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Test bank with answers for advanced accounting 3e by jeter chapter 07

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Chapter 7
Elimination of Unrealized Gains or Losses on
Intercompany Sales of Property and Equipment
Multiple Choice
1.

In the year a subsidiary sells land to its parent company at a gain, a workpaper entry is made debiting
1. Retained Earnings - P Company.

2. Retained Earnings - S Company.
3. Gain on Sale of Land.
a. 1
b. 2
c. 3
d. both 1 and 2.

2.

In years subsequent to the year a 90% owned subsidiary sells equipment to its parent company at a gain, the
noncontrolling interest in consolidated income is computed by multiplying the noncontrolling interest percentage
by the subsidiary‟s reported net income
a. minus the net amount of unrealized gain on the intercompany sale.
b. plus the net amount of unrealized gain on the intercompany sale.
c. minus intercompany gain considered realized in the current period.
d. plus intercompany gain considered realized in the current period.

3.

Company S sells equipment to its parent company (P) at a gain. In years subsequent to the year of the
intercompany sale, a workpaper entry is made under the cost method debiting
a. Retained Earnings - P.
b. Noncontrolling interest.
c. Equipment.
d. all of these.

4.

Pinick Corp. owns 90% of the outstanding common stock of Shell Company. On December 31, 2011, Shell sold
equipment to Pinick for an amount greater than the equipment‟s book value but less than its original cost. The
equipment should be reported on the December 31, 2011 consolidated balance sheet at
a. Pinick‟s original cost less 90% of Shell‟s recorded gain.
b. Pinick‟s original cost less Shell‟s recorded gain.
c. Shell‟s original cost.
d. Pinick‟s original cost.

5.

Pratt Company owns 100% of Sage Corporation. On January 1, 2011 Pratt sold equipment to Sage at a gain.
Pratt had owned the equipment for four years and used a ten-year straight-line rate with no residual value. Sage is


using an eight-year straight-line rate with no residual value. In the consolidated income statement, Sage‟s
recorded depreciation expense on the equipment for 2011 will be reduced by
a. 10% of the gain on sale.
b. 12 1/2% of the gain on sale.
c. 80% of the gain on sale.
d. 100% of the gain on sale.

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7-2

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

6.

Pratt Corporation owns 100% of Stone Company‟s common stock. On January 1, 2011, Pratt sold equipment
with a book value of $210,000 to Stone for $300,000. Stone is depreciating the equipment over a ten-year life by
the straight-line method. The net adjustments to compute 2011 and 2012 consolidated income would be an
increase (decrease) of
2011
2012
a. ($90,000)
$0
b. ($90,000)
$9,000
c. ($81,000)
$0
d. ($81,000)
$9,000

7.

In the year an 80% owned subsidiary sells equipment to its parent company at a gain, the noncontrolling interest
in consolidated income is calculated by multiplying the noncontrolling interest percentage by the subsidiary‟s
reported net income
a. plus the intercompany gain considered realized in the current period.
b. plus the net amount of unrealized gain on the intercompany sale.
c. minus the net amount of unrealized gain on the intercompany sale.
d. minus the intercompany gain considered realized in the current period.

8.

The amount of the adjustment to the noncontrolling interest in consolidated net assets is equal to the
noncontrolling interest‟s percentage of the
a. unrealized intercompany gain at the beginning of the period.
b. unrealized intercompany gain at the end of the period.
c. realized intercompany gain at the beginning of the period.
d. realized intercompany gain at the end of the period.

9.

In January 2008, S Company, an 80% owned subsidiary of P Company, sold equipment to P Company for
$1,980,000. S Company‟s original cost for this equipment was $2,000,000 and had accumulated depreciation of
$200,000. P Company continued to depreciate the equipment over its 9 year remaining life using the straight-line
method. This equipment was sold to a third party on January 1, 2011 for $1,440,000. What amount of gain should
P Company record on its books in 2011?
a. $60,000.
b. $120,000.
c. $240,000.
d. $360,000.

10.

