, Spin Company, as of December 31, 20X8, is as follows:

• Sales Revenue: Power: $200,000 | Spin: $140,000 | Consolidated: $308,000

• Accounts Receivable: Power: $26,000 | Spin: $19,000 | Consolidated: $39,000

• Inventory: Power: $30,000 | Spin: $25,000 | Consolidated: $52,000

• Spin Stockholders' Equity: $50,000

• Consolidated Patents: $20,000

• Noncontrolling Interest (NCI) in Net Assets: $14,000

What is the original carrying cost to the consolidated entity of the intercompany inventory remaining in Spin's possession at year-end?

• a. $3,000

• b. $6,000

• c. $9,000

• d. $12,000

c

• Why: Spin held $12,000 of the intercompany inventory at year-end. Wiping out the $3,000 internal markup profit reveals the true manufacturing cost of $9,000 to the parent company.

Selected information from the separate and consolidated balance sheets and income statements of Power Inc. (referred to as Pard Corp. in some editions) and its subsidiary, Spin Company, as of December 31, 20X8, is as follows:

• Sales Revenue: Power: $200,000 | Spin: $140,000 | Consolidated: $308,000

• Accounts Receivable: Power: $26,000 | Spin: $19,000 | Consolidated: $39,000

• Inventory: Power: $30,000 | Spin: $25,000 | Consolidated: $52,000

• Spin Stockholders' Equity: $50,000

• Consolidated Patents: $20,000

• Noncontrolling Interest (NCI) in Net Assets: $14,000

What is the noncontrolling interest (NCI) ownership percentage in Spin Company?

• a. 10%

• b. 20%

• c. 25%

• d. 30%

b

• Why: The noncontrolling interest's share of Spin's total adjusted book value is calculated by taking the $14,000 NCI and dividing it by Spin's combined equity and patent value ($70,000), which equals 0.20 or 20%.

Selected information from the separate and consolidated balance sheets and income statements of Power Inc. (referred to as Pard Corp. in some editions) and its subsidiary, Spin Company, as of December 31, 20X8, is as follows:

• Sales Revenue: Power: $200,000 | Spin: $140,000 | Consolidated: $308,000

• Accounts Receivable: Power: $26,000 | Spin: $19,000 | Consolidated: $39,000

• Inventory: Power: $30,000 | Spin: $25,000 | Consolidated: $52,000

• Spin Stockholders' Equity: $50,000

• Consolidated Patents: $20,000

• Noncontrolling Interest (NCI) in Net Assets: $14,000

Over how many total years has Power Inc. chosen to amortize its patents?

• a. 10 years

• b. 14 years

• c. 15 years

• d. 20 years

b

0.20 = $14,000 / [(Stockholders’ Equity $50,000) +(Patent $20,000)]

Red Company owns a 60 percent controlling interest in Blue Corporation. During the year, Blue produced inventory at a cost of $47,000 and sold it to Red for $60,000. Red subsequently sold all of this inventory to unrelated outside parties (non-affiliates) for $86,000.

Question 1

Question: What amount of sales revenue should be reported in the consolidated income statement for the year?

• a. $60,000

• b. $146,000

• c. $86,000

• d. $26,000

c

The only sales recorded are sales to non-affiliates.

Red Company owns a 60 percent controlling interest in Blue Corporation. During the year, Blue produced inventory at a cost of $47,000 and sold it to Red for $60,000. Red subsequently sold all of this inventory to unrelated outside parties (non-affiliates) for $86,000.

What amount of cost of goods sold (COGS) should be reported in the consolidated income statement for the year?

• a. $60,000

• b. $47,000

• c. $13,000

• d. $107,000

b

The amount of cost of goods sold is the cost at which Blue had produced the inventory.

Red Company owns a 60 percent controlling interest in Blue Corporation. During the year, Blue produced inventory at a cost of $47,000 and sold it to Red for $60,000. Red subsequently sold all of this inventory to unrelated outside parties (non-affiliates) for $86,000.

What amount of consolidated net income should be assigned to the controlling interest (the parent company)?

• a. $39,000

• b. $33,800

• c. $28,600 (Correct Answer)

• d. $23,400

c

c – Total income ($86,000 - $47,000) $39,000

Income assigned to noncontrolling

interest [0.40($86,000 - $60,000)] (10,400)

Consolidated net income assigned

to controlling interest $28,600

Question: Water Company owns 80 percent of Fire Company's outstanding common stock. On December 31, 20X9, Fire sold equipment to Water at a price in excess of Fire's carrying amount but less than its original cost. On a consolidated balance sheet at December 31, 20X9, the carrying amount of the equipment should be reported at:

• a. Water's original cost.

