Ch7 Problems Solution

Chapter 7 INTERCOMPANY PROFIT TRANSACTIONS — BONDS Answers to Questions 1

Intercompany borrowing gives rise to notes or advances receivable from and payable to affiliates, as well as reciprocal interest receivable and payable accounts and interest income and expense accounts.

2

Direct lending and borrowing transactions do not give rise to unrealized gains and losses. Any income reported by the lender is precisely reciprocal to an expense reported by the borrower, and the transactions are complete on the date consummated. Similarly, direct lending and borrowing transactions do not give rise to unrecognized gains and losses since intercompany amounts received and paid are both realized and recognized from the viewpoint of the separate legal entities.

3

Actual retirement occur in any of these three following options: a) The issuer (parent or subsidiary) use its available resources to purchase and retire its own bonds. b) The issuer (parent or subsidiary) borrow money from unaffiliated entities at the market rate of interest and use the proceeds to retire its own bonds. (This option constitutes refunding) c) The issuer can borrow money from an affiliate and use the proceeds to retire its own bonds.

4

The book value of the liability is $1,004,700, computed as $1,000,000 plus $10,000 minus $5,300. If an affiliate purchases half of the bonds at 98, it will record a bond investment of $490,000. From the viewpoint of the consolidated entity, the purchase of the bonds results in a constructive retirement of $500,000 par of bonds payable. The constructive gain on the bonds is $12,350 [($1,004,700  50%) – $490,000].

5

A constructive gain on bonds is a gain for consolidated statement purposes that is not recorded on the books of the separate affiliates. The affiliates continue to carry the bonds as a liability (issuer) and investment (purchaser) on their separate books. Alternatively, an unrealized gain on the sale of land is recorded on the books of the selling affiliate, but it is not recognized as a gain for consolidated statement purposes because the land is still held within the consolidated entity. Thus, a constructive gain on bonds is realized and recognized from the viewpoint of the consolidated entity but it is not recognized on the books of the affiliates. An unrealized gain on the sale of land is recognized on the books of the selling affiliate but is not realized or recognized from the viewpoint of the consolidated entity.

6

Constructive gains on intercompany bonds are realized and recognized through the interest income and expense reported on the separate books of the affiliates. The difference between the interest income reported by the investor and the interest expense reported by the issuer on the intercompany bonds is the amount of constructive gain recognized in each period. Constructive gains and losses are recognized in the consolidated financial statements before they are recognized on the books of the affiliates.

7

If a subsidiary purchases parent bonds at a price in excess of book value, a constructive loss results. The loss is attributed to the parent since it is the parent bonds that are constructively retired. This approach of associating constructive gains and losses on intercompany bonds with the issuer is consistent with the procedures used in earlier chapters of associating gains and losses on intercompany sales transactions with the selling affiliates.

Copyright © 2015 Pearson Education Limited

Intercompany Profit Transactions — Bonds

7-2

8a

Assume bonds were purchased at the beginning of the current year 10% bonds payable 52,000 Interest income 5,250 Interest payable 2,500 Investment in S bonds 49,000 Interest expense 4,500 Interest receivable 2,500 Constructive gain on bonds 3,750 To eliminate reciprocal bond investment and liability amounts, reciprocal interest income and expense amounts, reciprocal interest receivable and payable amounts, and enter the constructive gain on bonds. The constructive gain is computed as the $52,500 book value of bonds that were retired for $48,750.

8b

Assume bonds were purchased one year earlier 10% bonds payable 52,000 Interest income 5,250 Interest payable 2,500 Investment in S bonds 49,000 Interest expense 4,500 Interest receivable 2,500 Investment in S stock (90%) 3,375 Noncontrolling interest 375 To eliminate reciprocal bond investment and liability amounts, reciprocal interest income and expense amounts, reciprocal interest receivable and payable amounts, and adjust controlling and noncontrolling interest holdings for constructive gain less piecemeal recognition. The constructive gain is computed as: $53,000 book value - $48,500 cost = $4,500 of which $750 was recognized on the books of the affiliate in the prior year.