In years subsequent to the upstream intercompany sale of nondepreciable assets, the necessary consolidated
workpaper entry under the cost method is to debit the
a. Noncontrolling interest and Retained Earnings (Parent) accounts, and credit the nondepreciable asset.
b. Retained Earnings (Parent) account and credit the nondepreciable asset.
c. Nondepreciable asset, and credit the Noncontrolling interest and Investment in Subsidiary accounts.
d. No entries are necessary.

11.

When preparing consolidated financial statement workpapers, unrealized intercompany gains, as a result of
equipment or inventory sales by affiliates, are allocated proportionately by percent of ownership between parent
and subsidiary only when the selling affiliate is
a. the parent and the subsidiary is less than wholly owned.
b. a wholly owned subsidiary.
c. the subsidiary and the subsidiary is less than wholly owned.
d. the parent of a wholly owned subsidiary.

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Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

7-3

12.

Gain or loss resulting from an intercompany sale of equipment between a parent and a subsidiary is
a. recognized in the consolidated statements in the year of the sale.
b. considered to be realized over the remaining useful life of the equipment as an adjustment to depreciation in
the consolidated statements.
c. considered to be unrealized in the consolidated statements until the equipment is sold to a third party.
d. amortized over a period not less than 2 years and not greater than 40 years.

13.

In 2011, P Company sells land to its 80% owned subsidiary, S Company, at a gain of $50,000. What is the effect
of this sale of land on consolidated net income assuming S Company still owns the land at the end of the year?
a. consolidated net income will be the same as if the sale had not occurred.
b. consolidated net income will be $50,000 less than it would had the sale not occurred.
c. consolidated net income will be $40,000 less than it would had the sale not occurred.
d. consolidated net income will be $50,000 greater than it would had the sale not occurred.

14.

Several years ago, P Company bought land from S Company, its 80% owned subsidiary, at a gain of $50,000 to S
Company. The land is still owned by P Company. The consolidated working papers for this year will require:
a. no entry because the gain happened prior to this year.
b. a credit to land for $50,000.
c. a debit to P‟s retained earnings for $50,000.
d. a debit to Noncontrolling interest for $50,000.

15.

On January 1, 2010 S Corporation sold equipment that cost $120,000 and had a book value of $48,000 to P
Corporation for $60,000. P Corporation owns 100% of S Corporation and the equipment has a 4-year remaining
life. What is the effect of the sale on P Corporation‟s Equity from Subsidiary Income account for 2011?
a. no effect
b. increase of $12,000.
c. decrease of $12,000.
d. increase of $3,000.

16.

P Corporation acquired an 80% interest in S Corporation two years ago at an implied value equal to the book
value of S. On January 2, 2011, S sold equipment with a five-year remaining life to P for a gain of $120,000. S
reports net income of $600,000 for 2011 and pays dividends of $200,000. P‟s Equity from Subsidiary Income for
2011 is:
a. $480,000.
b. $384,000.
c. $403,200.
d. $576,000

17.

P Company purchased land from its 80% owned subsidiary at a cost of $100,000 greater than it subsidiary‟s book
value. Two years later P sold the land to an outside entity for $50,000 more than it‟s cost. In its current year
consolidated income statement P and its subsidiary should report a gain on the sale of land of:
a. $50,000.
b. $120,000.
c. $130,000.
d. $150,000.

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7-4

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

18.

On January 1, 2010, P Corporation sold equipment with a 3-year remaining life and a book value of $40,000 to its
70% owned subsidiary for a price of $46,000. In the consolidated workpapers for the year ended December 31,
2011, an elimination entry for this transaction will include a:
a. debit to Equipment for $6,000.
b. debit to Gain on Sale of Equipment for $6,000.
c. credit to Depreciation Expense for $6,000.
d. debit to Accumulated Depreciation for $4,000.

19.

Parks Corporation owns 100% of Starr Company‟s common stock. On January 1, 2011, Parks sold equipment
with a book value of $350,000 to Starr for $500,000. Starr is depreciating the equipment over a ten-year life by
the straight-line method. The net adjustments to compute 2011 and 2012 consolidated income would be an
increase (decrease) of
2011
2012
a. ($150,000)
$0
b. ($150,000) $15,000
c. ($135,000)
$0
d. ($135,000) $15,000

20.