• b. Fire's original cost.

• c. Water's original cost less Fire's recorded gain.

• d. Water's original cost less 80 percent of Fire's recorded gain.

c

Question: When preparing consolidated financial statements following a business combination, which valuation basis must be applied to the subsidiary’s acquired assets and liabilities on the acquisition date?

• a. The historical book value of the assets only.

• b. The historical book value of the liabilities only.

• c. The carrying values on the seller's books for both assets and liabilities.

• d. The acquisition-date fair values of both assets and liabilities.

d

Question: A parent company sold equipment to its subsidiary at a gain. The equipment had been owned by the parent for two years of its original five-year life. Over what period or at what rate should the intercompany gain be recognized in the consolidation process?

• a. Over the original five-year life of the asset.

• b. Over the remaining useful life of three years (33 1/3% per year)

• c. Decreased over the two years for which the equipment was already owned.

• d. Entirely in the year of the intercompany transfer.

b

Question: On January 1, 20X0, Poe Corporation sold a machine for $900,000 to Saxe Corporation, its wholly owned subsidiary. Poe had originally paid $1,100,000 for this machine, which had accumulated depreciation of $250,000 on the transfer date. Poe estimated a $100,000 salvage value and depreciated the machine on a straight-line basis over 20 years, a policy that Saxe continues. In the consolidated balance sheet at December 31, 20X0, this machine should be included in cost and accumulated depreciation at what respective amounts?

• a. Cost: $1,100,000 | Accumulated Depreciation: $300,000

• b. Cost: $1,100,000 | Accumulated Depreciation: $290,000

• c. Cost: $900,000 | Accumulated Depreciation: $40,000

• d. Cost: $850,000 | Accumulated Depreciation: $42,500

a

Question: Pirn Company owns a controlling interest in Scroll Corporation. During the year, Pirn recorded depreciation expense of $40,000 on its books, and Scroll recorded depreciation expense of $10,000. Scroll's depreciation includes a $3,000 excess depreciation charge resulting from an intercompany equipment transfer at a gain. What amount of depreciation expense should be reported in the consolidated income statement?

• a. $50,000

• b. $47,000

• c. $40,000

• d. $43,000

b

Depreciation expense recorded by Pirn $40,000

Depreciation expense recorded by Scroll 10,000

Total depreciation reported $50,000

Adjustment for excess depreciation charged

by Scroll as a result of increase in

carrying value of equipment due to gain

on intercompany sale ($12,000 / 4 years) (3,000)

Depreciation for consolidated statements $47,000

Top Corporation owns 90 percent of Gold Company’s common stock. On January 1, 20X6, Gold Company sold computer equipment to TLK Corporation (referred to as Top Corporation or Silver Corp in some book variations/sub-parts) for $39,000. Gold had originally purchased the equipment for $40,000 on January 1, 20X4 and chose to depreciate it using the straight-line method over a 5-year useful life with no salvage value. TLK Corporation plans to depreciate the equipment over its remaining 3-year useful life.

Question: On the consolidated worksheet for Upper Company and its subsidiaries at December 31, 20X5, a consolidation entry includes a debit to the Investment in Lower Company account. This indicates that a land sale transaction between Upper and Lower took place:

• a. From Lower to Upper during 20X5.

• b. From Lower to Upper prior to 20X5.

• c. From Upper to Lower during 20X5.

• d. From Upper to Lower prior to 20X5.

d

Why: The transaction occurred prior to 20X5 because investment account debits happen in subsequent years, and the lack of non-controlling interest debit or gain account adjustments points to a downstream, prior-period transaction.

Question: Bottom Corporation incurs costs to develop specialized production equipment on its own books. It subsequently transfers this equipment to its sister subsidiary, Lower Company, at an internal markup price. From the viewpoint of the consolidated entity, how should the development costs incurred by Bottom be handled?

• a. Expensed in full as research and development (R&D) costs in the period incurred.

• b. Capitalized in full as part of the historical cost of the equipment.

• c. Amortized over the combined useful life of the equipment starting on the transfer date.

• d. Capitalized by Lower Company and depreciated under its standard policies.

a

Why: Development costs are treated as R&D and must be expensed as incurred under ASC 730-10-25-1, an accounting treatment unaffected by internal asset transfers within the corporate group.

