CHAPTER 6 INTERCOMPANY INVENTORY TRANSACTIONS

Transcription

1 CHAPTER 6 INTERCOMPANY INVENTORY TRANSACTIONS ANSWERS TO QUESTIONS Q6-1 All inventory transfers between related companies must be eliminated to avoid an overstatement of revenue and cost of goods sold in the consolidated income statement. In addition, when unrealized profits exist at the end of the period, the eliminations are needed to avoid overstating inventory and consolidated net income. Q6-2 An inventory transfer at cost results in an overstatement of sales and cost of goods sold. While net income is not affected, gross profit ratios and other financial statement analysis may be substantially in error if appropriate eliminations are not made. Q6-3 An upstream sale occurs when the parent purchases items from one or more subsidiaries. A downstream sale occurs when the sale is made by the parent to one or more subsidiaries. Knowledge of the direction of sale is important when there are unrealized profits so that the person preparing the consolidation worksheet will know whether to reduce consolidated net income assigned to the controlling interest by the full amount of the unrealized profit (downstream) or reduce consolidated income assigned to the controlling and noncontrolling interestson a proportionate basis (upstream). Q6-4 As in all cases, the total amount of the unrealized profit must be eliminated in preparing the consolidated statements. When the profits are on the parent company's books, consolidated net income and income assigned to the controlling interest are reduced by the full amount of the unrealized profit. Q6-5 Consolidated net income is reduced by the full amount of the unrealized profits. In the upstream sale, the unrealized profits are apportioned between the parent company shareholders and the noncontrolling shareholders. Thus, consolidated net income assigned to the controlling and noncontrolling interests is reduced by a pro rata portion of the unrealized profits. Q6-6 Income assigned to the noncontrolling interest is affected when unrealized profits are recorded on the subsidiary's books as a result of an upstream sale. A downstream sale should have no effect on the income assigned to noncontrolling interest because the profits are on the books of the parent. Q6-7 The basic eliminating entry needed when the item is resold before the end of the period is: Sales Cost of Goods Sold XXXXXX XXXXXX 6-1

2 The debit to sales is based on the intercorporate sale price. This means that only the revenue recorded by the company ultimately selling to the nonaffiliate is to be included in the consolidated income statement. Cost of goods sold is credited for the amount paid by the purchaser on the intercorporate transfer, thereby permitting the cost of goods sold recorded by the initial owner to be reported in the consolidated statement. Q6-8 The basic eliminating entry needed when one or more of the items are not resold before the end of the period is: Sales Cost of Goods Sold Inventory XXXXXX XXXXXX XXXXXX The debit to sales is for the full amount of the transfer price. Inventory is credited for the unrealized profit at the end of the period and cost of goods sold is credited for the amount charged to cost of goods sold by the company making the intercompany sale. Q6-9 Cost of goods sold is reported by the consolidated entity when inventory is sold to an external party. The amount reported as cost of goods sold is based on the amount paid for the inventory when it was produced or purchased from an external party. If inventory has been purchased by one company and sold to a related company, the cost of goods sold recorded on the intercorporate sale must be eliminated. Q6-10 No adjustment to retained earnings is needed if the intercorporate sales have been made at cost or if all intercorporate sales have been resold to an external party in the same accounting period. If all of the intercorporate sales have not been resold by the end of the period, under the fully adjusted equity method, the parent defers unrealized profits in the investment in sub and income from sub accounts. This adjustment would be made to retained earnings under the modified equity method. However, regardless of the parent s method for accounting for the investment, the amount of the noncontrolling interest is reduced by the NCI s proportionate share of the unrealized profit associated with upstream sales. Q6-11 A proportionate share of the realized retained earnings of the subsidiary are assigned to the noncontrolling interest. Any unrealized profits on upstream sales are deducted proportionately from the amount assigned to the noncontrolling interest. Unrealized profits on downstream sales do not affect the noncontrolling interest. Q6-12 When inventory profits from a prior period intercompany transfer are realized in the current period, the profit is added to consolidated net income and to the income assigned to the shareholders of the company that made the intercompany sale. If the unrealized profits arise from a downstream sale, income assigned to the controlling interest will increase by the full amount of profit realized. When the profits arise from an upstream sale, income assigned to the controlling and noncontrolling interests will be increased proportionately in the period the profit is realized. Thus, knowledge of whether the profits resulted from an upstream or a downstream sale is imperative in assigning consolidated net income to the appropriate shareholder group. 6-2

3 Q6-13 Under the fully adjusted equity method, consolidated retained earnings is not affected directly by unrealized profits. Unrealized profits are deferred in the investment in sub and income from sub accounts on the parent s books. Income from sub is closed out to retained earnings, so the deferral of unrealized profits indirectly affects retained earnings. As a result, the amount reported for consolidated retained earnings is always equal to the parent s retained earnings. Q6-14 Consolidated retained earnings are always equal to the parent s retained earnings under the fully adjusted equity method. Since the parent company defers unrealized profits in the income from sub and investment in sub accounts and since income from sub is closed out to the parent s retained earnings, the ending balance in consolidated retained earnings will reflect the reduction associated with the deferral of unrealized profits. Q6-15* Sales between subsidiaries are treated in the same manner as upstream sales. Whenever the profits are on the books of one of the subsidiaries, the unrealized profits at the end of the period are eliminated and consolidated net income and income assigned to the controlling and noncontrolling interests is reduced. Q6-16* When a company is acquired in a business combinationthe transactions occurring before the combination generally are regarded as transactions with unrelated parties and no adjustments or eliminations are needed. All transactions between the companies following the combination must be fully eliminated. SOLUTIONS TO CASES C6-1 Measuring Cost of Goods Sold a. While the rule covers only a part of the elimination needed, Charlie is correct in that the cost of goods sold recorded by the selling company must be eliminated to avoid overstating that caption in the consolidated income statement. b. The rules will result in the proper consolidated totals if rule #1 is expanded to include a debit to sales and a credit to ending inventory for the amount of profit recorded by the company that sold to its affiliate. c. The way in which the rule is stated makes it appear to be incorrect, but it is correct. The rule is appropriate in that the cost of goods sold recorded by the purchasing affiliate is equal to the cost of goods sold to the first owner plus the profit the first owner recorded on the sale. Eliminating these amounts therefore eliminates the appropriate amount of cost of goods sold. If an equal amount of sales is eliminated, the rule should result in proper consolidated financial statement totals. d. The employee would be forced to look at the books of the selling affiliate and determine the difference between the intercorporate sale price and the price it paid to acquire or produce the items. If the items sold to affiliates are routinely produced and costs do not fluctuate greatly, it may be possible to use some form of gross profit ratio to estimate the amount of unrealized profit. 6-3