9

The amount of piecemeal recognition of a constructive gain or loss is always the difference between the intercompany interest expense and income account that are eliminated. If the straight-line amortization is used, the amount of piecemeal recognition of each year can be calculated with the constructive gain or loss divided by the remaining life of the bond when the retirement occurred. However, this approach cannot be applied if effective interest method is used.

10

Elimination of interest expense will eventually increase the controlling share of consolidated income and the opposite, elimination of interest income will eventually decrease the controlling share of consolidated income. Logically, interest expense is the debit account of the controlling share, so eliminating it will eventually increase the income or credit account and vice versa for the interest income.

11a

A constructive gain will result when interest income exceeds interest expense on the bonds that are constructively retired.

11b

The constructive gain is associated with the parent since the issuer reports interest expense.

11c

The $200 difference between interest income and expense represents a piecemeal recognition of the constructive gain on the books of the separate companies.

Copyright © 2015 Pearson Education Limited

Chapter 7

7-3

SOLUTIONS TO EXERCISES Solution E7-1 c 1 a 2

3 4

d a

Solution E7-2 a 1 Book value of Pan bond’s acquired by Sow ($900,000 + $48,000)  2/3 Cost to Sow Constructive gain d 2 Nominal interest on Pan’s remaining outstanding bonds $300,000  8% Less: Amortization of premium ($48,000  1/3)/ 4 years Interest expense on consolidated income statement

Copyright © 2015 Pearson Education Limited

$632,000 602,000 $ 30,000 $ 24,000 4,000 $ 20,000

Intercompany Profit Transactions — Bonds

7-4

Solution E7-3 c 1 Cost of $80,000 par of Pal bonds January 1, 2011 Book value acquired ($400,000 par - $8,000 discount)  20% Constructive gain d 2 Par value of bonds payable Less: Unamortized discount ($8,000 - $2,000) Book value of bonds Percent outstanding Bonds payable c 3 Constructive gain $2,400/4 years  3 years c 4 Nominal interest Add: Amortization of discount Percent outstanding Interest expense 5

b

Piecemeal recognition of gain is $2,400  25% in 2011.

Copyright © 2015 Pearson Education Limited

$ 76,000 78,400 $ 2,400 $400,000 (6,000) 394,000 80% $315,200 $

1,800

$ 40,000 2,000 42,000 80% $ 33,600

Chapter 7

7-5

Solution E7-4 1. Cost paid to retire 1/2 of Lenka SA’s bonds Book value of bonds retired (($1,000,000 - $200,000) x 0.5) Constructive loss on bond retirement 80% of Petr SA’s net income (80% x $500,000) Constructive loss on bond retirement Piecemeal recognition of constructive loss ($140,000 / 5) Income from Petr SA 2. Noncontrolling interest share: 20% of Petr SA’s net income (20% x $500,000)

$550,000 $400,000 $140,000 $400,000 ($140,000) $28,000 $288,000 $100,000

Solution E7-5 Pim Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2019 (in thousands) Sales Less: Cost of sales

$

Gross profit Add: Gain on constructive retirement of bondsb Less: Operating expenses Operating profit Other Items: Bond interest expensea Consolidated net income a b

750 (435) 315 3 (125) 193

$

(15) 178

Parent’s bond interest expense $25,000 less interest on bonds held intercompany $10,000 = $15,000. Book value of parent’s bonds purchased $100,000 less purchase price $97,000 = $3,000 gain on constructive retirement.

Copyright © 2015 Pearson Education Limited

Intercompany Profit Transactions — Bonds

7-6

Solution E7-6 1. Book value of Albert NL’s bonds at January 1, 2014 Amortization of bonds for 1 year ($200,000 / 10) Book value of Albert NL’s bonds at December 31, 2014 10 percent bonds payable that should be reported: 80% of book value of Albert NL’s bonds (80% x $2,180,000)

$2,200,000 ($20,000) $2,180,000 $1,774,000

2. Investment in Albert NL is a reciprocal account. Thus it should not be reported on the consolidated financial statements. 3. Total interest expense for the year (($2,000,000 x 10%) – ($200,000 / 10)) Interest expense that should be reported: 80% of total interest expense (80% x $180,000)