Top Corporation owns 90 percent of Gold Company’s common stock. On January 1, 20X6, Gold Company sold computer equipment to TLK Corporation (referred to as Top Corporation or Silver Corp in some book variations/sub-parts) for $39,000. Gold had originally purchased the equipment for $40,000 on January 1, 20X4 and chose to depreciate it using the straight-line method over a 5-year useful life with no salvage value. TLK Corporation plans to depreciate the equipment over its remaining 3-year useful life.

Question: In the preparation of the consolidated financial statements on December 31, 20X6, what adjustment is required to the combined Depreciation Expense line as a result of the intercompany equipment sale?

• a. Increased by $5,000.

• b. Decreased by $5,000.

• c. Decreased by $13,000.

• d. Decreased by $8,000.

b

Why: Top Corporation records $13,000 in annual depreciation ($39,000 over 3 years), whereas Gold Company originally recorded $8,000 annually ($40,000 over 5 years), requiring a consolidated reduction of $5,000.

Top Corporation owns 90 percent of Gold Company’s common stock. On January 1, 20X6, Gold Company sold computer equipment to TLK Corporation (referred to as Top Corporation or Silver Corp in some book variations/sub-parts) for $39,000. Gold had originally purchased the equipment for $40,000 on January 1, 20X4 and chose to depreciate it using the straight-line method over a 5-year useful life with no salvage value. TLK Corporation plans to depreciate the equipment over its remaining 3-year useful life.

Question: In the consolidating worksheet elimination entries at December 31, 20X6, what worksheet adjustment must be made to the Equipment account to properly reflect its historical cost to the corporate group?

• a. Debit of $1,000.

• b. Debit of $15,000.

• c. Credit of $24,000.

• d. Debit of $40,000.

a

Why: TLK recorded the purchase at $39,000 while Gold's historical cost was $40,000, necessitating a $1,000 worksheet debit to restore the original gross historical cost.

• Gold Company (Subsidiary) sold equipment to Top Corporation (Parent) on January 1, 20X6.

• The equipment had a book value of $32,000 ($40,000 cost - $8,000 accumulated depreciation) and was sold for $39,000, resulting in an initial $15,000 unadjusted gain on Gold's books.

• During 20X6, $5,000 of that profit was realized through consolidated depreciation adjustments.

• At year-end, Gold Company reported a standalone Net Income of $45,000, and Top Corporation reported a standalone Operating Income of $85,000.

Question: What amount of consolidated net income should be assigned to the Noncontrolling Interest (NCI) for 20X6?

• a. $18,000

• b. $14,000

• c. $12,000

• d. $16,000

b

Why: Because this is an upstream sale (subsidiary to parent), the unearned gain belongs to Gold Company. The NCI is entitled to its 40% share of Gold's realized net income. Gold's book income of $45,000 is adjusted downward by the remaining unrealized gain ($15,000 total gain - $5,000 piecemeal realization = $10,000 net unrealized gain), leaving $35,000 in realized income.

35,000 × 0.40 = 14,000

• Gold Company (Subsidiary) sold equipment to Top Corporation (Parent) on January 1, 20X6.

• The equipment had a book value of $32,000 ($40,000 cost - $8,000 accumulated depreciation) and was sold for $39,000, resulting in an initial $15,000 unadjusted gain on Gold's books.

• During 20X6, $5,000 of that profit was realized through consolidated depreciation adjustments.

• At year-end, Gold Company reported a standalone Net Income of $45,000, and Top Corporation reported a standalone Operating Income of $85,000.

Question: What is the total Consolidated Net Income that should be reported for the combined entity in 20X6?

• a. $130,000

• b. $125,000

• c. $120,000

• d. $105,000

c

Why: Combined unadjusted net income is $130,000 ($85,000 parent operating income + $45,000 subsidiary net income). To prevent double-counting internal gains, the remaining $10,000 in unrealized intercompany equipment profit must be subtracted out, leaving a final consolidated total of $120,000.

In the preparation of a consolidated income statement:

a. Income assigned to noncontrolling shareholders always is computed as a pro rata portion of the reported net income of the consolidated entity.

b. Income assigned to noncontrolling shareholders always is computed as a pro rata portion of the reported net income of the subsidiary.

c. Income assigned to noncontrolling shareholders in the current period is likely to be less than a pro rata portion of the reported net income of the subsidiary in the current period if the subsidiary had an unrealized gain on an intercompany sale of depreciable assets in the preceding period. Assume the depreciable asset was subsequently sold in the current period.

d. Income assigned to noncontrolling shareholders in the current period is likely to be more than a pro rata portion of the reported net income of the subsidiary in the current period if the subsidiary had an unrealized gain on an intercompany sale of depreciable assets in the preceding period. Assume the depreciable asset was subsequently sold in the current period.

d – Only when the depreciable asset is resold to a third party in the current period will the deferred gain be realized, making NCI in income greater than a pro-rata portion of the sub’s income for the period.

