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Consolidated FS-Intercompany Transactions 2
Objectives of the Chapter
To discuss the accounting andworking paper eliminations for relatedparty transactions between a parentcompany and its subsidiaries for:
I. intercompany transactions not
involving profit or loss such as loanson promissory notes, leases ofproperty under operating leases andrendering of services;
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Consolidated FS-Intercompany Transactions 3
Objectives of the Chapter (Contd.)
II.intercompany transactions involvingprofit or loss such as intercompanysale of merchandise, plant assets,intangible assets and leases ofproperty (under capital/sales-typeleases).
P i i l ll h
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Consolidated FS-Intercompany Transactions 4
Principle to ollow to account or theintercompany transactions for theconsolidated financial statements:
The consolidated financial statementsshould include only transactionsresulting from the consolidated groupsdealings with outsiders.
P i i l t ll t t th
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Consolidated FS-Intercompany Transactions 5
Principle to ollow to account or theintercompany transactions for theconsolidated financial statements: (Contd.)
Separate ledger accounts areestablished for all intercompany assets,liabilities, revenue and expenses.
These separate accounts clearlyidentify the intercompany items that
should be eliminated in the preparationof consolidated financial statements.
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Consolidated FS-Intercompany Transactions 6
I. Accounting for Intercompany TransactionsNot Involving Profit (Gain) or Loss
loans on Notes or Open Accounts
The parent company may make
loans to its subsidiaries.The interest rate charged by the
parent company usually exceeds the
parent companys borrowing rate.
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I. Accounting for Intercompany TransactionsNot Involving Profit (Gain) or Loss (Contd.)
Intercompany ledger accounts areused by the parent and the subsidiaryto account for these intercompanytransactions in order to differentiateintercompany loans and loans withoutsiders.
E l 8 1 I t L f
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Example 8.1: Intercompany Loans fromPalm (the parent company) to Starr (thesubsidiary)
Assume that Palm Corp. made the followingcash loans to its wholly owned subsidiary,Starr Company, on promissory notes:
Date of NoteTerm of Note,
MonthsInterest Rates,
% Amount
Feb.1, 2001 6 10 $10,000
Apr.1, 2001 6 10 15,000
Sept.1, 2001 6 10 21,000
Nov.1, 2001 6 10 24,000
E l 8 1 I t L
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Example 8.1: Intercompany Loans romPalm (the parent company) to Starr (thesubsidiary) (Contd.)
Palm Corp. and Starr Company will use thefollowing ledger accounts to record theforegoing transactions (assuming all notes
were paid by Starr when due):PALM CORPORATIONIntercompany Notes Receivable2001 2001
02/01 10,000 10,000 08/0104/01 15,000 15,000 10/0109/01 21,00011/01 24,000
Bal on11/01 45,000
STARR COMPANYIntercompany Notes Payable
2001 2001
08/01 10,000 10,000 02/0110/01 15,000 15,000 04/01
21,000 09/0124,000 11/01
45,000 Bal on11/01
E l 8 1 I t L
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Example 8.1: Intercompany Loans romPalm (the parent company) to Starr (thesubsidiary) (Contd.)
Intercompany InterestReceivable
2001
12/31 1,100
Intercompany Interest Payable
2001
1,100 12/31
Intercompany Interest Revenue
2001
500 08/01750 10/01
1,100 12/312,350 Bal on
12/31
Intercompany Interest Expense
2001
08/01 50010/01 75012/31 1,100Bal on
12/312,350
E l 8 1 I t L
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Example 8.1: Intercompany Loans romPalm (the parent company) to Starr (thesubsidiary) (Contd.)
In the working paper for consolidatedfinancial statements for Palm andsubsidiary for the year ended12/31/2001, the foregoing ledgeraccounts appear as shown below:
E l 8 1 I t L
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Example 8.1: Intercompany Loans romPalm (the parent company) to Starr (thesubsidiary) (Contd.)
PALM CORPORATION AND SUBSIDIARYPartial Working Paper for Consolidated Financial Statements
For Year Ended December 31, 2001
PalmCorporation
StarrCompany
EliminationsInc. (Dec.)
Consolidated
IncomeStatement
Intercompanyrev. (exp.) 2,350 (2,350)Balance Sheet
Intercompanyrec. (pay.) 46,100* (46,100)
*45,000 + $1,100 = $46,100
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Discounting of Intercompany Notes
If an intercompany note receivable isdiscounted at a bank (by the payee,i.e., Palm in example 8.1), the notebecomes payable to an outsiderthebank.
Therefore, discounted intercompanynotes are not eliminated in the workingpaper.
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Example 8.2: Discounting ofIntercompany Notes
Continued with Example 8.1 and Assumedthat on 12/1/2001, Palm had discounted at a12% discount rate the $24,000 note
receivable from Starr. Palm would recordthe following entry:Cash 23,940Interest Expense($1,260 discount1,000*) 260
Intercompany Notes Receivable 24,000Intercompany Interest Revenue 200($24,000 x 0.10 x 1/12)
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Example 8.2: Discounting ofIntercompany Notes (Contd.)
To record discounting of 10%,six-monthnote receivable from Starr Companydated Nov. 1,2001, at a discount rate of12%. Cash proceeds are computed asfollows:
Maturity value of note[$24,000 + ($24,000 x 0.10 x 6/12)] 25,200
Less: Discount ($25,200 x 0.12 x 5/12) 1,260Proceeds $23,940
*Interest on note that accrues to discounting bank during discounting period.
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Example 8.2: Discounting ofIntercompany Notes (Contd.)
Palm should inform Starr of the discounting.Starr would prepare the following journalentry on 12/1/2001:
Intercompany Notes Payable 24,000Intercompany Interest Expense 200
Notes Payable 24,000
Interest Payable 200To transfer 10%, six-month note payable toPalm Corporation dated Nov. 1, 2001, fromintercompany notes to outsider notes.
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Example 8.2: Discounting ofIntercompany Notes (Contd.)
Under the note discounting assumption,the ledger accounts related to theintercompany notes would appear inthe 12/31/2001 working paper forconsolidated financial statements asfollows:
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Example 8.2: Discounting ofIntercompany Notes (Contd.)
PALM CORPORATION AND SUBSIDIARYPartial Working Paper for Consolidated Financial Statements
For Year Ended December 31, 2001Palm
CorporationStarr
CompanyEliminations
Inc. (Dec.)Consolidated
IncomeStatement
Intercompanyrev. (exp.) 2,150* (2,150)*
Balance SheetIntercompanyrec. (pay.) 21,700 (21,700) *$200 less than in illustration on page 348 because $24,000 discounted noteearned interest for one month rather than two months.
$21,000 note dated Sept. 1, 2001, plus $700 accrued interest.
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Leases of Property under OperatingLeases
When both the parent and subsidiaryaccount the lease as an operatinglease, the lessee will record the leasepayment as intercompany rentexpense, while the lessor will record thelease payment received as
intercompany rent revenue.
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Leases of Property under OperatingLeases (Contd.)
For an intercompany operating lease,there is no profit or loss involved.
The inercompany rent revenue wouldbe offset against intercompany rentexpense in the manner similar to theoffset of intercompany interest revenueand expense illustrated earlier.
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Rendering of Services
One affiliate may render services toanother and result in intercompany feerevenue and expense (i.e.,management fee charged tosubsidiaries by a parent company).
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Consolidated FS-Intercompany Transactions 22
Rendering of Services (Contd.)
The intercompany fee revenue andexpense are offset in the workingpaper.
Both the parent company and thesubsidiary should record the fee billingin the same accounting period.
I T A li bl t
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Consolidated FS-Intercompany Transactions 23
Income Texas Applicable toIntercompany Transactions
No income tax effects associated withthe elimination of the intercompanyrevenue or expenses since no profit or
loss involved in these intercompanytransactions.
It does not matter whether the parent
company and its subsidiaries fileseparate income tax returns or aconsolidated tax return.
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Consolidated FS-Intercompany Transactions 24
II. Accounting for IntercompanyTransactions Involving Profit (Gain) or Loss
For intercompany transactions involvingprofit or loss, the unrealized profits orlosses must be eliminated in thepreparation of consolidated financialstatements until they are realized.
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Consolidated FS-Intercompany Transactions 25
The Importance of Eliminating or IncludingIntercompany Profits (Gains) and Losses
Failure to eliminate unrealized profitsand losses would result in consolidatedincome statements that report not onlyresults of transactions with outsidersbut also the results of related partyactivities within the affiliated group.
The Importance o Eliminating or Including
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Consolidated FS-Intercompany Transactions 26
The Importance o Eliminating or IncludingIntercompany Profits (Gains) and Losses(Contd.)