4 C6-2 Inventory Values and Intercompany Transfers MEMO To: From: Re: President Water Products Corporation, CPA Inventory Sale and Purchase of New Inventory If Water Products holds only a small percent of the ownership of Plumbers Products and Growinkle Manufacturing, it should have no difficulty in reporting the desired results. This would not be the case if the two companies are subsidiaries of Water Products. If both Plumbers Products and Growinkel are subsidiaries of Water Products, both the sale of inventory to Plumbers Supply and the purchase of inventory from Growinkle Manufacturing must be eliminated.in addition, the unrealized profit on any unsold inventory involved in these transfers must be eliminated in preparing the financial statements for the current period. The consolidated income statement should include the same amount of income on the inventory sold to Plumbers Supply and resold during the year as would have been recorded if Water Products had sold the inventory directly to the purchaser. Any income recorded by Water Products on inventory not resold by Plumbers Supply must be eliminated. Similarly, the consolidated income statement should include the same amount of income on the inventory purchased by Water Products and resold during the year as would have been recorded if Growinkle Manufacturing had sold the inventory directly to the purchaser. Any income recorded by Growinkle Manufacturing on inventory not resold by Water Products must be eliminated. Consolidated net income may increase if Plumbers Supply is able to sell the inventory it purchased from Water Products at a higher price than would have been received by Water Products or if it is able to sell a larger number of units. The same can be said for the inventory purchased by Water Products from Growinkle Manufacturing. It is important to recognize that the transfer of inventory between Water Products and its subsidiaries does not in itself generate income for the consolidated entity. An additional level of complexity may arise in this situation if Water Products uses the LIFO inventory method. It might, for example, be forced to carry over its LIFO cost basis on the old inventory sold to Plumbers Supply to the new inventory purchased from Growinkle Manufacturing since it was replaced within the accounting period. Primary citation: ARB 51, Par. 6 (ASC 810) 6-4

5 C6-3 Intercorporate Inventory Transfers MEMO To: From: Re: Treasurer Evert Corporation, CPA Inventory Sale to Parent This memo is prepared in response to your request for information on the appropriate treatment of intercompany inventory transfers in consolidated financial statements. The specific eliminating entries required in this case depend on the valuation assigned to the inventory at December 31, 20X2. Frankle Company sold inventory with a carrying value of $240,000 to Evert for $180,000 on December 20, 20X2. Since the exchange price was well below Frankle s cost, consideration should be given to whether the inventory should be reported at $180,000 or $240,000 in the consolidated statements at December 31, 20X2, under the lower-of-cost-or-market rule. While the value of the inventory apparently had fallen below Frankle s carrying value, the accounting standards indicate no loss should be recognized when the evidence indicates that cost will be recovered with an approximately normal profit margin upon sale in the ordinary course of business. [ARB 43, Chapter 4, Par. 9; ASC 330] We are told the management of Frankle considered the drop in prices to be temporary and Evert was able to sell the inventory for $70,000 more than the original amount paid by Frankle. It therefore seems appropriate for the consolidated entity to report the inventory at Frankle s cost of $240,000 at December 31, 20X2. In preparing the consolidated statements at December 31, 20X2 and 20X3, the effects of the intercompany transfer should be eliminated. [ARB 51, Par. 6; ASC 810] The following eliminating entry is required at December 31, 20X2: Sales 180,000 Inventory 60,000 Cost of Goods Sold 240,000 The above entry will increase the carrying value of the inventory to $240,000. Eliminating sales of $180,000 and cost of goods sold of $240,000 will increase consolidated net income by $60,000 and income assigned to the noncontrolling interestby$6,000 ($60,000 x 0.10). These changes will result in an increase in consolidated retained earnings and the amount assigned to the noncontrolling shareholders in the consolidated balance sheet by $54,000 and $6,000, respectively. 6-5

6 C6-3 (continued) The following eliminating entry is required at December 31, 20X3: Cost of Goods Sold 60,000 Investment in Sub 54,000 NCI in NA of Sub 6,000 The above entry will reduce consolidated net income by $60,000 and income assigned to the noncontrolling interest by $6,000 ($60,000 x.10). The credits to Investment in Sub and NCI in NA of Sub needed to bring the beginning balances into agreement with those reported at December 31, 20X2. No eliminations are required for balances reported at December 31, 20X3, because the inventory has been sold to a nonaffiliate prior to year-end. Primary citations: ARB 43, CH 4, Par. 9 (ASC 330) ARB 51, Par. 6 (ASC 810) C6-4 Unrealized Inventory Profits a. When the amount of unrealized inventory profits on the books of the subsidiary at the beginning of the period is greater than the amount at the end of the period, the income assigned to the noncontrolling interest for the period will exceed a pro rata portion of the reported net income of the subsidiary. b. The subsidiary apparently had less unrealized inventory profit at the end of the period than it did at the start of the period. In addition, the parent must have had more unrealized profit on its books at the end of the period than it did at the beginning. The negative effect of the latter apparently offset the positive effect of the reduction in unrealized profits by the subsidiary. c. The most likely reason is that a substantial amount of the parent company sales was made to its subsidiaries and the cost of goods sold on those items was eliminated in preparing the consolidated statements. d. A loss was recorded by the seller on an intercompany sale of inventory to an affiliate and the purchaser continues to hold the inventory. 6-6