$180,000

$144,000

4. There is no interest income that should be reported because the interest income is the result of constructive retirement. Solution E7-7 1

2 3

a January 1, 2011 cost of $400,000 par bonds Book value acquired ($2,000,000 + $90,000 premium)  20% Constructive gain

$391,000 418,000 $ 27,000

b Constructive gain $27,000/5 years  4 years

$ 21,600

c Book value $2,072,000  80% outstanding

$1,657,600

Copyright © 2015 Pearson Education Limited

Chapter 7

7-7

Solution E7-8 1a

Constructive gain Book value of bonds January 1, 2012 Amortization for 6 months ($15,000/4 years  1/2 year) Book value of bonds July 1, 2012

$485,000 1,875 486,875

Percent purchased by Say

1b

60%

Book value of bonds purchased Purchase price

$292,125 287,400

Constructive gain

$

Consolidated bond interest expense for 2012 Bond interest expense January 1 to July 1 ($500,000  8%  1/2 year) + $1,875 amortization

$ 21,875

Bond interest expense July 1 to December 31 [($500,000  8%  1/2 year) + $1,875 amortization]  40% Consolidated bond interest expense 1c

8,750 $ 30,625

Bond liability of Par January 1, 2012 Amortization 2012 December 31, 2012

Par $500,000 $500,000

Discount $15,000 - 3,750 $11,250

Consolidated bond liability $488,750  40% outstanding 2

4,725

Book Value $485,000 + 3,750 $488,750 $195,500

The amounts would not be different if Say had been the issuer and Par the purchaser. However, the constructive retirement gains would ‘belong’ to Say and would have been allocated to both Par and the noncontrolling interests in Say.

Copyright © 2015 Pearson Education Limited

Intercompany Profit Transactions — Bonds

7-8

Solution E7-9 (amounts in thousands) Subsidiary purchases parent company bonds: Gain on constructive retirement of bonds 1a Book value of Pin’s bonds constructively retired ($5,000 - $100 unamortized discount)  40% Purchase price of $1,000 par bonds Gain on constructive bond retirement

$1,960 1,900 $ 60

Consolidated interest payable ($3,000 + $1,000)  10% interest  1/2 year

$

1c

Bonds payable at par ($3,000 + $1,000)

$4,000

1d

None But Sid’s investment in Pin bonds will be $1,920.

1b

Cost January 2 Add: Amortization ($100,000/5 years)

2a

2b

200

$1,900 20 $1,920

Parent purchases subsidiary bonds: Loss on constructive retirement of bonds Sid’s bonds payable ($1,000 + $20) Price paid by Pin Loss on constructive retirement of bonds

$1,020 1,030 $ (10)

Consolidated interest expense Pin bonds ($5,000  10% interest) + $20 amortization

$

2c

None Interest receivable of $50 is eliminated in consolidation.

2d

Book value of bonds payable Pin’s bonds December 31, 2011 Add: Amortization for 2012 ($100 / 5 years) Book value of bonds payable

Copyright © 2015 Pearson Education Limited

520

$4,900 20 $4,920

Chapter 7

7-9

Solution E7-10 1. Cost paid to retire 20% of Noa DD’s bonds Book value of bonds retired (20% x $800,000) Constructive loss on bond retirement

$185,000 $160,000 $25,000

90% of Noa DD net income (90% x $400,000) 90% of Constructive loss on bond retirement (90% x $25,000) 90% of piecemeal recognition of constructive loss (90 % x $25,000 / 5) Income from Noa DD

$360,000 ($22,500)

2. 10% of Noa DD net income (10% x $400,000) 10% of Constructive loss on bond retirement (10% x $25,000) 10% of piecemeal recognition of constructive loss (10 % x $25,000 / 5) Noncontrolling interest share

$40,000 ($2,500)