Similarly, no recognition of realizedgains (losses) would misstate theconsolidated net income.
The management can manipulateconsolidated net income if unrealizedintercompany profits and losses werenot eliminated.
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Consolidated FS-Intercompany Transactions 27
Intercompany Sales of Merchandise
Types of Sales
Downstream intercompany sales
Upstream intercompany salesLateral intercompany sales
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Intercompany Sales of Merchandise(Contd.)
a. Intercompany Sales at Cost
Example 8.3: Intercompany sale at cost
Assume that Palm sold merchandisecosting $150,000 to Starr during the yearended 12/31/2001 at a selling price equalsto Palms cost.
The ending inventories of Starr on12/31/2001 included $25,000 ofmerchandise obtained form Palm.
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Consolidated FS-Intercompany Transactions 29
Intercompany Sales of Merchandise (Contd.)
Example 8.3 : (Contd.)
By 12/31/2001, Starr still owedPalm $15,000 for merchandisepurchased during 12/31/2001.
Assuming perpetual inventorysystem for both companies, thefollowing aggregate entries wouldbe prepared by both companies forthe foregoing transactions:
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Consolidated FS-Intercompany Transactions 30
Intercompany Sales of Merchandise (Contd.)
Example 8.3 : (Contd.)
Palm Corporation Journal EntriesIntercompany AccountsReceivable 150,000
Intercompany Sales 150,000
To record sales to Starr Company
Intercompany Cost of Goods Sold 150,000Inventories 150,000
To record cost of goods sold to Satrr Company.
Cash 135,000Intercompany AccountsReceivable 135,000
To record payments received from StarrCompany
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Intercompany Sales of Merchandise (Contd.)
Example 8.3 : (Contd.)
The following is a partial working paperfor consolidated financial statements ofPalm and subsidiary (include only thedata related to this intercompany saleof merchandise at cost):
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Consolidated FS-Intercompany Transactions 33
Intercompany Sales of Merchandise (Contd.)
Example 8.3 : (Contd.)
PALM CORPORATION AND SUBSIDIARYPartial Working Paper for Consolidated Financial Statements
For Year Ended December 31, 2001Palm
CorporationStarr
CompanyEliminations
Inc. (Dec.)Consolidated
IncomeStatement
Intercompanyrev. (exp.) *
Balance SheetIntercompanyrec. (pay.) 15,000 (15,000)*Palm Corporations $15,000 intercompany sales and intercompany cost ofgoods sold are offset in Palms separate income statement in the working
paper.
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Consolidated FS-Intercompany Transactions 34
Intercompany Sales of Merchandise (Contd.)
Example 8.3 : (Contd.)
Note:
Starr Companys cost of goods sold
and inventories are not affected byworking paper eliminations. BothStarrs cost of goods sold andinventories are stated at cost.
I t S l f M h di
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Consolidated FS-Intercompany Transactions 35
Intercompany Sales of Merchandise(Contd.)
b.Intercompany Sales with UnrealizedIntercompany Profit in EndingInventories
Without the working paper elimination,the consolidated ending inventory andcost of goods sold are both overstated.
Intercompany Sales of Merchandise
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Consolidated FS-Intercompany Transactions 36
Intercompany Sales of Merchandise(Contd.)
The ending inventory is overstated forthe mark up of the unsold endinginventory (the unrealized gain).
The cost of goods sold is overstated forthe mark up of the cost of goods sold(the realized gain).
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I t S l f M h di (C td )
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Consolidated FS-Intercompany Transactions 38
Intercompany Sales of Merchandise (Contd.)
Example 8.4: (Contd.)
On 12/31/2001, Post still owed$30,000 to Sage for merchandise.Both companies use the perpetualinventory system.
The foregoing transactions are
recorded in summary form by thetwo companies as follows:
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Consolidated FS-Intercompany Transactions 39
Intercompany Sales of Merchandise (Contd.)
Example 8.4 : (Contd.)
Post Company Journal EntriesInventories 120,000
Intercompany AccountsPayable 120,000
To record purchases from Sage.Intercompany Accounts Payable 90,000
Cash 90,000To record payments made to Sage Company.
Trade Accounts Receivable 100,000Sales 100,000
To record sales.
Cost of Goods Sold 80,000Inventories 80,000
To record cost of goods sold.
I S l f M h di (C d )
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Consolidated FS-Intercompany Transactions 40
Intercompany Sales of Merchandise (Contd.)
Example 8.4 : (Contd.)
Sage Corporation Journal EntriesIntercompany AccountsReceivable 120,000
Intercompany Sales 120,000
To record sales to Post CorporationIntercompany Cost of Goods Sold 96,000
Inventories 96,000To record cost of goods sold to PostCorporation.
Cash 90,000Intercompany AccountsReceivable 90,000
To record payments received from PostCorporation.
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I t S l f M h di (C td )
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Consolidated FS-Intercompany Transactions 42
Intercompany Sales of Merchandise (Contd.)
Example 8.4 : (Contd.)
The following working paper elimination isrequired for Sages intercompanys sales ofmerchandise to Post for the year ended
12/31/2001:(b) Intercompany Sales--Sage 120,000Intercompany Cost ofGoods SoldSage 96,000
Cost of Goods SoldPost 16,000Inventories--Post 8,000To eliminate intercompany sales, cost ofgoods sold, and unrealized intercompanyprofit in inventories. (Income tax effects aredisregarded.)
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I t S l f M h di (C td )
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Consolidated FS-Intercompany Transactions 44
Intercompany Sales of Merchandise (Contd.)
Example 8.4 : (Contd.)
IncomeStatement
PostCorp.
SageCompany
EliminationsInc.(Dec.)
Consolidated
Revenue:Sales: 5,800,000 1,200,000 7,000,000Intercompanysales 120,000 (b)(120,000)
Costs and
expenses:Cost of goodssold 4,100,000 760,000 (b) (16,000) 4,844,000
Intercompanycost of goods
sold 96,000 (b) (96,000)
POST CORPORATION AND SUBSIDIARYPartial Working Paper for Consolidated Financial StatementsFor Year Ended December 31, 2001
I t S l f M h di (C td )
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Consolidated FS-Intercompany Transactions 45
Intercompany Sales of Merchandise (Contd.)
Example 8.4 : (Contd.)
Contd.
PostCorp.
SageCompany
EliminationsInc.(Dec.)
Consolidated
Balance SheetAssets
Intercompanyrec.(pay.) (30,000) 30,000
Inventories 900,000 475,000 (b) (8,000) 1,367,000
Notes to the Intercompany ales o
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Consolidated FS-Intercompany Transactions 46
Notes to the Intercompany ales oMerchandise at a Mark Up by a PartiallyOwn Subsidiary
1.The $8,000 unrealized intercompanyprofit is attributable to Sage (the seller,a partially-owned subsidiary).
This unrealized intercompany profitshould be taken into account in thecomputation of the minority interest in
Sages net income for year 2001 (wouldbe illustrated in Example 8.9).
Notes to the Intercompany Sales of
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Consolidated FS-Intercompany Transactions 47
Notes to the Intercompany Sales ofMerchandise at a Mark Up by a PartiallyOwn Subsidiary (Contd.)
2.Also, this $8,000 would be entered into theSages portion of consolidated retainedearnings on 12/31/2001.
3.If the intercompany sales of merchandiseare made by a parent company or by awholly owned subsidiary, the unrealized
intercompany profit will not have any effecton any minority interest in net income.
This is because the selling agent does nothave minority stockholders.
I t (U li d) P fit i
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Consolidated FS-Intercompany Transactions 48
Intercompany (Unrealized) Profit inBeginning and Ending Inventories
It is assumed that, on a FIFO basis, theintercompany profit in the purchasersbeginning inventories is realized
through sales of the merchandise tooutsiders during the followingaccounting period.
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Intercompany (Unrealized) Profit in
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Consolidated FS-Intercompany Transactions 50
Intercompany (Unrealized) Profit inBeginning and Ending Inventories(contd.)
Analysis of Gross Profit
SellingPrice
Cost
Gross Profit(25% of Cost;20%Of Selling
Price)
Beginning inventories $40,000 $32,000 $8,000Add: Sales 150,000 120,000 30,000
Subtotals $190,000 $152,000 $38,000Less: Endinginventories 60,000 48,000 12,000
Cost of goods sold $130,000 $104,000 $26,000
Intercompany (Unrealized) Profit in
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Consolidated FS-Intercompany Transactions 51
Intercompany (Unrealized) Profit inBeginning and Ending Inventories(contd.)
Sages intercompany sales ($120,000)and intercompany cost of goods sold($96,000) for the year ended
12/31/2001 had been closed to Sagesretained earnings at the end of 2001.