7 C6-5 Eliminating Inventory Transfers a. If no intercompany sales are eliminated, the income statement may include overstated sales revenue and cost of goods sold. The net impact on income will depend upon whether there were more unrealized profits at the beginning or end of the year. If ReadyBuilding does not hold total ownership of the subsidiaries, the amount of income assigned to noncontrolling shareholders is likely to be incorrect as well. Inventory, current assets and total assets, retained earnings, and stockholders' equity are likely to be overstated if inventories are sold to affiliates at a profit. If the companies pay income taxes on their individual earnings, the amount of income tax expense also will be overstated in the period in which unrealized profits are reported and understated in the period in which the profits are realized. b. Because profit margins vary considerably, the amount of unrealized profit may vary considerably if uneven amounts of product are purchased by affiliates from period to period. ReadyBuilding needs to establish a formal system to monitor intercompany sales. Perhaps the best alternative would be to establish a separate series of accounts to be used solely for intercompany transfers. Alternatively, it may be possible to use unique shipping containers for intercompany sales or to specifically mark the containers in some way to identify the intercompany shipments at the time of receipt. The purchaser might then use a different type of inventory tag or mark these units in some way when the product is received and placed in inventory. Inventory count teams could then easily identify the product when inventories are taken. c. A number of factors might be considered. The most important inventory system is the one used by the company making the intercompany purchase. When intercompany inventory purchases are bunched at the end of the year, the amount of unrealized profit included in ending inventory may be quite different under FIFO versus LIFO. If intercompany purchases are placed in a LIFO inventory base, inventories may be misstated for a period of years before the inventory is resold. Eliminating entries must be made each of the years until resale to avoid a misstatement of assets and equities. In those cases where the intercompany purchases are in high volume and the inventory turns over very quickly, a small amount of inventory left at the end of the period may be immaterial and of little concern. Typically, a parent will align inventory costing methods subsequent to a subsidiary acquisition to avoid problems caused by differences in accounting for the same items or types of items. d. It may be necessary to start by looking at intercorporate cash receipts and disbursements to determine the extent of intercorporate sales. One or more months might be selected and all vouchers examined to establish the level of intercorporate sales and the profit margins recorded on the sales. For those products sold throughout the year, it may be possible to estimate for the year as a whole based on an examination of several months. Once total intercompany sales and profit margins have been estimated, the amount of unrealized profit at year end should be estimated. One approach would be to take a physical inventory of the specific product types which have been identified and attempt to trace back using the product identification numbers or shipping numbers to determine what portion of the inventory on hand was purchased from affiliates. 6-7

8 C6-6 Intercompany Profits and Transfers of Inventory a. The intercompany transfers of Xerox ( between segments are apparently relatively insignificant because they are not reported in the notes to the consolidated financial statements relating to segment reporting. For consolidation purposes, all significant intercompany accounts and transactions are eliminated. b. Exxon Mobil ( prices intercompany transfers at estimated market prices. The amount of intercompany transfers is large. In the fiscal year ending December 31, 2009, Exxon Mobil reported eliminations of $302.6 billion of intersegment transfers, which does not include intercompany transfers within segments. This amount represents nearly 50 percent of total reported segment sales. For consolidation purposes, Exxon Mobil eliminates the effects of intercompany transactions. c. Ford Motor Company ( intercompany transfers consist primarily of vehicles, parts, and components manufactured by the company and its subsidiaries, with a smaller amount of financial and other services included. The amount of intercompany transfers is relatively small in relation to sales to unaffiliated customers. The amount has been decreasing in recent years. The effects of intercompany transfers are eliminated in consolidation. SOLUTIONS TO EXERCISES E6-1 Multiple-Choice Questions on Intercompany Inventory Transfers [AICPA Adapted] 1. a 2. c 3. a 4. c 5. c 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, c 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,

9 E6-2 Multiple-Choice Questions on the Effects of Inventory Transfers [AICPA Adapted] 1. b Cost of goods sold reported by Park $ 800,000 Cost of goods sold reported by Small 700,000 Total cost of goods sold reported $1,500,000 Cost of goods sold reported by Park on sale to Small ($500,000 x 0.40) (200,000) Reduction of cost of goods sold reported by Small for profit on intercompany sale [($500,000 x 4 / 5) x 0.60] (240,000) Cost of goods sold for consolidated entity $1,060,000 Note: Answer b in the actual CPA examination question was $1,100,000, requiring candidates to select the closest answer. 2. d $32,000 = ($200,000 + $140,000) $308, b $6,000 = ($26,000 + $19,000) $39, c $9,000 = Inventory held by Spin $12,000 ($32,000 x 0.375) Unrealized profit on sale [($30,000 + $25,000) $52,000] (3,000) Carrying cost of inventory for Power $ 9, b 0.20 = $14,000 / [(Stockholders Equity $50,000) +(Patent $20,000)] 6. b 14 years = ($28,000 / [(28,000 - $20,000) / 4 years] E6-3 Multiple Choice Consolidated Income Statement 1. c 2. b 3. 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,

10 E6-4 Multiple-Choice Questions Consolidated Balances 1. c 2. a Amount paid by Lorn Corporation $120,000 Unrealized profit (45,000) Actual cost $ 75,000 Portion sold x 0.80 Cost of goods sold $ 60, e Consolidated sales $140,000 Cost of goods sold (60,000) Consolidated net income $ 80,000 Income to Dresser s noncontrolling interest: Sales $120,000 Reported cost of sales (75,000) Report income $ 45,000 Portion realized x 0.80 Realized net income $ 36,000 Portion to Noncontrolling Interest x 0.30 Income to noncontrolling Interest (10,800) Income to controlling interest $ 69, a Inventory reported by Lorn $ 24,000 Unrealized profit ($45,000 x.20) (9,000) inventory reported $ 15,000 E6-5 Multiple-Choice Questions Consolidated Income Statement 1. a $20,000 = $30,000 x [($48,000 - $16,000) / $48,000] 2. d Sales reported by Movie Productions Inc. $67,000 Cost of goods sold ($30,000 x 2/3) (20,000) Consolidated net income $47, a $7,000 = [($67,000 - $32,000) x 0.20] 6-10

11 E6-6 Realized Profit on Intercompany Sale a. Journal entries recorded by Nordway Corporation: (1) Inventory 960,000 Cash (Accounts Payable) 960,000 (2) Cash (Accounts Receivable) 750,000 Sales 750,000 (3) Cost of Goods Sold 600,000 Inventory 600,000 b. Journal entries recorded by Olman Company: (1) Inventory 750,000 Cash (Accounts Payable) 750,000 (2) Cash (Accounts Receivable) 1,125,000 Sales 1,125,000 (3) Cost of Goods Sold 750,000 Inventory 750,000 c. Eliminating entry: Sales 750,000 Cost of Goods Sold 750,