Check: Noncontrolling interest share: Income from Noa DD x 10% / 90%

Copyright © 2015 Pearson Education Limited

$4,500 $342,000

$

500

$38,000

$38,000

Intercompany Profit Transactions — Bonds

7-10

Solution E7-11 Preliminary computations: Book value of Saw bonds on January 1, 2012 Purchase price paid by Par Gain on constructive retirement of Saw bonds Amortization of gain on bonds ($217,000/7 years) Computation of noncontrolling interest share: Share of Saw’s reported income ($140,000  20%) Add: Share of constructive gain ($217,000  20%) Less: Piecemeal recognition of constructive gain ($31,000  20%) Noncontrolling interest share

$1,000,000 783,000 $ 217,000 $

31,000

$

28,000 43,400 (6,200) 65,200

$

Par Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2012 (in thousands) Sales Less: Cost of sales

$1,800 950

Gross profit Add: Gain from constructive retirement of Saw bonds Less: Operating expenses Consolidated net income Less: Noncontrolling interest share Controlling interest share of NI

Copyright © 2015 Pearson Education Limited

$ $

850 217 400 667 65.2 601.8

Chapter 7

7-11

Solution E7-12 1

Pub Corporation and Subsidiary, December 31, 2011

Interest receivable Investment in Sap bonds Interest payable ($40,000  90%) 8% bonds payable (($1,000,000  90%)- 13,500 discount) Interest income Interest expense ($86,000/2) + .9(86,000/2) Loss on constructive retirement of bonds a

Amounts Appearing in Consolidated Financial Statements 0 0 36,000 886,500

Computation of loss on intercompany bonds Balance of investment in bonds at December 31, 2011 Add: Amount amortized for July 1 to December 31, 2011 ($5,000 balance at December 31  30/36 months = $6,000 unamortized at July 1) Investment cost July 1, 2011 Less: Book value acquired [$1,000,000 - ($15,000 unamortized discount at December 31  30/36 months)]  10% Loss on constructive retirement of bonds

2

0 81,700 7,800a $105,000 1,000 $106,000 $

98,200 7,800

Consolidation working paper entries at December 31, 2011 Interest income 3,000 8% bonds payable 98,500 Loss on retirement of bonds 7,800 Investment in Sap bonds 105,000 Interest expense 4,300 To eliminate intercompany bonds, record constructive loss on retirement, and eliminate intercompany interest income and expense. Interest payable 4,000 Interest receivable 4,000 To eliminate reciprocal interest payable and receivable amounts.

3

Consolidation working paper entries at December 31, 2012 Investment in Sap (80%) 5,200 Noncontrolling interest(20%) 1,300 Interest income 6,000 8% bonds payable 99,100 Investment in Sap bonds 103,000 Interest expense 8,600 To eliminate intercompany bonds, interest income and expense, and to charge the unrecognized portion of the constructive loss at the beginning of the period 80% to the investment in Sap and 20% to the noncontrolling interest. Interest payable 4,000 Interest receivable 4,000 To eliminate reciprocal interest payable and receivable amounts.

Copyright © 2015 Pearson Education Limited

Intercompany Profit Transactions — Bonds

7-12

Solution E7-13 1

Gain on constructive retirement of bonds Purchase price of bonds Book value Gain on constructive retirement of bonds

2

$ 97,600 100,000 $ 2,400

Son accounts for its investment in Pap bonds January 2, 2013 Investment in Pap bonds 97,600 Cash To record investment in $100,000 par, 8% Pap bonds. July 1, 2013 Cash Investment in Pap bonds Interest income To record interest and amortization.

4,000 400 4,400

December 31, 2013 Interest receivable 4,000 Investment in Pap bonds 400 Interest income To accrue interest and record amortization. 3

4,400

Pap accounts for its bonds payable July 1, 2013 Interest expense Cash To record interest payment for 6 months. December 31, 2013 Interest expense Interest payable To accrue interest for 6 months.

4

97,600

8,000 8,000

8,000 8,000

Pap accounts for its investment in Son December 31, 2013 Investment in Son 81,600 Income from Son 81,600 To record income from Son (80%  $100,000) + $2,400 constructive gain - $800 piecemeal recognition of gain.