Thus, from a consolidated point of view
Sages 12/31/2001 retained earningswas overstated by $7,600 (95% *$8,000).
Intercompany (Unrealized) Profit in
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Consolidated FS-Intercompany Transactions 52
Intercompany (Unrealized) Profit inBeginning and Ending Inventories(contd.)
The remaining $400 unrealized profit on12/31/2001 is attributable to theminority interest in net assets of Sage.
The following working paper elimination
would be prepared on 12/31/2002 toreflect the above facts:
Intercompany (Unrealized) Profit in
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Intercompany (Unrealized) Profit inBeginning and Ending Inventories(contd.)
(b) Retained EarningsSage($8,000 x 0.95)* 7,600Minority Interest in Net Assets ofSubsidiary($8,000 x 0.05)
400
Intercompany Sales--Sage 150,000Intercompany Cost of Goods Sold-Sage 120,000
Cost of Goods SoldPost 26,000
InventoriesPost 12,000
To eliminate intercompany sales, cost of goods sold,and unrealized intercompany profit in inventories.(Income tax effects are disregarded.)
*As indicated in Chapter 7 (Page 29), this elimination is posted to the beginning-of-year retained
earnings in the statement of retained earnings section of the working paper for consolidatedfinancial statements.
Issues in Intercompany Profit in Ending
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Consolidated FS-Intercompany Transactions 54
Issues in Intercompany Profit in EndingInventories and Amount of MinorityInterest A general principle is that all the
unrealized intercompany profit in theending inventory of the buyer (i.e., a
partially owned or wholly ownersubsidiary or a parent), should beeliminated for the consolidated financialstatement as long as the selleris either
the parentor other whollyownedsubsidiaries.
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Issues in Intercompany Profit in Ending
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Consolidated FS-Intercompany Transactions 56
Issues in Intercompany Profit in EndingInventories and Amount of MinorityInterest (Contd.) The argument is :
The intercompany sale to the minoritystockholder is considered as a sale to
outsiders.Therefore the unrealized intercompanyprofit in the ending inventory attributes tominority stockholders interest should betreated as realized.
It should not to be eliminated in theconsolidated financial statements.
Issues in Intercompany Profit in Ending
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Consolidated FS-Intercompany Transactions 57
Issues in Intercompany Profit in EndingInventories and Amount of MinorityInterest (Contd.)
The following table illustrates the typesof intercompany sales and the relatedissues of the unrealized intercompany
profit in the ending inventory:
ssues n n ercompany ro n n ngI t i d A t f Mi it
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ssues n n ercompany ro n n ngInventories and Amount of MinorityInterest (Contd.)
Type Seller Buyer Issue CurrentPractice
A Parent orwhollyownSubsidiary
Partially-ownsubsidiary
Should allunrealizedintercompanyprofit in theending inventoryof the buyerbeeliminated?
All unrealizedintercompanyprofit in theendinginventory iseliminated
B
(as inExample8.4)
Partially-
owna
subsidiary
Parent or
subsidiary
Should all
unrealizedintercompanyprofit in theending inventoryof the buyer beeliminated?
Same as for
type A due toFASBspreference
ssues n n ercompany ro n n ng
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Consolidated FS-Intercompany Transactions 59
ssues n n ercompany ro n n ngInventories and Amount of MinorityInterest (Contd.)Note to the above table:
a.The unrealized intercompany profit is
attributable to the seller(the partially-own sub.) and must be considered inthe computation of the minority interestin net income of the partially own sub.of the year (see Example 8.4 andExample 8.9).
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Consolidated FS-Intercompany Transactions 60
Intercompany Sales of Plant Assets
Intercompany sales of plant assetsdiffer from intercompany sales ofmerchandise in two ways:
1. Intercompany sales of plant assetsbetween affiliated companies arerare transactions.
Intercompany Sales of Plant Assets
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Consolidated FS-Intercompany Transactions 61
Intercompany Sales of Plant Assets(Contd.)
2. Due to the long economic lives ofplant assets, it requires manyaccounting periods before the
intercompany gains (losses) onsales of these assets are realized intransactions with outsiders.
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Consolidated FS-Intercompany Transactions 62
Intercompany Gain on Sale of Land
Example 8.5:
Assume that on 12/31/2001, Post (the
parent company) sold to Sage (thepartially owned subsidiary) a parcel ofland costing $125,000 for $175,000.The two companies would record thefollowing entries:
Intercompany Gain on Sale of Land (Contd )
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Consolidated FS-Intercompany Transactions 63
Intercompany Gain on Sale of Land (Contd.)
Example 8.5: (Contd.)
Post Corporation Journal Entry Sage Company Journal Entry
Cash 175,000 Land 175,000
Land 125,000 Cash 175,000
IntercompanyGain on Saleof Land 50,000
To record acquisition ofland from PostCorporation.
To record sale of land toSage Company
Intercompany Gain on Sale of Land (Contd.)
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Consolidated FS-Intercompany Transactions 64
Intercompany Gain on Sale of Land (Contd.)
Example 8.5: (Contd.)
In the consolidated financial statement,the land should be reported at thehistorical cost and the intercompany
gain should be eliminated until it isrealized (i.e., sold to an outsider bySage).
Intercompany Gain on Sale of Land (Contd.)
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Consolidated FS-Intercompany Transactions 65
Intercompany Gain on Sale of Land (Contd.)
Example 8.5: (Contd.)
The working paper elimination preparedon 12/31/2001 for the intercompanysale of land with gain transaction is as
follows:(c) Intercompany Gain on Sale
of LandPost50,000
Land--Sage 50,000To eliminate unrealized intercompanygain on Sale of land. (Income Taxeffects are disregarded.)
Intercompany Gain on Sale of Land (Contd.)
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Consolidated FS-Intercompany Transactions 66
Intercompany Gain on Sale of Land (Contd.)
Example 8.5: (Contd.)
The above working paper elimination isentered in the working paper forconsolidated financial statements for
the year ended 12/31/2001 as follows:
Intercompany Gain on Sale of Land (Contd.)
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Intercompany Gain on Sale of Land (Contd.)
Example 8.5: (Contd.)
POST CORPORATION AND SUBSIDIARYPartial Working Paper for Consolidated Financial Statements
For Year Ended December 31, 2001
Post
Corp.
Sage
Company
Eliminations
Inc. (Dec.)
Consolidated
IncomeStatement
Intercompany gainon sale of land 50,000 (c)(50,000)Balance Sheet
Land (for buildingsite) 175,000 (c)(50,000) 125,000
Intercompany Gain on Sale of Land (Contd.)
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Intercompany Gain on Sale of Land (Contd.)
Example 8.5: (Contd.)
No journal entries affecting land wouldbe made by Sage in the subsequentyears due to land is not depreciable.
In the consolidated financial statementsof subsequent years, the land shouldalways be reported at the historical cost
of $125,000 as long as it is not sold toan outsider.
Intercompany Gain on Sale of Land (Contd.)
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Consolidated FS-Intercompany Transactions 69
Intercompany Gain on Sale of Land (Contd.)
Example 8.5: (Contd.)
Therefore, the following working paperelimination applies to all subsequentyears as long as Sage does not sell the
land to an outsider:(c) Retained EarningsPost 50,000
LandSage 50,000
To eliminate unrealized intercompanygain in land. (Income tax effects aredisregarded.)
Intercompany Gain on Sale of Land (Contd.)
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p y ( )
Example 8.5: (Contd.)
Note: The foregoing working paperelimination has no effect on the minorityinterest in net income or net assets of
the subsidiary, because the unrealizedgain is attributable to the seller that isnot a partially own subsidiary.
Intercompany Gain on Sale of Land (Contd.)
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Consolidated FS-Intercompany Transactions 71
p y ( )
Example 8.5: (Contd.)
Assume that, Sage sold the land to anoutsider for $200,000 in the year ended12/31/2003, the following entry would
be recorded by Sage:
Cash 200,000
Land 175,000
Gain on Sale of Land 25,000To record sale of land to anoutsider.
Intercompany Gain on Sale of Land (Contd.)
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Consolidated FS-Intercompany Transactions 72
p y ( )
Example 8.5: (Contd.)
A realized gain of $75,000 ($25,000 +$50,000) should be reported on theconsolidated financial statement of
2002. Thus, the following workingpaper elimination is needed:(c) Retained EarningsPost 50,000
Gain on Sale of Land
Post 50,000To recognize $50,000 gain on PostCorporations sale of land to SageCompany resulting from sale of landby Sage to an outsiders. (Income taxeffects are disregarded.)