In January 2008, S Company, an 80% owned subsidiary of P Company, sold equipment to P Company for
$990,000. S Company‟s original cost for this equipment was $1,000,000 and had accumulated depreciation of
$100,000. P Company continued to depreciate the equipment over its 9 year remaining life using the straight-line
method. This equipment was sold to a third party on January 1, 2011 for $720,000. What amount of gain should P
Company record on its books in 2011?
a. $30,000.
b. $60,000.
c. $120,000.
d. $180,000.

21.

P Corporation acquired an 80% interest in S Corporation two years ago at an implied value equal to the book
value of S. On January 2, 2011, S sold equipment with a five-year remaining life to P for a gain of $180,000. S
reports net income of $900,000 for 2011 and pays dividends of $300,000. P‟s Equity from Subsidiary Income for
2011 is:
a. $720,000.
b. $576,000.
c. $604,800.
d. $864,000

22.

P Company purchased land from its 80% owned subsidiary at a cost of $30,000 greater than it subsidiary‟s book
value. Two years later P sold the land to an outside entity for $15,000 more than it‟s cost. In its current year
consolidated income statement P and its subsidiary should report a gain on the sale of land of:
a. $15,000.
b. $36,000.
c. $39,000.
d. $45,000.

23.

On January 1, 2010, P Corporation sold equipment with a 3-year remaining life and a book value of $100,000 to
its 70% owned subsidiary for a price of $115,000. In the consolidated workpapers for the year ended December
31, 2011, an elimination entry for this transaction will include a:
a. debit to Equipment for $15,000.
b. debit to Gain on Sale of Equipment for $15,000.
c. credit to Depreciation Expense for $15,000.

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Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

7-5

d. debit to Accumulated Depreciation for $10,000.
Problems
7-1

Parker Company, a computer manufacturer, owns 90% of the outstanding stock of Santo Company. On January
1, 2011, Parker sold computers to Santo for $500,000. The computers, which are inventory to Parker, had a cost
to Parker of $350,000. Santo Company estimated that the computers had a useful life of six years from the date of
purchase.
Santo Company reported net income of $310,000, and Parker Company reported net income of $870,000 from its
independent operations (including sales to affiliates) for the year ended December 31, 2011.
Required:
A. Prepare in general journal form the workpaper entries necessary because of the intercompany sales in the
consolidated statements workpaper for both 2011 and 2012.
B. Calculate controlling interest in consolidated net income for 2011.

7-2

On January 1, 2008, Penny Company purchased a 90% interest in Stein Company for $800,000, the same as the
book value on that date. On January 1, 2011, Stein sold new equipment to Penny for $16,000. The equipment
cost $11,000 and had a five year estimated life as of January 1, 2011.
During 2012, Penny sold merchandise to Stein at 20% above cost in the amount (selling price) of $126,000. At
the end of the year, Stein had one-third of this merchandise in its ending inventory. At the beginning of 2012,
Stein had $48,000 of inventory purchased in 2011 from Penny
Required:
A. Prepare all workpaper entries necessary to eliminate the effects of the intercompany sales on the consolidated
financial statements for 2012.
B. Calculate the amount of noncontrolling interest to be deducted from consolidated net income in the
consolidated income statement for 2012. Stein Company reported $40,000 of net income in 2012.

7-3

Pringle Company owns 104,000 of the 130,000 shares outstanding of Seely Corporation. Seely Corporation sold
equipment to Pringle Company on January 1, 2011 for $740,000. The equipment was originally purchased by
Seely Corporation on January 1, 2010 for $1,280,000 and at that time its estimated depreciable life was 8 years.
The equipment is estimated to have a remaining useful life of four years on January 1, 2011. Both companies use
the straight-line method to depreciate equipment. In 2012 Pringle Company reported net income from its
independent operations of $3,270,000, and Seely Corporation reported net income of $820,000 and declared
dividends of $60,000. Pringle Company uses the cost method to record the investment in Seely Company.
Required:
A. Prepare, in general journal form, the workpaper entries relating to the intercompany sale of equipment that are
necessary in the December 31, 2012 consolidated financial statements workpapers.
B. Calculate the amount of noncontrolling interest to be deducted from consolidated net income in the
consolidated income statement for 2012.
C. Calculate controlling interest in consolidated net income for 2012.