5

Noncontrolling interest share ($100,000  20%)

$ 20,000

Controlling share of NI ($400,000 + $81,600) Consolidated net income

$481,600 $501,600

Copyright © 2015 Pearson Education Limited

Chapter 7

7-13

SOLUTIONS TO PROBLEMS Solution P7-1 1

Loss on constructive retirement of bonds Purchase price of $50,000 par bonds April 1, 2011 Book value of bonds acquired: Par value Less: Unamortized discount $1,800 for 27 of 36 months ($1,800  .75) Book value of bonds Intercompany bonds

$53,600 $100,000 2,400 97,600 50%

Loss on constructive retirement of bonds 2

4

$ 4,800

Interest income and expense Interest income in consolidated income statement — 2011 Interest expense in consolidated income statement — 2011 $8,800 - ($8,800  3/4 year  50%)

3

48,800

0 $ 5,500

Interest receivable and payable Interest receivable in consolidated balance sheet at December 31, 2011

0

Interest payable in consolidated balance sheet at December 31, 2011

$ 1,000

Consolidation working paper entries Loss on constructive retirement of bonds 4,800 8% bonds payable 49,100 Interest income 2,100 Investment in Pan bonds 52,700 Interest expense 3,300 To eliminate reciprocal interest income and expense amounts and reciprocal bond investment and liability amounts and enter unrecognized constructive loss. Interest payable 1,000 Interest receivable To eliminate reciprocal payables and receivables.

Copyright © 2015 Pearson Education Limited

1,000

Intercompany Profit Transactions — Bonds

7-14

Solution P7-2 Pew Corporation and Sat Corporation Schedule to Determine Pew’s Net Income and Controlling Share of Consolidated Net Income Pew’s separate income

2011 $250,000

2012 $187,500

2013 $230,000

2014 $255,000

$

Total 922,500

80% of Sat’s net income

+ 40,000

+ 48,000

+ 44,000

+ 48,000

+

180,000

$2,500 unrealized profit in Sat’s December 31, 2011 Inventory

-

+

2,500

-

5,000

2,500

$5,000 unrealized profit in Sat’s December 31, 2012 Inventory

+

5,000

$7,500 unrealized profit in 2013 on sale of land upstream  80%

-

6,000

-

6,000

$15,000 unrealized profit on sale of equipment in 2013

- 15,000

-

15,000

$3,750 depreciation on unrealized profit on equipment in 2013 and 2014

+

+

3,750

+

7,500

$4,000 constructive loss on purchase of Pew’s bonds in 2014

-

4,000

-

4,000

$1,000 piecemeal recognition of constructive loss in 2014

+

1,000

+

1,000

Pew’s net income

$287,500

$233,000

3,750

$261,750

Copyright © 2015 Pearson Education Limited

$303,750

$1,086,000

Chapter 7

7-15

Solution P7-3 Preliminary computations: 90% of Merry SA’s net income $720,000 (90% x ($3,700,000 +$200,000 - $2,400,000 - $700,000)) Unrealized profit from ending inventory ($100,000)b (100% x $100,000) Unrealized gain on sale of land ($180,000) (90% x ($1,000,000 - $800,000) Unrealized gain on sale of equipment ($100,000)d (100% x $100,000) Constructive gain on bond retirement $ 60,000 (($1,000,000 / 2) - $440,000)) Piecemeal recognition of constructive gain ($ 20,000) ($60,000 / 3) Income from Merry SA’s $380,000 10% of Merry SA’s net income $ 80,000 (10% x ($3,700,000 +$200,000 - $2,400,000 - $700,000)) Unrealized gain on sale of land ($ 20,000) (10% x ($1,000,000 - $800,000) Noncontrolling interest share: $ 60,000i Investment in Merry SA before adjustment Add: Income from Merry SA Adjusted investment in Merry SA

$3,600,000 $ 380,000 $3,980,000

Unadjusted ending investment in Merry SA Add: Dividends ($100,000 x 90%) Beginning investment in Merry SA Implied fair value of Merry SA ($3,690,000 / 90%) Beginning Merry SA’s stockholders’ equity ($2,000,000 + $2,085,000) Goodwill