Intercompany Gain on Sale of
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Consolidated FS-Intercompany Transactions 73
Intercompany Gain on Sale ofDepreciable Plant Asset
Assume that Sage (the partially ownedsubsidiary) sold machinery to Post (theparent) on 12/31/2001. Details of the
sale and depreciation policy of themachinery are as follows:
Intercompany Gain on Sale of
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Consolidated FS-Intercompany Transactions 74
Intercompany Gain on Sale ofDepreciable Plant Asset (Contd.)
Selling price of machinery to Post Corp. $ 60,000Cost of machinery to Sage Companywhen acquired Jan. 2,1999 50,000
Estimated residual value:
To Sage Company, Jan.2,1999 $ 4,000To Post Corporation, Dec. 31,2001 4,000Economic life:
To Sage Company, Jan.2,1999 10 years
To Post Corporation, Dec. 31,2001 5 yearsAnnual depreciation expense (straight-line method):
To Sage Company ($46,000 x 0.10) $ 4,600To Post Corporation($56,000 x 0.20) 11,200
Intercompany Gain on Sale of
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Consolidated FS-Intercompany Transactions 75
Intercompany Gain on Sale ofDepreciable Plant Asset (Contd.)
Post Corp. Journal Entry Sage Company Journal EntryMachinery 60,000 Cash 60,000
Cash 60,000 AccumulatedDepreciation($4,600 x 3) 13,800
Machinery 50,000To record acquisition ofmachinery from SageCompany.
IntercompanyGain on Saleof Machinery 23,800
To record sale of machinery
to Post Corp..
The two companies would account for thesale on 12/31/2001 as follows:
Intercompany Gain on Sale of
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Consolidated FS-Intercompany Transactions 76
Intercompany Gain on Sale ofDepreciable Plant Asset (Contd.) The following working paper elimination
is required for the consolidated financialstatements on 12/31/2001:
(d) Intercompany Gain on Sale ofMachinerySage
23,800
Machinery-Post 23,800To eliminate unrealized intercompany gain on sale
of machinery.(Income tax effects are disregarded.)
Intercompany Gain on Sale of
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Consolidated FS-Intercompany Transactions 77
Intercompany Gain on Sale ofDepreciable Plant Asset (Contd.) The elimination results the machine to
be reported on the consolidatedfinancial statements at its carrying
amount to Sage as follows:Cost of machinery to Post Corporation $ 60,000
Less:Amount of elimination
intercompany gain 23,800Differenceequal to carrying amount
$ 36,200
Intercompany Gain on Sale of
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te co pa y Ga o Sa e oDepreciable Plant Asset (Contd.) Note: the elimination of the $23,800
gain should be taken into account in theminority interest in the net income of
Sage (the seller) for year 2001. The$23,800 is also included in the Sagesretained earnings, for consolidationpurposes, on 12/31/2001 I (see
textbook 376-378).
Intercompany Gain subsequent to Date of
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Consolidated FS-Intercompany Transactions 79
Intercompany Gain subsequent to Date ofSale of Depreciable Plant Asset
The following working paper eliminationis required for the consolidated financialstatements of 12/31/2002:
(d) Retained EarningsSage
($23,800 x 0.95)
22,610
Minority Interest in Net Assets ofSubsidiary ($23,800 x 0.05) 1,190
Accumulated DepreciationPost 4,760
MachineryPost 23,800Depreciation Expense-Post 4,760To eliminate unrealized intercompany gain inmachinery and in related depreciation.(Income taxeffects are disregarded.) Gain element in straight-line depreciation computed as $23,800 x 0.2 =
$4,760,based on five-year economic life.
Intercompany Gain subsequent to Date of
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Consolidated FS-Intercompany Transactions 80
Intercompany Gain subsequent to Date ofSale of Depreciable Plant Asset (Contd.)
The elimination of the Postsdepreciation expense can also beverified as follows:
Posts annual straight-line depreciationexpense [($60,000-$4,000) x 0.2] $ 11,200Less:Straight-line depreciation expensefor a five-year economic life, based onSages carrying amount on date of sale[(36,200-$4,000) x 0.20] 6,440
Differenceequal to intercompany gainelement in Posts annual depreciationexpense $ 4,760
Intercompany Gain in Depreciation
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Consolidated FS-Intercompany Transactions 81
p y pand Minority Interest
From the consolidation view point, theintercompany gain element of theacquiring affiliates annual depreciation
expense represents a realization of aportion of the total intercompany gainby the selling affiliate .
Intercompany Gain in Depreciation
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Consolidated FS-Intercompany Transactions 82
p y pand Minority Interest (Contd.)
Thus the $4,760 credit to Postsdepreciation expense in the 12/31/2001working paper elimination increases
Sages net income for consolidatedpurposes.
This increase must be considered in thecomputation of the minority interest inthe subsidiarys net income for the yearended 12/31/2002.
Intercompany Gain in later Years
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Consolidated FS-Intercompany Transactions 83
Intercompany Gain in later Years
The following working paper eliminationis required for the consolidated financialstatements on 12/31/2003:
(d) Retained EarningsSage[($23,800-$4,760) x 0.95]
18,088
Minority Interest in Net Assets ofSubsidiary [($23,800-$4,760) x 0.05] 952
Accumulated DepreciationPost
($4,760 x 2)
9,520
MachineryPost 23,800Depreciation Expense-Post 4,760
To eliminate unrealized intercompany gain inmachinery and in related depreciation.(Income tax
effects are disregarded.)
Intercompany Gain in later Years
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Consolidated FS-Intercompany Transactions 84
p y(Contd.)
Note to the working paper elimination:The sum of the debit amounts forretained earnings and minority interest
in net assets of subsidiary is $4,760less that that in 2002.
This is because $4,760 intercompany
gain has been realized in 2002 throughthe depreciation process in 2002.
Intercompany Gain in later Years
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Consolidated FS-Intercompany Transactions 85
p y(Contd.) The sum of the debit amounts for retainedearnings and minority interest in net
assets represents the unrealized portionof the intercompany gain at the beginning
of the year. For each succeeding year, the unrealized
position of the intercompany gain
decreases (in the amount of $4,760), asindicated in the following summary of theworking paper elimination debits for thoseyears:
Intercompany Gain in later Years
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Consolidated FS-Intercompany Transactions 86
p y(Contd.)
POST CORPORATION AND SUBSIDIARYPartial Working Paper Eliminations-Debits OnlyDecember 31,2004 though 2006
Year Ended Dec. 31,2004 2005 2006
Debits(d)Retained earnings-
Sage $13,566 $ 9,044 $ 4,522Minority interest in
net assets ofsubsidiary 714 476 238
Accumulateddepreciation-Post 14,280 19,040 23,800
Intercompany Gain in later Years
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Consolidated FS-Intercompany Transactions 87
p y(Contd.)
Similar working paper elimination willbe prepared for year 2004,2005 and2006. The changes are only in the debit
accounts as indicated in the abovetable.
Intercompany Gain in later Years
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Consolidated FS-Intercompany Transactions 88
p y(Contd.) At the end of year 2006, the entire
intercompany gain of $23,800 has beenrealized through Posts annual depreciationexpense. The following working paperelimination is required for the machine until itis sold:
Accumulated Depreciation-
Post
23,800
Machinery-Psot 23,800To eliminate intercompany gain inmachinery and related accumulateddepreciation.(Income tax effects are
disregarded.)
Intercompany Lease of Property under
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Consolidated FS-Intercompany Transactions 89
p y p yCapital/Sale-Type Lease
Land, building, machinery, equipmentand other property may be transferredbetween affiliate entities in the form of a
sales-type lease to the lessor and acapital lease to the lessee.
Intercompany Lease of Property under
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Consolidated FS-Intercompany Transactions 90
p y p yCapital/Sale-Type Lease (Contd.)
Example 8.6 :Assume that Palm leased equipment
to Starr (the wholly owned subsidiary)
on 1/2/2001 under a sales-type leaserequiring Starr to pay Palm $10,000at beginning of each year starting1/2/2001 through 2004, with abargain purchase option of $1,000payable on 1/2/2005.
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 91
yp ( )
Example 8.6: (Contd.)
Palms implicit interest rate, which wasknown to Starr and was less thanStarrs incremental borrowing rate, was8%.
The economic life of the equipment toStarr was 6 years, with no residualvalue.
The cost of the leased equipment was$30,000.
There were no initial direct costs underthe lease.
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 92
Type Lease (Contd.)
Example 8.6: (Contd.)
The present value of the minimumlease payment is computed as follows:
Present value of $10,000 each year forfour years at 8% ($10,000 x 3.577097) $ 35,711Present value of $1,000 in four years at8%(1,000 x 0.735030) 735
Palm Corporations net investment in thelease $ 36,506
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 93
ype ease (Co td )
Example 8.6: (Contd.) Journal entries of Palm Corporation for Year
2001:
1/2 Intercompany Lease Receivables[($10,000 x 4)+$1,000] 41,000
Intercompany Cost of Goods Sold 30,000Intercompany Sales 36,506Unearned IntercompanyInterest Revenue ($41,000-$36,506) 4,494
Inventories 30,000To record Sales-type lease with StarrCompany at inception and cost of leasedequipment.