12 E6-7 Sale of Inventory to Subsidiary a. Journal entries recorded by Nordway Corporation: (1) Inventory 960,000 Cash (Accounts Payable) 960,000 (2) Cash (Accounts Receivable) 750,000 Sales 750,000 (3) Cost of Goods Sold 600,000 Inventory 600,000 b. Journal entries recorded by Olman Company: (1) Inventory 750,000 Cash (Accounts Payable) 750,000 (2) Cash (Accounts Receivable) 810,000 Sales 810,000 (3) Cost of Goods Sold 540,000 Inventory 540,000 c. Eliminating entry: Sales 750,000 Cost of Goods Sold 708,000 Inventory 42,000 Calculations Total = Re-Sold + Inventory Sales 750, , ,000 COGS 600, , ,000 Gross Profit 150, ,000 42,000 Gross Profit % 20% 6-12

13 E6-8 Inventory Transfer between Parent and Subsidiary a. Karlow Corporation reported cost of goods sold of $820,000 ($82 x 10,000 desks) and Draw Company reported cost of goods sold of $658,000 ($94 x 7,000 desks). b. Cost of goods sold for the consolidated entity is $574,000 ($82 x 7,000 desks). c. Eliminating entry: Sales 940,000 Cost of Goods Sold 904,000 Inventory 36,000 Calculations Total = Re-sold + Inventory Sales 940, , ,000 COGS 820, , ,000 Gross Profit 120,000 84,000 36,000 Gross Profit % 12.77% d. Eliminating entry: e. Eliminating entry: Investment in Draw Company 36,000 Cost of Goods Sold 36,000 Investment in Draw Company 21,600 NCI in NA of Draw Company 14,400 Cost of Goods Sold 36,

14 E6-9 Income Statement Effects of Unrealized Profit a. Sale price to Holiday Bakery per bag ($900,000 / 100,000) $ 9.00 Profit per bag [$ ($9.00 / 1.5)] (3.00) Cost per bag $ 6.00 Bags sold by Holiday Bakery (100,000-20,000) x 80,000 Consolidated cost of goods sold $480,000 b. Sales 900,000 Cost of Goods Sold 840,000 Inventory ($3.00 x 20,000 bags) 60,000 Calculations Total = Re-sold + Inventory Sales 900, , ,000 COGS 600, , ,000 Gross Profit 300, ,000 60,000 Gross Profit % 33.33% Required Adjustment to Cost of Goods Sold: Cost of goods sold Farmco ($900,000 / 1.5) $ 600,000 Cost of goods sold Holiday ($9.00 x 80,000 units) 720,000 $1,320,000 Consolidated cost of goods sold ($6.00 x 80,000 units) (480,000) Required adjustment $ 840,000 c. Operating income of Holiday Bakery $400,000 Net income of Farmco Products 150,000 $550,000 Less: Unrealized inventory profits (60,000) Consolidated net income $490,000 Less: Income assigned to noncontrolling interest ($150,000 - $60,000 unrealized profit) x 0.40 (36,000) Income assigned to controlling interest $454,000 Alternate computation: Operating income of Holiday Bakery $400,000 Net income of Farmco Products $150,000 Unrealized profits ($3.00 x 20,000 units) (60,000) Realized net income $ 90,000 Ownership held by Holiday Bakery x ,000 Income assigned to controlling interest $454,

15 E6-10 Prior-Period Unrealized Inventory Profit a. Cost per bag of flour ($9.00 / 1.5) $ 6.00 Bags sold x 20,000 Cost of goods sold from inventory held, January 1, 20X9 $120,000 b. Investment in Farmco 36,000 NCI in NA of Farmco 24,000 Cost of Goods Sold 60,000 $60,000 = 20,000 bags x $3.00 c. Operating income of Holiday Bakery $300,000 Net income of Farmco Products 250,000 $550,000 Add: Inventory profits realized in 20X9 60,000 Consolidated net income $610,000 Less: Income assigned to noncontrolling shareholders ($250,000 + $60,000) x 0.40 (124,000) Income assigned to controlling interest $486,000 Alternate computation: Operating income of Holiday Bakery $300,000 Net income of Farmco Products $250,000 Inventory profits realized in 20X9 60,000 Realized net income $310,000 Ownership held by Holiday Bakery x ,000 Income assigned to controlling interest $486,

16 E6-11 Computation of Consolidated Income Statement Data Downstream Transaction Calculations Total = Re-sold + Inventory Sales 30,000 24,000 6,000 COGS 20,000 16,000 4,000 Gross Profit 10,000 8,000 2,000 Gross Profit % 33.33% Worksheet Entry (not requested in problem) Sales 30,000 Cost of Goods Sold 28,000 Inventory 2,000 Upstream Transaction Calculations Total = Re-sold + Inventory Sales 80,000 60,000 20,000 COGS 50,000 37,500 12,500 Gross Profit 30,000 22,500 7,500 Gross Profit % 37.50% Worksheet Entry (not requested in problem) Sales 80,000 Cost of Goods Sold 72,500 Inventory 7,500 a. Reported sales of Prem Company $400,000 Reported sales of Cooper Company 200,000 $600,000 Intercompany sales by Prem Company in 20X5 $ 30,000 Intercompany sales by Cooper Company in 20X5 80,000 (110,000) Sales reported on consolidated income statement $490,

17 E6-11 (continued) b. Cost of goods sold reported by Prem Company $250,000 Cost of goods sold reported by Cooper Company 120,000 $370,000 Adjustment due to intercompany sales (100,500) Consolidated cost of goods sold $269,500 Adjustment to cost of goods sold: CGS charged by Prem on sale to Cooper $ 20,000 CGS charged by Cooper ($30,000 - $6,000) 24,000 Total charged to CGS $ 44,000 CGS for consolidated entity $20,000 x ($24,000 / $30,000) (16,000) Required adjustment to CGS $ 28,000 CGS charged by Cooper on sale to Prem $ 50,000 CGS charged by Prem ($80,000 - $20,000) 60,000 Total charged to CGS $110,000 CGS for consolidated entity $50,000 x ($60,000 / $80,000) (37,500) Required adjustment to CGS 72,500 Total adjustment required $100,500 c. Reported net income of Cooper Company $ 45,000 Unrealized profit on sale to Prem Company $30,000 x ($20,000 / $80,000) (7,500) Realized net income $ 37,500 Noncontrolling interest's share x 0.40 Income assigned to noncontrolling interest $ 15,000 d. Reported net income of Pem Company $107,000 Less: Income from Cooper (27,000) $ 80,000 Net income of Cooper Company 45,000 Operating income $125,000 Less: Unrealized inventory profits of Prem Company [$10,000 x ($6,000 / $30,000)] $ 2,000 Unrealized inventory profits of Copper Company [$30,000 x ($20,000 / $80,000)] 7,500 Income assigned to noncontrolling interest 15,000 (24,500) Income assigned to controlling interest $ 98,