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7-6
7-4

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
P Company bought 60% of the common stock of S Company on January 1, 2011. On January 1, 2011 there was
an intercompany sale of equipment at a gain of $63,000. The equipment had an estimated remaining life of six
years. Net incomes of the two companies from their own operations (including sales to affiliates) were as
follows:
2011
2012
P Company
$280,000
$210,000
S Company
70,000
105,000
A. If S Company sold the equipment to P Company, fill in the following matrix:
2011
2012
Noncontrolling interest in consolidated net income
Controlling Interest in Consolidated net income
B. If P Company sold the equipment to S Company, fill in the following matrix:
2011
2012
Noncontrolling interest in consolidated net income
Controlling interest in consolidated net income

7-5

On January 1, 2011, Pinkel Company purchased equipment from its 80%-owned subsidiary for $2,400,000. On
the date of the sale, the carrying value of the equipment on the books of the subsidiary company was $1,800,000.
The equipment had a remaining useful life of six years on January 2011. On January 1, 2012, Pinkel Company
sold the equipment to an outside party for $2,200,000.
Required:
A. Prepare, in general journal form, the entries necessary in 2011 and 2012 on the books of Pinkel Company to
account for the purchase and sale of the equipment.
B. Determine the consolidated gain or loss on the sale of the equipment and prepare, in general journal form, the
entry necessary on the December 31, 2012 consolidated statements workpaper to properly reflect this gain or
loss.

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Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment
7-6

7-7

P Corporation acquired 80% of the outstanding voting stock of S Corporation when the fair values equaled the
book values.
On July 1, 2010, P sold land to S for $300,000. The land originally cost P $200,000. S recently resold the land
on October 30, 2011 for $350,000.
On October 1, 2011, S Corporation sold equipment to P Corporation for $80,000. S originally paid $100,000 for
this equipment and had accumulated depreciation of $40,000 thus far. The equipment has a five-year remaining
life.
Required:
A. Complete the consolidated income statement for P Corporation and subsidiary for the year ended December
31, 2011.

Sales
Dividend Income from S

P

S

1,200,000

600,000

7-7

Noncontrolling
Interest

Consolidated
Balances

80,000

Gain on Sale of
Equipment
Gain on Sale of Land

20,000
50,000

Cost of Sales

(800,000)

(300,000)

Depreciation Expense

(160,000)

(80,000)

Other Expenses

(200,000)

(160,000)

120,000

130,000

Noncontrolling Interest
in Income
Net Income

Elimination Entries
Dr.
Cr.

Pike Company owns 90% of the outstanding common stock of Sanka Company. On January 1, 2011, Sanka
Company sold equipment to Pike Company for $300,000. Sanka Company had purchased the equipment for
$450,000 on January 1, 2006 and has been depreciating it over a 10 year life by the straight-line method. The
management of Pike Company estimated that the equipment had a remaining life of 5 years on January 1, 2011.
In 2011, Pike Company reported $225,000 and Sanka Company reported $150,000 in net income from their
independent operations.
Required:
A. Prepare in general journal form the workpaper entries relating to the intercompany sale of equipment that are
necessary in the December 31, 2011 and 2012 consolidated statements workpapers. Pike Company uses the
cost method to record its investment in Sanka Company.
B. Calculate equity in subsidiary income for 2011 and noncontrolling interest in net income for 2011.

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7-8
7-8

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
On January 1, 2010, Peine Company acquired an 80% interest in the common stock of Stine Company on the
open market for $3,000,000, the book value at that date.
On January 1, 2011, Peine Company purchased new equipment for $58,000 from Stine Company. The equipment
cost $36,000 and had an estimated life of five years as of January 1, 2011.
During 2012, Peine Company had merchandise sales to Stine Company of $400,000; the merchandise was priced
at 25% above Peine Company‟s cost. Stine Company still owes Peine Company $70,000 on open account and
has 20% of this merchandise in inventory at December 31, 2012. At the beginning of 2012, Stine Company had
in inventory $100,000 of merchandise purchased in the previous period from Peine Company.
Required:
A. Prepare all workpaper entries necessary to eliminate the effects of the intercompany sales on the consolidated
financial statements for the year ended December 31, 2012.
B. Assume that Stine Company reports net income of $160,000 for the year ended December 31, 2012.
Calculate the amount of noncontrolling interest to be deducted from consolidated income in the consolidated
income statement for the year ended December 31, 2012.