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 94
yp ( )
Example 8.6: (Contd.) Contd.
1/2 Cash 10,000Intercompany Lease Receivable 10,000
To record receipt of first payment onintercompany lease.
12/31 Unearned Intercompany InterestRevenue [(31,000-$4,494) x 0.08]
2,120
Intercompany Interest Revenue 2,120
To recognize interest earned for first year ofintercompany sales-type lease.
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 95
yp ( )
Example 8.6: (Contd.) Journal entries of Starr Company for Year 2001:
1/2 Lease Equipment-Capital Lease 36,506Intercompany Liability underCapital Lease (net) 36,506
To record intercompany capital lease atinception.
1/2 Intercompany Liability under CapitalLease(net) 10,000
Cash 10,000To record lease payment for first year ofintercompany lease.
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 96
yp ( )
Example 8.6: (Contd.) Contd.12/31 Intercompany Interest Expense
[($36,506-$10,000) x 0.08] 2,120
Intercompany Interest Payable 2,120
To record accrued interest on intercompanylease obligation on 12/31/2001.
12/31Depreciation Expense ($36,560/6) 6,084
Lease Equipment-Capital Lease 6,084
To record depreciation expense (straight-line method) forfirst year of intercompany lease. (Six-year economic life ofleased equipment is used because lease contains a
bargain purchase option.)
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 97
yp ( )
Example 8.6: (Contd.) The selected ledger accounts for both
companies relative to the lease are as follows:PALM CORPORATION
Intercompany Lease Receivable
01/02/01 41,000a
10,000b 01/02/0110,000c 01/02/02
10,000d 01/02/0310,000e 01/02/04
1,000f 01/02/05
0Bal on 01/02/05
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 98
yp ( )
Example 8.6: (Contd.)
a. Inception of lease
b. Receipt of first payment
c. Receipt of second payment
d. Receipt of third payment
e. Receipt of fourth payment
f. Receipt of purchase option
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 99
yp ( )
Example 8.6: (Contd.)
Unearned Intercompany Interest Revenue
4,494 a 01/02/01
12/31/01 2,120b
Bal. 2,37412/31/02 1,490 c Bal. 88412/31/03 809 d Bal. 7512/31/04 75 e Bal. 0Bal on 12/31/04 0
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 100
yp ( )
Example 8.6: (Contd.)
a. Inception of lease ($41,000 - $36,506)
b. Interest for year [($31,000 - $4,494) x 0.08)]
c. Interest for year [($21,000 - $2,374) x 0.08)]
d. Interest for year [($11,000 - $884) x 0.08)]
e. Interest for year [($1,000 - $75) x 0.08)];Adjusted $1 for rounding.
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 101
y ( )
Example 8.6: (Contd.)
Intercompany Interest Revenue2,120a 12/31/01
12/31/01 2,120b
1,490c
12/31/0212/31/02 1,490d
809e 12/31/0312/31/03 809f
75g 12/31/0412/31/04 75h
Bal on 12/31/04 0
Intercompany Lease of Property under Capital/Sale-TypeLease (Contd.)
E l 8 6 (C td )
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Consolidated FS-Intercompany Transactions 102
Example 8.6: (Contd.)
a. Interest for Year 2001b. Closing entryc. Interest for Year 2002
d. Closing entrye. Interest for Year 2003f. Closing entry
g. Interest for Year 2004;Adjusted $ 1 forrounding.h. Closing entry
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 103
Example 8.6: (Contd.)
STARR COMPANYLeased EquipmentCapital Lease
01/02/01 36,506a
6,084b 12/31/016,084c 12/31/026,084d 12/31/03
6,084e
12/31/046,085f 12/31/056,085g 12/31/06
0 Bal on 01/02/06
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 104
Example 8.6: (Contd.)
a. Capital lease at Inceptionb. Depreciation for Year 2001
c. Depreciation for Year 2002
d. Depreciation for Year 2003e. Depreciation for Year 2004
f. Depreciation for Year 2001;Adjusted $1
for rounding.g. Depreciation for Year 2001;Adjusted $1
for rounding.
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Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
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Consolidated FS-Intercompany Transactions 106
Example 8.6: (Contd.)
a. Capital lease at inception
b. First lease payment
c. ($10,000-$2,120 interest)
d. ($10,000-$1,490 interest)
e. ($10,000-$890 interest)
f. ($10,000-$75 interest)
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
(C )
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Consolidated FS-Intercompany Transactions 107
Example 8.6: (Contd.)
Intercompany Interest Expense12/31/01 2,120a
2,120b 12/31/01
12/31/02 1,490c
1,490d 12/31/0212/31/03 809e
809f 12/31/0312/31/04 75g
75h 12/31/040 Bal on 12/31/04
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Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
E l 8 6 (C td )
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Consolidated FS-Intercompany Transactions 109
Example 8.6: (Contd.)
Depreciation Expense12/31/01 6,084a
6,084b 12/31/0112/31/02 6,084c
6,084d 12/31/02
12/31/03 6,084e6,084f 12/31/03
12/31/04 6,084g
6,084h 12/31/04
12/31/05 6,085i 6,085j 12/31/0512/31/06 6,085k
6,085l 12/31/06
0 Bal on 12/31/06
Intercompany Lease of Property under Capital/Sale-TypeLease (Contd.)
Example 8 6: (Contd )
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Consolidated FS-Intercompany Transactions 110
Example 8.6: (Contd.)
a. ($36,506/6)b. Closing entryc. ($36,506/6)d. Closing entry
e. ($36,506/6)f. Closing entryg. ($36,506/6)h. Closing entry
i. ($36,506/6); Adjusted $1 for rounding.j. Closing entryk. ($36,506/6);Adjusted $1 for rounding.l. Closing entry
Intercompany Lease of Property under Capital/Sale-TypeLease (Contd.)
Example 8 6: (Contd )
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Consolidated FS-Intercompany Transactions 111
Example 8.6: (Contd.)
Partial working paper eliminations (injournal entry format) for theconsolidated financial statements for
year 2001 and year 2002 are as follows(note: intercompany interest revenueand intercompany interest expense areself-eliminated on the same line of theincome statement section of theworking paper for consolidated financialstatements):
Intercompany Lease of Property under Capital/Sale-TypeLease (Contd.)
E l 8 6 (C td )
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Consolidated FS-Intercompany Transactions 112
Example 8.6: (Contd.)
PALM CORPORATION AND SUBSIDIARYPartial Working Paper EliminationsDecember 31, 2001
(b) Intercompany Liability under Capital Lease-Starr 26,506Intercompany Interest Payable-Starr 2,120
Unearned Intercompany Interest Revenue- Palm 2,374Intercompany Sales-Palm 36,506Intercompany Cost of Goods Sold-Palm 30,000Intercompany Lease Receivables-Palm 31,000Leased Equipment-Capital Lease-Starr
($36,506-$30,000-$1,084) 5,422Depreciation Expense-Starr[($36,506-$30,000)/6] 1,084
To eliminate intercompany accounts assciated withintercompany lease and to defer unrealized portion ofintercompany gross profit on sales-type lease.(Income tax
effects are disregarded.)
Intercompany Lease of Property under Capital/Sale-TypeLease (Contd.)
E l 8 6 (C td )
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Consolidated FS-Intercompany Transactions 113
Example 8.6: (Contd.)
PALM CORPORATION AND SUBSIDIARYPartial Working Paper EliminationsDecember 31, 2002
(b) Intercompany Liability under Capital Lease-Starr 18,626
Intercompany Interest Payable-Starr 1,490Unearned Intercompany Interest Revenue-Palm 884
Retained Earnings-Palm [($36,506-$30,000)-$1,084] 5,422Intercompany Lease Receivables-Palm 21,000
Leased Equipment-Capital Lease-Starr($5,422-$1,084) 4,388Depreciation Expense-Starr 1,084
To eliminate intercompany accounts assciated withintercompany lease and to defer unrealized portion ofintercompany gross profit on sales-type lease.(Income tax
effects are disregarded.)
Intercompany Lease of Property under Capital/Sale-TypeLease (Contd.)
E l 8 6 (C td )
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Consolidated FS-Intercompany Transactions 114
Example 8.6: (Contd.)
Note:The elimination of 12/31/2001
removes the parent companysintercompany sale and cost of goodssold.The subsidiarys depreciation
expense of $1,084 for 2001
represents the realization of a portionof the parents gross profit margin onthe intercompany sale.