18 E6-12 Sale of Inventory at a Loss a. Entries recorded by Trent Company: Inventory 400,000 Cash 400,000 Purchase inventory. Cash 300,000 Sales 300,000 Sale of inventory to Gord Corporation. Cost of Goods Sold 400,000 Inventory 400,000 Record cost of goods sold. Entries recorded by Gord Corporation Inventory 300,000 Cash 300,000 Purchase of inventory from Trent. Cash 360,000 Sales 360,000 Sale of inventory to nonaffiliates. Cost of Goods Sold 180,000 Inventory 180,000 Record cost of goods sold: $180,000 = $300,000 x.60 b. Consolidated cost of goods sold for 20X8 should be reported as $240,000 ($400,000 x 0.60). c. Operating income reported by Gord $230,000 Net income reported by Trent $ 80,000 Unrealized loss on intercorporate sale ($400,000 - $300,000) x , ,000 Consolidated net income $350,000 Income to assigned to noncontrolling interest ($120,000 x 0.25) (30,000) Income assigned to controlling interest $320,

19 E6-12 (continued) d. Eliminating entry, December 31, 20X8: Sales 300,000 Inventory 40,000 Cost of Goods Sold 340,000 Computation of cost of goods sold to be eliminated Cost of goods sold recorded by Trent $400,000 Cost of goods sold recorded by Gord 180,000 Total recorded $580,000 Consolidated cost of goods sold (240,000) Required elimination $340,000 Intercompany Transaction Calculations Total = Re-sold + Inventory Sales 300, , ,000 COGS 400, , ,000 Gross Profit (100,000) (60,000) (40,000) Gross Profit % % 6-19

20 E6-13 Intercompany Sales 20X4 Calculations: 20X5 Calculations: Total = Re-sold + Inventory Sales 180, ,000 45,000 COGS 120,000 90,000 30,000 Gross Profit 60,000 45,000 15,000 Gross Profit % 33.33% Worksheet Entry (not required in problem) Sales 180,000 Cost of Goods Sold 165,000 Inventory 15,000 20X5 Upstream Total = Re-sold + Inventory Sales 135, ,000 30,000 COGS 90,000 70,000 20,000 Gross Profit 45,000 35,000 10,000 Gross Profit % 33.33% 20X5 Downstream Total = Re-sold + Inventory Sales 280, , ,000 COGS 140,000 85,000 55,000 Gross Profit 140,000 85,000 55,000 Gross Profit % 50.00% Worksheet Elimination Entries (not required in problem): Eliminate Upstream Transactions Sales 135,000 Cost of Goods Sold 125,000 Inventory 10,000 Eliminate Downstream Transactions Sales 280,000 Cost of Goods Sold 225,000 Inventory 55,

21 E6-13 (continued) a. Consolidated net income for 20X4: Reversal of 20X4 Upstream Deferral Investment in Surg 10,500 NCI in NA of Surg 4,500 Cost of Goods Sold 15,000 Operating income of Hollow Corporation $160,000 Net income of Surg Corporation 90,000 $250,000 Less: Unrealized profit Surg Corporation (15,000) Consolidated net income $235,000 b. Inventory balance, December 31, 20X5: Inventory reported by Hollow Corporation $30,000 Unrealized profit on books of Surg Corporation ($135,000 - $90,000) x ($30,000/$135,000) (10,000) $20,000 Inventory reported by Surg Corporation $110,000 Unrealized profit on books of Hollow Corporation ($280,000 - $140,000) x ($110,000/$280,000) (55,000) 55,000 Inventory, December 31, 20X5 $75,000 c. Consolidated cost of goods sold for 20X5: COGS on sale of inventory on hand January 1, 20X5 $45,000 x ($120,000 / $180,000) $ 30,000 COGS on items purchased from Surg in 20X5 ($135,000 - $30,000) x ($90,000 / $135,000) 70,000 COGS on items purchased from Hollow in 20X5 ($280,000 - $110,000) x ($140,000 / $280,000) 85,000 Total cost of goods sold $185,

22 d. Income assigned to controlling interest: Operating income of Hollow Corporation $220,000 Net income of Surg Corporation 85,000 $305,000 Add: Inventory profit of prior year realized in 20X5 15,000 Less: Unrealized inventory profit Surg Corporation (10,000) Unrealized inventory profit Hollow Corporation (55,000) Income to noncontrolling interest ($85,000 + $15,000 - $10,000) x 0.30 (27,000) Income assigned to controlling interest $228,000 E6-14 Consolidated Balance Sheet Worksheet a. Equity Method Entries on Doorst Corp.'s Books: Investment in Hingle Co. 49,000 Income from Hingle Co. 49,000 Record Doorst Corp.'s 70% share of Hingle Co.'s 20X8 income Cash 9,800 Investment in Hingle Co. 9,800 Record Doorst Corp.'s 70% share of Hingle Co.'s 20X8 dividend Income from Hingle Co. 10,000 Investment in Hingle Co. 10,000 Eliminate the deferred gross profit from downstream sales in 20X8 Income from Hingle Co. 28,000 Investment in Hingle Co. 28,000 Eliminate the deferred gross profit from upstream sales in 20X8 Book Value Calculations: NCI 30% + Doorst Corp. 70% = Common Stock + Retained Earnings Original book value 103, , , ,000 + Net Income 21,000 49,000 70,000 - Dividends (4,200) (9,800) (14,000) book value 120, , , ,