$3,600,000 $ 90,000 $3,690,000 $4,100,000 $4,085,000 $

15,000j

THANOS SA AND SUBSIDIARY CONSOLIDATION WORKPAPER FOR THE YEAR ENDED DECEMBER 31, 2014 (IN THOUSANDS)

Thanos SA

Merry SA

Adjustments and Eliminations Debits

Credits

Consolida ted Statement s

Income Statement Sales

$ 4,800

Income from Merry SA

$ 3,700

$ 380

Gain on sale of land Interest income

$ 100 $ 70

$ 7,700

h. 380 $ 200

Gain on sale of equipment

a. 800 c. 200 d. 100 f. 70

Gain on retirement of bonds

e. 40 f. 20

Copyright © 2015 Pearson Education Limited

$ 60

Intercompany Profit Transactions — Bonds

7-16

Cost of sales

-$ 2,800

Interest expense

$ 2,400

b. 100

-$ 100

Other expenses

-$ 1,100

f. 50 -$ 700

Noncontrolling interest share Controlling share of net income

a. 800

-$ 50 -$ 1,800

i. 60 $ 1,350

-$ 4,500

-$ 60

$ 800

$ 1,350

Retained Earnings Statement Retained earnings - Thanos SA

$ 3,380

Retained earnings - Merry SA Controlling share of net income Dividends

$ 3,380

$ 1,350

$ 2,085 $ 800

-$ 300

-$ 100

j. 2085 $ 1,350 h. 90

-$ 300

i. 10 Retained earnings - December 31

$ 4,430

$ 2,785

$ 4,430

$ 700

$ 600

$ 1,300

$ 1,000

$ 400

$ 1,400

Balance Sheet Cash Accounts receivable Interest receivable

$ 25

g. 25

Inventory

$ 1,100

$ 700

b. 100

$ 1,700

Land

$ 1,900

$ 800

c. 200

$ 2,500

Equipment-net

$ 1,100

$ 1,400

d. 100

$ 2,400

Building-net

$ 2,000

$ 1,400

Investment in Thanos SA bonds Investment in Merry SA

$ 3,400

$ 460

e. 460

$ 3,980

h. 290 j. 3690

Goodwill

j. 15

Total Assets Accounts payable Interest payable

$ 15

$ 11,780

$ 5,785

$ 12,715

$ 1,300

$ 1,000

$ 2,300

$ 50

g. 25

10% bonds payable

$ 1,000

Common stock

$ 5,000

$ 2,000

Retained earnings

$ 4,430

$ 2,785

$ 11,780

$ 5,785

$ 25

e. 500

$ 500

j. 2000

Noncontrolling interest January 1 Noncontrolling interest December 31 Total liabilities and equities

Copyright © 2015 Pearson Education Limited

$ 5,000 $ 4,430

j. 410 i. 50

$ 460 $ 12,715

Chapter 7

7-17

Solution P7-4 Preliminary Computations: Acquisition price Implied fair value of She ($640,000 / 80%) She’s book value Excess allocated to plant & equipment with 8 year life

$ 640,000 $ 800,000 (600,000) $ 200,000

Annual depreciation of excess ($200,000 / 8 years)

$

1

2

3

4

5

6

7

25,000

Loss is from the constructive retirement of bonds Purchase price of bonds Book value of bonds ($200,000 + $6,000 premium) Loss on retirement of bonds

$212,000 206,000 $ 6,000

Consolidated sales Combined sales Less: Intercompany sales Consolidated sales

$560,000 100,000 $460,000

Consolidated cost of goods sold Combined cost of goods sold Less: Intercompany sales Less: Unrealized profits in beginning inventory Add: Unrealized profits in ending inventory Consolidated cost of goods sold

$ 340,000 (100,000) (40,000) 20,000 $ 220,000

Unrealized profit in beginning inventory Forced computations ($340,000 + $20,000) - ($100,000 + $220,000)

$

40,000

Unrealized profit in ending inventory Combined inventories ($200,000 + $100,000) Less: Consolidated inventories Unrealized profit in ending inventory

$300,000 280,000 $ 20,000

Consolidated accounts receivable Combined accounts receivable ($240,000 + $120,000) Less: Intercompany receivables Consolidated accounts receivable