Intercompany Lease of Property under Capital/Sale-TypeLease (Contd.)
E l 8 6 (C td )
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Consolidated FS-Intercompany Transactions 115
Example 8.6: (Contd.)
In Year 2002 elimination, the original$6,506 unrealized gross profitelement in the subsidiarys leased
equipment has been reduced by$1,084 (the reduction of thesubsidiarys year 2001 depreciation
expense).
Intercompany Sales of IntangibleAssets
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Consolidated FS-Intercompany Transactions 116
Assets
The working paper eliminations forintercompany gains on sales ofintangible assets are similar to those for
intercompany gains in depreciable plantassets, except that no accumulatedamortization is involved.
Intercompany Sales of Intangible Assets(Contd.)
Example 8 7:
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Consolidated FS-Intercompany Transactions 117
Example 8.7:
On 1/2/2002 Palm sold a patent to itswholly own subsidiary,Starr, for$40,000. The carrying amount of this
patent for Palm is $32,000. The patent had a remaining economic
life of 4 years on 1/2/2002 and wasamortized by the straight-line method.
The working paper elimination for year2002 and year 2003 related to thisintercompany transaction is as follows:
Intercompany Sales of Intangible Assets(Contd.)
Example 8 7: (Contd )
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Consolidated FS-Intercompany Transactions 118
Example 8.7: (Contd.)
PALM CORPORATION AND SUBSIDIARYPartial Working Paper EliminationsDecember 31, 2002
(c) Intercompany Gain on Sale of
Patent--Palm ($40,000- $32,000) 8,000Amortization ExpenseStarr($8,000/4) 2,000
Patent-Starr ($8,000-2,000) 6,000To eliminate unrealized intercompany gain inpatent and related amortization.(Income taxeffects are disregarded.)
Intercompany Sales of Intangible Assets(Contd.)
Example 8 7: (Contd )
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Consolidated FS-Intercompany Transactions 119
Example 8.7: (Contd.)
PALM CORPORATION AND SUBSIDIARYPartial Working Paper EliminationsDecember 31, 2003
(c) Retained Earnings--Palm
($8,000-$2,000) 6,000Amortization ExpenseStarr($8,000/4) 2,000Patent-Starr ($6,000-$2,000) 4,000
To eliminate unrealized intercompany gain inpatent and related amortization.(Income taxeffects are disregarded.)
Acquisition of Affiliates Bonds inAn Open Market
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Consolidated FS-Intercompany Transactions 120
An Open Market
Intercompany gains and losses may berealized by the consolidated entitywhen one affiliate acquires outstanding
bonds of another affiliate in the openmarket.
No realized or unrealized gain or loss
would result from the direct acquisitionof one affiliates bonds by anotheraffiliate.
Acquisition of Affiliates Bonds inAn Open Market (Contd )
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Consolidated FS-Intercompany Transactions 121
An Open Market (Contd.)
Example 8.8:Assume that on 1/2/2001, Sage (thepartially owned subsidiary) issued to
the public $500,000 face account of10% bonds due 1/1/2006.
The effective interest rate (market yield
rate) is 12%. Interest was payableannually on 1/1.
Acquisition of Affiliates Bonds in An Open Market(Contd.)
Example 8 8: (Contd )
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Consolidated FS-Intercompany Transactions 122
Example 8.8: (Contd.)
The net proceeds of the bond issue toSage were $463,952, computed asfollows (bond issue costs are
disregarded):Present value of $500,000 in five yearsat 12%, with interest paid annually($500,000 x 0.567427) $ 283,713
Add: Present value of $50,000 eachyear for five years at 12%
($50,000 x 3.604776) 180,239Proceeds of bond issue $ 463,952
Acquisition of Affiliates Bonds in An Open Market(Contd.)
Example 8 8: (Contd )
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Consolidated FS-Intercompany Transactions 123
Example 8.8: (Contd.)
The following entries were recordedby Sage for year 2001 regardingthe issuance of the bond and the
accrued interest:
Acquisition of Affiliates Bonds in An Open Market(Contd.)
Example 8 8: (Contd )
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Consolidated FS-Intercompany Transactions 124
Example 8.8: (Contd.)
2001 Sage Company Journal Entries1/2 Cash 463,952
Discount on Bonds Payable 36,048Bonds Payable 500,000
To record issuance of 10% bonds dueJan. 1, 2006, at a discount to yield 12%.
12/31 Interest Expense ($463,952 x 0.12) 55,674Interest Payable($500,000 x 0.10) 50,000
Discount on BondsPayable 5,674
To record accrual of annual interest on10% bonds.
Acquisition of Affiliates Bonds in An Open Market(Contd.)
Example 8.8: (Contd.)
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Consolidated FS-Intercompany Transactions 125
Example 8.8: (Contd.)
Assume that on 12/31/2001, Post (theparent company) had cash available forinvestment.
The effective interest rate at the time is15%. Thus, Sages bonds can bepurchased in the open market at asubstantial discount.
Post acquired 60% of Sages bonds on12/31/2001 at $257,175 plus $30,000accrued interest.
Acquisition of Affiliates Bonds in An Open Market(Contd.)
Example 8.8: (Contd.)
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Consolidated FS-Intercompany Transactions 126
Example 8.8: (Contd.)
The acquisition cost of 60% of Sagesbonds is computed as follows:
Present value of $300,000 in four years
at 15%, with interest paid annually($300,000 x 0.571753) $ 171,526
Add: Present value of $30,000 eachyear for four years at 15%
($30,000 x 2.854978) 85,649Cost to Post Corporation of $300,000face amount of bonds $ 257,175
Acquisition of Affiliates Bonds in An Open Market(Contd.)
Example 8.8: (Contd.)
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Consolidated FS-Intercompany Transactions 127
Example 8.8: (Contd.)
Post prepared the following journalentry on 12/31/2001 to record theacquisition of Sages bonds:
Investment in Sage CompanyBonds 257,175Intercompany InterestReceivable 30,000
Cash 287,175To record acquisition of $300,000 faceamount of Sage Companys 10% bondsdue Jan. 1, 2006, and accrued interest forone year.
Acquisition of Affiliates Bonds in An Open Market(Contd.)
Example 8.8: (Contd.)
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Consolidated FS-Intercompany Transactions 128
Example 8.8: (Contd.)
The following entry is prepared by Sage(the bond issuer) on 12/31/2001 whennotified by the parent company of thisacquisition:Bonds Payable 300,000Discount on IntercompanyBonds Payable ($30,374 x 0.6) 18,224
Interest Payable ($50,000 x 0.6) 30,000
Intercompany Bonds Payable 300,000Discount on Bonds Payable 18,224Intercompany Interest Payable 30,000
To transfer to intercompany accounts all amountsattributable to bonds acquired by parent company in open
market.
Acquisition of Affiliates Bonds in An Open Market(Contd.)
Example 8.8: (Contd.)
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Consolidated FS-Intercompany Transactions 129
Example 8.8: (Contd.)
From the viewpoint of the consolidatedentity, Posts acquisition of Sages bondsis equivalent to the extinguishment of thebonds at a realized gain of $24,601,
computed as follows:Carrying amount of Sage Companysbonds acquired by Post Corporation onDec.31,2001($300,00018,224) $ 281,776
Less: Cost of Post Corporationsinvestment 257,175
Realized gain on extinguishment ofbonds $ 24,601
Acquisition of Affiliates Bonds in An Open Market(Contd.)
Example 8.8: (Contd.)
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Consolidated FS-Intercompany Transactions 130
Example 8.8: (Contd.)
The $24,601 realized gain is notrecorded in the accounting records ofeither the parent company or thesubsidiary.
However, it is recognized in the workingpaper elimination (in journal entry
format) on 12/31/2001, shown asfollows:
Acquisition of Affiliates Bonds in An Open Market(Contd.)
Example 8.8: (Contd.)
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Consolidated FS-Intercompany Transactions 131
Example 8.8: (Contd.)
POST CORPORATION AND SUBSIDIARYPartial Working Paper EliminationDecember 31,2001
(e) Intercompany Bonds PayableSage 300,000
Discount on IntercompanyBonds Payable-Sage 18,224Investment in SageCompany Bonds-Post 257,175
Gain on Extinguishment ofBonds-Sage 24,601
To eliminate subsidiarys bonds acquired by parentand to recognize gain on the extinguishment of thebonds.(Income tax effects are disregarded.)
Acquisition of Affiliates Bonds inAn Open Market (Contd )
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Consolidated FS-Intercompany Transactions 132
An Open Market (Contd.)
Notes to the partial working paperelimination:
1. The intercompany interest receivable-- Post ($30,000) and intercompanyinterest payable-Sage ($30,000) areoffset in the working paper
elimination.