Short Answer
1.

When there have been intercompany sales of depreciable property, workpaper entries are necessary to accomplish
several financial reporting objectives. Identify three of these financial reporting objectives for depreciable
property.

2.

An eliminating entry is needed to adjust the consolidated financial statements when the purchasing affiliate sells a
depreciable asset that was acquired from another affiliate. Describe the necessary eliminating entry.

Short Answer Questions from the Textbook
1.

From a consolidated point of view, when should profit be recognized on intercompany sales of depreciable assets?
Nondepreciable assets?

2.

In what circumstances might a consolidated gain be recognized on the sale of assets to a nonaffiliate when the
selling affiliate recognizes a loss?

3.

What is the essential procedural difference between workpaper eliminating entries for un-realized intercompany
profit when the selling affiliate is a less than wholly owned subsidiary and such entries when the selling affiliate is
the parent company or a wholly owned subsidiary?

4.

Define the controlling interest in consolidated net income using the t-account approach.

5.

Why is it important to distinguish between up-stream and downstream sales in the analysis of intercompany profit
eliminations?

6.

In what period and in what manner should profits relating to the intercompany sale of depreciable property and
equipment be recognized in the consolidated financial statements?

7.

Define consolidated retained earnings using the analytical approach.

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Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment
Business Ethics Question from the Textbook
Some people believe that the use of executive stock options is directly related to the increased number of earnings
restatements. For each of the following items, discuss the potential ethical issues that might be related to earnings
management within the firm.
1.
Should stock options be expensed on the Income Statement?
2.
Should the CEO or CFO be a past employee of the firm‟s audit firm?
3.
Should the firm‟s audit committee be com-posed entirely of outside members and be
solely responsible for hiring the firm‟s auditors?

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7-9


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7-10 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
ANSWER KEY
Multiple Choice

1.
2.
3.
4.
5.
6.

c
d
d
b
b
d

7.
8.
9.
10.
11.
12.

c
a
b
a
c
b

13.
14.
15.
16.
17.
18.

a
b
d
c
d
d

19.
20.
21.
22.
23.

d
b
c
d
d

Problems
7-1

A. 2011
Sales

500,000
Cost of Sales
Equipment

350,000
150,000

Accumulated Depreciation
Depreciation Expense (150,000/6)
2012
Beginning R/E – Parker
Equipment

25,000
25,000

150,000
150,000

Accumulated Depreciation
Depreciation Expense
Beginning R/E – Parker

50,000

B. Parker‟s net income from independent operations
- Unrealized profit on 2011 sales to Santo
+ Profit on sales to Santo realized through
2011 depreciation
Parker‟s income from independent operations that
has been realized from third party transactions
Income of Santo that has been realized in
transactions with third parties
$310,000
Parker‟s share thereof (.9 × $310,000)
Controlling Interest in Consolidated Net Income – 2011

25,000
25,000
$870,000
(150,000)
25,000
745,000

279,000
$1,024,000

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Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment
7-2

A. Sales

126,000
Cost of Sales

126,000

Cost of Sales
Inventory [42,000 – (42,000/1.20)

7,000

Beginning R/E – Penny
Cost of Sales [48,000 – (48,000/1.20)]

8,000

Beginning R/E – Penny ($5,000 × .9)
Noncontrolling interest ($5,000 × .1)
Equipment (16,000 – 11,000)

4,500
500

Accumulated Depreciation
Depreciation Expense (5,000/5)
Beginning R/E – Penny ($1,000 × .9)
Noncontrolling interest ($1,000 × .1)