(a) Incorrect. Income assigned to noncontrolling shareholders does not include income from the parent company, which would be included in consolidated income.

(b) Incorrect. Income of the subsidiary can also include unrealized gains from intercompany sales, which would be eliminated before the proportionate share is computed.

(c) Incorrect. When the asset is resold to a third party, income assigned to noncontrolling shareholders would be more than a pro rata portion of the subsidiary's reported net income, not less.

2. When a 90 percent-owned subsidiary records a gain on the sale of land to an affiliate during the current period and the land is not resold before the end of the period:

a. Ninety percent of the gain will be excluded from consolidated net income.

b. Consolidated net income will be increased by the full amount of the gain.

c. A proportionate share of the unrealized gain will be excluded from income assigned to noncontrolling interest.

d. The full amount of the unrealized gain will be excluded from income assigned to noncontrolling interest.

c – The noncontrolling shareholders will reduce their income from the subsidiary by a proportionate share of the unrealized gain. This will be a deferred gain that will subsequently be recognized when the land is later sold to a third party.

(a) Incorrect. The entire gain should be eliminated from consolidated net income, not just the 90%.

(b) Incorrect. When the gain is eliminated, consolidated net income is decreased by the full amount of the gain, not increased.

(d) Incorrect. While the entire gain is eliminated from consolidated net income, only the noncontrolling interest's proportionate share of the gain will be excluded from income assigned to noncontrolling interest.

3. Minor Company sold land to Major Company on November 15, 20X4, and recorded a gain of $30,000 on the sale. Major owns 80 percent of

Minor’s common shares. Which of the following statements is correct?

a. A proportionate share of the $30,000 must be treated as a reduction of income assigned to the noncontrolling interest in the consolidated

income statement unless the land is resold to a nonaffiliate in 20X4.

b. The $30,000 will not be treated as an adjustment in computing income assigned to the noncontrolling interest in the consolidated

income statement in 20X4 unless the land is resold to a nonaffiliate in 20X4.

c. In computing consolidated net income, it does not matter whether the land is or is not resold to a nonaffiliate before the end of the period;

the $30,000 will not affect the computation of consolidated net income in 20X4 because the profits are on the subsidiary’s books.

d. Minor’s trial balance as of December 31, 20X4, should be adjusted to remove the $30,000 gain because the gain is not yet realized.

a – Unless the land is resold in the same period the unrealized gain will have to be eliminated and a proportionate share of the gain will have to reduce NCI net income.

(b) Incorrect. The gain will have to be eliminated and reduce income unless the land is resold in the same period. The gain is not reduced if the land has been sold.

(c) Incorrect. It does matter when the land is resold because any unrealized gain will affect the computation of consolidated net income in the period.

(d) Incorrect. Without knowing whether the land had been resold as of December 31, 20X4, it cannot be determined whether the gain has been realized.

Lewis Company owns 80 percent of Tomassini Corporation’s stock. You are told that Tomassini has sold equipment to Lewis and that the following consolidation entries are needed to prepare consolidated statements for 20X9:

D Equipment 20,000

D Gain on Sale of Equipment 40,000

C Accumulated Depreciation 60,000

D Accumulated Depreciation 5,000

C Depreciation Expense 5,000

Which of the following is incorrect?

a. The parent paid $40,000 in excess of the subsidiary’s carrying amount to acquire the asset.

b. From a consolidated viewpoint, depreciation expense as Lewis recorded it is overstated.

c. The asset transfer occurred in 20X9 before the end of the year.

d. Consolidated net income will be reduced by $40,000 when these consolidation entries are made.

d – Consolidated income will be reduced by $35,000 (i.e., the gain of $40,000 will be removed, but the extra depreciation of $5,000 will also be removed, thus the net adjustment will be $35,000).

(a) Incorrect. The gain is accurately computed, which represents the excess of what was paid over the book value of the asset.

(b) Incorrect. Depreciation expense is overstated by Lewis, as evidenced by the credit to depreciation expense.

(c) Incorrect. The asset transfer must have occurred prior to year-end because of the debit to gain rather than to the investment account.