Acquisition of Affiliates Bonds inAn Open Market (Contd )
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Consolidated FS-Intercompany Transactions 133
An Open Market (Contd.)
2. The gain is attributes to Sagethebond issuer (the subsidiary).
This treatment assumes that parentsopen market acquisition of thesubsidiarys bonds was, insubstance, the extinguishment of the
bonds by the subsidiary.
Acquisition of Affiliates Bonds inAn Open Market (Contd )
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Consolidated FS-Intercompany Transactions 134
An Open Market (Contd.)
3. The gain is included in theconsolidated income statement ofPost and subsidiary for the yearended 12/31/2001.
If the gain is material, it is displayedas an extraordinary item.
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Accounting for Gain (from Acquisition ofAffiliates Bonds) in Subsequent Years
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Consolidated FS-Intercompany Transactions 137
Affiliate s Bonds) in Subsequent Years
In the following four years, the realizedgain which is unrecorded by eitheraffiliate on the date of acquisition,is
reported by the consolidated entitythrough the differences in the twoaffiliates interest expense and the
interest revenue.
Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 138
(Contd.)
The accounting for the bond interest bythe two affiliates for the year ended12/31/2002 and related ledger accounts
for four remaining years for bothcompanies are as follows:
Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 139
(Contd.)
2002 Post Corporation Journal Entries1/2 Cash 30,000
Intercompany InterestReceivable
30,000
To record receipt of accrued intereston Sage Companys 10% bonds.12/31 Intercompany Interest
Receivable 30,000Investment in Sage Company
Bonds 8,576Intercompany InterestRevenue 38,576
To accrue annual interest on SageCompanys 10% bonds ($257,175 x
0 15 =$38 576)
Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 140
(Contd.) 2002 Sage Company Journal Entries
1/2 Intercompany Interest Payable 30,000Interest Payable 20,000
Cash 50,000To record payment of accrued interest on 10%bonds.
12/31 Intercompany Interest Expense 33,813Interest Expense 22,542Intercompany Interest Payable 30,000Interest Payable 20,000Discount on Intercompany Bonds
Payable 3,813Discount on Bonds Payable 2,542To accrue annual interest on 10% bonds.Interest is computed as follows:Intercompany ($300,000-$18,224) x 0.12=$33,813Other ($200,000- $12,150) x 0.12= $22,542
Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 141
(Contd.)
POST CORPORATIONInvestment in Sage Company Bonds
12/31/01 257,175 a
12/31/02 8,576 b
12/31/03 9,863 c
12/31/04 11,342 d
12/31/05 13,044 eBal on 12/31/05 300,000
Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 142
a.Acquisition of $300,000 face amount of bondsb.Accumulation of discount ($38,576-$ 30,000)
c.Accumulation of discount ($39,863-$30,000)
d.Accumulation of discount ($41,342-$30,000)
e.Accumulation of discount ($43,044-$30,000)
(Contd.)
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Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 144
a.($257,175 x 0.15)b.Closing entry
c.($265,751 x 0.15)
d.Closing entry
e.($275,614 x 0.15)
f. Closing entry
g.($286,956 x 0.15),Adjusted $ 1 for rounding.
h. Closing entry
(Contd.)
Accounting for Gain (from Acquisition ofAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 145
Sage CompanyIntercompany Bonds Payable
300,000a 12/31/01
300,000Bal on 12/31/01
a. Bonds acquired by parent company
(Contd.)
Accounting for Gain (from Acquisition ofAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 146
Discount on Intercompany Bonds Payable12/31/01 18,224a
3,813b 12/31/02
4,271c 12/31/034,783d 12/31/045,357e 12/31/05
0Bal on 12/31/05
(Contd.)
Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 147
a.Bonds acquired by parent company
b.Amortization ($33,813-$30,000)
c.Amortization ($34,271-$30,000)
d.Amortization ($34,783-$30,000)
e.Amortization ($35,357-$30,000)
(Contd.)
Accounting for Gain (from Acquisition ofAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 148
Intercompany Interest Expense12/31/02 33,813a
33,813b 12/31/0212/31/03 34,271c
34,271d 12/31/0312/31/04 34,783e
34,783f 12/31/04
12/31/05 35,357g35,357h 12/31/05
0 Bal on 12/31/05
(Contd.)
Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 149
a.[($300,000-$18,224) x 0.12]b.Closing entry
c.[($300,000-$14,411) x 0.12]
d.Closing entry
e.[($300,000-$10,140) x 0.12]
f. Closing entry
g.[($300,000-$5,357) x 0.12]
h. Closing entry
(Contd.)
Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd.)
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Consolidated FS-Intercompany Transactions 150
A summary of the differencesbetween the intercompany interestrevenuePost and intercompany
interest expenseSage is asfollows:
(Contd.)
Accounting for Gain (from Acquisition ofAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 151
Year Ended
Dec. 31,
PostCorporationsIntercompany
Interest
Revenue
SageCompanys
IntercompanyInterest
Expense
Difference-RepresentingRecording of
Realized Gain
2002 $ 38,576 $ 33,813 $ 4,763
2003 39,863 34,271 5,592
2004 41,342 34,783 6,559
2005 43,044 35,357 7,687Totals $ 162,825 $138,224 $ 24,601
(Contd.)
Accounting for Gain (from Acquisition ofAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 152
Notes to the above summary table:1. Although the acquisition gain is not
recognized by either affiliate at
acquisition, the gain is recognized bythe consolidated entities in thefollowing four years through thedifferences in the intercompany
interest revenuePost and theintercompany interest expenseSage.
(Contd.)
Accounting for Gain (from Acquisition ofAffiliates Bonds) in Subsequent Years(Contd )
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Consolidated FS-Intercompany Transactions 153
2. The total of differences betweenparents intercompany interestrevenue and subsidiary
intercompany interest expense isequal to the realized gain on parentsacquisition of subsidiarys bonds.
(Contd.)
Working Paper Elimination on 12/31/2002(One Year Subsequently to Acquisition ofBonds)
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Consolidated FS-Intercompany Transactions 154
Bonds)
The working paper elimination for the bondsand interest on 12/31/2002 is as follows:(e)Intercompany Interest Revenue-Post 38,576
Intercompany Bonds Payable-Sage 300,000Discount on Intercompany Bonds Payable-Sage 14,411Investment in Sage Company Bonds- Post 265,751Intercompany Interest Expense-Sage 33,813Retained Earnings-Sage($24,601 x 0.95) 23,371
Minority Interest in Net Assets of Subsidiary($24,601 x 0.05) 1,230
To eliminate subsidiarys bonds owned by parent company, andrelated interest revenue and expense; and to increase subsidiarysbeginningretained earnings by amount of unamortized realizedgain on the extinguishments of the bonds.(Income tax effects are
disregarded )
Working Paper Elimination on 12/31/2002(One Year Subsequently to Acquisition ofBonds) (Contd )
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Consolidated FS-Intercompany Transactions 155
Bonds) (Contd.)
Note to the above working paperelimination:
The foregoing working paper elimination
reduces the consolidated income(before minority interest) by $4,796 (thedifference between the intercompanyinterest revenue and intercompany
interest expense for year 2002).
Working Paper Elimination on 12/31/2002(One Year Subsequently to Acquisition ofBonds) (Contd )
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Consolidated FS-Intercompany Transactions 156
Bonds) (Contd.) Note (contd.):
This is because the entire gain of $24,601had been recognized in the consolidatedincome statement of year 2001.
This is evident by the credit of retainedearnings and the minority interest in netassets of subsidiary of $23,371 and$1,230, respectively.
If the gain of $4,796 is not eliminated, theconsolidated income of year 2002 will beoverstated by $4,796.
Working paper elimination on12/31/2002
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Consolidated FS-Intercompany Transactions 157
Similar working paper elimination foryears 2004 and 2005 would beprepared. Assume that Sage paid the
bonds in full on maturity 1/2/2006.Therefore, no further working papereliminations for the bonds would berequired.
Working paper elimination on12/31/2002 (Contd.)
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Consolidated FS-Intercompany Transactions 158
( )
The working paper elimination on12/31/2003 is as follows:(e)Intercompany Interest Revenue-Post 39,863
Intercompany Bonds Payable-Sage 300,000Discount on Intercompany Bonds Payable-Sage 10,140Investment in Sage Company Bonds- Post 275,614Intercompany Interest Expense-Sage 34,271Retained Earnings-Sage[($24,601-$4,763) x 0.95] 18,846
Minority Interest in Net Assets of Subsidiary[($24,601-$4,763) x 0.05] 992To eliminate subsidiarys bonds owned by parent company, andrelated interest revenue and expense; and to increase subsidiarysbeginningretained earnings by amount of unamortized realizedgain on the extinguishments of the bonds.(Income tax effects are
disregarded )
Effect of Intercompany Profits onMinority Interest in Net Income
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Consolidated FS-Intercompany Transactions 159
y
The following working paper eliminations forPost and its 95%-owned subsidiary (Sage)are taken from p138and p139 of chapter 7,and from pages 42,65,76, and 131of thischapter.