$360,000 30,000 $330,000

Noncontrolling interest share She’s reported net income Less: Depreciation of excess Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory Sher’s realized income Noncontrolling interest percentage Noncontrolling interest share

$ 60,000 (25,000) 40,000 (20,000) 55,000 20% $ 11,000

Copyright © 2015 Pearson Education Limited

Intercompany Profit Transactions — Bonds

7-18

Solution P7-4 (continued) 8

Noncontrolling interest December 31, 2013 Beginning noncontrolling interest (($670,000 + $150,000 unamortized excess)  20%) Less: Unrealized profit in beginning inventory ($40,000  20%) Less: Noncontrolling interest dividends ($30,000  20%) Add: Noncontrolling interest share Noncontrolling interest December 31

$164,000 (8,000) (6,000) 11,000 $161,000

Alternative computation: Ending equity of She ($700,000 + $125,000 unamortized $165,000 excess)(  20%) (4,000) Less: Unrealized profit in ending inventory ($20,000  20%) Noncontrolling interest December 31, 2013 $161,000 9

Investment in She stock at December 31, 2012 Investment in She stock at cost $640,000 Add: Changes in retained earnings to December 31, 2012 56,000 ($270,000 - $200,000)  80% Less: 80% of Excess of ($200,000/8 years) = $20,000 per year (40,000)  2 years Less: Unrealized profit in beginning inventory (32,000) ($40,000  80%) Investment in She stock December 31, 2012 $624,000 Alternative computation: Investment in She stock December 31, 2013 Less: Income from She for 2013 Add: Dividends from She ($30,000  80%) Investment in She stock December 31, 2012

10

Income from She Share of She’s reported net income Less: Depreciation on excess ($200,000/8 years) Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory She’s adjusted and realized income Pet’s 80% controlling share Less: Constructive loss on retirement of bonds ($6,000 - $2,000) Pet’s income from She

Copyright © 2015 Pearson Education Limited

$640,000 (40,000) 24,000 $624,000 $ 60,000 (25,000) 40,000 (20,000) $ 55,000 $ 44,000 (4,000) $ 40,000

Chapter 7

7-19

Solution P7-5 [AICPA adapted] 1

Consolidated cash ($50,000 + $15,000)

$ 65,000

2

Equipment — net ($800,000 equipment - $320,000 accumulated depreciation - $21,000 unrealized profit + $7,000 profit realized through depreciation of excess)

$466,000

3

Investment in Saw does not appear in consolidated statements.

4

Bonds payable (Saw’s bonds payable of $200,000  1/2 held outside the consolidated entity)

$100,000

5

Common stock (Poe’s stock)

$100,000

6

Beginning retained earnings (Poe’s retained earnings)

$272,000

7

Dividends paid (Poe’s dividends)

$ 80,000

8

Gain on retirement of bonds (Book value of Saw’s bonds acquired by Poe $100,000 less acquisition cost of $91,000. Since bonds were acquired on December 31, 2011, none of the $9,000 gain has been amortized.)

$

Cost of goods sold ($860,000 combined - $60,000 intercompany sales + $10,000 unrealized profit in ending inventory)

$810,000

Interest expense (Saw paid interest for the entire year to outside entities so all of Saw’s interest is reported)

$ 16,000

Depreciation expense ($45,000 combined - depreciation on the unrealized gain $7,000)

$ 38,000

9

10 11

Copyright © 2015 Pearson Education Limited

9,000

Intercompany Profit Transactions — Bonds

7-20

Solution P7-6 Preliminary computations: 80% ofNuro AO’s net income (80% x ($12,000,000 + $1,000,000 - $8,800,000 – $200,000 – $2,100,000)) Unrealized profit from ending inventory (80% x $1,000,000 / 2 x 20%) Unrealized gain on sale of building (80% x ($5,000,000 - $4,000,000)) Piecemeal recognition of gain on sale of building (80% x ($5,000,000 - $4,000,000) / 10 / 2) Constructive loss on bond retirement (80% x ($900,000 - $800,000) Piecemeal recognition of constructive gain (80% x ($900,000 – $800,000) / 2) Income from Nuro AO’s