2,000

7,000
8,000

5,000
1,000
900
100

B. Noncontrolling Interest in Consolidated net Income:
.1 × (40,000 + 1,000) = $4,100
7-3

A. Equipment
Beginning R/E – Pringle ($100,000 × .80)
Noncontrolling Interest ($100,000 × .20)
Accumulated Depreciation
Accumulated Depreciation ($100,000/4) × 2
Depreciation Expense
Beginning R/E – Pringle ($25,000 × .80)
Noncontrolling Interest ($25,000 × .20)
B. Noncontrolling Interest Calculation:
Reported income of Seely Company
Plus: Intercompany profit considered realized
in the current period
Noncontrolling interest in Seely Company
(.20 × 845,000)
C. Controlling Interest in Consolidated Net Income:
Pringle Company‟s income from its
independent operations
Reported net income of Seely Company
Plus profit on intercompany sale of
equipment considered to be realized
through depreciation in 2011
Reported subsidiary income that has been
realized in transactions with third
parties
Pringle Company‟s share thereof
Controlling Interest in Consolidated net income

540,000
80,000
20,000
640,000
50,000
25,000
20,000
5,000
$820,000
25,000
$845,000
$169,000

$3,270,000
$820,000

25,000

845,000
× .8
676,000
$3,946,000

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7-11


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7-12 Test Bank to accompany Jeter and Chaney Advanced Accounting
7-4

2011

2012

Noncontrolling interest in
Consolidated net income

$ 7,000 (1)

$ 46,200 (2)

Controlling interest in
Consolidated net income

290,500 (3)

279,300 (4)

A.

(1)
(2)
(3)
(4)

.4($70,000 – $63,000 + $10,500) = $7,000
.4($105,000 + $10,500) = $46,200
$280,000 + .6($70,000 – $63,000 + $10,500) = $290,500
$210,000 + .6($105,000 + $10,500) = $279,300
2011

2012

B.
Noncontrolling interest in
$ 28,000 (5)
$ 42,000 (6)
Consolidated income
Controlling interest in
269,500 (7)
283,500 (8)
Consolidated net income
(5) .4($70,000) = $28,000
(6) .4($105,000) = $42,000
(7) ($280,000 – $63,000 + $10,500) + .6($70,000) = $269,500
(8) ($210,000 + $10,500) + .6($105,000) = $283,500

7-5

A. 2011
(1) Equipment
Cash

2,400,000
2,400,000

(2) Depreciation Expense (1/6 × $2,400,000)
Accumulated Depreciation
2012
(3) Cash
Accumulated Depreciation
Equipment
Gain on Sale of Equipment
B.
Cost
Accumulated Depreciation
1/1/12 Book Value
Proceeds from Sale
Gain on Sale

400,000
400,000

2,200,000
400,000
2,400,000
200,000
Pinkel Company Consolidated
$2,400,000
(400,000)
2,000,000
$1,500,000*
2,200,000
2,200,000
$ 200,000
$700,000

*$1,800,000 – 1/6($1,800,000) = $1,500,000
1/1 Retained Earnings - Pinkel
[.8 × ($600,000 – $100,000)]
1/1 Noncontrolling interest [.2 × ($600,000 – $100,000)]
Gain on Sale of Equipment

400,000
100,000

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500,000


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Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

7-13

$2,400,000 – $1,800,000 = $600,000
$600,000/6 = $100,000
Unrealized intercompany gain on date of sale to outsiders = $600,000 – $100,000 = $500,000

7-6

Sales
Dividend Income from S

P

S

$1,200,000

$600,000

80,000

Elimination Entries
Dr.
Cr.

Noncontrolling
Interest

Consolidating
Balances
$1,800,000

(a)80,000

Gain on Sale of Equipment

20,000

Gain on Sale of Land

50,000

Cost of Sales

(800,000) (300,000)

Depreciation Expense

(160,000)

Other Expenses

(200,000) (160,000)

(b)20,000

(80,000)

(d)100,000

150,000
(1,100,000)

(c) 1,000

(239,000)
(360,000)

Noncontrolling Interest in Income
($130,000 – $20,000 + 1,000) × .20
Net Income
a.

b.

c.

d.