Wagner, a holder of a $1,000,000 Palmer Inc. bond, collected the interest due on March 31, 20X8, and then sold the bond to Seal Inc. for $975,000. On that date, Palmer, a 75 percent owner of Seal, had a $1,075,000 carrying amount for this bond. What was the effect of Seal’s purchase of Palmer’s bond on the retained earnings and noncontrolling interest amounts reported in Palmer’s March 31, 20X8, consolidated balance sheet? Retained Earnings Noncontrolling Interest

a. $100,000 increase No effect

b. $75,000 increase $25,000 increase

c. No effect $25,000 increase

d. No effect $100,000 increase

a – A constructive gain of $100,000 is included in consolidated net income for the period ended March 31, 20X8, and consolidated retained earnings at March 31, 20X8. Because the bonds of the parent are constructively retired, there is no effect on the amounts assigned to the noncontrolling interest since the bond was originally issued by the parent not the subsidiary. [AICPA Adapted].

(b) Incorrect. Because the bonds are constructively retired, there is no effect on the amount assigned to the noncontrolling interest. As such, the constructive gain is not proportionately allocated.

(c) Incorrect. Because the bonds are constructively retired, there is no effect on the amount assigned to the noncontrolling interest. Additionally, the constructive gain will increase the retained earnings.

(d) Incorrect. Because the bonds are constructively retired, there is no effect on the amount assigned to the noncontrolling interest. As such, the entire constructive gain results in an increase to retained earnings on the consolidated balance sheet, not an increase to the noncontrolling interest.

P Company purchased term bonds at a premium on the open market. These bonds represented 20 percent of the outstanding class of bonds issued at a discount by S Company, P’s wholly owned subsidiary. P intends to hold the bonds to maturity. In a consolidated balance sheet, the difference between the bond carrying amounts of the two companies would be

a. Included as a decrease to retained earnings.

b. Included as an increase in retained earnings.

c. Reported as a deferred debit to be amortized over the remaining life of the bonds.

d. Reported as a deferred credit to be amortized over the remaining life of the bonds.

a – The loss on bond retirement will result in a reduction in consolidated retained earnings. [AICPA Adapted]

(b) Incorrect. The difference represents a loss, which would decrease retained earnings, not increase it.

(c) Incorrect. A deferred debit does not arise in this situation. The difference results in a loss, causing a decrease in retained earnings.

(d) Incorrect. A deferred credit does not arise in this situation. The difference results in a loss, causing a decrease in retained earnings.

Kruse Corporation holds 60 percent of the voting common shares of Gary’s Ice Cream Parlors. On January 1, 20X6, Gary’s purchased $50,000 par value, 10 percent first mortgage bonds of Kruse from Cane for $58,000. Kruse originally issued the bonds to Cane on January 1, 20X4, for $53,000 (assuming a market interest rate of 9.074505 percent). The bonds have a 10-year maturity from the date of issue and pay interest semiannually on June 30th and December 31st. Gary’s reported net income of $20,000 for 20X6, and Kruse reported income (excluding income from ownership of Gary’s stock) of $40,000.

3. What amount of interest expense does Kruse record for 20X6?

a. $4,777

b. $4,767

c. $4,756

d. 4,805

Year Period Beginning Carrying Value Semiannual Interest Expense

(Carrying Value \(\times \) 4.5372525%) Semiannual Cash Interest Paid Premium Amortization

(Cash Paid - Expense) Ending Carrying Value

20X4 1 53,000.00 $2,404.74 $2,500.00 $95.26 $52,904.74

20X4 2 $52,904.74 $2,400.42 $2,500.00 $99.58 $52,805.16

20X5 3 $52,805.16 $2,395.91 $2,500.00 $104.09 $52,701.07

20X5 4 $52,701.07 $2,391.18 $2,500.00 $108.82 $52,592.25

20X6 5 $52,592.25 $2,386.24 $2,500.00 $113.76 $52,478.49

20X6 6 $52,478.49 $2,381.08 $2,500.00 $118.92 $52,359.57

b

2,385.24 + 2,3,81.08

Kruse Corporation holds 60 percent of the voting common shares of Gary’s Ice Cream Parlors. On January 1, 20X6, Gary’s purchased $50,000 par value, 10 percent first mortgage bonds of Kruse from Cane for $58,000. Kruse originally issued the bonds to Cane on January 1, 20X4, for $53,000 (assuming a market interest rate of 9.074505 percent). The bonds have a 10-year maturity from the date of issue and pay interest semiannually on June 30th and December 31st. Gary’s reported net income of $20,000 for 20X6, and Kruse reported income (excluding income from ownership of Gary’s stock) of $40,000.