23 Reversal/Deferred GP Calculations: Total = Doorst Corp.'s share + NCI's share Downstream Reversal Upstream Reversal Downstream Deferred GP (10,000) (10,000) 0 Upstream Deferred GP (40,000) (28,000) (12,000) Total (50,000) (38,000) (12,000) E6-14 (continued) Basic elimination entry Common stock 150,000 Original amount invested (100%) Retained earnings 194,000 Beginning balance in retained earnings Income from Hingle Co. 11,000 Doorst s % of NI - Deferred GP + Reversal NCI in NI of Hingle Co. 9,000 NCI share of NI - Deferred GP + Reversal Dividends declared 14, % of Hingle Co.'s dividends declared Investment in Hingle Co. 242,000 Net book value - Deferred GP + Reversal NCI in NA of Hingle Co. 108,000 NCI share of BV - Deferred GP + Reversal Deferral of this year's unrealized profits on inventory transfers Sales 400,000 Cost of Goods Sold 350,000 Inventory 50,000 20X8 Downstream Transactions Total = Re-sold + Inventory Sales 100,000 75,000 25,000 COGS 60,000 45,000 15,000 Gross Profit 40,000 30,000 10,000 Gross Profit % 40.00% 6-23

24 20X8 Upstream Transactions Total = Re-sold + Inventory Sales 300, ,000 95,000 COGS 173, ,684 55,000 Gross Profit 126,316 86,316 40,000 Gross Profit % 42.11% Acquisition Price 240,800 Investment in Hingle Co. Income from Hingle Co. 70% Net Income 49,000 49,000 70% Net Income 9,800 70% Dividends 38,000 Deferred GP 38,000 Balance 242,000 11,000 Balance E6-14 (continued) b. 242,000 Basic 11, Doorst Hingle Elimination Entries Corp. Co. DR CR Consolidated Balance Sheet Cash and Receivables 98,000 40, ,000 Inventory 150, ,000 50, ,000 Buildings & Equipment (net) 310, , ,000 Investment in Hingle Co. 242, ,000 0 Total Assets 800, , , ,000 Accounts Payable 70,000 20,000 90,000 Common Stock 200, , , ,000 Retained Earnings 530, , ,000 14, ,000 11, ,000 9, ,000 NCI in NA of Hingle Co. 108, ,000 Total Liabilities & Equity 800, , , , ,

25 E6-15* Multiple Transfers between Affiliates a. Entries recorded by Klon Corporation Cash 150,000 Sales 150,000 Sale of inventory to Brant Company. Cost of Goods Sold 100,000 Inventory 100,000 Record cost of goods sold. Entries recorded by Brant Company Inventory 150,000 Cash 150,000 Purchase of inventory from Klon. Cash 150,000 Sales 150,000 Sale of inventory to Torkel Company. Cost of Goods Sold 150,000 Inventory 150,000 Record cost of goods sold. Entries recorded by Torkel Company Inventory 150,000 Cash 150,000 Purchase of inventory from Brant. Cash 120,000 Sales 120,000 Sale of inventory to nonaffiliates. Cost of Goods Sold 90,000 Inventory 90,000 Record cost of goods sold. b. Cost of goods sold for 20X8 should be reported as $60,000 [$90,000 x ($100,000 / $150,000)]. c. Inventory at December 31, 20X8, should be reported at $40,000 [$60,000 x ($100,000 / $150,000)]. 6-25

26 E6-15* (continued) d. Eliminating entry for inventory: Sales 300,000 Cost of Goods Sold 280,000 Inventory 20,000 Computation of cost of goods sold to be eliminated Cost of goods sold recorded by Klon $100,000 Cost of goods sold recorded by Brant 150,000 Cost of goods sold recorded by Torkel 90,000 Total recorded $340,000 Consolidated cost of goods sold (60,000) Required elimination $280,000 Computation of reduction to carrying value of inventory Inventory reported by Torkel $60,000 Inventory balance to be reported (40,000) Required elimination $20,

27 E6-16 Inventory Sales a. Journal entries recorded by Spice Company: (1) Inventory 150,000 Cash (Accounts Payable) 150,000 Record purchases from nonaffiliate. (2) Cash (Accounts Receivable) 60,000 Sales 60,000 Record sale to Herb Corporation. (3) Cost of Goods Sold 40,000 Inventory 40,000 Record cost of goods sold to Herb Corporation. Journal entries recorded by Herb Corporation: (1) Inventory 60,000 Cash (Accounts Payable) 60,000 Record purchases from Spice Company. (2) Cash (Accounts Receivable) 90,000 Sales 90,000 Record sale of items to nonaffiliates. (3) Cost of Goods Sold 45,000 Inventory 45,000 Record cost of goods sold. (4) Income from Herb 5,000 Investment in Herb 5,000 Eliminate unrealized gross profit on inventory purchases from Herb. b. Eliminating entry: Total = Re-sold + Inventory Sales 60,000 45,000 15,000 COGS 40,000 30,000 10,000 Gross Profit 20,000 15,000 5,000 Gross Profit % 33.33% Sales 60,000 Cost of Goods Sold 55,000 Inventory 5,000 Eliminate intercompany sale of inventory. 6-27

28 E6-17 Prior-Period Inventory Profits a. 20X8 Sale: Total = Re-sold + Inventory Sales 180, ,000 30,000 COGS 120, ,333 20,000 Gross Profit 60,000 56,667 10,000 Gross Profit % 33.33% 20X9 Sale: Total = Re-sold + Inventory Sales 240, , ,000 COGS 160, , ,000 Gross Profit 80,000 56,667 50,000 Gross Profit % 33.33% Investment in Level Brothers 7,500 NCI in NA of Level Brothers 2,500 Cost of goods sold 10,000 Reversal of 20X8 gross profit deferral Sales 240,000 Cost of Goods Sold 190,000 Inventory 50,000 Eliminate 20X9 intercompany sale of inventory. b. 20X8 20X9 Reported net income of Level Brothers $350,000 $420,000 Unrealized profit, December 31, 20X8 (10,000) 10,000 Unrealized profit, December 31, 20X9 (50,000) Realized net income $340,000 $380,000 Noncontrolling interest's share of ownership x 0.25 x 0.25 Income assigned to noncontrolling interest $ 85,000 $ 95,