$120,000

22,200
22,200

$130,000

Dividend Income from S
Dividends Declared

80,000

Gain on Sale of Equipment
Equipment
Accumulated Depreciation

20,000
20,000

Accumulated Depreciation
Depreciation Expense

1,000*

Retained Earnings – P
Gain on Sale of Land

100,000

80,000

40,000

1,000

100,000

* ($20,000/5) × 3/12

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(22,200)
$228,800


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7-14 Test Bank to accompany Jeter and Chaney Advanced Accounting
7-7
A.

2011
Gain on Sale of Equipment
Equipment
Accumulated Depreciation
Accumulated Depreciation
Depreciation Expense
2012
Retained Earnings – Pike
Noncontrolling Interest
Equipment
Accumulated Depreciation

75,000
150,000
225,000
15,000
15,000

67,500
7,500
150,000
225,000

Accumulated Depreciation
30,000
Depreciation Expense
Beginning Retained Earnings – Pike
Noncontrolling Interest
B.
Sanka Company net income
Unrealized gain-equipment
($75,000) upstream
Confirmed gain

7-8

Equity in
Sub. Income
$135,000

15,000
13,500
1,500
Noncontrolling
Interest
$15,000

(67,500)
13,500
$81,000

(7,500)
1,500
$ 9,000

A. (1) Sales

400,000
Cost of Sales

400,000

(2) Accounts Payable
Accounts Receivable

70,000

(3) Cost of Sales (beginning inventory – income statement)
Inventory ($80,000 – ($80,000/1.25))

16,000

(4) Beginning Retained Earnings – Peine ($100,000 – ($100,000/1.25))
Cost of Sales (beginning inventory – income statement)

20,000

(5) Beginning Retained Earnings – Peine ($22,000 × .8)
Noncontrolling Interest ($22,000 × .2)
Property, Plant and Equipment

17,600
4,400

(6) Accumulated Depreciation
Depreciation Expense ($22,000/5)
Beginning Retained Earnings – Peine ($4,400 × .8)
Noncontrolling Interest ($4,400 × .2)

70,000

16,000

20,000

22,000
8,800

B. Noncontrolling Interest in Consolidated Income .2 × ($160,000 + $4,400) = $32,880

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4,400
3,520
880


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Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

7-15

Short Answer
1.

Workpaper entries are necessary to accomplish the following financial reporting objectives:
a. To report as gains or losses in the consolidated income statement only those that result from the sale of
depreciable property to parties outside the affiliated group.
b. To present property in the consolidated balance sheet at its cost to the affiliated group.
c. To present accumulated depreciation in the consolidated balance sheet and depreciation expense in the
consolidated income statement based on the cost to the affiliated group of the related assets.

2.

The eliminating entry adjusts the gain or loss reported by the purchasing affiliate from the amount it recorded to
the correct amount from the perspective of the consolidated entity, and adjusts the controlling and noncontrolling
interests for the unrealized intercompany profit associated with the equipment on the date of its premature
disposal.

Solutions to Short Answer Questions from the Textbook

1. Intercompany profit in depreciable asset transfers is realized as a result of the utilization of the asset in the generation
of revenue. Such utilization is measured by depreciation and, accordingly, the recognition of the realization of
intercompany profit is accomplished through depreciation adjustments in the periods following the intercompany
transfers.

When intercompany sales involve nondepreciable assets, any profit recognized by the selling affiliate will
remain unrealized from the consolidated entity‟s point of view for all subsequent periods or until the asset is
disposed of.
2. Intercompany profit may be included in the selling affiliate‟s carrying value of an asset that is sold to third parties. If
the sales price in the sale to the third party is less that the inflated carrying value, the selling affiliate will recognize a
loss on the sale. From the point of view of the consolidated entity, however, the carrying value of the asset is its cost
to the affiliated group (selling affiliate‟s cost less unrealized intercompany profit) and if this value is less than the
selling price to the third party, the consolidated group will recognize a gain. In effect, previously unrecognized
intercompany profit is realized upon the sale of the asset to a third party.
3. The only procedural difference in the workpaper entries relating to the elimination of unrealized intercompany profit
in depreciable or nondepreciable assets when the selling affiliate is a less than wholly owned subsidiary is that the
noncontrolling interest in the unrealized intercompany profit at the beginning of the year must be recognized by
debiting or crediting the noncontrolling shareholders‟ percentage interest in such adjustments to the beginning
retained earnings of the subsidiary.