4. What amount of interest income does Gary’s Ice Cream Parlors record

for 20X6?

a. $4,233

b. $5,000

c. $4,145

d. 6,000

Period Year / Date Beginning Carrying Value Interest Income

(Carrying Value \(\times \) 3.6610%) Cash Interest Received

(50,000 \(\times \) 10% \(\times \) 6/12) Premium Amortization

(Cash − Income) Ending Carrying Value

1 June 30, 20X6 $58,000.00 $2,123.38 $2,500.00 $376.62 $57,623.38

2 Dec 31, 20X6 $57,623.38 $2,109.59 $2,500.00 $390.41 $57,232.97

3 June 30, 20X7 $57,232.97 $2,095.30 $2,500.00 $404.70 $56,828.27

4 Dec 31, 20X7 $56,828.27 $2,080.48 $2,500.00 $419.52 $56,408.75

5 June 30, 20X8 $56,408.75 $2,065.12 $2,500.00 $434.88 $55,973.87

6 Dec 31, 20X8 $55,973.87 $2,049.20 $2,500.00 $450.80 $55,523.07

7 June 30, 20X9 $55,523.07 $2,032.70 $2,500.00 $467.30 $55,055.77

8 Dec 31, 20X9 $55,055.77 $2,015.59 $2,500.00 $484.41 $54,571.36

9 June 30, 20X0 $54,571.36 $1,997.86 $2,500.00 $502.14 $54,069.21

10 Dec 31, 20X0 $54,069.21 $1,979.47 $2,500.00 $520.53 $53,548.69

11 June 30, 20X1 $53,548.69 $1,960.42 $2,500.00 $539.58 $53,009.10

12 Dec 31, 20X1 $53,009.10 $1,940.66 $2,500.00 $559.34 $52,449.76

13 June 30, 20X2 $52,449.76 $1,920.18 $2,500.00 $579.82 $51,869.95

14 Dec 31, 20X2 $51,869.95 $1,898.96 $2,500.00 $601.04 $51,268.90

15 June 30, 20X3 $51,268.90 $1,876.95 $2,500.00 $623.05 $50,645.86

16 Dec 31, 20X3 $50,645.86 $1,854.14 $2,500.00 $645.86 $50,000.00

a

2123 + 2109 = 4233

Kruse Corporation holds 60 percent of the voting common shares of Gary’s Ice Cream Parlors. On January 1, 20X6, Gary’s purchased $50,000 par value, 10 percent first mortgage bonds of Kruse from Cane for $58,000. Kruse originally issued the bonds to Cane on January 1, 20X4, for $53,000 (assuming a market interest rate of 9.074505 percent). The bonds have a 10-year maturity from the date of issue and pay interest semiannually on June 30th and December 31st. Gary’s reported net income of $20,000 for 20X6, and Kruse reported income (excluding income from ownership of Gary’s stock) of $40,000.