$1,520,000 ($80,000) ($800,000) $40,000 ($80,000) $40,000 $640,000

20% of Nuro AO’s net income (20% x ($12,000,000 + $1,000,000 - $8,800,000 – $200,000 – $2,100,000)) Unrealized profit from ending inventory (20% x $1,000,000 / 2 x 20%) Unrealized gain on sale of building (20% x ($5,000,000 - $4,000,000)) Piecemeal recognition of gain on sale of building (20% x ($5,000,000 - $4,000,000) / 10 / 2) Constructive loss on bond retirement (20% x ($900,000 - $800,000) Piecemeal recognition of constructive gain (20% x ($900,000 – $800,000) / 2) Noncontrolling interest share:

$380,000 ($20,000) ($200,000) $10,000 ($20,000) $ 10,000 $160,000i

Investment in Nuro AO before adjustment Add: Income from Nuro AO Adjusted investment in Nuro AO Price to acquire 80 percent interest of Nuro AO Implied fair value of Nuro AO ($8,000,000 / 80%) Beginning Merry SA’s stockholders’ equity ($5,000,000 + $5,000,000) Goodwill

Copyright © 2015 Pearson Education Limited

$7,360,000 $640,000 $8,000,000 $8,000,000 $10,000,000 $10,000,000 $

0

Chapter 7

7-21

Solution P7-6 (continued) KEN AO AND SUBSIDIARY Consolidation Working Papers

FOR THE YEAR ENDED DECEMBER 31, 2014 (IN THOUSANDS) Adjustments and Eliminations Ken AO

Nuro AO

$ 14,000

$ 12,000

Debits

Credits

Consolidated Statements

Income Statement Sales Income from Nuro AO

$ 640

Gain on sale of building

$ 25,000

h. 640 $ 1,000

Interest income

a. 1,000

$ 150

c. 1000 f. 150

Loss on retirement of bonds

e. 50

-$ 100

f. 50 $ 11,100

Cost of sales Interest expense

-$ 8,800

b. 100

-$ 200

Other expenses

-$ 1,700

Noncontrolling interest share Controlling share of net income

a. 1,000

-$ 2,100

d. 50 i. 160

$ 1,990

-$ 19,000

f. 200 -$ 3,750 -$ 160

$ 1,900

$ 1,990

Retained Earnings Statement Retained earnings - Ken AO

$ 12,000

Retained earnings - Nuro AO Controlling share of net income Dividends

$ 12,000 $ 5,000

$ 1,990

$ 1,900

-$ 500

-$ 800

j. 5000 $ 1,990 h. 640

-$ 500

i. 160 Retained earnings - December 31

$ 13,490

$ 6,100

$ 13,490

Cash

$ 1,500

$ 2,000

$ 3,500

Accounts receivable

$ 3,640

$ 1,900

$ 5,540

Interest receivable

$ 100

Balance Sheet

g. 100

Inventory

$ 1,600

$ 1,800

Land

$ 2,000

$ 4,200

Equipment-net

$ 2,100

$ 1,100

Building-net Investment in Nuro AO bonds

$ 6,000

$ 2,000

b. 100

$ 3,300 $ 6,200 $ 3,200

d. 50

$ 950 Copyright © 2015 Pearson Education Limited

c. 1,000 e. 950

$ 7,050

Intercompany Profit Transactions — Bonds

7-22

Investment in Nuro AO

$ 8,000

Total Assets Accounts payable

j. 8000

$ 25,890

$ 13,000

$ 28,790

$ 2,400

$ 900

$ 3,300

Interest payable

$ 100

g. 100

10% bonds payable

$ 900

e. 900

Common stock

$ 10,000

$ 5,000

Retained earnings

$ 13,490

$ 6,100

$ 25,890

$ 13,000

j. 5000

Noncontrolling interest January 1 Noncontrolling interest December 31

$ 10,000 $ 13,490 j. 2,000 $ 2,000

Total liabilities and equities

Copyright © 2015 Pearson Education Limited

$ 28,790