29 SOLUTIONS TO PROBLEMS P6-18 Consolidated Income Statement Data a. $180,000 = $550,000 + $450,000 - $820,000 b. January 1, 20X2: $25,000 = $75,000 - $50,000 December 31, 20X2: $15,000 = $180,000 + $210,000 - $375,000 c. Investment in Bitner 15,000 NCI in NA of Bitner 10,000 Cost of Goods Sold 25,000 Eliminate beginning inventory profit. Sales 180,000 Cost of Goods Sold 165,000 Inventory 15,000 Eliminate intercompany sale of inventory. d. Reported net income of Bitner Company $ 90,000 Prior-period profit realized in 20X2 25,000 Unrealized profit on 20X2 sales (15,000) Realized income $100,000 Proportion held by noncontrolling interest x 0.40 Income assigned to noncontrolling interest $ 40,

30 P6-19 Unrealized Profit on Upstream Sales 20X2 Total = Re-sold + Inventory Sales 200, ,000 70,000 COGS 160, ,000 56,000 Gross Profit 40,000 26,000 14,000 Gross Profit % 20.00% 20X3 Total = Re-sold + Inventory Sales 175,000 70, ,000 COGS 140,000 56,000 84,000 Gross Profit 35,000 14,000 21,000 Gross Profit % 20.00% 20X4 Total = Re-sold + Inventory Sales 225, , ,000 COGS 180,000 84,000 96,000 Gross Profit 45,000 21,000 24,000 Gross Profit % 20.00% 20X2 20X3 20X4 Operating income reported by Pacific $150,000 $240,000 $300,000 Net income reported by Carroll 100,000 90, ,000 $250,000 $330,000 $460,000 Inventory profit, December 31, 20X2 $70,000 - ($70,000 / 1.25) (14,000) 14,000 Inventory profit, December 31, 20X3 $105,000 - ($105,000 / 1.25) (21,000) 21,000 Inventory profit, December 31, 20X4 $120,000 - ($120,000 / 1.25) (24,000) Consolidated net income $236,000 $323,000 $457,000 Income to noncontrolling interest: ($100,000 - $14,000) x 0.40 (34,400) ($90,000 + $14,000 - $21,000) x 0.40 (33,200) ($160,000 + $21,000 - $24,000) x 0.40 (62,800) Income to controlling interest $201,600 $289,800 $394,

31 P6-20 Net Income of Consolidated Entity Operating income of Master for 20X5 $118,000 Net income of Crown for 20X5 65,000 $183,000 Add: Prior year profits realized by Master 25,000 Prior year profits realized by Crown 40,000 Less: Unrealized profits for 20X5 by Master (14,000) Unrealized profits for 20X5 by Crown (55,000) Amortization of differential ($45,000 / 15 years) (3,000) Consolidated net income, 20X5 $176,000 Less: Income to noncontrolling interest ($65,000 + $40,000 - $55,000 - $3,000) x 0.30 (14,100) Income to controlling interest $161,900 P6-21 Correction of Eliminating Entries a. Proportion of intercompany inventory purchases resold during 20X5: Unrealized profit at year end $ 12,000 Intercompany transfer price $140,000 Cost of inventory sold ($140,000 / 1.40) (100,000) Total Profit 40,000 Proportion of intercompany sale held by Bolger at year end 0.30 Proportion of intercompany purchases resold by Bolger during 20X5 ( ) 0.70 b. Eliminating entries, December 31, 20X5: Intercompany Transactions Total = Re-sold + Inventory Sales 140,000 98,000 42,000 COGS 100,000 70,000 30,000 Gross Profit 40,000 28,000 12,000 Gross Profit % 28.57% Accounts Payable 80,000 Accounts Receivable 80,000 Eliminate intercompany receivable/payable. Sales 140,000 Cost of Goods Sold 128,000 Inventory 12,000 Eliminate intercompany sale of inventory. 6-31

32 P6-22 Incomplete Data a. Increase in fair value of buildings and equipment: Consolidated total $ 680,000 Balance reported by Lever (400,000) Balance reported by Tropic (240,000) Increase in value $ 40,000 b. Accumulated depreciation for consolidated entity: Accumulated depreciation reported by Lever $180,000 Accumulated depreciation reported by Tropic 110,000 Cumulative write-off of differential ($5,000 x 6 years) 30,000 Accumulated depreciation for consolidated entity $320,000 c. Amount paid by Lever to acquire ownership in Tropic: Common stock outstanding $ 60,000 Retained earnings at acquisition 30,000 Total book value at acquisition $ 90,000 Increase in value of buildings and equipment 40,000 Fair value of net assets acquired $130,000 Proportion of ownership acquired x 0.75 Amount paid by Lever $ 97,500 d. Investment in Tropic Company stock reported at December 31, 20X6: Tropic's common stock outstanding December 31, 20X6 $ 60,000 Tropic's retained earnings reported December 31, 20X6 112,000 Total book value $172,000 Proportion of ownership held by Lever x 0.75 Lever's share of net book value $129,000 Unamortized differential ($5,000 x 2 years) x ,500 20X6 Gross Profit Deferral on Downstream Sale (3,000) Investment in Tropic Company stock $133,500 e. Intercorporate sales of inventory in 20X6: Sales reported by Lever $420,000 Sales reported by Tropic 260,000 Total sales $680,000 Sales reported in consolidated income statement (650,000) Intercompany sales during 20X6 $ 30,

33 P6-22 (continued) f. Unrealized inventory profit, December 31, 20X6: Inventory reported by Lever $125,000 Inventory reported by Tropic 90,000 Total inventory $215,000 Inventory reported in consolidated balance sheet (211,000) Unrealized inventory profit, December 31, 20X6 $ 4,000 g. Eliminating entry to remove the effects of intercompany inventory sales during 20X6: Sales 30,000 Cost of Goods Sold 26,000 Inventory 4,000 h. Unrealized inventory profit at January 1, 20X6: Cost of goods sold reported by Lever $310,000 Cost of goods sold reported by Tropic 170,000 Reduction of cost of goods sold for intercompany sales during 20X6 (26,000) Adjusted cost of goods sold $454,000 Cost of goods sold reported in consolidated income statement (445,000) Additional adjustment to cost of goods sold due to unrealized profit in beginning inventory $ 9,000 i. Accounts receivable reported by Lever at December 31, 20X6: Accounts receivable reported for consolidated entity $145,000 Accounts receivable reported by Tropic (55,000) Difference $ 90,000 Adjustment for intercompany receivable/payable: Accounts payable reported by Lever $ 86,000 Accounts payable reported by Tropic 20,000 Total reported accounts payable $106,000 Accounts payable reported for consolidated entity (89,000) Adjustment for intercompany receivable/payable 17,000 Accounts receivable reported by Lever $107,