5. What gain or loss on the retirement of bonds should be reported in the 20X6 consolidated income statement?

a. $2,423 gain

b. $5,617 gain

c. $5,408 loss

d. 8,004 loss

Period Year / Date Beginning Carrying Value Interest Income

(Carrying Value \(\times \) 3.6610%) Cash Interest Received

(50,000 \(\times \) 10% \(\times \) 6/12) Premium Amortization

(Cash − Income) Ending Carrying Value

1 June 30, 20X6 $58,000.00 $2,123.38 $2,500.00 $376.62 $57,623.38

2 Dec 31, 20X6 $57,623.38 $2,109.59 $2,500.00 $390.41 $57,232.97

3 June 30, 20X7 $57,232.97 $2,095.30 $2,500.00 $404.70 $56,828.27

4 Dec 31, 20X7 $56,828.27 $2,080.48 $2,500.00 $419.52 $56,408.75

5 June 30, 20X8 $56,408.75 $2,065.12 $2,500.00 $434.88 $55,973.87

6 Dec 31, 20X8 $55,973.87 $2,049.20 $2,500.00 $450.80 $55,523.07

7 June 30, 20X9 $55,523.07 $2,032.70 $2,500.00 $467.30 $55,055.77

8 Dec 31, 20X9 $55,055.77 $2,015.59 $2,500.00 $484.41 $54,571.36

9 June 30, 20X0 $54,571.36 $1,997.86 $2,500.00 $502.14 $54,069.21

10 Dec 31, 20X0 $54,069.21 $1,979.47 $2,500.00 $520.53 $53,548.69

11 June 30, 20X1 $53,548.69 $1,960.42 $2,500.00 $539.58 $53,009.10

12 Dec 31, 20X1 $53,009.10 $1,940.66 $2,500.00 $559.34 $52,449.76

13 June 30, 20X2 $52,449.76 $1,920.18 $2,500.00 $579.82 $51,869.95

14 Dec 31, 20X2 $51,869.95 $1,898.96 $2,500.00 $601.04 $51,268.90

15 June 30, 20X3 $51,268.90 $1,876.95 $2,500.00 $623.05 $50,645.86

16 Dec 31, 20X3 $50,645.86 $1,854.14 $2,500.00 $645.86 $50,000.00

Year Period Beginning Carrying Value Semiannual Interest Expense

(Carrying Value \(\times \) 4.5372525%) Semiannual Cash Interest Paid Premium Amortization

(Cash Paid - Expense) Ending Carrying Value

20X4 1 $53,000.00 $2,404.74 $2,500.00 $95.26 $52,904.74

20X4 2 $52,904.74 $2,400.42 $2,500.00 $99.58 $52,805.16

20X5 3 $52,805.16 $2,395.91 $2,500.00 $104.09 $52,701.07

20X5 4 $52,701.07 $2,391.18 $2,500.00 $108.82 $52,592.25

20X6 5 $52,592.25 $2,386.24 $2,500.00 $113.76 $52,478.49

20X6 6 $52,478.49 $2,381.08 $2,500.00 $118.92 $52,359.57

c – $5,408 = $58,000 purchase price - $52,592 carrying value

Kruse Corporation holds 60 percent of the voting common shares of Gary’s Ice Cream Parlors. On January 1, 20X6, Gary’s purchased $50,000 par value, 10 percent first mortgage bonds of Kruse from Cane for $58,000. Kruse originally issued the bonds to Cane on January 1, 20X4, for $53,000 (assuming a market interest rate of 9.074505 percent). The bonds have a 10-year maturity from the date of issue and pay interest semiannually on June 30th and December 31st. Gary’s reported net income of $20,000 for 20X6, and Kruse reported income (excluding income from ownership of Gary’s stock) of $40,000.

6. What amount of consolidated net income should be reported for 20X6?

a. $47,253

b. $54,410

c. $55,126

d. $60,256

c – Operating income of Kruse Corporation $40,000

Net income of Park's Ice Cream Parlors 20,000

$60,000

Less: Loss on bond retirement (5,408)

Recognition during 20X6

($4,767 - $4,233) 534

Consolidated net income $55,126

On January 1, 20X4, Passive Heating Corporation paid $104,000 for $100,000 par value, 9 percent bonds of Solar Energy Corporation. Solar had issued $300,000 of the 10-year bonds on January 1, 20X2, for $360,000. The bonds pay interest semiannually. Passive previously had purchased 80 percent of the common stock of Solar on January 1, 20X1, at underlying book value. Passive reported operating income (excluding income from subsidiary) of $50,000, and Solar reported net income of $30,000 for 20X4.

Select the correct answer for each of the following questions.

1. What amount of interest expense should be included in the 20X4 consolidated income statement?

a. $14,626

b. $18,415

c. $21,678

d. $27,112

a – $14,626 = 21,939 x ($200,000 / $300,000)

On January 1, 20X4, Passive Heating Corporation paid $104,000 for $100,000 par value, 9 percent bonds of Solar Energy Corporation. Solar had issued $300,000 of the 10-year bonds on January 1, 20X2, for $360,000. The bonds pay interest semiannually. Passive previously had purchased 80 percent of the common stock of Solar on January 1, 20X1, at underlying book value. Passive reported operating income (excluding income from subsidiary) of $50,000, and Solar reported net income of $30,000 for 20X4.

2. What amount of gain or loss on bond retirement should be included in the 20X4 consolidated income statement?

a. $4,243 gain

b. $4,243 loss

c. $12,923 gain

d. $16,115 loss

c – $12,923 = 116,923 - $104,000

On January 1, 20X4, Passive Heating Corporation paid $104,000 for $100,000 par value, 9 percent bonds of Solar Energy Corporation. Solar had issued $300,000 of the 10-year bonds on January 1, 20X2, for $360,000. The bonds pay interest semiannually. Passive previously had purchased 80 percent of the common stock of Solar on January 1, 20X1, at underlying book value. Passive reported operating income (excluding income from subsidiary) of $50,000, and Solar reported net income of $30,000 for 20X4.