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7-16 Test Bank to accompany Jeter and Chaney Advanced Accounting

4. Consolidated income is equal to the parent company‟s income from its independent operations that has been realized
in transactions with third parties plus subsidiary income that has been realized in transactions with third parties and
adjusted for the amortization, depreciation, or impairment of the differences between implied and book values (this
total is then allocated to the controlling and noncontrolling interests). The controlling interest in consolidated income
is equal to the parent company‟s income from its independent operations that has been realized in transactions with
third parties plus its share of subsidiary income that has been realized in transactions with third parties and adjusted
for the amortization, depreciation, or impairment of the differences between implied and book values.
Controlling Interest in Consolidated Income
Unrealized gain on intercompany
sale (downstream sales)

Net income internally generated by P Company
Gain realized through usage (depreciation adjustment)

Unrealized profit on downstream
sales to S Company (ending
Inventory)

Realized profit (downstream sales) from beginning inventory
P Company's percentage of S Company's adjusted income
realized from third parties

Controlling interest in Consolidated Income

5. It is important to distinguish between upstream and downstream sales of property and equipment because calculation
of the noncontrolling interest in the consolidated financial statements differs depending on whether the sale giving rise
to the intercompany profit is upstream or downstream.
6. Profit relating to the intercompany sale of property and equipment is recognized in the consolidated financial
statements over the useful life of the equipment. It is recognized in the consolidated financial statements by reducing
depreciation expense (thus increasing consolidated income).
7. Consolidated retained earnings may be defined as the parent company‟s cost basis retained earnings that has been
realized in transactions with third parties plus (minus) the parent company‟s share of the increase (decrease) in
subsidiary retained earnings that has been realized in transactions with third parties from the date of acquisition to the
current date and adjusted for the cumulative effect of amortization of the difference between implied and book values.

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Chapter 7 Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

7-17

ANSWERS TO BUSINESS ETHICS CASE
1. The arguments against expensing options include the following:
Valuation is subjective, involves assumptions that may be unrealistic, and may yield numbers that time
will prove to be of limited usefulness.
Disclosure is a reasonable substitute.
Companies may alter their reward systems with the result that lower level employees are most affected.
Options are not a “real” expense and may never be exercised.
Option valuation opens the door for manipulation as managers can alter their assumptions.
Diluted earnings per share are already disclosed, and expensing options amounts to double counting.
Expensing may destroy any advantage held by the U.S. as a world leader in technology, and distract
corporate America from more important issues related to executive compensation and governance in
general.

The arguments in favor of expensing options include the following:
Difficulty or subjectivity in valuation is not a reason for avoidance of recording other relevant financial
statement items, such as deferred taxes, pension liabilities, etc.
Transparency is a major objective of financial reporting, and without proper expensing of executive
compensation, transparency is lacking.
Not expensing options generates costs of misinformation.
If employees are over-compensated, the users need to be aware of that fact.
When options qualify as a “real” expense, as defined in the conceptual framework, based on the best
available information at the balance sheet date, they should be reflected as such in the financial
statements.
2.

Ideally the CEO or CFO should not be a past employee of the company‟s audit firm, as such a relationship could
jeopardize his or her independence. However, it is not unusual for a company to hire a former auditor, who might
later be promoted to CEO or CFO, or might even be hired to such a position. If this happens, the company might
want to consider switching auditors or taking other measures to make sure that the audit firm is viewed as
sufficiently independent. Under the Sarbanes-Oxley Act of 2002 mandates that the audit firm‟s independence is
impaired if a former member of the audit engagement team accepts a supervisory accounting position, unless the
individual observes a one-year „cooling off‟ period.

3.

The Sarbanes-Oxley Act of 2002 mandates that each member of the audit committee be a outside member of the
board of directors of the issuer and to be independent. Independent means not receiving any consulting, advisory,
or other compensatory fee from the issuer. At least one member must be a financial expert. The audit committee is
responsible for appointment, compensation, retention, and oversight of the independent auditors.

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