These eliminations are followed by a revisedelimination (which differs from the one on
p150 of chapter 7) for minority interest in netincome of subsidiary.
Intercompany Profits on MinorityInterest in Net Income (contd.)
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Consolidated FS-Intercompany Transactions 160
( )
POST CORPORATION AND SUBSIDIARYWorking Paper EliminationsDecember 31, 2001
(a)Common StockSage 400,000
Additional Paid-in Capital-Sage 235,000
Retained Earnings-Sage($384,000-$4,750) 379,250Retained Earnings of Subsidiary-Post 4,750Intercompany Investment Income-Post 81,700Plant Assets(net)-Sage($176,000-$14,000) 162,000
Leasehold(net)-Sage ($25,000-$5,000) 20,000Goodwill (net)-Post($37,050-$950) 36,100Cost of Goods Sold-Sage 17,000Operating Expenses-Sage 2,000
Intercompany Profits on MinorityInterest in Net Income (contd.)
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Consolidated FS-Intercompany Transactions 161
( )
Contd.
Investment in Sage CompanyCommon Stock-Post 1,229,300
Dividends Declared-Sage 50,000Minority Interest in Net Assets ofSubsidiary ($61,000 - $2,500) 58,500
Intercompany Profits on MinorityInterest in Net Income (contd.)
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Consolidated FS-Intercompany Transactions 162
( )
The above working paper elimination (a) isto carry out the following:
(1) Eliminate intercompany investment andequity accounts of subsidiary at the
beginning of year,and subsidiarydividends.
(2) Provide for Year 2001 depreciation andamortization on differences betweencurrent fair values and carrying amountsof Sage's identifiable net assets asfollows:
Intercompany Profits on MinorityInterest in Net Income (contd.)
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( )
Cost ofGoods Sold
OperatingExpenses
Building depreciation $ 2,000 $ 2,000
Machinery depreciation 10,000
Leasehold amortization 5,000 $ 2,000
Totals $ 17,000 $ 2,000
Intercompany Profits on MinorityInterest in Net Income (contd.)
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Consolidated FS-Intercompany Transactions 164
(3) Allocate unamortized differencesbetween combination date current fairvalues and carrying amounts toappropriate assets.
(4) Establish minority interest in net assets ofsubsidiary at beginning of year ($61,000),less minority interest in dividendsdeclared by subsidiary during year($50,000 x 0.05=$2,500).
(Income tax effects are disregarded.)
Intercompany Profits on MinorityInterest in Net Income (contd.)
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Consolidated FS-Intercompany Transactions 165
(b)Intercompany Sales-Sage 120,000
Intercompany Costof Goods Sold-Sage 96,000
Cost of Goods Sold-Post 16,000
Inventories-Post 8,000To eliminate intercompany sales, cost ofgoods sold, and unrealized profit ininventories.(Income tax effects aredisregarded.)
Intercompany Profits on MinorityInterest in Net Income (contd.)
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Consolidated FS-Intercompany Transactions 166
(c)Intercompany Gain on Saleof Land- Post 50,000
Land-Sage 50,000
To eliminate unrealized intercompanygain on sale of land.(Income taxeffects are disregarded.)
(d)Intercompany Gain on Sale
of Machinery- Sage 23,800Machinery-Post 23,800To eliminate unrealized intercompanygain on sale of machinery.(Income taxeffects are disregarded.)
Intercompany Profits on MinorityInterest in Net Income (contd.)
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Consolidated FS-Intercompany Transactions 167
(e)Intercompany Bonds Payable-Sage 300,000Discount onIntercompany BondsPayable-Sage 18,224
Investment in SageCompany Bonds-Post 257,175
Gain on
Extinguishment ofBonds-Sage 24,601To eliminate subsidiarys bonds acquiredby parent, and to recognize gain on theextinguishments of the bonds.(Incometax effects are disregarded.)
Intercompany Profits on MinorityInterest in Net Income (contd.)
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Consolidated FS-Intercompany Transactions 168
(f)Minority Interest in Net Income ofsubsidiary 3,940Minority Interest in NetAssets of Subsidiary 3,940
To establish minority interest in subsidiarys
adjusted net incomes for Year 2001 as follows:Net income of subsidiary $ 105,000Adjustments for working papereliminations:(a) ($17,000+$2,000) (19,000)(b) (8,000)(d) (23,800)(e) 24,601
Adjusted net income of subsidiary $ 78,801Minority interest share ($78,801 x 0.05) $ 3,940
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Working Paper for ConsolidatedFinancial Statements (contd.)
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Consolidated FS-Intercompany Transactions 170
Partial Working Paper for Consolidated Financial StatementsFor Year Ended December 31, 2001
Statement of RetainedEarnings
Post Corp. SageCompany
EliminationInc. (Dec.)
Consolidated
Retained earnings,
beginning of year 1,348,500 384,000 (a)(379,250) 1,353,250Net income 352,600 105,000 (161,839)* 295,761
Subtotals 1,701,000 489,000 (541,089) 1,649,011
Dividends declared 158,550 50,000 (a)(50,000) 158,550
Retained earnings, endof year 1,542,550 439,000 (491,089) 1,490,461
Working Paper for ConsolidatedFinancial Statements (contd.)
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Consolidated FS-Intercompany Transactions 171
Contd.Balance Sheet / Liabilities &
Stockholders EquityPost Corp. Sage
CompanyEliminationInc. (Dec.)
Consolidated
Minority interest in net assets ofsubsidiary
(a) 58,500(f) 3,940
62,440
Total liabilities x,xxx,xxx xxx,xxx 62,440 x,xxx,xxxCommon stock, $ 1 par 1,057,000 1,057,000Common stock, $ 10 par 400,000 (a) (400,000)
Additional paid-in capital 1,560,250 235,000 (a) (235,000) 1,560,250Retained earnings 1,542,550 439,000 (491,089) 1,490,461Retained earnings of subsidiary 4,750 (a) (4,750)
Total stockholders equity 4,164,550 1,074,000 (1,130,839)
Total liabilities & stockholdersequity x,xxx,xxx x,xxx,xxx (1,068,399) x,xxx,xxx
Net decrease in revenue ( and gains): $81,700 + $120,000 + $50,000 + $23,800 - $24,601 $250,899Less: Net decrease in costs and expenses: $96,000 + $16,000 -$19,000 - $3,940 89,060Decrease in combined net incomes to compute consolidated net income $161,839#Adecreasein dividends and an increasein retained earnings
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Working Paper for ConsolidatedFinancial Statements( for Year 2002)
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Consolidated FS-Intercompany Transactions 173
Continued with the example of Post andits subsidiary (Sage), the followings areselected Post's t-accounts(investment
in Sage, retained earnings) and Sage'st-account of retained earnings.
Review of these accounts will help in
understanding the working paper forconsolidated financial statements of
Year 2002.
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Working Paper for ConsolidatedFinancial Statements( for Year 2002) (cont.)
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Consolidated FS-Intercompany Transactions 175
a.Total cost of business combinationb.Dividend declared by Sagec.Net income of Saged.Amortization of differencese.Amortization of goodwillf. Dividend declared by Sageg.Net income of Sageh.Amortization of differencesi.Amortization of goodwill
j. Dividend declared by Sagek.Net income of Sagel.Amortization of differencesm. Amortization of goodwill
Working Paper for ConsolidatedFinancial Statements( for Year 2002) (cont.)
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Consolidated FS-Intercompany Transactions 176
Retained Earnings
1,050,000a 12/31/99457,050b 12/31/00
12/31/00 158,550 c
318,400d 12/31/0112/31/01 158,550 e
1,508,350 Bal on 12/31/01
Working Paper for ConsolidatedFinancial Statements( for Year 2002) (cont.)
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Consolidated FS-Intercompany Transactions 177
a.Balance
b.Close net income available for dividends
c.Close Dividends Declared account
d. Close net income available for dividends
e.Close Dividends Declared account
Working Paper for ConsolidatedFinancial Statements( for Year 2002) (cont.)
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178/195
Consolidated FS-Intercompany Transactions 178
Retained Earnings of Subsidiary4,750a 12/31/00
34,200b 12/31/01
38,950 Bal on 12/31/01
a.Close net income not available fordividends
b.Close net income not available fordividends
Working Paper for ConsolidatedFinancial Statements( for Year 2002) (con