34 P6-23 Eliminations for Upstream Sales a. Equity Method Entries on Clean Air's Books: Investment in Special Filter 32,000 Income from Special Filter 32,000 Record Clean Air's 80% share of Special Filter's 20X8 income Investment in Special Filter 16,000 Income from Special Filter 16,000 Reverse of the deffered gross profit from upstream sales in 20X7 Income from Special Filter 12,000 Investment in Special Filter 12,000 Eliminate the deffered gross profit from upstream sales in 20X8 Book Value Calculations: NCI 20% + Clean Air 80% = Common Stock + Retained Earnings Original book value 62, ,000 90, ,000 + Net Income 8,000 32,000 40,000 book value 70, ,000 90, ,000 Reversal/Deferred GP Calculations: Total = Downstream Reversal 0 0 Clean Air's share + NCI's share Upstream Reversal 20,000 16,000 4,000 Downstream Deferred GP 0 0 Upstream Deferred GP (15,000) (12,000) (3,000) Total 5,000 4,000 1,000 Basic elimination entry: Common stock 90,000 Original amount invested (100%) Retained earnings 220,000 Beginning balance in RE Income from Special Filter 36,000 Parent s % of NI - Def. GP + Reversal NCI in NI of Special Filter 9,000 NCI share of NI - Def. GP + Reversal Investment in Special Filter 284,000 Net book value - Def. GP + Reversal NCI in NA of Special Filter 71,000 NCI share of BV - Def. GP + Reversal 6-34

35 P6-23 (continued) 20X7 Upstream Transactions 20X8 Beg. Inventory Sales 60,000 COGS 40,000 Gross Profit 20,000 Gross Profit % 33.33% Reversal of last year's deferral: 20X8 Upstream Transactions Total = Re-sold + Inventory Sales 150, ,000 45,000 COGS 100,000 70,000 30,000 Gross Profit 50,000 35,000 15,000 Gross Profit % 33.33% Investment in Special Filter 16,000 NCI in NA of Special Filter 4,000 Cost of Goods Sold 20,000 Deferral of this year's unrealized profits on inventory transfers Sales 150,000 Cost of Goods Sold 135,000 Inventory 15,

36 P6-23 (continued) b. Computation of consolidated net income and income assigned to controlling interest: Operating income reported by Clean Air Products ($250,000 - $175,000 - $30,000) $ 45,000 Net income of Superior Filter ($200,000 - $140,000 - $20,000) 40,000 $ 85,000 Inventory profit realized from 20X7 20,000 Unrealized inventory profit for 20X8 (15,000) Consolidated net income $ 90,000 Income assigned to noncontrolling interest ($40,000 + $20,000 - $15,000) x 0.20 (9,000) Income assigned to controlling interest $ 81,000 c. Noncontrolling interest, December 31, 20X8: Common stock $ 90,000 Retained earnings ($220,000 + $40,000) 260,000 Less: Unrealized inventory profit (15,000) $335,000 Proportion of stock held by noncontrolling interest x 0.20 Noncontrolling interest $ 67,

37 P6-24 Multiple Inventory Transfers a. Consolidated net income for 20X8: Operating income of Ajax Corporation $80,000 Unrealized profit, December 31, 20X8 ($35,000 - $15,000) x ($7,000 / $35,000) (4,000) $ 76,000 Net income of Beta Corporation $37,500 Profit realized from 20X7 ($30,000 - $24,000) x ($10,000 / $30,000) 2,000 Unrealized profit, December 31, 20X8 ($72,000 - $63,000) x ($12,000 / $72,000) (1,500) 38,000 Net income of Cole Corporation $20,000 Profit realized from 20X7 ($72,000 - $60,000) x ($18,000 / $72,000) 3,000 Unrealized profit, December 31, 20X8 ($45,000 - $27,000) x ($15,000 / $45,000) (6,000) 17,000 Consolidated net income $131,000 b. Inventory balance, December 31, 20X8: Balance per Beta Corporation $ 7,000 Less: Unrealized profit (4,000) $ 3,000 Balance per Cole Corporation $12,000 Less: Unrealized profit (1,500) 10,500 Balance per Ajax Corporation $15,000 Less: Unrealized profit (6,000) 9,000 Inventory balance per consolidated statement $22,500 c. Income assigned to noncontrolling interest in 20X8: Realized income of Beta Corporation $38,000 Proportion of stock held by noncontrolling interest x 0.30 $11,400 Realized income of Cole Corporation $17,000 Proportion of stock held by noncontrolling interest x ,700 Income to noncontrolling interest $13,

38 P6-25 Consolidation with Inventory Transfers and Other Comprehensive Income 20X4 Downstream Transactions Total = Re-sold + Inventory Sales 108,000 60,000 48,000 COGS 90,000 50,000 40,000 Gross Profit 18,000 10,000 8,000 Gross Profit % 16.67% 20X4 Upstream Transactions Total = Re-sold + Inventory Sales 45,000 27,000 18,000 COGS 30,000 18,000 12,000 Gross Profit 15,000 9,000 6,000 Gross Profit % 33.33% 20X5 Downstream Transactions Total = Re-sold + Inventory Sales 36,000 24,000 12,000 COGS 30,000 20,000 10,000 Gross Profit 6,000 4,000 2,000 Gross Profit % 16.67% 20X5 Upstream Transactions Total = Re-sold + Inventory Sales 48,000 6,000 42,000 COGS 32,000 4,000 28,000 Gross Profit 16,000 2,000 14,000 Gross Profit % 33.33% Investment in Income from Tall Corp. Tall Corp. Beg. Balance 1,246,600 90% Net Income 81,000 81,000 90% Net Income 54,000 90% Dividends 90% of OCI 18,000 Gain 20X4 Reversal 13,400 14,600 Deferred GP 14,600 13,400 20X4 Reversal Balance 1,290,400 79,800 Balance Reversal 13,400 1,285,800 Basic 79,800 18,000 OCI Entry