3. Income assigned to the noncontrolling interest in the 20X4

consolidated income statement should be

a. $6,534.

b. $8,321.

c. $8,388.

d. $16,826.

3. b – Net income of Solar Corporation $30,000

Unrecognized portion of gain

on bond retirement ($12,923 - $1,317) 11,606

$41,606

Proportion of stock held by

noncontrolling interest x 0.20

Income to noncontrolling interest $ 8,321

Are intercompany transactions eliminated at 100% or at the ownership percentage? Which JEs involve NCI?

Always 100%, no matter the ownership %. NCI is only assigned to the sub's share of income affected (e.g. upstream transactions)

When consolidating over MULTIPLE years, what changes from the first year?

Prior-year effects flow through beginning retained earnings (and NCI), so the entries must carry forward prior-year amounts (accumulated excess amortization, prior-year deferrals)

What are the necessary steps in the consolidation process?

1) Eliminate sub's equity vs. investment 2) Allocate excess to FV adjustments and goodwill 3) Eliminate equity income and dividends 4) Eliminate intercompany transactions/balances 5) Assign income and equity to NCI

What kind of account is the noncontrolling interest (NCI)?

An equity account, shown separately within equity on the consolidated balance sheet

How do intercompany payables and receivables affect the consolidated balance sheet?

They are eliminated against each other, so neither appears

How do you compute consolidated sales revenue when there are intercompany inventory sales?

Parent sales + Sub sales - intercompany transfers (at transfer price)

What is the effect of intercompany inventory transfers between parent and sub before consolidation?

The seller books sales, COGS and gross profit. The buyer books inventory at transfer price. Sales and COGS are overstated and any unsold inventory carries unrealized profit

What is an upstream vs. downstream sale of inventory?

Upstream = Sub sells to Parent. Downstream = Parent sells to Sub

Until when must unrealized gross profit on intercompany inventory be deferred?

Until the inventory is sold to outsiders

How do you calculate unrealized gross profit?

Ending intercompany inventory (at transfer price) x seller's gross profit %

Who accrues the gross profit, and who bears the deferral, in upstream vs. downstream sales?

The seller accrues it. Downstream: all deferral is parent's. Upstream: deferral is shared between parent and NCI by ownership %

Last year's profit was deferred, but this year the goods are sold to outsiders. What is the JE?

Dr Beginning Retained Earnings (parent; plus NCI if upstream), Cr COGS

How do unrealized profits affect consolidated net income?

Deferral lowers consolidated NI in the year deferred. Realization raises it in the year the goods are sold to outsiders

What inventory-related balances appear on the consolidated balance sheet?

Inventory at the original cost to the consolidated entity (unrealized profit removed). Intercompany receivable/payable eliminated

When is an intercompany gain/loss on PPE recognized in the consolidated statements?

Only when the asset is sold to outsiders (land) or as the asset is used up over its life (depreciable equipment)

How are gains/losses on PPE handled on the individual books vs. the consolidated statements?

Recognized on the individual books of the seller. Deferred (eliminated) on the consolidated statements

How does an intercompany PPE gain impact consolidated net income?

Year of sale: NI decreases by the deferred gain. Later years: NI increases by the excess depreciation (equipment). Land: NI rises in the year it's sold outside

What is DIRECT vs. INDIRECT intercompany debt?

Direct = one affiliate lends directly to another (note between them). Indirect = an affiliate buys an affiliate's debt from an OUTSIDE party

Indirect = repurchase of debt for consolidation. Where is the debt retired?

On the consolidated financial statements (constructive retirement), NOT on the individual books

For DIRECT intercompany debt, what is done for the consolidated statements?

Reverse everything: eliminate notes receivable/payable, interest income/expense, and accrued interest receivable/payable

JEs for either direct or indirect debt: what differs between CY and PY?

CY: eliminate current-year balances, gain/loss and interest. PY: adjust beginning retained earnings (and NCI) for prior-year effects, with the CY entries on top

When do you use the Parent's JE and reversal with assigning NCI?

In INDIRECT debt only. The constructive gain/loss is assigned to the affiliate that issued the debt, so if the sub's debt was retired, NCI shares in it

How does the constructive gain/loss affect consolidated net income?

A gain increases consolidated NI and a loss decreases it, in the year of the repurchase. In later years NI is adjusted as interest expense/income no longer match (the effect reverses)